Certified Public Accountant CPA Questions + Answers Part 29

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QUESTION 383
As the acceptable level of detection risk increases, an auditor may change the: A. Assessedlevelofcontrolriskfromlowtohigh.

B. Assuranceprovidedbytestsofcontrolsbyusingalargersamplesizethanplanned. C. Timing of substantive tests from year-end to an interim date.
D. Nature of substantive tests from a less effective to a more effective procedure.
Correct Answer: C
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "c" is correct. As the acceptable level of detection risk increases, the assurance (effectiveness) that must be provided from substantive tests can decrease. Thus the auditor may change the timing of substantive tests from year-end to an interim date. Choice "a" is incorrect. The assessed level of control risk is used to determine the acceptable level of detection risk, not vice versa.
Choice "b" is incorrect. The acceptable level of detection risk affects the nature, timing and extent of substantive audit procedures, not control tests. Choice "d" is incorrect. As the acceptable level of detection risk increases, the level of assurance required from substantive tests decreases, and therefore the substantive procedures need not be as effective.
QUESTION 384
An auditor plans to apply substantive tests to the details of asset and liability accounts as of an interim date rather than as of the balance sheet date. The auditor should be aware that this practice:
A. Eliminatestheuseofcertainstatisticalsamplingmethodsthatwouldotherwisebeavailable.
B. Presumesthattheauditorwillreperformthetestsasofthebalancesheetdate.
C. Should be especially considered when there are rapidly changing economic conditions.
D. Potentially increases the risk that errors that exist at the balance sheet date will not be detected.
Correct Answer: D
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "d" is correct. Applying substantive tests to the details of asset and liability accounts as of an interim date increases risk, as it is possible that errors will occur between the date of interim testing and the balance sheet date. For this reason, the auditor generally selects for interim examination only accounts that are reasonably predictable with respect to amount, relative significance, and composition, and must also identify procedures sufficient to extend interim conclusions to year-end.
Choice "a" is incorrect. The use of statistical sampling methods is not affected by the timing of audit procedures.
Choice "b" is incorrect. Applying substantive tests to the details of asset and liability accounts as of an interim date increases risk, but it does not require all such

tests to be reperformed. Instead, the auditor should perform procedures designed to extend the interim conclusions to year-end. Such procedures should be less in scope than the initial procedures performed at interim; otherwise, it would make more sense to have simply applied the more extensive tests at year-end in the first place.
Choice "c" is incorrect. Generally, accounts selected for interim examination should be reasonably predictable with respect to amount, relative significance, and composition. Rapidly changing economic conditions might affect the valuation, significance, or composition of certain assets or liabilities, and therefore would make testing at interim less likely.
QUESTION 385
Regardless of the assessed level of control risk, an auditor would perform some:
A. Testsofcontrolstodeterminetheeffectivenessofinternalcontrol.
B. Analyticalprocedurestoverifythedesignofinternalcontrol.
C. Substantive tests to restrict detection risk for significant transaction classes.
D. Dual purpose tests to evaluate both the risk of monetary misstatement and preliminary control risk.
Correct Answer: C
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "c" is correct. Regardless of the assessed level of control risk, an auditor would perform some level of substantive tests to restrict detection risk for significant transaction classes. Even with the lowest possible assessed level of control risk, substantive testing cannot be entirely eliminated for significant transaction classes or balances. Choice "a" is incorrect. An auditor generally would not perform tests of controls if it would not be efficient to do so.
Choice "b" is incorrect. Analytical procedures are substantive audit procedures used by the auditor to test account balances, not to verify the design of internal controls. Choice "d" is incorrect. Dual purpose tests are often performed because they increase audit efficiency, but they are not required to be performed in every case.
QUESTION 386
In assessing the competence of a client's internal auditor, an independent auditor most likely would consider the:
A. Internalauditor'scompliancewithprofessionalinternalauditingstandards.
B. Client'spoliciesthatlimittheinternalauditor'saccesstomanagementsalarydata. C. Evidence supporting a low assessed level of control risk.
D. Results of ratio analysis that may identify unusual transactions and events.
Correct Answer: A
Section: Auditing and Attestation (I) (Volume C) Explanation

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Choice "a" is correct. In assessing the competence of a client's internal auditor, an independent auditor would consider the internal auditor's compliance with professional auditing standards. Such compliance could be evaluated by reviewing the audit plan and auditing procedures used by the internal auditor, as well as by assessing the quality of audit documentation provided. Choice "b" is incorrect. The internal auditor's access to management salary data has no bearing on his or her competency.
Choice "c" is incorrect. The external auditor's assessment of control risk might be based in part on the existence and effectiveness of an internal audit group, but such assessment would not provide information regarding the competency of the internal auditor. Choice "d" is incorrect. Ratio analysis might be used to identify unusual transactions or events, but it would not provide information regarding the competency of the internal auditor.
QUESTION 387
When an auditor increases the assessed level of control risk because certain control activities were determined to be ineffective, the auditor would most likely increase the:
A. Extentoftestsofcontrols. B. Levelofdetectionrisk.
C. Extent of tests of details. D. Level of inherent risk.
Correct Answer: C
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "c" is correct. As the assessed level of control risk increases, the acceptable level of detection risk for financial statement assertions decreases. To attain a decreased level of detection risk, greater assurance is needed from substantive tests. Increasing the extent of tests will provide greater assurance.
Choice "a" is incorrect. Tests of controls are used to assess the level of control risk. Once such assessment is made, there is no need to perform further tests of controls. Choice "b" is incorrect. As the assessed level of control risk increases, the acceptable level of detection risk decreases. In this way, the auditor can keep total audit risk to an acceptable level. Choice "d" is incorrect. Inherent risk is based on the nature of the assertion and cannot be changed.
QUESTION 388
A successor auditor is required to attempt communication with the predecessor auditor prior to:
A. Performingtestofcontrols.
B. Testingbeginningbalancesforthecurrentyear. C. Making a proposal for the audit engagement.

D. Accepting the engagement.
Correct Answer: D
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "d" is correct. A successor auditor is required to attempt communication with the predecessor auditor prior to accepting a new engagement. Choice "a" is incorrect. A successor auditor is required to attempt communication with the predecessor auditor prior to accepting a new engagement. This certainly implies that such attempt will be made before any audit tests are performed; however, the requirement is stated in reference to the date of acceptance.
Choice "b" is incorrect. A successor auditor is required to attempt communication with the predecessor auditor prior to accepting a new engagement. This certainly implies that such attempt will be made before any audit tests are performed; however, the requirement is stated in reference to the date of acceptance.
Choice "c" is incorrect. A successor auditor is not required to attempt communication with the predecessor auditor prior to making a proposal for the audit engagement (remember that more than one auditor may be bidding for the engagement -- and it wouldn't be reasonable to expect the predecessor auditor to respond to all bidders). However, once a successor has been selected, that auditor must attempt communication with the predecessor auditor before actually accepting the engagement.
QUESTION 389
If the business environment is experiencing a recession, the auditor most likely would focus increased attention on which of the following accounts?
A. Purchasereturnsandallowances.
B. Allowancefordoubtfulaccounts.
C. Common stock.
D. Noncontrolling interest of a subsidiary purchased during the year.
Correct Answer: B
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "b" is correct. During an economic downturn, it is more likely that customers will default on payments owed. The auditor should therefore focus increased attention on the allowance for doubtful accounts, to ensure that it has been adjusted to appropriately reflect this increased risk. Choice "a" is incorrect. A recession is not likely to affect purchase returns and allowances, though it might result in a decline in purchases.
Choice "c" is incorrect. A recession is not likely to directly affect the common stock account. Choice "d" is incorrect. A recession is not likely to directly affect a pre- existing, noncontrolling interest in a subsidiary.
QUESTION 390

The existence of audit risk is recognized by the statement in the auditor's standard report that the auditor:
A. Obtainsreasonableassuranceaboutwhetherthefinancialstatementsarefreeofmaterialmisstatement.
B. Assessestheaccountingprinciplesusedandalsoevaluatestheoverallfinancialstatementpresentation.
C. Realizes some matters, either individually or in the aggregate, are important while other matters are not important. D. Is responsible for expressing an opinion on the financial statements, which are the responsibility of management.
Correct Answer: A
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "a" is correct. The existence of audit risk is recognized by the statement in the auditor's standard report that the auditor obtains "reasonable assurance" (as opposed to absolute assurance) about whether the financial statements are free of material misstatement. The existence of audit risk (the risk that the auditor may unknowingly fail to appropriately modify his or her opinion on materially misstated financial statements) is implied in this statement. Choice "b" is incorrect. Assessing the accounting principles used and evaluating the overall financial statement presentation relate to determining that the statements have been prepared in conformity with GAAP, not to recognizing the existence of audit risk. Choice "c" is incorrect. Realizing that some matters are more important than others illustrates the concept of materiality; however, this is not a statement included in the auditor's standard report. Choice "d" is incorrect. Indicating that the financial statements are the responsibility of management while the auditor's responsibility is to express an opinion on those financial statements delineates responsibility rather than illustrating the concept of audit risk.
QUESTION 391
As the acceptable level of detection risk decreases, the assurance directly provided from:
A. Substantivetestsshouldincrease. B. Substantivetestsshoulddecrease. C. Tests of controls should increase. D. Tests of controls should decrease.
Correct Answer: A
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "a" is correct. As the acceptable level of detection risk (the risk that an auditor will not detect a material misstatement that exists in an assertion) decreases, the assurance directly provided from substantive tests should increase. The level of detection risk will decline as the benefit of direct tests increases.

Choice "b" is incorrect. If the assurance directly provided from substantive tests decreased, detection risk would increase because the direct tests have become less beneficial. Choices "c" and "d" are incorrect. Changing the extent of tests of controls does not affect the level of detection risk.
QUESTION 392
On the basis of audit evidence gathered and evaluated, an auditor decides to increase the assessed level of control risk, and therefore the risk of material misstatement, from that originally planned. To achieve an overall audit risk level that is substantially the same as the planned audit risk level, the auditor would:
A. Increaseinherentrisk.
B. Increasematerialitylevels.
C. Decrease substantive testing. D. Decrease detection risk.
Correct Answer: D
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "d" is correct. Decrease "detection risk." Overall audit risk is made up of the risk of material misstatement and detection risk. The risk of material misstatement is itself comprised of two separate risks, inherent risk and control risk. When the assessed level of control risk is increased, the risk of material misstatement also increases, and detection risk must be decreased to achieve an overall audit risk level that is substantially the same as the planned audit risk level. Choice "a" is incorrect. The auditor cannot change inherent risk. Choice "b" is incorrect. The established materiality level is not a component of overall audit risk. Choice "c" is incorrect. If the assurance directly provided from substantive tests decreased, detection risk would increase because direct tests have become less beneficial.
QUESTION 393
Which of the following would an auditor most likely use in determining the auditor's preliminary judgment about materiality?
A. Theresultsoftheinitialassessmentofcontrolrisk.
B. Theanticipatedsamplesizeforplannedsubstantivetests.
C. The entity's financial statements of the prior year.
D. The assertions that are embodied in the financial statements.
Correct Answer: C
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "c" is correct. The auditor would most likely use the entity's financial statements of the prior year in the preliminary determination of materiality. The prior year financial statements would be a good starting point in estimating the current year's expected results, especially for a continuing client.
Choice "a" is incorrect. The assessment of control risk affects the design of audit procedures but is not relevant in determining materiality.
Choice "b" is incorrect. The anticipated sample size for planned substantive tests is set after the preliminary materiality level is determined.
Choice "d" is incorrect. Management assertions embodied in the financial statements have little relationship to materiality.
QUESTION 394
Holding other planning considerations equal, a decrease in the amount of misstatements in a class of transactions that an auditor could tolerate most likely would cause the auditor to:
A. Applytheplannedsubstantivetestspriortothebalancesheetdate.
B. Performtheplannedauditingproceduresclosertothebalancesheetdate.
C. Increase the assessed level of control risk for relevant financial statement assertions. D. Decrease the extent of auditing procedures to be applied to the class of transactions.
Correct Answer: B
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "b" is correct. A decrease in the amount of misstatements that the auditor can tolerate will cause the auditor to modify the nature, timing and/or extent of auditing procedures. Performing the planned procedures closer to the balance sheet date is a timing modification that addresses this change.
Choice "a" is incorrect. The auditor would perform substantive procedures before year-end if the amount of misstatements the auditor could tolerate were increased. The earlier in the year that the auditor performs substantive testing, the greater the incremental risk the auditor accepts regarding the year-end financial statements.
Choice "c" is incorrect. A change in the level of tolerable misstatement does not have a direct effect on the assessed level of control risk.
Choice "d" is incorrect. A decrease in the amount of misstatements that can be tolerated would necessitate an increase in the extent of auditing procedures.
QUESTION 395
When issuing an unqualified opinion, the auditor who evaluates the audit findings should be satisfied that the:
A. Amountofknownmisstatementisdocumentedinthemanagementrepresentationletter.
B. Estimateofthetotalmisstatementislessthanamaterialamount.
C. Amountofknownmisstatementisacknowledgedandrecordedbytheclient.
D. Estimate of the total likely misstatement includes the adjusting entries already recorded by the client.
Correct Answer: B

Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "b" is correct. An unqualified opinion states that the financial statements are presented fairly, in all material respects. Accordingly, if the auditor believes that total misstatement (including both known and likely misstatements) is immaterial, an unqualified opinion is appropriate.
Choice "a" is incorrect. Documenting misstatements in the management representation letter is not required, nor would it eliminate the need to modify the opinion if the known misstatements were material.
Choice "c" is incorrect. Even if the client adjusts the financial statements to correct known misstatements, the auditor still must feel comfortable that any remaining unidentified misstatements would not be material to the financial statements before rendering an unqualified opinion.
Choice "d" is incorrect. An auditor is not concerned with misstatements already corrected by the client. It is the auditor's estimate of uncorrected--and perhaps unknown--errors that affects the type of opinion rendered.
QUESTION 396
Which of the following procedures would an auditor most likely include in the planning phase of a financial statement audit?

A. Obtainanunderstandingoftheentity'sriskassessmentprocess. B. Identifyspecificinternalcontrolactivitiesdesignedtopreventfraud. C. Evaluate the reasonableness of the entity's accounting estimates. D. Perform cutoff tests of the entity's sales and purchases.
Correct Answer: A
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "a" is correct. In all audits, the auditor should obtain a sufficient understanding of each of the five components of internal control in order to properly plan the audit. The entity's risk assessment process is one of the five components of internal control. Choice "b" is incorrect. Identification and testing of specific control

activities generally occurs during the performance of the audit.
Choice "c" is incorrect. Evaluating the reasonableness of accounting estimates generally occurs during the performance of the audit. Choice "d" is incorrect. Cutoff testing of sales and purchases generally occurs during the performance of the audit.
QUESTION 397
Which of the following is not a type of financial statement assertion?
A. Rightsandobligations.
B. Fairnessandaccuracy.
C. Valuation and allocation.
D. Understandabilityandclassification.
Correct Answer: B
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "b" is correct. "Fairness and accuracy" is not a type of financial statement assertion. Choices "a", "c", and "d" are incorrect. The assertions include: Rights and obligations
Valuation and allocation
Understandability and classification
QUESTION 398
Which of the following factors most likely would influence an auditor's determination of the auditability of an entity's financial statements?
A. Thecomplexityoftheaccountingsystem.
B. Theexistenceofrelatedpartytransactions.
C. The adequacy of the accounting records.
D. The operating effectiveness of control activities.
Correct Answer: C
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "c" is correct. An auditor cannot audit inadequate accounting records (i.e., records that do not exist or are so poor that they cannot be relied upon). Choices

"a" and "b" are incorrect. The following factors would be considered when accepting an audit engagement and might require extensions of audit work, but are not factors that would prevent the financial statements from being audited:
A. The complexity of the accounting system.
B. The existence of related party transactions.
Choice "d" is incorrect. The operating effectiveness of control activities does not affect the auditability of financial statements, and it is not considered when accepting an audit engagement.
QUESTION 399
Which of the following auditor concerns most likely could be so serious that the auditor concludes that a financial statement audit cannot be conducted?
A. Theentityhasnoformalwrittencodeofconduct.
B. Theintegrityoftheentity'smanagementissuspect.
C. Procedures requiring segregation of duties are subject to management override. D. Management fails to modify prescribed controls for changes in conditions.
Correct Answer: B
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "b" is correct. An auditor's faith in the integrity of management is of the utmost importance in performing a financial statement audit. When an auditor is concerned that the integrity of management is suspect, the situation is serious enough to prevent the auditor from performing the audit.
Choice "a" is incorrect. A lack of a written code of conduct is not unusual in a small company and certainly would not prevent an audit from being performed. Choice "c" is incorrect. Procedures requiring segregation of duties are almost always subject to management override, even in the best internal control system. Choice "d" is incorrect. An auditor would simply modify the appropriate audit procedures when management fails to modify prescribed controls for changes in conditions.
QUESTION 400
In developing an overall audit strategy, an auditor should consider:
A. Whethertheallowanceforsamplingriskexceedstheachievedupperprecisionlimit.
B. Findingsfromsubstantivetestsperformedatinterimdates.
C. Whether the inquiry of the client's attorney identifies any litigation, claims, or assessments not disclosed in the financial statements. D. Preliminary evaluations of materiality, audit risk, and internal control.
Correct Answer: D
Section: Auditing and Attestation (I) (Volume C) Explanation

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Choice "d" is correct. In developing an overall audit strategy, an auditor should consider preliminary evaluations of materiality, audit risk, and internal control. Choice "a" is incorrect. Evaluation of results from sampling applications would be performed during fieldwork, after the planning process has been completed. Choice "b" is incorrect. Findings from interim audit testing would be considered during fieldwork, after the planning process has been completed. Choice "c" is incorrect. Inquiry of a client's attorney and evaluation of the attorney's response is performed during fieldwork, after the planning process has been completed.
QUESTION 401
A retailing entity uses the Internet to execute and record its purchase transactions. The entity's auditor recognizes that the documentation of details of transactions will be retained for only a short period of time. To compensate for this limitation, the auditor most likely would:
A. Compareasampleofpaidvendors'invoicestothereceivingrecordsatyear-end. B. Planforalargemeasureoftolerablemisstatementinsubstantivetests.
C. Perform tests several times during the year, rather than only at year-end.
D. Increase the sample of transactions to be selected for cutoff tests.
Correct Answer: C
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "c" is correct. When an entity transmits, processes, maintains, or accesses significant information electronically, some accounting data and source documents may be available only in electronic form, or only at a certain point in time. The auditor would generally perform tests of controls several times during the year to compensate for this limitation. Choice "a" is incorrect. Comparing a sample of paid vendors' invoices to receiving records provides evidence that the company received the goods for which it paid, but only if records are available in sufficient detail to make such a comparison. If detailed records are retained for only a short period of time, such comparisons would need to be performed throughout the year, not just at year-end.
Choice "b" is incorrect. The auditor's judgment as to an appropriate level of tolerable misstatement is based on considerations of materiality and audit risk. Increasing this level implies that the auditor is willing to accept a larger error, which would not be an appropriate response to the limitation described.
Choice "d" is incorrect. Increasing the sample size related to cutoff testing will not provide evidence about transactions occurring throughout the period under audit, since cutoff testing relates to year-end.
QUESTION 402
Prior to commencing fieldwork, an auditor usually discusses the general audit strategy with the client's management. Which of the following matters do the auditor and management agree upon at this time?
A. Theappropriatenessoftheentity'splansfordealingwithadverseeconomicconditions.

B. Thedeterminationofthefraudriskfactorsthatexistwithintheclient'soperations.
C. The control weaknesses to be included in the communication with those charged with governance. D. The coordination of the assistance of the client's personnel in data preparation.
Correct Answer: D
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "d" is correct. Prior to commencing fieldwork, an auditor would establish an understanding with the client as to the services to be performed and the overall audit strategy. This understanding may include arrangements involving the conduct of the engagement, such as timing, client assistance, and the availability of documents. Choice "a" is incorrect. The auditor does not evaluate the appropriateness of the entity's plans for dealing with adverse economic conditions prior to commencing fieldwork. The auditor might consider this as part of evaluating the client's ability to continue as a going concern, but this would not occur prior to commencing fieldwork.
Choice "b" is incorrect. Determination of existing fraud risk factors is generally made during the fieldwork stage of the audit, as information and evidence is obtained. Also, fraud risk factors are assessed by the auditor, and would not necessarily be agreed upon with management. Choice "c" is incorrect. Identification and evaluation of control weaknesses generally occurs during the fieldwork stage of the audit, as information and evidence is obtained, not prior to the commencement of fieldwork.
QUESTION 403
An auditor's engagement letter most likely would include a statement that:
A. Listspotentialsignificantdeficienciesdiscoveredduringtheprioryear'saudit. B. Explainstheanalyticalproceduresthattheauditorexpectstoapply.
C. Describes the auditor's responsibility to evaluate going concern issues.
D. Limits the auditor's responsibility to detect errors and fraud.
Correct Answer: D
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "d" is correct. An auditor's engagement letter typically includes discussion of limitations of the engagement, such as the fact that the auditor will obtain only reasonable assurance, and therefore a material misstatement may remain undetected. Choice "a" is incorrect. An auditor's engagement letter typically covers the objectives of the engagement, management's responsibilities, the auditor's responsibilities, limitations of the engagement, and other matters involving the conduct of the audit. Potential significant deficiencies discovered during the prior year's audit would not typically be included in the engagement letter.

Choice "b" is incorrect. While the auditor's engagement letter might include a discussion of the overall audit strategy, it typically would not include specific audit procedures. Choice "c" is incorrect. While the auditor's engagement letter might include a discussion of the auditor's responsibilities, this is usually discussed in fairly general terms. An engagement letter would not describe the auditor's responsibility with respect to specific issues (such as going concern issues).
QUESTION 404
Which of the following statements is correct concerning materiality in a financial statement audit?
A. Analyticalproceduresperformedduringanaudit'sreviewstageusuallydecreasematerialitylevels.
B. Ifthematerialityamountusedinevaluatingauditfindingsincreasesfromtheamountusedinplanning,theauditorshouldapplyadditionalsubstantivetests.
C. The auditor's materiality judgments generally involve quantitative, but not qualitative, considerations.
D. Materiality levels are generally considered in terms of the smallest aggregate level of misstatement that could be considered material to any one of the financial statements.
Correct Answer: D
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "d" is correct. Because the financial statements are interrelated, materiality levels are generally considered in terms of the smallest level of misstatement that could be material to any one of the financial statements.
Choice "a" is incorrect. Analytical procedures are performed during an audit's review stage to evaluate the overall financial statement presentation and to assess the conclusions reacheD. They generally would not result in a change in materiality levels. Choice "b" is incorrect. If the materiality amount used in evaluating audit findings increases from the amount used in planning, the auditor should consider whether the audit plan needs to be modified.
Typically, an increase in materiality levels would result in a decrease in audit risk, which would result in less substantive testing, not more.
Choice "c" is incorrect. Qualitative considerations may lead to situations in which misstatements that do not exceed materiality limits are still likely to influence the economic decisions of users. In such cases, an otherwise immaterial misstatement is deemed to be material.
QUESTION 405
Which of the following is an analytical procedure that an auditor most likely would perform when planning an audit?
A. Confirmingbankbalanceswiththefinancialinstitutions.
B. Scanningaccountsreceivableforamountsovercreditlimits.
C. Recalculating inventory extensions of physical inventory counts.
D. Comparing the current-year account balances for conformity with predictable patterns.
Correct Answer: D
Section: Auditing and Attestation (I) (Volume C) Explanation

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Choice "d" is correct. During planning, analytical procedures consist of a review of data aggregated at a high level, with an objective of enhancing the auditor's understanding of the client. Comparing the current-year account balances for conformity with predictable patterns would fulfill this purpose.
Choice "a" is incorrect. Confirmation of bank balances is a substantive audit procedure (not an analytical procedure) that would be performed during the fieldwork stage of the audit. Choice "b" is incorrect. Scanning accounts receivable for amounts over credit limits is a detailed procedure related to one specific account, and it would be performed during the fieldwork stage of the audit.
Choice "c" is incorrect. Recalculating inventory extensions of physical inventory counts is a detailed procedure related to one specific account, and it would be performed during the fieldwork stage of the audit.
QUESTION 406
An auditor intends to use the work of an actuary who has a relationship with the client. Under these circumstances, the auditor:
A. Isrequiredtodisclosethecontractualrelationshipintheauditor'sreport.
B. Shouldassesstheriskthattheactuary'sobjectivitymightbeimpaired.
C. Is not permitted to rely on the actuary because of a lack of independence.
D. Should communicate this matter to those charged with governance as a significant deficiency in internal control.
Correct Answer: B
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "b" is correct. While a specialist who is unrelated to the client will provide the auditor with greater assurance of reliability, a specialist who is related to the client may be acceptable in certain circumstances. In such situations, the auditor would likely perform additional procedures to verify objectivity.
Choice "a" is incorrect. If the auditor is expressing a standard unqualified opinion, no reference would be made to the specialist in the auditor's report. Choice "c" is incorrect. While a specialist who is unrelated to the client will provide the auditor with greater assurance of reliability, a specialist who is related to the client may be acceptable in certain circumstances.
Choice "d" is incorrect. The fact that the actuary has a relationship with the client is not considered to be a significant deficiency in internal control.
QUESTION 407
Before applying principal substantive tests to an entity's accounts receivable at an interim date, an auditor should:
A. Considerthelikelihoodofassessingtheriskofincorrectrejectiontoolow.
B. Projectsamplingriskatthemaximumfortestscoveringtheremainingperiod. C. Ascertain that accounts receivable are immaterial to the financial statements.

D. Assessthedifficultyincontrollingtheincrementalauditrisk.
Correct Answer: D
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "d" is correct. When audit procedures are performed before year-end, the auditor must assess the incremental risk involved and determine whether sufficient alternative procedures exist to extend the interim conclusions to year-end. Choice "a" is incorrect. The risk of incorrect rejection relates to the efficiency of audit testing, since an item that is initially (and erroneously) rejected will be subject to additional audit testing that should correct the error. The likelihood of assessing this risk lower than it should be does not affect the auditor's decision regarding the appropriate timing of audit work. Choice "b" is incorrect. When audit procedures are performed before year-end, the auditor must assess the incremental risk involved, but this risk would not necessarily be assessed at the maximum level.
Choice "c" is incorrect. Interim testing may be performed on material accounts, as long as the auditor assesses the incremental risk involved and determines whether sufficient alternative procedures exist to extend the interim conclusions to year-end. Immaterial accounts would not need to be tested.
QUESTION 408
Which statement is true regarding the three fraud risk factors (incentives/pressures, opportunity, and rationalization/attitude)?
A. Theauditorshoulddeterminewhetherandtowhatextentfraudriskfactorsarepresentaspartofthefinaloverallreviewstageoftheaudit. B. Thefraudriskfactorsshouldbediscussedbyengagementpersonnelduringplanning.
C. The existence of all three fraud risk factors indicates that fraud has occurred.
D. Lack of observation of all three fraud risk factors indicates that fraud has not occurred.
Correct Answer: B
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "b" is correct. During planning, the audit team is required to discuss the potential for material misstatement due to fraud, and the fraud risk factors should be included in that discussion.
Choice "a" is incorrect. The auditor should determine whether and to what extent fraud risk factors are present during the planning stage of the audit, not during the final overall review stage.
Choice "c" is incorrect. The existence of all three fraud risk factors does not necessarily imply that fraud has occurred, although it is indicative of a greater risk of fraud. Choice "d" is incorrect. Lack of observation of all three fraud risk factors does not necessarily imply that fraud has not occurred, as one factor may be significant enough on its own to result in fraud.

QUESTION 409
Which of the following is not an inquiry the auditor should make to identify the risks of material misstatement due to fraud?
A. Howmanagementcommunicatestoemployeesitsviewsonacceptablebusinesspractices.
B. Whetheroperatingpersonnelhavecommunicatedtomanagementregardinginternalcontrolandhowitfunctionstoprevent,deter,ordetectmaterial misstatement due to fraud.
C. Whether there are any particular business segments for which a risk of fraud may be more likely to exist. D. Whether management is aware of any allegations of fraud.
Correct Answer: B
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "b" is correct. The auditor should inquire whether management (not operating personnel) has communicated to those charged with governance (not management) regarding internal control and how it functions to prevent, deter, or detect material misstatement due to fraud. Choice "a" is incorrect. The auditor should inquire how management communicates to employees its views on acceptable business practices. Choice "c" is incorrect. The auditor should inquire whether there are any particular business segments for which a risk of fraud may be more likely to exist. Choice "d" is incorrect. The auditor should inquire whether management is aware of any allegations of fraud.
QUESTION 410
Which of the following journal entries would the auditor least likely examine in an effort to address the risk of management override of controls?
A. Ajournalentrymadetorecordrecurringperiodicaccountingestimates.
B. Ajournalentrymadebyanindividualwhodoesnottypicallymakejournalentries.
C. Ajournalentryrecordedasapost-closingentrythathasnoexplanationordescription. D. Ajournalentrymadetoaseldom-usedaccount.
Correct Answer: A
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "a" is correct. Inappropriate or unauthorized journal entries are often used to override controls and manipulate the financial reporting process. Periodic, recurring accounting estimates are least likely to be subject to management override since they are expected and occur regularly. Choice "b" is incorrect. Inappropriate or unauthorized journal entries are often used to override controls and manipulate the financial reporting process. A journal entry made by a person

who generally does not have that responsibility might be indicative of such management override. Choice "c" is incorrect. Inappropriate or unauthorized journal entries are often used to override controls and manipulate the financial reporting process. A journal entry recorded after closing without an appropriate explanation or description might be indicative of such management override.
Choice "d" is incorrect. Inappropriate or unauthorized journal entries are often used to override controls and manipulate the financial reporting process. A journal entry made to a seldom-used account might be indicative of such management override.
QUESTION 411
Which of the following is least likely to aid the auditor in evaluating the risk of improper revenue recognition due to fraud?
A. Analysisofsalescommissionsoverthemostrecentfive-yearperiod.
B. Comparisonofsalesvolume,asdeterminedfromrecordedrevenueamounts,withproductioncapacity. C. Trend analysis of revenues and sales returns by month.
D. Comparison of revenue reported by month and by product line for the current and prior years.
Correct Answer: A
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "a" is correct. Items other than revenue may affect sales commissions (e.g., changes to the commission structure), and therefore analyzing sales commissions is least likely to aid the auditor in evaluating the risk of improper revenue recognition due to fraud. Choice "b" is incorrect. An excess of sales volume over production capacity may be indicative of the recording of fictitious sales.
Choice "c" is incorrect. Analysis of sales and returns by month might indicate situations where unauthorized shipments are sent in an effort to overstate revenue. (Larger than average sales in one month would be followed by larger than average returns in the next month.) Choice "d" is incorrect. Analytical procedures using disaggregated revenue data may indicate unusual relationships that are indicative of fraud.
QUESTION 412
An auditor has identified a risk of material misstatement due to fraud related to the inventory function. Which is least likely to be an appropriate response?
A. Observinginventorycountsonanunannouncedbasis.
B. Requestingthatmanagementmorecloselymonitortheinventoryfunction.
C. Assigningmoreexperiencedpersonneltotheengagement.
D. Requesting that inventory be counted on a date close to the end of the reporting period.
Correct Answer: B
Section: Auditing and Attestation (I) (Volume C) Explanation

Explanation/Reference:
Explanation:
Explanation
Choice "b" is correct. An auditor should respond to fraud risk by designing appropriate audit procedures. Requesting that management more closely monitor the inventory function does not improve the auditor's likelihood of detecting fraud. Choice "a" is incorrect. Observing inventory counts on an unannounced basis improves the likelihood that the auditor will detect fraud, since perpetrators may be caught unaware and may be less able to hide their fraudulent activities.
Choice "c" is incorrect. Assigning more experienced personnel to the engagement is an appropriate response to identified risk, since more experienced personnel may be less likely to overlook a condition indicative of fraud.
Choice "d" is incorrect. Requesting that inventory be counted on a date close to the end of the reporting period is an appropriate response to identified risk, since it minimizes the risk of manipulation of balances prior to the end of the reporting period.
QUESTION 413
Which of the following factors most likely would heighten an auditor's concern about the risk of fraudulent financial reporting?
A. Largeamountsofliquidassetsthatareeasilyconvertibleintocash.
B. Lowgrowthandprofitabilityascomparedtootherentitiesinthesameindustry.
C. Financial management's participation in the initial selection of accounting principles. D. Anoverlycomplexorganizationalstructureinvolvingunusuallinesofauthority.
Correct Answer: D
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "d" is correct. The auditor identifies factors indicative of potential fraud ("fraud risk factors") as part of assessing the risk of material misstatement. An overly complex organization structure involving unusual lines of authority provides an opportunity for fraudulent financial reporting that would heighten the auditor's concern. Choice "a" is incorrect. Large amounts of liquid assets that are easily convertible into cash would heighten an auditor's concern about misappropriation of assets, not about fraudulent financial reporting.
Choice "b" is incorrect. Low growth and profitability might heighten an auditor's concern if it became severe or if management faced excessive pressure to meet financial expectations, but would not necessarily in and of itself heighten an auditor's concern. Choice "c" is incorrect. Nonfinancial management's participation in the selection of accounting principles might heighten the auditor's concern; financial management is expected to participate in such activities.
QUESTION 414
Which of the following procedures would an auditor most likely perform during an audit engagement's overall review stage in formulating an opinion on an entity's financial statements?
A. Obtainassurancefromtheentity'sattorneythatallmateriallitigationhasbeendisclosedinthefinancialstatements. B. Verifytheclericalaccuracyoftheentity'sproofofcashanditsbankcutoffstatement.

C. Determine whether inadequate provisions for the safeguarding of assets have been corrected.
D. Consider whether the results of audit procedures affect the assessment of the risk of material misstatement due to fraud.
Correct Answer: D
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "d" is correct. During every stage of the audit, the auditor should consider the assessment of the risk of material misstatement. During the overall review stage, the auditor should consider whether the results of any of the audit procedures affect the assessment of the risk of material misstatement due to fraud. Choice "a" is incorrect. The entity's attorney does not provide assurance regarding financial statement disclosure.
Choice "b" is incorrect. Verifying clerical accuracy of client schedules would be performed during the audit, not during the overall review stage. Choice "c" is incorrect. Evaluating whether control weaknesses have been corrected is not typically performed during the overall review stage.
QUESTION 415
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:
A. Externalpoliciesestablishedbypartiesoutsidetheentityaffectitsaccountingpractices.
B. Managementisdominatedbyoneindividualwhoisalsoashareholder.
C. Internal auditors have direct access to the board of directors and the entity's management.
D. Those charged with governance are active in overseeing the entity's financial reporting policies.
Correct Answer: B
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "b" is correct. When management is dominated by one individual who is also a shareholder, there may be an opportunity for management to override control procedures. Choice "a" is incorrect. Influence of external parties serves an oversight role that strengthens the control environment and minimizes the effect of management's attitude. Choice "c" is incorrect. Existence of internal auditors with direct access to the board of directors strengthens the control environment and lessens the effect of management's attitude. Choice "d" is incorrect. Active participation of those charged with governance serves an oversight role that strengthens the control environment and lessens the effect of management's attitude.