TEST BANK for Auditing & Assurance Services A Systematic Approach By William Messier Jr, Steven Glov

TABLE OF CONTENTS Chapter 1: An Introduction to Assurance and Financial Statement Auditing Chapter 2: The Financial Statement Auditing Environment Chapter 3: Audit Planning, Types of Audit Tests, and Materiality Chapter 4: Risk Assessment Chapter 5: Evidence and Documentation Chapter 6: Internal Control in a Financial Statement Audit Chapter 7: Auditing Internal Control over Financial Reporting Chapter 8: Audit Sampling: An Overview and Application to Tests of Controls Chapter 9: Audit Sampling: An Application to Substantive Tests of Account Balances Chapter 10: Auditing the Revenue Process Chapter 11: Auditing the Purchasing Process Chapter 12: Auditing the Human Resource Management Process Chapter 13: Auditing the Inventory Management Process Chapter 14: Auditing the Financing/Investing Process: Prepaid Expenses, Intangible Assets, and Property, Plant, and Equipment Chapter 15: Auditing the Financing/Investing Process: Long-Term Liabilities, Stockholders’ Equity, and Income Statement Accounts Chapter 16: Auditing the Financing/Investing Process: Cash and Investments Chapter 17: Completing the Audit Engagement Chapter 18: Reports on Audited Financial Statements Chapter 19: Professional Conduct, Independence, and Quality Management Chapter 20: Legal Liability Chapter 21: Assurance, Attestation, and Internal Auditing Services

Student name:__________ 1)

Why do auditors often use a sampling approach to evidence gathering?

A) Auditors are experts and do not need to look at much to know whether the financial statements are correct or not.

B) Auditors must balance the cost of the audit with the need for precision and for some types of evidence, computer data analytic approaches can’t be used.

C) Auditors must limit their exposure to their auditee to maintain independence.

D) The auditor's relationship with the auditee is generally adversarial, so the auditor will not have access to all of the financial information of the company.

2) Which of the following statements best describes a relationship between sample size and other elements of auditing?

A) If materiality increases, so will the sample size.

B) If the desired level of assurance increases, sample sizes can be smaller.

C) If materiality decreases, sample size will need to increase.

D) There is no relationship between sample size and materiality or the desired level of assurance.

3)

Which of the following statements about the study of auditing is NOT true?

A) The study of auditing can be valuable to future accountants and business decision makers whether or not they plan to become auditors.

B) The study of auditing focuses on learning the analytical and logical skills necessary to evaluate the relevance and reliability of information.

C) The study of auditing focuses on learning the rules, techniques, and computations required to analyze financial statements for making investment recommendations.

D) The study of auditing begins with the understanding of a coherent logical framework and techniques useful for gathering and analyzing evidence about others’ assertions.

4)

The basic definition of auditing essentially indicates that, overall, auditing is a process to:

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A) detect fraud.

B) examine individual transactions so that the auditor may certify as to their validity.

C) objectively obtain and evaluate evidence regarding assertions made by another party.

D) assure the consistent application of correct accounting procedures.

5)

Assurance services may improve all of the following except: A) relevance.

B) credibility.

C) periodicity.

D) reliability.

6)

Evidence is reliable if it: A) signals the true state of a management assertion.

B) applies to the period being audited.

C) relates to the audit assertion being tested.

D) is sufficient to justify a conclusion.

7)

Which of the following best describes the concept of audit risk?

A) The risk of the auditor being sued because of association with an auditee.

B) The risk that the auditor will provide an inappropriate opinion on financial statements that are, in fact, materially misstated.

C) The overall risk that a material misstatement exists in the financial statements.

D) The risk that auditors use audit procedures that are inappropriate.

8) An auditor who accepts an audit engagement and does not possess expertise with respect to the business entity’s industry at that point, should:

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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 and the industry in which it operates.

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.

9) For publicly-held companies, which of the following is integrated with the audit of financial statements?

A) budgetary information audit B) the audit of internal controls C) audit of management forecasts D) audit of interim financial statements

10)

During the first phase of an audit, a CPA most likely would:

A) identify specific internal control activities that are likely to prevent fraud.

B) evaluate the reasonableness of the company’s accounting estimates.

C) evaluate the integrity of management.

D) inquire of the company's attorney as to whether any unrecorded claims are probable or asserted.

11)

In the context of agency theory, information asymmetry refers to the idea that:

A) information can vary in its reliability.

B) information can vary in its relevance.

C) management has more information about the entity’s true financial results and position than do the absentee owners (i.e. stockholders).

D) management likely will not act in the best interests of the absentee owners.

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12) Which of the following best describes why an independent auditor is engaged to express an opinion on the fair presentation of financial statements?

A) It is difficult to prepare financial statements that fairly present a company’s financial position and changes in cash flows without the expertise of an independent auditor.

B) It is management’s responsibility to seek available independent aid in the appraisal of the financial information shown in its financial statements.

C) The opinion of an independent party is needed because a company is not likely to be considered objective with respect to its own financial statements.

D) It is a customary courtesy that all stockholders of a company receive an independent report on management’s stewardship in managing the affairs of the business.

13) Which of the following best describes the fundamental, underlying reason for why there is demand for an independent auditor to report on financial statements?

A) A management fraud may exist and it is more likely to be detected by auditors if they are independent.

B) Different interests may exist between the company preparing the statements and the parties using the statements.

C) A misstatement of account balances may exist and it is the independent auditor’s responsibility to ensure that financial statements are not misstated.

D) A poorly designed internal control system may be in place.

14) Which of the following best describes why publicly-traded companies follow the practice of having the external auditor appointed by the audit committee and ratified by the stockholders?

A) to promote an adversarial relationship between the auditor and the corporation’s management B) to comply with requirements set forth by the Sarbanes-Oxley Act of 2002 and to enhance auditor independence from the management of the corporation C) to encourage a policy of rotation of the independent auditors D) to give management more leverage over the auditor’s decisions

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15) Auditing can be defined as a “systematic process of objectively obtaining and evaluating evidence regarding assertions...” What is meant by “systematic process” in this definition?

A) All audits involve obtaining the same evidence.

B) All audits involve evaluating evidence in the same manner.

C) There should be a well-planned approach for obtaining and evaluating evidence that is relevant and reliable for each particular audit engagement.

D) All assertions are equally important for all audits.

16)

Which of the following would best be described as an assurance service?

A) preparing a report representing a client’s position during an IRS audit B) working with a company to develop a more efficient method of processing financial transactions C) offering an opinion concerning the validity of statements made on an entity’s website relating to its online privacy policies D) assisting a company in identifying potential sources of capital for potential acquisitions

17) Which of the following statements is not true with respect to assurance, attest, and audit services?

A) These services are applied only to financial statements and financial statement accounts.

B) These services all involve obtaining and evaluating evidence.

C) These services all involve determining the correspondence of some information to a set of criteria.

D) These services all involve issuing a report.

18)

Auditors are most likely to use the most rigorous audit procedures to examine:

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A) routine transactions.

B) management assertions that are deemed to be of low risk in a particular engagement.

C) only the rights and obligations assertion.

D) management assertions that are deemed to be of high risk in a particular engagement.

19) When obtaining an understanding of the entity and its environment, the auditor should obtain an understanding of internal controls primarily to: A) identify areas of relatively high risk of misstatement and plan the audit accordingly.

B) provide suggestions for improvement to the company.

C) serve as a basis for setting audit risk and materiality.

D) decide whether to perform an audit for the company.

20)

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

A) Materiality is determined by reference to specific quantitative guidelines established by the AICPA. B) Materiality depends only on the dollar amount of an item relative to other items in the financial statements.

C) Materiality depends on the nature of an item but not on the dollar amount of the item.

D) Materiality is largely a matter of professional judgment and reflects both quantitative and qualitative considerations.

21)

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

A) make inquiries of the predecessor auditor.

B) tell the company whether or not the auditor is willing to issue a “clean” opinion.

C) prepare a memorandum setting forth the staffing requirements and documenting the preliminary audit plan.

D) become a member of the entity’s board of directors.

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22) An investor is reading the financial statements of the Peres Corporation and observes that the statements are accompanied by an auditor’s unqualified report. From this, the investor may conclude that: A) any disputes over whether Peres’ financial statements are fairly stated in accordance with GAAP have been settled to the auditor's satisfaction.

B) the auditor is satisfied that Peres will be highly profitable in the future.

C) the auditor is certain that Peres’ financial statements have been prepared accurately and that all account balances are precisely correct.

D) the auditor has determined that Peres’ management is not qualified to lead the company.

23)

Preliminary engagement activities include: A) evaluating internal controls.

B) assessing audit risk at the account balance level.

C) setting materiality.

D) performing background checks on top management.

24)

The auditor's report is generally addressed to the: A) chief operating officer.

B) securities and exchange commission.

C) stockholders of the company.

D) chief financial officer.

25)

An auditor would issue an adverse opinion if:

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A) the auditor encounters adverse attitudes toward the auditor on the part of company management.

B) a qualified opinion cannot be given because the auditor is not qualified to do so.

C) an immaterial misstatement is present.

D) the financial statements taken as a whole do not fairly present the financial condition and results of operations of the company.

26)

Which of the following is true with respect to the auditor’s report?

A) The report indicates that the company’s financial statements were audited in accordance with generally accepted accounting standards.

B) The report indicates that the company’s financial statements were audited in accordance with applicable auditing standards.

C) The report indicates that the company’s financial statements were audited in accordance with the auditor's best judgment.

D) The report indicates that the company’s financial statements were audited in accordance with statements issued by the FASB.

27) Which of the following is not a concept that is included in the audit report in the paragraph on the auditor’s responsibilities?

A) The conformance of the financial statements with generally accepted accounting principles.

B) The audit was conducted in accordance with applicable auditing standards.

C) The audit was planned and performed to obtain reasonable, rather than absolute, assurance.

D) A description of when misstatements are considered material.

28)

Which of the following is not a benefit of emerging audit technologies?

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A) automate much of the more tedious work that auditors perform B) the potential to dramatically enhance the effectiveness and the value of the external audit C) leave more time for auditors to better understand the businesses they are auditing and the underlying risks related to financial reporting D) remove the challenge of junior auditor work and make that work less interesting

29)

Information Risk is defined as:

A) the risk that information conveyed by a company’s management will be false, inaccurate, or misleading.

B) the risk that an assertion contains a misstatement, before considering internal controls.

C) the risk that the auditor has followed appropriate auditing standards and issued a standard unqualified opinion, and the financial statements contain a material misstatement.

D) the risk that the internal controls will not prevent or detect a misstatement in the financial statements.

30) The accounting processes of a business involve, among other things, individual transactions, internal controls, and account balances.

Required:A.Describe the relationship between internal controls, individual transactions, and account balances presented in the financial statements.

B.Discuss how evidence regarding each of these three areas can help an auditor determine if the financial statements are fairly stated.

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31) Sally Thompson’s company, Sally’s Shoes, is a successful shoe retail business with one store. Sally would like to expand to two locations, but the bank has asked for an independent audit before it will provide financing. Sally hires her brother-in-law, George Thompson, to perform the audit. George has experience in auditing non-profit organizations, and he decides to perform the audit the same way as his other audits. After completing all the steps of the audit process, George issues an unqualified opinion indicating that he is certain that the company’s financial statements contain no misstatements. Comment on any potential problems with George’s audit of Sally’s Shoes.

32)

Explain the relationship between audit, attest and assurance services.

33) Define “information asymmetry” and discuss how it plays a role in companies in the context of the principal-agent model. Include in your discussion how information asymmetry can be reduced.

34) The textbook presents the concept of auditing using an analogy that involves buying a house and hiring a house inspector. Name three desirable qualities of a house inspector and discuss how those qualities apply to an auditor and why those qualities are important for an auditor to possess.

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35) Provide a brief overview of the financial statement audit process using the terms “assertion,” “evidence,” and “report.”

36) You are a new employee at the accounting firm Murray & Murray, CPAs. Before you are assigned to your first audit, your supervisor tests your knowledge and asks you to explain the term “scope” in the context of a financial statement audit.

Required:A.Provide a definition of scope.

B.Describe what influences an auditor's determination of scope.

37)

Why must an auditor assess materiality as part of planning an audit engagement?

38) You are a new staff auditor, and you are auditing a company’s inventory account. Briefly describe one way you might obtain direct evidence and one way you might obtain indirect evidence that the inventory account balance is fairly stated.

39)

Name and discuss the seven phases of the audit process.

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40) A standard, unqualified auditor’s report for a public company contains three sections.

Provide a brief (one or two sentences) description for each section.

41) Explain the relationship between sample size and materiality, and between sample size and desired level of assurance.

42) Other than a financial statement audit, give examples of two other assurance services?

How do these assurance services differ from a financial statement audit?

43) The cost of capital can be generally defined as the rate of return expected by a party that provides capital to a company (e.g. an investor or a creditor). How can a financial statement audit reduce the cost of capital for a company?

44) Auditing focuses on rules, techniques, and computations required to prepare and analyze financial information. ⊚ true ⊚ false

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45) Decision makers demand reliable information that is provided by accountants and accounting information systems. ⊚ true ⊚ false

46)

Information asymmetry seldom occurs. ⊚ true ⊚ false

47) Conflicts of interest often occur between absentee owners (principals) and managers (agents). ⊚ true ⊚ false

48)

Auditing services and attestation services are exactly the same thing. ⊚ true ⊚ false

49)

Auditing is a type of attest service. ⊚ true ⊚ false

50) Testing all transactions that occurred during the period is cost prohibitive in the absence of computer data analytic approaches. ⊚ true ⊚ false

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Answer Key Test name: ch 1 1) B 2) C 3) C 4) C 5) C 6) A 7) B 8) B 9) B 10) C 11) C 12) C 13) B 14) B 15) C 16) C 17) A 18) D 19) A 20) D 21) A 22) A 23) D 24) C 25) D 26) B Version 1

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27) A 28) D 29) A 44) FALSE 45) TRUE 46) FALSE 47) TRUE 48) FALSE 49) TRUE 50) TRUE

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Student name:__________ 1)

The Audit Committee consists of: A) members of management.

B) a subcommittee of the AICPA who establish the SAS. C) members of the Board of Directors.

D) appointed government overseers.

2) What organization is responsible for setting auditing standards for audits of publicly traded companies in the U.S.?

A) AICPA B) FASB C) GASB D) PCAOB

3)

The Public Company Accounting Oversight Board’s role is to: A) conduct the final review of auditors’ work before the auditor’s opinion is issued.

B) oversee the auditors of public companies in order to protect the interests of investors.

C) conduct audits of governmental entities.

D) sanction auditors who fail to follow GAAS.

4) The authoritative body empowered to promulgate standards concerning a CPA’s association with audited financial statements of an entity that is required to file financial statements with the SEC is the: A) financial accounting standards board.

B) government accountability office.

C) public company accounting oversight board.

D) auditing standards board.

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5)

The auditor must be independent of the auditee unless: A) the lack of independence does not influence his or her professional judgment.

B) both parties agree that the independence issue is not a problem.

C) the lack of independence is insignificant.

D) none of the above—the auditor cannot lack independence.

6) Which principle of the Principles Underlying an Audit Conducted in Accordance with GAAS describes where auditors are required to plan the work and properly supervise any assistants?

A) purpose of an Audit and Premise upon which an Audit is Conducted B) performance C) reporting D) responsibilities

7) Which of the following best describes the general character of the three principles that are listed in the Performance section of the Principles Underlying an Audit Conducted in Accordance with GAAS? A) the purpose and value of a financial statement audit and lays out the responsibilities of management for an effective audit to be possible B) the fundamental responsibilities and characteristics of an auditor C) auditors’ responsibilities in performing an effective audit D) auditors provide a written report that expresses their opinion about the financial statements

8) The Responsibilities section of the Principles Underlying an Audit Conducted in Accordance with GAAS states that auditors are responsible for having appropriate competence and:

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A) independence with respect to the financial statements and supplementary disclosures.

B) exercising professional care as judged by peer reviewers.

C) capabilities to perform the audit.

D) objectivity as an auditor as verified by proper supervision.

9) The Reporting section of the Principles Underlying an Audit Conducted in Accordance with GAAS requires that the report, “states whether the financial statements are presented fairly, in all material respects, in accordance with the applicable financial reporting framework.” This passage requires: A) a statement of fact by the auditor.

B) an opinion by the auditor.

C) an implied measure of fairness.

D) an objective measure of compliance.

10) Because of the risk of material misstatement, an audit of financial statements in accordance with generally accepted auditing standards should be planned and performed with an attitude of: A) objective cynicism.

B) independent differentialism.

C) professional skepticism.

D) impartial conservatism.

11) The accuracy of information included in notes accompanying the audited financial statements issued by a company whose shares are traded on a stock exchange is the primary responsibility of:

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A) the stock exchange officials.

B) the independent auditor.

C) the company’s management.

D) the Securities and Exchange Commission.

12) The primary responsibility for the adequacy of disclosures in the financial statements of a publicly held company rests with the: A) partner assigned to the audit engagement.

B) management of the company.

C) auditor in charge of the fieldwork.

D) securities and exchange commission.

13)

The largest public accounting firms typically are structured as: A) subchapter S corporations.

B) professional corporations.

C) limited liability partnerships or limited liability companies.

D) limited liability corporations.

14)

Typically, an external auditor first gets supervisory experience at what level of authority?

A) associate B) senior C) manager D) partner

15)

An “in-charge” auditor typically holds the rank of:

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A) associate.

B) senior.

C) manager.

D) partner.

16) Which of the following best describes the concept of risk assessment on which auditors can provide independent assurance?

A) the risk that financial statements are misstated because of fraud B) the risk that financial statements are misstated because of error or fraud C) whether management has systems in place to identify, evaluate, and effectively manage the entity’s business risks D) developing client acceptance and continuance practices that minimize the likelihood of lawsuits against the auditor

17)

Fraud audits include all of the following except: A) criminal investigations.

B) manufacturers’ assertions about product quality.

C) employee fraud.

D) management fraud.

18)

A typical objective of an operational audit is for the auditor to: A) determine whether the financial statements present fairly the entity’s operations.

B) evaluate the feasibility of attaining the entity’s operational objectives.

C) make recommendations for improving performance.

D) report on the entity’s relative success in attaining profit maximization.

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19) Governmental auditing often extends beyond examinations leading to the expression of an opinion on the fairness of financial presentation and includes audits of efficiency, effectiveness, and: A) monetary stimulus.

B) evaluation.

C) accuracy.

D) compliance.

20)

External auditors are referred to as “external” because: A) they report to users outside of the audited entity.

B) they are paid by parties outside of the audited entity.

C) they are not employees of the entity being audited.

D) their offices are not at the entity’s place of business.

21)

Which is not an attribute of an external auditor?

A) independence B) auditee advocacy C) objectivity D) concern for the public interest

22) What is the general character of the work conducted in performing a fraud audit for a company?

A) providing assurance that the financial statements are not materially misstated B) detecting or deterring fraudulent activity C) offering an opinion on the reliability of the specific assertions made by management D) identifying the causes of an entity's financial difficulties

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23)

Which of the following is NOT a requirement of the Sarbanes-Oxley Act?

A) Audit firms cannot provide most types of nonaudit services to their public company auditees.

B) Audit firms are required to rotate audit partners off audit engagements every five years for public company audits.

C) Firms that audit public companies are subject to inspection by the PCAOB. D) A certain number of hours, which is based on the size of the company being audited, must be spent on each audit engagement.

24) A CPA is most likely to refer to one or more of the items listed in the Responsibilities section of the Principles Underlying an Audit Conducted in Accordance with GAAS in determining: A) the nature of the CPA's report qualification.

B) the scope of the CPA's auditing procedures.

C) requirements for the review of the entity and its environment.

D) whether the CPA should undertake an audit engagement.

25)

Who bears ultimate responsibility for the financial statements?

A) management of the organization, equally with the external auditor that audits the statements B) management and the shareholders of the organization C) the external auditor that audits the statements D) management of the organization

26) The Responsibilities section of the Principles Underlying an Audit Conducted in Accordance with GAAS is concerned with:

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A) proper planning and supervision, appropriate materiality levels, and sufficient appropriate audit evidence.

B) an audit opinion in accordance with the auditor’s findings, whether the financial statements are presented fairly, and whether the financial statements are in accordance with the applicable financial reporting framework.

C) whether the auditor has unrestricted access to those within the entity from whom the auditor needs to obtain audit evidence.

D) complying with ethical requirements, possessing appropriate competence to perform the audit, and maintaining professional skepticism.

27) The Responsibilities section of Principles Underlying an Audit Conducted in Accordance with GAAS recognizes that regardless of how capable an individual may be in other fields, the individual cannot meet the requirements of the auditing standards without the proper: A) business and finance courses.

B) quality control and peer review.

C) competence in auditing and ability to exercise professional skepticism.

D) supervision and review skills.

28)

The main difference between SAS and AU-C is:

A) they are the same except that SAS are organized chronologically and the AU-C are organized by topical area.

B) SAS are issued by the ASB and AU-C are issued by the PCAOB. C) SAS are issued by the PCAOB and AU-C are issued by the ASB. D) SAS define minimum standards of performance for auditors while AU-C define financial accounting principles that must be followed according to GAAP.

29)

The AICPA's Statements on Auditing Standards can be described as:

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A) providing very specific guidance about the specific activities an auditor must perform on each engagement.

B) similar to financial accounting standards in that they are developed by the government.

C) tend to be general in nature and require a great deal of professional judgment.

D) providing assurance that an auditor will not issue an incorrect opinion.

30)

Due professional care requires auditors to:

A) obtain independent, third party (non-auditee) documentation as evidence for all information presented in the financial statements.

B) exercise professional skepticism during the audit.

C) disregard any evidence generated by the auditee during the audit.

D) find every error contained in the financial statements prepared by management.

31) The objectives of the Reporting section of Principles Underlying an Audit Conducted in Accordance with GAAS are to provide assurance and include all of the following except for: A) an opinion statement of whether the financial statements present fairly.

B) an opinion statement of whether the financials are free of material misstatements.

C) an opinion statement of whether the financials are in accordance with an applicable financial reporting framework.

D) an opinion statement of whether internal controls over financial reporting are effective.

32) An internal auditor is likely to be more concerned with __________ than the external auditor.

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A) internal administrative procedures affecting the control environment B) financial accounting procedures C) the efficiency of operations D) internal control effectiveness

33)

Which of the following is not included in the broad category of assurance services?

A) operational audit B) reporting on internal control C) accounting or review services D) evaluation of the auditee's risk management framework

34)

Which of the following is not explicitly a part of the IIA's definition of internal auditing?

A) Internal auditing is an objective assurance activity.

B) Internal auditing is a consulting activity.

C) Internal auditing should help an organization accomplish its objectives.

D) Internal auditors should help external auditors complete the annual financial statement

audit.

35)

Which of the following statements regarding the PCAOB is incorrect?

A) It is a public-sector, nonprofit corporation.

B) It is overseen by the SEC. C) It sets standards for public company audits.

D) It has delegated all of its standard-setting authority to the AICPA.

36)

Due professional care requires:

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A) auditors to maintain an attitude that includes a questioning mind and a critical assessment of audit evidence.

B) the examination of all available corroborating evidence.

C) the exercise of error-free judgment.

D) a study and review of internal controls that includes tests of controls.

37)

Which of the following best describes the role of corporate governance?

A) Management decides which accounting principles are the most appropriate.

B) Shareholders vote to decide who should be members of the board of directors.

C) Management is accountable to shareholders and other constituents for the utilization of the entity’s resources.

D) Management often is compensated based on the company's profitability.

38) The Performance section of Principles Underlying an Audit Conducted in Accordance with GAAS states that the auditor is unable to obtain absolute assurance that the financials are free of material misstatements because of inherent limitations which arise from all of the following except: A) the presentation of the financial statements based on GAAS. B) the nature of financial reporting.

C) the nature of audit procedures.

D) the need for the audit to be conducted within a reasonable period of time and so as to achieve a balance between benefit and cost.

39) Which of the following best describes what is meant by generally accepted auditing standards?

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A) audit assertions generally determined on audit engagements B) acts to be performed by the auditor C) standards of quality for the auditor's performance D) procedures to be used to gather evidence to support financial statements

40) The ‘Purpose of an Audit and Premise upon which an Audit is Conducted’ section of Principles Underlying an Audit Conducted in Accordance with GAAS states that management is responsible for all the following except for: A) the preparation and fair presentation of the financial statements in accordance with the applicable financial reporting framework.

B) the design, implementation, and maintenance of internal control.

C) providing financial statement users with an opinion on whether the financial statements present fairly.

D) ensuring that the financial statements are free from material misstatement, whether due to error or fraud.

41) The Performance section of Principles Underlying an Audit Conducted in Accordance with GAAS states that for auditors to obtain reasonable assurance, they need to do all of the following except: A) make sure all audit team members have adequate training.

B) obtain sufficient appropriate audit evidence.

C) identify and assesses risks of material misstatement.

D) determine and applies appropriate materiality levels.

42) The Reporting section of Principles Underlying an Audit Conducted in Accordance with GAAS requires the auditor's report to contain either an expression of opinion regarding the financial statements taken as a whole or an assertion to the effect that an opinion cannot be expressed. The objective of this requirement is to prevent:

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A) an auditor from reporting on one basic financial statement and not the others.

B) an auditor from expressing different opinions on each of the basic financial statements.

C) management from reducing its final responsibility for the basic financial statements.

D) misinterpretations regarding the degree of responsibility the auditor is assuming.

43) The Performance section of the Principles Underlying an Audit Conducted in Accordance with GAAS is concerned with: A) proper planning and supervision, appropriate materiality levels, and sufficient appropriate audit evidence.

B) an audit opinion in accordance with the auditor's findings, whether the financials are presented fairly, and whether the financial are in accordance with the applicable financial reporting framework.

C) whether the auditor has unrestricted access to those within the entity from whom the auditor needs to obtain audit evidence.

D) complying with ethical requirement, appropriate competence and maintaining professional skepticism.

44) The Reporting section of the Principles Underlying an Audit Conducted in Accordance with GAAS is concerned with: A) proper planning and supervision, appropriate materiality levels, and sufficient appropriate audit evidence.

B) the auditor expressing an audit opinion in accordance with the auditor’s findings, whether the financials are presented fairly, and whether the financial are in accordance with the applicable financial reporting framework.

C) whether the auditor has unrestricted access to those within the entity from whom the auditor needs to obtain audit evidence.

D) complying with ethical requirements, appropriate competence and maintaining professional skepticism.

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45) The ASB articulated the principles underlying an audit conducted in accordance with generally accepted auditing standards. These principles are grouped into four categories. What are the four categories?

46) The principles underlying an audit conducted in accordance with generally accepted auditing standards are grouped into four categories. The second category is that of “personal responsibility of the auditor.” Generally explain what is intended by this principle.

47) You are the owner of a small grocery store, Corner Marketplace. Briefly explain the five basic business processes and how they apply to your business.

48) Briefly define corporate governance, the board of directors, and the audit committee and explain how they relate to each other.

49) Describe the organizations involved in standard setting for auditors in the United States and what their respective roles are in setting current auditing standards for audits of companies in the United States.

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50) What are the four things required of an auditor to obtain reasonable assurance that are outlined in the Performance section of the Principles Underlying an Audit Conducted in Accordance with GAAS?

51) Jane Goodperson performed an audit on the Quagmire Corporation and issued an unqualified opinion. Jane performed the audit with due professional care and in accordance with generally accepted auditing standards. Two months after the report is issued, Jane discovers on the news that the CEO of Quagmire, Johnny Best, had been stealing small amounts of inventory.

The amount, however, is immaterial compared to the overall inventory of the corporation. Jane soon receives a call from Quagmire's CFO, Mark Beastly. Mark wants Jane to refund her audit fees. Mark thinks Jane did not properly perform the audit, as she did not discover this fraud.

Further, he feels that now Quagmire's financial statements are not fairly stated because of Jane.

How should Jane respond to this claim?

52) Mike has just graduated from State University with a bachelor's degree in accounting. He would like to pursue a career in auditing. What options does Mike have? Describe three auditing career options, including a description of the organization Mike would work for.

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53) With respect to an entity's financial statements, describe both the responsibility of management and that of the auditor.

54) What auditing standards are used to conduct an audit for a privately held corporation?

What auditing standards are used to conduct an audit for a publicly traded corporation? What organization is responsible for setting each of these sets of standards?

55) There are several types of audit services that are provided by auditors. Identify and define three of these types of audits.

56) A series of business and related auditing failures led to the passage of the Sarbanes-Oxley Act (2002). ⊚ true ⊚ false

57) The primary audit context with which an auditor is concerned is the auditee’s industry or business. ⊚ true ⊚ false

58)

The audit committee generally includes senior executives of the organization.

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⊚ ⊚

true false

59) A financial statement audit is generally organized based on the five basic business processes or cycles. ⊚ true ⊚ false

60)

One of the five basic business processes is the warehousing cycle. ⊚ true ⊚ false

61) The ASB’s auditing standards contain a preface that includes Principles Underlying an Audit Conducted in Accordance with GAAS. ⊚ true ⊚ false

62) PCAOB auditing standards must be followed on all financial statement audits performed in the U.S. ⊚ true ⊚ false

63)

A financial statement audit must be conducted in accordance with GAAP. ⊚ true ⊚ false

64) Generally, the financial statements of U.S. companies must be prepared in accordance with GAAP. Version 1

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⊚ ⊚

true false

65) PCAOB auditing standards must be followed on all audits of public companies’ financial statements. ⊚ true ⊚ false

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Answer Key Test name: ch 2 1) C 2) D 3) B 4) C 5) D 6) D 7) C 8) C 9) B 10) C 11) C 12) B 13) C 14) B 15) B 16) C 17) B 18) C 19) D 20) C 21) B 22) B 23) D 24) D 25) D 26) D Version 1

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27) C 28) A 29) C 30) B 31) D 32) C 33) C 34) D 35) D 36) A 37) C 38) A 39) C 40) C 41) A 42) D 43) A 44) B 56) TRUE 57) TRUE 58) FALSE 59) TRUE 60) FALSE 61) TRUE 62) FALSE 63) FALSE 64) TRUE 65) TRUE

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Student name:__________ 1) Hawkins requested permission to communicate with the predecessor auditor and review certain portions of the predecessor auditor’s working papers. The prospective client's refusal to permit this will bear directly on Hawkins’ decision concerning the:

A) adequacy of the preplanned audit program.

B) ability to establish consistency in application of accounting principles between years.

C) apparent scope limitation.

D) integrity of management.

2)

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

A) the current financial health of the prospective client.

B) the integrity of management.

C) the CPA's overall engagement risk.

D) All of these choices are correct.

3)

Evaluating a prospective client requires which of the following steps?

A) communicate with the predecessor auditor B) preplan the audit C) establish the terms of the engagement D) none of these

4) An auditor inspects a document for proper authorization of a transaction and verifies a transaction amount that is stated within the document. The auditor has performed a(n)

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A) test of details.

B) substantive analytical procedure.

C) test of controls.

D) dual-purpose test

5) Which of the following should an auditor obtain from the predecessor auditor prior to accepting an audit engagement?

A) analysis of balance sheet accounts B) analysis of income statement accounts C) all matters of continuing accounting significance D) facts that might bear on management integrity

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

A) the prospective client's unwillingness to permit inquiry of its legal counsel B) the inability to review the predecessor auditor’s documentation C) the CPA's lack of understanding of the prospective client’s operations and industry D) indications that management has not investigated employees in key positions before hiring them

7) An auditor who discovers that a client’s employees paid small bribes to municipal officials most likely would withdraw from the engagement if:

A) the payments violated the client’s policies regarding the prevention of illegal acts.

B) the client receives financial assistance from a federal government agency.

C) documentation that is necessary to prove that the bribes were paid does not exist.

D) management fails to take the appropriate remedial action.

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8) A successor auditor should request the new client to authorize the predecessor auditor to allow a review of the predecessor’s:

A) engagement letter.

B) audit working papers.

C) engagement letter and audit working papers.

D) it would not be typical to allow a review of either the engagement letter or the audit working papers.

9)

Evaluating a prospective client requires which of the following steps?

A) communicate with the SEC B) preplan the audit C) determine if the firm is independent of the client D) communicate with the AICPA

10) Which of the following factors most likely would lead a CPA to conclude that a potential audit engagement should be rejected?

A) The details of most recorded transactions are not available after a specified period of time.

B) Internal control activities requiring segregation of duties are subject to management override.

C) It is unlikely that sufficient appropriate evidence is available to support an opinion on the financial statements.

D) Management has a reputation for consulting with several accounting firms about significant accounting issues.

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11) 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 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 procedures before the year-end

12)

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 on the engagement 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.

13)

Which of the following situations would most likely require special audit planning?

A) Some items of factory and office equipment do not bear identification numbers.

B) Depreciation methods used on the client's tax return differ from those used on the books.

C) Assets costing less than $500 are expensed even though the expected life exceeds one year.

D) Inventory is comprised of precious stones.

14)

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

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A) identify specific internal control activities that are likely to prevent fraud.

B) evaluate the reasonableness of the client’s accounting estimates.

C) discuss the timing of the audit procedures with the client’s management.

D) inquire of the client’s attorney as to any unrecorded claims.

15) An auditor is required to establish an understanding with a client regarding the responsibilities for each engagement. This understanding generally includes:

A) management’s responsibility to guarantee that there are no material misstatements due to fraud.

B) the auditor’s responsibility to plan and perform the audit to provide reasonable, but not absolute, assurance of detecting material errors or fraud.

C) management’s responsibility for providing the auditor with an assessment of the risk of material misstatement due to fraud.

D) the auditor’s responsibility for the fairness of the financial statements.

16) A written understanding between the auditor and the client concerning the auditor’s responsibility for the discovery of illegal acts is usually set forth in a(n):

A) client representation letter.

B) letter of audit inquiry.

C) management letter.

D) engagement letter.

17)

Engagement letters include all of the following except:

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A) a list of additional services, if any, that will be provided.

B) a list of adjusting journal entries.

C) information about the audit fee.

D) arrangements involving the use of specialists.

18)

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 liability for illegal acts committed by its employees D) the auditor’s responsibility to guarantee accuracy of the financial statements

19) To provide for the greatest degree of independence in performing internal audit activities, the internal audit function most likely should report to the:

A) vice-president - finance.

B) corporate controller.

C) audit committee of the board of directors.

D) corporate stockholders.

20)

All of the following refer to the competence of the internal audit function except:

A) the party in the entity to which the internal audit function reports.

B) the quality of internal audit documents and reports.

C) professional certifications held by the internal auditors.

D) supervision and review of internal audit activities.

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21) An independent auditor might consider the procedures performed by the internal audit function because:

A) they are employees whose work must be reviewed during substantive testing.

B) they are employees whose work might be relied upon.

C) their work impacts the cost/benefit tradeoff in evaluating inherent limitations.

D) their degree of independence may be inferred by the nature of their work.

22) As generally conceived, the audit committee of a publicly held company should be made up of:

A) representatives of the major equity interests (preferred stock, common stock).

B) the audit partner, the chief financial officer, the legal counsel, and at least one outsider.

C) representatives from the client’s management, investors, suppliers, and customers.

D) members of the board of directors who are not officers or employees.

23) To emphasize auditor independence from management, publicly traded corporations are required to:

A) appoint a partner of the CPA firm conducting the examination to the corporation’s audit committee.

B) establish a policy of discouraging social contact between employees of the corporation and the independent auditors.

C) request that a representative of the independent auditor be on hand at the annual stockholders’ meeting.

D) have the independent auditor report to an audit committee of independent members of the board of directors.

24)

An auditor obtains knowledge about a new client’s business and its industry in order to:

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A) make constructive suggestions concerning improvements to the client’s internal control.

B) develop an attitude of professional skepticism concerning management’s financial statement assertions.

C) evaluate whether the aggregation of known misstatements causes the financial statements taken as a whole to be materially misstated.

D) understand the events and transactions that may have an effect on the client’s financial statements.

25)

Which of the following is an example of a related party transaction?

A) An action is taken by the directors of Company A to provide additional compensation for vice presidents in charge of the principal business functions of Company A. B) A long-term agreement is made by Company A to provide merchandise or services to Company B, a long-time, friendly competitor.

C) A short-term loan is granted to Company A by a bank that has a depositor who is a member of the board of directors of Company A. D) A nonmonetary exchange occurs whereby Company A exchanges property for similar property owned by Company B, an unconsolidated subsidiary of Company A.

26) An independent auditor finds that Holdaway Corporation occupies office space, at no charge, in an office building owned by a shareholder. This finding likely indicates the existence of:

A) management fraud.

B) related party transactions.

C) window dressing.

D) weak internal control.

27)

Which of the following would not necessarily be a related party transaction?

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A) sales to another corporation with a similar name B) purchases from another corporation that is controlled by the corporation’s chief stockholder C) loan from the corporation to a major stockholder D) sale of land to the corporation by the spouse of a director

28)

The existence of a related party transaction may be indicated when another entity:

A) sells real estate to the corporation at a price that is comparable to its appraised value.

B) absorbs expenses of the corporation under audit.

C) borrows from the corporation at a rate of interest which equals the current market rate.

D) lends to the corporation at a rate of interest which equals the current market rate.

29) In the context of an audit of financial statements, substantive procedures are audit procedures that:

A) may be eliminated under certain conditions.

B) are primarily designed to discover significant subsequent events.

C) may be either tests of details of transactions, tests of details of account balances, or analytical procedures.

D) will increase proportionately with an increase in the auditor's reliance on internal control.

30) Which of the following is not an audit procedure that is commonly used in performing tests of controls?

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A) inquiring B) observing C) confirming D) inspecting

31)

Tolerable misstatement (also referred to as performance materiality) is:

A) materiality allocated to an assertion.

B) materiality for the balance sheet as a whole.

C) materiality for the income statement as a whole.

D) materiality allocated to a specific account.

32) Which of the following would an auditor most likely use in determining the auditor’s overall materiality?

A) the anticipated sample size for planned substantive procedures B) the entity’s annualized interim (i.e. quarterly) financial statements C) the results of the internal control questionnaire D) the contents of the management representation letter

33) Which of the following isnot a qualitative factor that may affect an auditor’s establishment of materiality?

A) potential for fraud B) the company is close to violating loan covenants C) firm policy sets materiality at 4% of pretax income D) a small misstatement would interrupt an earnings trend

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34) Which of the following isnot a concern as to whether a misstatement is qualitatively material?

A) The misstatement hides a failure to meet analysts’ expectations.

B) The misstatement is less than 5% of pretax income.

C) The misstatement increases management’s compensation.

D) The misstatement changes a small amount of profit to a small reported loss.

35) In assessing the competence of the internal audit function, an independent CPA most likely would obtain information about the:

A) quality of the work of the internal audit function.

B) organization’s commitment to integrity and ethical values.

C) influence of management on the scope of the internal audit function duties.

D) organizational levels to which the internal audit function reports.

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

A) perform detailed testing of the individual balance sheet accounts B) examining documents to detect illegal acts having a material effect on the financial statements C) considering whether the client’s accounting estimates are reasonable in the circumstances D) determining the extent of involvement of the client’s internal audit function

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

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A) that immaterial fraud is not to be reported to the client’s audit committee.

B) how the results of various auditing procedures performed by the assistants should be evaluated.

C) how the overall audit strategy will allow the firm to reach a sufficiently low level of audit risk.

D) how overall materiality was selected.

38) Which of the following audit procedures would be least likely to disclose the existence of related party transactions of a client during the period under audit?

A) reading “conflict-of-interest” statements obtained by the client from its management B) scanning accounting records for large transactions at or just prior to the end of the period under audit C) reading minutes of the Board of Directors meetings for authorization or discussion of material transactions D) confirming purchases and sales transactions with the vendors and/or customers involved

39)

A dual-purpose test:

A) simultaneously tests debits and credits.

B) is a procedure completed by both the internal and external auditors.

C) is useful to both the entity and the auditor.

D) is both a substantive test of transactions and a test of controls.

40) 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:

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A) methods of statistical sampling to be used in confirming accounts receivable.

B) pending legal matters to be included in the inquiry of the client’s attorney.

C) evidence to be gathered to provide a sufficient basis for the auditor’s opinion.

D) timing of the audit.

41) The audit client's board of directors and audit committee refused to take any action with respect to an immaterial illegal act which was brought to their attention by the auditor. Because of their failure to act, the auditor withdrew from the engagement. The auditor’s decision to withdraw was primarily due to doubts concerning:

A) adequate financial statement disclosures.

B) compliance with the statutory laws and regulations.

C) scope limitations resulting from their inaction.

D) the integrity of management.

42) Which of the following procedures would an auditor most likely include in the initial planning of an examination of financial statements?

A) assess the need for the use of specialists in the audit B) inquiring of the client’s attorney as to any claims that are likely to be asserted C) perform detailed testing of the individual financial statement accounts D) determining whether necessary internal controls procedures are being applied as prescribed

43) An entity's financial statements were misstated over a period of years due to large amounts of revenue being recorded in journal entries that involved debits and credits to an illogical combination of accounts. The auditor could most likely have been alerted to this fraud by:

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A) scanning the general journal for unusual entries.

B) performing a revenue cutoff test at year-end.

C) tracing a sample of journal entries to the general ledger.

D) examining documentary evidence of sales returns and allowances recorded after yearend.

44) Under the Sarbanes-Oxley Act, the audit committee of a public company has the following requirement(s):

A) each member of the committee must be a board member and shall be independent.

B) the audit committee must preapprove all audit and nonaudit services.

C) the audit committee must establish and maintain procedures to handle issues that relate to accounting, internal control, and auditing.

D) All of these.

45)

Which of the following is a general type of audit procedure?

A) fee assessment procedures B) tests of controls C) preparation of corporate tax returns D) active testing procedures

46) Which of the following arranges the general types of audit procedures in the order they are normally performed in an audit?

A) substantive procedures, tests of controls, and risk assessment procedures B) substantive procedures, risk assessment procedures, and tests of controls C) risk assessment procedures, tests of controls, and substantive procedures D) risk assessment procedures, substantive procedures, and tests of controls

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47) Which of the following relatively small misstatements most likely would 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

48) Which of the following is the most important qualitative factor that auditors should consider when making materiality judgments?

A) A misstatement exceeded five percent of net income.

B) The auditor also provides consulting services to the audit client.

C) The misstatement will cause the client to fail to meet an earnings forecast.

D) The audit committee is not well-educated about the accounting principle in question.

49) Which element(s) is/are pervasive to the application of the Principles Underlying an Audit Conducted in Accordance with GAAS particularly the Performance and Reporting sections?

A) the elements of materiality and audit risk B) the element of internal control C) the element of corroborating evidence D) the element of reasonable assurance

50) An auditor uses data visualization software to discover anomalies that may represent risk and require further testing. Which of the following best describes the procedure being performed by the auditor?

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A) tests of controls B) inspection of client data C) audit data analytics D) review of client data with auditor reperformance

51)

Which of the following statements isnot correct about materiality?

A) The concept of materiality recognizes that some matters are important for fair presentation of financial statements in conformity with GAAP, while other matters are not important.

B) An auditor considers materiality for the aggregate level of misstatements that could be material to any one of the financial statements individually.

C) Materiality judgments are made in light of surrounding circumstances and necessarily involve both quantitative and qualitative judgments.

D) An auditor’s consideration of materiality is influenced by the auditor’s perception of the needs of a reasonable person who will rely on the financial statements.

52) Cart and Blanche, a regional accounting firm is determining whether it wants to accept a new client, Ivy Photos. Ivy Photos is currently a privately held photography studio operating 24 studios in several states, but the company's management is planning an Initial Public Offering in the near future. This is the company's first audit. What steps should Cart and Blanche take in evaluating this new client?

53)

Define the engagement letter and discuss its importance.

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54) BDK Accounting is auditing a new client, A La Carte Catering. BDK could save audit time by using work from A La Carte's internal audit staff. The staff consists of three accountants with public accounting experience and certification. A La Carte requires every member of its accounting department to spend two out of every five years on the internal audit staff. Then, the employee is rotated back into the accounting department for a couple of years. What factors should BDK consider when determining whether or not it can use work of the internal audit staff? In this case, what should BDK decide?

55) Name three Sarbanes-Oxley Act requirements and duties of the members of the audit committee of a public company.

56)

How would an auditor identify related parties and what is the importance of doing so?

57) In the planning stages of an audit, what information does an auditor gain through analytical procedures?

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58) Discuss the purposes for planning the audit and identify the steps that are performed during this phase of the engagement.

59) Name and describe three supervisory activities that should be performed by the engagement partner and other engagement team members performing supervisory activities.

60) Often in an audit, total combined tolerable misstatement is greater than overall materiality. Why is this the case?

61)

The first phase of audit planning is risk assessment. ⊚ ⊚

true false

62) When the prospective client has previously been audited, auditing standards require that the successor auditor make certain inquiries of the predecessor auditor before accepting the engagement. ⊚ ⊚

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63) With few exceptions, the Code of Professional Conduct does not allow an auditor to disclose confidential client information without the client’s consent. ⊚ ⊚

true false

64) If the prospective client refuses to allow the predecessor auditor to communicate with the successor auditor, the successor auditor should have reservations about accepting the client. ⊚ ⊚

true false

65) In order to properly preplan the audit, the auditor must determine the engagement team requirements and ensure the independence of the audit team and audit firm. ⊚ ⊚

true false

66) If the internal audit function is competent and objective, the auditor may generally rely on the work of an internal audit function in certain areas to reduce the amount of external audit work in these areas. ⊚ ⊚

67)

true false

All companies must have an audit committee. ⊚ ⊚

true false

68) The audit committee is directly responsible for the appointment, compensation, and oversight of the work of any accounting firm employed by a public company.

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⊚ ⊚

true false

69) The external auditor is required to make a number of important communications to the audit committee during or at the end of the audit engagement. ⊚ ⊚

70)

The engagement partner is typically responsible for doing the detailed audit testing. ⊚ ⊚

71)

true false

true false

There are five general types of audit procedures. ⊚ ⊚

true false

72) Materiality significantly impacts the auditor’s decisions about how much and what kind of evidence to gather. ⊚ ⊚

73)

true false

Materiality is based only on a quantitative analysis of the financial statements. ⊚ ⊚

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20

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Answer Key Test name: ch 3 1) D 2) D 3) A 4) D 5) D 6) A 7) D 8) B 9) C 10) C 11) B 12) D 13) D 14) C 15) B 16) D 17) B 18) A 19) C 20) A 21) B 22) D 23) D 24) D 25) D 26) B Version 1

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27) A 28) B 29) C 30) C 31) D 32) B 33) C 34) B 35) A 36) D 37) B 38) D 39) D 40) D 41) D 42) A 43) A 44) D 45) B 46) C 47) A 48) C 49) A 50) C 51) B 61) FALSE 62) TRUE 63) TRUE 64) TRUE 65) TRUE Version 1

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66) TRUE 67) FALSE 68) TRUE 69) TRUE 70) FALSE 71) FALSE 72) TRUE 73) FALSE

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Student name:__________ 1)

Engagement risk is:

A) the risk of issuing an incorrect audit opinion.

B) the auditor's risk of loss from events arising in connection with financial statements audited and reported upon.

C) the overall risk of material misstatement.

D) the risk of the entity's financial failure.

2)

Client risk as defined in the text is:

A) the auditor's risk of loss from events arising in connection with financial statements audited and reported upon.

B) the overall risk of material misstatement.

C) the risk that audit procedures will fail to detect material misstatements.

D) the risk of the entity's financial failure.

3)

Under Auditing Standards, which of the following would be classified as an error?

A) misappropriation of assets for the benefit of management B) misinterpretation by management of facts that existed when the financial statements were prepared C) preparation of records by employees to cover a fraudulent scheme D) intentional omission of the recording of a transaction to benefit a third party

4) When assessing the risk of material misstatement, auditors evaluate the reasonableness of an entity's accounting estimates. An auditor normally would be concerned about assumptions that are:

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A) susceptible to bias.

B) consistent with prior periods.

C) insensitive to variations.

D) similar to industry guidelines.

5) Which of the following characteristics most likely would heighten an auditor's concern about the risk of intentional manipulation of financial statements?

A) Turnover of senior accounting personnel is low.

B) Insiders recently purchased additional shares of the entity's stock.

C) Management places substantial emphasis on meeting earnings projections.

D) The rate of change in the entity's industry is slow.

6)

Which of the following is a factual misstatement?

A) a management estimate that is outside the range of reasonable outcomes determined by the auditor B) a fixed asset being recorded at the incorrect cost C) a projected misstatement resulting from errors found during sampling D) difference in judgment between the auditor and management

7)

Engagement risk can be eliminated by: A) establishing policies for client acceptance and continuance.

B) lowering audit risk.

C) lowering materiality.

D) engagement risk cannot be eliminated.

8)

The achieved (actual) level of audit risk:

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A) can always be accurately assessed by the auditor.

B) should be greater than or equal to acceptable audit risk.

C) can never be known with certainty.

D) is the same for all audit engagements.

9) An auditor knows that an audit client operating in an industry in which common stock is valued based on the price-earnings ratio will soon make an initial public offering. All of the following are true except: A) materiality should be reduced.

B) risk of material misstatement should increase.

C) detection risk should decrease.

D) audit risk should increase.

10) The risk that an auditor will conclude, based on substantive procedures, that a material error does not exist in an account balance when, in fact, such an error does exist is referred to as: A) materiality risk.

B) detection risk.

C) control risk.

D) inherent risk.

11)

The risk of material misstatement differs from detection risk in that it: A) arises from the misapplication of auditing procedures.

B) may be assessed in either quantitative or qualitative terms.

C) exists independently of the actions of the auditor.

D) can be changed at the auditor's discretion.

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12) All of the following are inherent risk factors that are pervasive to the financial statements except: A) highly complex significant transactions.

B) non-routine transactions.

C) classes of transactions are not processed systematically.

D) supplies inventory is difficult to count.

13) When an auditor increases the assessed level of risk of material misstatement because certain control procedures 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 substantive tests.

D) level of inherent risk.

14) On the basis of audit evidence gathered and evaluated, an auditor decides to increase the assessed level of 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 amount of substantive testing.

B) decrease detection risk.

C) increase detection risk.

D) increase materiality levels.

15)

The risk of material misstatement includes which of the following?

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A) detection risk B) audit risk C) inherent risk D) nonsampling risk

16) An auditor learns that a client's employee in control of inventory gets divorced and is responsible for paying a large amount of child support. All of the following for the audit of inventory likely are true except: A) fraud risk increases.

B) the risk of misappropriation of assets increases.

C) risk of material misstatement increases.

D) detection risk increases.

17)

Which of the following audit risk components may be assessed in qualitative terms?

A) risk of material misstatement B) detection risk C) neither risk of material misstatement nor detection risk D) both risk of material misstatement and detection risk

18) When an entity moves into a significant new line of business, all of the following increase except: A) client risk.

B) acceptable audit risk.

C) risk of material misstatement.

D) entity business risk.

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19) Which of the following procedures would not be used to obtain an understanding of the entity and its environment?

A) observe entity operations B) reperform entity processes C) verify proper valuation of inventory subject to technological obsolescence D) review prior year's audit documentation

20) Which of the following is not an important consideration in an auditor's evaluation of an entity's business risk?

A) The specific business risks an entity faces that may result in financial statement errors and fraud.

B) Business risk factors that impact the ability of the entity to be profitable and survive.

C) Audit standards include many entity business risk factors that identify circumstances that increase the likelihood of material misstatements.

D) Audit standards require the auditor to evaluate the entity's business risk in order to provide suggestions to improve the entity's profitability.

21)

Which of the following is a source of detection risk?

A) unstable business environment B) poor client controls C) a nonrepresentative sample D) inherent risk assessed too high

22) In general, material frauds perpetrated by which of the following are most difficult to detect?

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A) internal audit function B) keypunch operator C) cashier D) controller

23) Which of the following circumstances most likely would cause an auditor to believe that material misstatements may exist in an entity's financial statements?

A) Accounts receivable confirmation requests yield significantly fewer responses than expected.

B) Audit trails of computer-generated transactions exist only for a short time.

C) The chief financial officer does not sign the management representation letter until the last day of the auditor's fieldwork.

D) Management consults with other accountants about significant accounting matters.

24)

The primary responsibility for preventing fraud in an organization lies with: A) the audit committee of the board of directors.

B) the internal audit function.

C) the external auditor.

D) the organization's management.

25)

Which of the following is not a misstatement of the financial statements?

A) The entity uses different inventory accounting methods for internal and external reporting.

B) A departure from GAAP. C) The footnote for pensions is omitted.

D) A clerk incorrectly based the allowance for doubtful accounts on 31% of sales as opposed to 13% of sales as determined by the controller.

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26) All of the following represent an increased opportunity for management to commit fraud except: A) significant related party transactions.

B) the auditor's relationship with management is strained.

C) management is dominated by a single person.

D) the financial statements include highly subjective estimates.

27)

The auditor can respond to an increased risk of fraud by doing all of the following except:

A) evaluating whether the accounting policies selected may be indicative of fraudulent financial reporting through earnings management.

B) assigning more experienced personnel to the audit.

C) increasing detection risk.

D) taking steps to obtain more reliable evidence.

28) An auditor discovers a likely fraud during an audit but concludes that the overall effect of the fraud is not sufficiently material to affect the audit opinion. The auditor should probably: A) disclose the fraud to the appropriate level of the client's management.

B) disclose the fraud to appropriate authorities external to the client.

C) discuss with the client the additional audit procedures that will be needed to identify the exact amount of the fraud.

D) modify the audit program to include tests specifically designed to identify the fraud and its impact on the financial statements.

29)

The acceptable level of detection risk is inversely related to the:

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A) extent of the substantive procedures.

B) risk of misapplying auditing procedures.

C) overall materiality.

D) risk of failing to discover material misstatements.

30)

As the acceptable level of detection risk decreases, an auditor may change the: A) timing of tests of controls by performing them at an interim date rather than at year-

end.

B) nature of substantive procedures from less effective to more effective procedures.

C) timing of tests of controls by performing them at several dates rather than at one time.

D) assessed level of risk of material misstatement to a higher amount.

31)

As the acceptable level of detection risk decreases, the assurance directly provided from: A) substantive procedures should increase.

B) substantive procedures should decrease.

C) tests of controls should increase.

D) tests of controls should decrease.

32)

Increased fraud risk could result in all of the following except: A) lower detection risk.

B) higher inherent risk.

C) lower control risk.

D) higher client risk.

33)

The objectives of the engagement partner's communication with the audit team include:

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A) maintaining an adversarial atmosphere between the auditor and management.

B) complying with SEC rules.

C) complying with FASB rules.

D) emphasizing the importance of professional skepticism.

34) The auditor is most likely to presume that a high risk of a fraud relating to the misappropriation of assets exists if: A) the entity is a multinational company that does business in numerous foreign countries.

B) the entity does business with several related parties.

C) inadequate segregation of duties places an employee in a position to perpetrate and conceal theft.

D) inadequate employee training results in lengthy EDP exception reports each month.

35) Which of the following factors most likely would heighten an auditor's concern about the risk of fraudulent financial reporting?

A) Inability to generate cash flows from operations while reporting substantial earnings growth.

B) Management's lack of interest in increasing the entity's earnings trend.

C) Large amounts of liquid assets that are easily converted into cash.

D) Inability to borrow necessary capital without granting debt covenants.

36) A properly planned and performed audit may fail to detect a material misstatement resulting from fraud because:

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A) audit procedures that are otherwise effective may be ineffective for fraud that is concealed through collusion.

B) an audit is planned and performed to provide reasonable assurance of detecting material misstatements caused by errors but not by fraud.

C) the factors considered in assessing control risk indicated an increased risk of error but only a low risk of fraud in the financial statements.

D) the auditor did not consider factors influencing audit risk for account balances that have effects pervasive to the financial statements taken as a whole.

37) Which of the following is correct concerning required auditor communications about fraud?

A) Fraud that involves senior management should be reported directly by the auditor to the audit committee regardless of the amount involved.

B) Fraud with a material effect on the financial statements should be reported directly by the auditor to the Securities and Exchange Commission.

C) Any requirement to disclose fraud outside the entity is the responsibility of management and not that of the auditor.

D) The professional standards provide no requirements related to the communication of fraud, but the auditor should use professional judgment in determining communication responsibilities.

38) Using the audit risk model, identify the relationship between the following elements. For each of the items below, highlight whether the two elements have an inverse relationship, a direct relationship, or no relationship. When considering each item, assume that the other components of the risk model remain constant.a.Engagement Risk and Acceptable Audit Risk b.Assessed Inherent Risk and Planned Detection Risk c.Materiality and Amount of substantive evidence needed d.Assessed Inherent Risk and Assessed Control Risk e.Acceptable Audit Risk and Assessed Control Risk f.Amount of substantive evidence collected and Achieved Detection Risk g.Actual Inherent Risk and Actual Control Risk h.Achieved Detection Risk and Achieved Audit Risk

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39)

What is the difference between audit risk and engagement risk?

40) You are teaching a class of new hires at your international accounting firm. Explain the audit risk model using a mathematical formula.

AR = RMM × DR AR = Audit risk RMM = Risk of material misstatement DR = Detection risk

41) Stacey, the partner in charge of the audit of RIF Enterprises, sets the planned level of audit risk for the audit of accounts payable at 0.06. The risk of material misstatement is assessed at 0.65. What is the detection risk for this audit?

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42) Stacey, the partner in charge of the audit of GHER Corporation, calculates detection risk to be 5.7% for the audit of accounts payable. Stacey is also the partner in charge of the audit of RIF Enterprises and calculates detection risk to be 6.2% for the audit of accounts payable for RIF. GHER Corporation and RIF Enterprises are in the same industry, close to the same size, and have similar balances in accounts payable. What do the different detection risks tell you about the planned audit evidence that will be gathered for the GHER Corporation audit as compared with the planned audit evidence that will be gathered for RIF Enterprises?

43) Using the Audit Risk Model, what are the risks involved in the model and what relationship does each risk in the model have with planned audit evidence (Inverse or Direct)?

44) Your classmate asserts, "Accountants shouldn't need to take business courses besides accounting, because they are only interested in the financial statements of a company." Defend or refute this statement.

45) You are the senior on an audit of Two Be Gone, a large public company. The company recently completed an acquisition of its fifth largest competitor, a process that included integrating the information system of the acquired company with Two Be Gone’s information system. What risks might this present? How will you, the auditor, respond to these risks (i.e. what actions should you take)?

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46) In one sentence each, define misstatements arising from fraudulent financial reporting and misstatements arising from misappropriation of assets.

47) DATRIX, Incorporated, a Fortune 500 company, has been experiencing poor performance. Industry analysts have been issuing negative reports and the company's stock price has been steadily declining. As an auditor, what would concern you about the audit engagement of DATRIX, Incorporated?

48) During the course of the audit of FF Financial, you find that some accounting entries have been altered. You believe this may be the result of management fraud and you have determined that the effect of this could be material to the financial statements. What steps should you take in response to the accounting entries and your concern about management fraud?

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49) Assume that you are the new audit senior on the LV Drug Corporation (LVD) engagement. LVD is a pharmaceutical company that has three successful drugs and a number of drugs in progress in its research and development pipeline. You are considering your audit plan and it is important to identify the inherent risks that LVD has and how they relate to the planning process.

Required:For each of the following factors, indicate whether it will tend to increase, decrease, or have no effect on inherent risk, and the reasoning for your answer. a.Dr. Jones is the major shareholder of LVD and its CEO. b.Your firm has audited LVD for the last four years. c.There has been high turnover of key accounting personnel during the last two years. d.The internal audit function reports to the audit committee. e.LVD has been the subject of lawsuits by users of Framadon who claim that the drug affects their liver functions. LVD is confident that there are no such side effects from the use of Framadon.

50) Auditors are required to hold a brainstorming session about fraud risk for each audit engagement. Describe the topics that should be discussed during the brainstorming session.

51) Audit risk is the auditor's exposure to loss or injury of his or her reputation from events arising in connection with financial statements audited. ⊚ true ⊚ false

52) Engagement risk is the auditor's exposure to loss or injury of his or her reputation from events arising in connection with financial statements audited. ⊚ true ⊚ false

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53) risk.

The components of the audit risk model include inherent risk, control risk, and detection ⊚ ⊚

true false

54) Inherent risk is the susceptibility of an assertion to material misstatement, assuming no related controls. ⊚ true ⊚ false

55)

Professional judgment must be used when evaluating business risk. ⊚ true ⊚ false

56)

The risk of a material misstatement includes inherent risk and sampling risk. ⊚ true ⊚ false

57)

The combination of inherent risk and control risk is referred to as client risk. ⊚ true ⊚ false

58)

Inherent risk includes sampling risk and detection risk. ⊚ true ⊚ false

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Answer Key Test name: ch 4 1) B 2) B 3) B 4) A 5) C 6) B 7) D 8) C 9) D 10) B 11) C 12) D 13) C 14) B 15) C 16) D 17) D 18) B 19) C 20) D 21) C 22) D 23) A 24) D 25) A 26) B Version 1

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27) C 28) A 29) A 30) B 31) A 32) C 33) D 34) C 35) A 36) A 37) A 51) FALSE 52) TRUE 53) TRUE 54) TRUE 55) TRUE 56) FALSE 57) TRUE 58) FALSE

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Student name:__________ 1)

A confirmation is used to:

A) verify the inventory count is correct.

B) verify that a control is being observed.

C) verify a representation using information from a third party.

D) verify that a specific trend is correct.

2) Which of the following elements ultimately determines the amount of audit work that is necessary in the circumstances to afford a reasonable basis for an opinion?

A) auditor judgment B) materiality C) relative risk D) reasonable assurance

3) In testing plant and equipment balances, an auditor may physically inspect new additions listed on the summary of plant and equipment transactions for the year. This procedure is designed to obtain evidence concerning management's assertions about account balances, and specifically, which assertion?

A) existence B) rights and obligations C) completeness D) classification

4) Which assertions may be tested for the “account balances, and related disclosures” category of management assertions?

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A) existence, cutoff, rights and obligations, completeness B) existence, rights and obligations, completeness, accuracy, valuation and allocation, classification, and presentation C) occurrence, rights and obligations, completeness, valuation and allocation D) occurrence, accuracy, rights and obligations, completeness

5) Which assertions may be tested for the “transactions and events, and related disclosures” category of management assertions?

A) existence, completeness, rights and obligations, accuracy, cutoff, classification, and presentation B) occurrence, completeness, rights and obligations, accuracy, cutoff, and classification C) occurrence, completeness, accuracy, cutoff, classification, and presentation D) existence, rights and obligations, accuracy, authorization, and completeness

6) Tracing is used primarily to test which of the following assertions about classes of transactions?

A) occurrence B) completeness C) cutoff D) classification

7) Vouching is used primarily to test which of the following assertions about classes of transaction?

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A) occurrence B) completeness C) authorization D) classification

8) test:

In designing written audit programs, an auditor should plan specific audit procedures to

A) timing of audit procedures.

B) cost-benefit of gathering evidence.

C) selected audit techniques.

D) management assertions.

9)

Footing is an example of:

A) recalculation.

B) confirmation.

C) inquiries.

D) analytical procedures.

10) In determining whether transactions have been recorded, the direction of the audit testing should start from the:

A) general ledger balances.

B) adjusted trial balance.

C) original source documents.

D) general journal entries.

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11) To test for unsupported entries in the ledger, the direction of audit testing should start from the:

A) ledger entries.

B) sales invoices or shipping documents.

C) externally generated documents.

D) original source documents.

12) Which of the following presumptions does not relate to the appropriateness of audit evidence?

A) The more effective the internal control system, the more assurance it provides about the accounting data and financial statements.

B) An auditor's opinion, to be economically useful, is formed within a reasonable time and based on evidence obtained at a reasonable cost.

C) Evidence obtained from independent sources outside the entity is more reliable than evidence secured solely within the entity.

D) The independent auditor's direct personal knowledge, obtained through observation and inspection, is more persuasive than information obtained indirectly.

13)

Of the following, which is the least reliable type of audit evidence?

A) documents mailed by knowledgeable persons outside the entity to the auditor B) correspondence between the auditor and third party vendors C) asking the controller about an end of period adjustment D) computations made by the auditor

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14) Audit documentation is the principal record of the audit and provides the principal support for the representations in the auditor’s report. Because of this, audit documentation should do all of the following except for: A) demonstrate how the audit complied with auditing and related professional practice standards.

B) support the audit firm’s human resource department in employee retention decisions.

C) support the basis for the auditor’s conclusions concerning each material financial statement assertion.

D) demonstrate that the underlying accounting records agreed or reconciled with the financial statements.

15) Which of the following show the detailed general ledger accounts that make up a financial statement category on the auditor's working trial balance?

A) account analyses B) supporting schedules C) control accounts D) lead schedules

16) The permanent (continuing) file of an auditor's working papers most likely would include copies of the

A) bank statements.

B) organizational chart.

C) lead schedules.

D) audit plan.

17) An example of an audit procedure that results in evidence with a medium level of reliability is:

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A) analytical procedures.

B) recalculation.

C) observation.

D) All of these choices are correct.

18)

Audit documentation prepared on audits of public entities is the property of the:

A) shareholders.

B) auditor.

C) management of the entity being audited.

D) securities and exchange commission.

19)

All of the following are typically in the current file except:

A) adjusting journal entries.

B) copies of the audit report.

C) chart of accounts.

D) lead schedules.

20) You are auditing a store that sells merchandise. Some of the store merchandise is held on consignment. Which account balance assertion for inventory should you be most concerned about verifying?

A) existence B) completeness C) rights and obligations D) accuracy, valuation, and allocation

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21) You are auditing a manufacturing company that has a large production facility. Some of the production equipment is held through lease agreements. Which of the following is the account balance assertion you would be most concerned about?

A) existence B) completeness C) rights and obligations D) accuracy, valuation, and allocation

22) Which of the following procedures would an auditor most likely perform to verify management's assertion of completeness?

A) Compare a sample of shipping documents to related sales invoices.

B) Observe the entity's distribution of payroll checks.

C) Confirm a sample of recorded receivables by direct communication with the debtors.

D) Review standard bank confirmations for indications of kiting.

23) Each of the following might, by itself, form a valid basis for an auditor to reduce substantive testing except for the:

A) difficulty and expense involved in testing a particular item.

B) assessment of control risk at a low level.

C) low inherent risk involved.

D) high quality of the evidence gathered.

24)

Of the following, the most reliable type of evidence typically is:

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A) confirmation.

B) inspection of records and documents.

C) reperformance.

D) observation.

25)

Which of the following presumptions is correct about the reliability of audit evidence?

A) Information obtained indirectly from knowledgeable outside sources is the most reliable audit evidence.

B) Sufficiency and appropriateness of audit evidence are interrelated and they affect the persuasiveness of audit evidence.

C) Reliability of audit evidence refers to the amount of corroborative evidence obtained.

D) An effective internal control system provides more reliable audit evidence than a system with ineffective controls.

26) Which of the following types of documentary evidence should the auditor consider to be the most reliable?

A) a sales invoice issued by the entity and supported by a delivery receipt from an outside trucker B) confirmation of an account payable balance mailed by and returned directly to the auditor C) a check issued by the company and bearing the payee's endorsement that is included with the bank statement mailed directly to the auditor D) a working paper prepared by the entity's controller and reviewed by the entity's treasurer

27) Which of the following is the least persuasive documentation in support of an auditor's opinion?

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A) schedules of details of physical inventory counts conducted by the entity B) notation of auditor's inferences drawn from ratios and trends C) notation of an independent appraiser's conclusions documented in the auditor's working papers D) lists of negative confirmation requests for which no response was received by the auditor

28) Which of the following statements is generally correct about the appropriateness of audit evidence?

A) The more effective the internal control, the more assurance it provides about the reliability of the accounting data and financial statements.

B) Appropriateness of audit evidence refers to the amount of corroborative evidence obtained.

C) Information obtained indirectly from independent outside sources is more persuasive than the auditor's direct personal knowledge obtained through observation and inspection.

D) Appropriateness of audit evidence refers only to audit evidence obtained from outside the entity.

29)

Which of the following types of audit evidence is the most persuasive?

A) prenumbered internal purchase order forms B) auditee worksheets supporting cost allocations C) bank statements obtained from the auditee D) auditee personnel responses to auditor inquiries

30) Following are several statements regarding accounting records or audit documentation.

Which of the statements is correct?

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A) Accounting records belong to the auditee.

B) Documentation of an auditor's understanding of the entity's internal control system is not necessary.

C) Audit documents may be regarded as a substitute for the company's accounting records.

D) The independent auditor may discard audit documents after two years.

31) Audit documents record the results of the auditor's evidence-gathering procedures. When preparing audit documents, the auditor should remember that:

A) audit documents should be kept on the client's premises so that the client can have access to them for reference purposes.

B) audit documents should be the primary support for the financial statements being examined.

C) audit documents should be considered as a substitute for the company's accounting records.

D) audit documents should be designed to facilitate the review and supervision of work done by auditors assigned to the engagement.

32) be:

Audit documents that record the procedures used by the auditor to gather evidence should

A) considered the primary support for the financial statements being examined.

B) viewed as the connecting link between the accounting records and the financial statements.

C) designed in an orderly fashion to facilitate the review of audit work by the senior, manager, and partner on the engagement.

D) retained until the audited entity ceases to be a client.

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33) In creating lead schedules for an audit engagement, what financial information is needed to begin?

A) interim financial information, such as third quarter sales, net income, and inventory and receivables balances B) specialized journal information, such as the invoice and purchase order numbers of the last few sales and purchases of the year C) general ledger information, such as account numbers, prior-year account balances, and current year unadjusted information D) adjusting entry information, such as deferrals and accruals and reclassification journal entries

34)

Audit documentation:

A) must be in electronic form.

B) must be in paper form only.

C) is not required, but is strongly recommended.

D) may be in paper, electronic, or some other medium.

35) Based on conversations with the owner-manager of an audit client, the auditor ascertained that the company's primary motivation is to avoid paying income taxes. Based on this motivation, which account balance assertion for ending inventory will the auditor be most concerned about verifying?

A) existence or occurrence B) completeness C) rights and obligations D) observation

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36) Your audit client is under intense pressure to meet an earnings target. Which assertion related to classes of transactions are you most concerned with for transactions within the purchasing process?

A) existence or occurrence B) completeness C) accuracy D) presentation

37) You are concerned with unrecorded transactions in the purchasing cycle. Which audit procedure are you most likely to use when auditing purchases?

A) vouching transactions in accounting records to vendor invoices B) tracing vendor invoices to accounting records C) recalculation of vendor invoice amounts D) confirmation of customer accounts

38)

Which of the following statements concerning audit evidence is correct?

A) appropriate evidence supporting management's assertions is never persuasive B) effective internal controls contribute little to the reliability of the evidence created within the entity C) the cost of obtaining evidence is not an important consideration to an auditor in deciding what evidence should be obtained D) a company's accounting data cannot be considered sufficient audit evidence to support the financial statements

39)

The permanent audit file usually includes:

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A) working trial balance.

B) organizational chart.

C) audit plan.

D) audit programs.

40)

The current audit file usually includes:

A) working trial balance.

B) organizational chart.

C) documentation of internal control (e.g., flowcharts).

D) copies of important contracts.

41)

All audit documentation should have a heading, which includes:

A) name of the company under audit.

B) title of the working paper.

C) company's year-end date.

D) all of these.

42)

The audit working papers belong to:

A) the company under audit.

B) the government.

C) the audit firm.

D) they are public record documents.

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43) A company sells a particular product only in the last month of its fiscal year. The company uses commission agents for such sales and pays them 6% of their net sales 30 days after the sales are made. The agents' sales were $10 million. Experience indicates that 10% of the sales are usually not collected and 2% are returned in the first month of the new year. The auditor would expect the year-end balance in the accrued commissions payable account to be:

A) $528,000.

B) $540,000.

C) $588,000.

D) $600,000.

44) Which of the following nonfinancial information 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

45) A not-for-profit organization published a monthly magazine that had 15,000 subscribers on January 1, 2013. The number of subscribers increased steadily throughout the year and on December 31, 2013, there were 16,200 subscribers. The annual magazine subscription cost was $10 on January 1, 2013 and was increased to $12 for new members on April 1, 2013.

Subscriptions are paid in full at the beginning of the member term. An auditor should expect that the revenue from subscriptions for the year ended December 31, 2013, would be approximately:

A) $179,400.

B) $171,600.

C) $164,400.

D) $163,800.

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

A) fraud exists within the relevant accounts.

B) internal control activities are not operating effectively.

C) additional tests of details are required.

D) the communication with the audit committee should be revised.

47)

Which of the following is not a typical analytical procedure?

A) study of relationships of the financial information with relevant nonfinancial information B) comparison of the financial information with similar information regarding the industry in which the entity operates C) comparison of recorded amounts of major disbursements with appropriate invoices D) comparison of the financial information with budgeted amounts

48)

Analytical procedures may be classified as being primarily which of the following?

A) tests of controls B) substantive procedures C) tests of ratios D) detailed tests of balances

49) An abnormal fluctuation in gross profit that might suggest the need for extended audit procedures for sales and inventories would most likely be identified in the planning phase of the audit by the use of:

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A) tests of transactions and balances.

B) a preliminary review of internal controls.

C) specialized audit programs.

D) analytical procedures.

50)

An example of an analytical procedure is the comparison of:

A) financial information with similar information regarding the industry in which the entity operates.

B) recorded amounts of major disbursements with appropriate invoices.

C) results of a statistical sample with the expected characteristics of the actual population.

D) EDP generated data with similar data generated by a manual accounting system.

51)

Analytical procedures used in planning an audit should focus on identifying:

A) material weaknesses in internal control.

B) the predictability of financial data from individual transactions.

C) the various assertions that are embodied in the financial statements.

D) areas that may represent specific risks relevant to the audit.

52) As a result of analytical procedures conducted during the planning phase, the independent auditor determines that the gross profit percentage has declined from 30% in the preceding year to 20% in the current year. The auditor should:

A) express an opinion that is qualified due to the inability of the company to continue as a going concern.

B) evaluate management's performance in causing this decline.

C) require footnote disclosure.

D) consider the possibility of an error in the financial statements.

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53) The auditor generally finds more predictability in the ratio and trend analysis in the examination of the:

A) Statement of Changes in Stockholders' Equity and Retained Earnings.

B) Income Statement.

C) Balance Sheet.

D) Statement of Cash Flows.

54) The auditor notices significant fluctuations in key elements of the company's financial statements. If management is unable to provide an acceptable explanation, the auditor should:

A) consider the matter a scope limitation.

B) perform additional audit procedures to investigate the matter further.

C) intensify the examination with the expectation of detecting management fraud.

D) withdraw from the engagement.

55) Which of the following tends to be most predictable for purposes of analytical procedures applied as substantive procedures?

A) relationships involving balance sheet accounts B) transactions subject to management discretion C) relationships involving income statement accounts D) data subject to audit testing in the prior year

56) Analytical procedures enable the auditor to predict the balance or quantity of an item under audit. Information to develop this estimate can be obtained from all of the following except:

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A) tracing transactions through the system to determine whether procedures are being applied as prescribed.

B) comparison of financial data with data for comparable prior periods, anticipated results (e.g., budgets and forecasts) and similar data for the industry in which the entity operates.

C) study of the relationships of elements of financial data that would be expected to conform to a predictable pattern based upon the entity's experience.

D) study of the relationships of financial data with relevant nonfinancial data.

57) An auditor's analytical procedures performed during the overall review stage indicated that the entity's accounts receivable balance had doubled since the end of the prior year.

However, the allowance for doubtful accounts as a percentage of accounts receivable remained about the same. Which of the following explanations most likely would satisfy the auditor?

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

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

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

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

58) Which of the following would be least likely to be comparable between similar corporations in the same industry or line of business?

A) earnings per share B) return on total assets before interest and taxes C) accounts receivable turnover D) operating cash flow

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

A) quick assets divided by accounts payable B) accounts receivable divided by inventory C) interest payable divided by interest receivable D) total debt divided by stockholders’ equity

60)

Which of the following best describes audit data analytics?

A) use of the financial statements as the primary source of data B) use of financial data to analyze reliability of audit evidence C) use of evidence to support the audit opinion in the audit report D) use of data visualization to identify patterns and anomalies

61) Explain the occurrence and completeness assertions. How does failure to meet each assertion affect the financial statements?

62) Name two management assertions pertaining to the inventory account balance and explain why they are considered in an audit.

63)

For an auditor, how are management assertions useful?

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64) Why is appropriateness important for audit evidence? What qualities must evidence have to be considered appropriate?

65) Several factors may influence the reliability of evidence. Identify and describe two of these factors.

66) Sarah is auditing the sales of a new client. In one procedure Sarah performs, she begins with the original sales documents and then searches the accounting records to find the corresponding entry. What test is Sarah performing and what management assertion is she testing?

67) Auditors obtain evidence about the inventory account through, among other procedures, observing the counting of inventory. What are some limitations "observation" has as an audit procedure?

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68)

The audit testing hierarchy is considered to be more effective and more efficient. Why?

69)

According to the text, what are the three functions of working papers?

70) Who is responsible for the financial statements? What does the term "assertions" mean?

Identify the assertion categories and the specific assertions for each category.

71) Discuss the reliability of the types of audit evidence and identify the level of reliability for each type of evidence.

72) When using analytical procedures, the auditor first needs to develop an expectation with which to compare recorded results. What is meant by "precision of the expectation," and what factors affect the precision of analytical procedures?

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73) In deciding to implement analytical procedures, what are some factors the auditor will consider in determining a tolerable difference between the expectation and the recorded amount?

74) Stan is auditing First Financial Services and would like to use financial ratios to test the ability of First Financial Services to meet its current obligations. Identify two ratios that would help Stan in this task. Indicate how each ratio is calculated and what a high ratio would signify to Stan.

75) Name the three types of analytical procedures and provide a definition and example for each.

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76) For each of the following specific audit procedures, indicate the type of audit evidence it is gathering: (1) inspection of records or documents, (2) inspection of an asset, (3) observation, (4) inquiry, (5) confirmation, (6) recalculation, (7) reperformance and (8) analytical procedures.

The audit evidences can be used more than once. a.Discussing the recording of sales discounts in the fourth quarter with the accounts receivable manager. b.Examining sales invoices for supporting customer order and shipping documents. c.Reviewing the accounts payable subsidiary ledger for debit balances or interest bearing payables. d.Sending a written request to the entity’s bank requesting the cash balances in the entity’s accounts and any other liability balances that the entity owes the bank. e.Comparing the current-year accounts receivable turnover with the accounts receivable turnover for the industry. f.Examining a new piece of equipment to ensure that a major acquisition was received and is operational. g.Watching the entity’s accounting personnel while they prelist cash receipts. h.Footing the entity’s bank reconciliation and tracing the balance per the books to the general ledger. i.Recomputing sales price and extensions on sales invoices. j.For a sample of sales transactions recorded in the sales journal, tracing the sales invoices back to customer orders and shipping documents.

77) Audit evidence includes only written information used by the auditor in arriving at an opinion about the fairness of financial statements. ⊚ ⊚

78)

true false

The auditor gathers audit evidence to test management's assertions. ⊚ ⊚

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79)

Management assertions fall into four main categories. ⊚ ⊚

true false

80) The classification assertion refers to transactions and events being recorded in the correct accounting period. ⊚ ⊚

true false

81) The completeness assertion refers to ensuring that transactions and events that should have been recorded actually have been recorded. ⊚ ⊚

true false

82) The cutoff assertion relates to whether transactions and events have been recorded in the correct accounting period. ⊚ ⊚

83)

true false

Audit procedures are designed to test management assertions. ⊚ ⊚

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84) The relevance of audit evidence or specific audit procedures depends on the assertion being tested. ⊚ ⊚

true false

85) The auditor must use his or her professional judgment to determine the amount of audit evidence to be gathered. ⊚ ⊚

86)

true false

The sufficiency of evidence refers to the quality of audit evidence. ⊚ ⊚

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Answer Key Test name: ch 5 1) C 2) A 3) A 4) B 5) C 6) B 7) A 8) D 9) A 10) C 11) A 12) B 13) C 14) B 15) D 16) B 17) A 18) B 19) C 20) C 21) C 22) A 23) A 24) C 25) D 26) B Version 1

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27) A 28) A 29) C 30) A 31) D 32) C 33) C 34) D 35) B 36) B 37) B 38) D 39) B 40) A 41) D 42) C 43) C 44) C 45) D 46) C 47) C 48) B 49) D 50) A 51) D 52) D 53) B 54) B 55) C 56) A Version 1

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57) D 58) A 59) D 60) D 77) FALSE 78) TRUE 79) FALSE 80) FALSE 81) TRUE 82) TRUE 83) TRUE 84) TRUE 85) TRUE 86) FALSE

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Student name:__________ 1)

Internal controls are not designed to provide reasonable assurance that:

A) transactions are executed in accordance with management’s authorization.

B) embezzlement will be eliminated.

C) access to assets is permitted only in accordance with management’s authorization.

D) amounts recorded for assets are compared with the actual existing assets at reasonable intervals.

2) The basic concept of internal control that recognizes the cost of internal control should not exceed the benefits expected to be derived is known as:

A) reasonable assurance.

B) management responsibility.

C) limited liability.

D) management by exception.

3) An auditor would most likely be concerned with internal control policies and procedures that provide reasonable assurance about the:

A) efficiency of management’s decision-making process.

B) appropriate prices that the entity should charge for its products.

C) methods of assigning production tasks to employees.

D) entity’s ability to accurately process and summarize financial data.

4) Management’s attitude toward aggressive financial reporting and its emphasis on meeting projected profit goals most likely would significantly influence an entity’s control environment when:

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A) external policies established by parties outside the entity affect its accounting practices.

B) management is dominated by one individual.

C) internal audit personnel have direct access to the board of directors and the entity’s management.

D) the audit committee is active in overseeing the entity’s financial reporting policies.

5) Management philosophy and operating style most likely would have a significant influence on an entity’s control environment when:

A) internal audit personnel have direct access to the board of directors and the entity’s management.

B) the entity does not have sound personnel policies for hiring, training, and evaluating competent individuals.

C) accurate management job descriptions delineate specific duties.

D) the audit committee actively oversees the financial reporting process.

6) Proper monitoring within an internal control framework may include all of the following except:

A) an external auditor.

B) an effective audit committee.

C) an internal audit function.

D) the internal revenue service.

7)

An entity’s control activities include all of the following except:

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A) performance reviews.

B) information processing.

C) external auditor’s tests of controls.

D) segregation of duties.

8) Potential benefits of an entity’s controls in an IT environment include all of the following except:

A) reduction in the risk that controls will be circumvented.

B) eliminate human errors or mistakes.

C) consistent application of predefined business rules.

D) more timely information.

9)

An entity’s IT infrastructure refers to:

A) hardware components.

B) programmers.

C) software.

D) data provided by the system.

10)

Auditors are most likely to gather audit evidence solely using substantive procedures:

A) if transactions are recurring.

B) if the implemented controls are assessed as ineffective.

C) if control risk is very low.

D) if the entity has a well-designed automated system.

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11) Proper segregation of functional responsibilities in an effective system of internal control calls for separation of the functions of:

A) authorization, execution, and payment.

B) authorization, recording, and custody.

C) custody, execution, and reporting.

D) authorization, payment, and recording.

12) Factors that the auditor should consider as increasing the effectiveness of the audit committee include all of the following except:

A) It is independent of management.

B) It is comprised almost exclusively of members of management, ensuring detailed knowledge of the company’s operations.

C) It asks management difficult questions.

D) It interacts regularly with internal audit personnel.

13)

The documentation of an auditor’s understanding of internal controls:

A) is optional.

B) must be exclusively in narrative, questionnaires, or flowchart form.

C) must include flowcharts.

D) can include any combination of narratives, questionnaires, or flowcharts.

14)

A well-prepared flowchart should make it easier for the auditor to:

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A) prepare audit procedure manuals.

B) prepare detailed job descriptions.

C) perform walkthroughs.

D) assess the degree of accuracy of financial data.

15)

A flowchart is most frequently used by an auditor in connection with the:

A) preparation of generalized computer audit programs.

B) review of the entity’s internal controls.

C) use of statistical sampling in performing an audit.

D) performance of analytical procedures of account balances.

16) An advantage of using systems flowcharts to document information about internal control instead of using internal control questionnaires is that systems flowcharts:

A) identify whether segregation of duties prevent collusion.

B) provide a visual depiction of the entity’s activities.

C) indicate whether controls are operating effectively.

D) reduce the need to observe the entity’s employees performing routine tasks.

17)

Which of the following audit tests would be regarded as a test of controls?

A) Tests of the specific items making up the balance in a given general ledger account.

B) Tests comparing inventory pricing to vendors’ invoices.

C) Tests of the signatures on canceled checks to the board of directors’ authorizations.

D) Tests of the additions to property, plant, and equipment by physical inspections.

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18) The independent auditor selects several transactions in each functional area and traces them through the entire system, paying special attention to evidence about whether or not the control activities are in operation. This is an example of a(n):

A) analytical procedure.

B) test of controls.

C) substantive procedure.

D) functional test.

19) To obtain evidential matter about control risk, an auditor selects from a variety of audit procedures including:

A) inquiry.

B) analytical procedures.

C) calculation.

D) confirmation.

20) Which of the following procedures most likely would provide an auditor with evidence about whether an entity’s internal control is suitably designed to prevent or detect material misstatements?

A) Scanning the journals produced by the internal control system.

B) Performing analytical procedures using data aggregated at a high level.

C) Vouching a sample of transactions directly related to the controls.

D) Observing the entity’s personnel applying the controls.

21)

Reports on service organizations typically:

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A) provide reasonable assurance that their financial statements are free of material misstatements.

B) ensure that the entity will not have any misstatements in areas related to the service organization’s activities.

C) ensure that the auditee is billed correctly.

D) assess whether the service organization’s controls are suitably designed to achieve internal control objectives.

22) Where computer processing is used in significant accounting applications, internal control activities may be defined by classifying control activities into two types: general and

A) administrative B) specific C) application D) authorization

23) Which of the following data validation controls is a numeric value computed to provide assurance that the original value has not been altered in construction or transmission?

A) hash total B) parity check C) encryption D) check digit

24)

General controls include all of the following except:

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A) data center and network operations controls.

B) data validation controls.

C) access security controls.

D) application system acquisition controls.

25)

A limit test is a:

A) test to ensure that a numerical value does not exceed some predetermined value.

B) check to ensure that the value in a field falls within an allowable range of values.

C) check to ensure that the data in a field have the proper arithmetic sign.

D) check on a field to ensure that it contains either all numeric or alphabetic characters.

26)

A field test is a:

A) test to ensure that a numerical value in a field does not exceed some predetermined value.

B) check to ensure that the value in a field falls within an allowable range of values.

C) check to ensure that the data in a field have the proper arithmetic sign.

D) check on a field to ensure that it contains either all numeric or all alphabetic characters.

27) An entity’s internal controls are most relevant to the auditor when the policies and procedures:

A) affect the financial statement assertions.

B) relate to management’s planning decisions.

C) address management’s operating decisions.

D) reflect management’s philosophy and operating style.

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28) In evaluating internal control, the auditor is basically concerned that the system provides reasonable assurance that:

A) operational efficiency has been achieved in accordance with management plans.

B) material misstatements have been prevented, or detected and corrected.

C) controls have not been circumvented by collusion.

D) management cannot override the system.

29) The concept of reasonable assurance in the context of an entity’s internal controls recognizes that:

A) auditors may fail to detect material misstatements.

B) proper internal controls guarantee that material misstatements will not occur.

C) proper internal controls preclude fraud.

D) the costs of some controls may be too high to implement in relation to potential benefits.

30)

An effective control environment:

A) identifies and responds to all business risks.

B) creates a commitment to competence.

C) guarantees that all controls are followed as prescribed.

D) does not need an effective board of directors or internal audit function.

31) The control environment component of internal control includes all of the following except:

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A) management’s philosophy and operating style.

B) access to computer programs.

C) organizational structure.

D) human resource policies and practices.

32)

Information and communication includes all of the following except:

A) identifying and recording all valid transactions.

B) determining the time period in which transactions occurred.

C) communicating price changes to customers.

D) properly presenting transactions and related disclosures in the financial statements.

33)

An organizational structure is important for all of the following reasons except:

A) ensuring proper accountability.

B) defining areas of authority.

C) creating clear lines of reporting.

D) ensuring a proper commitment to controls.

34)

The risk assessment component of internal control refers to

A) the auditor’s assessment of control risk.

B) the auditor’s assessment of client risk.

C) the entity’s identification and analysis of risks relevant to achievement of its objectives.

D) the entity’s monitoring of the potential for material misstatements.

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35)

As opposed to a manual control, an automated control:

A) can never be circumvented.

B) should function consistently in the absence of program changes.

C) need not be tested by the auditor.

D) must be tested using the same techniques as a manual control.

36)

An IT specialist is least likely to be necessary when:

A) data are shared extensively among systems.

B) the entity participates heavily in electronic commerce.

C) the system has not changed from the prior year.

D) significant audit evidence is in electronic form.

37) A substantive strategy differs from a reliance strategy in that a substantive strategy includes:

A) increased implementation of detailed tests of transactions and balances.

B) extra tests of controls.

C) increased emphasis on verbal representations from management.

D) setting control risk at a minimum level.

38)

Assessing control risk at a lower level most likely would involve:

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A) changing the timing of substantive procedures by omitting interim testing and performing the tests at year-end.

B) identifying specific internal controls relevant to specific assertions.

C) performing more extensive substantive procedures with larger sample sizes than originally planned.

D) reducing inherent risk for most of the assertions relevant to significant account balances.

39) In the audit of financial statements, an auditor’s primary consideration regarding an internal control policy or procedure is whether the policy or procedure:

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.

40) Which of the following most likely would not be considered an inherent limitation of the potential effectiveness of an entity's internal controls?

A) incompatible duties B) management override C) mistakes in judgment D) collusion among employees

41) It is important for the CPA to consider the competence of the entity's employees because their competence bears directly and importantly upon the:

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A) cost/benefit relationship of the system of internal control.

B) achievement of the objectives of the system of internal control.

C) comparison of recorded accountability with assets.

D) timing of the tests to be performed.

42) As part of gaining an initial understanding of internal control, an auditor is required to do all of the following except:

A) consider factors that affect the risk of material misstatement.

B) ascertain whether internal control policies and procedures have been placed in operation.

C) identify the types of potential misstatements that can occur.

D) obtain knowledge about the operating effectiveness of the internal control.

43) A CEO requires the internal audit function report to them and not communicate directly with the Audit Committee. Which component of internal control does this most closely relate to?

A) information and communication B) control environment C) authorization D) risk assessment

44) In obtaining an understanding of an entity's internal control in a financial statement audit of a nonpublic company, an auditor is not obligated to:

A) determine whether the control activities have been placed in operation.

B) perform procedures to understand the design of the internal control policies.

C) document the understanding of the entity's internal control components.

D) search for significant deficiencies in the operation of the internal control.

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45) After completing the preliminary phase of the review of internal control, the auditor decides not to rely on the system of internal control to reduce the risk of material misstatement.

Documentation may be limited to the auditor’s:

A) understanding of the internal control.

B) reasons for deciding not to extend the review.

C) basis for concluding that errors and fraud will be prevented.

D) completed internal control questionnaire.

46) For a complex IT system, auditors are least likely to use which of the following when documenting their understanding of internal controls?

A) narratives B) internal control questionnaires C) flowcharts D) organizational charts

47)

Assessing control risk at a lower level involves all of the following except:

A) identifying specific controls to rely on.

B) concluding that controls are ineffective.

C) performing tests of controls.

D) analyzing the achieved level of control risk after performing tests of controls.

48) 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:

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A) extent of tests of details.

B) level of inherent risk.

C) extent of tests of controls.

D) level of detection risk.

49) Which of the following procedures most likely would be included as part of an auditor's tests of controls?

A) inspection B) reconciliation C) confirmation D) analytical procedures

50)

An auditor is least likely to test the internal controls that provide for:

A) approval of the purchase and sale of marketable securities.

B) vouching a sample of sales transactions to make sure each one has an accompanying shipping document.

C) segregation of the functions of recording disbursements and reconciling the bank account.

D) comparison of receiving reports and vendors' invoices with purchase orders.

51) For certain controls, such as segregation of duties, documentary evidence may not exist.

An auditor would most likely test the procedures by:

A) reperformance and corroboration.

B) observation and inquiry.

C) inspection and vouching.

D) confirmation and recomputation.

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52)

Walkthroughs usually involve all of the following audit procedures except:

A) reperformance.

B) inquiry.

C) observation.

D) inspection.

53) Before applying substantive procedures to the details of accounts at an interim date (a date prior to the balance sheet date), an auditor should:

A) assess control risk at high 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 the availability of information at a later date that will be necessary for the auditor’s subsequent procedures after year-end.

D) obtain written representations from management that all financial records and related data will be made available.

54) An audit strategy that sets the allowable detection risk as “high” likely includes all of the following except:

A) interim testing.

B) reduced testing of transactions.

C) heavy reliance on analytical procedures as substantive procedures.

D) audit work only completed at year-end.

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A) the control environment and other relevant controls.

B) scheduling conflicts in the audit firm that make interim testing more convenient.

C) the purpose of the substantive procedure.

D) the assessed risk of material misstatement.

56) If auditors conduct substantive procedures as of 10/31 for a nonpublic entity with a 12/31 year-end:

A) additional tests are seldom conducted for the remaining period.

B) additional control tests are required in the remaining period.

C) the entity’s controls likely are ineffective.

D) additional tests likely will be performed in the remaining period.

57) Based on a study and evaluation completed at an interim date, the auditor concludes that no significant internal control weaknesses exist. The records and procedures would most likely be tested again at year-end if: A) compliance tests were not performed by the internal audit staff during the remaining period.

B) the internal control system provides a basis for reliance in reducing the extent of substantive procedures.

C) the auditor used nonstatistical sampling during interim compliance testing.

D) inquiries and observations lead the auditor to believe that conditions within the internal control system have changed.

58) The auditor’s communication of material weaknesses in internal control to management and those charged with governance for a nonpublic company is:

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A) required to enable the auditor to state that the examination has been made in accordance with generally accepted auditing standards.

B) the principle reason for studying and evaluating the system of internal controls.

C) required even though the financial statement audit for private companies does not require an audit of the entity’s system of internal control.

D) required to be included as part of the audit opinion.

59) Significant deficiencies are matters that come to an auditor’s attention that should be communicated to an entity’s audit committee because they represent:

A) disclosures of information that significantly contradict the auditor’s going concern assumption.

B) material fraud or illegal acts perpetrated by high-level management.

C) deficiencies in the design of controls or failures in the operation of internal controls that merit the attention of those charged with governance.

D) manipulation or falsification of accounting records or documents from which financial statements are prepared.

60)

All of the following are significant deficiencies except:

A) inadequate design of internal control over a significant account or process.

B) management override of controls.

C) inadequate provisions for safeguarding assets.

D) inventory is highly subject to obsolescence.

61) is:

The normal sequence of documents and operations on a well-prepared systems flowchart

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A) top to bottom and left to right.

B) bottom to top and left to right.

C) top to bottom and right to left.

D) bottom to top and right to left.

62) When documenting an entity’s internal control, the independent auditor sometimes uses a systems flowchart, which can best be described as a:

A) pictorial presentation of the flow of instructions in an entity’s internal computer system.

B) diagram which clearly indicates an organization’s internal reporting structure.

C) graphic illustration of the flow of operations which is used to replace the auditor’s internal control questionnaire.

D) symbolic representation that represents the flow of documents and the processing steps among departments in the entity.

63) Which of the following is an IT general control that would most likely assist an entity whose systems analyst left the entity in the middle of a major project?

A) processing controls B) input and output validation routines C) systems documentation D) error controls

64) A customer intended to order 100 units of product Z96014, but incorrectly ordered 100 units of a nonexistent product Z96015. Which of the following controls most likely would detect this error?

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A) existence (validity) test B) limit test C) field test D) sign test

65) After obtaining an understanding of internal controls and assessing control risk of an entity, an auditor decided not to perform tests of controls for purposes of the audit. The auditor most likely decided that:

A) the available evidential matter 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 procedures.

D) the assessed level of inherent risk exceeded the assessed level of control risk.

66) After the auditor has prepared a flowchart of the internal controls surrounding sales and evaluated the design of the system, the auditor would perform tests of controls on all control activities:

A) documented in the flowchart.

B) considered to be weaknesses that might allow errors to enter the accounting system.

C) that the auditor plans to rely on.

D) that would aid in preventing fraud.

67)

As the acceptable level of detection risk increases, an auditor may change the:

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A) assessed level of control risk from a lower level to a higher level.

B) assurance provided by tests of controls by using a larger sample size than planned.

C) timing of substantive procedures from year-end to an interim date.

D) nature of substantive procedures from less effective to more effective procedures.

68)

In a properly designed internal control system, the same employee may be permitted to:

A) receive and deposit checks and also approve write-offs of customer accounts.

B) approve vouchers for payment and also sign checks.

C) reconcile the bank statements and also receive and deposit cash.

D) sign checks and also cancel supporting documents.

69) A procedure that would most likely be used by an auditor in performing tests of control activities that involve segregation of functions but which leave no transaction trail is:

A) inspection.

B) observation.

C) reperformance.

D) reconciliation.

70)

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 the control activities.

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71) While substantive procedures may support the accuracy of underlying records, these tests frequently provide no affirmative evidence of segregation of duties because:

A) substantive procedures rarely guarantee the accuracy of the records if only a sample of the transactions has been tested.

B) the records may be accurate even though they are maintained by persons having incompatible functions.

C) substantive procedures relate to the entire period under audit, but compliance tests ordinarily are confined to the period during which the auditor is on the entity’s premises.

D) many computerized procedures leave no audit trail of who performed them, so substantive procedures may necessarily be limited to inquiries and observation of office personnel.

72) Before applying substantive procedures to the details of asset and liability accounts at an interim date, the auditor should:

A) consider the ability of the auditor to perform appropriate substantive procedures to cover the remaining period.

B) investigate significant fluctuations that have occurred in the asset and liability accounts since the previous balance sheet date.

C) select only those accounts which can effectively be sampled during year-end audit work.

D) consider the compliance tests that must be applied at the balance sheet date to extend the audit conclusions reached at the interim date.

73)

The program flowcharting symbol representing a decision is a:

A) triangle.

B) circle.

C) rectangle.

D) diamond.

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74) Internal control has become a very important focus for publicly traded and privately-held companies alike. Internal control is intended to accomplish at least three objectives and consists of five components of internal control. List the three objectives and five components of internal control.

75) What are two potential benefits and two potential risks of using IT for an entity’s internal control?

76) In terms of an audit, define substantive strategy and reliance strategy. Include in your definition how the different strategies relate to internal control. Which strategy would best relate to a lower control risk?

77)

Describe the limitations of internal control. Why do limitations on internal control exist?

78) What are four potential tools available to the auditor for documenting their understanding of an entity’s system of internal control?

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79) What are some typical types of evidence that may be collected in testing an entity’s internal controls?

80)

Why might an auditor decide to test controls at an interim date?

81) While performing an audit on the internal controls over financial reporting for AirWaves Corporation, your audit team finds what it considers to be a significant deficiency. AirWaves is a large, private company. What steps would you take to communicate this finding?

82) Data capture occurs through source documentation, direct data entry, or a combination of the two. List three purposes of data capture controls.

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83) What are the differences between document flowcharts, system flowcharts, and program flowcharts?

84) Trumpeter Corporation is a small publicly traded company that specializes in the restoration and sale of fine musical instruments. The audit committee is made up of a CEO from a technology company, a college accounting professor, and a local marketing executive. All are sufficiently independent from management. Members of the audit committee meet three times a year. Each time they meet, a different member, who chooses the topics to discuss, leads the meeting. The audit committee then sends the minutes of its meetings to the entity’s CFO. Solely from this information, what are your conclusions about this audit committee’s role within the control environment?

85)

The concept of internal control includes IT systems and manual systems. ⊚ ⊚

86)

The auditor must understand internal control before assessing inherent risk. ⊚ ⊚

87)

true false

true false

The extent of an entity’s use of IT can affect internal control. ⊚ ⊚

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88)

One of the risks associated with internal control from IT is potential loss of data. ⊚ ⊚

true false

89) COSO’s Internal Control – Integrated Framework identifies six components of an effective system of internal control. ⊚ ⊚

90)

Internal control includes monitoring of controls. ⊚ ⊚

91)

true false

A substantive strategy is used when control risk has been set at high. ⊚ ⊚

93)

true false

A reliance strategy is used when control risk has been set at high. ⊚ ⊚

92)

true false

true false

Once a level of control risk has been established, it cannot be changed.

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⊚ ⊚

94)

true false

Tests of controls must be performed if control risk is set at a lower level. ⊚ ⊚

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Answer Key Test name: ch 6 1) B 2) A 3) D 4) B 5) B 6) D 7) C 8) B 9) A 10) B 11) B 12) B 13) D 14) C 15) B 16) B 17) C 18) B 19) A 20) D 21) D 22) C 23) D 24) B 25) A 26) D Version 1

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27) A 28) B 29) D 30) B 31) B 32) C 33) D 34) C 35) B 36) C 37) A 38) B 39) B 40) A 41) B 42) D 43) B 44) D 45) A 46) A 47) B 48) A 49) A 50) B 51) B 52) A 53) C 54) D 55) B 56) D Version 1

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57) D 58) C 59) C 60) D 61) A 62) D 63) C 64) A 65) C 66) C 67) C 68) D 69) B 70) D 71) B 72) A 73) D 85) TRUE 86) FALSE 87) TRUE 88) TRUE 89) FALSE 90) TRUE 91) FALSE 92) TRUE 93) FALSE 94) TRUE

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Student name:__________ 1) In order for an external auditor to complete an audit of a public company, the entity’s management must comply with all of the following except:

A) accept responsibility for the effectiveness of the entity’s internal control over financial reporting.

B) evaluate the effectiveness of the entity’s internal control over financial reporting using suitable control criteria.

C) support its evaluation with sufficient evidence, including documentation.

D) present an oral assessment of the effectiveness of the entity’s internal control over financial reporting as of the end of the entity’s most recent fiscal year.

2)

An “integrated audit” as stated in Section 404 of the Sarbanes-Oxley Act means:

A) the auditor must consider the integrated thoughts and ideas of everyone on the audit staff.

B) the auditor must conduct two audits, one on the effectiveness of internal control and one on the financial statements, in an integrated way.

C) the auditor must integrate the same objectives whether auditing internal control or auditing the financial statements.

D) two independent CPA firms must work together on the audit.

3) The PCAOB Auditing Standards require the auditor to provide which of the following when performing an integrated audit?

A) reasonable assurance on the financial statements, absolute assurance on internal control B) reasonable assurance on internal control, absolute assurance on the financial statements C) absolute assurance on both the financial statements and internal control D) reasonable assurance on both the financial statements and internal control

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4) According to the PCAOB, who is responsible for certifying the reliability of the internal controls over financial reporting process of an entity?

A) the entity’s CEO and/or CFO B) the entity’s board of directors C) an internal control specialist D) the external auditor

5) The person in charge of authorizing credit to customers does not properly understand what constitutes a credit risk. This is an example of:

A) a material misstatement.

B) a design deficiency.

C) a deficiency in operation.

D) this is not an internal control deficiency.

6) A deficiency that implies that there is a reasonable possibility of misstatement in the financial statements that is significant but not material is:

A) a material weakness.

B) a significant deficiency.

C) an insignificant deficiency.

D) a probable deficiency.

7) Which of the following is not a topic that requires special consideration by management during management’s internal control assessment process and by the auditor during the audit of internal control?

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A) multiple locations and business units B) service organizations C) the role of the auditor in internal control D) safeguarding assets

8) Management documentation of the ICFR assessment should include all of the following except:

A) documentation regarding every control in a process.

B) documentation regarding reasonable support for the basis for management’s assessment and conclusion.

C) documentation regarding the design of controls management has placed in operation.

D) documentation on the controls management concludes are adequate to address the entity’s financial reporting risks.

9) Which of the following is not a primary objective of internal control as established by COSO?

A) efficiency and effectiveness of operations B) effective purchasing systems C) compliance with laws and regulations D) reliable financial reporting

10) An auditor performing an audit of internal control over financial reporting would be required to:

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A) rely on the work of internal auditors.

B) test all of the entity’s internal controls.

C) form an opinion on the effectiveness of internal control.

D) randomly identify accounts for an audit of internal control.

11) In determining the extent to which the auditor may use the work of others in the audit of ICFR, the auditor should do all of the following except:

A) be ready to document the extent to which he or she relied on the work.

B) evaluate the risks associated with the controls subjected to the work of others.

C) evaluate the competence and objectivity of the individuals who performed the work.

D) All of these are required.

12) Which of the following is least likely to represent a material weakness in internal control for Flynt Corporation?

A) Flynt Corporation’s computer systems were not working properly for two days; consequently, employees needed to do all reconciliations manually.

B) Flynt Corporation’s CFO was arrested last year for embezzling money from the entity.

C) For the current year, the auditor found a material misstatement in Flynt’s sales recognition that was undetected by the internal controls.

D) Flynt’s audit committee is deemed to be ineffective.

13) S&H Associates has just performed an audit of Bob’s Bikes. S&H was unable to obtain a written representation from management about internal control. Which of the following is true?

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A) S&H must still assume that management has assessed the effectiveness of internal control.

B) Depending on other factors in the audit, S&H can still issue an unqualified opinion.

C) S&H should consider this situation a limitation on the scope of the audit.

D) Management does not need to give S&H a letter if it has disclosed all known internal control deficiencies.

14) Public reporting on the effectiveness of internal control over financial reporting, as required by the Sarbanes-Oxley Act, includes:

A) a statement that the public accounting firm that audited the financial statements has provided input on the design of internal controls.

B) the auditor provides an opinion on whether the entity maintained, in all material respects, effective ICFR as of the specified date, based on the control criteria.

C) an explicit statement as to whether management agrees with the public accounting firm’s assessment of internal controls.

D) a detailed statement describing changes or additions to the internal control environment that occurred in the current year.

15) Which of the following concerning the auditor’s report on internal control over financial reporting is correct?

A) The auditor’s report contains an opinion on the effectiveness of internal control over financial reporting based on the auditor’s independent work.

B) In the report on internal control over financial reporting, the auditor can issue only a qualified or an unqualified opinion.

C) The auditor needs to state management’s assessment of internal control over financial reporting, but does not necessarily need to comment on whether he or she agrees.

D) An unqualified opinion is required if a material weakness is identified.

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16) Prior to issuing a report on internal controls over financial reporting, an auditor is required to:

A) perform procedures sufficient to identify all control deficiencies.

B) communicate to management, in writing, all control deficiencies previously included in written communication from the internal auditors.

C) communicate to management, in writing, all control deficiencies identified during the audit and inform the audit committee when such a communication has been made.

D) represent that no significant deficiencies were noted during the audit of internal control.

17)

Which of the following is not true?

A) The auditor should not communicate with management until the audit of internal control over financial reporting is finished.

B) Written communication between the auditor and management about internal control over financial reporting should include the definitions of control deficiencies, significant deficiencies, and material weaknesses.

C) The auditor should not include in the audit report that no significant deficiencies were noted during an audit of internal control over financial reporting.

D) If fraud is discovered, the auditor must report it to the appropriate level of management.

18)

An “integrated audit”:

A) will, in most cases, lead to a substantive audit strategy.

B) denies the auditor access to information about the entity’s controls.

C) may be performed by two separate audit firms.

D) is comprised of audits of internal control over financial reporting and of financial statements.

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19)

One of the advantages of generalized audit software is that:

A) it involves auditingafter the entity has processed the data rather than while the data are being processed.

B) it provides a limited ability to verify programming logic because its application is usually directed to testing entity files or databases.

C) it is limited to audit procedures that can be conducted on data avail-able in electronic form.

D) limited IT expertise or program-ming skills are required.

20) Which of the following audit procedures would an auditor be least likely to perform using a generalized audit software?

A) searching records of accounts receivable balances for credit balances B) investigating inventory for possible damaged goods C) selecting accounts receivable for positive and negative confirmations D) listing of unusually large inventory balances

21)

The auditor is least likely to use generalized audit software to:

A) perform analytical procedures on the entity’s data.

B) access information stored on the entity’s IT files.

C) identify design deficiencies in the entity’s IT controls.

D) test the accuracy of the entity’s computations.

22)

The five step process in the audit of ICFR includes:

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A) form an opinion on the safeguarding of the entity’s assets.

B) identify controls to test using a top-down, risk-based approach.

C) form an opinion on the fairness of the presentation of the financial statements.

D) plan the audit of the financial statements.

23)

Which of the following is an advantage of generalized audit software?

A) They are all written in one identical computer language.

B) They can be used for audits of entities that use differing IT equipment and file formats.

C) They have reduced the need for the auditor to study input controls for IT-related procedures.

D) Their use can be substituted for a relatively large part of the required compliance testing.

24)

IDEA is an example of:

A) an EDI software package.

B) custom Audit Software.

C) a generalized audit software program that is widely used in practice.

D) a type of networking.

25) Which of the following is not an element of management’s assessment process for the effectiveness of internal control?

A) identifying financial reporting risks and related controls B) determining the locations and business units to include in the evaluation C) evaluating evidence about the operating effectiveness of ICFR D) obtaining the auditor’s assessment of the internal control effectiveness

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26) Which of the following is true regarding management's documentation of internal controls?

A) Some documentation should focus on controls management has placed in operation to adequately address identified financial reporting risks.

B) Documentation should focus on controls over the interim financial reporting process.

C) Documentation must be done on paper.

D) Inadequate documentation is usually considered an insignificant deficiency in internal control.

27)

Which of the following statements is false?

A) Management identifies controls that are in place to address the financial reporting risks.

B) Management is required to base internal controls on a recognized control framework.

C) Nearly all reporting companies use the internal control framework developed by COSO. D) All controls relevant to financial reporting are accounting controls.

28)

Management’s written representations concerning internal control are:

A) addressed to the users of the financial statements.

B) normally drafted by management.

C) included in the auditor’s final report.

D) signed by the CEO and CFO.

29) In the context of an audit of internal controls, the auditor must document all of the following except:

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A) the extent to which he or she relied upon work performed by others.

B) the auditor’s understanding and evaluation of the design of each of the components of the entity’s internal control over financial reporting.

C) transcripts of the auditor’s discussion with management concerning the points at which misstatements could occur.

D) the evaluation of any deficiencies discovered that could result in a modification of the auditor’s report.

30)

Examples of entity-level controls include:

A) management’s risk assessment process.

B) controls to monitor results of operations.

C) the period-end financial reporting process.

D) all of these are examples of entity-level controls.

31) Which of the following statements included in management’s assessment of the effectiveness of internal control over financial reporting would not cause the auditor to disclaim an opinion?

A) Management includes disclosures about corrective actions taken by the entity after the date of management’s assessment.

B) The entity plans to implement new controls before the end of the reporting period.

C) Management believes the cost of correcting a material weakness would exceed the benefits derived from implementing the new controls.

D) Disclosure of material weaknesses corrected during the period.

32) A modification of the standard report is required for all of the following conditions except:

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A) there is a restriction on the scope of the engagement.

B) the presence of a material weakness at the end of the period.

C) management has concluded that internal controls are effective.

D) the auditor was not able to apply all the procedures necessary.

33) AAA & Associates recently finished auditing LinktheEarth Corporation’s internal control over financial reporting. AAA found a number of material weaknesses in the entity’s internal control. LinktheEarth’s management remediated all of the weaknesses that AAA found.

However, the auditors did not have sufficient time to retest the controls. What report should AAA issue with regards to internal control over financial reporting at year-end?

A) unqualified report B) adverse report C) qualified report D) disclaimer on opinion

34) According to the COSO definition of safeguarding of assets, effective controls over financial reporting will provide reasonable assurance that:

A) asset losses will not occur.

B) asset losses are properly reflected in the financial statements.

C) asset losses will not occur and that losses are properly reflected in the financial statements.

D) asset losses will not negatively impact the company.

35) An auditor will use the IT test data method in order to gain certain assurances with respect to the

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A) input data.

B) machine capacity.

C) application controls contained within the program.

D) degree of keypunching accuracy.

36)

Which of the following is true of generalized audit software packages?

A) They can be used only in auditing online computer systems.

B) It involves auditing while data is being processed.

C) They can be used to examine an entire population and eliminate the need for sampling.

D) They enable the auditor to perform all manual test procedures less expensively.

37)

The advantages of generalized audit software include all of the following except:

A) it involves auditing while the data are being processed (real-time).

B) it is easy to use.

C) the time to develop the application or audit procedure is usually short.

D) an entire population can be examined in some instances.

38)

Section 404 of the Sarbanes-Oxley Act includes which of the following?

A) a requirement that management of a privately held company issues an assessment of internal control that covers the entire year B) specific guidance on what constitutes adequate internal control C) a requirement that management of a publicly traded company accepts responsibility for establishing and maintaining adequate internal controls D) a requirement that management of a publicly traded company issues an assessment regarding the efficiency of internal control for the year

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39) For which of the following internal controls would an auditor be least likely to perform tests of internal controls closer to the “as of” date?

A) withdrawals from Federal Bank of more than $5 million must include a manager’s signature B) at the end of each day at Federal Bank, the total cash in the vault is reconciled with daily registers of deposits and withdrawals C) federal Bank has just started establishing trusts for its customers and it has only set up ten such trusts. Before making an investment for a trust, bank employees must verify that the investment is in accordance with stated investment policies D) on an annual basis, Federal Bank management performs credit checks on its loan customers before determining the value of loans it will not be able to collect on

40)

Which of the following is false?

A) Regardless of the achieved level of control risk in connection with the audit of the financial statements, auditing standards require the auditor to perform some substantive procedures for all significant accounts and disclosures.

B) The absence of misstatements in financial statements is considered convincing evidence that existing controls are effective.

C) The audit of internal control is intended to draw conclusions about the effectiveness of internal control over financial reporting as of a specific date.

D) The auditor is required to evaluate the implications of the financial statement audit for the effectiveness of internal control over financial reporting.

41) When testing a computerized accounting system, which of the following is false regarding the test data approach?

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A) The test data need to consist of only those valid and invalid conditions in which the auditor is interested.

B) Only one transaction of each type needs be tested.

C) Test data are processed by the entity’s computer programs under the auditor’s control.

D) The test data must consist of all possible valid and invalid conditions.

42) When an auditor tests a computerized accounting system, which of the following is true of the test data approach?

A) Test data are processed by the entity’s computer programs under the auditor’s control.

B) Test data must consist of all possible valid and invalid conditions.

C) Testing a program at year end provides assurance that the entity’s processing was accurate for the entire year.

D) Several transactions of each type must be tested.

43) You are an experienced audit senior. The new staff accountant on your audit team does not understand what a control deficiency is. Give him a definition of “control deficiency.”

Include examples of two types of control deficiencies.

44) You are performing an audit on North South Natural Gas (NSNG). Alana, an NSNG employee, has responsibility for reconciling bank statements with the entity’s cash accounts. You determine, however, that Alana has never been taught how to reconcile statements. In effect, the statements have not been properly reconciled for two years. How would you judge the significance of this control deficiency? How would you classify this deficiency?

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45) CBA Associates is auditing a large publicly traded company. The audit of internal controls over financial reporting has been properly planned and the auditors have already identified controls to test using a top-down, risk-based approach. What is the next step? Give three examples of procedures that may be completed in the next step in the audit.

46)

Identify indicators of a material weakness in internal control over financial reporting.

47) PCAOB Auditing Standards require that the auditor appropriately document the processes, procedures, judgments, and results relating to the audit of internal control.

Specifically, what must this documentation include?

48) On the audit of Technology Unlimited, a leading manufacturer of computer chips, the external audit staff discovers that the internal audit staff has performed extensive evaluation and testing on the control environment. What should the external auditors do to determine the extent to which they may use the work of the internal audit staff? Can the external audit staff rely on the internal audit staff for evaluating and testing the control environment?

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49) Discuss the differences between a control deficiency, a significant deficiency, a material weakness, and the two dimensions of the control deficiency - likelihood and magnitude.

50)

Discuss entity-level controls and provide examples of these types of controls.

51)

All companies must follow the Sarbanes-Oxley Act requirements. ⊚ ⊚

52)

true false

Most public companies must follow Sarbanes-Oxley Act requirements. ⊚ ⊚

true false

53) In a public company, management must assess and report on internal control over financial reporting. ⊚ ⊚

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54) In a public company, management’s report on internal control must be signed by the members of the audit committee. ⊚ ⊚

true false

55) Based on PCAOB guidelines, the audit of ICFR and financial statements audit should be conducted as an “integrated audit.” ⊚ ⊚

true false

56) The PCAOB makes it clear that the CEO and CFO are responsible for the internal control over financial reporting and the preparation of the statements. ⊚ ⊚

57)

true false

The likelihood of an event is more than remote when it is “reasonably possible.” ⊚ ⊚

true false

58) When performing an integrated audit of a public company, the auditor must form an opinion on the effectiveness of internal control over financial reporting, or issue a disclaimer in the event of a scope limitation. ⊚ ⊚

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Answer Key Test name: ch 7 1) D 2) B 3) D 4) A 5) C 6) B 7) C 8) A 9) B 10) C 11) D 12) A 13) C 14) B 15) A 16) C 17) A 18) D 19) D 20) B 21) C 22) B 23) B 24) C 25) D 26) A Version 1

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27) D 28) D 29) C 30) D 31) D 32) C 33) B 34) B 35) C 36) C 37) A 38) C 39) B 40) B 41) D 42) A 51) FALSE 52) TRUE 53) TRUE 54) FALSE 55) TRUE 56) TRUE 57) TRUE 58) TRUE

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Student name:__________ 1)

Which of the following best illustrates the concept of sampling risk?

A) A randomly chosen sample may not be representative of the population as a whole (regarding the characteristic being tested).

B) An auditor may select audit procedures that are not appropriate to achieve the specific objective.

C) An auditor may fail to recognize errors in the documents examined for the chosen sample.

D) The documents related to the chosen sample may not be available for inspection.

2) Jones, CPA, believes the industry-wide deviation rate of client billing errors is 3% and has established a tolerable deviation rate of 5%. In the review of client invoices, Jones should use:

A) discovery sampling.

B) attributes sampling.

C) stratified sampling.

D) variables sampling.

3)

The tolerable deviation rate for a test of controls is generally:

A) lower than the expected rate of deviations in the related accounting records.

B) higher than the expected rate of deviations in the related accounting records.

C) identical to the expected rate of deviations in the related accounting records.

D) unrelated to the expected rate of deviations in the related accounting records.

4)

The risk of incorrect acceptance relates to the:

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A) effectiveness of the audit.

B) efficiency of the audit.

C) preliminary estimates of materiality levels.

D) tolerable misstatement.

5) The likelihood of assessing control risk too high is the risk that the sample selected to test controls:

A) does not support the auditor's planned assessed level of control risk when the true operating effectiveness of internal control justifies such an assessment.

B) contains misstatements that could be material to the financial statements when aggregated with misstatements in other account balances or transactions classes.

C) contains proportionately fewer deviations from prescribed internal controls than exist in the balance or class as a whole.

D) does not support the tolerable misstatement for some or all of management's assertions.

6) For which of the following audit tests would an auditor most likely use attributes sampling?

A) making an independent estimate of the amount of LIFO inventory B) examining invoices in support of the valuation of fixed asset additions C) selecting accounts receivable balances for confirmation D) inspecting purchase orders for proper approval

7) Harvey Jones, CPA, uses statistical sampling to test control procedures. What is a benefit of using statistical sampling?

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A) It provides a means of mathematically measuring the sampling risk that result from examining only a part of the data.

B) It eliminates the use of judgment required of Jones because the AICPA has established numerical criteria for this type of testing.

C) It increases Jones' knowledge of the entity's prescribed procedures and their limitations.

D) It is required by generally accepted auditing standards.

8) In addition to evaluating the frequency of deviations in tests of controls, an auditor should also consider certain qualitative aspects of the deviations. The auditor most likely would give broader consideration to the implications of a deviation if it was:

A) the only deviation discovered in the sample.

B) identical to a deviation discovered during the prior year's audit.

C) caused by an employee's oversight.

D) initially concealed by a forged document.

9)

An underlying feature of random-based selection of items is that each:

A) stratum of the accounting population be given equal representation in the sample.

B) item in the accounting population be randomly ordered.

C) item in the accounting population should have an opportunity to be selected.

D) item must be systematically selected using replacement.

10) An auditor plans to examine a sample of 20 checks for countersignatures as prescribed by the entity's internal control procedures. One of the checks in the chosen sample of 20 cannot be found. The auditor should consider the reasons for this limitation and:

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A) evaluate the results as if the sample size had been 19.

B) treat the missing check as a deviation for the purpose of evaluating the sample.

C) treat the missing check in the same manner as the majority of the other 19 checks (i.e., countersigned or not).

D) choose another check to replace the missing check in the sample.

11) An auditor is testing internal control procedures that are evidenced on an entity's vouchers. To select the vouchers for testing, the auditor obtains random numbers between the first and last voucher number in the period. If a random number matches the number of a voided voucher, that voucher ordinarily should be replaced by another voucher in the random sample if the voucher:

A) constitutes a deviation.

B) has been properly voided.

C) cannot be located.

D) represents an immaterial dollar amount.

12) Which of the following statements is correct concerning statistical sampling for tests of controls?

A) The population size has little or no effect on determining sample size except for very small populations.

B) The expected population deviation rate has little or no effect on determining sample size except for very small populations.

C) As the population size doubles, the sample size also should double.

D) For a given tolerable deviation rate, a larger sample size should be selected as the expected population deviation rate decreases.

13) In determining the sample size for a test of controls, an auditor should consider the expected population deviation rate, desired confidence level, and the:

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A) tolerable deviation rate.

B) risk of incorrect acceptance.

C) nature and cause of deviations.

D) population size.

14) In attributes sampling, a 10% change in which of the following factors normally will have the least effect on the size of a statistical sample?

A) population size B) tolerable deviation rate C) expected population deviation rate D) desired Confidence Interval

15)

The computed upper deviation rate is:

A) the maximum rate of deviations that the auditor is willing to accept before deciding not to rely on the control.

B) the rate of deviations that the auditor expects to occur in the population.

C) a point estimate of the population deviation rate.

D) the sum of the sample deviation rate and an appropriate allowance for sampling risk.

16) In attributes sampling, population size has little or no effect on sample size once the population exceeds approximately:

A) 1,000.

B) 5,000.

C) 100,000.

D) 1,000,000.

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17) A control is deemed to be more important than thought at the time that attributes sampling parameters were set. The auditor is most likely to respond by:

A) decreasing the risk of assessing control risk too high.

B) increasing population size.

C) decreasing the tolerable deviation rate.

D) decreasing the expected deviation rate.

18) If auditors conducting attributes sampling found that the entity deviated from a prescribed control in nine of the first 10 items examined, the auditor is most likely to:

A) increase sample size.

B) increase the computed upper deviation rate.

C) decrease the tolerable deviation rate.

D) stop the test and increase control risk.

19) In which of the following cases would the auditor determine that statistical sampling should not be performed?

A) Tolerable deviation is large and expected population deviation is low.

B) Tolerable deviation is small and expected population deviation is high.

C) Tolerable deviation is large and expected population deviation is high.

D) Tolerable deviation is small and expected population deviation is low.

20) Which of the following factors does an auditor generally need to consider in planning a particular audit sample for a test of controls?

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A) number of items in the population B) total dollar amount of the items to be sampled C) desired confidence level D) risk of assessing control risk too high

21) As a result of tests of controls, an auditor incorrectly assessed control risk too low and decreased substantive testing. This assessment occurred because the true deviation rate in the population was:

A) more than the risk of assessing control risk too low based on the auditor's sample.

B) more than the deviation rate in the auditor's sample.

C) less than the risk of assessing control risk too low based on the auditor's sample.

D) less than the deviation rate in the auditor's sample.

22) As a result of tests of controls, an auditor over relied on internal control and decreased substantive testing. This overreliance occurred because the true deviation rate in the population was:

A) less than the risk of assessing control risk too low on the auditor's sample.

B) less than the deviation rate in the auditor's sample.

C) more than the risk of assessing control risk too low on the auditor's sample.

D) more than the deviation rate in the auditor's sample.

23) If the expected deviation rate exceeds the tolerable deviation rate, the auditor is most likely to:

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A) have a large sample size.

B) set control risk at the maximum without sampling.

C) set control risk at the minimum without sampling.

D) pick a lower risk of assessing control risk too low to increase sample size.

24) For an attributes sampling plan, the tolerable deviation rate is 4.5%, the computed upper deviation rate is 7%, the sample deviation rate is 3%, and the desired confidence level is 95%.

What is the allowance for sampling risk included in the computed upper deviation rate?

A) 1.5% B) 3% C) 4% D) 5%

25) Based on a 5% risk of assessing control risk too low, how would an auditor interpret a computed upper deviation rate of 7%?

A) The auditor is willing to accept a deviation rate of 7% before deciding not to rely on the control.

B) There is a 5% chance that the deviation rate in the population is less than 7%.

C) There is a 5% chance that the deviation rate in the population exceeds 7%.

D) There is a 95% chance that the deviation rate in the population equals 7%.

26)

Which of the following best describes the distinguishing feature of statistical sampling?

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A) It requires the examination of a smaller number of supporting documents.

B) It permits the auditor to use the most efficient sample size and to quantify the sampling risk to reach a statistical conclusion about the population.

C) It reduces the problems associated with the auditor's judgment concerning materiality.

D) It is evaluated in terms of two parameters: statistical mean and random selection.

27)

Statistical sampling provides a technique for:

A) exactly defining materiality.

B) greatly reducing the amount of substantive testing.

C) eliminating the additional cost of designing and conducting the sampling application.

D) measuring the sufficiency of evidential matter.

28) Auditors who prefer statistical sampling to nonstatistical sampling may do so because statistical sampling helps the auditor:

A) measure the sufficiency of the evidential matter obtained.

B) eliminate the cost of training auditors in the proper use of sampling techniques.

C) reduce the level of tolerable misstatement to a relatively low amount.

D) minimize the failure to detect a material misstatement due to nonsampling risk.

29) An advantage of using statistical over nonstatistical sampling methods in tests of controls is that the statistical methods:

A) afford greater assurance than a nonstatistical sample of equal size.

B) provide an objective basis for quantitatively evaluating sample risks.

C) can more easily convert the sample into a dual-purpose test useful for substantive testing.

D) eliminate the need to use judgment in determining appropriate sample sizes.

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30) An auditor who uses statistical sampling for attributes in testing internal controls is most likely to reduce the planned reliance on a prescribed control when the:

A) sample deviation rate plus the allowance for sampling risk equals the tolerable deviation rate.

B) sample deviation rate is less than the expected population deviation rate used in planning the sample.

C) tolerable deviation rate less the allowance for sampling risk exceeds the sample deviation rate.

D) sample deviation rate plus the allowance for sampling risk exceeds the tolerable deviation rate.

31) If the size of the sample to be used in a particular test of controlshas not been determined by utilizing statistical concepts, but the samplehas been chosen in accordance with random selection procedures:

A) no inferences can be drawn from the sample.

B) the auditor has committed a nonsampling error.

C) depending on the size of the sample chosen, the auditor may actually achieve desired precision.

D) the auditor will have to evaluate the results by reference to the principles of discovery sampling.

32) For attributes sampling, of the three factors that enter into sample size determination, which two factors can the auditor adjust to reflect the importance of the control?

A) tolerable deviation rate and confidence level B) expected deviation rate and confidence level C) population size and tolerable deviation rate D) tolerable deviation rate and expected deviation rate

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33)

Which of the following combinations guarantees a larger sample size?

A) Decrease the desired confidence level and decrease the tolerable deviation rate.

B) Increase the desired confidence level and decrease the tolerable deviation rate.

C) Decrease the desired confidence level and increase the expected deviation rate.

D) Increase the tolerable deviation rate and increase the expected deviation rate.

34) For a large population of cash disbursement transactions, Smith, CPA is testing controls by using attribute sampling techniques. Anticipating an expected deviation rate of 3 percent, Smith found from a table that the required sample size is 400 with a tolerable deviation rate of 5 percent and a desired confidence level of 95 percent. If Smith anticipated an expected deviation rate of only 2 percent but wanted to maintain the same tolerable deviation rate and confidence level, the sample size would be closest to:

A) 200.

B) 400.

C) 533.

D) 800.

35) In nonstatistical sampling for tests of controls, increasing the desired confidence level results in a:

A) higher tolerable deviation rate.

B) lower expected deviation rate.

C) larger sample size.

D) smaller sample size.

36) To determine the sample size for a test of controls, an auditor should consider the tolerable deviation rate, the desired confidence level, and the: Version 1

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A) expected population deviation rate.

B) computed upper precision limit.

C) risk of assessing control risk too high.

D) risk of incorrect rejection.

37) Which of the following statements is correct concerning statistical sampling in tests of controls?

A) As the population size increases, the sample size should increase proportionately.

B) Deviations from specific internal control procedures at a given rate ordinarily result in misstatements at a lower rate.

C) There is an inverse relationship between the expected population deviation rate and the sample size.

D) In determining tolerable deviation rate, an auditor considers detection risk and the sample size.

38) For an attributes sampling plan, the tolerable deviation rate is 4%, the computed upper deviation rate is 7%, the sample deviation rate is 3%, and the risk of assessing control risk too low is 5%. Which of the following is true?

A) The auditor must increase control risk because the risk of assessing control risk too low is greater than the tolerable deviation rate.

B) The auditor is likely to increase control risk because the risk of assessing control risk too low is greater than the tolerable deviation rate.

C) The auditor must increase control risk because the computed upper deviation rate is greater than the tolerable deviation rate.

D) The auditor is likely to increase control risk because the computed upper deviation rate is greater than the tolerable deviation rate.

39)

Which of the following risks is related to effectiveness of testing?

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A) the risk of incorrect rejection B) inherent risk C) the risk of incorrect acceptance D) none of these

40)

Which of the following risks is related to efficiency of testing?

A) the risk of incorrect rejection B) inherent risk C) the risk of incorrect acceptance D) none of these

41)

The term precision relates to:

A) the difference between confidence level and estimated error.

B) the difference between confidence level and tolerable error.

C) the difference between expected and tolerable deviation rate.

D) the difference between expected and sample deviation rate.

42)

Audit sampling is commonly used for which type of audit evidence?

A) reperformance B) analytical procedures C) inquiry D) observation

43)

Audit sampling is not used for which type of audit evidence?

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A) inquiry B) inspection of tangible assets C) reperformance D) confirmation

44) Why must an auditor use sampling? What tradeoffs occur when an auditor uses sampling?

45) "Computer assisted audit techniques and audit data analytics have steadily reduced the number of situations in which audit sampling is necessary and, in the future, will probably eliminate the need for auditors to rely on sampling." Defend or refute the preceding statement.

46)

Define Type I and Type II errors.

47)

Define sampling risk and nonsampling risk.

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48) When determining the sample size of accounts receivable to test, what are three factors that are important for you to consider?

49) Your manager, Sally, believes that nonstatistical sampling is the best method to use on the audit of YaYa Corporation. You, however, believe that statistical sampling is by far the better method. In addition, you have a great deal of training in the proper use of sampling techniques.

Prepare an argument to convince Sally why statistical sampling should be used.

50) Indicate which of the following audit procedures, used as tests of controls, do not involve audit sampling.1.Observing and evaluating segregation of duties.

2.Testing of whether sales invoices are supported by authorized customer orders and shipping documents.

3.Reviewing entity's procedures for accounting for the numerical sequence of shipping documents.

4.Examining sales orders for proper credit approval.

5.Recomputing the information on copies of sales invoices.

6.Comparing the average days outstanding in accounts receivable with industry averages.

51) For a particular audit, the sample size for testing controls over the revenue cycle is relatively large. What can you infer about the desired confidence level, the tolerable deviation rate, and the expected population deviation rate?

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52) Before performing sampling procedures in an audit of controls, Sue set the tolerable deviation rate at 4.0%. After the procedures, she computes a computed upper deviation rate of 5.4%. What can Sue conclude about the entity's controls?

53) Your uncle Bob, a CPA, has recently started auditing and he wants your advice on some tests of sales transactions he is conducting. Bob selected a haphazard sample of 15 sales with a total book value of $75,000. In his sample, he found a total of $500 in net overstatement errors.

The total sales balance per book is $10,000,000. Overall materiality for the engagement is $300,000. Tolerable misstatement for sales is $70,000. If the sample results indicate that Bob's best estimate of total misstatement in sales is $35,000, can Bob safely conclude that no additional work is needed in this area? Include in your answer a clear discussion of how sample results are compared to tolerable misstatement.

54)

Identify the types of audit evidence that are tested using audit sampling techniques.

55) Determine the sample size for each of the control procedures shown in the following table (assuming a very large population) using the Table 8-5 and 8-6 above

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Control Procedure Parameters Risk of incorrect acceptance Tolerable deviation rate Expected population deviation rate Sample size

1 10% 5% 1.00%

2 10% 10% 0.50%

3 5% 4% 0.00%

4 5% 5% 1.25%

56) Using the risk of incorrect acceptance, tolerable deviation rate, sample size, and the number of deviations shown here, determine the sample deviation rate, computed upper deviation rate, and the auditor’s conclusion (i.e., testing results do or do not support operating effectiveness of the control) for each control procedure Use Table 8-8 and 8-9 above for reference.: Control Procedure Parameters Risk of incorrect acceptance Tolerable deviation date Sample size Number of deviations Sample deviation rate

1 10% 5% 80 0

2 10% 10% 45 2

3 5% 4% 75 1

4 5% 5% 125 2

Computed upper deviation rate Auditor's Conclusion

57)

Auditing standards permit both statistical and nonstatistical methods of audit sampling. ⊚ ⊚

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58)

A Type I error is the risk of incorrect acceptance. ⊚ ⊚

59)

A Type II error is the risk of incorrect acceptance. ⊚ ⊚

60)

true false

The larger the sample, the lower the confidence level and the lower the sampling risk. ⊚ ⊚

63)

true false

Confidence level and sampling risk are related to sample size. ⊚ ⊚

62)

true false

Confidence level is the complement of sampling risk. ⊚ ⊚

61)

true false

true false

Audit sampling is commonly used to gather confirmation audit evidence. ⊚ ⊚

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64)

Audit sampling is commonly used to gather audit evidence through analytical procedures. ⊚ ⊚

true false

65) Attribute sampling is used to estimate the proportion of a population that possesses a specified characteristic. ⊚ ⊚

true false

66) With a nonstatistical sampling application, the auditor relies on professional judgment rather than the laws of probability to reach a conclusion about the audit test. ⊚ ⊚

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Answer Key Test name: ch 8 1) A 2) B 3) B 4) A 5) A 6) D 7) A 8) D 9) C 10) B 11) B 12) A 13) A 14) A 15) D 16) A 17) C 18) D 19) B 20) C 21) B 22) D 23) B 24) C 25) C 26) B Version 1

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27) D 28) A 29) B 30) D 31) C 32) A 33) B 34) A 35) C 36) A 37) B 38) D 39) C 40) A 41) C 42) A 43) A 57) TRUE 58) FALSE 59) TRUE 60) TRUE 61) TRUE 62) FALSE 63) TRUE 64) FALSE 65) TRUE 66) TRUE

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Student name:__________ 1)

The risk of incorrect acceptance and the risk of overreliance (Type II Errors) relate to the: A) preliminary estimates of materiality levels.

B) allowable risk of tolerable error.

C) efficiency of the audit.

D) effectiveness of the audit.

2) While performing a substantive test of details during an audit, the auditor determined that the sample results supported the conclusion that the recorded account balance was materially misstated. It was, in fact, not materially misstated. Such a situation illustrates the risk of: A) incorrect rejection.

B) incorrect acceptance.

C) assessing control risk too high.

D) assessing control risk too low.

3) A number of factors influence the sample size for a substantive test of details of an account balance. All other factors being equal, which of the following would lead to a larger sample size?

A) greater reliance on internal controls B) greater reliance on analytical procedures C) smaller expected frequency of misstatements D) smaller measure of tolerable misstatements

4) Which of the following sample planning factors would influence the sample size for a substantive test of details for a specific account?

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A) expected amount of misstatement but not the measure of tolerable misstatement B) expected amount of misstatement and the measure of tolerable misstatement C) measure of tolerable misstatement but not the expected amount of misstatement D) neither the expected amount of misstatement nor the measure of tolerable misstatement

5) In statistical or nonstatistical sampling methods used in substantive testing, an auditor most likely would stratify a population into meaningful groups if: A) monetary-unit sampling (MUS) is used.

B) classical variables sampling is used in order to focus on large items.

C) the auditor's estimated tolerable misstatement is extremely small.

D) the standard deviation of recorded amounts is relatively small.

6) An auditor is preparing to sample an entity's customer receivables for overstatement. A statistical sampling method that automatically provides stratification when using systematic selection is: A) attribute sampling.

B) ratio-estimation sampling.

C) monetary-unit sampling.

D) mean-per-unit sampling.

7) Which of the following statements best describes an inherent limitation of the monetaryunit sampling method?

A) It can only be used for substantive testing of asset accounts.

B) It requires the use of a computer system to perform the required calculations.

C) Misstatement rates must be large and the misstatements must be overstatements.

D) Misstatement rates must be small and the misstatements must be overstatements.

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8)

For monetary-unit sampling, the number of items tested is: A) always equal to sample size.

B) always greater than sample size.

C) always greater than or equal to sample size.

D) always less than or equal to sample size.

9)

Monetary-unit sampling should not be used if: A) the population includes several large items.

B) the auditor expects overstatement errors.

C) many items in the account are expected to have errors.

D) no items in the account are expected to have errors.

10)

In monetary-unit sampling, population size is: A) the dollar balance in an account.

B) the number of items in an account.

C) unrelated to sample size.

D) included in the denominator of the formula to determine sample size.

11)

Monetary-unit sampling is said to eliminate the need to stratify the sample because: A) sampled items are selected in proportion to their dollar amount.

B) the risk of incorrect acceptance is inversely related to sample size.

C) tolerable misstatement is considered when determining sample size.

D) the upper limit on misstatements can be computed based on statistical principles.

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12) An accounts receivable account balance is $500,000 and the auditor determines a sample size of 30 would provide adequate assurance. The auditor plans to use a monetary-unit sampling plan with systematic sample selection. The auditor notices that there are six customer accounts of at least $15,000 and would like the systematic selection technique to select all items that are at least $15,000, even if that means the sample size is slightly larger than 30. To achieve the auditor's objectives, the sampling interval should be: A) 6.

B) 20.

C) 16,666.

D) 15,000.

13)

For monetary-unit sampling, a sampling interval of 400 means that: A) every 400th customer account will be selected in the sample.

B) the average size of items in the account is 400.

C) every 400th dollar in the account will be included in the sample.

D) the average misstatement in sample items is $400.

14) Which of the following sampling methods would be used to estimate a numerical measurement of population, such as the dollar value of an account?

A) attributes sampling B) stop-or-go sampling C) classical variables sampling D) random-number sampling

15)

In applying classical variables sampling, an auditor attempts to:

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A) estimate a qualitative characteristic of interest.

B) determine various rates of occurrence for specified attributes.

C) discover at least one instance of a critical deviation.

D) predict a monetary population value within a range of precision.

16) In a monetary-unit sample with a sampling interval of $5,000, an auditor discovers that a selected account receivable with a recorded amount of $10,000 has an audit amount of $8,000. If this were the only error discovered by the auditor, the projected misstatement for this sample would be: A) $5,000.

B) $4,000.

C) $2,000.

D) $1,000.

17) Using nonstatistical sampling, which of the following courses of action would an auditor most likely follow in planning a sample of cash disbursements if the auditor is aware of several unusually large cash disbursements?

A) Set the tolerable deviation rate at a lower level than originally planned.

B) Identify the large and unusual disbursements as individually significant and test 100 percent.

C) Increase the sample size to reduce the effect of the unusually large disbursements.

D) Continue to draw new samples until all the unusually large disbursements appear in the sample.

18) What is the primary objective of testing all individually significant items rather than sample testing?

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A) to increase the audit risk at which a decision will be reached from the results of the sample selected B) to increase sample size C) to accept no sampling risk for items greater than tolerable misstatement D) to increase the size of the confidence bound around the projected misstatement

19) Which of the following would be an improper technique when using monetary-unit statistical sampling in an audit of accounts receivable?

A) combining negative and positive dollar misstatements in the appraisal of a sample B) using a sampling technique in which the same account balance could be selected more than once C) selecting a random starting point and then sampling every nth dollar D) defining the sampling unit in the population as an individual dollar and not as an individual account balance

20) In a monetary-unit sampling plan, the upper misstatement limit is $11,200 and the risk of incorrect acceptance is 5%. This means that: A) tolerable misstatement is $11,200.

B) there is a 95% chance that the actual misstatement in the account is $11,200 or more.

C) there is a 95% chance that the actual misstatement in the account is $11,200.

D) there is a 95% chance that the actual misstatement in the account is $11,200 or less.

21) If the upper limit on misstatements exceeds tolerable misstatement, the auditor is least likely to: A) increase sample size.

B) conduct other substantive procedures.

C) adjust the account balance.

D) increase the risk of incorrect rejection.

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22) Which of the following most likely would be an advantage in using classical variables sampling rather than monetary-unit sampling?

A) An estimate of the standard deviation of the population's recorded amounts is not required.

B) The auditor rarely needs the assistance of a computer program to design an efficient sample.

C) Inclusion of zero and negative balances generally does not require special design considerations.

D) Any amount that is individually significant is automatically identified and selected.

23)

The confidence factor for nonstatistical sampling is based on: A) the number of items in the account.

B) auditor judgment.

C) the risk of misstatement in the account and the level of desired confidence.

D) variability in the population and the risk of misstatement in the account.

24)

The formula for nonstatistical sampling sample sizes provided by the AICPA: A) must be used for nonstatistical sampling.

B) includes a provision for the risk of incorrect acceptance.

C) includes a measure for the expected misstatement in the population.

D) is largely based on the variation of items in the account.

25)

The use of the ratio projection is most effective when:

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A) the dollar amount of the misstatement is expected to relate to the dollar amount of items tested.

B) a small number of differences exist in the population.

C) estimating populations whose records consist of quantities but not book values.

D) large understatement differences exist in the population.

26) Which one of the following statements is true regarding two random samples, drawn in the same way, from the same population, one of size 30 and one of size 300?

A) The two samples are expected to have the same sample mean.

B) The larger sample is more likely to produce a large sample mean.

C) The smaller sample will have a smaller 95% confidence interval for the mean.

D) The smaller sample will, on average, produce a lower estimate of the variance of the population.

27) The accounting department reports that the balance of accounts receivable is $210,000.

You are willing to accept that balance if audit sampling suggests it is within $15,000 of the actual balance. Using a classical variables sampling plan, you compute a 95% confidence interval of $208,000 to $225,000. You would therefore: A) not be able to determine the acceptability of the receivable balance.

B) accept the balance but with a lower level of confidence.

C) take a larger sample before totally rejecting the balance and requiring adjustments.

D) accept the $210,000 balance because the confidence interval is within the materiality limits.

28) In a monetary-unit sample with a sampling interval of $10,000, an auditor discovered that a selected account receivable with a recorded amount of $5,000 had an audit amount of $2,000.

The projected misstatement of this sample was:

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A) $3,000.

B) $4,000.

C) $6,000.

D) $8,000.

29) An auditor established a $60,000 tolerable misstatement for an account balance of $1,000,000. The auditor selected a sample of every twentieth item from the population of 1,000 items that represented the asset account balance and discovered overstatements of $3,700 and understatements of $200. Under these circumstances, the auditor most likely would conclude that: A) there is an unacceptably high risk that the actual misstatements in the population exceed the tolerable misstatement because the total projected misstatement is more than the tolerable misstatement.

B) there is an unacceptably high risk that the tolerable misstatement exceeds the sum of actual overstatements and understatements.

C) the asset account is fairly stated because the total projected misstatement is less than the tolerable misstatement.

D) the asset account is fairly stated because the tolerable misstatement exceeds the net of projected actual overstatements and understatements.

30) An auditor is performing substantive procedures of pricing and extension of perpetual inventory balances consisting of a large number of items. Past experience indicates numerous pricing and extension errors. Which of the following approaches is most appropriate?

A) unstratified mean-per-unit B) monetary-unit sampling C) stop or go D) difference projection

31) Summarize the concept behind monetary-unit sampling (MUS). How does MUS use attribute-sampling theory?

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32)

Describe two advantages and two disadvantages of monetary-unit sampling (MUS).

33) You have been placed in charge of determining the sample size for an audit of accounts receivable. Your superior would like a confidence level of 99%. How does this affect your determination of sample size? What can you infer about the level of risk of incorrect acceptance that your superior is willing to accept?

34) Match each factor of sample size to (1) its relationship to sample size (A-Direct or BInverse) and (2) the appropriate effect on the sample size if the factor increases (C-Increase or DDecrease).

1.Tolerable misstatement 2.Population size 3.Desired confidence level 4.Expected misstatement

35) Whenever a statistical method is used, a decision rule determines whether the population is acceptable. The decision rule for monetary-unit sampling is "Accept the conclusion that the book value is not misstated by a material amount if _____________."

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36) In nonstatistical sampling, describe the two methods auditors use to project sample results to the population. How does an auditor determine which method to use?

37) You are auditing accounts receivable for a small company and have found the following results: Number and Size of Client Accounts 1,202 accounts < $1,000 532 accounts > $1,000

Book Value of Book Value of Audit Value Stratum Sample of Sample $ 948,378 $ 59,175 $ 51,256 $ 777,504 $ 36,400 $ 34,400

Use ratio projection to project your results.

38)

What is one advantage and one disadvantage of classical variables sampling?

39) When auditing accounts payable using classical variables sampling, Sue finds evidence indicating that the account may be materially misstated. What are Sue's options?

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40) The purpose of audit sampling is to draw inferences about the entire population from the results of a sample. ⊚ true ⊚ false

41) The size of the upper limit on misstatement is largely dependent on the sample size, which is inversely related to the desired confidence level. ⊚ true ⊚ false

42)

Monetary-unit sampling is based on attribute sampling concepts. ⊚ true ⊚ false

43)

Confidence level is inversely related to sample size. ⊚ true ⊚ false

44)

Expected misstatement is directly related to sample size. ⊚ true ⊚ false

45)

Monetary-unit sampling is commonly used by auditors to test controls. ⊚ true ⊚ false

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46) The objective of monetary-unit sampling is to test the assertion that no material misstatements exist in an account balance or class of transactions. ⊚ true ⊚ false

47)

Haphazard selection allows the auditor to select items with bias. ⊚ true ⊚ false

48) After a sample is drawn randomly, the allowance for sampling risk must be statistically quantified within a specified level of confidence when using nonstatistical sampling techniques. ⊚ true ⊚ false

49) Classical variables sampling uses normal distribution theory to evaluate the characteristics of a population based on sample data. ⊚ true ⊚ false

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Answer Key Test name: ch 9 1) D 2) A 3) D 4) B 5) B 6) C 7) D 8) D 9) C 10) A 11) A 12) D 13) C 14) C 15) D 16) C 17) B 18) C 19) A 20) D 21) D 22) C 23) C 24) C 25) A 26) A Version 1

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27) D 28) C 29) A 30) D 40) TRUE 41) FALSE 42) TRUE 43) FALSE 44) TRUE 45) FALSE 46) TRUE 47) FALSE 48) FALSE 49) TRUE

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Student name:__________ 1)

In general, revenue is recognized when: A) goods are shipped.

B) an entity satisfies a performance obligation.

C) it is recorded in the sales journal.

D) it is received in cash.

2) According to FASB ASC 606, which of the following is not part of the five-step approach for revenue recognition?

A) identify the contract(s) with a customer B) determine the transaction price C) determine whether the buyer will take a discount D) identify the performance obligations in the contract

3)

What is channel stuffing?

A) A company records revenue before delivery terms can be arranged.

B) A company records revenue on goods that will be shipped overseas.

C) A company induces distributors to buy substantially more inventory than they can promptly resell.

D) A company alters the terms and conditions of recorded sales to entice customers to accept delivery of goods.

4) At which point in an ordinary sales transaction of a wholesaling business would a lack of specific authorization be of least concern to the auditor?

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A) granting of credit B) shipment of goods C) determination of discounts D) selling of goods for cash

5)

Tracing copies of sales invoices to shipping documents will provide evidence that all: A) shipments to customers were recorded as receivables.

B) billed sales were shipped.

C) accounts receivable ledger is complete.

D) shipments to customers were billed.

6) An auditor tests an entity's policy of obtaining credit approval before shipping goods to customers in support of management's assertion about account balances’: A) accuracy, valuation and allocation.

B) completeness.

C) existence or occurrence.

D) rights and obligations.

7) Which of the following tests of controls most likely would help assure an auditor that goods shipped are properly billed?

A) scan the sales journal for sequential and unusual entries B) examine shipping documents for matching sales invoices C) compare the accounts receivable ledger to daily sales summaries D) inspect unused sales invoices for consecutive prenumbering

8)

Tracing shipping documents to prenumbered sales invoices provides evidence that:

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A) no duplicate shipments or billings occurred.

B) shipments to customers were properly billed.

C) all goods ordered by customers were shipped.

D) all prenumbered sales invoices were accounted for.

9) Tests designed to detect credit sales made after the end of the year that have been recorded in the current year provide assurance about management's assertion of: A) classification.

B) cutoff.

C) occurrence.

D) accuracy.

10)

Which of the following is not an inherent risk factor for the revenue process?

A) complexity of revenue recognition issues B) difficulty of auditing transactions C) special industry practices D) the entity does not follow its stated policies for sales order approvals

11) Data Corporation has just computerized its billing and accounts receivable record keeping. You want to make maximum use of computer-assisted audit techniques in your audit of Data Corporation. Which of the following audit techniques could not be performed through a computer program?

A) tracing audited cash receipts to accounts receivable credits B) selecting accounts to be confirmed on a random basis C) examining sales invoices for completeness, consistency between different items, valid conditions, and reasonable amounts D) resolving differences reported by customers on confirmation requests

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12) In auditing accounts receivable, the negative form of confirmation request most likely would be used when: A) recipients are likely to return positive confirmation requests without verifying the accuracy of the information.

B) the combined assessed level of inherent and control risk relative to accounts receivable is low.

C) a small number of accounts receivable are involved but a relatively large number of errors are expected.

D) the auditor performs a dual purpose test that assesses control risk and obtains substantive evidence.

13) Auditors may use positive and/or negative forms of confirmation requests for accounts receivable. Which of the following statements is true regarding the auditor's use of confirmations?

A) The positive confirmation form must always be used to confirm all balances regardless of size.

B) A combination of the two confirmation types can be used, with the positive form used for large balances and the negative form used for small balances.

C) A combination of the two confirmation types can be used, with the positive form used for trade receivables and the negative form for other receivables.

D) The positive confirmation form should be used when controls related to receivables are satisfactory and the negative confirmation form should be used when controls related to receivables are unsatisfactory.

14) In determining the adequacy of the allowance for uncollectible accounts, the least reliance should be placed upon which of the following?

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A) the credit manager's opinion B) an aging schedule of past due accounts C) subsequent year collections of amounts in accounts receivable at the balance sheet date D) ratios calculated showing the past relationship of the valuation allowance to net credit sales

15) Audit documents often include an aged trial balance of accounts receivable as of the balance sheet date. This aging is used by the auditor to: A) evaluate internal control over credit sales.

B) test the accuracy of recorded credit sales.

C) evaluate the allowance for doubtful accounts.

D) verify the existence of the recorded receivables.

16) Which of the following is the best argument against the use of negative accounts receivable confirmations?

A) the cost-per-response is excessively high B) there is no way of knowing if the intended recipients received them C) recipients are likely to feel that, in reality, the confirmation is a subtle request for payment D) the inference drawn from receiving no reply may not be correct

17) An auditor's purpose in reviewing credit ratings of customers with delinquent accounts receivable most likely is to obtain evidence concerning management's assertions about: A) accuracy, valuation and allocation.

B) completeness.

C) existence.

D) rights and obligations.

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18) Which of the following controls most likely would be effective in offsetting the tendency of sales personnel to maximize sales volume at the expense of high bad debt write-offs?

A) Employees responsible for authorizing sales and bad debt write-offs are denied access to cash.

B) Shipping documents and sales invoices are matched by an employee who does not have authority to write-off bad debts.

C) Employees involved in the credit-granting function are separated from the sales function.

D) Subsidiary accounts receivable records are reconciled to the control account by an employee independent of the authorization of credit.

19) Alpha Company uses its sales invoices to record revenue and update perpetual inventory records. Inadequate control activities over the invoicing function allow goods to be shipped that are not invoiced. The inadequate control activities could cause an: A) understatement of revenues, receivables, and inventory.

B) overstatement of revenues and receivables and an understatement of inventory.

C) understatement of revenues and receivables and an overstatement of inventory.

D) overstatement of revenues, receivables, and inventory.

20) Alpha Company uses its sales invoices to record revenue and update perpetual inventory records. Inadequate control activities over the invoicing function allow goods to be invoiced that are not shipped. The inadequate control activities could cause an: A) understatement of revenues, receivables, and inventory.

B) overstatement of revenues and receivables and an understatement of inventory.

C) understatement of revenues and receivables and an overstatement of inventory.

D) overstatement of revenues, receivables, and inventory.

21)

Immediately upon receipt of cash, a responsible employee should:

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A) record the amount in the cash receipts journal.

B) prepare a control listing.

C) update the subsidiary accounts receivable records.

D) prepare a deposit slip in triplicate.

22) Which one of the following would the auditor consider to be an incompatible operation if the cashier receives remittances from the mailroom?

A) The cashier prepares the daily deposit.

B) The cashier makes the daily deposit at a local bank.

C) The cashier posts the receipts to the accounts receivable subsidiary ledger cards.

D) The cashier endorses the checks.

23)

Which is not a key segregation of duties for the revenue process?

A) Different parties should prepare shipping orders and prepare bills of lading.

B) Different parties should perform the credit and billing functions.

C) Different parties should perform the shipping and billing functions.

D) Different parties should receive cash and adjust accounts receivable.

24)

All of the following are important controls over credit memos except:

A) proper segregation of duties to ensure that sales discounts taken were earned.

B) credit memos should be approved by someone other than whoever initiated it.

C) credit memos should be supported by a receiving document for returned goods.

D) proper segregation of duties between access to customer records and authorizing credit memos.

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25) Auditors are more concerned with the occurrence assertion for revenues than the completeness assertion because: A) entities are more likely to overstate than understate revenues.

B) entities are more likely to understate than overstate revenues.

C) it is difficult to determine when services have been performed.

D) the allowance for doubtful accounts often is understated.

26) An auditor selects a sample from the file of shipping documents to determine whether invoices were prepared. This test is performed to assess the assertion of: A) authorization and accuracy.

B) completeness.

C) cutoff.

D) occurrence.

27) Which of the following control activities may prevent the failure to bill customers for some shipments?

A) Each shipment should be supported by a prenumbered sales invoice that is accounted for.

B) Each sales order should be approved by authorized personnel.

C) Sales journal entries should be reconciled to daily sales summaries.

D) Each sales invoice should be supported by a shipping document.

28) Which of the following internal control activities most likely would ensure that all billed sales are correctly posted to the accounts receivable ledger?

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A) Daily sales summaries are compared to daily postings to the accounts receivable ledger.

B) Each sales invoice is supported by a prenumbered shipping document.

C) The accounts receivable ledger is reconciled daily to the control account in the general ledger.

D) Each shipment on credit is supported by a prenumbered sales invoice.

29) A CPA auditing an electric utility wishes to determine whether all customers are being billed. The CPA's best direction of test is from the: A) meter department records to the billing (sales) register.

B) billing (sales) register to the meter department records.

C) accounts receivable ledger to the billing (sales) register.

D) billing (sales) register to the accounts receivable ledger.

30) To determine whether the system of internal control operated effectively to minimize errors of failure to invoice a shipment, the auditor would select a sample of transactions from the population represented by the: A) customer order file.

B) bills of lading file.

C) open invoice file.

D) sales invoice file.

31) Which of the following procedures would ordinarily be expected to best reveal improper cutoff of sales at the balance sheet date?

A) compare shipping documents with sales records B) apply gross profit rates to inventory disposed of during the period C) trace payments received subsequent to the balance sheet date D) send accounts receivable confirmation requests

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32) If the objective of a test of details is to detect the overstatement of sales, the auditor should: A) vouch transactions from the cash receipts journal to the sales journal.

B) trace transactions from the sales journal to the cash receipts journal.

C) trace transactions from the shipping documents to the accounting records.

D) vouch transactions from the accounting records to the shipping documents.

33) Which of the following misstatements is not related to the completeness assertion for current year revenue?

A) Goods are shipped, but revenue is not recorded.

B) This year's revenue is recorded next year.

C) Next year's revenue is recorded this year.

D) Revenue is not recognized for services that have been performed.

34) Which of the following is a test of controls for the transaction assertion of completeness for revenue?

A) Test a sample of sales invoices for authorized customer orders.

B) Review sales orders for proper credit approval.

C) Trace shipping documents to sales invoices and the sales journal.

D) Examine reconciliation of subsidiary ledger to general ledger control account.

35) To achieve good internal control, which department should perform the activities of matching shipping documents with sales orders?

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A) billing B) shipping C) credit D) sales Order

36) An auditor confirms a representative number of open accounts receivable as of December 31 and investigates respondents' exceptions and comments. By this procedure, the auditor would be most likely to learn about which of the following?

A) One of the cashiers has been covering a personal embezzlement by lapping.

B) One of the sales clerks has not been preparing charge slips for credit sales to family and friends.

C) One of the EDP control clerks has been removing all sales invoices applicable to his account from the data file.

D) The credit manager has misappropriated remittances from customers whose accounts have been written-off.

37) An auditor most likely would limit substantive tests of sales transactions when control risk is assessed as low for the existence or occurrence assertions concerning sales transactions and the auditor has already gathered evidence supporting: A) opening and closing inventory balances.

B) cash receipts and accounts receivable.

C) receiving activities.

D) cutoffs of sales and purchases.

38) Cooper, CPA is auditing the financial statements of a small rural municipality. The receivable balances represent residents' delinquent real estate taxes. Internal control at the municipality is weak. To determine the existence of the accounts receivable balances at the balance sheet date, Cooper would most likely:

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A) send positive confirmation requests.

B) send negative confirmation requests.

C) examine evidence of subsequent cash receipts.

D) inspect the internal records, such as copies of the tax invoices that were mailed to the residents.

39) Auditors sometimes use ratios as audit evidence. For example, an unexplained increase in the ratio of gross profit to sales may suggest which of the following possibilities?

A) fictitious purchases B) fictitious sales C) selling and general expenses erroneously being recorded as merchandise purchases D) unrecorded sales

40) Which of the following might be detected by an auditor's review of the entity's sales cutoff?

A) excessive goods returned for credit B) unrecorded sales discounts C) lapping of year-end accounts receivable D) overstated sales for the year

41) An auditor reconciles the total of the accounts receivable subsidiary ledger to the general ledger control account as of October 31. By this procedure, the auditor would be most likely to learn about which of the following?

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A) An October invoice was improperly computed.

B) An October check from a customer was posted in error to the account of another customer with a similar name.

C) An opening balance in a subsidiary ledger account was improperly carried forward from the previous accounting period.

D) An account balance is past due and should be written-off.

42) Once an auditor has determined that the accounts receivable account balance has increased because of slow collection in a “tight money” environment, the auditor would be likely to: A) increase the balance in the allowance for bad debts account.

B) review the going concern ramifications.

C) require the entity to tighten its credit policy.

D) expand tests regarding the collectability of receivables.

43)

Which of the following is not an issue related to the valuation of accounts receivable?

A) the credit granting function B) a proper allowance for doubtful accounts C) the net realizable value of accounts receivable D) proper cutoff

44)

In the confirmation of accounts receivable, the auditor would most likely:

A) send negative confirmations when the assessed risk of material misstatement is high.

B) seek to obtain positive confirmations for at least 50% of the total dollar amount of the receivables.

C) require confirmation of all receivables from agencies of the federal government.

D) require that confirmation requests be sent as soon as possible after fiscal year-end.

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45) Confirmation is least likely to be a relevant form of evidence with regard to assertions about accounts receivable when the auditor has concerns about the receivables': A) valuation.

B) classification.

C) existence.

D) completeness.

46) In which of the following circumstances would the use of the negative form of accounts receivable confirmation most likely be justified?

A) A substantial number of accounts may be in dispute and the accounts receivable balance arises from sales to a few major customers.

B) A substantial number of accounts may be in dispute and the accounts receivable balance arises from sales to many customers with small balances.

C) A small number of accounts may be in dispute and the accounts receivable balance arises from sales to a few major customers.

D) A small number of accounts may be in dispute and the accounts receivable balance arises from sales to many customers with small balances.

47) To reduce the risks associated with accepting electronic responses to requests for confirmation of accounts receivable, an auditor most likely would: A) validate the sender of electronic information.

B) examine subsequent cash receipts for the accounts in question.

C) consider the electronic responses to the confirmations to be exceptions.

D) mail second requests to the electronic respondents.

48) The confirmation of customers' accounts receivable rarely provides reliable evidence about the completeness assertion because:

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A) many customers merely sign and return the confirmation without verifying its details.

B) recipients usually respond only if they disagree with the information on the request.

C) customers may not be inclined to report understatement errors in their accounts.

D) auditors typically select many accounts with low recorded balances to be confirmed.

49) Which of the following most likely would be the result of ineffective internal control policies and procedures in the revenue process?

A) Final authorization of credit memos by personnel in the Sales Department could permit an employee defalcation scheme.

B) Fictitious transactions could be recorded, causing an understatement of revenues and an overstatement of receivables.

C) Irregularities in recording transactions in the subsidiary accounts could result in a delay in goods shipped.

D) Omission of shipping documents could go undetected, causing an understatement of inventory.

50) Upon receipt of customers' checks in the mailroom, a responsible employee should prepare a control listing. A copy of the listing should be sent to the: A) internal auditor to investigate the listing for unusual transactions.

B) treasurer to compare the listing with the monthly bank statement.

C) accounts receivable bookkeeper to update the subsidiary accounts receivable records.

D) entity's bank to compare the listing with the deposit slip.

51) During a review of a small business entity's internal control system, the auditor discovered that the accounts receivable clerk approves credit memos and has access to cash.

Which of the following controls would be most effective in offsetting this weakness?

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A) The owner reviews errors in billings to customers and postings to the subsidiary ledger.

B) A controller receives the monthly bank statement directly and reconciles the checking accounts.

C) The owner reviews credit memos before they are recorded.

D) The controller reconciles the total of the detailed accounts receivable accounts to the amount shown in the ledger.

52) Which of the following procedures most likely would not be an internal control activity designed to reduce the risk of errors in the billing process?

A) comparing control totals for shipping documents with corresponding totals for sales invoices B) using computer programmed controls on the pricing and mathematical accuracy of sales invoices C) matching shipping documents with approved sales orders before invoice preparation D) reconciling the control totals for sales invoices with the accounts receivable subsidiary ledger

53) Smith is engaged in the audit of a cable TV firm that services a rural community. All receivable balances are small, customers are billed monthly, and internal control is effective. To determine the existence of the accounts receivable balances at the balance sheet date, Smith would most likely: A) send positive confirmation requests.

B) send negative confirmation requests.

C) examine evidence of subsequent cash receipts instead of sending confirmation requests.

D) use statistical sampling instead of sending confirmation requests.

54) Which of the following most likely would give the most assurance concerning the valuation assertion for accounts receivable?

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A) tracing amounts in the subsidiary ledger to details on shipping documents B) comparing receivable turnover ratios to industry statistics for reasonableness C) inquiring about receivables pledged under loan agreements D) assessing the allowance for uncollectible accounts for reasonableness

55) An auditor is reviewing sales cutoff as of March 31, 20X9. All sales are shipped FOB destination and the company records sales three days after shipment (i.e., shipments on the 3rd of the month are recorded on the 6th of the month). The auditor notes the following transactions: Date Shipped

Month Recorded

March 28 March 29 March 30 April 2 April 5

March March April March April

Selling Price (OOO's) $ 200 44 81 220 92

Cost (OOO's)

$ 192 40 77 208 84

If the entity records the required adjustments, the net effect on income (in thousands of dollars) for the period ended March 31, 20X9 is A) an increase of 12.

B) an increase of 16.

C) a decrease of 12.

D) a decrease of 16.

56) Customers having substantial year-end past due balances fail to reply after second request confirmation forms have been mailed directly to them. Which of the following is the most appropriate audit procedure?

A) examine shipping documents B) review collections during the year being examined C) intensify the study of the entity's system of internal control with respect to receivables D) increase the balance in the allowance for uncollectible accounts

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57) Which of the following strategies most likely could improve the accuracy of the confirmation of accounts receivable?

A) including a monthly statement of the customer's account with the confirmation B) restricting the selection of accounts to be confirmed to those customers with relatively large balances C) requesting customers to respond to the confirmation requests directly to the auditor by fax or e-mail D) notifying the recipients that second requests will be mailed if they fail to respond in a timely manner

58) In confirming accounts receivable, an auditor decided to confirm customers' account balances rather than individual invoices. Which of the following most likely would be included with the confirmation letter?

A) An auditor-prepared letter explaining that a nonresponse may cause an inference that the account balance is correct.

B) A client-prepared letter reminding the customer that a nonresponse will cause a second request to be sent.

C) An auditor-prepared letter requesting the customer to supply missing and incorrect information directly to the auditor.

D) A client-prepared statement of account showing the details of the customer's account balance.

59) When comparing prices and terms on a sample of sales invoices with the authorized price list and terms of trade, the auditor is testing the _____________ assertion.

A) cutoff B) authorization and accuracy C) occurrence D) completeness

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60) When a sample of sales transactions recorded in the sales journal is vouched to the customer orders and shipping documents, the auditor is testing the _____________ assertion.

A) cutoff B) authorization and accuracy C) completeness D) occurrence

61) When tracing a sample of shipping documents from throughout the year to the details of the sales invoices and to the sales journal and customers' accounts receivable subsidiary ledger, the auditor is testing the _____________ assertion.

A) classification B) cutoff C) existence D) completeness

62) When reviewing bank confirmations for any liens on receivables, the auditor is testing the _____________ assertion.

A) valuation and allocation B) rights and obligations C) existence D) completeness

63) Explain why auditors’ knowledge of the accounting for revenue is important to the audit of the revenue process.

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64) Listed below are several assertions about classes of transactions and events made in the revenue process. For each, give an example of how an auditor could use one of the types of documents contained in the revenue process to test the assertion. ● Occurrence ● Completeness ● Cutoff ● Classification

65) The XYZ Company billing department has decided to assign one employee to each of its customers. This employee will be responsible for granting credit to the entity and then handling the billing. XYZ believes this will result in better customer service, because the entity will only have to deal with one person and that one person will be very familiar with the credit terms. As an auditor, would you agree with XYZ's decision?

66) What inherent risk factors should an auditor consider when auditing the revenue process of a computer manufacturer?

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67) Assume an account receivable confirmation is returned with a note to the auditor describing a difference between your client's records and the customer's records. Clearly describe below two potential non-misstatement timing differences that could cause a discrepancy between a client's receivable records and his/her customer's records. The timing differences you describe should be such that after investigation you would determine that your client's receivable balance is not misstated due to these differences.

68) Identify whether the following tests are tests of controls, substantive analytical procedures, tests of details of transactions, or tests of details of account balances.

1.Select a sample of customer receivables and send positive confirmations to each customer.

2.Examine monthly bank reconciliations for the internal auditors' initials indicating internal verification and review of the reconciliation.

3.Select a sample of entries in the sales journal and trace each to the shipping documents.

4.Compute receivable turnover and compare with previous years.

5.For a sample of new customers, determine whether credit approval was properly administered and documented.

6.Compare the dates on a sample of sales invoices with the dates of shipment and the dates the transactions were recorded in the sales journal.

69)

Describe the two types of confirmations and indicate which one is more reliable and why.

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70) Assume you are working on a 12/31 year-end audit. It is now March 31st and the 12/31 accounts receivable aging shows a large receivable that was outstanding on 12/31 for 120 days.

Further, the entity's receivables are typically collected in less than 45 days. You anticipate that the entity's allowance for doubtful account should be increased and inform the entity about your position. Management disagrees. Is there an alternative substantive procedure that you could perform that would provide convincing evidence that this balance is collectible? If so, explain.

71) According to the Association of Certified Fraud Examiners, there are eight common methods for committing financial statement fraud. List 4 of the 8 methods.

72) Identify four of the seven primary functions in the revenue cycle and describe each function.

73) Revenue is realized when a product or service is exchanged for inflows or other enhancement of assets. ⊚ true ⊚ false

74) Accounting standards require entities to follow a five-step approach for recognizing revenue. ⊚ true ⊚ false

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75) Channel stuffing is an improper practice used to boost sales by inducing distributors to buy more inventory than they can promptly resell. ⊚ true ⊚ false

76)

The return of vendor purchases is a part of the revenue process. ⊚ true ⊚ false

77)

The revenue process affects numerous accounts in the financial statements. ⊚ true ⊚ false

78)

A remittance advice is used to track purchases. ⊚ true ⊚ false

79)

Order entry is the initial function in the revenue cycle. ⊚ true ⊚ false

80)

Credit authorization is used to determine if a customer is able to pay for goods. ⊚ true ⊚ false

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81) A negative confirmation requests that customers respond whether they agree or not with the amount due to the entity stated in the confirmation. ⊚ true ⊚ false

82) A positive confirmation requests that customers respond whether they agree or not with the amount due to the entity stated in the confirmation. ⊚ true ⊚ false

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Answer Key Test name: ch 10 1) B 2) C 3) C 4) D 5) B 6) A 7) B 8) B 9) B 10) D 11) D 12) B 13) B 14) A 15) C 16) D 17) A 18) C 19) C 20) B 21) B 22) C 23) A 24) A 25) A 26) B Version 1

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27) A 28) A 29) A 30) B 31) A 32) D 33) C 34) C 35) A 36) A 37) B 38) A 39) B 40) D 41) C 42) D 43) D 44) D 45) B 46) D 47) A 48) C 49) A 50) C 51) C 52) D 53) B 54) D 55) D 56) A Version 1

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57) A 58) D 59) B 60) D 61) D 62) B 73) TRUE 74) TRUE 75) TRUE 76) FALSE 77) TRUE 78) FALSE 79) TRUE 80) TRUE 81) FALSE 82) TRUE

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Student name:__________ 1)

A product cost is: A) an expense allocated by a systematic procedure.

B) recognized during the period in which a liability is incurred.

C) recognized in the period during which related revenue is recognized.

D) recognized in the period in which cash is spent.

2)

Which of the following accounts is not affected by cash disbursement transactions?

A) cash B) accounts payable C) purchase discounts D) purchase returns

3)

A debit memo: A) reduces the amount of accounts payable due to a vendor.

B) reduces accounts payable when payment is made.

C) is used by vendors to record cash payments received.

D) authorizes a debit to purchases when goods are received.

4) In assessing control risk for purchases, an auditor vouches a sample of entries in the voucher register to the supporting documents. Which assertion would this test of controls most likely support?

A) completeness B) occurrence C) accuracy D) classification

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5)

The existence assertion for accounts payable includes:

A) determining whether all accounts payable are recorded.

B) determining whether all accounts payable actually are liabilities.

C) determining whether all accounts payable are recorded in the proper period.

D) determining whether all accounts payable are properly classified in the financial statements.

6)

The cutoff assertion for accounts payable includes:

A) determining whether all accounts payable are recorded.

B) determining whether all accounts payable actually are liabilities.

C) determining whether all accounts payable are recorded in the proper period.

D) determining whether all accounts payable are properly classified in the financial statements.

7) The accounts payable department receives the purchase order form to accomplish all of the following except to: A) compare invoice price to purchase order price.

B) ensure that the purchase had been properly authorized.

C) ensure that the goods had been received by the party requesting the goods.

D) compare quantity ordered to quantity purchased.

8) Unrecorded liabilities are most likely to be found during the review of which of the following documents?

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A) unpaid vendor invoices and receiving reports B) shipping records C) bills of lading D) unmatched sales invoices

9) To determine whether accounts payable are complete, an auditor performs a test to verify that all merchandise received is recorded. The population of documents for this test consists of all: A) payment vouchers.

B) receiving reports.

C) purchase requisitions.

D) vendors' invoices.

10) An important primary purpose of the auditor's review of the entity's procurement system should be to determine the effectiveness of the activities to protect against: A) improper materials handling.

B) unauthorized persons issuing purchase orders.

C) mispostings of purchase returns.

D) excessive shrinkage or spoilage.

11) An entity erroneously recorded a large purchase twice. Which of the following internal controls would be most likely to detect this error in a timely and efficient manner?

A) footing the purchases journal B) reconciling vendors' monthly statements with subsidiary payable ledger accounts C) tracing totals from the purchases journal to the ledger accounts D) sending written quarterly confirmations to all vendors

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12) An auditor performs a test to determine whether all merchandise was received for which the entity was billed. The population for this test consists of all: A) merchandise received.

B) vendors' invoices.

C) canceled checks.

D) receiving reports.

13) An auditor compares information on canceled checks with information contained in the cash disbursements journal, paying particular attention to the amount for which the check was issued and recorded. The objective of this test is to determine that: A) recorded cash disbursement transactions are properly authorized.

B) proper cash purchase discounts have been recorded.

C) cash disbursements are for goods and services actually received.

D) no discrepancies exist between the data on the checks and the data in the journal.

14) Which of the following procedures would an auditor most likely perform in searching for unrecorded payables?

A) reconcile receiving reports with related cash payments made just prior to year-end B) contrast the ratio of accounts payable to purchases with the prior year's ratio C) vouch a sample of creditor balances to supporting invoices, receiving reports and purchase orders D) for cash payments occurring after the balance sheet date, examine the date on the associated receiving report or vendor invoice to determine if it relates to the current period under audit

15) Tests designed to detect purchases made before the end of the year that have been recorded in the subsequent year most likely would provide assurance about management's assertion of: Version 1

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A) accuracy.

B) occurrence.

C) cutoff.

D) classification.

16) The audit procedures used to verify accrued liabilities differ from those employed for the verification of accounts payable because: A) accrued liabilities usually pertain to services of a continuing nature, while accounts payable are the result of completed transactions.

B) accrued liability balances are less material than accounts payable balances.

C) evidence supporting accrued liabilities is nonexistent, while evidence supporting accounts payable is readily available.

D) accrued liabilities at year-end will become accounts payable during the following year.

17)

The auditor is most likely to verify accrued commissions payable in conjunction with the: A) sales cutoff review.

B) verification of employees.

C) review of post balance sheet date disbursements.

D) examination of trade accounts payable.

18) Which of the following procedures relating to the examination of accounts payable could the auditor delegate entirely to the entity's employees?

A) test footings in the accounts payable ledger B) reconcile unpaid invoices to vendors' statements C) prepare a schedule/listing of accounts payable D) mail confirmations for selected account balances

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19)

Which of the following audit procedures is least likely to detect an unrecorded liability?

A) analysis and recomputation of interest expense B) analysis and recomputation of depreciation expense C) mailing of standard bank confirmation forms D) reading of the minutes of meetings of the board of directors

20) An entity's procurement system ends with the assumption of a liability and the eventual payment of the liability. Which of the following best describes the auditor's primary concern with respect to liabilities resulting from the procurement system?

A) Accounts payable are not materially understated.

B) Authority to incur liabilities is restricted to one designated person.

C) Acquisition of materials is not made from one vendor or one group of vendors.

D) Commitments for all purchases are made only after established competitive bidding procedures are followed.

21) For effective internal control over accuracy of transactions, the accounts payable department should compare the information on each vendor's invoice with the: A) receiving report and the purchase order.

B) receiving report and the voucher.

C) vendor's packing slip and the purchase order.

D) vendor's packing slip and the voucher.

22)

The authority to accept incoming goods in receiving should be based on a(an):

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A) vendor's invoice.

B) materials requisition.

C) bill of lading.

D) approved purchase order.

23)

A voucher: A) is a bill from the vendor.

B) is a document that records the receipt of goods.

C) is a document that requests goods from an authorized individual in the entity.

D) serves as the basis for recording a vendor's invoice in the purchases journal.

24) the:

Operating control over the check signature plate normally should be the responsibility of

A) secretary.

B) chief accountant.

C) vice President of Finance.

D) treasurer.

25) In testing controls over cash disbursements, an auditor most likely would determine that the person who signs the checks also: A) reviews the monthly bank reconciliation.

B) returns the checks to accounts payable.

C) is denied access to the supporting documents.

D) is responsible for mailing the checks.

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26) With respect to a small company's system of purchasing supplies, an auditor's primary concern should be to obtain satisfaction that supplies ordered and paid for have been: A) requested and approved by authorized individuals who have no incompatible duties.

B) received, counted, and checked to quantities and amounts on purchase orders and invoices.

C) properly recorded as assets and systematically amortized over the estimated useful life of the supplies.

D) used in the course of business and solely for business purposes during the year under audit.

27) As an in-charge auditor, you are reviewing a summary of control weaknesses in cash disbursement procedures. Which one of the following weaknesses, standing alone, should cause you the least concern?

A) Checks are signed by only one person.

B) Signed checks are distributed by the controller to approved payees.

C) Treasurer fails to establish validity of names and addresses of check payees.

D) Cash disbursements are made directly out of cash receipts.

28) Tests of controls for the occurrence assertion for purchases include all of the following except: A) evaluating proper segregation of duties.

B) testing a sample of vouchers for an authorized purchase order.

C) testing a sample of vouchers for matching receiving reports.

D) tracing a sample of vouchers to purchases journal.

29) An internal control questionnaire indicates that an approved receiving report is required to accompany every check request for payment of merchandise. Which of the following procedures provides the greatest assurance that this control is operating effectively?

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A) select and examine receiving reports and ascertain that the related canceled checks are dated no earlier than the receiving reports B) select and examine receiving reports and ascertain that the related canceled checks are dated no later than the receiving reports C) select and examine canceled checks and ascertain that the related receiving reports are dated no earlier than the checks D) select and examine canceled checks and ascertain that the related receiving reports are dated no later than the checks

30) An auditor wishes to perform tests of controls on an entity's cash disbursements procedures. If the control activities leave no audit trail of documentary evidence, the auditor most likely will test the procedures by: A) inquiry and analytical procedures.

B) confirmation and observation.

C) observation and inquiry.

D) analytical procedures and confirmation.

31) An entity's internal control requires that for every check request there be an approved voucher, supported by a prenumbered purchase order and a prenumbered receiving report. To determine whether checks are being issued for unauthorized expenditures, an auditor most likely would select items for testing from the population of all: A) purchase orders.

B) canceled checks.

C) receiving reports.

D) approved vouchers.

32) To provide assurance that each voucher is submitted and paid only once, an auditor most likely would examine a sample of paid vouchers and determine whether each voucher is:

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A) supported by a vendor's invoice.

B) stamped "paid" by the check signer.

C) prenumbered and accounted for.

D) approved for authorized purchases.

33) Which of the following is the most effective control activity to detect vouchers prepared for the payment of goods that were not received?

A) counting of goods upon receipt in the storeroom B) matching of purchase order, receiving report, and vendor invoice for each voucher in the accounts payable department C) comparison of goods received with goods requisitioned in the receiving department D) verification of vouchers for accuracy and approval in the internal audit department

34) When an auditor selects a sample of items from the vouchers payable register for the last month of the period under audit and vouches these items to underlying documents, the auditor is gathering evidence primarily in support of the assertion that: A) recorded obligations were paid.

B) incurred obligations were recorded in the correct period.

C) recorded obligations were valid.

D) cash disbursements were recorded as incurred obligations.

35) An auditor traced a sample of purchase orders and the related receiving reports to the purchases journal and the cash disbursements journal. The purpose of this substantive procedure most likely was to: A) identify unusually large purchases that should be investigated further.

B) verify that cash disbursements were for goods actually received.

C) determine that purchases were properly recorded.

D) test whether payments were for goods actually ordered.

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36)

Substantive procedures to examine the occurrence assertion for accounts payable include: A) selecting a sample of vouchers and agreeing them to authorized purchase orders.

B) selecting a sample of vouchers and tracing them to the purchases journal.

C) comparing dates on vouchers to dates in the purchases journal.

D) recomputing the mathematical accuracy of a sample of vendor invoices.

37) Substantive procedures to examine the completeness assertion for accounts payable include: A) selecting a sample of vouchers and agreeing them to authorized purchase orders.

B) selecting a sample of vouchers and tracing them to the purchases journal.

C) comparing dates on vouchers to dates in the purchases journal.

D) recomputing the mathematical accuracy of a sample of vendor invoices.

38)

Substantive procedures to examine the cutoff assertion for accounts payable include:

A) selecting a sample of vouchers and agreeing them to authorized purchase orders.

B) selecting a sample of vouchers and agreeing them to the purchases journal.

C) selecting a sample of receiving reports around year-end and comparing dates on related vouchers to dates in the purchases journal.

D) recomputing the mathematical accuracy of a sample of vendor invoices.

39)

Purchase cutoff procedures should be designed to test whether or not all inventory: A) purchased and received before the year-end was recorded before year-end.

B) on the year-end balance sheet was carried at lower of cost or net realizable value.

C) on the year-end balance sheet was paid for by the company.

D) owned by the company is in the possession of the company.

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40) When searching for unrecorded liabilities at year-end, the population identified for sampling would be: A) cash receipts from related parties recorded before year-end.

B) creditors whose accounts appear on a subsidiary trial balance of accounts payable.

C) cash disbursements recorded in the period subsequent to year-end.

D) invoices dated a few days before and after year-end.

41) Which of the following is a substantive procedure that an auditor most likely would perform to verify the existence of recorded accounts payable?

A) Investigating the open purchase order file to ascertain that prenumbered purchase orders are used and accounted for.

B) Receiving the entity's mail, unopened, for a reasonable period of time after the yearend to search for unrecorded vendor's invoices.

C) Vouching selected entries in the accounts payable subsidiary ledger to purchase orders and receiving reports.

D) Confirming accounts payable balances with known suppliers who have zero balances.

42) Which of the following procedures would an auditor most likely perform in searching for unrecorded liabilities?

A) vouch a sample of accounts payable entries recorded just before year-end to the unmatched receiving report file B) compare a sample of purchase orders issued just after year-end with the year-end accounts payable trial balance C) test a sample of cash disbursements recorded just after year-end for the presence of receiving reports and vendor invoices D) scan the cash disbursements entries recorded just before year-end for indications of unusual transactions

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43) Which of the following procedures would an auditor least likely perform before the balance sheet date?

A) assessment of inherent risk B) observation of merchandise inventory count C) assessment of control risk D) identification of related parties

44) to:

An examination of the balance in the accounts payable account is ordinarily not designed

A) determine that the amounts represent obligations of the company.

B) verify that accounts payable were properly authorized.

C) ascertain the reasonableness of recorded liabilities.

D) determine that all existing liabilities at the balance sheet date have been recorded.

45)

Accounts payable confirmations are used to test: A) both the existence and completeness audit assertions.

B) only the existence audit assertion.

C) only the completeness audit assertion.

D) either existence or completeness, depending upon the response rate.

46) If completeness is a concern for accounts payable, auditors will send accounts payable confirmations to: A) primarily vendors with large accounts payable balances.

B) primarily vendors with small or zero accounts payable balances.

C) all vendors.

D) a random sample of all vendors.

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47) In auditing accounts payable, an auditor's procedures most likely would focus primarily on management's assertion of: A) existence.

B) rights and obligations.

C) completeness.

D) accuracy, valuation, and allocation.

48) Budd, the purchasing agent for Lake Hardware Wholesalers, has a relative who owns a retail hardware store. Budd arranged for hardware to be delivered by manufacturers to the retail store on a C.O.D. basis, thereby enabling his relative to buy at Lake's wholesale prices. Budd was probably able to accomplish this because of Lake's poor internal control over: A) cash disbursements.

B) cash receipts.

C) perpetual inventory records.

D) purchase orders.

49) Which of the following control activities is not usually performed in the accounts payable department?

A) determining the mathematical accuracy of the vendor's invoice B) having an authorized person approve the voucher C) controlling the mailing of the check and remittance advice D) matching the receiving report with the purchase order

50) Which of the following is an internal control that would prevent a paid disbursement voucher from being presented for payment a second time?

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A) Vouchers should be prepared by individuals who are responsible for signing disbursement checks.

B) Disbursement vouchers should be approved by at least two responsible management officials.

C) The date on a disbursement voucher should be within a few days of the date the voucher is presented for payment.

D) The official who is signing the check should compare the check with the voucher and should "cancel" the voucher documents by marking them "paid."

51) The mailing of disbursement checks and remittance advices should be controlled by the employee who: A) signed the checks last.

B) approved the vouchers for payment.

C) matched the receiving reports, purchase orders and vendors' invoices.

D) verified the mathematical accuracy of the vouchers and remittance advices.

52)

Assertions about classes of transactions and events for the period under audit include: A) existence, completeness, and accuracy, valuation, and allocation.

B) existence, completeness, and classification.

C) occurrence, completeness, and cutoff.

D) occurrence, completeness, and accuracy, valuation, and allocation.

53)

Assertions about account balances at the period end include: A) existence, cutoff, and accuracy, valuation, and allocation.

B) occurrence, completeness, and classification.

C) existence, rights and obligations, and completeness.

D) occurrence, cutoff, and classification.

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54) Which of the following test(s) of details of transactions can be used as a dual-purpose test in conjunction with tests of controls?

A) test a sample of purchase requisitions for proper authorization B) obtain selected vendors' statements and reconcile to vendor accounts C) obtain listing of accounts payable and compare total to general ledger D) review results of confirmations of selected accounts payable

55) Which of the following questions would most likely be included in an internal control questionnaire concerning the completeness assertion for purchases?

A) Is an authorized purchase order required before the receiving department can accept a shipment or the vouchers payable department can record a voucher?

B) Are purchase requisitions prenumbered and independently matched with vendor invoices?

C) Is the unpaid voucher file periodically reconciled with inventory records by an employee who does not have access to purchase requisitions?

D) Are purchase orders, receiving reports, and vouchers prenumbered and periodically accounted for?

56) If payables turnover has increased significantly since the prior year, this is an indication that which of the following assertions for accounts payable might be violated?

A) existence or occurrence B) completeness C) rights and obligations D) accuracy, valuation, and allocation

57)

Which of the following describes a temporary difference?

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A) A difference that will be corrected in an amended tax return.

B) A difference arising from an uncertain tax position.

C) A fundamental difference in what constitutes revenue or expense for GAAP and tax purposes.

D) A timing difference between the recognition of revenue or expense under GAAP and tax purposes.

58)

Which of the following describes a permanent difference?

A) A difference that will be corrected in an amended tax return.

B) A difference arising from an uncertain tax position.

C) A fundamental difference in what constitutes revenue or expense for GAAP and tax purposes.

D) A timing difference between the recognition of revenue or expense under GAAP and tax purposes.

59) that:

The primary distinction between a temporary and permanent income tax difference is

A) a permanent difference results in a deferred tax asset or deferred tax liability, while a temporary difference does not.

B) a temporary difference is due to the correction of an error, while a permanent difference is due to an error that has not been detected.

C) a temporary difference will reverse in the future, while a permanent difference will not.

D) a permanent difference stems from a difference in the timing of revenue recognition, while a temporary difference stems from a difference in the timing of expense recognition and the related tax deduction.

60)

Describe three categories of expenses outlined in FASB Concept Statement No. 5.

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61) Listed below are assertions about classes of transactions and events made in the purchasing process. For each, give an example of how an auditor could use one of the typical documents in the purchasing process to test the assertion. ● Occurrence ● Completeness ● Accuracy ● Cutoff ● Classification

62)

Identify the primary functions in the purchases cycle and describe each function.

63) Listed below are the major functions of the purchasing process.

1.Purchasing function.

2.General ledger function.

3.Invoice-processing function.

4.Disbursement function.

5.Accounts payable function.

6.Requisition and receiving function.

Name four pairs of functions that should be segregated from each other and explain why the segregation is important.

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64) The key inherent risk factors an auditor must consider when auditing the purchasing process are industry factors. Which two are most important and why?

65) Identify the types of substantive procedures used by the auditor to test accounts payable and accrued expenses. Provide an example of how the auditor may use each substantive procedure. Identify if any of the substantive procedures can be used as a test of controls or a dual-purpose test.

66) Identify whether the following tests are tests of controls, substantive analytical procedures, tests of details of transactions, or tests of details of account balances: 1.Test a sample of purchase requisitions for proper authorization.

2.Test transactions around year-end to determine if they are recorded in the proper period.

3.Review results of confirmation of selected accounts payable.

4.Compare payables turnover to previous years' data.

5.Obtain selected vendors' statements and reconcile to vendor accounts.

6.Compare purchase returns and allowances as a percentage of revenue or cost of sales to industry data.

67) There are several important disclosure items to consider when auditing the purchasing process. Discuss what they are and why they are important.

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68) Which type of confirmation is used more frequently by auditors―accounts receivable confirmations or accounts payable confirmations? Why?

69) The auditor can often obtain sufficient appropriate evidence in the audit of a tax provision without the use of a specialist. However, several situations may indicate a need for the auditor to involve a tax specialist. Identify three of these situations.

70) Product costs should be matched directly with specific transactions and are recognized upon recognition of revenue. ⊚ true ⊚ false

71)

A purchase transaction usually begins with the preparation of a purchase order. ⊚ true ⊚ false

72)

A receiving report is used to document the ordering of goods. ⊚ true ⊚ false

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73)

The purchase journal is referred to as a check register. ⊚ true ⊚ false

74) The principal business objectives of the purchasing process are acquiring goods and services and paying for those goods and services. ⊚ true ⊚ false

75) The accounts payable department is responsible for ensuring that all vendor invoices, cash disbursements, and adjustments are recorded in the accounts payable records. ⊚ true ⊚ false

76)

After the controls are tested, the auditor sets the assessed level of control risk. ⊚ true ⊚ false

77) Because of the low volume of purchase return transactions, the auditor normally does not test the controls associated with these transactions. ⊚ true ⊚ false

78) Analytical procedures can be used to examine the reasonableness of accounts payable and accrued expenses. ⊚ true ⊚ false Version 1

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79) Accounts payable confirmations are used less frequently by auditors than accounts receivable confirmations. ⊚ true ⊚ false

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Answer Key Test name: ch 11 1) C 2) D 3) A 4) B 5) B 6) C 7) C 8) A 9) B 10) B 11) B 12) B 13) D 14) D 15) C 16) A 17) A 18) C 19) B 20) A 21) A 22) D 23) D 24) D 25) D 26) B Version 1

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27) A 28) D 29) D 30) C 31) B 32) B 33) B 34) C 35) C 36) A 37) B 38) C 39) A 40) C 41) C 42) C 43) B 44) B 45) A 46) B 47) C 48) D 49) C 50) D 51) A 52) C 53) C 54) A 55) D 56) B Version 1

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57) D 58) C 59) C 70) TRUE 71) FALSE 72) FALSE 73) FALSE 74) TRUE 75) TRUE 76) TRUE 77) TRUE 78) TRUE 79) TRUE

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Student name:__________ 1) Which of the following departments most likely would approve changes in pay rates and deductions from employee salaries?

A) human resource B) treasurer C) controller D) payroll

2) Possible misstatements related to the occurrence assertion for payroll transactions include all of the following except: A) payments to fictitious employees.

B) payments to terminated employees.

C) payments to valid employees who have not worked.

D) payments to valid employees at a rate in excess of the authorized amount.

3) The proper use of prenumbered termination notice forms by the Payroll Department should provide assurance that all: A) uncashed payroll checks were issued to employees who have not been terminated.

B) personnel files are kept up to date.

C) employees who have not been terminated receive their payroll checks.

D) terminated employees are removed from the payroll.

4) An auditor vouched data for a sample of employees in a payroll register to approved time sheet data to provide assurance that:

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A) payments to employees are computed at authorized rates.

B) employees worked the number of hours for which they are paid.

C) segregation of duties exists between the preparation and distribution of the payroll.

D) internal controls relating to unclaimed payroll checks are operating effectively.

5) Which of the following internal control objectives is likely to be a larger concern in the audit of the payroll cycle?

A) Payroll transactions are properly disclosed.

B) Recorded payroll transactions are valid.

C) Payroll transactions are recorded in the appropriate time period.

D) All payroll transactions have been recorded.

6) Which of the following circumstances most likely would cause an auditor to suspect an employee payroll fraud scheme?

A) There are significant unexplained variances between standard and actual labor cost.

B) Payroll checks are disbursed by the same employee each payday.

C) Employee time sheets are approved by individual departmental supervisors.

D) A separate payroll bank account is maintained on an imprest basis.

7)

Which of the following could test the assertion of cutoff for payroll-related liabilities?

A) compare items in accrued payroll taxes to the supporting payroll tax return B) search for unrecorded liabilities C) examine payroll tax returns to determine that the expense was recorded in the proper

period D) review payroll liabilities for proper classification as short-or long-term

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8) Which of the following could test the assertion of classification for payroll-related liabilities?

A) compare items in accrued payroll taxes to the supporting payroll tax return B) search for unrecorded liabilities C) examine payroll tax returns to determine that the expense was recorded in the proper period D) review payroll liabilities for proper reporting as short- or long-term

9) All of the following are incorporated into valuation models for share-based compensation except: A) the exercise price of the option.

B) the term of the option.

C) expected dividends.

D) current tax rates.

10) A surprise observation by an auditor of an entity's regular distribution of paychecks is primarily designed to satisfy the auditor that: A) all unclaimed payroll checks are properly returned to the cashier.

B) the paymaster is not involved in the distribution of payroll checks.

C) all employees have in their possession proper employee identification.

D) names on the company payroll are those of bona fide employees presently on the job.

11) Which of the following is the best reason why an auditor should consider observing an entity's distribution of regular payroll checks?

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A) to ensure that names on the company payroll are those of bona fide employees presently on the job B) total payroll costs are a significant part of total operating costs C) the auditor did not observe the distribution of the entire regular payroll during the audit in the prior year D) employee turnover is excessive

12) The purpose of segregating the duties of distributing payroll checks and hiring personnel is to separate the: A) duties within the accounting function.

B) custody of assets from the accounting for those assets.

C) authorization of transactions from the custody of related assets.

D) operational responsibility from record keeping responsibility.

13) Which of the following is an effective internal control used to prove that production department employees are properly validating payroll time sheets?

A) Time sheets should be carefully inspected by those persons who distribute pay envelopes to the employees.

B) One person should be responsible for maintaining records of employee time for which salary payment is not to be made.

C) Daily reports showing time charged to jobs should be approved by the foreman and compared to the total hours worked on the employee time sheets.

D) Internal auditors should make observations of distribution of paychecks on a surprise basis.

14) A large retail enterprise has established a policy that requires that the paymaster deliver all unclaimed payroll checks to the Internal Auditing Department at the end of each payroll distribution day. This policy was most likely adopted in order to:

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A) assure that employees who were absent on a payroll distribution day are not paid for that day.

B) prevent the paymaster from cashing checks that are unclaimed for several weeks.

C) prevent a bona fide employee's check from being claimed by another employee.

D) detect any fictitious employee who may have been placed on the payroll.

15) In the weekly computer run to prepare payroll checks, a check was printed for an employee who had been terminated the previous week. Which of the following controls, if properly utilized, would have been most effective in preventing the error or ensuring its prompt detection?

A) a control total for hours worked, prepared from time sheets collected by the Timekeeping Department B) requiring the treasurer's office to account for the numbers of the prenumbered checks issued to the EDP department for the processing of the payroll C) use of a check digit for employee numbers D) use of a header label for the payroll input sheet

16) Which of the following is the best way for an auditor to determine that every name on a company's payroll is that of a bona fide employee presently on the job?

A) examine personnel records for accuracy and completeness B) examine employees' names listed on payroll accounting records C) make a surprise observation of the company's regular distribution of paychecks D) visit the working areas and confirm with employees their badge or identification numbers

17)

Transactions processed through the payroll process include all of the following except:

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A) payments to employees for services rendered.

B) payments to independent contractors for services rendered.

C) accrual of social security taxes.

D) payment of unemployment taxes.

18) Vouching hours worked per the payroll register to employee time sheets that have been approved by supervisory personnel provides evidence that: A) internal controls relating to payroll disbursements were operating effectively.

B) payroll checks were signed by an appropriate officer independent of the payroll preparation process.

C) only bona fide employees worked and their pay was properly computed.

D) employees worked the number of hours for which their pay was computed.

19) Which of the following activities most likely would detect whether payroll data are accurately processed?

A) monitor authorized distribution of data control sheets B) use computer-assisted audit techniques and test data to verify the accurate performance of payroll processing C) examine source documents for approval by supervisors D) segregate duties between approval of hardware and software specifications

20) Which of the following procedures would normally be performed by the auditor when conducting tests of payroll transactions?

A) interview employees selected in a statistical sample of payroll transactions B) vouch a sample of payroll checks to the master employee list C) confirm amounts withheld from employees' salaries with proper governmental authorities D) examine signatures on paid salary checks

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21)

A substantive test of transactions to test the completeness assertion includes: A) tracing a sample of time sheets to the payroll register.

B) testing a sample of payroll checks for the presence of an authorized time sheet.

C) testing postings to the payroll register for a sample of payroll checks.

D) recomputing the accuracy of a sample of payroll checks.

22) Comparing selected items from the payroll register to employee time records that have been approved by supervisory personnel tests which of the following assertions for payroll expense?

A) occurrence B) completeness C) classification D) cutoff

23)

An auditor most likely would extend substantive tests of payroll when: A) payroll is extensively audited by the state government.

B) payroll expense is substantially higher than in the prior year due to company growth.

C) overpayments are discovered in performing tests of details.

D) employees complain to management about too much overtime.

24)

Which of the following could test the existence assertion for payroll-related liabilities?

A) compare items in accrued payroll taxes to the supporting payroll tax return B) search for unrecorded liabilities C) examine payroll tax returns to determine that the expense was recorded in the proper

period D) review payroll liabilities for proper classification as short- or long-term

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25) Which of the following is required of an auditor who is testing the fair value of options in share-based compensation?

A) using a specialist B) evaluating the reasonableness of the inputs used in the valuation model C) becoming an expert in option-pricing D) using the work of the internal audit function

26)

Effective internal control over the payroll function would include which of the following?

A) Total time recorded on time sheets should be reconciled to job reports by employees responsible for those specific jobs.

B) Payroll Department employees should be supervised by the management of the Human Resource Department.

C) Payroll Department employees should be responsible for maintaining employee personnel records.

D) Total time spent on jobs should be compared with total time indicated on time sheets.

27) A CPA reviews an entity's payroll procedures. The CPA would consider internal control to be less than effective if a payroll department supervisor was assigned the responsibility for: A) distributing payroll checks to employees.

B) reviewing and approving time reports for subordinate employees.

C) hiring subordinate employees.

D) initiating requests for salary adjustments for subordinate employees.

28) An auditor would consider internal control over an entity's payroll procedures to be ineffective if the payroll department supervisor is responsible for:

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A) hiring subordinate payroll department employees.

B) having custody over unclaimed paychecks.

C) updating employee earnings records.

D) applying pay rates to time tickets.

29) Which of the following is a control activity that most likely could help prevent employee payroll fraud?

A) The Human Resource department promptly sends employee termination notices to the payroll supervisor.

B) Employees who distribute payroll checks forward unclaimed payroll checks to the absent employees' supervisors.

C) Salary rates resulting from new hires are approved by the payroll supervisor.

D) Total hours used for determination of gross pay are calculated by the payroll supervisor.

30)

An effective system of internal control over the payroll function would include:

A) verification of agreement of job time sheets with employee recorded hours by a payroll department employee.

B) reconciliation of totals on job time sheets with job reports by employees responsible for those specific jobs.

C) custody of rate authorization records by the supervisor of the payroll department.

D) preparation of payroll transaction journal entries by an employee who reports to the supervisor of the human resource department.

31) Key segregations of duties in the human resource management process include all of the following except:

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A) the supervision function should be separate from the payroll-processing function.

B) the disbursement function should be separate from the supervision function.

C) the human resource function should be separate from setting salaries.

D) the payroll-processing function should be separate from the general ledger function.

32) In testing the payroll of a large company, the auditor wants to establish that the individuals included in a sample actually were employees of the company during the period under review. What will be the best source to determine this?

A) telephone contacts with the employees B) examining the paychecks issued during the period C) confirmation with the union or other independent organization D) examination of Human Resource Department records

33)

Authorization of employees’ overtime should be completed by the: A) Payroll Department.

B) Human Resource Department.

C) Operating Department.

D) Payroll Department in conjunction with IT.

34) Which of the following internal control activities could best prevent direct labor from being charged to manufacturing overhead?

A) reconciliation of work in process inventory with cost records B) comparison of daily journal entries with the factory labor summary C) comparison of period costs budgets and time sheets D) reconciliation of the unfinished job summary and production cost records

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35) Which of the following internal control activities most likely would prevent direct labor hours from being charged to manufacturing overhead?

A) periodic independent counts of work-in-process for comparison to recorded amounts B) comparison of daily journal entries with approved production orders C) use of time sheets to record actual labor worked on production orders D) reconciliation of work-in-process inventory with periodic cost budgets

36) An auditor most likely would assess control risk at high if the payroll department supervisor is responsible for: A) examining authorization forms for new employees.

B) comparing payroll registers with original batch transmittal data.

C) authorizing payroll rate changes for all employees.

D) hiring all subordinate payroll department employees.

37) In determining the effectiveness of an entity's policies and procedures relating to the existence or occurrence assertion for payroll transactions, an auditor most likely would inquire about and: A) observe the segregation of duties concerning human resource responsibilities and payroll disbursement.

B) inspect evidence that all prenumbered payroll checks are accounted for.

C) recompute the payroll deductions for employee fringe benefits.

D) verify the preparation of the monthly payroll account bank reconciliation.

38) In the substantive audit procedures for payroll where the control risk is set at low, an auditor most likely would:

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A) verify that checks representing unclaimed wages are mailed.

B) trace individual employee deductions to entity journal entries.

C) observe entity employees during a payroll distribution.

D) compare payroll costs with entity standards or budgets.

39) Tracing a sample of time sheets before and after period end to the weekly payroll report and tracing the weekly payroll report to the general ledger to verify that payroll transactions are recorded in the proper period would provide evidence primarily for which assertion?

A) classification B) occurrence C) cutoff D) accuracy

40) Comparing amounts selected from the payroll account analysis for payroll accruals to supporting documentation would provide evidence primarily for which assertion?

A) completeness B) existence C) classification D) presentation

41)

In performing tests concerning the granting of stock options, an auditor should: A) confirm the transaction with the Secretary of State in the state of incorporation.

B) verify the existence of option holders in the entity's payroll records or stock ledgers.

C) determine that sufficient treasury stock is available to cover any new stock issued.

D) vouch the authorization for the transaction to a vote of the board of directors.

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42)

Explain how the human resource management process can affect the financial statements.

43) Listed below are descriptions of various types of documents used in the payroll process.

Identify the document being described for each of the following: 1.The document used to record hours worked by an employee.

2.The document that summarizes all payroll payments issued to employees.

3.The document that contains information on an employee's work history.

4.The form used to authorize deductions from an employee's pay.

5.The computer file that contains all the entity's records related to payroll.

44) Generally, is the inherent risk level for the human resource management process set at low, moderate or high? For what area of the process might the appropriate level differ from the previous answer? Why?

45) For the payroll function, give an example of a test of controls that could be used by an auditor to test for the following assertions: Occurrence, Accuracy, and Cutoff.

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46) Identify whether the following tests are substantive analytical procedures, tests of details of transactions, or tests of details of account balances.

1.Vouch a sample of payroll checks to the master employee list to verify occurrence.

2.Recalculate the mathematical accuracy of a sample of payroll checks.

3.Test a sample of bank reconciliations for the payroll bank account.

4.Estimate sales commissions by applying commission formulas to recorded sales totals.

5.Compare amounts accrued to supporting documentation, such as payroll tax returns.

6.Compare payroll costs as a percentage of sales to industry data.

47) For each of the following tests, identify the assertion to which the test applies.

1.Vouch a sample of payroll checks to the master employee list.

2.Recalculate a sample of payroll checks.

3.Review supporting documentation to determine that the entity is legally obligated to pay the liability.

4.Estimate sales commissions by applying commission formulas to recorded sales totals.

5.Compare amounts accrued to supporting documentation, such as payroll tax returns.

6.Compare payroll costs as a percentage of sales to industry data.

48) The Hamster Stop has $93,650 in the Accrued Payroll account. Hamster's weekly payroll is $156,000 and the accrual represents payroll for 3 days. If controls are strong, determine whether additional audit work should be performed on this account.

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49) When an auditor sets control risk low, sufficient evidence can be obtained for most payroll accounts through an understanding of internal controls, substantive analytical procedures, and tests of details of transactions. However, there are certain types of employee accounts and compensation in the payroll cycle that may require more attention. Name the accounts and explain why the additional testing is necessary.

50)

Payroll-related expenses normally are not a material cost to the organization. ⊚ true ⊚ false

51)

An entity must provide employees with a W-2 form at the end of the year. ⊚ true ⊚ false

52) The human resource function is responsible for managing the personnel needs of the organization. ⊚ true ⊚ false

53) The payroll-processing function is responsible for paying employees for services and benefits. ⊚ true ⊚ false

54)

Proper segregation of duties is critical for the human resource management process. ⊚ true ⊚ false

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55) There are few inherent risk factors that directly affect the human resource management process and its related accounts for non-officers. ⊚ true ⊚ false

56) Inherent risk associated with officer compensation is frequently set high because officers have motive and opportunity to take advantage of their high-ranking offices in the form of excessive compensation. ⊚ true ⊚ false

57) If the results of the control tests do not support the planned level of control risk, the detection risk will have to be set higher. ⊚ true ⊚ false

58)

Tests of details of transactions are often conducted in conjunction with tests of controls. ⊚ true ⊚ false

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Answer Key Test name: ch 12 1) A 2) D 3) D 4) B 5) B 6) A 7) C 8) D 9) D 10) D 11) A 12) C 13) C 14) D 15) A 16) C 17) B 18) D 19) B 20) B 21) A 22) A 23) C 24) A 25) B 26) D Version 1

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27) A 28) B 29) A 30) A 31) C 32) D 33) C 34) B 35) C 36) C 37) A 38) D 39) C 40) B 41) D 50) FALSE 51) TRUE 52) TRUE 53) FALSE 54) TRUE 55) TRUE 56) TRUE 57) FALSE 58) TRUE

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Student name:__________ 1)

Shipping orders are forwarded from the revenue process to: A) the materials requisitions department.

B) finished goods stores.

C) raw materials stores.

D) inventory management.

2)

Which of the following departments typically approves purchase requisitions?

A) raw materials stores B) cost accounting C) inventory management D) IT

3)

Which of the following best describes the occurrence assertion for inventory?

A) purchase requisitions initiated by authorized personnel B) recorded inventory transactions actually happened C) inventory properly accumulated from journals and ledgers D) all inventory is recorded

4)

Auditors are most likely to ensure that no production activity is scheduled prior to: A) determining standard costs.

B) observing physical inventory.

C) completing the book to physical adjustment.

D) determining the amount of consigned inventory.

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5) Failure to record inventory in the proper period can affect all of the following accounts except: A) sales.

B) receivables.

C) cost of goods sold.

D) prepaid expenses.

6) The audit of year-end physical inventories should include steps to verify that the entity's purchases and sales cutoffs were adequate. The audit steps should be designed to detect whether merchandise included in the physical count at year-end was not recorded as a: A) sale in the subsequent period.

B) purchase in the current period.

C) sale in the current period.

D) purchase return in the subsequent period.

7) For the purpose of determining proper cutoff for inventory, the auditor will select a sample from which of the following for a few days before and after year-end?

A) materials requisitions B) production schedules C) receiving documents D) purchase orders

8) Which of the following auditing procedures most likely would provide assurance about a manufacturing entity's inventory valuation?

A) vouching the raw materials' costs to vendors' invoices B) obtaining confirmation of inventories pledged under loan agreements C) reviewing shipping and receiving cutoff activities for inventories D) tracing test counts to the entity's inventory listing

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9) An auditor will usually trace the details of the test counts made during the observation of the physical inventory count to a final inventory schedule. This audit procedure is undertaken to provide evidence that items physically present and observed by the auditor at the time of the physical inventory count are: A) owned by the entity.

B) not obsolete.

C) physically present at the time of the preparation of the final inventory schedule.

D) included in the final inventory schedule.

10) An entity's physical count of inventories was lower than the inventory quantities shown in its perpetual records. This situation could be the result of the failure to record: A) sales.

B) sales returns.

C) purchases.

D) purchase discounts.

11) An auditor has accounted for a sequence of inventory tags and is now going to trace information on a representative number of tags to the physical inventory sheets. The purpose of this procedure is to obtain assurance that: A) the final inventory is valued at cost.

B) all inventory represented by an inventory tag is listed on the inventory sheets.

C) all inventory represented by an inventory tag is bona fide.

D) inventory sheets do not include untagged inventory items.

12) An entity's physical count of inventories was higher than the inventory quantities per the perpetual records. This situation could be the result of the failure to record:

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A) sales.

B) sales discounts.

C) purchases.

D) purchase returns.

13) If the perpetual inventory records show lower quantities of inventory than the physical count, an explanation of the difference might be unrecorded: A) sales.

B) sales discounts.

C) purchases.

D) purchase discounts.

14) An auditor selected items for test counts while observing an entity's physical inventory.

The auditor then traced the test counts to the entity's inventory listing. This procedure most likely provided evidence concerning management's assertion of: A) rights and obligations.

B) completeness.

C) existence.

D) valuation.

15) While observing an entity's annual physical inventory, an auditor recorded test counts for several items and noticed that certain test counts were higher than the recorded quantities in the entity's perpetual records. This situation could be the result of the entity's failure to record: A) purchase discounts.

B) purchase returns.

C) sales.

D) sales returns.

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16) In a manufacturing company, which one of the following audit procedures would give the least assurance about the valuation of inventory at the audit date?

A) testing the computation of standard overhead rates B) examining paid vendors' invoices C) reviewing direct labor rates D) obtaining confirmation of inventories pledged under loan agreements

17) Which of the following is least likely to be a possible cause of book-to-physical differences in inventory quantities?

A) inventory cutoff errors B) misapplication of LIFO C) unreported scrap or spoilage D) theft

18) An auditor most likely would make inquiries of production and sales personnel concerning possible obsolete or slow-moving inventory to support management's financial statement assertion of: A) accuracy, valuation, and allocation.

B) rights and obligations.

C) existence.

D) completeness.

19) Which of the following is a plausible explanation for a large increase in the number of days outstanding in inventory?

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A) obsolete inventory B) new product line where sales exceed production C) manufacturing overhead was not allocated to the production process D) manufacturing salaries were recorded as administrative expenses

20) Key segregations of duties in the inventory management process include all of the following except separating: A) cost accounting from review of variance reports.

B) inventory management from cost accounting.

C) cost accounting from the general ledger function.

D) supervision of physical inventory from inventory management.

21)

An auditor generally tests physical security controls over inventory by: A) test counts and cutoff procedures.

B) examination and reconciliation.

C) inspection and recomputation.

D) review and observation.

22) When perpetual inventory records are maintained in quantities and in dollars and internal control over inventory is weak, the auditor would probably: A) want the entity to schedule the physical inventory count at the end of the year.

B) insist that the entity perform physical counts of inventory items several times during the year.

C) increase the extent of tests for unrecorded liabilities at the end of the year.

D) have to disclaim an opinion on the income statement for that year.

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23) In obtaining an understanding of a manufacturing entity's internal control concerning inventory balances, an auditor most likely would: A) review the entity's description of inventory policies and procedures.

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.

24) For several years, an entity's physical inventory count has been lower than what was shown on the books at the time of the count so that downward adjustments to the inventory account were required. Contributing to the inventory problem could be weaknesses in internal controls that led to the failure to record some: A) purchases returned to vendors.

B) sales returns received.

C) sales discounts allowed.

D) cash purchases.

25) Which of the following control activities would most likely be used to maintain accurate perpetual inventory records?

A) independent storeroom count of goods received B) periodic independent reconciliation of control and subsidiary records C) periodic independent comparison of records with goods on hands D) independent matching of purchase orders, receiving reports, and vendors' invoices

26)

An inventory turnover analysis is useful to the auditor because it may detect: A) inadequacies in inventory pricing.

B) methods of avoiding cyclical holding costs.

C) the optimum automatic reorder points.

D) the existence of obsolete merchandise.

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27) Vouching the costs used to price inventory to the underlying vendors' invoices tests which of the following assertions?

A) occurrence B) cutoff C) accuracy D) classification

28) The auditor tests the quantity of materials charged to work in process by tracing these quantities to: A) cost ledgers.

B) perpetual inventory records.

C) receiving reports.

D) material requisitions.

29) Purchase cutoff activities should be designed to test that merchandise is included in the inventory of the entity company if the company: A) has paid for the merchandise.

B) has physical possession of the merchandise.

C) holds legal title to the merchandise.

D) holds the shipping documents for the merchandise issued in the company's name.

30) Which one of the following procedures would not be appropriate for an auditor in discharging his or her responsibilities concerning the entity's physical inventories?

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A) confirmation of goods in the hands of public warehouses B) supervising the annual physical inventory count C) carrying out physical inventory procedures at an interim date D) obtaining written representation from the entity as to the existence, quality, and dollar amount of the inventory

31) When outside firms of non-accountants specializing in physical inventory counts are used to count, list, price, and subsequently compute the total dollar amount of inventory on hand at the date of the physical count, the auditor will ordinarily: A) consider the report of the outside inventory firm to be an acceptable alternative procedure to the observation of physical inventories.

B) make or observe some physical counts of the inventory, recompute certain inventory calculations, and test certain inventory transactions.

C) increase the extent of work on the physical count of inventory.

D) consider the reduced audit effort with respect to the physical count of inventory as a scope limitation.

32) Which of the following is the best audit procedure for the discovery of damaged merchandise in an entity's ending inventory?

A) compare the physical quantities of slow-moving items with corresponding quantities of the prior year B) observe the condition of merchandise and raw materials during the entity's physical inventory count C) review the management's inventory representation letter for accuracy D) test overall fairness of inventory values by comparing the company's turnover ratio with the industry average

33) The physical count of inventory of a retailer was higher than shown in its perpetual records. Which of the following could explain the difference?

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A) Inventory items had been counted but tags placed on the items had not been taken off the items and added to the inventory accumulation sheets.

B) Credit memos for several items returned by customers had not been prepared.

C) No journal entry had been made on the retailer's books for several items returned to its suppliers.

D) An item purchased "FOB shipping point" had not arrived at the date of the inventory count and had not been reflected in the perpetual records.

34)

In an audit of inventories, an auditor would least likely verify that: A) all inventory owned by the entity is on hand at the time of the count.

B) the entity has used proper inventory pricing.

C) the financial statement presentation of inventories is appropriate.

D) damaged goods and obsolete items have been properly accounted for.

35) To gain assurance that all inventory items in an entity's inventory listing schedule are valid, an auditor most likely would vouch: A) inventory tags noted during the auditor's observation to items listed in the inventory listing schedule.

B) inventory tags noted during the auditor's observation to items listed in receiving reports and vendors' invoices.

C) items listed in the inventory listing schedule to inventory tags and the count sheets.

D) items listed in receiving reports and vendors' invoices to the inventory listing schedule.

36)

Observing an entity's inventory held on consignment by others tests the assertion of:

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A) existence.

B) completeness.

C) accuracy, valuation, and allocation.

D) rights and obligations.

37) When an auditor tests an entity's cost accounting system, the auditor's tests are primarily designed to determine that: A) quantities on hand have been computed based on acceptable cost accounting techniques that reasonably approximate actual quantities on hand.

B) physical inventories are in substantial agreement with book inventories.

C) the system is in accordance with generally accepted accounting principles and is functioning as planned.

D) costs have been properly assigned to work in process, finished goods, and cost of goods sold.

38) Which of the following is not one of the independent auditor's objectives regarding the examination of inventories?

A) verifying that inventory counted is owned by the entity B) verifying that the entity has used proper inventory pricing C) ascertaining the physical quantities of inventory on hand D) verifying that all inventory owned by the entity is on hand at the time of the count

39) An auditor concluded that no excessive costs for an idle plant were charged to inventory.

This conclusion most likely related to the auditor's objective to obtain evidence about the financial statement assertions regarding inventory, including presentation and:

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A) accuracy, valuation, and allocation.

B) completeness.

C) existence.

D) rights and obligations.

40) Which assertion for ending inventory is most likely violated if the gross profit percentage is much greater than last year?

A) existence B) completeness C) rights and obligations D) valuation and allocation

41) Which of the following is a question that the auditor would expect to find on the production process section of an internal control questionnaire?

A) Are vendors' invoices for raw materials approved for payment by an employee who is independent of the cash disbursements function?

B) Are signed checks for the purchase of raw materials mailed directly after signing without being returned to the person who authorized the invoice processing?

C) Are all releases by storekeepers of raw materials from storage based on approved requisition documents?

D) Are details of individual disbursements for raw materials balanced with the total to be posted to the appropriate general ledger account?

42) In order to efficiently establish the correctness of the accounts payable cutoff, an auditor will be most likely to:

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A) coordinate cutoff tests with physical inventory observation.

B) compare cutoff reports with purchase orders.

C) compare vendors' invoices with vendors' statements.

D) coordinate mailing of confirmations with cutoff tests.

43) The accuracy of perpetual inventory records may be established, in part, by comparing perpetual inventory records with: A) purchase requisitions.

B) receiving reports.

C) purchase orders.

D) vendor payments.

44) The audit of the inventory management process is affected by the audit results from multiple other processes. Identify the processes, other than the inventory management process, that affect the audit of inventory and explain how each affect the audit of inventory.

45) State the six functions that make up the inventory management process. For each function, identify the related documents and/or records that would be used by a manufacturing company.

46) The audit of inventory is often the most involved aspect of an audit. Describe at least three inherent risk factors that affect the audit of inventory.

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47) For each of the following, state whether it is a test of details of account balances or a test of details of disclosures. Then note for which assertion(s) the test provides evidence.

1.Inspect loan agreements under which an entity's inventories are pledged.

2.Review inventory compilation for proper classification among raw materials, work in process, and finished goods.

3.Observe the count of physical inventory.

4.Trace test counts and tag control information to the inventory compilation.

5.Inquire of management about issues related to LIFO liquidations.

6.Review book-to-physical adjustments for possible misstatements.

48) You are auditing SBT, which has a December 31st year-end. On December 24th, the person responsible for processing receiving reports and recording the receipt of inventory became very ill and was out of the office for a week. Due to the company's small staff and the holiday season, a number of the receiving reports were not processed on a timely basis. As an auditor, on which assertion would you place a high importance for this entity and how would you test for it?

49) Below is information relating to the inventory management of Quick Sell. Using analytical procedures, identify any concerns you have about misstatements in the financial statements.

Inventory Inventory Turnover

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$ 16,500 12

$ 26,250 9

Industry Average $ 25,000 18

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50) We know from cost accounting that there are three components that make up the standard costs for inventory. Explain how an auditor could test each of these components for a company that manufactures pillows.

51)

Explain the importance of observing physical inventory during an audit.

52) List five things an auditor should do during the observation of the physical count of inventory.

53) The "cradle-to-grave" cycle for inventory begins when goods are purchased and stored and ends when the finished goods are shipped to customers. ⊚ true ⊚ false

54)

A receiving report records the shipment of goods to customers. ⊚ true ⊚ false

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55)

Sale of finished goods is a part of the inventory management process. ⊚ ⊚

true false

56) Once the controls in the inventory system have been tested, the auditor sets the level of control risk. ⊚ true ⊚ false

57) The major control procedure for preventing fictitious inventory transactions from being recorded is proper segregation of duties. ⊚ true ⊚ false

58)

Inventory should be valued using the lower-of-cost-or-net realizable value rule. ⊚ true ⊚ false

59)

A high inventory turnover ratio normally indicates inefficient inventory policies. ⊚ true ⊚ false

60) The three components that make up the cost of producing a product include materials, direct labor, and indirect labor. ⊚ true ⊚ false

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61)

The auditor's observation of inventory is a generally accepted auditing procedure. ⊚ true ⊚ false

62) Obsolete inventory should be written down to its current net realizable value (i.e., market value). ⊚ true ⊚ false

63) In the audit of inventory, the entity is responsible for actually making and recording the count of physical inventory; the auditor's responsibility is to evaluate and observe the entity's procedures and draw conclusions about the adequacy of the physical inventory. ⊚ true ⊚ false

64)

An approved purchase requisition form authorizes shipment of goods to customers. ⊚ true ⊚ false

65) A comparison of the current year's inventory turnover ratio with previous years' may indicate the presence of obsolete inventory. ⊚ true ⊚ false

66) When the entity's perpetual inventory master files are inadequate, the auditor will probably choose to test the physical inventory prior to the balance sheet date.

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⊚ ⊚

true false

67) The audit test of control "Review and test procedures for issuing materials to manufacturing departments" provides assurance mainly for the occurrence assertion for inventory management. ⊚ true ⊚ false

68) Production personnel should ordinarily be responsible for maintaining perpetual inventory records. ⊚ true ⊚ false

69) Inherent risk is typically assessed at a low to moderate level for inventory due to the nature of the asset. ⊚ true ⊚ false

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Answer Key Test name: ch 13 1) B 2) C 3) B 4) B 5) D 6) C 7) C 8) A 9) D 10) A 11) B 12) C 13) C 14) B 15) D 16) D 17) B 18) A 19) A 20) A 21) D 22) A 23) A 24) A 25) C 26) D Version 1

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27) C 28) D 29) C 30) B 31) B 32) B 33) B 34) A 35) C 36) A 37) D 38) D 39) A 40) A 41) C 42) A 43) B 53) TRUE 54) FALSE 55) FALSE 56) TRUE 57) TRUE 58) TRUE 59) FALSE 60) FALSE 61) TRUE 62) TRUE 63) TRUE 64) FALSE 65) TRUE Version 1

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66) FALSE 67) TRUE 68) FALSE 69) FALSE

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Student name:__________ 1)

An auditor typically sets inherent risk for intangible assets at this level: A) low.

B) moderate.

C) zero.

D) high.

2) Which of the following policies constitutes a control weakness related to the acquisition of factory equipment?

A) Acquisitions are to be made through and approved by the department in need of the equipment.

B) Advance executive approvals are required for equipment acquisitions.

C) Variances between authorized equipment expenditures and actual costs are to be immediately reported to management.

D) Depreciation policies are reviewed once a year.

3) Which of the following questions would an auditor least likely include on an internal control questionnaire concerning the initiation and execution of equipment transactions?

A) Are requests for major repairs approved at a higher level than the department initiating the request?

B) Are dispositions authorized at a level above the department initiating the disposition?

C) Are requests for purchases of equipment reviewed for consideration of soliciting competitive bids?

D) Are procedures in place to monitor and properly restrict access to equipment?

4)

The auditor is most likely to seek information from the plant manager with respect to the:

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A) adequacy of the provision for uncollectible accounts.

B) appropriateness of physical inventory observation procedures.

C) existence of obsolete machinery.

D) deferral or procurement of certain necessary insurance coverage.

5) In the examination of property, plant, and equipment, the auditor tries to determine all of the following except the: A) adequacy of controls.

B) extent of property abandoned, retired, or sold during the year.

C) adequacy of replacement funds.

D) reasonableness of the depreciation.

6)

The auditor may conclude that depreciation charges are insufficient by noting: A) insured values greatly in excess of book values.

B) large amounts of fully depreciated assets.

C) continuous trade-ins of relatively new assets.

D) excessive recurring losses on assets retired.

7) The auditor is least likely to learn of retirement of equipment through which of the following?

A) reviewing the purchase return and allowance account B) reviewing depreciation C) analyzing debits to the accumulated depreciation account D) reviewing the insurance register for policies cancelled during the year

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8) Which of the following accounts would most likely be reviewed by the auditor to gain reasonable assurance that additions to property, plant, and equipment are not understated or incorrectly classified?

A) depreciation expense B) accounts payable C) cash D) repairs and maintenance expense

9) In auditing intangible assets, an auditor would determine if the valuation model used by the specialist is appropriate and consistent with GAAP in support of management's financial statement assertion of: A) accuracy, valuation, and allocation.

B) existence.

C) completeness.

D) rights and obligations.

10) Testing depreciation calculations for a sample of property, plant, and equipment tests the assertion of: A) existence.

B) completeness.

C) accuracy, valuation, and allocation.

D) rights and obligations.

11) In testing plant and equipment balances, an auditor examines new additions listed on an analysis of plant and equipment. This procedure most likely obtains evidence concerning management's assertion of:

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A) completeness.

B) existence.

C) classification.

D) accuracy, valuation, and allocation.

12)

The accuracy, valuation, and allocation assertion for prepaid insurance: A) is never tested because amounts always are immaterial.

B) is best tested as part of the testing of property and equipment purchasing.

C) is best tested exclusively by sending confirmations to vendors.

D) is best tested by recomputing the unexpired portion of insurance policies in effect.

13) Recomputing the unexpired portion of insurance policies in effect tests which of the following assertions for prepaid insurance?

A) existence B) classification C) rights and obligations D) accuracy, valuation, and allocation

14) In verifying the amount of goodwill recorded by an entity, the most convincing evidence that an auditor can obtain is by comparing the recorded value of assets acquired with the: A) assessed value as evidenced by tax bills.

B) seller's book value as evidenced by financial statements.

C) insured value as evidenced by insurance policies.

D) appraised value as evidenced by independent appraisals.

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15) To achieve effective control over fixed-asset additions, a company should establish activities that require: A) capitalization of the cost of fixed asset additions in excess of a specific dollar amount.

B) performance of recurring fixed asset maintenance work solely by maintenance department employees.

C) any fixed asset additions that are not used in the business to be classified as investments.

D) authorization and approval of major fixed asset additions.

16) To improve accountability for fixed asset retirements, management most likely would implement a system of internal control that includes: A) continuous analysis of the repairs and maintenance account.

B) periodic inquiry of plant executives by internal auditors as to whether any plant assets have been retired.

C) a level of authorization above the department initiating the retirement.

D) periodic inspection of insurance policies by the internal auditors.

17) Complex accounting issues for property, plant, and equipment include all of the following except: A) lease accounting.

B) testing goodwill for impairment.

C) capitalized interest.

D) self-constructed assets.

18) When there are numerous property and equipment transactions during the year, an auditor planning to set control risk at low usually plans to obtain an understanding of internal control and to perform:

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A) tests of controls and extensive tests of property and equipment balances at the end of the year.

B) extensive tests of current year property and equipment transactions.

C) tests of controls and limited tests of current year property and equipment transactions.

D) analytical procedures for property and equipment balances at the end of the year.

19) Equipment acquisitions that are misclassified as maintenance expenses most likely would be detected by a control activity that provides for: A) segregation of duties of employees in the accounts payable department.

B) independent verification of invoices for disbursements recorded as equipment acquisitions.

C) investigation of variances within a formal budgeting system.

D) authorization by the board of directors of significant equipment acquisitions.

20) Which of the following situations has the best chance of being detected when a CPA computes the ratio of repairs and maintenance expense to the related property, plant, and equipment accounts, compares to prior years’ ratios, and investigates all changes exceeding a fixed percentage?

A) Depreciation has not been taken on some assets.

B) The cashier began lapping accounts receivable in the current year.

C) Because of worsening economic conditions, the current year provision for uncollectible accounts was inadequate.

D) The company is failing to capitalize major repairs that increase the useful life of equipment.

21) Tennessee Company violated company policy by erroneously capitalizing the cost of painting its warehouse. The CPA examining Tennessee's financial statements would most likely learn of this error by:

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A) discussing Tennessee's capitalization policies with its controller.

B) reviewing the titles and descriptions for all construction work orders issued during the year.

C) observing during the physical inventory observation that the warehouse has been painted.

D) examining in detail a sample of construction work orders.

22) Which of the following is likely the most effective audit procedure for the verification of the legal ownership of real property?

A) examination of correspondence with the corporate counsel concerning acquisitions B) examination of ownership documents registered and on file at a public hall of records C) examination of corporate minutes and resolutions concerning the approval to acquire property, plant, and equipment D) examination of deeds and title guaranty policies on hand

23) A normal audit procedure is to analyze the current year's repairs and maintenance accounts to provide evidence in support of the audit proposition that: A) expenditures for fixed assets have been recorded in the proper period.

B) capital expenditures have been properly authorized.

C) non-capitalizable expenditures have been properly expensed.

D) expenditures for fixed assets have been capitalized.

24) Which of the following audit procedures would be least likely to lead the auditor to find unrecorded fixed asset disposals?

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A) examination of insurance policies for evidence of a dropped or cancelled policy B) review of repairs and maintenance expense C) review of property tax files D) scanning of invoices for fixed asset additions for evidence of a purchase to replace a previously owned fixed asset

25)

In testing for unrecorded retirements of equipment, an auditor most likely would:

A) select items of equipment from the accounting records and then locate them during the plant tour.

B) compare depreciation journal entries with similar prior-year entries in search of fully depreciated equipment.

C) inspect items of equipment observed during the plant tour and then trace them to the equipment subsidiary ledger.

D) scan the general journal for unusual equipment additions and excessive debits to repairs and maintenance expense.

26) An auditor analyzes repairs and maintenance accounts primarily to obtain evidence in support of the audit assertion that all: A) non-capitalizable expenditures for repairs and maintenance have been recorded in the proper period.

B) expenditures for property and equipment have been recorded in the proper period.

C) non-capitalizable expenditures for repairs and maintenance have been properly charged to expense.

D) expenditures for property and equipment have not been charged to expenses.

27) Which of the following explanations might satisfy an auditor who discovers significant debits to an accumulated depreciation account?

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A) several fully depreciated assets were retired during the year B) prior years' depreciation charges were erroneously understated C) a reserve for possible loss on retirement has been recorded D) an asset has been recorded at its fair value

28) In testing plant and equipment balances, an auditor may inspect new additions listed on the analysis of plant and equipment. This procedure is designed to obtain evidence concerning management's assertion(s) about: A) presentation.

B) existence.

C) both (1) presentation and (2) existence.

D) neither (1) presentation nor (2) existence.

29) By selecting a sample of additions to property, plant, and equipment and then examining the related vendor invoices, the auditor is testing which of the following assertions for property, plant, and equipment?

A) occurrence B) completeness C) cutoff D) classification

30) Physically examining a sample of capital assets and tracing them into the property, plant, and equipment subsidiary ledger tests which of the following assertions for the property, plant, and equipment account?

A) existence B) completeness C) classification D) rights and obligations

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31) Testing a sample of repairs and maintenance expense items to ensure that they were properly classified as repairs as opposed to property, plant, and equipment tests which of the following assertions?

A) classification B) completeness C) cutoff D) authorization

32)

Auditors will examine the insurance register primarily to: A) ensure that dollar coverage amounts are adequate.

B) examine policy expiration dates to verify that prepaid insurance is properly stated.

C) ensure that insurance agents are not related parties.

D) ensure that all assets are insured.

33) If the ratio of insurance expense to related property, plant, and equipment is higher than expected, which of the following is a plausible explanation?

A) Too much expired insurance is still included in prepaid insurance.

B) PP&E insurance expense includes some expenses related to product liability insurance.

C) Depreciation expense was based on overly short useful lives.

D) Some routine maintenance on equipment was added to the equipment asset account.

34) In an interview with the plant manager regarding operations, the auditor is most likely to obtain evidence that raises concerns regarding:

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A) the capitalization vs. expensing policy.

B) the allocation of fixed and variable costs.

C) the need to write-off equipment that has become obsolete.

D) the adequacy of depreciation expense.

35) Due to a weakness observed in internal control over recording retirements of equipment, the auditor may decide to: A) inspect certain items of equipment in the plant and trace those items to the accounting records.

B) review the subsidiary ledger to ascertain whether depreciation was taken on each item of equipment during the year.

C) trace additions to the "other assets" account to search for equipment that is still on hand but no longer is being used.

D) select certain items of equipment from the accounting records and locate them in the plant.

36) If the ratio of repairs and maintenance expense to property, plant, and equipment is higher than expected, which of the following is a plausible explanation?

A) Routine maintenance on an important piece of machinery was charged to repairs and maintenance expense.

B) An addition to a building was charged to repairs and maintenance expense.

C) The company forgot to depreciate all of its equipment.

D) The company purchased an unusual amount of new equipment.

37) Which of the following best describes the independent auditor's approach to obtaining satisfaction concerning depreciation expense in the income statement?

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A) verifying the mathematical accuracy of the amounts charged to income as a result of depreciation expense B) determining the method for computing depreciation expense and ascertaining that it is in accordance with generally accepted accounting principles C) reconciling the amount of depreciation expense to those amounts credited to accumulated depreciation accounts D) establishing the reasonableness of useful lives and depreciation methods for depreciable assets and recomputing the depreciation expense

38) Determining that proper amounts of depreciation are expensed provides assurance about management's assertions of presentation and: A) accuracy, valuation, and allocation.

B) completeness.

C) rights and obligations.

D) existence.

39) Describe the types of information that should be included in the insurance register that is used by the auditor for auditing prepaid insurance.

40) Auditors can usually gather sufficient, competent evidence on prepaid insurance by performing substantive analytical procedures. Why is this?

41)

List two ways an auditor can test the existence and completeness of insurance policies.

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42) Property, plant, and equipment is often a significant portion of a company's assets.

Describe the inherent risk factors that can affect the audit of this account.

43) For each of the following tests, state whether it is a test of details of account balances or a test of details of transactions. Then note for which property management assertion the test provides evidence.

1.Test depreciation calculations for a sample of capital assets 2.For assets written off, test amounts charged against income and accumulated depreciation 3.Physically examine the capital asset additions 4.Vouch transactions included in repairs and maintenance for items that should be capitalized 5.Vouch significant additions and dispositions to vendor invoices or other supporting documentation 6.Examine or confirm deeds or title documents for proof of ownership

44) What tests do auditors typically perform on a lead schedule for property, plant, and equipment and what assertion are they testing?

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45) For each analytical procedure listed below, identify a potential misstatement in the property management accounts it could help find. a.Compute the ratio of depreciation expense to the related property, plant, and equipment accounts and compare to prior years' ratios b.Compare monthly or annual repairs and maintenance with previous years c.Compute ratio of insurance expense to the related property, plant, and equipment accounts and compare to prior years' ratios

46) There are a number of important disclosure items to consider when auditing the property management process. List two. Where in the financial statements can some of the disclosures relating to property, plant, and equipment be found?

47) How do accounting standards regarding accounting for the impairment or disposal of long-lived assets affect the audit of property, plant, and equipment?

48)

Identify the types of transactions that occur in the property management process.

49)

Prepaid expenses provide economic benefit for longer than a year. ⊚ true ⊚ false

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50)

An example of a prepaid account is prepaid interest. ⊚ true ⊚ false

51) Inherent risk for prepaid expenses would generally be assessed as low because these accounts do not usually include complex transactions. ⊚ true ⊚ false

52)

Substantive analytical procedures are commonly used to test prepaid accounts. ⊚ true ⊚ false

53) Disposition of capital assets through sale, exchange, retirement, or abandonment are transactions that occur in the property management process. ⊚ true ⊚ false

54) If the auditor has detected misstatements in prior audits, the assessment of inherent risk for the property management process will usually be set higher. ⊚ true ⊚ false

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56) Substantive analytical procedures should not be used in the audit of property, plant, and equipment. ⊚ true ⊚ false

57) Reviewing capital budgets and comparing the amounts spent with amounts budgeted is an example of a substantive analytical procedure for auditing prepaid accounts. ⊚ true ⊚ false

58) Inquiry of entity personnel and a review of lease transactions for the same period can provide evidence on proper cutoff for leases. ⊚ true ⊚ false

59) The purchase of capital assets should be consistent with the authorization table used by the entity to approve such transactions. However, no such table is normally used for lease transactions. ⊚ true ⊚ false

60) If a periodic physical inventory of property, plant, and equipment is taken, the individual responsible for the inventory should be independent of the custodial and record-keeping functions. ⊚ true ⊚ false

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61) Generally, auditors rely on controls when auditing the property management function and therefore less substantive testing is used. ⊚ true ⊚ false

62) Assets no longer used in operations are accounted for in essentially the same manner as those used in operations. ⊚ true ⊚ false

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Answer Key Test name: ch 14 1) D 2) A 3) D 4) C 5) C 6) D 7) A 8) D 9) A 10) C 11) B 12) D 13) D 14) D 15) D 16) C 17) B 18) C 19) C 20) D 21) B 22) D 23) D 24) B 25) A 26) D Version 1

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27) A 28) B 29) A 30) B 31) A 32) B 33) B 34) C 35) D 36) B 37) D 38) A 49) FALSE 50) TRUE 51) TRUE 52) TRUE 53) TRUE 54) TRUE 55) TRUE 56) FALSE 57) FALSE 58) TRUE 59) FALSE 60) TRUE 61) FALSE 62) FALSE

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Student name:__________ 1) Several years ago, Conway, Incorporated, secured a conventional real estate mortgage loan. Which of the following audit procedures would least likely be performed by an auditor examining the mortgage balance?

A) examine the current year's canceled checks B) review the mortgage amortization schedule C) inspect public records of lien balances D) recompute mortgage interest expense

2) The auditor can best verify an entity's bond sinking fund transactions and year-end balance by: A) recomputation of interest expense, interest payable, and amortization of bond discount or premium.

B) confirmation with individual holders of retired bonds.

C) confirmation with the bond trustee.

D) examination and count of the bonds retired during the year.

3) A control which ensures that long-term borrowing is properly initiated by appropriate individuals is an example of what type of control: A) segregation of duties.

B) authorization.

C) reconciliation.

D) review.

4) The auditor's program for the examination of long-term debt should include steps that require the:

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A) verification of the existence of the bond holders.

B) examination of any bond agreement.

C) inspection of the accounts payable subsidiary ledger.

D) investigation of credits to the bond interest income account.

5)

Accuracy, valuation, and allocation is most likely an issue for long-term debt if: A) bonds are sold on the open market.

B) bonds are issued at a discount or premium.

C) the loans are from banks.

D) the company has many short-term leases.

6) Reviewing notes paid or renewed after the balance sheet date to determine if there are unrecorded liabilities at year-end can be used to test the assertion of: A) existence.

B) completeness.

C) rights and obligations.

D) accuracy, valuation, and allocation.

7)

All corporate capital stock transactions should ultimately be vouched to the: A) minutes of the board of directors.

B) cash receipts journal.

C) cash disbursements journal.

D) numbered stock certificates.

8)

A substantive strategy is typically used to audit stockholders' equity because:

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A) the number of transactions is small.

B) controls over stockholders' equity transactions typically are weak.

C) a reliance strategy is most efficient.

D) a substantive strategy likely was used in prior years.

9) An auditor usually obtains evidence of stockholders' equity transactions by reviewing the entity's: A) minutes of the board of directors' meetings.

B) transfer agent's records.

C) canceled stock certificates.

D) treasury stock certificate book.

10) The auditor is concerned with establishing that dividends are paid to stockholders of the entity owning stock as of the: A) issue date.

B) declaration date.

C) record date.

D) payment date.

11) The auditor gathers evidence about dividends that are declared and paid primarily because of: A) concerns with violations of corporate bylaws or debt covenants.

B) the large dollar value of the transactions.

C) the ease with which the transactions can be audited.

D) fraud concerns.

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12) In the audit of a medium-sized manufacturing concern, which one of the following areas can be expected to require the least amount of audit time?

A) retained earnings B) revenue C) assets D) liabilities

13) In connection with the examination of bonds payable, an auditor would expect to find in a bond agreement: A) the issue date and maturity date of the bond.

B) the names of the original subscribers to the bond issue.

C) the yield to maturity of the bonds issued.

D) the company's debt-to-equity ratio at the time of issuance.

14) During the year under audit, a company has completed a private placement of a substantial amount of bonds. Which of the following would the auditor use to test the completeness assertion in the auditor's program for the audit of bonds payable?

A) confirming the interest rate with the bond trustee B) tracing the cash received from the issue to the accounting records C) examining the bond agreement for a sinking fund provision D) recomputing the annual interest cost and the effective yield

15) A company issued bonds for cash during the year under audit. To ascertain that this transaction was properly recorded, the auditor's best course of action is to:

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A) request a statement from the bond trustee as to the amount of the bonds issued and outstanding.

B) confirm the results of the issuance with the underwriter or investment banker.

C) trace the cash received from the issuance to the accounting records.

D) verify that the net cash received is credited to an account entitled "Bonds Payable."

16) During its fiscal year, a company issued, at a discount, a substantial amount of bonds.

When performing audit work in connection with the bond issue, the independent auditor should: A) confirm the existence of the bond holders.

B) review the board of directors' minutes for authorization.

C) trace the net cash received from stock issuance to the stockholders’ equity account.

D) inspect the records maintained by the bond trustee.

17) During the course of an audit, a CPA's substantive analytical procedure calculates an expected interest expense that is significantly higher than the amount recorded in the entity's accounting records. This observation would most likely lead the auditor to suspect that: A) the entity failed to record all debt.

B) the face value of the bonds is misstated.

C) interest income is overstated.

D) the entity failed to record all interest expense.

18) During an examination of a public company, the auditor should obtain written confirmation regarding bond transactions from the: A) transfer agent.

B) entity's attorney.

C) internal auditors.

D) trustee.

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19)

In auditing long-term bonds payable, an auditor most likely would: A) perform analytical procedures on the bond premium and discount accounts.

B) examine documentation of assets purchased with bond proceeds for liens.

C) compare interest expense with the bonds payable amount for reasonableness.

D) confirm the existence of individual bond holders at year-end.

20) Which audit procedure is most closely related to management's assertion regarding presentation of liabilities?

A) tracing cash received from a bond issue to the accounting records B) confirmation with the bond trustee of amounts owed on a private placement of bonds C) reviewing loan contracts for restrictive covenants that must be disclosed D) testing a sample of receipts and payments

21) If recorded interest expense is higher than the auditor's expectation calculated using recorded debt, all of the following are potential explanations except that: A) the entity failed to record debt.

B) debt was recorded as equity.

C) the entity used the face interest rate to calculate interest expense on a bond issued at a discount.

D) the entity used the face interest rate to calculate interest expense on a bond issued at a premium.

22) Reviewing interest expense to examine payments to debt holders not listed on the debt analysis schedule is a procedure that can be used to test the audit assertion of:

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A) occurrence.

B) completeness.

C) cutoff.

D) accuracy.

23) During the course of an audit, a CPA observes that the recorded interest expense seems to be excessive in relation to the balance in the long-term debt account. This observation could lead the auditor to suspect that: A) long-term debt is understated.

B) amortization of the discount on bonds payable is overstated.

C) long-term debt is overstated.

D) amortization of the premium on bonds payable is understated.

24) Two months before year-end, the bookkeeper erroneously recorded the receipt of a longterm bank loan by a debit to cash and a credit to sales. Which of the following is the most effective procedure for detecting this type of error?

A) Analysis of the notes payable journal.

B) Analysis of bank confirmation information.

C) Preparation of a year-end bank reconciliation.

D) Preparation of a year-end bank transfer schedule.

25)

Examining cancelled stock certificates addresses the assertion of: A) occurrence B) presentation C) cutoff D) completeness

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26)

An audit of stockholders' equity ordinarily should include: A) tracing individual dividend payments to the capital stock records.

B) reviewing minutes of board meetings to determine the number of shares outstanding.

C) confirming shares outstanding with state officials.

D) determining that dividend declarations comply with debt agreements.

27) Which audit procedure is most closely related to management's assertions about the presentation of stockholders' equity?

A) determining whether restrictions have been imposed on retained earnings B) counting treasury stock certificates C) inspecting minutes of the board of directors to verify that cash dividends were declared D) establishing that treasury stock is valued at cost

28) An audit program for the examination of the retained earnings account should include a step that requires verification of the: A) gain or loss resulting from disposition of treasury shares.

B) market value used to charge retained earnings to account for a two-for-one stock split.

C) authorization for both cash and stock dividends.

D) approval of the adjustment to the beginning balance as a result of a write-down of an account receivable.

29) Which of the following transactions is an auditor most likely to examine when auditing the retained earnings account?

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A) changing from one method of depreciation to another B) adjusting the percentage used to estimate the allowance for doubtful accounts C) changing the useful life of an asset D) correcting an error in depreciation in a prior year

30) Before expressing an opinion concerning the results of operations, the auditor would most likely proceed with the examination of the income statement by: A) applying a rigid measurement standard designed to test for understatement of net income.

B) analyzing the beginning and ending balance sheet inventory amounts.

C) making net income comparisons to published industry trends and ratios.

D) examining income statement accounts concurrently with the related balance sheet accounts.

31) Many of Granada Corporation's convertible bond holders have converted their bonds into stock during the year under examination. The independent auditor should review Granada Corporation's statement of cash flows to ascertain that it shows: A) only cash used to reduce convertible debt.

B) only cash provided by issuance of stock.

C) cash provided by the issuance of stock and used to reduce convertible debt.

D) nothing relating to the conversion because it does not affect cash.

32) Which of the following is an important consideration of an auditor when examining the stockholders' equity section of an entity's balance sheet?

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A) Changes in the capital stock account are verified by an independent stock transfer agent.

B) Stock dividends and/or stock splits during the year under audit were approved by the stockholders.

C) Stock dividends are capitalized at par or stated value on the dividend declaration date.

D) Entries in the capital stock account can be vouched to a resolution in the minutes of the board of directors' meetings.

33) Overall analysis of income statement accounts may bring to light errors, omissions, and inconsistencies not disclosed in the overall analysis of balance sheet accounts. The income statement analysis can best be accomplished by comparing: A) income statement ratios to balance sheet ratios.

B) revenue and expense account balances to the monthly reported net income.

C) income statement ratios to published industry averages.

D) revenue and expense account totals to the corresponding figures of the preceding years.

34) Of the following, which is an important procedure that an auditor should use when making an overall review of the income statement?

A) obtain a schedule of the retained earnings activity for the period B) compare actual revenues and expenses with the corresponding figures of the previous year and investigate significant differences C) obtain, from the proper entity representative, inventory certificates for the beginning and ending inventory amounts that were used to determine cost of sales D) ascertain that the net income amount in the statement of cash flows agrees with the net income amount in the income statement

35) You have been assigned the duty of auditing long-term debt and retained earnings for Keys, Incorporated Describe the tests you would use to support management's assertions regarding presentation for these accounts.

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36) Erik Rekdahl, senior-in-charge, is auditing Koonce Katfood, Incorporated's long-term debt for the year ended December 31. Long-term debt is composed of two bond issues, which are due in 10 and 15 years, respectively. The debt is held by two insurance companies. Rekdahl has examined the bond agreements for each issue. The agreements provide that if Koonce fails to comply with the covenants of the contract, the debt becomes payable immediately. Rekdahl identified the following covenants when reviewing the bond agreements: ● "The debtor company shall endeavor to maintain a working capital ratio of 2 to 1 at all times, and in any fiscal year following a failure to maintain said ratio, the company shall restrict compensation of officers to a total of $650,000. Officers include the chairperson of the board and the president." ● "The debtor company shall keep all property that is security for these debt agreements insured against loss by fire to the extent of 100 percent of its actual value. Policies of insurance comprising this protection shall be filed with the trustee." ● "The company is required to restrict 40 percent of retained earnings from availability for paying dividends." ● "A sinking fund shall be established with the First Morgan Bank of Austin, and semiannual payments of $500,000 shall be deposited in the fund. The bank may, at its discretion, purchase bonds from either issue."a.Provide any audit steps that Rekdahl should conduct to determine if the company is in compliance with the bond indentures. b.List any reporting requirements that the financial statements or footnotes should include.

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37) For each of the following substantive procedures, first note whether it is a test of details of transactions or a test of details of account balances. Then decide for which assertion the test provides the best evidence.

1.Trace large cash receipts and payments to the general ledger.

2.Examine copies of note, bond, and financing lease agreements.

3.Recompute accrued interest payable.

4.Review debt activity for a few days before and after year-end to determine whether transactions are included in the proper period.

5.Examine due dates on notes and bonds for proper classification between current and long-term debt.

38)

Identify the three major types of transactions that occur in stockholders' equity.

39) Identify the four major assertions made regarding stockholders' equity and describe one control activity for each.

40) Give an example of how the audit of income statement accounts could be affected by results of audit work done in other areas of the audit.

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41) What kind of information would typically be found on an income statement account analysis working paper? What kind of tests can an auditor perform using this information? Why would an auditor conduct additional analysis on an income statement account?

42)

Notes receivable is a common type of long-term financing. ⊚ true ⊚ false

43)

Long-term borrowing should be properly authorized. ⊚ true ⊚ false

44) One major issue associated with long-term debt is the classification of the short-term portion of long-term debt that is due in the next year. ⊚ true ⊚ false

45) For most companies, stockholders' equity only includes the following three accounts: preferred stock, paid-in capital, and retained earnings. ⊚ true ⊚ false

46) Three types of transactions usually occur in stockholders' equity: issuance of stock, repurchase of stock, and payment of dividends. ⊚ true ⊚ false

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47) The repurchase of stock includes the reacquisition of stock (treasury stock), but not the retirement of stock. ⊚ true ⊚ false

48) The registrar is responsible for preparing stock certificates and maintaining adequate stockholders' records. ⊚ true ⊚ false

49) Substantive analytical procedures can be used extensively to test revenue and expense accounts. ⊚ true ⊚ false

50)

Income statement accounts must be accounted for in accordance with GAAP. ⊚ true ⊚ false

51) When auditing capital-stock accounts, the cutoff assertion is the most important to consider. ⊚ true ⊚ false

52) The occurrence assertion is being tested when the auditor vouches stock repurchases to the canceled stock certificates.

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⊚ ⊚

true false

53) There are a number of disclosure items that need to be considered for stockholders' equity. ⊚ true ⊚ false

54)

Generally, all dividends that are declared and paid will be audited. ⊚ true ⊚ false

55) The auditor typically begins an audit of retained earnings by obtaining a schedule of account activity for the period. ⊚ true ⊚ false

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Answer Key Test name: ch 15 1) C 2) C 3) B 4) B 5) B 6) B 7) A 8) A 9) A 10) C 11) A 12) A 13) A 14) B 15) C 16) B 17) D 18) D 19) C 20) C 21) C 22) B 23) A 24) B 25) A 26) D Version 1

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27) A 28) C 29) D 30) D 31) D 32) D 33) D 34) B 42) FALSE 43) TRUE 44) TRUE 45) FALSE 46) TRUE 47) FALSE 48) FALSE 49) TRUE 50) TRUE 51) FALSE 52) TRUE 53) TRUE 54) TRUE 55) TRUE

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Student name:__________ 1) Which of the following internal controls most likely would reduce the risk of diversion of customer receipts by an entity's employees?

A) a bank lockbox system B) prenumbered remittance advices C) monthly bank reconciliations D) daily deposit of cash receipts

2)

The least crucial element of internal control over cash is: A) separation of cash record-keeping from custody of cash.

B) preparation of the monthly bank reconciliation.

C) batch processing of checks.

D) separation of cash receipts from cash disbursements.

3) Which of the following audit procedures is the most appropriate when internal control over cash is weak or when an entity requests an investigation of cash transactions?

A) proof of cash B) bank reconciliation C) cash confirmation D) evaluate ratio of cash to current liabilities

4) An unrecorded check issued during the last week of the year would most likely be discovered by the auditor when the: A) check register for the last month is reviewed.

B) cutoff bank statement is reconciled.

C) bank confirmation is reviewed.

D) search for unrecorded liabilities is performed.

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5) Which of the following is one of the better auditing techniques that might be used by an auditor to detect kiting between intercompany banks?

A) review the composition of authenticated deposit slips B) review subsequent bank statements received directly from the banks C) prepare an interbank transfer schedule D) prepare year-end bank reconciliations

6)

An interbank transfer schedule: A) is another name for the proof of cash.

B) helps the auditor test for kiting.

C) is on a standard bank confirmation.

D) is used to examine entity bank reconciliations.

7)

If fraud is suspected, auditors may complete all of the following procedures except:

A) testing for kiting.

B) footing the bank reconciliation and the outstanding checks listing.

C) performing a proof of cash.

D) performing extended bank reconciliation procedures, including detailed examination of reconciling items.

8) Of the following, which is the most efficient audit procedure for verification of interest earned on bond investments?

A) tracing interest declarations to an independent record book B) recomputing interest earned using the interest rate and bond amount C) confirming the interest rate with the issuer of the bonds D) vouching the receipt and deposit of interest checks

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9) To satisfy the accuracy, valuation, and allocation assertion when auditing an investment, an auditor most likely would: A) inspect the stock certificates evidencing the investment.

B) examine the audited financial statements of the investee company.

C) review the broker's advice or canceled check for the investment's acquisition.

D) obtain market quotations from financial newspapers, periodicals, or electronic outlets.

10) An auditor usually tests the reasonableness of dividend income from investments in stock of public companies by computing the amounts that should have been received by referring to: A) comparisons of current-year dividend income with the reported income from prior years.

B) stock indentures published by corporate transfer agents.

C) stock ledgers maintained by independent registrars.

D) annual audited financial statements issued by the investee companies.

11) Which of the following pairs of accounts would an auditor most likely analyze on the same working paper?

A) notes receivable and interest income B) accrued interest receivable and accrued interest payable C) notes payable and notes receivable D) interest income and interest expense

12) In confirming with an outside agent, such as a financial institution, that the agent is holding investment securities in the entity's name, an auditor most likely gathers evidence in support of management's financial statement assertions regarding:

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A) existence.

B) rights and obligations.

C) completeness.

D) existence, rights and obligations, and completeness.

13) All of the following can assist the auditor in testing the existence assertion for investment securities except: A) physical examination.

B) comparing fair value to cost.

C) confirmation with the issuer.

D) confirmation with the custodian.

14)

An imprest cash account is: A) used for investing in marketable securities.

B) the principal cash account for an entity.

C) one that contains a stipulated amount of money and is used for limited purposes.

D) the principal checking account for a branch of an entity.

15) An auditor ordinarily should send a standard confirmation request to all banks with which the entity has done business during the year under audit, regardless of the year-end balance, because this procedure: A) provides for confirmation regarding compensating balance arrangements.

B) detects kiting activities that may not otherwise be discovered.

C) seeks information about indebtedness to the bank.

D) verifies securities held by the bank in safekeeping.

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16) Tracing a sample of remittance advices to entries in the cash receipts journal tests which of the following assertions for cash?

A) occurrence B) completeness C) presentation D) cutoff

17) Examining a sample of cancelled checks for an authorized signature tests which of the following types of control?

A) authorization B) reconciliation C) custody D) physical security

18) The cashier of Brooke Company covered a shortage in the cash working fund with cash obtained on December 31 from a local bank by cashing, but not recording, a check drawn on the company's out-of-town bank. How would the auditor discover this manipulation?

A) Confirming all December 31 bank balances.

B) Counting the cash working fund at the close of business on December 31.

C) Preparing independent bank reconciliations as of December 31.

D) Preparing and detail testing an interbank transfer schedule.

19) An auditor who is engaged to examine the financial statements of a business enterprise will request a cutoff bank statement primarily to: A) verify the cash balance reported on the bank confirmation inquiry form.

B) verify reconciling items on the entity's bank reconciliation.

C) detect lapping.

D) detect kiting.

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20) An auditor should trace interbank transfers for the last part of the audit period and first part of the subsequent period to detect whether: A) the cash receipts journal was held open for a few days after the year-end.

B) the last checks recorded before the year-end were actually mailed by the year-end.

C) cash balances were overstated because of kiting.

D) any unusual payments to or receipts from related parties occurred.

21) To gather evidence regarding the balance per bank in a bank reconciliation, an auditor would examine all of the following except the: A) cutoff bank statement.

B) year-end bank statement.

C) bank confirmation.

D) general ledger.

22)

A primary purpose of the proof of cash is to:

A) prevent fraud.

B) reconcile actual cash receipts and disbursements to budgeted receipts and disbursements.

C) investigate variances from expected cash balances.

D) ensure that all cash receipts recorded in the cash receipts journal were deposited in the bank account.

23) A company has additional temporary funds to invest. The Board of Directors decided to purchase marketable securities and assigned the future purchase and sale decisions to a responsible financial executive. The best person(s) to make periodic reviews of the investment activity authorized by that executive should be:

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A) an investment committee of the Board of Directors.

B) the chief operating officer.

C) the corporate controller.

D) the treasurer.

24) Which of the following controls would an entity most likely use in safeguarding against the loss of marketable securities?

A) An independent custodian that has no direct contact with the employees who have recordkeeping responsibilities has possession of the securities.

B) The internal auditor verifies the marketable securities in the entity's safe each year on the balance sheet date.

C) The independent auditor traces all purchases and sales of marketable securities through the subsidiary ledgers to the general ledger.

D) A designated member of the board of directors controls the securities in a bank safedeposit box.

25) Which of the following procedures most likely would give the greatest assurance that securities held as investments are safeguarded?

A) There is no access to securities between the year-end and the date of the auditor's security count.

B) Proceeds from the sale of investments are received by an employee who does not have access to securities.

C) Investment acquisitions are authorized by a member of the Board of Directors before execution.

D) When securities are held by the entity, they are stored in a safe or safe-deposit box and periodically inspected.

26) When an entity uses a trust company as custodian of its marketable securities, the possibility of concealing fraud most likely would be reduced if the:

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A) trust company has no direct contact with the entity employees responsible for maintaining investment accounting records.

B) securities are registered in the name of the trust company, rather than the entity itself.

C) interest and dividend checks are mailed directly to an entity employee who is authorized to sell securities.

D) trust company places the securities in a bank safe-deposit vault under the custodian's exclusive control.

27) In a manufacturing company, which one of the following audit procedures would give the least assurance for the existence of the general ledger balance of investment in stocks and bonds at the audit date?

A) confirmation from the broker B) inspection and count of stocks and bonds C) reconciling information contained in the broker confirmation with the entity’s investment record D) examination of canceled checks issued in payment of securities purchased

28) The auditor should insist that a representative of the entity be present during the physical examination of securities in order to: A) lend authority to the auditor's directives.

B) detect forged securities.

C) coordinate the return of all securities to proper locations.

D) acknowledge the receipt of securities returned.

29) Which of the following is not one of the auditor's primary objectives in an examination of marketable securities?

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A) to determine whether securities are authentic B) to determine whether securities are the property of the entity C) to determine whether securities actually exist D) to determine whether securities are properly classified on the balance sheet

30) Jones was engaged to examine the financial statements of Virginia Corporation for the year ended June 30. Having completed an examination of the investment securities, which of the following is the best method of verifying the accuracy of recorded dividend income?

A) tracing recorded dividend income to cash receipts records and validated deposit slips B) utilizing analytical procedures and statistical sampling C) comparing recorded dividends with amounts appearing on federal information forms 1099 D) comparing recorded dividends with a standard financial reporting service's record of dividends

31) An entity has a large and active investment portfolio that is kept in a bank safe-deposit box. If the auditor is unable to examine and count the securities at the balance sheet date but will examine and count the securities shortly thereafter, the auditor most likely will: A) request that the bank confirm to the auditor the contents of the safe-deposit box at the balance sheet date.

B) examine supporting evidence for transactions occurring during the year.

C) count the securities at a subsequent date and confirm with the bank whether securities were added or removed since the balance sheet date.

D) request that the entity have the bank seal the safe-deposit box until the auditor can count the securities at a subsequent date.

32) In establishing the existence and ownership of a long-term investment in stock of a publicly traded company, an auditor should inspect the securities or:

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A) correspond with the investee company to verify the number of shares owned.

B) inspect the audited financial statements of the investee company.

C) confirm the number of shares owned that are held by an independent custodian.

D) determine that the investment is carried at fair value.

33) Examining brokers' advices for a sample of securities purchased during the year is a test for the assertion of: A) completeness.

B) presentation.

C) accuracy, valuation, and allocation.

D) rights and obligations.

34) Under which of the following circumstances would an auditor be most likely to intensify an examination of a $1,000 petty cash fund maintained on an imprest basis?

A) Reimbursement vouchers are not prenumbered.

B) Reimbursement of the fund from the general cash account occurs twice or more each week.

C) The custodian occasionally uses the cash fund to cash employee checks.

D) The custodian endorses reimbursement checks.

35) As one of the year-end audit procedures, the auditor instructed the entity's personnel to prepare a standard bank confirmation request for a bank account that had been closed during the year. After the entity's treasurer had signed the request, it was mailed to the bank by the assistant treasurer. What is the major flaw in this audit procedure?

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A) The confirmation request was signed by the treasurer.

B) Sending the request was meaningless because the account was closed before the yearend.

C) The request was mailed by the assistant treasurer.

D) The CPA did not sign the confirmation request before it was mailed.

36) One purpose of sending a standard confirmation request to financial institutions with which the entity has done business during the year is to: A) detect kiting activities that may otherwise not be discovered.

B) corroborate information regarding deposit and loan balances.

C) provide the data necessary to prepare a proof of cash.

D) request information about contingent liabilities and secured transactions.

37) Which of the following control activities would an entity most likely use to assist in satisfying the completeness assertion related to long-term investments?

A) Senior management verifies that securities in the bank safe-deposit box are registered in the entity's name.

B) Maintenance of a securities ledger that records all securities owned by the entity.

C) The treasurer vouches the acquisition of securities by comparing brokers' advices with canceled checks.

D) The controller compares the current market prices of recorded investments with the brokers' advices on file.

38) Which of the following controls would a company most likely use to safeguard marketable securities when an independent trust agent is not employed?

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A) The investment committee of the board of directors periodically reviews the investment decisions delegated to the treasurer.

B) There is periodic inspection of securities in a safe or safe-deposit box by an individual independent of both the custodial and accounting responsibilities for securities.

C) The internal auditor and the controller independently trace all purchases and sales of marketable securities from the subsidiary ledgers to the general ledger.

D) The chairman of the board verifies the marketable securities, which are kept in a bank safe-deposit box, each year on the balance sheet date.

39) When there is a large number of negotiable securities in multiple locations, careful planning of the physical inspection and count of the securities by the auditor is necessary to guard against: A) unauthorized negotiation of the securities before they are counted.

B) unrecorded sales of securities after they are counted.

C) substitution of securities already counted at one location for other securities that should be on hand at a different location but are not.

D) substitution of authentic securities with counterfeit securities.

40) When an auditor is unable to inspect and count an entity's investment securities until after the balance sheet date, the bank where the securities are held in a safe-deposit box should be notified on or before the balance sheet date that it will be asked to: A) verify any differences between the contents of the box and the balances in the entity's subsidiary ledger.

B) provide a list of securities added and removed from the box between the balance sheet date and the security-count date.

C) confirm that there has been no access to the box between the balance sheet date and the security-count date.

D) count the securities in the box so that the auditor will have an independent direct verification.

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41) Which of the following procedures would be important in the audit of an investment valued at fair value?

A) Compare the balance in the investment account to the prior year.

B) Read the footnote disclosure related to the investment.

C) Inquire of management regarding the accuracy and reliability of the underlying data.

D) Develop an independent estimate of the fair value measurement.

42) Auditors will need to perform more substantive tests than normal to obtain sufficient appropriate evidence that a financial instrument is fairly stated if which of the following conditions exist?

A) Management is objective and transparent in their assumptions.

B) Management's key assumptions are subject to volatility.

C) The entity's portfolio is composed of only stocks issued by Fortune 100 firms traded in an active market.

D) The entity does not have control weaknesses in its valuation processes.

43)

Explain how cash plays a role in all business processes.

44) For each assertion about cash listed below, give an example of a test of transactions for (1) cash receipts and (2) cash disbursements. a.Classification. b.Occurrence. c.Authorization. d.Completeness.

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45) Explain the importance of the bank reconciliation to the audit and list some of the items found on the reconciliation.

46) Identify 3 of the 6 tests an auditor uses on the bank reconciliation.

(Only 3 are required for the student's answer)

47) You are auditing cash for Moonbeam, Inc. In meeting with the CFO during the planning stages of the audit, she indicated that there was a high risk of misstatement due to fraud in the cash account, given the lack of proper segregation of duties. As the auditor, what tests could you perform to detect fraudulent activities in the cash account?

48) The first step in auditing petty cash is to gain an understanding of the entity's controls over petty cash. Describe some important controls an entity should have over its petty cash fund.

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49) For each test of transactions and each test of account balances for investments listed below, identify the assertion for which the test provides evidence.

1.Determine whether there has been any permanent impairment in the value of the cost basis of an individual security.

2.Inspect securities if they are maintained by the entity or obtain a confirmation from an independent custodian.

3.Search for purchases of securities by examining transactions for a few days after year-end.

4.Examine brokers' advices for a sample of securities purchased during the year.

50) What should an auditor look for when testing for proper classification and presentation of securities?

51) What are the factors that must be considered to determine if a permanent decline in the value of an investment security has occurred?

52)

The cash account is affected by all of the entity's business processes. ⊚ true ⊚ false

53)

The general cash account is normally the principal account used to disburse payroll. ⊚ true ⊚ false

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54) An imprest cash account is used for specific purposes and contains a stipulated amount of money. ⊚ true ⊚ false

55)

The auditor's use of analytical procedures for auditing cash is limited. ⊚ true ⊚ false

56) A major control that directly affects the audit of cash is the bank reconciliation prepared by the auditor. ⊚ true ⊚ false

57) A cutoff bank statement is used to verify the propriety of the reconciling items shown on the bank reconciliation. ⊚ true ⊚ false

58)

Kiting is an audit procedure used to test the accuracy of the cash receipts. ⊚ true ⊚ false

59)

It is generally more efficient to follow a substantive strategy for auditing investments. ⊚ true ⊚ false

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60) If the entity maintains custody of its investments, the auditor normally examines the actual securities. ⊚ true ⊚ false

61) Level 1 inputs are more risky and difficult to audit than Level 3 inputs to a valuation model. ⊚ true ⊚ false

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Answer Key Test name: ch 16 1) A 2) C 3) A 4) B 5) C 6) B 7) B 8) B 9) D 10) A 11) A 12) D 13) B 14) C 15) C 16) B 17) A 18) D 19) B 20) C 21) D 22) D 23) A 24) A 25) D 26) A Version 1

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27) D 28) D 29) A 30) D 31) D 32) C 33) D 34) B 35) C 36) B 37) B 38) B 39) C 40) C 41) D 42) B 52) TRUE 53) FALSE 54) TRUE 55) TRUE 56) FALSE 57) TRUE 58) FALSE 59) TRUE 60) TRUE 61) FALSE

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Student name:__________ 1) When auditing contingent liabilities, which of the following procedures would be least effective?

A) reading the minutes of the board of directors B) obtaining a letter of audit inquiry from the entity’s attorneys C) examining customer confirmation replies D) examining invoices for legal services

2) When obtaining evidence regarding litigation against an entity, the CPA would be least interested in determining: A) an estimate of when the matter will be resolved.

B) the period in which the underlying cause of the litigation occurred.

C) the probability of an unfavorable outcome.

D) an estimate of the potential loss.

3) The auditor's primary means of obtaining corroboration of management's information concerning litigation is a: A) letter of audit inquiry to the entity's lawyer.

B) letter of corroboration from the auditor's lawyer upon review of the legal documentation.

C) confirmation of claims and assessments from the other parties to the litigation.

D) confirmation of claims and assessments from an officer of the court presiding over the litigation.

4) An auditor should obtain evidential matter relevant to all the following factors concerning third-party litigation against an entity except the:

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A) period in which the underlying cause for legal action occurred.

B) probability of an unfavorable outcome.

C) jurisdiction in which the matter will be resolved.

D) existence of a situation indicating an uncertainty as to the possible loss.

5)

An auditor will ordinarily examine invoices from lawyers primarily to: A) substantiate accruals.

B) assess the legal ramifications of litigation in progress.

C) estimate the dollar amount of contingent liabilities.

D) identify actual or potential litigation against the entity.

6) If a lawyer refuses to furnish corroborating information regarding litigation, claims, and assessments, the auditor should: A) honor the confidentiality of the client-lawyer relationship.

B) consider the refusal to be a scope limitation.

C) seek to obtain the corroborating information from management.

D) disclose this fact in a footnote to the financial statements.

7) The refusal of an entity's attorney to provide information requested in the letter of audit inquiry is generally: A) sufficient reason to issue a "subject to" qualified opinion.

B) considered to be a scope limitation.

C) insufficient reason to modify the auditor's report because of the attorney's obligation of confidentiality.

D) proper grounds to withdraw from the engagement without further consideration.

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8) Which of the following material events occurring subsequent to the balance sheet date would require an adjustment to the financial statements before they could be issued?

A) sale of long-term debt or capital stock B) loss of a plant as a result of a flood C) major purchase of a business that is expected to double sales volume D) settlement of litigation, in excess of the previously recorded liability

9) Which of the following situations would require adjustment to or disclosure in the financial statements?

A) a merger discussion B) the application for a patent on a new production process C) discussions with a customer that could lead to a 40 percent increase in the entity's sales if agreement is successful D) the bankruptcy of a customer who regularly purchased 30 percent of the company's output

10)

An example of a Type I subsequent event is:

A) a tornado that destroys an entity's factory after the balance sheet date.

B) an event after the balance sheet date that confirms the auditor's belief (documented prior to the end of the entity's fiscal year) that a large portion of the entity's inventory is obsolete.

C) notification of an IRS audit after the balance sheet date.

D) the entity's Board of Directors unexpectedly resigns after the balance sheet date.

11) An auditor issued an audit report that was dual dated for a subsequent event that occurred after the completion of fieldwork but before issuance of the auditor's report. The auditor's responsibility for events occurring subsequent to the completion of fieldwork was:

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A) limited to the specific event referenced.

B) limited to include only events occurring before the date of the last subsequent event referenced.

C) extended to subsequent events occurring through the date of issuance of the report.

D) extended to include all events occurring since the completion of fieldwork.

12) Which of the following procedures should an auditor generally perform regarding subsequent events?

A) Compare the latest available interim financial statements issued after year-end with the financial statements being audited.

B) Send second requests to the entity's customers who failed to respond to initial accounts receivable confirmation requests.

C) Communicate material weaknesses in internal controls to those charged with governance.

D) Review the cutoff bank statements for several months after year-end.

13) The purpose of analytical procedures at the completion of the audit includes all of the following except: A) revising the audit plan.

B) assessing the conclusions reached on the financials statement components.

C) evaluating the overall financial statement presentation.

D) recalculating some of the ratios examined during audit planning to evaluate how these ratios may have been affected by audit adjustments.

14)

Which of the following auditing procedures is ordinarily performed last?

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A) confirming accounts payable B) testing the purchasing function C) reading the minutes of directors' meetings for evidence of authorization of acquisition of fixed assets D) obtaining a management representation letter

15)

The date of the management representation letter generally coincides with the: A) date of the latest subsequent event referred to in the notes to the financial statements.

B) balance sheet date.

C) date of the auditor's report.

D) date of the engagement agreement.

16) Which of the following items should an auditor communicate to those charged with governance in a publicly traded company?

A) significant unusual transactions, critical estimates, and management's consultation with other accountants about significant accounting matters B) significant unusual transactions and critical estimates, but not management's consultation with other accountants about significant accounting matters C) management's consultation with other accountants about significant accounting matters but not significant unusual transactions and critical estimates D) neither significant unusual transactions, critical estimates, nor management's consultation with other accountants about significant accounting matters

17)

The management letter is used: A) to allow management to document, in writing, oral representations to the auditor.

B) to confirm the terms of the audit engagement.

C) to list all reportable conditions with respect to internal controls.

D) to make recommendations to the entity based on observations made during the audit.

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18)

Generally, loss contingencies that are judged to be remote: A) should be disclosed in the footnotes.

B) should be recorded in the financial statements.

C) should not be disclosed in the footnotes.

D) should be recorded in the financial statements and the footnotes.

19) Which of the following procedures would an auditor most likely perform to obtain evidence about an entity's subsequent events?

A) Reconcile bank activity for the month after the balance sheet date with cash activity reflected in the accounting records.

B) Ask legal counsel about any developments relating to litigation, claims, or assessments against the company.

C) Review the treasurer's monthly reports on temporary investments owned, purchased, and sold.

D) Examine on a test basis the purchase invoices and receiving reports for several days after the inventory date.

20) Which of the following procedures would an auditor ordinarily perform during the review of subsequent events?

A) an analysis of related party transactions for the discovery of possible irregularities B) a review of the cut-off bank statements for the period after the year-end C) a reading of the available minutes of meetings of stockholders, directors, or other committees for the subsequent-events period D) an investigation of material weaknesses in internal control previously communicated to the entity

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21) Which of the following is not an audit procedure that the independent auditor would perform with respect to litigation, claims, and assessments in audit procedures for subsequent events and contingent liabilities?

A) Inquire of and discuss with management the policies and procedures adopted for identifying, evaluating, and accounting for litigation, claims, and assessments.

B) Obtain a letter of audit inquiry from the entity’s attorneys.

C) Obtain a written representation from management that all litigation, asserted and unasserted claims, and assessments have been disclosed.

D) Confirm directly with the entity's attorneys that all claims have been recorded in the financial statements.

22) An attorney is responding to an independent auditor as a result of the entity's letter of inquiry. The attorney may appropriately limit the response to: A) asserted claims and litigation.

B) matters to which the attorney has given substantive attention in the form of legal consultation or representation.

C) asserted, overtly threatened, or pending claims and litigation.

D) items that have an extremely high probability of being resolved to the entity's detriment.

23) Which of the following is generally requested in a letter of audit inquiry sent to the entity’s attorneys?

A) a request that the attorney comment on unasserted claims where his or her views differ from management's evaluation B) a list of all attorneys that performed any work for the entity during the year C) a statement indicating that the attorney is responsible for the fair presentation of unasserted claims in the entity's financial statements D) a request that the attorney provide a copy of all invoices given to the entity during the year

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24) Which of the following subsequent events will be least likely to result in an adjustment to the financial statements?

A) culmination of events affecting the realization of accounts receivable owned as of the balance sheet date B) culmination of events affecting the realization of inventories owned as of the balance sheet date C) material changes in the settlement of liabilities that were estimated as of the balance sheet date D) material changes in the quoted market prices of listed investment securities since the balance sheet date

25) Subsequent events for which the auditor has a responsibility to actively search are defined as events that occur subsequent to the: A) balance sheet date.

B) date of the auditor's report.

C) balance sheet date but prior to the issuance of the financial statements.

D) date of the auditor's report and concern contingencies that are not reflected in the financial statements.

26) An auditor is concerned with completing various phases of the examination after the balance sheet date. This "subsequent period" involving formal audit procedures extends to the date of the: A) issuance of the financial statements.

B) final review of the audit work papers.

C) auditor’s report.

D) delivery of the auditor's report to the entity.

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27) A major customer of an entity suffers a fire after year-end, but just prior to completion of audit fieldwork. The entity believes that this event could have a significant direct effect on the financial statements. The auditor should: A) advise management to disclose the event in the notes to the financial statements.

B) disclose the event in the auditor's report.

C) withhold submission of the auditor's report until the extent of the direct effect on the financial statements is known.

D) advise management to adjust the financial statements.

28) If an auditor dates the auditor's report on financial statements for the year ended December 31, 20X3, as of February 10, 20X4, except for Note J, as to which the date is March 3, 20X4, the auditor is acknowledging responsibility to actively search for and ensure proper handling by management of: A) all subsequent events occurring through March 3, 20X4.

B) all subsequent events occurring through February 10, 20X4.

C) all subsequent events occurring through February 10, 20X4 and the specific subsequent event referred to in Note J through March 3, 20X4.

D) only the specific subsequent event referred to in Note J as of March 3, 20X4.

29) Harvey, CPA, is preparing an audit program for the purpose of ascertaining the occurrence of subsequent events that may require adjustment or disclosure essential to a fair presentation of the financial statements in conformity with generally accepted accounting principles. Which one of the following procedures would be least appropriate for this purpose?

A) Confirm, as of the completion of fieldwork, accounts receivable that have increased significantly from the year-end date.

B) Read the minutes of the board of directors.

C) Inquire of management concerning events that may have occurred.

D) Ask legal counsel about any developments relating to litigation, claims, or assessments against the company.

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30)

A Type II subsequent event usually requires: A) an adjustment to the financial statements and the footnotes.

B) an adjustment to the financial statements but no special disclosure is required.

C) disclosure in the footnotes.

D) neither an adjustment to the financial statements nor disclosure in the footnotes.

31) After fieldwork audit procedures are completed for a public company and private company whose financial statements are expected to be widely distributed, a partner of the CPA firm who has not been involved in the audit performs an engagement quality review of the work papers. This review focuses on: A) an evaluation of the significant judgments made by the engagement teams and the conclusions reached in formulating the audit report.

B) irregularities involving the entity's management and its employees.

C) the materiality of the adjusting entries proposed by the audit staff.

D) the communication of internal control weaknesses to those charged with governance.

32) Which of the following ratios is least likely to assist the auditor in determining whether the entity is experiencing financial difficulties?

A) net worth/total liabilities B) cash/total assets C) total liabilities/total assets D) net income before taxes/net sales

33) As part of an audit, a CPA requests a management representation letter from the entity.

Which one of the following is not a valid purpose of such a letter?

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A) to provide audit evidence B) to emphasize to the entity their responsibility for the fairness of the financial statements C) to satisfy himself or herself that a certain account balance is fairly stated when certain customary auditing procedures are not performed D) to provide possible protection to the CPA against a charge of knowledge in cases where fraud is subsequently discovered to have existed in the accounts

34) Which of the following expressions is least likely to be included in a management representation letter?

A) No events have occurred subsequent to the balance sheet date that require adjustment to or disclosure in the financial statements.

B) The company has complied with all aspects of contractual agreements that would have a material effect on the financial statements in the event of noncompliance.

C) Management acknowledges responsibility for illegal actions committed by its employees.

D) Management has made available all financial statements and related data.

35) "There are no violations or possible violations of laws or regulations whose effects should be considered for disclosure in the financial statements or as a basis for recording a loss contingency." The foregoing passage most likely is from a(an): A) entity engagement letter.

B) report on compliance with laws and regulations.

C) management representation letter.

D) attestation report on internal controls.

36) Which of the following matters is an auditor required to communicate to those charged with governance?

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A) The basis for assessing control risk at low.

B) The disagreements with management, if any.

C) The auditor's preliminary judgments about materiality levels.

D) The justification for performing substantive procedures at interim dates.

37) "There have been no communications from regulatory agencies concerning noncompliance with or deficiencies in, financial reporting practices that could have a material effect on the financial statements." The foregoing passage is most likely from a: A) report on internal control.

B) special report.

C) management representation letter.

D) letter for underwriters.

38) A written representation from an entity's management that, among other matters, acknowledges responsibility for the fair presentation of financial statements should normally be signed by the: A) chief executive officer and the chief financial officer.

B) chief financial officer and the chairman of the board of directors.

C) chairman of the audit committee of the board of directors.

D) chief executive officer, the chairman of the board of directors and the entity's lawyer.

39) Communications between the auditor and those charged with governance should include all of the following except: A) a summary of specific audit procedures used.

B) a summary of uncorrected misstatements.

C) consultations with other accountants.

D) major issues discussed with management before the auditor was retained.

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40) Which of the following events occurring after the issuance of an entity's financial statements and the auditor's report most likely would cause the auditor to make further inquiries about the previously issued financial statements?

A) An uninsured natural disaster occurs that may affect the entity's ability to continue as a going concern.

B) A contingency is resolved that had been disclosed in the audited financial statements.

C) New information is discovered concerning undisclosed lease transactions in the audited period.

D) A subsidiary that accounts for 25 percent of the entity's consolidated net income is sold.

41) On February 25, a CPA issued an auditor's report expressing an unqualified opinion on financial statements for the year ended January 31. On March 2, the CPA learned that, on February 11, the entity incurred a material loss on an uncollectible trade receivable as a result of the ongoing deterioration of the financial condition of the entity's principal customer, which finally led to the customer's bankruptcy. Management then refused to adjust the financial statements for this subsequent event. The CPA determined that the information is reliable and that there are creditors currently relying on the financial statements. The CPA's next course of action most likely would be to: A) notify the entity's creditors that the financial statements and the related auditor's report should no longer be relied upon.

B) notify each member of the entity's board of directors about management's refusal to adjust the financial statements.

C) issue revised financial statements and distribute them to each creditor known to be relying on the financial statements.

D) issue a revised auditor's report and distribute it to each creditor known to be relying on the financial statements.

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42) After an audit report containing an unqualified opinion on a nonpublic entity's financial statements is issued with the entity’s financial statements, the auditor learns that the entity has decided to sell the shares of a subsidiary that accounts for 30 percent of its revenue and 25 percent of its net income. The auditor should: A) determine whether the information is reliable and, if it is determined to be reliable, request that revised financial statements be issued.

B) notify the entity that the auditor's report may no longer be associated with the financial statements.

C) describe the effects of this subsequently discovered information in communications with persons known to be relying on the financial statements.

D) take no action because the auditor has no obligation to make any further inquiries.

43) An entity has violated a minor requirement of its bond indenture that could result in the trustee requiring immediate payment of the principal amount due. The entity refuses to seek a waiver from the bond trustee. Request for immediate payment is not considered likely. Under these circumstances, the auditor must: A) require classification of bonds payable as a current liability.

B) contact the bond trustee directly.

C) evaluate whether there is substantial doubt about the entity’s ability to continue as a going concern if immediate payment of the principal is required.

D) obtain an opinion from the company's attorney as to the likelihood of the trustee's enforcement of the requirement.

44) The primary reason an auditor requests letters of audit inquiry be sent to an entity's attorneys is to provide the auditor with:

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A) a description and evaluation of litigation, claims, and assessments that existed at the date of the balance sheet.

B) an expert opinion as to whether a loss is possible, probable, or remote.

C) the opportunity to examine the documentation concerning litigation, claims, and assessments.

D) corroboration of the information furnished by management concerning litigation, claims, and assessments.

45) Which of the following statements extracted from an entity's lawyer's letter concerning litigation, claims, and assessments most likely would cause the auditor to request clarification?

A) "I believe that the possible liability to the company is nominal in amount."

B) "I believe that the action can be settled for less than the damages claimed."

C) "I believe that the plaintiff's case against the company is without merit."

D) "I believe that the company will be able to defend this action successfully."

46) An auditor's decision concerning whether or not to "dual date" the audit report is based upon the auditor's willingness to: A) extend auditing procedures.

B) accept responsibility for all events between year-end and the audit report date.

C) permit inclusion of a footnote captioned: event (unaudited) subsequent to the date of the auditor's report.

D) assume responsibility for events subsequent to the issuance of the auditor's report.

47)

A Type I subsequent event usually requires: A) an adjustment to the financial statements.

B) no adjustment to the financial statements.

C) withdrawal from the engagement.

D) no action.

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48) A disclosure of a contingent liability in the footnotes is made rather than adjusting the financial statement accounts when: A) the outcome of the event is judged to be probable and the loss can be reasonably estimated.

B) the loss can be reasonably estimated, but the outcome is unknown.

C) the outcome of the event is judged to be reasonably possible or the loss cannot be reasonably estimated.

D) the outcome is unknown and the loss is reasonably estimable but the entity does not want to book the loss.

49) Which of the following statements ordinarily is included among the written management representations obtained by the auditor?

A) Compensating balances and other arrangements involving restrictions on cash balances have been disclosed.

B) Management acknowledges responsibility for illegal actions committed by employees.

C) Sufficient evidential matter has been made available to permit the issuance of an unqualified opinion.

D) Management acknowledges that there are no material misstatements in the internal controls.

50) Which of the following statements is correct about an auditor's required communication with management and those charged with governance?

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A) Any matters communicated to those charged with governance are also required to be communicated to the entity's management.

B) The auditor is required to discuss considerations relating to assessment of going concern.

C) The auditor does not have any requirement to communicate with anyone outside of management.

D) Deficiencies in internal control previously reported to those charged with governance are required to be communicated to those charged with governance after each subsequent audit.

51) Which of the following statements is correct concerning an auditor's required communication with those charged with governance?

A) This communication is required to occur before the auditor's report on the financial statements is issued.

B) This communication should provide timely observations arising from the audit that are significant to the financial reporting process.

C) Any significant matter communicated to those charged with governance also should be communicated to management.

D) Significant audit adjustments proposed by the auditor and recorded by management need not be communicated to those charged with governance.

52) For which of the following matters should an auditor obtain written management representations?

A) management's cost-benefit justifications for not correcting internal control weaknesses B) management's knowledge of future plans that may affect the price of the entity's stock C) management's addressing control deficiencies communicated to the audit committee during previous engagements D) management's acknowledgment of its responsibility for employees' violations of laws

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53) After issuance of the financial statements and the accompanying auditor's report, the auditor has no obligation to make any further inquiries with respect to audited financial statements covered by an auditor's report unless: A) a lawsuit in which risk of loss was considered remote is resolved in the company's favor.

B) a development occurs that may affect the entity's ability to continue as a going concern.

C) a material fraud is initiated by an employee after the report is issued.

D) evidence of significant, non-arms-length, related party transactions that happened prior to year-end is discovered.

54) After the financials have been issued with an accompanying audit report on a nonpublic entity, there is no obligation to make any further audit tests or inquiries with respect to the audited financial statements covered by that report unless: A) new information comes to the auditor's attention concerning an event that occurred prior to the date of the auditor's report that may have affected the auditor's report.

B) material adverse events occur after the date of the auditor's report.

C) final determination or resolution was made on matters that had resulted in a qualification in the auditor's report.

D) final determination or resolution was made of a contingency that had been disclosed in the financial statements and no liability arose from the resolution.

55) When a question arises about an entity's continued existence, the auditor should consider factors tending to mitigate the significance of negative information concerning the entity's means for maintaining adequate cash flow. An example of such a factor is the: A) possibility of purchasing certain assets rather than leasing them.

B) capability of extending the due dates of existing debt.

C) appropriateness of changing depreciation methods from double declining balance to straight line.

D) marketability of property and equipment that management plans to keep.

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56) The adverse effects of events causing an auditor to believe there is substantial doubt about an entity's ability to continue as a going concern would most likely be mitigated by evidence relating to the: A) ability to expand operations into new product lines in the future.

B) feasibility of plans to purchase leased equipment at less than market value.

C) marketability of assets that management plans to sell.

D) committed arrangements to convert preferred stock to long-term debt.

57) Which of the following auditing procedures most likely would assist an auditor in identifying conditions and events that may indicate substantial doubt about an entity's ability to continue as a going concern?

A) Inspecting title documents to verify whether any assets are pledged as collateral.

B) Confirming with third parties the details of arrangements to maintain financial support.

C) Reconciling the cash balance per books with the cut-off bank statement and the bank confirmation.

D) Comparing the entity's depreciation and asset capitalization policies to other entities in the industry.

58) Which of the following conditions or events most likely would cause an auditor to have substantial doubt about an entity's ability to continue as a going concern?

A) Cash flows from operating activities are negative.

B) Research and development projects are postponed.

C) Significant related party transactions are pervasive.

D) Stock dividends replace annual cash dividends.

59) Which of the following conditions or events most likely would cause an auditor to have substantial doubt about an entity's ability to continue as a going concern?

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A) Significant related party transactions are pervasive.

B) Usual trade credit from suppliers is denied.

C) Arrearages in preferred stock dividends are paid.

D) Restrictions on the disposal of principal assets are present.

60) When a CPA is approached to perform an audit for the first time, the CPA should make inquiries of the predecessor auditor. This is a necessary procedure because the predecessor may be able to provide the successor with information that will assist the successor in determining: A) whether the predecessor's work should be utilized.

B) whether, in the predecessor's opinion, the financial statements are materially correct.

C) whether, in the predecessor's opinion, the company's internal controls have been satisfactory.

D) whether the engagement should be accepted.

61) Pretty People Incorporated is the defendant in a pending discrimination lawsuit. What information about the lawsuit would you, as an auditor, need to know to decide whether to disclose the litigation in the financial statements?

62) Define the term "contingent liability" and discuss the criteria used to classify these events or conditions. Provide some examples of contingent liabilities.

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63) From the list below, select the procedures that an auditor would use to test for contingent liabilities. a.Inquire of SEC officials regarding reported violations by the entity that create claims. b.Read the entity's contracts, loan agreements, leases, and other documents. c.Read the entity's minutes of meetings of shareholders, directors, and committees. d.Request a representation letter from all the entity's employees. e.Read the legal briefs of all suits filed against the entity's competitors. f.Request the entity's management to prepare a letter of audit inquiry to the entity's attorney regarding pending litigation against the entity.

64) While auditing other business processes, an auditor may identify information about contingent liabilities. What specific audit procedures relating to other business processes could uncover these liabilities?

65)

What information is typically requested in a letter of audit inquiry to an entity's attorney?

66)

What is the difference between a contingent liability and a commitment?

67) Identify the two primary types of subsequent events that require consideration by management and evaluation by the auditor and give two examples of each type.

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68) Discuss the steps used by an auditor to evaluate an entity's ability to continue as a going concern.

69) Discuss the internal control communication requirements of the PCAOB. What must auditors of public companies report to those charged with governance?

70)

State the two primary purposes of the management representation letter.

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71) The fieldwork for the December 31, 20X8 audit of Pumpkin Corporation ended on March 13, 20X9. The financial statements and auditor's report were issued and mailed to stockholders on March 23, 20X9. In each of the situations below, select from the list at the end of the problem the appropriate action to be taken by the auditor. Assume all situations are material.

Situations:1.On April 5, 20X9, you discovered that on February 16, 20X9, a flood destroyed the entire uninsured inventory in one of Pumpkin's warehouses.

2.On February 17, 20X9, you discovered that on February 16, 20X9, a flood destroyed the entire uninsured inventory in one of Pumpkin's warehouses.

3.On February 17, 20X9, you discovered that on November 30, 20X8, a flood destroyed the entire uninsured inventory in one of Pumpkin's warehouses.

4.On April 5, 20X9, you discovered that on March 30, 20X9, a fire destroyed one of Pumpkin's 10 plants.

5.On April 7, 20X9, you discovered that a debtor of Pumpkin went bankrupt on January 6, 20X9.

6.On January 16, 20X9, a lawsuit was filed against Pumpkin for a patent infringement action that allegedly took place in early 20X8. In the opinion of Pumpkin's attorneys, there is a reasonable (but not probable) danger of a significant loss to Pumpkin.

7.On February 19, 20X9, Pumpkin settled a lawsuit out of court that had originated in 20X8 and is currently listed as a contingent liability.

Possible Actions:a.Adjust the December 31, 20X8 financial statements. b.Disclose the information in a footnote in the December 31, 20X8 financial statements. c.Request the entity revise and reissue the December 31, 20X8 financial statements. The revision should involve an adjustment to the December 31, 20X8 financial statements. d.Request the entity revise and reissue the December 31, 20X8 financial statements. The revision should involve the addition of a footnote, but no adjustment, to the December 31, 20X8 financial statements. e.No action is required.

72)

Every contingent liability must be recorded. ⊚ true ⊚ false

73)

An example of a contingent liability is an income tax dispute.

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⊚ ⊚

true false

74) Reading contracts and loan agreements is one way to identify unrecorded contingent liabilities. ⊚ true ⊚ false

75) A letter of audit inquiry sent to the entity’s attorneys will include an evaluation all contingent liabilities of the company. ⊚ true ⊚ false

76) Type II subsequent events are conditions that require an adjustment to the account balance shown on the financial statements. ⊚ true ⊚ false

77) An example of a Type I event or condition is the settlement of a lawsuit after the balance sheet date for an amount different from the amount recorded in the year-end financial statements. ⊚ true ⊚ false

78) An example of a Type II event or condition is an uncollectible account receivable resulting from deterioration in a customer's financial condition prior to year end, about which the entity is unaware. The customer declares bankruptcy after the balance sheet date but prior to the issuance of the financial statements. ⊚ true ⊚ false

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79)

Dual dating is used to identify unrecorded contingent liabilities. ⊚ true ⊚ false

80) The auditor must perform final analytical procedures before deciding on the appropriate audit report to issue for the entity. ⊚ true ⊚ false

81) If there is substantial doubt about the entity's ability to continue as a going concern, the auditor should obtain information about the management's plans to mitigate the problem and assess the likelihood that such plans can be implemented. ⊚ true ⊚ false

82) The responsibility to assess the entity's ability to continue as a going concern rests solely with the auditor. ⊚ true ⊚ false

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Answer Key Test name: ch 17 1) C 2) A 3) A 4) C 5) D 6) B 7) B 8) D 9) D 10) B 11) A 12) A 13) A 14) D 15) C 16) A 17) D 18) C 19) B 20) C 21) D 22) B 23) A 24) D 25) C 26) A Version 1

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27) A 28) C 29) A 30) C 31) A 32) B 33) C 34) C 35) C 36) B 37) C 38) A 39) A 40) C 41) B 42) D 43) C 44) D 45) B 46) A 47) A 48) C 49) A 50) B 51) B 52) C 53) D 54) A 55) B 56) C Version 1

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57) B 58) A 59) B 60) D 72) FALSE 73) TRUE 74) TRUE 75) FALSE 76) FALSE 77) TRUE 78) FALSE 79) FALSE 80) TRUE 81) TRUE 82) FALSE

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Student name:__________ 1) Which of the following parties is responsible for the fairness of the representations made in financial statements?

A) entity's management B) independent auditor C) audit committee D) AICPA

2) Which of the following situations will not result in modification of the auditor's report because of a scope limitation?

A) restriction imposed by the client B) reliance placed on the report of another auditor C) inability to obtain sufficient appropriate evidential matter D) restriction caused by the circumstance of the engagement

3) When the audited financial statements of the prior year are presented together with those of the current year, the continuing auditor's report should cover: A) both years.

B) only the current year.

C) only the current year, but the prior year's report should be presented.

D) only the current year, but the prior year's report should be referred to.

4) Management believes, and the auditor is satisfied, that a material loss probably will occur when pending litigation is resolved. Management is unable to make a reasonable estimate of the amount or range of the potential loss, but fully discloses the situation in the notes to the financial statements. If the auditor wishes to call attention to the matter and management does not make an accrual in the financial statements, the auditor should issue a(an):

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A) qualified report due to a scope limitation.

B) qualified report due to a departure from GAAP. C) unqualified report with an emphasis paragraph.

D) standard unmodified auditor's report.

5) For which of the following events would an auditor issue a report that does not include any reference to comparability?

A) a change in the method of accounting for inventories B) a change from an accounting principle that is not generally accepted to one that is generally accepted C) a change in the service life used to calculate depreciation expense D) a correction of a material misstatement in previously issued financial statements

6) If the auditor believes that there is minimal likelihood that resolution of an uncertainty will have a material effect on the financial statements, the auditor would issue a(n): A) "except for" opinion.

B) adverse opinion.

C) unqualified opinion.

D) disclaimer of opinion.

7) When comparative financial statements are presented, the auditor’s report should be considered to apply to the financial statements of the: A) periods presented plus the one preceding period.

B) current period only.

C) current period and those of the other periods presented.

D) current and immediately preceding period only.

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8) A predecessor auditor should complete the following before reissuing a report on statements presented on a comparative basis: A) read the financial statements of the current period.

B) read the financial statements of the past five years.

C) obtain a letter of representations from the current-year, successor auditor.

D) read the financial statements of the current period, compare prior-period financial statements with the current-year financial statements, and obtain letters of representation from the management of the entity and from the current-year, successor auditor.

9) In connection with the examination of the consolidated financial statements of Mott Industries, Frazier, CPA, plans to refer to another CPA's examination of the financial statements of a subsidiary company. Under these circumstances, Frazier's report must disclose: A) the name of the other CPA and the type of report issued by the other CPA. B) the division of responsibility and magnitude of the portion of the financial statements audited by the other auditor.

C) the nature of Frazier's review of the other CPA's work.

D) in a footnote the portions of the financial statements that were covered by the examinations of both auditors.

10) If the principal auditor decides to make reference to the other auditor's audit, the opinion section must specifically indicate the: A) portion of the financial statements examined by the other auditor.

B) name of the other auditor.

C) name of the consolidated subsidiary examined by the other auditor.

D) type of opinion expressed by the other auditor.

11) Which of the following would be considered a change that affects consistency and requires an explanatory paragraph?

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A) change in accounting estimate B) change in accounting principle C) change in classification from one acceptable classification to another D) all of the options are correct.

12) An auditor was unable to obtain audited financial statements or other evidence supporting an entity's material investment in a large foreign subsidiary. Between which of the following reports should the auditor choose?

A) adverse and unqualified with an explanatory or emphasis paragraph added B) disclaimer and unqualified with an explanatory or emphasis paragraph added C) qualified and adverse D) qualified and disclaimer

13) An auditor includes a separate paragraph in an otherwise unmodified report to emphasize that the entity being reported on had significant transactions with related parties. The inclusion of this separate paragraph: A) is considered an "except for" qualification of the opinion.

B) violates generally accepted auditing standards if this information is already disclosed in footnotes to the financial statements.

C) necessitates a revision of the opinion paragraph to include the phrase "with the foregoing explanation."

D) is appropriate and would not negate the unqualified opinion.

14) When the auditor is unable to determine the amounts associated with the illegal acts of entity personnel because of an inability to obtain adequate evidence, the auditor should issue a(n):

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A) "subject to" qualified opinion.

B) disclaimer of opinion.

C) adverse opinion.

D) unqualified opinion with a separate explanatory or emphasis paragraph.

15) When the entity fails to include information that is necessary for the fair presentation of financial statements in the body of the statements or in the related footnotes, it is the responsibility of the auditor to present the nature and impact of the faulty accounting or misstatement in the auditor's report and express a(n): A) qualified opinion or a disclaimer of opinion.

B) qualified opinion or an adverse opinion.

C) adverse opinion or a disclaimer of opinion.

D) qualified opinion or an unqualified opinion.

16)

When an auditor expresses an adverse opinion, the opinion paragraph should include:

A) the principal effects of the departure from generally accepted accounting principles.

B) a statement that the financial statements do not present fairly.

C) the substantive reasons for the financial statements being misleading.

D) a description of the uncertainty or scope limitation that prevents an unqualified opinion.

17)

An auditor would issue an adverse opinion if:

A) the audit was begun by other independent auditors who withdrew from the engagement.

B) a qualified opinion cannot be given because the auditor lacks independence.

C) a restriction on the scope of the audit was significant.

D) the statements taken as a whole do not fairly present the financial condition and results of operations of the company.

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18) Other bases of accounting (special purpose frameworks) include all of the following except: A) tax basis.

B) non-GAAP methods used for internal reporting.

C) cash basis.

D) regulatory basis.

19)

Which of the following would be considered a change that does not affect comparability?

A) change in accounting estimate B) change in accounting principle C) correction of a material misstatement in previously issued financial statements D) none of these are considered changes that do not affect comparability

20) Abbot, CPA, as principal auditor for consolidated financial statements, is using a qualified report of another auditor. Abbot does not consider the qualification material relative to the consolidated financial statements and Abbot is willing to accept responsibility for the work of the other auditor. What recognition, if any, must Abbot make in his report to the report of the other audit?

A) He need make no reference.

B) He must refer to the qualification of the other auditor and qualify his report likewise.

C) He must include the other auditor's report with his report but need not qualify his report.

D) He must include the other auditor's report with his report and give an explanation of its significance.

21) The predecessor auditor, after properly communicating with the successor auditor, has reissued a report because the entity desires comparative financial statements. The predecessor auditor's report should make: Version 1

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A) no reference to the report or the work of the successor auditor.

B) reference to the work of the successor auditor in the scope paragraph.

C) reference to both the work and the report of the successor auditor in the opinion paragraph.

D) reference to the report of the successor auditor in the scope paragraph.

22) In the auditor's report, the principal auditor decides not to make reference to another CPA who audited an entity's subsidiary. The principal auditor could justify this decision if, among other requirements, the principal auditor: A) issues an unqualified opinion on the consolidated financial statements.

B) learns that the other CPA issued an unqualified opinion on the subsidiary's financial statements.

C) is unable to review the other CPA's audit programs and working papers.

D) is satisfied as to the other CPA's independence and professional reputation.

23) An auditor concludes that there is substantial doubt about an entity's ability to continue as a going concern for a reasonable period of time. If the entity's financial statements adequately disclose its financial difficulties, the auditor's report is required to include an explanatory paragraph that specifically uses the phrase(s): A) "reasonable period of time, not to exceed one year" and "going concern."

B) "reasonable period of time, not to exceed one year" but not "going concern."

C) "going concern" but not "reasonable period of time, not to exceed one year."

D) neither "going concern" nor "reasonable period of time, not to exceed one year."

24) Comparative financial statements include the financial statements of a prior period that were examined by a predecessor auditor whose report is not presented. If the predecessor auditor's report was qualified, the successor auditor must:

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A) obtain written approval from the predecessor auditor to include the prior year's financial statements.

B) issue a standard comparative audit report indicating the division of responsibility.

C) express an opinion on the current year statements alone and make no reference to the prior year statements.

D) disclose the nature of and reasons for any qualification in the predecessor auditor's opinion.

25) When an auditor concludes there is substantial doubt about an entity's ability to continue as a going concern for a reasonable period of time, the auditor's responsibility is to: A) prepare prospective financial information to verify whether management's plans can be effectively implemented.

B) project future conditions and events for a period of time not to exceed one year following the date of the financial statements.

C) issue a qualified or adverse opinion, depending upon materiality, because of the possible effects on the financial statements.

D) consider the adequacy of disclosure about the entity's possible inability to continue as a going concern.

26) If a public company issues financial statements that purport to present its financial position and results of operations but omits the statement of cash flows, the auditor ordinarily will express a(an): A) disclaimer of opinion.

B) qualified opinion.

C) review report.

D) unqualified opinion with a separate explanatory paragraph.

27) Auditing standards define special purpose financial statements as including those prepared under the following base(s):

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A) regulatory basis.

B) tax basis.

C) contractual basis.

D) regulatory basis, tax basis, and contractual basis.

28) When reporting on comparative financial statements where the financial statements of the prior year have been examined by a predecessor auditor whose report is not presented, the successor auditor should make: A) no reference to the predecessor auditor.

B) reference to the predecessor auditor only if the predecessor auditor expressed a qualified opinion.

C) reference to the predecessor auditor only if the predecessor auditor expressed an unqualified opinion.

D) reference to the predecessor auditor in an explanatory paragraph regardless of the type of opinion expressed by the predecessor auditor.

29) Which of the following would not require an explanatory paragraph in the auditor's report?

A) Required supplementary information is omitted or departs materially from the requirement of the applicable financial reporting framework.

B) Lack of comparability in the financial statements due to accounting changes.

C) Going concern.

D) Significant litigation that the client has appropriately disclosed, but which represents a material risk of loss to the entity.

30) When are an auditor's reporting responsibilities not met by attaching an explanation of the circumstances and a disclaimer of opinion to the entity's financial statement?

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A) When the independent auditor with sufficient appropriate evidence believes the financial statements are not prepared in accordance with GAAP. B) When the auditor was unable to observe the taking of the physical inventory.

C) When the auditor is not independent.

D) When the auditor has performed insufficient auditing procedures to express an opinion.

31) A CPA who is not independent and is associated with financial statements should disclaim an opinion with respect to those financial statements. The disclaimer should: A) clearly state the specific reasons for lack of independence.

B) not mention any reason for the disclaimer other than that the CPA was unable to conduct the examination in accordance with generally accepted auditing standards.

C) not describe the reason for lack of independence but should state specifically that the CPA is not independent.

D) include a middle paragraph clearly describing the CPA's association with the entity and explaining why the CPA was unable to gather sufficient appropriate evidential matter to warrant the expression of an opinion.

32)

An auditor may reasonably issue an "except for" qualified opinion for: A) a scope limitation or an unjustified material accounting change.

B) a scope limitation, but not an unjustified material accounting change.

C) an unjustified material accounting change, but not a scope limitation.

D) neither an unjustified material accounting change nor a scope limitation.

33) The auditor's best course of action with respect to "other financial information" included in an annual report containing the auditor's report is to:

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A) indicate in the auditor's report that the "other financial information" is unaudited.

B) consider whether the "other financial information" is accurate by performing a limited review.

C) obtain written representations from management as to the material accuracy of the "other financial information."

D) read and consider the manner of presentation of the "other financial information."

34) When audited financial statements are presented in a document containing other information, the auditor: A) has an obligation to perform auditing procedures to corroborate the other information.

B) is required to issue an "except for" qualified opinion if the other information has a material misstatement of fact.

C) should read the other information to consider whether it is inconsistent with the audited financial statements.

D) has no responsibility for the other information because it is not part of the basic financial statements.

35) What is an auditor's responsibility for supplementary information, such as segment information, that is outside the basic financial statements, but required by the FASB? A) The auditor has no responsibility for required supplementary information as long as it is outside the basic financial statements.

B) The auditor's only responsibility for required supplementary information is to assist in preparing the supplementary information.

C) The auditor is required to read the other information and consider whether such information is consistent with the information in the financial statements.

D) The auditor should apply tests of details of transactions and balances to the required supplementary information and report any material misstatements in such information.

36) All of the following are true with respect to the auditor's consideration of information other than the audited financial statements that are included in an entity's annual report except: Version 1

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A) the auditor is under no obligation to perform audit procedures on this other information.

B) the auditor must consider whether the other information is consistent with the information contained in the audited financial statements.

C) the auditor must request that material inconsistencies be corrected.

D) the auditor must perform audit procedures on this other information.

37) When an auditor reports on financial statements prepared according to a comprehensive basis of accounting other than GAAP, the auditor's report should: A) have an explanatory paragraph added after the opinion paragraph to describe the framework.

B) disclaim an opinion on whether the statements were examined in accordance with generally accepted auditing standards.

C) not express an opinion on whether the statements are presented in conformity with the basis of accounting used.

D) include an explanation of how the results of operations differ from the cash receipts and disbursements basis of accounting.

38)

An engagement to express an opinion on a system of internal control will generally:

A) only require those procedures already applied in assessing control risk during a financial statement audit.

B) increase the reliability of the financial statements that have already been audited.

C) be more extensive in scope than the assessment of control risk made during a financial statement audit.

D) be more limited in scope than the assessment of control risk made during a financial statement audit.

39) When expressing an opinion on a specified account or item in the financial statements, the auditor need only consider that account or item. However, the auditor must have audited the entire set of financial statements if this engagement requires a report on the entity's: Version 1

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A) net income.

B) retained earnings.

C) assets.

D) working capital.

40)

A special report related to compliance with contractual provisions provides: A) positive assurance.

B) negative assurance.

C) no assurance.

D) none of these.

41) An auditor concludes that there is a material inconsistency in the other information in an annual report to shareholders containing audited financial statements. If the auditor concludes that the financial statements do not require revision, but the entity refuses to revise or eliminate the material inconsistency, the auditor may: A) issue an "except for" qualified opinion after discussing the matter with the entity's board of directors.

B) consider the matter closed since the other information is not in the audited financial statements.

C) disclaim an opinion on the financial statements after explaining the material inconsistency in a separate explanatory or emphasis paragraph.

D) revise the auditor's report to include a separate explanatory (or other matter) paragraph describing the material inconsistency.

42) Cravens was asked to perform the first audit of a wholesale business that does not maintain perpetual inventory records. Cravens has observed the current inventory but has not observed the physical inventory at the previous year-end date and concludes that the opening inventory balance, which is not auditable, is a material factor in the determination of cost of goods sold for the current year. Cravens will probably:

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A) decline the engagement.

B) express an unqualified opinion on the balance sheet and income statement except for inventory.

C) issue a disclaimer of opinion.

D) issue an adverse opinion.

43) When there has been a change in accounting principle that materially affects the comparability of the comparative financial statements presented for a public company and the auditor concurs with the change, the auditor should:

A. B. C. D.

Concur Explicitly In Issue an "Except for" Refer to the Change in the Change Qualified Opinion an Explanatory Paragraph No No Yes Yes No Yes Yes Yes No No Yes No

A) Option A. B) Option B. C) Option C. D) Option D.

44) In the first audit of an entity, because of the entity's record retention policies, an auditor was not able to gather sufficient evidence about the consistent application of accounting principles between the current and the prior year, as well as the amounts of assets or liabilities at the beginning of the current year. If the amounts in question could materially affect current operating results, the auditor would:

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A) be unable to express an opinion on the current year's results of operations and cash flows.

B) express a qualified opinion on the financial statements because of a client-imposed scope limitation.

C) withdraw from the engagement and refuse to be associated with the financial statements.

D) specifically state that the financial statements are not comparable to the prior year because of an uncertainty.

45) A scope limitation sufficient to preclude an unqualified opinion always will result when management: A) prevents the auditor from reviewing the working papers of the predecessor auditor.

B) engages the auditor after the year-end physical inventory is completed.

C) requests that certain material accounts receivable not be confirmed.

D) refuses to provide a representation letter acknowledging its responsibility for the fair presentation of the financial statements in conformity with GAAP.

46) In which of the following situations would an auditor ordinarily choose between expressing an "except for" qualified opinion and expressing an adverse opinion?

A) The auditor did not observe the entity's physical inventory and is unable to become satisfied as to its balance by other auditing procedures.

B) The financial statements fail to disclose information that is required by generally accepted accounting principles.

C) The auditor’s opinion is based in part on the report of another auditor.

D) Events disclosed in the financial statements cause the auditor to have substantial doubt about the entity's ability to continue as a going concern.

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47) In an engagement to express an opinion on one or more specified elements, accounts, or items of a financial statement, the auditor can generally audit only those specified elements and not the entire set of financial statements. However, the auditor is required to audit the entire set of financial statements if the elements specified include: A) net income.

B) stockholders' equity.

C) net income and stockholders' equity.

D) assets.

48) Jeff Johns is a staff accountant and has been assigned to the audit of Worldwide Enterprises, Incorporated Subsequent to the completion of fieldwork; Jeff was assigned to draft the audit report. The content of one of the paragraphs he has drafted reads as follows: As explained in Note 2 to the financial statements, Worldwide Enterprises has charged goodwill and certain other intangible assets acquired in two separate acquisitions directly to shareholders' equity. Under generally accepted accounting principles, these intangibles should have been recorded as assets. Had these intangibles been capitalized, total assets would have increased by $400,000 as of December 31, 20X1. a.Based on the contents of the paragraph above, which condition requiring a departure from a standard unqualified opinion exists in the engagement? b.Assuming that the engagement partner agrees with the paragraph Jeff has prepared above, where in the auditor's report should the paragraph be placed? c.How would the materiality of the condition above affect the final choice of opinion?

49) The following four situations require a modification to the standard unqualified audit report for public companies. Identify the modification required for each. a.Opinion based in part on the report of another auditor. b.Going concern. c.Lack of comparability. d.Emphasize a matter.

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50) Changes in an entity's accounting choices either affect consistency in the application of GAAP or they do not. For each item listed below, state whether the item affects consistency and identify the effect the change will have on the audit report.

1.Change in accounting estimate.

2.A change from the inappropriate use or application of accounting principle in prior years to an acceptable accounting principle in the current year.

3.A change from an incorrect to a correct classification of transactions or balances on the financial statements.

4.Reclassification from an acceptable classification to another.

5.Change in accounting principle.

6.An adjustment to account balances to correct a material error in previously issued financial statements.

51) For each of the following situations, indicate what type of audit report is most appropriate. a.The auditor lacks independence in fact, but not necessarily in appearance. b.There is a scope limitation and it is material but the overall financial statements are still presented fairly. c.The uncorrected misstatements are immaterial. d.There is a departure from GAAP and it is pervasively material.

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52) Identify the other comprehensive basis of accounting used in each of the following situations.

1.A real estate company reports to its partners on the basis used to complete the income tax return.

2.A company has its financial statements prepared on a price-level adjusted basis as required by its lender.

3.An insurance company reports in compliance with the rules of a state insurance commission.

4.A partnership reports on revenues received and expenses paid.

What modifications must be made to the non-public company standard auditor's report for these situations?

53) Discuss three circumstances that prohibit the auditor from issuing an unqualified or unmodified opinion and the types of reports that the auditor may issue for a financial statement audit because of these circumstances.

54) Discuss the enhancements implemented by the new PCAOB reporting standards for "listed" (public) entities.

55) A going concern issue requires an explanatory paragraph to be added to the standard unqualified audit report (public company). ⊚ true ⊚ false

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56) When the principal auditor decides to assume responsibility for the word of other auditors, an opinion based in part on the report of another auditor requires an explanatory paragraph be added to the standard unqualified audit report. ⊚ true ⊚ false

57) A basic assumption that underlies financial reporting is that an entity will continue as a going concern. ⊚ true ⊚ false

58) A change in accounting estimate is an example of an accounting change that affects comparability and requires an explanatory paragraph in the audit report. ⊚ true ⊚ false

59) A correction of a material misstatement in previously issued financial statements is an example of an accounting change that affects comparability and requires an explanatory paragraph in the audit report. ⊚ true ⊚ false

60) Changes that affect comparability but that do not involve a change in accounting principle or the correction of a misstatement (e.g., a change in accounting estimate) are normally disclosed in the footnotes but do not require an explanatory paragraph in the audit report. ⊚ true ⊚ false

61) An auditor may be unable to express an unqualified opinion if an immaterial departure from GAAP is present in the financial statements.

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⊚ ⊚

62)

true false

An auditor must disclaim an opinion when the auditor lacks independence. ⊚ true ⊚ false

63) The choice of which audit report to issue depends on the nature and the materiality of the condition giving rise to the departure from GAAP. ⊚ true ⊚ false

64) A scope limitation results from an inability to obtain sufficient appropriate evidence about some component of the financial statements. ⊚ true ⊚ false

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Answer Key Test name: ch 18 1) A 2) B 3) A 4) C 5) C 6) C 7) C 8) D 9) B 10) A 11) B 12) D 13) D 14) B 15) B 16) B 17) D 18) B 19) A 20) A 21) A 22) D 23) C 24) D 25) D 26) B Version 1

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27) D 28) D 29) D 30) A 31) C 32) A 33) D 34) C 35) C 36) D 37) A 38) C 39) A 40) B 41) D 42) C 43) A 44) A 45) D 46) B 47) C 55) TRUE 56) FALSE 57) TRUE 58) FALSE 59) TRUE 60) TRUE 61) FALSE 62) TRUE 63) TRUE Version 1

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64) TRUE

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Student name:__________ 1)

With respect to ethics, the rights-based approach: A) suggests that auditors should always verify ownership of a client's material tangible

assets.

B) is primarily concerned with equity and impartiality.

C) suggests that an individual's actions should not violate the rights of any individual.

D) recognizes that decisions involve trade-offs between costs and benefits.

2)

With respect to ethics, the utilitarian approach: A) suggests that auditors should always verify ownership of a client's material tangible

assets.

B) is primarily concerned with equity and impartiality.

C) suggests that an individual's actions should not violate the rights of any individual.

D) recognizes that decisions involve trade-offs between costs and benefits.

3)

With respect to ethics, the justice-based approach: A) suggests that auditors should always verify ownership of a client's material tangible

assets.

B) is primarily concerned with equity and impartiality.

C) suggests that an individual's actions should not violate the rights of any individual.

D) recognizes that decisions involve trade-offs between costs and benefits.

4) In auditing a publicly held company, an auditor must follow the professional standards established by all of the following except:

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A) The AICPA's Auditing Standards Board.

B) The SEC Independence Rules.

C) The AICPA’s Code of Professional Conduct.

D) The PCAOB Auditing Standards.

5) Which of the following is not a Principle of Professional Conduct as defined by the Code of Professional Conduct?

A) integrity B) due care C) reporting D) scope and nature of services

6)

For private companies, accounting firms are prohibited from providing: A) outsourced internal audit services.

B) audit services.

C) review services.

D) none of these.

7) A violation of the profession's ethical standards would most likely have occurred when a CPA: A) purchased a bookkeeping firm's practice of monthly write-ups for a percentage of fees received over a three-year period.

B) made arrangements with a bank to collect notes issued by a client in payment of fees due.

C) named Smith formed a partnership with two other CPAs and used "Smith & Company" as the firm name.

D) issued an unqualified opinion on the 20X1 financial statements when fees for the 20X0 audit were unpaid.

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8) Which of the following is required for a firm to designate itself as a "Member of the American Institute of Certified Public Accountants" on its letterhead?

A) At least one of the partners must be a member.

B) The partners whose names appear in the firm name must be members.

C) All CPA owners must be members of the institute.

D) The firm must be a dues-paying member.

9) A violation of the profession's ethical standards would least likely have occurred when a CPA in public practice: A) used a records-retention agency to store the CPA's working papers and client records.

B) served as an expert witness in a damage suit and received compensation based on the amount awarded to the plaintiff.

C) referred life insurance assignments to the CPA's spouse, who is a life insurance agent.

D) failed to file his personal tax return.

10) According to the Code of Professional Conduct, which of the following individuals is not in a position to influence an attest engagement (i.e., not a covered member)?

A) The office's managing partner (or partner equivalent) who determines the compensation of the attest engagement partner.

B) The office's IT expert partner, who consulted with the engagement partner (or partner equivalent) regarding the client's IT system and spent 15 hours on the engagement.

C) The partner (or partner equivalent) in another office in a nearby city who regularly plays golf with the engagement partner (or partner equivalent) and does not work on the engagement or have any interaction with the client.

D) The office's partner (or partner equivalent) who monitors quality management over the attest engagement.

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11) A CPA, while performing an audit, strives to achieve independence in appearance in order to: A) reduce risk and liability.

B) meet the minimum requirements of the code of professional conduct.

C) become independent in fact.

D) maintain public confidence in and reliance on the profession.

12) In which of the following instances would the independence of the CPA not be considered to be impaired? The CPA has been retained as the auditor of a brokerage firm: A) which owes the CPA audit fees for more than one year.

B) in which the CPA has a large active account.

C) in which the CPA's brother is the controller.

D) which owes the CPA audit fees for current year services and has just filed a petition for bankruptcy.

13) The SEC has issued independence rules that differ from the AICPA's in all of the following areas except: A) working paper documentation.

B) provision of other professional services.

C) human resource and compensation-related issues.

D) required communication.

14) Which of the following is not component of quality management as defined by Statement of Quality Management Standards No. 1?

A) monitoring and remediation process B) independence C) resources D) relevant ethical requirements

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15) A basic objective of a CPA firm is to provide professional services that conform to professional, legal, and regulatory requirements. Reasonable assurance of achieving this basic objective is provided through: A) compliance with generally accepted reporting standards.

B) a system of quality management.

C) a system of peer review.

D) continuing professional education.

16)

The quality management standards are concerned with: A) actions of individual auditors.

B) a firm's monitoring of its practice.

C) disciplinary actions against individual auditors.

D) preventing legal action.

17) Which of the following bodies ordinarily would have the authority to suspend or revoke a CPA's license to practice public accounting?

A) the SEC B) the AICPA C) a state CPA society D) a state board of accountancy

18) Which of the following statements best describes why the profession of certified public accountants has deemed it essential to promulgate a code of conduct and to establish a mechanism for enforcing observance of the code?

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A) Ethical standards are established so that users of accounting services know what to expect, the professionals know what behaviors are acceptable, and overseers can take disciplinary action when appropriate.

B) A prerequisite to success is the establishment of an ethical code that stresses primarily the professional's responsibility to clients and colleagues.

C) A requirement of most state laws calls for the profession to establish a code of conduct.

D) An essential means of self-protection for the profession is the establishment of flexible ethical standards by the profession.

19) A CPA's membership in the AICPA will ordinarily be suspended or revoked automatically for: A) controlling the bookkeeping for a compilation client.

B) conviction of willful failure to file personal income tax return.

C) refusing to respond to an inquiry by the AICPA practice review committee.

D) accepting compensation while honoring a subpoena to appear as an expert witness.

20)

A CPA's failure to file a tax return is: A) considered acceptable by the AICPA Code of Professional Conduct.

B) ill-advised because it would impair the CPA's independence with respect to attest

clients.

C) considered discreditable to the profession.

D) a violation of generally accepted auditing standards.

21)

Which of the following is allowable for a CPA?

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A) a used car loan from a banking client where the client has a lien on the car B) an uncollateralized signature loan from a client C) owning more than five percent of the outstanding shares of client stock in a retirement account D) the audit engagement partner (or partner equivalent) serves on the client's audit committee

22) In performing an audit, Jackson, CPA, discovers that the professional competence necessary for the engagement is lacking. Jackson informs management of the situation and recommends another local CPA firm and management engages this other firm. Under these circumstances, A) Jackson may request compensation from the other CPA firm for any professional services rendered to the other CPA firm in connection with the engagement.

B) Jackson may accept a referral fee from the other CPA firm.

C) Jackson has violated the AICPA Code of Professional Conduct because of nonfulfillment of the duty of performance.

D) Jackson's lack of competence should be construed to be a violation of generally accepted auditing standards.

23) In which one of the following situations would a CPA be in violation of the AICPA Code of Professional Conduct in determining a fee?

A) A fee based on whether the CPA's report on the client's financial statements results in the approval of a bank loan.

B) A fee based on an estimate of the number of hours needed to complete the engagement by auditors of various levels of experience.

C) A fee based on the nature of the service rendered and the CPA's particular expertise instead of the actual time spent on the engagement.

D) A fee based on the fee charged by the prior auditor.

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24) In connection with a lawsuit, a third party attempts to gain access to the auditor's working papers. The client's defense of privileged communication will be successful only to the extent it is protected by the: A) auditor's acquiescence in use of this defense.

B) common law.

C) AICPA Code of Professional Conduct.

D) state law.

25) The profession's ethical standards would most likely be considered to have been violated when the CPA represents that specific consulting services will be performed for a stated fee and it is apparent at the time of the representation that the: A) CPA would not be independent.

B) fee was a competitive bid.

C) actual fee would be substantially higher.

D) actual fee would be substantially lower than the fees charged by other CPAs for comparable services.

26) According to the ethical standards of the profession, which of the following acts is generally prohibited?

A) Issuing a modified report explaining a failure to follow a governmental regulatory agency's standards when conducting an attest service for a client.

B) Revealing confidential client information during a quality review of a professional practice by a team from the state CPA society.

C) Accepting a contingent fee for representing a client in an examination of the client's federal tax return by an IRS agent.

D) Retaining client records after an engagement is terminated prior to completion and the client has demanded their return.

27) According to the ethical standards of the profession, which of the following acts is generally prohibited?

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A) Purchasing a product from a third party and reselling it to a client.

B) Writing a financial management newsletter promoted and sold by a publishing company.

C) Accepting a commission for recommending a product to an audit client.

D) Accepting engagements obtained through the efforts of third parties.

28) In which of the following circumstances would a CPA who audits XM Corporation lack independence?

A) The CPA and XM's president are both on the board of directors of COD Corporation.

B) The CPA and XM's president each owns 25 percent of FOB Corporation, a closelyheld company.

C) The CPA has an automobile loan from XM, which is a savings and loan organization and the loan is collateralized by the automobile.

D) The CPA reduced XM's usual audit fee by 40 percent because XM's financial condition was unfavorable.

29) Mavis, CPA, has audited the financial statements of South Bay Sales Incorporated for several years and had always been paid promptly for services rendered. Last year's audit invoices have not been paid because South Bay is experiencing cash flow difficulties and the current year's audit is scheduled to commence in one week. With respect to the past due audit fees, Mavis should: A) perform the scheduled audit and allow South Bay to pay when the cash flow difficulties are alleviated.

B) perform the scheduled audit only after arranging a definite payment schedule and securing notes signed by South Bay. C) inform South Bay's management that the past due audit fees are considered an impairment of auditor independence.

D) inform South Bay's management that the past due audit fees may be considered a loan on which interest must be imputed for financial statement purposes.

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30) In which of the following instances would the independence of the CPA not be considered to be impaired? The CPA has been retained as the auditor of a: A) charitable organization in which an employee of the CPA serves as treasurer.

B) municipality in which the CPA owns $25,000 of the $2,500,000 indebtedness of the municipality.

C) restaurant where the CPA dines frequently.

D) company in which the CPA's private investment club owns a one-tenth interest.

31) A CPA firm's personnel partner periodically studies the CPA firm's personnel advancement experience to ascertain whether the individuals who were assigned increased degrees of responsibility met predetermined criteria. This is evidence of the CPA firm's adherence to prescribed standards of: A) quality management.

B) objectivity and independence.

C) supervision and review.

D) scope and nature of services.

32) A CPA firm would be reasonably assured of meeting its overall responsibility to provide services that conform with professional standards by: A) adhering to generally accepted accounting principles.

B) implementing an appropriate system of quality management.

C) joining professional societies that enforce ethical conduct.

D) maintaining an attitude of independence in its engagements.

33) Which of the following is an element of a CPA firm's quality management system that should be considered in establishing its quality management policies and procedures?

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A) using the audit risk model B) using statistical sampling techniques C) assigning personnel to engagements D) considering audit risk and materiality

34) What is a purpose of the acceptance and continuance of client relationships and specific engagements element of quality management?

A) Guarantee that firms do not associate with clients whose management lacks integrity.

B) Provide reasonable assurance that firms do not associate with clients whose management lacks integrity.

C) Guarantee that firms will not be sued as a result of association with a client.

D) Provide reasonable assurance that firms will not be sued as a result of association with a client.

35) In order to achieve effective quality management, a firm of independent auditors should establish policies and procedures for: A) determining the minimum procedures necessary for unaudited financial statements.

B) setting the scope of audit work.

C) deciding whether to accept or continue a client.

D) setting the scope of internal control study and evaluation.

36) A CPA firm evaluates its personnel advancement experience to ascertain whether individuals assigned to increased degrees of responsibility meet predetermined criteria. This policy is evidence of the firm's adherence to which of the following prescribed standards?

A) professional ethics B) supervision and review C) accounting and review services D) quality management

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37) A major purpose of establishing quality management policies and procedures for deciding whether to accept a new client is to: A) enable the CPA firm to attest to the reliability of the client.

B) satisfy the CPA firm's duty to the public concerning the acceptance of new clients.

C) minimize the likelihood of association with clients whose management lacks integrity.

D) anticipate before performing any fieldwork whether an unqualified opinion can be expressed.

38) Following the issuance of a PCAOB draft report, how many days does the CPA firm have to respond to accusations?

A) 10 days B) 30 days C) 50 days D) 90 days

39) who:

A violation of the profession's ethical standards would most likely occur when a CPA

A) is also admitted to the Bar represents on letterhead to be both an attorney and a CPA. B) writes a newsletter on financial management also permits a publishing company to solicit subscriptions by direct mail.

C) is controller of a bank permits the bank to use the controller's CPA title in the listing of officers in its publications.

D) refused to hire a new employee does so because the CPA deemed the candidate to be "too old."

40) In determining estimates of fees, an auditor may take into account each of the following, except the:

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A) value of the service to the client.

B) degree of responsibility assumed by undertaking the engagement.

C) skills required to perform the service.

D) attainment of specific findings.

41) An auditor is about to commence a recurring annual audit engagement. The continuing auditor's independence would ordinarily be considered to be impaired if the prior year's audit fee: A) was unusually large.

B) has not been paid and will not be paid for at least twelve months.

C) has not been paid and the client has filed a voluntary petition for bankruptcy.

D) was renegotiated during the prior year audit based on the need for expanded testing.

42) In which of the following circumstances would a CPA be bound by ethics to refrain from disclosing any confidential information obtained during the course of a professional engagement?

A) The CPA is issued a summons enforceable by a court order that orders the CPA to present confidential information.

B) A major stockholder of a client company seeks accounting information from the CPA after management declined to disclose the requested information.

C) Confidential client information is requested as part of a quality review of the CPA's practice by a review team authorized by the AICPA. D) An inquiry by a disciplinary body of a state CPA society requests confidential client information.

43) Under which of the following circumstances would the independence of a CPA be considered impaired if the CPA, who also is an attorney, serves as auditor and provides legal services to the same private client?

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A) When the CPA, as legal agent, consummates a business acquisition for the client.

B) When the CPA's audit fees and legal fees are not billed separately.

C) When the CPA uses legal expertise to research a question of income tax law.

D) When the legal services consist of an analysis of the terms of an existing lease agreement.

44) According to the profession's ethical standards, a CPA would be considered independent in which of the following instances?

A) A client leases part of an office building from the CPA, resulting in a material indirect financial interest to the CPA. B) The CPA has a material direct financial interest in a client, but transfers the interest into a blind trust.

C) The CPA owns an office building and the mortgage on the building is guaranteed by a client.

D) A client has not paid CPA fees from a 3rd Quarter review just prior to the annual audit.

45) When auditing a public company, which of the following impairs an auditor's independence?

A) Offering audit services as well as preparing the tax return for the same client.

B) The auditor's spouse works in the assembly line of an audit client.

C) Lack of fee disclosure in the client's annual report.

D) The auditor has been a partner on the engagement for ten years.

46) Why do professions establish codes of conduct that define ethical behaviors for members of the profession?

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47) Distinguish between the following theories of ethical behavior: a utilitarian approach, a rights-based approach, and a justice-based approach.

48) Which professional and regulatory bodies establish the ethical and professional rules for auditors of: (1) public companies and (2) private companies?

49) Listed below are definitions of the six Principles of Professional Conduct. For each, identify the principle being defined. a.A member should observe the profession's technical and ethical standards, strive continually to improve competence and the quality of services, and discharge professional responsibility to the best of the member's ability. b.Members should exercise sensitive professional and moral judgments in all their activities. c.A member should be free of conflicts of interest in discharging professional responsibilities. d.A member in public practice should observe the Principles of the Code of Professional Conduct in determining the type and extent of services to be provided. e.Members should accept the obligation to act in a way that will honor the public trust and demonstrate commitment to professionalism. f.To maintain and broaden public confidence, members should perform all professional responsibilities with the highest sense of _____________.

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50) Ms. Lembke is a partner for DTS, a CPA firm. She is the lead partner for the firm's largest client, The Grey Elephant. Ms. Zadina, who works in the same office as Ms. Lembke, has a sister who is the controller for The Grey Elephant. Because of potential independence issues, Ms. Zadina does no work for The Grey Elephant. Ms. Zadina is being considered for promotion to partner. What independence issues should Ms. Lembke consider before promoting Ms. Zadina?

51) The SEC's rules with respect to services provided by auditors are predicated on four basic principles of auditor objectivity and independence. What are the four basic principles?

52) Identify the primary purposes of the General Standards Rule, the Compliance with Standards Rule, and the Accounting Principles Rule of the Rules of Conduct.

53)

When can a CPA disclose confidential information without the client's consent?

54)

The term "ethics" refers to a person's propensity to follow the laws of the land. ⊚ true ⊚ false

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55) Professionalism refers to the conduct, aims, or qualities that characterize a given profession. ⊚ true ⊚ false

56) When auditing a public company, a CPA must follow the auditing standards of the PCAOB and Code of Professional Conduct of the AICPA. ⊚ true ⊚ false

57) The AICPA Code of Professional Conduct guidance starts at a conceptual level with the principles and progressively moves to general rules and then to detailed interpretation. ⊚ true ⊚ false

58)

The Principles of Professional Conduct set forth the minimum standards. ⊚ true ⊚ false

59)

Rules of Conduct are enforceable. ⊚ true ⊚ false

60)

Interpretations of Rules of Conduct are enforceable. ⊚ true ⊚ false

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61)

Principles are stated at a conceptual level, not a detailed level. ⊚ true ⊚ false

62) The rules contained in Section 1.100 cover issues relating to independence, integrity, and auditing standards. ⊚ true ⊚ false

63) If an auditor is not independent of the client, it is unlikely that a user of financial statements will place much reliance on the CPA's work. ⊚ true ⊚ false

64) As per the Conceptual Framework for AICPA Independence Standards, a CPA is required to identify and assess the extent to which a threat to independence exists. ⊚ true ⊚ false

65) An indirect financial interest is defined as a financial interest that is owned or is under the control of an individual or entity. ⊚ true ⊚ false

66) A financial interest is "beneficially owned" when an individual or entity is NOT the recorded owner of the interest but has a right to some or all of the underlying benefits of ownership.

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⊚ ⊚

true false

67) If a CPA owns an insurance policy issued by an attest client, independence would be considered impaired, even if the policy was purchased under the insurance company's normal terms and procedures and does not offer an investment option. ⊚ true ⊚ false

68) The independence standards issued by the PCAOB do not prohibit the provision of tax services to an attest client. ⊚ true ⊚ false

69) PCAOB rules require tax services provided by a public company auditor to be considered and approved by the company's audit committee. ⊚ true ⊚ false

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Answer Key Test name: ch 19 1) C 2) D 3) B 4) A 5) C 6) D 7) D 8) C 9) A 10) C 11) D 12) D 13) A 14) B 15) B 16) B 17) D 18) A 19) B 20) C 21) A 22) A 23) A 24) D 25) C 26) D Version 1

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27) C 28) B 29) C 30) C 31) A 32) B 33) C 34) B 35) C 36) D 37) C 38) B 39) D 40) D 41) B 42) B 43) A 44) D 45) D 54) FALSE 55) TRUE 56) TRUE 57) TRUE 58) FALSE 59) TRUE 60) FALSE 61) TRUE 62) FALSE 63) TRUE 64) TRUE Version 1

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65) FALSE 66) TRUE 67) FALSE 68) TRUE 69) TRUE

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Student name:__________ 1) Which of the following is not one of the four general stages in the initiation and disposition of audit-related disputes?

A) discovery of fraud subsequent to issuance of the audit report B) users of financial statements incur losses C) the legal process commencing with the filing of a lawsuit D) final resolution of the dispute

2) Which of the following elements, if present, would support a finding of constructive fraud on the part of a CPA? A) gross negligence in applying generally accepted auditing standards B) ordinary negligence in applying generally accepted accounting principles C) identified third party users D) scienter

3) An audit client loses a lawsuit and the judgment is for an amount in excess of the contingent liability the client had recorded in the audited financial statements. The auditor, using the typical degree of due care as other members of the profession, determined that the amount of contingent liability recorded by the client in the financial statements for the pending lawsuit was reasonable, given the facts at the time of the audit. This judgment by the auditor is likely to result in: A) sanctions by the PCAOB levied against the individual auditor as well as the accounting firm.

B) a successful lawsuit claiming auditor negligence.

C) a successful lawsuit claiming breach of contract.

D) no legal action whatsoever since due care was exercised.

4) An auditor, using the same degree of due care as other members of the profession, fails to identify an inadequate allowance for bad debts. This occurrence is an example of: Version 1

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A) negligence.

B) fraud.

C) an error in judgment.

D) constructive negligence.

5) Which of the following is not required for establishing an auditor's liability for negligence?

A) an undetected material misstatement B) failure to exercise due care C) a connection between the auditor's negligence and a plaintiff's loss D) a duty to conform to a standard of care

6) Which of the following is the best statement of the duty owed by an accountant in his or her professional work?

A) to do the job correctly and discover all irregularities B) to follow generally accepted accounting principles (GAAP) and generally accepted auditing standards (GAAS) C) to act as a professional and not commit fraud D) to exercise the skill and care of the ordinarily prudent accountant in the same circumstances

7)

When performing an audit, a CPA:

A) must exercise the level of care, skill, and judgment expected of a reasonably prudent CPA under the circumstances.

B) must strictly adhere to generally accepted accounting principles.

C) is strictly liable for failing to discover client fraud.

D) is not liable under any legal standard unless the CPA commits gross negligence or intentionally disregards generally accepted auditing standards.

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8)

A CPA's duty of due care to a client most likely will be breached when a CPA: A) gives a client a written audit report.

B) gives a client incorrect advice based on an honest error of judgment.

C) fails to give tax advice that saves the client money.

D) fails to follow generally accepted auditing standards.

9) Which of the following is not within the class of foreseen users of an accountant's work product?

A) a prospective shareholder of the client B) a lender bank when the accountant knows only that the client will use the financial statements to obtain a loan from an unspecified source C) a bank when the accountant knows the client will rely on the financial statements as the basis for a loan from the bank D) an investor if the accountant knows that the client is seeking capital from a select group of investors

10)

The Securities Exchange Act of 1934: A) established a voluntary disclosure mechanism for issuers of publicly traded securities.

B) primarily relates to initial sales of securities to the public.

C) regulates all sales of securities.

D) regulates ongoing reporting of securities listed and traded on exchanges.

11) What is the primary reason that Congress passed the Securities Litigation Uniform Standards Act of 1998?

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A) To overturn the Private Securities Litigation Reform Act of 1995.

B) As a result of concerns that plaintiff attorneys could get around the Private Securities Litigation Reform Act of 1995 by filing class action lawsuits involving nationally traded securities in state courts.

C) To provide for joint and several liability rather than proportionate liability.

D) To ensure that all publicly held companies receive similar audits.

12)

Why are plaintiffs motivated to bring actions under RICO? A) It pertains exclusively to auditors' actions.

B) It guarantees that cases will be heard in state courts.

C) It provides for treble damages.

D) It holds auditors to standards that exceed reasonable assurance.

13) Under the Rusch Factors doctrine, to which of the following parties will an accountant be liable for negligence?

A) only parties in privity and not those reasonably foreseeable third parties B) both parties in privity and reasonably foreseeable third parties C) only reasonably foreseeable third parties and not those parties in privity D) neither reasonably foreseeable third parties nor parties in privity

14) Ritz Corporation wished to acquire the stock of Stale, Incorporated In conjunction with its plan of acquisition, Ritz hired Fein, CPA, to audit the financial statements of Stale. Based on the audited financial statements and Fein's unqualified opinion, Ritz acquired Stale. Within 6 months, it was discovered that the inventory of Stale had been overstated by $500,000. Ritz commenced an action against Fein. Ritz believes that Fein failed to exercise the knowledge, skill, and judgment commonly possessed by CPAs in the locality, but is not able to prove that Fein either intentionally deceived it or showed a reckless disregard for the truth. Ritz also is unable to prove that Fein had any knowledge that the inventory was overstated. Which of the following two causes of action would Ritz need to prove to prevail in a lawsuit?

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A) negligence and breach of contract B) negligence and gross negligence C) negligence and fraud D) gross negligence and breach of contract

15) In a common law action against an accountant in a state following the Ultramares doctrine, lack of privity is a viable defense if the plaintiff: A) can prove the presence of gross negligence which amounts to a reckless disregard for the truth.

B) bases the action upon fraud.

C) is the client's creditor who sues the accountant for negligence.

D) is the accountant's client.

16) Ford & Company, CPAs, issued an unqualified opinion on Owens Corporation's financial statements. Relying on these financial statements, Century Bank lent Owens $750,000. Ford was unaware that Century would receive a copy of the financial statements or that Owens would use them to obtain a loan. Owens defaulted on the loan. To succeed in a common law fraud action against Ford, Century must prove, in addition to other elements, that: A) century was free from contributory negligence.

B) century was in privity of contract with Ford.

C) ford intended to induce Century to rely on false representations.

D) century was in privity of contract with Owens.

17) Under the "Ultramares" doctrine, to which of the following parties will an accountant be liable for negligence?

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A) parties in privity and foreseen parties B) parties in privity but not foreseen parties C) foreseen parties but not parties in privity D) neither foreseen parties nor parties in privity

18) While conducting an audit, Larson Associates, CPAs, failed to detect material misstatements included in its client's financial statements. Larson's unqualified opinion was included with the financial statements in a registration statement and prospectus for a public offering of securities made by the client. Larson knew that its opinion and the financial statements would be used for this purpose. In a suit by a purchaser against Larson for commonlaw negligence, Larson's best defense would be that the: A) audit was conducted in accordance with generally accepted auditing standards.

B) client was aware of the misstatements.

C) purchaser was not in privity of contract with Larson.

D) identity of the purchaser was not known to Larson at the time of the audit.

19) Gold, CPA, rendered an unqualified opinion on the financial statements of Eastern Power Company. Egan purchased Eastern bonds in a public offering subject to the Securities Act of 1933. The registration statement filed with the SEC included the audited financial statements.

Gold is being sued by Egan under Section 11 of the Securities Act of 1933 for the misstatements contained in the financial statements. To prevail, Egan must prove: A) neither scienter nor reliance.

B) reliance but not scienter.

C) scienter but not reliance.

D) both scienter and reliance.

20)

An auditor can be held criminally liable for:

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A) illegal acts under common law.

B) illegal acts under statutory law.

C) negligent acts when the third party has privity status.

D) tort of contract for failing to follow due professional care.

21)

The Sarbanes-Oxley Act enhances prosecutorial tools available in major fraud cases by: A) expanding laws against fraud and obstruction of justice.

B) increasing criminal penalties for fraud and its cover-up.

C) strengthening sentencing guidelines applicable to large-scale frauds.

D) all of these are true.

22)

A CPA who fraudulently performs an audit of a corporation's financial statements will:

A) probably be liable to any person who suffered a loss as a result of the fraud.

B) be liable only to the corporation and to third parties who are members of a class of intended users of the financial statements.

C) probably be liable to the corporation even though its management was aware of the fraud and did not rely on the financial statements.

D) be liable only to third parties in privity of contract with the CPA.

23) Hark, CPA, failed to follow all generally accepted auditing standards in auditing Long Corporation's financial statements, but the failure would not amount to gross negligence. Long's management had told Hark that the audited statements would be submitted to several banks to obtain financing. Relying on the statements, Third Bank gave Long a loan. Long defaulted on the loan. In a jurisdiction applying the Ultramares doctrine, if Third sues Hark, Hark will:

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A) win because there was no privity of contract between Hark and Third.

B) lose because Hark knew that banks would be relying on the financial statements.

C) win because there was contributory negligence on the part of Third in granting the loan.

D) lose because Hark was negligent in performing the audit.

24) Under common law, which of the following statements most accurately reflects the liability of a CPA who fraudulently gives an opinion on an audit of a client's financial statements?

A) The CPA is liable only to third parties in privity of contract with the CPA. B) The CPA is liable only to known users of the financial statements.

C) The CPA probably is liable to any person who suffered a loss as a result of the fraud.

D) The CPA probably is liable to the client even if the client was aware of the fraud and did not rely on the opinion.

25)

Common law: A) requires that the CPA guarantee their work.

B) requires that the auditor performs work with due care.

C) requires that the auditor performs work with due diligence.

D) does not recognize the concept of constructive fraud.

26) Quincy bought Teal Corporation common stock in an offering registered under the Securities Act of 1933. Worth & Company, CPAs, gave an unqualified opinion on Teal's financial statements that were included in the registration statement filed with the SEC. Quincy sued Worth under the provisions of the 1933 Act that deal with omission of facts required to be in the registration statement. Quincy must prove that:

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A) there was fraudulent activity by Worth.

B) there was a material misstatement in the financial statements.

C) Quincy relied on Worth's opinion.

D) Quincy was in privity with Worth.

27) To be successful in a civil action under Section 11 of the Securities Act of 1933 concerning liability for a misleading registration statement, the plaintiff must prove: A) the plaintiff's reliance on the registration statement and the defendant's intent to deceive.

B) neither the plaintiff's reliance on the registration statement nor the defendant's intent to deceive.

C) the plaintiff's reliance on the registration statement but not the defendant's intent to deceive.

D) the defendant's intent to deceive but not the plaintiff's reliance on the registration statement.

28) While conducting an audit, Larson Associates, CPAs, failed to detect material misstatements included in its client's financial statements. Larson's unqualified opinion was included with the financial statements in a registration statement and prospectus for a public offering of securities made by the client. Larson knew that its opinion and the financial statements would be used for this purpose. Which of the following statements is correct with regard to a suit against Larson and the client by a purchaser of the securities under Section 11 of the Securities Act of 1933?

A) The purchaser must prove that Larson was negligent in conducting the audit.

B) The purchaser must prove that Larson knew of the material misstatements.

C) Larson will not be liable if it had reasonable grounds, based on work performed, to believe the financial statements were accurate.

D) Larson will be liable unless the purchaser did not rely on the financial statements.

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29) Under Section 11 of the Securities Act of 1933, which of the following standards may a CPA use as a defense?

A) The auditor exercised due diligence in following PCAOB auditing standards and generally accepted fraud detection standards.

B) The auditor exercised due diligence in following PCAOB auditing standards but not generally accepted fraud detection standards.

C) The auditor exercised due diligence in following PCAOB fraud detection standards but not generally accepted auditing standards.

D) The auditor exercised due diligence in following neither PCAOB auditing standards nor generally accepted fraud detection standards.

30)

Which statement is correct concerning an auditor's statutory legal liability?

A) The Securities Act of 1933 broadened the auditor's common law liability and the Securities Exchange Act of 1934 narrowed it.

B) The auditor has a greater burden of defense under the Securities Act of 1933 than under the Securities Exchange Act of 1934.

C) Criminal liability only arises under state law.

D) Statutory liability usually modifies the auditor's liability to the client.

31) Rule 10b-5 under Section 10(b) of the Securities Exchange Act of 1934 imposes liability on an accountant for violation of certain duties. Which of the following is an investor not required to prove to recover from a CPA? A) a material, factual misrepresentation or omission B) reliance by the plaintiff on the financial statements C) damages suffered as a result of reliance on the financial statements D) the security price was artificially inflated as a result of the materially misstated financial statements

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32) West & Company, CPAs, was engaged by Sand Corporation to audit its financial statements. West issued an unqualified opinion on Sand's financial statements. Sand has been accused of making negligent misrepresentations in the financial statements that Reed relied upon when purchasing Sand's stock. West was not aware of the misrepresentations and was not negligent in performing the audit. If Reed sues West for damages based on Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934, West will: A) lose, because the statements contained negligent misrepresentations.

B) lose, because Reed relied upon the financial statements.

C) prevail, because some element of scienter must be proved.

D) prevail, because Reed was not in privity of contract with West.

33) Which of the following is something that the plaintiff must prove in order for an accountant to be liable for damages under Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934?

A) The accountant was ordinarily negligent.

B) There was a material omission.

C) The security involved was stock.

D) The security was part of an original issuance.

34) Under the antifraud provisions of Section 10(b) of the Securities Exchange Act of 1934, a CPA may be liable if the CPA acted: A) negligently.

B) with independence.

C) without due diligence.

D) without good faith.

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35) Jay and Company, CPAs, audited the financial statements of Maco Corporation Jay intentionally gave an unqualified opinion on the financial statements even though material misstatements were discovered as a result of the audit. The financial statements and Jay's unqualified opinion were included in a 10-K (annual report filed with the SEC) for the company.

Which of the following statements is correct regarding Jay's liability to a purchaser of the offering under Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934?

A) Jay will be liable if the purchaser relied on Jay's unqualified opinion on the financial statements.

B) Jay will be liable if Jay was negligent in conducting the audit.

C) Jay will not be liable if the purchaser's loss was under $500.

D) Jay will not be liable if the misstatement resulted from an omission of a material fact

by Jay.

36)

In regards to the Foreign Corrupt Practices Act (FCPA), external auditors:

A) are responsible for ensuring that sufficient internal controls are maintained.

B) should immediately report any discovered violation of the FCPA to the client's management.

C) should verify compliance with corporate codes of conduct.

D) are not subject to any penalties.

37)

This act increased legal protections available to whistleblowers.

A) sarbanes-Oxley Act of 2002 B) securities Act of 1933 C) securities Act of 1934 D) securities Litigation Uniform Standards Act of 1998

38)

The Foreign Corrupt Practices Act requires that:

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A) auditors engaged to examine the financial statements of public companies report all illegal payments to the SEC. B) public companies establish independent audit committees to monitor the effectiveness of their system of internal control.

C) U.S. firms doing business abroad report sizable payments to non-U.S. citizens to the Justice Department.

D) public companies devise and maintain an adequate system of internal control.

39) When performing an audit, a CPA will most likely be considered negligent when the CPA fails to: A) detect all of a client's fraudulent activities.

B) include a negligence disclaimer in the client engagement letter.

C) warn a client of known internal control weaknesses.

D) warn a client's customers of embezzlement by the client's employees.

40) Which of the following is the best defense a CPA firm can assert in a suit for common law fraud based on its unqualified opinion on materially false financial statements?

A) contributory negligence on the part of the client B) a disclaimer contained in the engagement letter C) lack of privity D) lack of scienter

41) While conducting an audit, Larson Associates, CPAs, failed to detect material misstatements included in its client's financial statements. Larson's unqualified opinion was included with the financial statements in a registration statement and prospectus for a public offering of securities made by the client. Larson knew that its opinion and the financial statements would be used for this purpose. In suit by a purchaser against Larson for common-law fraud, Larson's best defense would be that:

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A) Larson did not have actual or constructive knowledge of the misstatements and the auditor followed PCAOB Auditing Standards in the audit.

B) Larson’s client knew or should have known of the misstatements.

C) Larson did not have actual knowledge that the purchaser was an intended beneficiary of the audit.

D) Larson was not in privity of contract with its client.

42) In general, the third-party (primary) beneficiary rule as applied to a CPA's legal liability in conducting an audit is relevant to which of the following causes of action against a CPA? A) fraud and constructive fraud, but not negligence B) fraud, but not constructive fraud or negligence C) constructive fraud and negligence, but not fraud D) negligence, but not fraud or constructive fraud

43) Under the liability provisions of Section 11 of the Securities Act of 1933, a CPA may be liable to any purchaser of a security for certifying materially misstated financial statements that are included in the security's registration statement. Under Section 11, a CPA usually will not be liable to the purchaser: A) if there is contributory negligence on the part of the purchaser.

B) if the CPA can prove due diligence.

C) unless the purchaser can prove privity with the CPA. D) unless the purchaser can prove scienter on the part of the CPA.

44) Under the liability provisions of Section 11 of the Securities Act of 1933, a CPA may be liable to any purchaser of a security for certifying materially misstated financial statements that are included in the security's registration statement. Under Section 11, which of the following must be proven by a purchaser of the security?

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A) The CPA committed fraud and the purchaser relied on the financial statements.

B) The purchaser relied on the financial statements, but not that the CPA committed fraud.

C) The CPA committed fraud, but not that the purchaser relied on the financial statements.

D) Neither that the CPA committed fraud, nor that the purchaser relied on the financial statements.

45) Ocean and Associates, CPAs, audited the financial statements of Drain Corporation. As a result of Ocean's negligence in conducting the audit, a material misstatement in the financial statements went undetected. Ocean was unaware of this fact. The financial statements and Ocean's unqualified opinion were included in a registration statement and prospectus for an initial public offering of stock by Drain. Sharp purchased shares in the offering. Sharp received a copy of the prospectus prior to the purchase but did not read it. The shares declined in value as a result of the misstatements in Drain's financial statements becoming known. Under which of the following acts is Sharp most likely to prevail in a lawsuit against Ocean?

A) the Securities Exchange Act of 1934, the Securities Act of 1933, and the SarbanesOxley Act of 2002 provide equal likelihoods of prevailing B) the Securities Exchange Act of 1934 C) the Securities Act of 1933 D) the Sarbanes-Oxley Act of 2002

46) The Sarbanes-Oxley Act of 2002 is considered the most sweeping securities law since the 1933 and 1934 Acts. Which item in the list below was not part of the Sarbanes-Oxley Act of 2002?

A) enhances prosecutorial tools available in fraud cases B) legislates new guidelines for ethics and integrity for public accounting firms C) expands statutory prohibitions against fraud and obstruction of justice D) increases authorized penalties for securities and financial fraud E) strengthens the legal protections accorded whistleblowers

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47) Auditors can be held liable under two classes of law when sued by clients, investors, creditors, or the government. Identify and briefly explain both classes of law.

48) Suits are often brought against auditors that allege that the auditors did not detect some type of fraud or theft. List the six defenses that the auditors could mount against client negligence claims.

49) The most restrictive view under common law is that auditors have no liability to third parties who do not have a privity relationship with the auditor. Briefly define privity and the effect it has on the auditor, client, investors, and creditors under common law.

50) Section 11 under the Securities Act of 1933 treats claims against auditors more favorably than common law. What two things does a plaintiff need to prove to have a case against the auditor of a company in which she purchased new investments? What does the auditor have to do to have the case dismissed?

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51) One of the greatest sources of liability for auditors under the 1934 Act is Section 10(b) and the related Rule 10b-5, which states that it is unlawful for any person to defraud, make any untrue statement of a material fact, or engage in any act in connection with the purchase or sale of a security. Once a plaintiff has established that he or she can sue under Rule 10b-5, there are four elements that must be proven. List the four elements.

52) What type of liability has the Private Securities Litigation Reform Act of 1995 created for cases filed under federal statutory law? How did this change from previous legislation? How has this impacted the cases against auditors and the way cases are now presented?

53) Briefly describe the Sarbanes-Oxley Act of 2002. Be sure to mention (1) who passed the Act, (2) its primary objectives, (3) major aspects of the Act, (4) the parties that it affects, and (5) its relationship to the SEC rules.

54) The Sarbanes-Oxley Act of 2002 grants the PCAOB the ability to undertake two functions over registered public accounting firms and persons associated with such firms. Briefly explain the purpose of the PCAOB, making sure to reference their major functions.

55) Briefly describe the relationship between litigation risk, audit fees, and audit quality that has been found in academic research.

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56)

Common law is written law enacted by the legislative branches of governments. ⊚ true ⊚ false

57)

An auditor can be sued by a client for negligence under common law. ⊚ true ⊚ false

58) An auditor can be sued by a third party under statutory law for willful violation of federal statutes. ⊚ true ⊚ false

59) An auditor can be guilty under federal statutory law if s/he was reckless in performance of her/his professional duties. ⊚ true ⊚ false

60)

Common law requires the auditor perform professional services with due care. ⊚ true ⊚ false

61) The auditor failing to complete the services agreed to in the contract with the client is subject to liability under breach of contract.

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⊚ ⊚

62)

true false

A tort is a breach of contract for which civil action may be taken. ⊚ true ⊚ false

63) To recover against an auditor in a negligence case, the client must prove that the client sustained an actual loss or damage. ⊚ true ⊚ false

64) To prevail in a suit alleging negligence, a third party must prove that the auditor had a duty to the auditor's client to exercise due care. ⊚ true ⊚ false

65)

Privity of contract is the most restrictive view for plaintiffs under common law. ⊚ true ⊚ false

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Answer Key Test name: ch 20 1) A 2) A 3) D 4) C 5) A 6) D 7) A 8) D 9) A 10) D 11) B 12) C 13) B 14) A 15) C 16) C 17) B 18) A 19) A 20) B 21) D 22) A 23) A 24) C 25) B 26) B Version 1

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27) B 28) C 29) B 30) B 31) D 32) C 33) B 34) D 35) A 36) B 37) A 38) D 39) C 40) D 41) A 42) D 43) B 44) D 45) C 46) B 56) FALSE 57) TRUE 58) FALSE 59) TRUE 60) TRUE 61) TRUE 62) FALSE 63) TRUE 64) FALSE 65) TRUE Version 1

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Student name:__________ 1)

In performing a review engagement, a CPA typically: A) supplies litigation support services.

B) assesses control risk at a low level.

C) expresses a conclusion about an assertion.

D) provides management consulting advice.

2)

Prospective financial statements may be prepared for: A) only general use.

B) only limited use.

C) only internal use.

D) general, limited, and internal use.

3) Given one or more hypothetical assumptions, a responsible party may prepare, to the best of his knowledge and belief, an entity's expected financial position, results of operations, and changes in cash flows. Such prospective financial statements are known as: A) pro forma financial statements.

B) financial projections.

C) partial presentations.

D) financial forecasts.

4) Which of the following are prospective financial statements upon which an accountant may appropriately report for general use?

A) pro forma financial statements B) financial projections C) partial presentations D) financial forecasts

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5) Accepting an engagement to examine an entity's financial projections would most likely be appropriate if distribution of the projections were limited to: A) the general public on the entity's website.

B) potential stockholders who request a prospectus or a registration statement.

C) a bank with which the entity is negotiating for a loan.

D) all stockholders of record as of the report date.

6)

An examination of a financial forecast is a professional service that involves:

A) compiling or assembling a financial forecast that is based on management's assumptions.

B) limiting the distribution of the accountant's report to management and the board of directors.

C) assuming responsibility to update management on key events for one year after the report's date.

D) evaluating whether the prospective financial information is presented in accordance with AICPA presentation guidelines and whether the underlying assumptions are well founded and reasonable.

7)

Limited assurance is provided in: A) an audit engagement.

B) a compilation engagement.

C) a review engagement.

D) none of the items listed.

8)

Absolute assurance is provided in:

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A) an audit engagement.

B) a compilation engagement.

C) a review engagement.

D) none of the items listed.

9)

Reasonable assurance is provided in: A) an audit engagement.

B) a compilation engagement.

C) a review engagement.

D) none of the items listed.

10) Which of the following should not be included in an accountant's standard report based upon the compilation of an entity's financial statements?

A) A statement that a compilation is limited to presenting, in the form of financial statements, information that is the representation of management.

B) A statement that the compilation was performed in accordance with standards established by the American Institute of CPAs. C) A statement that the accountant has not audited or reviewed the financial statements.

D) A statement that the accountant does not express an opinion but expresses only limited assurance on the financial statements.

11) During a review of the financial statements of a nonpublic entity, the CPA finds that the financial statements contain a material departure from generally accepted accounting principles.

If management refuses to correct the problem, the CPA should: A) disclose the departure in a separate paragraph of the report.

B) issue an adverse opinion.

C) attach a footnote explaining the effects of the departure.

D) issue a compilation report.

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12) Which of the following procedures is not included in a review engagement of a nonpublic entity?

A) inquiries of management B) inquiries regarding significant events subsequent to the balance sheet date C) any procedures designed to identify relationships among data that appear to be unusual D) a study and evaluation of internal control

13) Inquiry of the entity's personnel and analytical procedures are the primary bases for the issuance of a(n): A) compilation report on financial statements for a nonpublic company in its first year of operations.

B) auditor's report on financial statements supplemented with price-level information.

C) review report on comparative financial statements for a nonpublic company in its second year of operations.

D) management advisory report prepared at the request of the entity's audit committee.

14) The report of a CPA on a review of the financial statements of a nonpublic entity should not include a statement that: A) management is responsible for the preparation and fair presentation of the financials in accordance with GAAP. B) the review was performed in accordance with generally accepted auditing standards.

C) the CPA is not aware of any material modifications that should be made to the financial statements in order for them to be in conformity with generally accepted accounting principles.

D) a review consists principally of inquiries of company personnel and analytical procedures applied to financial data.

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15) Prior to commencing the compilation of financial statements of a nonpublic entity, the accountant should: A) perform analytical procedures sufficient to determine whether fluctuations among account balances appear reasonable.

B) complete the preliminary phase of the study and evaluation of the entity's internal control.

C) verify that the financial information supplied by the entity agrees with the books of original entry and supporting documentation.

D) acquire a knowledge of any specialized accounting principles and practices used in the entity's industry.

16)

Compilation reports may include: A) compilations when the accountant is not independent.

B) compilations with full disclosure.

C) compilations that omits substantially all disclosures.

D) any of the items listed.

17) In an examination of prospective financial statements, which of the following would not require a revision of prospective financial information?

A) mathematical errors B) unreasonable or internally inconsistent assumptions C) inappropriate or incomplete presentation D) all of the items listed may require a revision of prospective financial information

18) May an accountant plan and perform an engagement to compile or review the financial statements of a not-for-profit entity if the accountant is unfamiliar with the specialized industry accounting principles?

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A) Only a compilation could be performed without the specialized knowledge.

B) Only a review could be performed without the specialized knowledge.

C) Both a compilation and a review could be performed without the specialized knowledge.

D) Neither a compilation nor a review could be performed without the specialized knowledge.

19)

The report in a review engagement provides: A) limited assurance.

B) positive assurance.

C) an opinion.

D) a summary of findings.

20) Compilations provide which of the following types of assurance about the fair presentation of financial statements?

A) no assurance B) negative assurance C) limited assurance D) reasonable assurance

21)

Which of the following is not a main goal of the internal auditing profession?

A) add value to an organization's operations B) help an organization to accomplish its objectives C) provide reliable information to external users D) improve the effectiveness of risk management of an organization

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22) The International Professional Practices Framework developed by the IIA includes all of the following types of guidance, except: A) International Standards for the Professional Practice of Internal Auditing.

B) Explanations of Standards.

C) Code of Ethics D) Implementation Guidance.

23) Which of the following statements is true regarding the performance of an assurance service on information systems reliability by a CPA? A) The CPA is not permitted to provide any other services for the entity if he or she is to perform the service.

B) The service will require the CPA to apply all of the attestation and auditing standards.

C) The service provides information regarding whether the information system provides reliable information for internal operating decisions.

D) Performing the service will not require the collection of evidence.

24)

Which of the following statements is not true concerning assurance services?

A) The growth in assurance services has been driven by users' demands for those services.

B) Assurance services focus on improving the quality of information or its context, for decision makers.

C) Unlike audit and attestation engagements, an engagement to perform assurance services does not require the CPA to consider information reliability.

D) Auditing and attestation services can be viewed as subsets of assurance services since there is overlap in their objectives.

25) Which of the following would be considered a part of a consulting services (nonassurance) engagement?

1.Expressing a conclusion about the reliability of an entity's financial statements.

2.Reviewing and commenting on a client-prepared business plan.

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A) I only B) II only C) both I and II D) neither I nor II

26)

Independence is: A) required for financial statement audits but not for assurance services.

B) required for both financial statement audits and assurance services.

C) required for assurance services but not financial statement audits.

D) preferred but not required for financial statement audits and assurance services.

27) Blue Company, a privately-held entity, asked its tax accountant, Cook, a CPA in public practice, to reproduce Blue's internally-prepared interim financial statements on Cook's computer when Cook prepared Blue's quarterly tax return. Cook should not submit these financial statements to Blue unless, at a minimum, Cook complies with the provisions of: A) statements on Responsibilities in Tax Practice.

B) statements on Standards for Accounting and Review Services.

C) statements on Responsibilities in Unaudited Financial Services.

D) statements on Standards for Attestation Engagements.

28) An accountant may accept an engagement to apply agreed-upon procedures to prospective financial statements provided that: A) distribution of the report is restricted to the specified users involved.

B) the prospective financial statements also are examined.

C) responsibility for the adequacy of the procedures performed is taken by the accountant.

D) negative assurance is expressed on the prospective financial statements taken as a whole.

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29) Accepting an engagement to compile a financial projection for a public company most likely would be inappropriate if the projection were to be distributed to: A) a bank with which the entity is negotiating for a loan.

B) a labor union with which the entity is negotiating a contract.

C) the principal stockholder, to the exclusion of the other stockholders.

D) all stockholders of record as of the report date.

30) The party responsible for assumptions identified in the preparation of prospective financial statements is usually: A) a third-party lending institution.

B) the entity's management.

C) the reporting accountant.

D) the entity's independent auditor.

31) Responding to a question such as "What would happen if..." is an attribute of which of the following types of engagements?

A) financial projection B) financial forecast C) financial forecast and financial projection D) review

32) When an accountant is not independent of an entity and is requested to perform a compilation of the entity's financial statements, the accountant:

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A) is precluded from accepting the engagement.

B) may accept the engagement and need not disclose the lack of independence.

C) may accept the engagement, should disclose the lack of independence, and may indicate the reason for the lack of independence.

D) may accept the engagement and must disclose both the lack of independence and the reason for the lack of independence.

33) Before performing a compilation of the financial statements of a nonpublic entity, an accountant should: A) perform a thorough study and evaluation of the internal control system.

B) complete a series of inquiries concerning the entity's procedures for recording, classifying, and summarizing transactions.

C) design working papers intended to provide sufficient competent evidential matter to afford a reasonable basis for a compilation opinion.

D) obtain an understanding of the accounting principles and practices of the industry in which the entity operates.

34) During a review of financial statements of a nonpublic entity, the CPA would be least likely to: A) perform analytical procedures designed to identify relationships that appear to be unusual.

B) obtain written confirmation from banks regarding loans to the entity.

C) obtain reports from other accountants who reviewed a portion of the total entity.

D) read the financial statements and consider their conformance with generally accepted accounting principles.

35) Which of the following should be included in an accountant's standard report based upon the review of a nonpublic entity's financial statements?

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A) a statement that the review was performed in accordance with generally accepted audit standards B) a statement that a review consists principally of inquiries and analytical procedures C) a statement that the review includes a study and evaluation of the internal controls of the entity D) a statement that a review is substantially greater in scope than a compilation

36) Which of the following procedures is usually included in a review engagement of a nonpublic entity?

A) the confirmation of accounts receivable B) a study and evaluation of internal control C) an inquiry concerning subsequent events D) the observation of physical inventory counts

37) Inquiry and analytical procedures ordinarily performed during a review of a nonpublic entity's financial statements include: A) analytical procedures designed to identify material weaknesses in internal control.

B) inquiries concerning actions taken at meetings of the stockholders and the board of directors.

C) analytical procedures designed to test the accounting records by obtaining corroborating evidential matter.

D) inquiries of knowledgeable outside parties such as the entity's attorneys and bankers.

38) During a review of the financial statements of a nonpublic entity, an accountant becomes aware of inadequate disclosure that is material to the financial statements. If management refuses to correct the financial statement presentations, the accountant should:

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A) issue an adverse opinion.

B) issue an "except for" qualified opinion.

C) disclose this departure from generally accepted accounting principles in a separate paragraph of the report.

D) express only limited assurance on the financial statement presentations.

39) Statements on Standards for Accounting and Review Services establish standards and procedures for which of the following engagements?

A) Assisting in adjusting the books of account for a partnership.

B) Examining prospective financial statements.

C) Processing financial data for clients of other accounting firms.

D) Compiling an individual's personal financial statement to be used to obtain a mortgage.

40)

Categories of the IIA Standards include: A) attribute standards.

B) performance standards.

C) interpretations.

D) both attribute standards and performance standards.

41) An accountant is required to comply with the provisions of Statements on Standards for Accounting and Review Services when: 1.Typing client-prepared financial statements, without modification, as an accommodation to a client.

2.Preparing standard monthly journal entries for depreciation and expiration of prepaid expenses.

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A) I only B) II only C) both I and II D) neither I nor II

42) In a review engagement, the accountant must make all of the following inquiries except those to: A) identify subsequent events having a material effect on the statements.

B) understand internal controls.

C) identify actions taken at stockholders' meetings.

D) ascertain whether statements are in accordance with GAAP.

43) Which of the following procedures is not usually performed by the accountant during a review engagement of a nonpublic entity?

A) inquiry about actions taken at meetings of the board of directors that may affect the financial statements B) issuance of a report stating that the review was performed in accordance with standards established by the AICPA C) reading of the financial statements to determine if they conform with generally accepted accounting principles D) communication of any material weaknesses discovered during the consideration of internal control

44) The expectation that an internal auditor does not accept gifts that may impair judgment is based on the code of ethics principle of:

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A) integrity.

B) objectivity.

C) confidentiality.

D) competency.

45)

Trust Service criteria cover: A) hardware design.

B) confidentiality.

C) software design.

D) physical protection of computer systems.

46) According to the Statements on Standards for Accounting and Review Services, what response is appropriate when an accountant, who is not independent, performs a compilation of financial statements?

A) The accountant should state in the report that he or she is not independent.

B) The accountant should withdraw from the engagement.

C) The accountant should express a disclaimer opinion on the compilation.

D) The accountant should express an adverse opinion on the compilation.

47) Which of the following would an accountant not need to know when conducting a compilation?

A) The accounting principles and practices of the industry in which the entity operates.

B) A general understanding of the nature of the entity's business transactions and the form of its accounting records.

C) The accounting basis on which the financial statements are to be presented.

D) The accountant would need to know all of the options.

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48) Which of the following procedures is more likely to be performed in a review engagement of a nonpublic entity than in a compilation engagement?

A) gaining an understanding of the entity's business transactions B) gaining an understanding of the accounting principles and practices in the industry C) obtaining a representation letter from the chief executive officer D) assisting the entity in adjusting the accounting records

49) Statements on Standards for Accounting and Review Services (SSARS) require an accountant to report when the accountant has: A) typed client-prepared financial statements, without modification, as an accommodation to the client.

B) provided an entity with a financial statement format that does not include dollar amounts, to be used by the entity in preparing financial statements.

C) proposed correcting journal entries to be recorded by the client that change clientprepared financial statements.

D) generated financial statements prepared in accordance with a special purpose framework other than GAAP.

50) A CPA's report on agreed-upon procedures related to management's assertion about an entity's compliance with specified requirements should contain: A) a statement of limitations on the use of the report.

B) an opinion about whether management's assertion is fairly stated.

C) negative assurance that control risk has not been assessed.

D) an acknowledgement of responsibility for the sufficiency of the procedures.

51) Which of the following represents the order from the least assurance to the most assurance provided for the types of services provided?

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A) review, compilation, audit B) compilation, review, audit C) audit, review, compilation D) audit, compilation, review

52) Jones Retailing, a nonpublic entity, has asked Winters, CPA, to compile financial statements that omit substantially all disclosures required by generally accepted accounting principles. Winters may compile such financial statements, provided the: A) reason for omitting the disclosures is explained in the engagement letter and acknowledged in the management representation letter.

B) financial statements are prepared on a comprehensive basis of accounting other than generally accepted accounting principles.

C) distribution of the financial statements is restricted to internal use only.

D) omission is not undertaken to mislead the users of the financial statements and is properly disclosed in the accountant's report.

53) During an engagement to review the financial statements of a nonpublic entity, an accountant becomes aware of a material departure from GAAP. If the accountant decides to modify the standard review report because management will not revise the financial statements, the accountant should: A) express negative assurance on the accounting principles that do not conform with GAAP. B) disclose the departure from GAAP in a separate paragraph of the report.

C) issue an adverse or an "except for" qualified opinion, depending on materiality.

D) express positive assurance on the accounting principles that conform with GAAP.

54) Which set of standards was created by the AICPA to cover services relating to unaudited financial statements?

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A) Standards on Selective Audits and Review Services (SSARS) B) Statement on Auditing Standards (SAS) C) Statements on Compilation and Review Standards (SCRS) D) Statements on Standards for Accounting and Review Services (SSARS)

55) When engaged to compile the financial statements of a nonpublic entity, an accountant is required to possess a level of knowledge of the entity's accounting principles and practices. This requirement most likely will include obtaining a general understanding of the: A) stated qualifications of the entity's accounting personnel.

B) design of the entity's internal controls placed in operation.

C) risk factors relating to misstatements arising from illegal acts.

D) internal control awareness of the entity's senior management.

56) This concept, while used by both internal and external auditors, is typically assessed quite differently for each.

A) competence B) objectivity C) integrity D) materiality

57) In your own words, describe how the Institute of Internal Auditors (IIA) defines internal auditing.

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58) The IIA’s professional guidance is organized into an International Professional Practices Framework. This framework consists of two broad categories of guidance. List these categories of guidance and what they include.

59) As with most professionals, internal auditors must follow guidelines promoting ethical conduct. The IIA Code of Ethics is important for internal auditors because the reliability of their work depends on a reputation for a high level of personal integrity. The Code of Ethics consists of four main principles of ethical conduct and some associated rules that underpin the expected conduct of IIA members. List the four main principles of the Code of Ethics and explain each.

60) Internal audit engagements fall into two primary categories—assurance services and consulting services. Briefly explain these two categories in relation to internal auditors.

61)

How has the advancement in technology led to the creation of the Trust Services?

62) Assurance services are independent professional services that improve the quality of information specifically for internal decision makers. ⊚ true ⊚ false

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63)

Electronic commerce is an example of a category of assurance services. ⊚ true ⊚ false

64) An attestation engagement involves a CPA providing assurance either directly on underlying subject matter of the engagement or on subject matter information that comes from another party’s measurement or evaluation of the underlying subject matter. ⊚ true ⊚ false

65) Examples of attest engagements include assertion-based examination, direct examination, review, and agreed-upon procedures engagements. ⊚ true ⊚ false

66)

Limited assurance is provided in a review engagement. ⊚ true ⊚ false

67)

A review engagement results in reasonable assurance that the material is fairly stated. ⊚ true ⊚ false

68) Negative assurance occurs when the auditor is certain that the underlying information is not fairly presented. ⊚ true ⊚ false Version 1

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69) Under the attestation standards, a practitioner can either examine or perform agreed-upon procedures on prospective financial information. ⊚ true ⊚ false

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Answer Key Test name: ch 21 1) C 2) D 3) B 4) D 5) C 6) D 7) C 8) D 9) A 10) D 11) A 12) D 13) C 14) B 15) D 16) D 17) D 18) D 19) A 20) A 21) C 22) B 23) C 24) C 25) B 26) B Version 1

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27) B 28) A 29) D 30) B 31) A 32) C 33) D 34) B 35) B 36) C 37) B 38) C 39) D 40) D 41) D 42) B 43) D 44) B 45) B 46) A 47) D 48) C 49) D 50) A 51) B 52) D 53) B 54) D 55) A 56) D Version 1

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62) FALSE 63) TRUE 64) TRUE 65) TRUE 66) TRUE 67) FALSE 68) FALSE 69) TRUE

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