Certified Public Accountant CPA Questions + Answers Part 30
Posted: Tue Feb 22, 2022 6:37 pm
QUESTION 416
Which of the following characteristics most likely would heighten an auditor's concern about the risk of material misstatements in an entity's financial statements?
A. Theentity'sindustryisexperiencingdecliningcustomerdemand. B. Employeeswhohandlecashreceiptsarenotbonded.
C. Bank reconciliations usually include in-transit deposits.
D. Equipment is often sold at a loss before being fully depreciated.
Correct Answer: A
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "a" is correct. In assessing the risk related to material misstatements in an entity's financial statements, the auditor would consider situations that threaten financial stability or profitability, since such situations might provide an incentive to fraudulently misstate the financial statements. Included as one of these characteristics is declining customer demand. Choice "b" is incorrect. Even though the bonding of employees who handle cash is recommended, it is not a significant characteristic in assessing the risk related to material misstatement in an entity's financial statements.
Choice "c" is incorrect. Bank reconciliations with in-transit deposits are not unusual and would not heighten the auditor's concern about the risk of material misstatement. In-transit deposits can be verified with the bank at a later date.
Choice "d" is incorrect. Since depreciation does not adjust an asset to market value, the sale of equipment at a loss before being fully depreciated is not unusual and would not heighten an auditor's concern.
QUESTION 417
Which of the following statements reflects an auditor's responsibility for detecting errors and fraud?
A. Anauditorisresponsiblefordetectingemployeeerrorsandfraud,butnotfordiscoveringfraudinvolvingemployeecollusionormanagementoverride. B. AnauditorshouldplantheaudittodetecterrorsandfraudthatarecausedbydeparturesfromGAAP.
C. An auditor is not responsible for detecting errors and fraud unless the application of GAAS would result in such detection.
D. An auditor should design the audit to provide reasonable assurance of detecting errors and fraud that are material to the financial statements.
Correct Answer: D
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "d" is correct. The auditor should assess the risk that errors and fraud may cause the financial statements to contain a material misstatement. Based on that assessment, the auditor should design the audit to provide reasonable assurance of detecting material errors and fraud. Choice "a" is incorrect. An auditor is responsible for designing the audit to provide reasonable assurance of detecting material misstatement. This responsibility is the same regardless of the cause of
the misstatement. The presence of employee collusion or management override does not change the auditor's responsibility, although it might explain why a properly planned and executed audit did not result in the discovery of material fraud. Choice "b" is incorrect. The audit should be designed to detect material errors and fraud, regardless of the cause.
Choice "c" is incorrect. The auditor is not "responsible for detecting errors and fraud," but is responsible for designing the audit to provide reasonable assurance of detecting material misstatement, whether due to errors or fraud. Note that the auditor's responsibility relates to the design and execution of the audit, and that even an audit performed in accordance with GAAS may miss a material misstatement.
QUESTION 418
During the annual audit of Ajax Corp., a publicly held company, Jones, CPA, a continuing auditor, determined that illegal political contributions had been made during each of the past seven years, including the year under audit. Jones notified the board of directors about the illegal contributions, but they refused to take any action because the amounts involved were immaterial to the financial statements.
Jones should reconsider the intended degree of reliance to be placed on the:
A. Letterofauditinquirytotheclient'sattorney. B. Prioryears'auditplan.
C. Management representation letter.
D. Preliminaryjudgmentaboutmaterialitylevels.
Correct Answer: C
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "c" is correct. The auditor should consider the implications of an illegal act in relation to other aspects of the audit, particularly the reliability of representations of management. Choice "a" is incorrect. The integrity of the client's attorney would not necessarily be affected by illegal acts performed by the client.
Choice "b" is incorrect. The prior year audit plan would not be affected by the discovery of illegal acts in past years.
Choice "d" is incorrect. The auditor should consider the quantitative and qualitative materiality of the illegal act. However, this does not change the preliminary judgment about materiality levels.
QUESTION 419
Which of the following circumstances most likely would cause an auditor to consider whether material misstatements exist in an entity's financial statements?
A. Managementplaceslittleemphasisonmeetingearningsprojections.
B. Theboardofdirectorsmakesallmajorfinancingdecisions.
C. Significant deficiencies in internal control previously communicated to management are not corrected. D. Transactions selected for testing are not supported by proper documentation.
Correct Answer: D
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "d" is correct. Vouching recorded transactions to supporting documentation provides support for the occurrence assertion. The lack of supporting documentation calls into question the occurrence of the transactions under examination. Choice "a" is incorrect. Little emphasis on meeting earnings projections would be considered a positive factor in preventing material misstatements from occurring. Choice "b" is incorrect. As the representatives of shareholder interests, an active board of directors is considered a positive control.
Choice "c" is incorrect. The existence of significant deficiencies in internal control may represent a conscious decision by management to accept that degree of risk because of cost or other considerations.
Therefore, although failure to correct such deficiencies is considered a fraud risk factor, the auditor is more likely to be concerned about transactions that are not supported by proper documentation.
QUESTION 420
An auditor concludes that a client has committed an illegal act that has not been properly accounted for or disclosed. The auditor should withdraw from the engagement if the:
A. Auditorisprecludedfromobtainingsufficientappropriateevidenceabouttheillegalact.
B. Illegalacthasaneffectonthefinancialstatementsthatisbothmaterialanddirect.
C. Auditorcannotreasonablyestimatetheeffectoftheillegalactonthefinancialstatements. D. Client refuses to accept the auditor's report as modified for the illegal act.
Correct Answer: D
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "d" is correct. The auditor should withdraw from the engagement if the client refuses to accept the auditor's modified report.
Choice "a" is incorrect. If the auditor is precluded from obtaining sufficient evidence, the auditor should consider disclaiming an opinion.
Choice "b" is incorrect. The auditor must consider the effects of a direct material illegality on the financial statements and on other aspects of the audit, but need not withdraw from the engagement.
Choice "c" is incorrect. If the auditor cannot estimate the effect of the illegal act on the financial statements, the auditor should consider disclaiming an opinion.
QUESTION 421
An auditor who discovers that client employees have committed an illegal act that has a material effect on the client's financial statements most likely would withdraw from the engagement if:
A. Theillegalactisaviolationofgenerallyacceptedaccountingprinciples.
B. Theclientdoesnottaketheremedialactionthattheauditorconsidersnecessary. C. The illegal act was committed during a prior year that was not audited.
D. The auditor has already assessed control risk at a high level.
Correct Answer: B
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "b" is correct. The auditor may conclude that withdrawal is necessary if the client does not take the remedial action that the auditor considers necessary in the circumstances, even when the illegal act is not material to the financial statements. Choice "a" is incorrect. Whether or not the illegal act is a violation of GAAP does not determine the need to withdraw from the engagement.
Choice "c" is incorrect. An illegal act committed in the prior year would not necessarily cause an auditor to withdraw from a current engagement.
Choice "d" is incorrect. Assessment of control risk at a high level would cause an auditor to modify the nature, timing, or extent of audit procedures, but would not cause withdrawal from an engagement.
QUESTION 422
Which of the following factors most likely would heighten an auditor's concern about the risk of fraudulent financial reporting?
A. Inabilitytogeneratecashflowsfromoperationswhilereportingsubstantialearningsgrowth. B. Management'slackofinterestinincreasingtheentity'sstocktrend.
C. Large amounts of liquid assets that are easily convertible into cash.
D. Inability to borrow necessary capital without granting debt covenants.
Correct Answer: A
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "a" is correct. An auditor's concern about the risk of fraudulent financial reporting would be heightened if the entity were unable to generate cash flows from operations, but still reported substantial earnings growth, since these two occurrences are somewhat inconsistent. Choice "b" is incorrect. Management's excessive interest in increasing the stock price and earnings trend is a fraud risk factor; lack of such interest would not cause concern. Choice "c" 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 "d" is incorrect. The need to grant debt covenants when borrowing capital is an ordinary occurrence that would not heighten the auditor's concern.
QUESTION 423
Which of the following statements is correct concerning an auditor's responsibility to report fraud?
A. Theauditorisrequiredtocommunicatetothosechargedwithgovernanceallminorfraudulentactsperpetratedbylow-levelemployees,eveniftheamounts involved are inconsequential.
B. Thedisclosureofmaterialmanagementfraudtoprincipalstockholdersisrequiredwhenbothseniormanagementandtheboardofdirectorsfailtoacknowledge the fraudulent activities.
C. Fraudulent activities involving senior management of which the auditor becomes aware should be reported directly to the SEC.
D. The disclosure of fraudulent activities to parties other than the client's senior management and those charged with governance is not ordinarily part of the auditor's responsibility.
Correct Answer: D
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "d" is correct. The disclosure of fraudulent activities to parties other than the client's senior management and those charged with governance is not ordinarily part of the auditor's responsibility.
Choice "a" is incorrect. Only fraud that causes a material misstatement of the financial statements or fraud involving senior management should be reported to those charged with governance.
Choice "b" is incorrect. The disclosure of fraudulent activities to parties other than the client's senior management and those charged with governance is not ordinarily part of the auditor's responsibility.
Although there are certain exceptions to this rule, disclosure to stockholders is not one of them. Choice "c" is incorrect. Fraudulent activities involving senior management of which the auditor becomes aware should be reported directly to those charged with governance, not to the SEC. (Only in certain limited circumstances would fraud be disclosed to the SEC via required regulatory reports.)
QUESTION 424
Which of the following procedures would least likely result in the discovery of possible illegal acts?
A. Readingtheminutesoftheboardofdirectors'meetings. B. Makinginquiriesoftheclient'smanagement.
C. Performing tests of details of transactions.
D. Reviewing an internal control questionnaire.
Correct Answer: D
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "d" is correct. Reviewing an internal control questionnaire provides information about control policies and procedures, but does not provide information about actual transactions or events that have occurred. Therefore, it is not likely to uncover any illegal acts. Choices "a" and "b" are incorrect. The auditor generally does not include procedures specifically to detect illegal acts, but may discover such acts through other procedures, such as reading the board minutes or making inquiries of management or of legal counsel. Choice "c" is incorrect. Performing tests of details of transactions may provide information indicative of illegal acts, such as information regarding unauthorized or improperly recorded transactions; payments of unusual fines or penalties; payments that are unusually large or excessive, especially those made in cash; unexplained payments; or payments for unspecified services.
QUESTION 425
Which of the following circumstances most likely would cause an auditor to suspect that there are material misstatements in an entity's financial statements?
A. Seniorfinancialmanagementparticipatesintheselectionofaccountingprinciplesandthedeterminationofsignificantestimates. B. Supportingaccountingrecordsandfilesthatshouldbereadilyavailablearenotproducedpromptlywhenrequested.
C. Related party transactions take place in the ordinary course of business with an entity that is audited by another CPA firm.
D. Senior management has an excessive interest in upgrading the entity's information technology capabilities.
Correct Answer: B
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "b" is correct. Missing or unavailable documents or electronic evidence may be indicative of an intentional material misstatement in the entity's financial statements (fraud). Choice "a" is incorrect. Senior financial management should participate in the selection of accounting principles and the determination of significant estimates. This would not be indicative of material misstatements in the entity's financial statements. Choice "c" is incorrect. The auditor would need to audit related party transactions to ensure that there is proper financial statement disclosure, but the existence of such transactions would not be indicative of material misstatements in the entity's financial statements. Choice "d" is incorrect. The fact that senior management wants to upgrade the entity's information technology capabilities would not be indicative of material misstatements in the entity's financial statements.
QUESTION 426
Which of the following circumstances would an auditor most likely consider a risk factor relating to misstatements arising from fraudulent financial reporting?
A. Severalmembersofmanagementhaverecentlypurchasedadditionalsharesoftheentity'sstock.
B. Severalmembersoftheboardofdirectorshaverecentlysoldsharesoftheentity'sstock.
C. The entity distributes financial forecasts to financial analysts that predict conservative operating results.
D. Management is interested in maintaining the entity's earnings trend by using aggressive accounting practices.
Correct Answer: D
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "d" is correct. If the auditor becomes aware of management's interest in maintaining the entity's earnings trend by using aggressive accounting practices, this would be indicative of an attitude conducive to fraud.
Choice "a" is incorrect. Management purchase of company stock does not necessarily indicate an increased risk of fraud.
Choice "b" is incorrect. Sale by board members of company stock does not necessarily indicate an increased risk of fraud.
Choice "c" is incorrect. Prediction of conservative operating results is not a fraud risk factor; commitment to aggressive or unrealistic predictions would more likely be indicative of fraud risk.
QUESTION 427
Which of the following characteristics most likely would heighten an auditor's concern about the risk of material misstatement arising from fraudulent financial reporting?
A. Thereisalackofinterestbymanagementinmaintaininganearningstrend. B. Computerhardwareisusuallysoldatalossbeforebeingfullydepreciated.
C. Management had frequent disputes with the auditor on accounting matters. D. Monthly bank reconciliations usually include several large checks outstanding.
Correct Answer: C
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "c" is correct. Frequent disputes between management and the auditor is a fraud risk factor that would heighten an auditor's concern about the risk of material misstatement arising from fraudulent financial reporting.
Choice "a" is incorrect. Management's excessive interest in maintaining or increasing the stock price and earnings trend is a fraud risk factor, but management's lack of interest in maintaining an earnings trend would not constitute a fraud risk factor. Choice "b" is incorrect. Since depreciation does not adjust an asset to market value, the sale of computer hardware at a loss before being fully depreciated is not unusual and would not heighten an auditor's concern.
Choice "d" is incorrect. Bank reconciliations with outstanding checks are not unusual and would not heighten the auditor's concern about the risk of material misstatement. Outstanding checks can also be verified with the bank at a later date, when the checks clear.
QUESTION 428
Which of the following statements is correct regarding the auditor's consideration of the possibility of illegal acts by clients?
A. Theauditorhasaresponsibilitytoplanandperformtheaudittoobtainreasonableassurancethatnoillegalactshavebeencommittedbyclients.
B. Theauditor'straining,experience,andunderstandingoftheclientshouldbeusedtoprovideabasisforthedeterminationastowhetherillegalactshave occurred.
C. If specific information concerning an illegal act comes to the auditor's attention, the auditor should apply audit procedures specifically directed to ascertaining whether an illegal act has occurred.
D. If an illegal act has occurred, the auditor should express a qualified opinion or an adverse opinion on the financial statements taken as a whole.
Correct Answer: C
Section: Auditing and Attestation (I) (Volume C) Explanation
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Explanation
Choice "c" is correct. If specific information concerning a possible illegal act comes to the auditor's attention, the auditor should apply additional audit procedures to determine whether an illegal act has in fact occurred.
Choice "a" is incorrect. The auditor has a responsibility to plan and perform the audit to obtain reasonable assurance that the financial statements are free of material misstatement. This is a different level of assurance than stating that "no illegal acts" have been committed by clients, since it is possible for an immaterial illegal act (for example a theft of a few dollars from the petty cash fund) to occur and not be identified by the auditor. Choice "b" is incorrect. The auditor's training, experience, and understanding of the client may not be sufficient to provide a basis for the determination as to whether illegal acts (especially indirect effect illegal acts) have occurred.
Choice "d" is incorrect. If an illegal act has occurred, but the act has been properly accounted for and/or disclosed, there would be no need to express a qualified opinion or an adverse opinion.
Risk Assessment
QUESTION 429
In an audit of financial statements in accordance with generally accepted auditing standards, an auditor is required to:
A. Documenttheauditor'sunderstandingoftheentity'sinternalcontrol.
B. Searchforsignificantdeficienciesintheoperationofinternalcontrol.
C. Perform tests of controls to evaluate the effectiveness of the entity's information system relevant to financial reporting. D. Determine whether controls operated effectively to prevent or detect material misstatements.
Correct Answer: A
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "a" is correct. The auditor is required to document key elements of the understanding of the entity and its environment, including each of the components of internal control. Choice "b" is incorrect. Auditors are not required to search for significant deficiencies in the operation of internal control. They are merely required to report such conditions discovered during the audit to those charged with governance.
Choice "c" is incorrect. Auditors are not required to perform tests of controls unless they plan to place reliance on a particular control. Since auditors are not required to rely on the client's controls, tests of controls are generally not required. Choice "d" is incorrect. The auditor generally is not required to determine whether the client's controls operated effectively to prevent or detect material errors. Such determination would only be required for controls on which the auditor plans to rely.
QUESTION 430
The audit plan usually cannot be finalized until the:
A. Considerationoftheentity'sinternalcontrolhasbeencompleted.
B. Representationletterhasbeensignedbytheclient.
C. Significant deficiencies in internal control have been communicated to those charged with governance. D. Search for unrecorded liabilities has been performed and documented.
Correct Answer: A
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "a" is correct. The auditor should obtain a sufficient understanding of the entity and its environment, including its internal control, to plan the audit of the entity's financial statements. Choice "b" is incorrect. The representation letter is not obtained until the end of the audit. Choice "c" is incorrect. Informing those charged with governance of significant deficiencies in internal control generally occurs during or at the completion of the audit. It is not required before completion of the audit plan.
Choice "d" is incorrect. The search for unrecorded liabilities typically takes places after year-end, while the audit plan is prepared during planning. Information obtained from the search is not needed to finalize the audit plan.
QUESTION 431
The primary objective of procedures performed to obtain an understanding of the entity and its environment is to provide an auditor with:
A. Knowledgenecessaryforriskassessmentandauditplanning.
B. Auditevidencetouseinassessinginherentrisk.
C. A basis for issuing an opinion on the financial statements.
D. An evaluation of the consistency of application of management's policies.
Correct Answer: A
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "a" is correct. The auditor should obtain an understanding of the entity and its environment sufficient to assess the risk of material misstatement and to design and perform further audit procedures.
Choice "b" is incorrect. Assessing inherent risk is not the primary objective of obtaining an understanding of the entity and its environment.
Choice "c" is incorrect. Obtaining an understanding of the entity and its environment is not a sufficient basis for issuing an audit opinion.
Choice "d" is incorrect. Procedures performed to gain an understanding of the entity and its environment would not ordinarily test the consistency of the application of management's policies. If the auditor intends to rely on a control, its consistency in application would then be tested.
QUESTION 432
If an auditor's risk assessment is based on the effective operation of controls, the auditor will likely:
A. Applyanalyticalprocedurestobothfinancialdataandnonfinancialinformationtodetectconditionsthatmayindicateweakcontrols. B. Performtestsofdetailsoftransactionsandaccountbalancestoidentifypotentialerrorsandfraud.
C. Identify specific internal controls that are likely to detect or prevent material misstatements.
D. Document that the additional audit effort to perform tests of controls exceeds the potential reduction in substantive testing.
Correct Answer: C
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "c" is correct. Assessing risk based on the effective operation of controls involves (1) identifying specific internal controls relevant to specific assertions that are likely to prevent or detect material misstatements in those assertions, and (2) performing tests of such controls to evaluate their effectiveness.
Choice "a" is incorrect. Analytical procedures are used for planning purposes, as substantive tests, or as a final overall review. They are not used to support a risk assessment based on the effective operation of controls.
Choice "b" is incorrect. Tests of details of transactions and account balances to identify potential errors and fraud are substantive tests. They are not used to support a risk assessment based on the effective operation of controls.
Choice "d" is incorrect. The auditor may not assess risk based on the effective operation of controls unless tests of controls are performed. However, if the audit effort required to perform tests of controls exceeds the potential reduction in substantive testing, tests of controls will not be performed because doing so would reduce audit efficiency.
QUESTION 433
An advantage of using systems flowcharts to document information about internal control instead of using internal control questionnaires is that systems flowcharts:
A. Identifyinternalcontrolweaknessesmoreprominently.
B. Provideavisualdepictionofclient'sactivities.
C. Indicate whether control activities are operating effectively.
D. Reduce the need to observe client's employees performing routine tasks.
Correct Answer: B
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "b" is correct. An advantage of using systems flowcharts to document internal information is that flowcharts provide a visual depiction of clients' activities. Choice "a" is incorrect. Identification of internal control weaknesses requires the understanding, testing, and evaluation of controls. Either flowcharts or questionnaires can be used to obtain an understanding of internal control for this purpose.
Choice "c" is incorrect. Determining whether control activities are operating effectively requires tests of controls, and generally cannot be determined based on a flowchart or a questionnaire. Choice "d" is incorrect. Observing tasks being performed (routine or otherwise) are tests of controls. The need to perform tests of controls is not affected by the form of audit documentation selected.
QUESTION 434
An auditor's risk assessment is based on the assumption that controls are operating effectively. Which of the following was not a step in making this assessment?
A. Evaluatetheeffectivenessoftheinternalcontrolswithtestsofcontrols.
B. Obtainanunderstandingoftheentity'saccountingsystemandcontrolenvironment.
C. Perform tests of details of transactions to detect material misstatements in the financial statements. D. Consider whether control activities can have a pervasive effect on financial statement assertions.
Correct Answer: C
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "c" is correct. Tests of details of transactions are used to detect material misstatements in the financial statements after the auditor has assessed risk, not as part of making this assessment. Choice "a" is incorrect. Tests of controls are required to support the auditor's assumption that controls are operating effectively. Choice "b" is incorrect. Obtaining an understanding of each of the five components of internal control is required before making an assessment of control risk. The entity's accounting system (part of the information and communication component) and control environment are part of the five components.
Choice "d" is incorrect. Considering whether control activities can have a pervasive effect on financial statement assertions is part of the auditor's risk assessment
process. Internal Control
QUESTION 435
Which of the following procedures most likely would provide an auditor with evidence about whether an entity's internal control activities are suitably designed to prevent or detect material misstatements?
A. Reperformingtheactivitiesforasampleoftransactions.
B. Performinganalyticalproceduresusingdataaggregatedatahighlevel. C. Vouching a sample of transactions directly related to the activities.
D. Observing the entity's personnel applying the activities.
Correct Answer: D
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "d" is correct. Observation and inspection may be used to evaluate the design of controls. Observation of entity personnel applying control activities is a procedure that would likely provide evidence about the design of the activities. Choice "a" is incorrect. Reperforming control activities provides the auditor with evidence about the operating effectiveness of specific control activities, not the design effectiveness. Choice "b" is incorrect. Analytical procedures would not provide the auditor with evidence about the design of specific control activities.
Choice "c" is incorrect. Vouching a sample of transactions directly related to control activities would not provide the auditor with evidence about the design of specific control activities.
QUESTION 436
Management philosophy and operating style most likely would have a significant influence on an entity's control environment when:
A. Theinternalauditorreportsdirectlytomanagement.
B. Managementisdominatedbyoneindividual.
C. Accurate management job descriptions delineate specific duties.
D. Those charged with governance actively oversee the financial reporting process.
Correct Answer: B
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "b" is correct. Management philosophy and operating style encompass a broad range of characteristics. Such characteristics may include the following: management's approach to taking and monitoring business risks, management's attitudes and actions toward financial reporting, and management's attitudes toward information processing and accounting functions and personnel. These characteristics are more likely to have a significant influence on the control environment when management is dominated by one individual, since there will be few alternative viewpoints presented.
Choice "a" is incorrect. The internal audit function is part of the monitoring component of internal control, not part of the control environment. If the internal auditor reports directly to management, this would reduce their objectivity and perhaps make the monitoring function less effective, but it would have minimal impact on the control environment. Choice "c" is incorrect. Accurate management job descriptions would not change the influence that management philosophy and operating style have on the entity's control environment. Choice "d" is incorrect. The involvement of those charged with governance in the reporting process would tend to moderate or offset the influence that management philosophy and operating style have on the entity's control environment.
QUESTION 437
Which of the following is a management control method that most likely could improve management's ability to supervise company activities effectively?
A. Monitoringcompliancewithinternalcontrolrequirementsimposedbyregulatorybodies. B. Limitingdirectaccesstoassetsbyphysicalsegregationandprotectivedevices.
C. Establishing budgets and forecasts to identify variances from expectations.
D. Supporting employees with the resources necessary to discharge their responsibilities.
Correct Answer: C
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "c" is correct. The use of budgets and forecasts to identify variances improves managers' ability to supervise company activities. Variances from budgets serve as signals to managers that a potential problem exists.
Choice "a" is incorrect. Compliance with internal controls mandated by a regulatory body may be necessary, but would not necessarily enhance the ability of a manager to supervise company activities.
Choice "b" is incorrect. Limiting access to assets serves as a deterrent to employee theft, but does not really improve managers' ability to supervise company activities. Choice "d" is incorrect. Supporting employees with adequate resources is important, but it does not necessarily increase the supervisory capability of a manager.
QUESTION 438
In obtaining an understanding of a manufacturing entity's internal control concerning inventory balances, an auditor most likely would:
A. Analyzetheliquidityandturnoverratiosoftheinventory.
B. Performanalyticalproceduresdesignedtoidentifycostvariances. C. Review the entity's descriptions of controls over inventory.
D. Perform test counts of inventory during the entity's physical count.
Correct Answer: C
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "c" is correct. This question asks about internal control. Review of descriptions of controls would typically be performed while gaining an understanding of an entity's internal control (for any system or cycle, not just inventory). Choice "a" is incorrect. Analysis of inventory ratios is an analytical procedure, which is not used to gain an understanding of internal control.
Choice "b" is incorrect. Analytical procedures are used in planning the audit, as a substantive test, or for final overall review; they are not used to gain an understanding of internal control. Choice "d" is incorrect. Observation of physical inventory counts is a substantive test, not a procedure used to gain an understanding of internal control.
QUESTION 439
The overall attitude and awareness of those charged with governance (i.e., an entity's board of directors) concerning the importance of internal control usually is reflected in its:
A. Computer-basedcontrols.
B. Systemofsegregationofduties. C. Control environment.
D. Safeguards over access to assets.
Correct Answer: C
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "c" is correct. The control environment reflects the overall attitude, awareness and actions of those charged with governance (i.e., the board of directors, management, owners, and others) concerning the importance of control and its emphasis in the entity. Choice "a" is incorrect. Computer-based controls are a control activity. The overall attitude and awareness of those charged with governance is not a control activity. Choice "b" is incorrect. A system of segregation of duties is a control activity. The overall attitude and awareness of those charged with governance is not a control activity. Choice "d" is incorrect. Safeguards over access to assets is a control activity. The overall attitude and awareness of those charged with governance is not a control activity.
QUESTION 440
In an audit of financial statements, an auditor's primary consideration regarding internal control is whether the control:
A. Reflectsmanagement'sphilosophyandoperatingstyle. B. Affectsmanagement'sfinancialstatementassertions. C. Provides adequate safeguards over access to assets. D. Enhances management's decision-making processes.
Correct Answer: B
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "b" is correct. Assessing control risk is the process of evaluating the effectiveness of an entity's internal control in preventing or detecting material misstatements in the financial statements.
Choice "a" is incorrect. Management's philosophy and operating style are considered a part of the control environment. They are not the primary consideration in evaluating internal control. Choice "c" is incorrect. Providing adequate safeguards over access to assets is a type of control activity, but it is not the auditor's primary consideration regarding internal control. Choice "d" is incorrect. Policies and procedures concerning the effectiveness, economy, and efficiency of certain management decision-making processes are not relevant to the auditor's consideration of internal control.
QUESTION 441
The ultimate purpose of assessing control risk is to contribute to the auditor's evaluation of the risk that:
A. Testsofcontrolsmayfailtoidentifyproceduresrelevanttoassertions.
B. Materialmisstatementsmayexistinthefinancialstatements.
C. Specified controls requiring segregation of duties may be circumvented by collusion. D. Entity policies may be overridden by senior management.
Correct Answer: B
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "b" is correct. The ultimate purpose of assessing control risk is to contribute to the auditor's evaluation of the risk that material misstatements exist in the financial statements. Choice "a" is incorrect. Tests of controls are used to assess control risk, not to identify procedures relevant to assertions.
Choice "c" is incorrect. Collusion represents an inherent limitation in the effectiveness of internal control.
The auditor does not assess control risk to evaluate such limitations. Choice "d" is incorrect. Management override of policies represents an inherent limitation in the effectiveness of internal control. The auditor does not assess control risk to evaluate such limitations.
QUESTION 442
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. Theauditcommitteeisactiveinoverseeingtheentity'sfinancialreportingpolicies.
B. Externalpoliciesestablishedbypartiesoutsidetheentityaffectitsaccountingpractices. C. Management is dominated by one individual who is also a shareholder.
D. Internal auditors have direct access to those charged with governance.
Correct Answer: C
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "c" is correct. When management is dominated by one individual who is also a shareholder, there may not be any factors to moderate management's aggressive style. In such situations, management's style is likely to have a strong impact on the control environment. Choice "a" is incorrect. An active audit committee tends to moderate management's aggressive reporting style.
Choice "b" is incorrect. External policies established by outside parties would tend to moderate management's aggressive reporting style.
Choice "d" is incorrect. An effective internal audit function would tend to moderate management's aggressive reporting style.
QUESTION 443
When obtaining an understanding of an entity's internal controls, an auditor should concentrate on the substance of the controls rather than their form because:
A. Theproceduresmaybeoperatingeffectivelybutmaynotbedocumented.
B. Managementmayestablishappropriateproceduresbutnotenforcecompliancewiththem. C. The procedures may be so inappropriate that no reliance is contemplated by the auditor. D. Management may implement procedures whose costs exceed their benefits.
Correct Answer: B
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "b" is correct. "Substance over form" concerns relate to controls that appear on the surface to exist but in reality are not operating effectively. When obtaining an understanding of a client's internal controls, an auditor should concentrate on the substance of controls rather than the form because even when
appropriate procedures are established, management may not enforce compliance.
Choice "a" is incorrect. "Substance over form" concerns relate to controls that appear on the surface to exist but in reality are not operating effectively. Procedures that are operating effectively, even if they are not documented, do not illustrate this situation. Choice "c" is incorrect. The auditor should first obtain an understanding of the controls in order to determine whether the controls are appropriate or inappropriate. The auditor would not focus at all on controls deemed to be inappropriate.
Choice "d" is incorrect. While the cost-benefit of internal control is of concern to management in the design of the system, it plays no role in the auditor's attempt to gain an understanding of internal controls.
QUESTION 444
When an auditor is to conduct an audit of a service organization, what considerations should the auditor make in the planning stages regarding internal controls of the organization?
A. Theauditorshouldassessthecontrolriskbeforeobtaininganunderstandingofinternalcontrols.
B. Theauditorshouldobtainanunderstandingoftheentity'sinternalcontrolsafterperformingsubstantiveprocedures. C. The auditor should obtain an understanding of the effect of the user organization upon the service organization.
D. The auditor should be engaged to perform agreed-upon procedures.
Correct Answer: C
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "c" is correct. In some situations, the controls at a service organization are designed under the assumption that there will be certain complementary controls implemented by user organizations. These complementary controls should be included in the description of controls. The service auditor should obtain an understanding of such situations, in order to evaluate whether the complementary controls are necessary to achieve stated control objectives. Choice "a" is incorrect. The auditor would need to understand controls before assessing their operating effectiveness.
Choice "b" is incorrect. Substantive procedures are not performed by a service auditor, who is either reporting on controls placed in operation, or on controls placed in operation and their operating effectiveness. Remember that a service auditor's engagement is not the same as an audit of financial statements.
Choice "d" is incorrect. Although a service auditor's engagement differs from an audit of financial statements, it is performed in accordance with the general standards as well as the relevant fieldwork and reporting standards. It is not considered to be an agreed-upon procedures engagement, as the auditor has not been engaged by the service organization to issue a report of findings based on specific, agreedupon procedures.
QUESTION 445
Proper segregation of duties reduces the opportunities to allow any employee to be in a position to both:
A. Journalizecashreceiptsanddisbursementsandpreparethefinancialstatements.
B. Monitorinternalcontrolsandevaluatewhetherthecontrolsareoperatingasintended. C. Adopt new accounting pronouncements and authorize the recording of transactions.
D. Record and conceal fraudulent transactions in the normal course of assigned tasks.
Correct Answer: D
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "d" is correct. Proper segregation of duties reduces the opportunities for any individual to both perpetrate and conceal errors or fraud.
Choice "a" is incorrect. Proper segregation of duties typically involves assigning different people the responsibilities of authorizing transactions, recording transactions, and maintaining custody of the related assets. Since journalizing cash receipts and disbursements and preparing the financial statements are both recordkeeping functions, this would not be a violation of proper segregation of duties.
Choice "b" is incorrect. Monitoring internal controls and evaluating whether those controls are operating as intended would properly be performed by one person. Combining these functions does not violate the concept of proper segregation of duties, since it does not encompass an inappropriate combination of authorization, recordkeeping, and custodial functions. Choice "c" is incorrect. Proper segregation of duties typically involves assigning different people the responsibilities of authorizing transactions, recording transactions, and maintaining custody of the related assets. Since adopting new accounting pronouncements and authorizing the recording of transactions are both authorization functions, this would not be a violation of proper segregation of duties.
QUESTION 446
Management's emphasis on meeting projected profit goals most likely would significantly influence an entity's control environment when:
A. Internalauditorshavedirectaccesstotheentity'sboardofdirectors.
B. Asignificantportionofmanagementcompensationisrepresentedbystockoptions.
C. External policies established by parties outside the entity affect accounting policies.
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. Management's emphasis on meeting projected profit goals would significantly influence an entity's control environment when a significant portion of management compensation is represented by stock options, because management would then have a personal interest that might be at odds with accurate financial reporting. Choice "a" is incorrect. An effective internal audit function would tend to moderate management's emphasis on meeting projected profit goals, and would therefore tend to dampen the effect on the control environment.
Choice "c" is incorrect. External policies established by outside parties would tend to moderate management's emphasis on meeting projected profit goals, and would therefore tend to dampen the effect on the control environment.
Choice "d" is incorrect. Active participation of those charged with governance would tend to moderate management's emphasis on meeting projected profit goals,
and would therefore tend to dampen the effect on the control environment.
QUESTION 447
Which of the following factors would most likely be considered an inherent limitation to an entity's internal control?
A. Thecomplexityoftheinformationprocessingsystem.
B. Humanjudgmentinthedecisionmakingprocess.
C. The ineffectiveness of the board of directors.
D. The lack of management incentives to improve the control environment.
Correct Answer: B
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "b" is correct. Human error is an inherent limitation in internal control, because even a properly designed and operating internal control system cannot prevent errors in the use of information provided by the system.
Choice "a" is incorrect. The complexity of the information processing system is not an inherent limitation of internal control, because controls can be adequately designed to take such complexity into account.
Choice "c" is incorrect. An ineffective board of directors is a weakness in internal control, but it is one that could and should be corrected. It is not an inherent limitation of internal control. Choice "d" is incorrect. Lack of appropriate incentives to improve the control environment is a weakness in internal control, but it is one that could and should be corrected. It is not an inherent limitation of internal control.
QUESTION 448
In planning the audit, the auditor obtains a sufficient understanding of the existing internal control. Which one of the following is not among the auditor's primary objectives for obtaining such knowledge?
A. Identifytypesofmaterialmisstatements.
B. Considerthefactorsthataffecttheriskofmaterialmisstatement. C. Make constructive suggestions to the client for improvement.
D. Design effective substantive tests.
Correct Answer: C
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "c" is correct. Making constructive suggestions to the client is not a primary objective for obtainingan understanding of internal control, although it may be a desirable by-product of an audit engagement.
Choices "a", "b", and "d" are incorrect, as the following are primary internal control planning objectives of an auditor in a financial statement audit:
A. Identify types of potential material misstatements. B. Consider factors that affect the risk of material misstatements. D. Design effective substantive tests.
QUESTION 449
Which of the following components (elements) of an entity's internal control includes the development of personnel manuals documenting employee promotion and training policies?
A. Monitoring.
B. Controlenvironment.
C. Information and communication system. D. Qualitycontrolsystem.
Correct Answer: B
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "b" is correct. The control environment element of an entity's internal control relates to the tone of the organization, which includes human resource policies and practices. Choice "a" is incorrect. Monitoring activities assess the quality of internal control performance over time.
Choice "c" is incorrect. The information and communication system relates to the identification, capture, and exchange of information.
Choice "d" is incorrect. A quality control system is not a component of an entity's internal control.
QUESTION 450
Which of the following statements about internal control is correct?
A. Properlymaintainedinternalcontrolreasonablyensuresthatcollusionamongemployeescannotoccur.
B. Theestablishmentandmaintenanceofinternalcontrolisanimportantresponsibilityoftheinternalauditor.
C. Exceptionally strong internal control is enough for the auditor to eliminate substantive tests on a significant account balance. D. The cost-benefit relationship is a primary criterion that should be considered in designing internal control.
Correct Answer: D
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "d" is correct. The concept of reasonable assurance recognizes that the cost of an entity's internal control should not exceed the benefits that are expected to be deriveD. The cost-benefit relationship is a primary criterion that should be considered in designing internal control. Choice "a" is incorrect. Even a properly maintained system of internal control is unable to reasonably ensure that collusion among employees cannot occur. Choice "b" is incorrect. Establishing and maintaining internal control is the responsibility of management - - not the internal auditor.
Choice "c" is incorrect. An exceptionally strong internal control that has been tested and can be relied upon by the auditor will allow the auditor to reduce (but not eliminate) substantive tests on significant account balances.
QUESTION 451
An auditor uses the knowledge provided by the understanding of internal control and the final assessed risk of material misstatement primarily to determine the nature, timing, and extent of the:
A. Attributetests.
B. Compliancetests. C. Tests of controls. D. Substantive tests.
Correct Answer: D
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "d" is correct. An auditor uses the knowledge provided by the understanding of internal control and the final assessed risk of material misstatement primarily to determine the nature, timing, and extent of the substantive tests to be performed. Choices "a", "b", and "c" are incorrect. Attribute tests, compliance tests, and tests of controls are all tests that assist the auditor in assessing control risk and determining the final assessed risk of material misstatement, not the other way around.
Which of the following characteristics most likely would heighten an auditor's concern about the risk of material misstatements in an entity's financial statements?
A. Theentity'sindustryisexperiencingdecliningcustomerdemand. B. Employeeswhohandlecashreceiptsarenotbonded.
C. Bank reconciliations usually include in-transit deposits.
D. Equipment is often sold at a loss before being fully depreciated.
Correct Answer: A
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "a" is correct. In assessing the risk related to material misstatements in an entity's financial statements, the auditor would consider situations that threaten financial stability or profitability, since such situations might provide an incentive to fraudulently misstate the financial statements. Included as one of these characteristics is declining customer demand. Choice "b" is incorrect. Even though the bonding of employees who handle cash is recommended, it is not a significant characteristic in assessing the risk related to material misstatement in an entity's financial statements.
Choice "c" is incorrect. Bank reconciliations with in-transit deposits are not unusual and would not heighten the auditor's concern about the risk of material misstatement. In-transit deposits can be verified with the bank at a later date.
Choice "d" is incorrect. Since depreciation does not adjust an asset to market value, the sale of equipment at a loss before being fully depreciated is not unusual and would not heighten an auditor's concern.
QUESTION 417
Which of the following statements reflects an auditor's responsibility for detecting errors and fraud?
A. Anauditorisresponsiblefordetectingemployeeerrorsandfraud,butnotfordiscoveringfraudinvolvingemployeecollusionormanagementoverride. B. AnauditorshouldplantheaudittodetecterrorsandfraudthatarecausedbydeparturesfromGAAP.
C. An auditor is not responsible for detecting errors and fraud unless the application of GAAS would result in such detection.
D. An auditor should design the audit to provide reasonable assurance of detecting errors and fraud that are material to the financial statements.
Correct Answer: D
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "d" is correct. The auditor should assess the risk that errors and fraud may cause the financial statements to contain a material misstatement. Based on that assessment, the auditor should design the audit to provide reasonable assurance of detecting material errors and fraud. Choice "a" is incorrect. An auditor is responsible for designing the audit to provide reasonable assurance of detecting material misstatement. This responsibility is the same regardless of the cause of
the misstatement. The presence of employee collusion or management override does not change the auditor's responsibility, although it might explain why a properly planned and executed audit did not result in the discovery of material fraud. Choice "b" is incorrect. The audit should be designed to detect material errors and fraud, regardless of the cause.
Choice "c" is incorrect. The auditor is not "responsible for detecting errors and fraud," but is responsible for designing the audit to provide reasonable assurance of detecting material misstatement, whether due to errors or fraud. Note that the auditor's responsibility relates to the design and execution of the audit, and that even an audit performed in accordance with GAAS may miss a material misstatement.
QUESTION 418
During the annual audit of Ajax Corp., a publicly held company, Jones, CPA, a continuing auditor, determined that illegal political contributions had been made during each of the past seven years, including the year under audit. Jones notified the board of directors about the illegal contributions, but they refused to take any action because the amounts involved were immaterial to the financial statements.
Jones should reconsider the intended degree of reliance to be placed on the:
A. Letterofauditinquirytotheclient'sattorney. B. Prioryears'auditplan.
C. Management representation letter.
D. Preliminaryjudgmentaboutmaterialitylevels.
Correct Answer: C
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "c" is correct. The auditor should consider the implications of an illegal act in relation to other aspects of the audit, particularly the reliability of representations of management. Choice "a" is incorrect. The integrity of the client's attorney would not necessarily be affected by illegal acts performed by the client.
Choice "b" is incorrect. The prior year audit plan would not be affected by the discovery of illegal acts in past years.
Choice "d" is incorrect. The auditor should consider the quantitative and qualitative materiality of the illegal act. However, this does not change the preliminary judgment about materiality levels.
QUESTION 419
Which of the following circumstances most likely would cause an auditor to consider whether material misstatements exist in an entity's financial statements?
A. Managementplaceslittleemphasisonmeetingearningsprojections.
B. Theboardofdirectorsmakesallmajorfinancingdecisions.
C. Significant deficiencies in internal control previously communicated to management are not corrected. D. Transactions selected for testing are not supported by proper documentation.
Correct Answer: D
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "d" is correct. Vouching recorded transactions to supporting documentation provides support for the occurrence assertion. The lack of supporting documentation calls into question the occurrence of the transactions under examination. Choice "a" is incorrect. Little emphasis on meeting earnings projections would be considered a positive factor in preventing material misstatements from occurring. Choice "b" is incorrect. As the representatives of shareholder interests, an active board of directors is considered a positive control.
Choice "c" is incorrect. The existence of significant deficiencies in internal control may represent a conscious decision by management to accept that degree of risk because of cost or other considerations.
Therefore, although failure to correct such deficiencies is considered a fraud risk factor, the auditor is more likely to be concerned about transactions that are not supported by proper documentation.
QUESTION 420
An auditor concludes that a client has committed an illegal act that has not been properly accounted for or disclosed. The auditor should withdraw from the engagement if the:
A. Auditorisprecludedfromobtainingsufficientappropriateevidenceabouttheillegalact.
B. Illegalacthasaneffectonthefinancialstatementsthatisbothmaterialanddirect.
C. Auditorcannotreasonablyestimatetheeffectoftheillegalactonthefinancialstatements. D. Client refuses to accept the auditor's report as modified for the illegal act.
Correct Answer: D
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "d" is correct. The auditor should withdraw from the engagement if the client refuses to accept the auditor's modified report.
Choice "a" is incorrect. If the auditor is precluded from obtaining sufficient evidence, the auditor should consider disclaiming an opinion.
Choice "b" is incorrect. The auditor must consider the effects of a direct material illegality on the financial statements and on other aspects of the audit, but need not withdraw from the engagement.
Choice "c" is incorrect. If the auditor cannot estimate the effect of the illegal act on the financial statements, the auditor should consider disclaiming an opinion.
QUESTION 421
An auditor who discovers that client employees have committed an illegal act that has a material effect on the client's financial statements most likely would withdraw from the engagement if:
A. Theillegalactisaviolationofgenerallyacceptedaccountingprinciples.
B. Theclientdoesnottaketheremedialactionthattheauditorconsidersnecessary. C. The illegal act was committed during a prior year that was not audited.
D. The auditor has already assessed control risk at a high level.
Correct Answer: B
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "b" is correct. The auditor may conclude that withdrawal is necessary if the client does not take the remedial action that the auditor considers necessary in the circumstances, even when the illegal act is not material to the financial statements. Choice "a" is incorrect. Whether or not the illegal act is a violation of GAAP does not determine the need to withdraw from the engagement.
Choice "c" is incorrect. An illegal act committed in the prior year would not necessarily cause an auditor to withdraw from a current engagement.
Choice "d" is incorrect. Assessment of control risk at a high level would cause an auditor to modify the nature, timing, or extent of audit procedures, but would not cause withdrawal from an engagement.
QUESTION 422
Which of the following factors most likely would heighten an auditor's concern about the risk of fraudulent financial reporting?
A. Inabilitytogeneratecashflowsfromoperationswhilereportingsubstantialearningsgrowth. B. Management'slackofinterestinincreasingtheentity'sstocktrend.
C. Large amounts of liquid assets that are easily convertible into cash.
D. Inability to borrow necessary capital without granting debt covenants.
Correct Answer: A
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "a" is correct. An auditor's concern about the risk of fraudulent financial reporting would be heightened if the entity were unable to generate cash flows from operations, but still reported substantial earnings growth, since these two occurrences are somewhat inconsistent. Choice "b" is incorrect. Management's excessive interest in increasing the stock price and earnings trend is a fraud risk factor; lack of such interest would not cause concern. Choice "c" 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 "d" is incorrect. The need to grant debt covenants when borrowing capital is an ordinary occurrence that would not heighten the auditor's concern.
QUESTION 423
Which of the following statements is correct concerning an auditor's responsibility to report fraud?
A. Theauditorisrequiredtocommunicatetothosechargedwithgovernanceallminorfraudulentactsperpetratedbylow-levelemployees,eveniftheamounts involved are inconsequential.
B. Thedisclosureofmaterialmanagementfraudtoprincipalstockholdersisrequiredwhenbothseniormanagementandtheboardofdirectorsfailtoacknowledge the fraudulent activities.
C. Fraudulent activities involving senior management of which the auditor becomes aware should be reported directly to the SEC.
D. The disclosure of fraudulent activities to parties other than the client's senior management and those charged with governance is not ordinarily part of the auditor's responsibility.
Correct Answer: D
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "d" is correct. The disclosure of fraudulent activities to parties other than the client's senior management and those charged with governance is not ordinarily part of the auditor's responsibility.
Choice "a" is incorrect. Only fraud that causes a material misstatement of the financial statements or fraud involving senior management should be reported to those charged with governance.
Choice "b" is incorrect. The disclosure of fraudulent activities to parties other than the client's senior management and those charged with governance is not ordinarily part of the auditor's responsibility.
Although there are certain exceptions to this rule, disclosure to stockholders is not one of them. Choice "c" is incorrect. Fraudulent activities involving senior management of which the auditor becomes aware should be reported directly to those charged with governance, not to the SEC. (Only in certain limited circumstances would fraud be disclosed to the SEC via required regulatory reports.)
QUESTION 424
Which of the following procedures would least likely result in the discovery of possible illegal acts?
A. Readingtheminutesoftheboardofdirectors'meetings. B. Makinginquiriesoftheclient'smanagement.
C. Performing tests of details of transactions.
D. Reviewing an internal control questionnaire.
Correct Answer: D
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "d" is correct. Reviewing an internal control questionnaire provides information about control policies and procedures, but does not provide information about actual transactions or events that have occurred. Therefore, it is not likely to uncover any illegal acts. Choices "a" and "b" are incorrect. The auditor generally does not include procedures specifically to detect illegal acts, but may discover such acts through other procedures, such as reading the board minutes or making inquiries of management or of legal counsel. Choice "c" is incorrect. Performing tests of details of transactions may provide information indicative of illegal acts, such as information regarding unauthorized or improperly recorded transactions; payments of unusual fines or penalties; payments that are unusually large or excessive, especially those made in cash; unexplained payments; or payments for unspecified services.
QUESTION 425
Which of the following circumstances most likely would cause an auditor to suspect that there are material misstatements in an entity's financial statements?
A. Seniorfinancialmanagementparticipatesintheselectionofaccountingprinciplesandthedeterminationofsignificantestimates. B. Supportingaccountingrecordsandfilesthatshouldbereadilyavailablearenotproducedpromptlywhenrequested.
C. Related party transactions take place in the ordinary course of business with an entity that is audited by another CPA firm.
D. Senior management has an excessive interest in upgrading the entity's information technology capabilities.
Correct Answer: B
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "b" is correct. Missing or unavailable documents or electronic evidence may be indicative of an intentional material misstatement in the entity's financial statements (fraud). Choice "a" is incorrect. Senior financial management should participate in the selection of accounting principles and the determination of significant estimates. This would not be indicative of material misstatements in the entity's financial statements. Choice "c" is incorrect. The auditor would need to audit related party transactions to ensure that there is proper financial statement disclosure, but the existence of such transactions would not be indicative of material misstatements in the entity's financial statements. Choice "d" is incorrect. The fact that senior management wants to upgrade the entity's information technology capabilities would not be indicative of material misstatements in the entity's financial statements.
QUESTION 426
Which of the following circumstances would an auditor most likely consider a risk factor relating to misstatements arising from fraudulent financial reporting?
A. Severalmembersofmanagementhaverecentlypurchasedadditionalsharesoftheentity'sstock.
B. Severalmembersoftheboardofdirectorshaverecentlysoldsharesoftheentity'sstock.
C. The entity distributes financial forecasts to financial analysts that predict conservative operating results.
D. Management is interested in maintaining the entity's earnings trend by using aggressive accounting practices.
Correct Answer: D
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "d" is correct. If the auditor becomes aware of management's interest in maintaining the entity's earnings trend by using aggressive accounting practices, this would be indicative of an attitude conducive to fraud.
Choice "a" is incorrect. Management purchase of company stock does not necessarily indicate an increased risk of fraud.
Choice "b" is incorrect. Sale by board members of company stock does not necessarily indicate an increased risk of fraud.
Choice "c" is incorrect. Prediction of conservative operating results is not a fraud risk factor; commitment to aggressive or unrealistic predictions would more likely be indicative of fraud risk.
QUESTION 427
Which of the following characteristics most likely would heighten an auditor's concern about the risk of material misstatement arising from fraudulent financial reporting?
A. Thereisalackofinterestbymanagementinmaintaininganearningstrend. B. Computerhardwareisusuallysoldatalossbeforebeingfullydepreciated.
C. Management had frequent disputes with the auditor on accounting matters. D. Monthly bank reconciliations usually include several large checks outstanding.
Correct Answer: C
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "c" is correct. Frequent disputes between management and the auditor is a fraud risk factor that would heighten an auditor's concern about the risk of material misstatement arising from fraudulent financial reporting.
Choice "a" is incorrect. Management's excessive interest in maintaining or increasing the stock price and earnings trend is a fraud risk factor, but management's lack of interest in maintaining an earnings trend would not constitute a fraud risk factor. Choice "b" is incorrect. Since depreciation does not adjust an asset to market value, the sale of computer hardware at a loss before being fully depreciated is not unusual and would not heighten an auditor's concern.
Choice "d" is incorrect. Bank reconciliations with outstanding checks are not unusual and would not heighten the auditor's concern about the risk of material misstatement. Outstanding checks can also be verified with the bank at a later date, when the checks clear.
QUESTION 428
Which of the following statements is correct regarding the auditor's consideration of the possibility of illegal acts by clients?
A. Theauditorhasaresponsibilitytoplanandperformtheaudittoobtainreasonableassurancethatnoillegalactshavebeencommittedbyclients.
B. Theauditor'straining,experience,andunderstandingoftheclientshouldbeusedtoprovideabasisforthedeterminationastowhetherillegalactshave occurred.
C. If specific information concerning an illegal act comes to the auditor's attention, the auditor should apply audit procedures specifically directed to ascertaining whether an illegal act has occurred.
D. If an illegal act has occurred, the auditor should express a qualified opinion or an adverse opinion on the financial statements taken as a whole.
Correct Answer: C
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "c" is correct. If specific information concerning a possible illegal act comes to the auditor's attention, the auditor should apply additional audit procedures to determine whether an illegal act has in fact occurred.
Choice "a" is incorrect. The auditor has a responsibility to plan and perform the audit to obtain reasonable assurance that the financial statements are free of material misstatement. This is a different level of assurance than stating that "no illegal acts" have been committed by clients, since it is possible for an immaterial illegal act (for example a theft of a few dollars from the petty cash fund) to occur and not be identified by the auditor. Choice "b" is incorrect. The auditor's training, experience, and understanding of the client may not be sufficient to provide a basis for the determination as to whether illegal acts (especially indirect effect illegal acts) have occurred.
Choice "d" is incorrect. If an illegal act has occurred, but the act has been properly accounted for and/or disclosed, there would be no need to express a qualified opinion or an adverse opinion.
Risk Assessment
QUESTION 429
In an audit of financial statements in accordance with generally accepted auditing standards, an auditor is required to:
A. Documenttheauditor'sunderstandingoftheentity'sinternalcontrol.
B. Searchforsignificantdeficienciesintheoperationofinternalcontrol.
C. Perform tests of controls to evaluate the effectiveness of the entity's information system relevant to financial reporting. D. Determine whether controls operated effectively to prevent or detect material misstatements.
Correct Answer: A
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "a" is correct. The auditor is required to document key elements of the understanding of the entity and its environment, including each of the components of internal control. Choice "b" is incorrect. Auditors are not required to search for significant deficiencies in the operation of internal control. They are merely required to report such conditions discovered during the audit to those charged with governance.
Choice "c" is incorrect. Auditors are not required to perform tests of controls unless they plan to place reliance on a particular control. Since auditors are not required to rely on the client's controls, tests of controls are generally not required. Choice "d" is incorrect. The auditor generally is not required to determine whether the client's controls operated effectively to prevent or detect material errors. Such determination would only be required for controls on which the auditor plans to rely.
QUESTION 430
The audit plan usually cannot be finalized until the:
A. Considerationoftheentity'sinternalcontrolhasbeencompleted.
B. Representationletterhasbeensignedbytheclient.
C. Significant deficiencies in internal control have been communicated to those charged with governance. D. Search for unrecorded liabilities has been performed and documented.
Correct Answer: A
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "a" is correct. The auditor should obtain a sufficient understanding of the entity and its environment, including its internal control, to plan the audit of the entity's financial statements. Choice "b" is incorrect. The representation letter is not obtained until the end of the audit. Choice "c" is incorrect. Informing those charged with governance of significant deficiencies in internal control generally occurs during or at the completion of the audit. It is not required before completion of the audit plan.
Choice "d" is incorrect. The search for unrecorded liabilities typically takes places after year-end, while the audit plan is prepared during planning. Information obtained from the search is not needed to finalize the audit plan.
QUESTION 431
The primary objective of procedures performed to obtain an understanding of the entity and its environment is to provide an auditor with:
A. Knowledgenecessaryforriskassessmentandauditplanning.
B. Auditevidencetouseinassessinginherentrisk.
C. A basis for issuing an opinion on the financial statements.
D. An evaluation of the consistency of application of management's policies.
Correct Answer: A
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "a" is correct. The auditor should obtain an understanding of the entity and its environment sufficient to assess the risk of material misstatement and to design and perform further audit procedures.
Choice "b" is incorrect. Assessing inherent risk is not the primary objective of obtaining an understanding of the entity and its environment.
Choice "c" is incorrect. Obtaining an understanding of the entity and its environment is not a sufficient basis for issuing an audit opinion.
Choice "d" is incorrect. Procedures performed to gain an understanding of the entity and its environment would not ordinarily test the consistency of the application of management's policies. If the auditor intends to rely on a control, its consistency in application would then be tested.
QUESTION 432
If an auditor's risk assessment is based on the effective operation of controls, the auditor will likely:
A. Applyanalyticalprocedurestobothfinancialdataandnonfinancialinformationtodetectconditionsthatmayindicateweakcontrols. B. Performtestsofdetailsoftransactionsandaccountbalancestoidentifypotentialerrorsandfraud.
C. Identify specific internal controls that are likely to detect or prevent material misstatements.
D. Document that the additional audit effort to perform tests of controls exceeds the potential reduction in substantive testing.
Correct Answer: C
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "c" is correct. Assessing risk based on the effective operation of controls involves (1) identifying specific internal controls relevant to specific assertions that are likely to prevent or detect material misstatements in those assertions, and (2) performing tests of such controls to evaluate their effectiveness.
Choice "a" is incorrect. Analytical procedures are used for planning purposes, as substantive tests, or as a final overall review. They are not used to support a risk assessment based on the effective operation of controls.
Choice "b" is incorrect. Tests of details of transactions and account balances to identify potential errors and fraud are substantive tests. They are not used to support a risk assessment based on the effective operation of controls.
Choice "d" is incorrect. The auditor may not assess risk based on the effective operation of controls unless tests of controls are performed. However, if the audit effort required to perform tests of controls exceeds the potential reduction in substantive testing, tests of controls will not be performed because doing so would reduce audit efficiency.
QUESTION 433
An advantage of using systems flowcharts to document information about internal control instead of using internal control questionnaires is that systems flowcharts:
A. Identifyinternalcontrolweaknessesmoreprominently.
B. Provideavisualdepictionofclient'sactivities.
C. Indicate whether control activities are operating effectively.
D. Reduce the need to observe client's employees performing routine tasks.
Correct Answer: B
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "b" is correct. An advantage of using systems flowcharts to document internal information is that flowcharts provide a visual depiction of clients' activities. Choice "a" is incorrect. Identification of internal control weaknesses requires the understanding, testing, and evaluation of controls. Either flowcharts or questionnaires can be used to obtain an understanding of internal control for this purpose.
Choice "c" is incorrect. Determining whether control activities are operating effectively requires tests of controls, and generally cannot be determined based on a flowchart or a questionnaire. Choice "d" is incorrect. Observing tasks being performed (routine or otherwise) are tests of controls. The need to perform tests of controls is not affected by the form of audit documentation selected.
QUESTION 434
An auditor's risk assessment is based on the assumption that controls are operating effectively. Which of the following was not a step in making this assessment?
A. Evaluatetheeffectivenessoftheinternalcontrolswithtestsofcontrols.
B. Obtainanunderstandingoftheentity'saccountingsystemandcontrolenvironment.
C. Perform tests of details of transactions to detect material misstatements in the financial statements. D. Consider whether control activities can have a pervasive effect on financial statement assertions.
Correct Answer: C
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "c" is correct. Tests of details of transactions are used to detect material misstatements in the financial statements after the auditor has assessed risk, not as part of making this assessment. Choice "a" is incorrect. Tests of controls are required to support the auditor's assumption that controls are operating effectively. Choice "b" is incorrect. Obtaining an understanding of each of the five components of internal control is required before making an assessment of control risk. The entity's accounting system (part of the information and communication component) and control environment are part of the five components.
Choice "d" is incorrect. Considering whether control activities can have a pervasive effect on financial statement assertions is part of the auditor's risk assessment
process. Internal Control
QUESTION 435
Which of the following procedures most likely would provide an auditor with evidence about whether an entity's internal control activities are suitably designed to prevent or detect material misstatements?
A. Reperformingtheactivitiesforasampleoftransactions.
B. Performinganalyticalproceduresusingdataaggregatedatahighlevel. C. Vouching a sample of transactions directly related to the activities.
D. Observing the entity's personnel applying the activities.
Correct Answer: D
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "d" is correct. Observation and inspection may be used to evaluate the design of controls. Observation of entity personnel applying control activities is a procedure that would likely provide evidence about the design of the activities. Choice "a" is incorrect. Reperforming control activities provides the auditor with evidence about the operating effectiveness of specific control activities, not the design effectiveness. Choice "b" is incorrect. Analytical procedures would not provide the auditor with evidence about the design of specific control activities.
Choice "c" is incorrect. Vouching a sample of transactions directly related to control activities would not provide the auditor with evidence about the design of specific control activities.
QUESTION 436
Management philosophy and operating style most likely would have a significant influence on an entity's control environment when:
A. Theinternalauditorreportsdirectlytomanagement.
B. Managementisdominatedbyoneindividual.
C. Accurate management job descriptions delineate specific duties.
D. Those charged with governance actively oversee the financial reporting process.
Correct Answer: B
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "b" is correct. Management philosophy and operating style encompass a broad range of characteristics. Such characteristics may include the following: management's approach to taking and monitoring business risks, management's attitudes and actions toward financial reporting, and management's attitudes toward information processing and accounting functions and personnel. These characteristics are more likely to have a significant influence on the control environment when management is dominated by one individual, since there will be few alternative viewpoints presented.
Choice "a" is incorrect. The internal audit function is part of the monitoring component of internal control, not part of the control environment. If the internal auditor reports directly to management, this would reduce their objectivity and perhaps make the monitoring function less effective, but it would have minimal impact on the control environment. Choice "c" is incorrect. Accurate management job descriptions would not change the influence that management philosophy and operating style have on the entity's control environment. Choice "d" is incorrect. The involvement of those charged with governance in the reporting process would tend to moderate or offset the influence that management philosophy and operating style have on the entity's control environment.
QUESTION 437
Which of the following is a management control method that most likely could improve management's ability to supervise company activities effectively?
A. Monitoringcompliancewithinternalcontrolrequirementsimposedbyregulatorybodies. B. Limitingdirectaccesstoassetsbyphysicalsegregationandprotectivedevices.
C. Establishing budgets and forecasts to identify variances from expectations.
D. Supporting employees with the resources necessary to discharge their responsibilities.
Correct Answer: C
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "c" is correct. The use of budgets and forecasts to identify variances improves managers' ability to supervise company activities. Variances from budgets serve as signals to managers that a potential problem exists.
Choice "a" is incorrect. Compliance with internal controls mandated by a regulatory body may be necessary, but would not necessarily enhance the ability of a manager to supervise company activities.
Choice "b" is incorrect. Limiting access to assets serves as a deterrent to employee theft, but does not really improve managers' ability to supervise company activities. Choice "d" is incorrect. Supporting employees with adequate resources is important, but it does not necessarily increase the supervisory capability of a manager.
QUESTION 438
In obtaining an understanding of a manufacturing entity's internal control concerning inventory balances, an auditor most likely would:
A. Analyzetheliquidityandturnoverratiosoftheinventory.
B. Performanalyticalproceduresdesignedtoidentifycostvariances. C. Review the entity's descriptions of controls over inventory.
D. Perform test counts of inventory during the entity's physical count.
Correct Answer: C
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "c" is correct. This question asks about internal control. Review of descriptions of controls would typically be performed while gaining an understanding of an entity's internal control (for any system or cycle, not just inventory). Choice "a" is incorrect. Analysis of inventory ratios is an analytical procedure, which is not used to gain an understanding of internal control.
Choice "b" is incorrect. Analytical procedures are used in planning the audit, as a substantive test, or for final overall review; they are not used to gain an understanding of internal control. Choice "d" is incorrect. Observation of physical inventory counts is a substantive test, not a procedure used to gain an understanding of internal control.
QUESTION 439
The overall attitude and awareness of those charged with governance (i.e., an entity's board of directors) concerning the importance of internal control usually is reflected in its:
A. Computer-basedcontrols.
B. Systemofsegregationofduties. C. Control environment.
D. Safeguards over access to assets.
Correct Answer: C
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "c" is correct. The control environment reflects the overall attitude, awareness and actions of those charged with governance (i.e., the board of directors, management, owners, and others) concerning the importance of control and its emphasis in the entity. Choice "a" is incorrect. Computer-based controls are a control activity. The overall attitude and awareness of those charged with governance is not a control activity. Choice "b" is incorrect. A system of segregation of duties is a control activity. The overall attitude and awareness of those charged with governance is not a control activity. Choice "d" is incorrect. Safeguards over access to assets is a control activity. The overall attitude and awareness of those charged with governance is not a control activity.
QUESTION 440
In an audit of financial statements, an auditor's primary consideration regarding internal control is whether the control:
A. Reflectsmanagement'sphilosophyandoperatingstyle. B. Affectsmanagement'sfinancialstatementassertions. C. Provides adequate safeguards over access to assets. D. Enhances management's decision-making processes.
Correct Answer: B
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "b" is correct. Assessing control risk is the process of evaluating the effectiveness of an entity's internal control in preventing or detecting material misstatements in the financial statements.
Choice "a" is incorrect. Management's philosophy and operating style are considered a part of the control environment. They are not the primary consideration in evaluating internal control. Choice "c" is incorrect. Providing adequate safeguards over access to assets is a type of control activity, but it is not the auditor's primary consideration regarding internal control. Choice "d" is incorrect. Policies and procedures concerning the effectiveness, economy, and efficiency of certain management decision-making processes are not relevant to the auditor's consideration of internal control.
QUESTION 441
The ultimate purpose of assessing control risk is to contribute to the auditor's evaluation of the risk that:
A. Testsofcontrolsmayfailtoidentifyproceduresrelevanttoassertions.
B. Materialmisstatementsmayexistinthefinancialstatements.
C. Specified controls requiring segregation of duties may be circumvented by collusion. D. Entity policies may be overridden by senior management.
Correct Answer: B
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "b" is correct. The ultimate purpose of assessing control risk is to contribute to the auditor's evaluation of the risk that material misstatements exist in the financial statements. Choice "a" is incorrect. Tests of controls are used to assess control risk, not to identify procedures relevant to assertions.
Choice "c" is incorrect. Collusion represents an inherent limitation in the effectiveness of internal control.
The auditor does not assess control risk to evaluate such limitations. Choice "d" is incorrect. Management override of policies represents an inherent limitation in the effectiveness of internal control. The auditor does not assess control risk to evaluate such limitations.
QUESTION 442
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. Theauditcommitteeisactiveinoverseeingtheentity'sfinancialreportingpolicies.
B. Externalpoliciesestablishedbypartiesoutsidetheentityaffectitsaccountingpractices. C. Management is dominated by one individual who is also a shareholder.
D. Internal auditors have direct access to those charged with governance.
Correct Answer: C
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "c" is correct. When management is dominated by one individual who is also a shareholder, there may not be any factors to moderate management's aggressive style. In such situations, management's style is likely to have a strong impact on the control environment. Choice "a" is incorrect. An active audit committee tends to moderate management's aggressive reporting style.
Choice "b" is incorrect. External policies established by outside parties would tend to moderate management's aggressive reporting style.
Choice "d" is incorrect. An effective internal audit function would tend to moderate management's aggressive reporting style.
QUESTION 443
When obtaining an understanding of an entity's internal controls, an auditor should concentrate on the substance of the controls rather than their form because:
A. Theproceduresmaybeoperatingeffectivelybutmaynotbedocumented.
B. Managementmayestablishappropriateproceduresbutnotenforcecompliancewiththem. C. The procedures may be so inappropriate that no reliance is contemplated by the auditor. D. Management may implement procedures whose costs exceed their benefits.
Correct Answer: B
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "b" is correct. "Substance over form" concerns relate to controls that appear on the surface to exist but in reality are not operating effectively. When obtaining an understanding of a client's internal controls, an auditor should concentrate on the substance of controls rather than the form because even when
appropriate procedures are established, management may not enforce compliance.
Choice "a" is incorrect. "Substance over form" concerns relate to controls that appear on the surface to exist but in reality are not operating effectively. Procedures that are operating effectively, even if they are not documented, do not illustrate this situation. Choice "c" is incorrect. The auditor should first obtain an understanding of the controls in order to determine whether the controls are appropriate or inappropriate. The auditor would not focus at all on controls deemed to be inappropriate.
Choice "d" is incorrect. While the cost-benefit of internal control is of concern to management in the design of the system, it plays no role in the auditor's attempt to gain an understanding of internal controls.
QUESTION 444
When an auditor is to conduct an audit of a service organization, what considerations should the auditor make in the planning stages regarding internal controls of the organization?
A. Theauditorshouldassessthecontrolriskbeforeobtaininganunderstandingofinternalcontrols.
B. Theauditorshouldobtainanunderstandingoftheentity'sinternalcontrolsafterperformingsubstantiveprocedures. C. The auditor should obtain an understanding of the effect of the user organization upon the service organization.
D. The auditor should be engaged to perform agreed-upon procedures.
Correct Answer: C
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "c" is correct. In some situations, the controls at a service organization are designed under the assumption that there will be certain complementary controls implemented by user organizations. These complementary controls should be included in the description of controls. The service auditor should obtain an understanding of such situations, in order to evaluate whether the complementary controls are necessary to achieve stated control objectives. Choice "a" is incorrect. The auditor would need to understand controls before assessing their operating effectiveness.
Choice "b" is incorrect. Substantive procedures are not performed by a service auditor, who is either reporting on controls placed in operation, or on controls placed in operation and their operating effectiveness. Remember that a service auditor's engagement is not the same as an audit of financial statements.
Choice "d" is incorrect. Although a service auditor's engagement differs from an audit of financial statements, it is performed in accordance with the general standards as well as the relevant fieldwork and reporting standards. It is not considered to be an agreed-upon procedures engagement, as the auditor has not been engaged by the service organization to issue a report of findings based on specific, agreedupon procedures.
QUESTION 445
Proper segregation of duties reduces the opportunities to allow any employee to be in a position to both:
A. Journalizecashreceiptsanddisbursementsandpreparethefinancialstatements.
B. Monitorinternalcontrolsandevaluatewhetherthecontrolsareoperatingasintended. C. Adopt new accounting pronouncements and authorize the recording of transactions.
D. Record and conceal fraudulent transactions in the normal course of assigned tasks.
Correct Answer: D
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "d" is correct. Proper segregation of duties reduces the opportunities for any individual to both perpetrate and conceal errors or fraud.
Choice "a" is incorrect. Proper segregation of duties typically involves assigning different people the responsibilities of authorizing transactions, recording transactions, and maintaining custody of the related assets. Since journalizing cash receipts and disbursements and preparing the financial statements are both recordkeeping functions, this would not be a violation of proper segregation of duties.
Choice "b" is incorrect. Monitoring internal controls and evaluating whether those controls are operating as intended would properly be performed by one person. Combining these functions does not violate the concept of proper segregation of duties, since it does not encompass an inappropriate combination of authorization, recordkeeping, and custodial functions. Choice "c" is incorrect. Proper segregation of duties typically involves assigning different people the responsibilities of authorizing transactions, recording transactions, and maintaining custody of the related assets. Since adopting new accounting pronouncements and authorizing the recording of transactions are both authorization functions, this would not be a violation of proper segregation of duties.
QUESTION 446
Management's emphasis on meeting projected profit goals most likely would significantly influence an entity's control environment when:
A. Internalauditorshavedirectaccesstotheentity'sboardofdirectors.
B. Asignificantportionofmanagementcompensationisrepresentedbystockoptions.
C. External policies established by parties outside the entity affect accounting policies.
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. Management's emphasis on meeting projected profit goals would significantly influence an entity's control environment when a significant portion of management compensation is represented by stock options, because management would then have a personal interest that might be at odds with accurate financial reporting. Choice "a" is incorrect. An effective internal audit function would tend to moderate management's emphasis on meeting projected profit goals, and would therefore tend to dampen the effect on the control environment.
Choice "c" is incorrect. External policies established by outside parties would tend to moderate management's emphasis on meeting projected profit goals, and would therefore tend to dampen the effect on the control environment.
Choice "d" is incorrect. Active participation of those charged with governance would tend to moderate management's emphasis on meeting projected profit goals,
and would therefore tend to dampen the effect on the control environment.
QUESTION 447
Which of the following factors would most likely be considered an inherent limitation to an entity's internal control?
A. Thecomplexityoftheinformationprocessingsystem.
B. Humanjudgmentinthedecisionmakingprocess.
C. The ineffectiveness of the board of directors.
D. The lack of management incentives to improve the control environment.
Correct Answer: B
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "b" is correct. Human error is an inherent limitation in internal control, because even a properly designed and operating internal control system cannot prevent errors in the use of information provided by the system.
Choice "a" is incorrect. The complexity of the information processing system is not an inherent limitation of internal control, because controls can be adequately designed to take such complexity into account.
Choice "c" is incorrect. An ineffective board of directors is a weakness in internal control, but it is one that could and should be corrected. It is not an inherent limitation of internal control. Choice "d" is incorrect. Lack of appropriate incentives to improve the control environment is a weakness in internal control, but it is one that could and should be corrected. It is not an inherent limitation of internal control.
QUESTION 448
In planning the audit, the auditor obtains a sufficient understanding of the existing internal control. Which one of the following is not among the auditor's primary objectives for obtaining such knowledge?
A. Identifytypesofmaterialmisstatements.
B. Considerthefactorsthataffecttheriskofmaterialmisstatement. C. Make constructive suggestions to the client for improvement.
D. Design effective substantive tests.
Correct Answer: C
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "c" is correct. Making constructive suggestions to the client is not a primary objective for obtainingan understanding of internal control, although it may be a desirable by-product of an audit engagement.
Choices "a", "b", and "d" are incorrect, as the following are primary internal control planning objectives of an auditor in a financial statement audit:
A. Identify types of potential material misstatements. B. Consider factors that affect the risk of material misstatements. D. Design effective substantive tests.
QUESTION 449
Which of the following components (elements) of an entity's internal control includes the development of personnel manuals documenting employee promotion and training policies?
A. Monitoring.
B. Controlenvironment.
C. Information and communication system. D. Qualitycontrolsystem.
Correct Answer: B
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "b" is correct. The control environment element of an entity's internal control relates to the tone of the organization, which includes human resource policies and practices. Choice "a" is incorrect. Monitoring activities assess the quality of internal control performance over time.
Choice "c" is incorrect. The information and communication system relates to the identification, capture, and exchange of information.
Choice "d" is incorrect. A quality control system is not a component of an entity's internal control.
QUESTION 450
Which of the following statements about internal control is correct?
A. Properlymaintainedinternalcontrolreasonablyensuresthatcollusionamongemployeescannotoccur.
B. Theestablishmentandmaintenanceofinternalcontrolisanimportantresponsibilityoftheinternalauditor.
C. Exceptionally strong internal control is enough for the auditor to eliminate substantive tests on a significant account balance. D. The cost-benefit relationship is a primary criterion that should be considered in designing internal control.
Correct Answer: D
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "d" is correct. The concept of reasonable assurance recognizes that the cost of an entity's internal control should not exceed the benefits that are expected to be deriveD. The cost-benefit relationship is a primary criterion that should be considered in designing internal control. Choice "a" is incorrect. Even a properly maintained system of internal control is unable to reasonably ensure that collusion among employees cannot occur. Choice "b" is incorrect. Establishing and maintaining internal control is the responsibility of management - - not the internal auditor.
Choice "c" is incorrect. An exceptionally strong internal control that has been tested and can be relied upon by the auditor will allow the auditor to reduce (but not eliminate) substantive tests on significant account balances.
QUESTION 451
An auditor uses the knowledge provided by the understanding of internal control and the final assessed risk of material misstatement primarily to determine the nature, timing, and extent of the:
A. Attributetests.
B. Compliancetests. C. Tests of controls. D. Substantive tests.
Correct Answer: D
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "d" is correct. An auditor uses the knowledge provided by the understanding of internal control and the final assessed risk of material misstatement primarily to determine the nature, timing, and extent of the substantive tests to be performed. Choices "a", "b", and "c" are incorrect. Attribute tests, compliance tests, and tests of controls are all tests that assist the auditor in assessing control risk and determining the final assessed risk of material misstatement, not the other way around.