Certified Public Accountant CPA Questions + Answers Part 32
Posted: Tue Feb 22, 2022 6:38 pm
QUESTION 495
Which of the following is not part of obtaining an understanding of internal control?
A. Consideringthetypesofmisstatementsthatmayoccurinanentity'sfinancialstatements. B. Determiningwhetherinternalcontrolsareoperatingeffectively.
C. Considering knowledge obtained from previous audits.
D. Determining the extent to which internal controls are computerized.
Correct Answer: B
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "b" is correct. The auditor is not required to obtain knowledge about operating effectiveness as part of the understanding of internal control. This knowledge is obtained later, for specific controls on which the auditor plans to rely. Choices "a", "c", and "d" are incorrect. During the planning phase of the audit, the auditor obtains an understanding of the internal control system by considering:
· The types of misstatements that may occur.
· The risk that misstatements may occur.
· Factors that influence the design of tests of controls and substantive tests.
· The assessment of inherent risk.
· Judgments about materiality.
· The complexity and sophistication of the entity's operations and systems. · The use of manual vs. computerized control procedures. Such knowledge may be obtained by appropriate inquiry, inspection, or observation. Knowledge may also be obtained based on previous experience with the client and/or an understanding of the industry in which the entity operates.
QUESTION 496
Audit evidence concerning segregation of duties ordinarily is best obtained by:
A. Performingtestsoftransactionsthatcorroboratemanagement'sfinancialstatementassertions. B. Observingtheemployeesastheyapplycontrolprocedures.
C. Obtaining a flowchart of activities performed by available personnel.
D. Developing audit objectives that reduce control risk.
Correct Answer: B
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "b" is correct. Audit evidence concerning segregation of duties ordinarily is best obtained by the auditor observing the employees as they apply control procedures. Generally the auditor's direct, personal knowledge obtained through observation, inspection and physical examination is more persuasive than indirect
information.
Choice "a" is incorrect. Performing tests of transactions that corroborate management's financial statement assertions would provide little audit evidence concerning segregation of duties. Choice "c" is incorrect. Obtaining a flowchart of activities performed by available personnel may assist the auditor in understanding the design of the internal control system, but it provides no audit evidence regarding whether the segregation of duties is actually functioning as designed. Choice "d" is incorrect. Developing audit objectives that reduce control risk provides no audit evidence regarding the segregation of duties.
QUESTION 497
After testing a client's internal control activities, an auditor discovers a number of significant deficiencies in the operation of a client's internal controls. Under these circumstances the auditor most likely would:
A. Issueadisclaimerofopinionabouttheinternalcontrolsaspartoftheauditor'sreport. B. Increasetheassessmentofcontrolriskandincreasetheextentofsubstantivetests. C. Issue a qualified opinion of this finding as part of the auditor's report.
D. Withdraw from the audit because the internal controls are ineffective.
Correct Answer: B
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "b" is correct. The auditor uses tests of controls to evaluate control risk. In situations where there are a number of significant deficiencies in the operation of the client's internal controls, the auditor would increase the assessment of control risk (and the risk of material misstatement) and revise substantive testing accordingly (for example, by increasing the extent of substantive tests).
Choice "a" is incorrect. An auditor is required to communicate significant deficiencies to management and those charged with governance, and a disclaimer of opinion on the effectiveness of controls would be included in this communication. However, such disclaimer would not be part of the auditor's report on the financial statements. Choice "c" is incorrect. Since the auditor's report provides an opinion on the financial statements (and not on internal control), significant deficiencies in internal control do not result in a qualified opinion.
Choice "d" is incorrect. The auditor need not withdraw from an audit simply because internal controls are ineffective, but rather would increase the assessment of control risk and revise substantive testing accordingly.
QUESTION 498
In which of the following circumstances is substantive testing of accounts receivable before the balance sheet date most appropriate?
A. Theclienthasanewsalesincentiveprograminplace.
B. Internalcontrolsduringtheremainingperiodareeffective. C. There is a high turnover of senior management.
D. It is a first engagement of a new client.
Correct Answer: B
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "b" is correct. The higher the auditor's risk assessment, the closer to period end substantive procedures should be performed. Conversely, effective controls reduce control risk and reduce the risk of material misstatement, allowing more interim testing to occur. Choice "a" is incorrect. A new sales incentive program results in an increase in the risk of material misstatement, making it less likely that interim testing will be performed. Choice "c" is incorrect. High turnover of senior management results in an increase in the risk of material misstatement, making it less likely that interim testing will be performed. Choice "d" is incorrect. In the first engagement of a new client, the auditor will have less knowledge of the client and therefore would be less inclined to utilize interim testing, which increases audit risk.
QUESTION 499
What is the most likely course of action that an auditor would take after determining that performing substantive tests on inventory will take less time than performing tests of controls?
A. Assesscontrolriskatalowlevel.
B. Performbothtestsofcontrolsandsubstantivetestsoninventory. C. Perform only substantive tests on inventory.
D. Perform only tests of controls on inventory.
Correct Answer: C
Section: Auditing and Attestation (I) (Volume C)
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Choice "c" is correct. If it would take less time to perform substantive tests than it would to perform tests of controls, and if there is no other reason to test controls (i.e., if there is not a high degree of electronic processing), the auditor would not be likely to test controls. Choice "a" is incorrect. In order to assess control risk at a low level, tests of controls would need to be performed. However, if it is more efficient to perform substantive tests, the auditor would not be likely to test controls. Choice "b" is incorrect. If it would take less time to perform substantive tests than it would to perform tests of controls, and if there is no other reason to test controls (i.e., if there is not a high degree of electronic processing), the auditor would not be likely to test controls. Choice "d" is incorrect. Substantive procedures are always be necessary for all assertions relevant to material transaction classes, account balances, and disclosures. Assuming inventory is material, tests of controls alone would not be sufficient.
QUESTION 500
Which of the following procedures would an auditor least likely perform before the balance sheet date?
A. Confirmationofaccountspayable.
B. Observationofmerchandiseinventory.
C. Assessment of the risk of material misstatement. D. Identification of related parties.
Correct Answer: A
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "a" is correct. The auditor should consider whether the year-end balances of the particular asset or liability accounts that might be selected for interim examination are reasonably predictable with respect to amount, relative significance, and composition. Accounts payable is relatively difficult to predict because it may fluctuate at management's discretion. Choice "b" is incorrect. The auditor should consider whether the year-end balances of the particular asset or liability accounts that might be selected for interim examination are reasonably predictable with respect to amount, relative significance, and composition. Inventory is relatively predictable with respect to amount, composition and relative significance. Choice "c" is incorrect. During planning, the auditor is required to obtain an understanding of the entity and its environment, including its internal control, and to assess risk. Such preliminary planning is often conducted prior to the balance sheet date. Choice "d" is incorrect. Audit testing at interim dates may permit early consideration of significant matters affecting the year-end financial statements, such as the identification of related parties.
Supplemental Questions
QUESTION 501
Which of the following factors are included in an entity's control environment?
A. Option A B. OptionB C. Option C D. Option D
Correct Answer: D
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "d" is correct. Yes - Yes - Yes. An entity's control environment includes participation of those charged with governance, management's philosophy, and the organizational structure.
QUESTION 502
Which of the following are considered control environment factors?
A. Option A B. OptionB C. Option C D. Option D
Correct Answer: C
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "c" is correct. Yes - No - Yes. Control environment factors include:
1. Communication and enforcement of integrity and ethical values. 2. Commitment to competence.
3. Participation of those charged with governance.
4. Management's philosophy and operating style.
5. Organizational structure.
6. Assignment of authority, responsibility, and accountability. 7. Human resource policies and practices.
Choice "a" is incorrect. Detection risk is the risk that an auditor's procedures will lead to the conclusion that a material error does not exist in an account balance when, in fact, such error does exist.
Choices "b" and "d" are incorrect, per the above.
QUESTION 503
Which of the following circumstances would most likely cause an auditor to suspect that material misstatements arising from fraud exist in a client's financial statements?
A. Propertyandequipmentareusuallysoldatalossbeforebeingfullydepreciated. B. Significantlyfewerresponsestoconfirmationrequestsarereceivedthanexpected. C. Monthly bank reconciliations usually include several in-transit items.
D. Clerical errors are listed on an EDP-generated exception report.
Correct Answer: B
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "b" is correct. Material fraud ("intentional" misstatements or omissions) may result from large amounts of fictitious accounts receivable. Receiving significantly fewer confirmation responses than expected implies some accounts receivable may be fictitious. Choice "a" is incorrect. Selling property and equipment at a loss from book value is not unusual and would not necessarily be indicative of fraud.
Choice "c" is incorrect. Bank reconciliations typically include in-transit items (e.g., deposits in transit and outstanding checks), and this would not necessarily be indicative of fraud. Choice "d" is incorrect. Clerical errors listed on an exception report would be a control over data processing that would tend to minimize the risk of material misstatement.
QUESTION 504
Which of the following factors is most important concerning an auditor's responsibility to detect errors and fraud?
A. Thesusceptibilityoftheaccountingrecordstointentionalmanipulations,alterations,andthemisapplicationofaccountingprinciples.
B. Theprobabilitythatunreasonableaccountingestimatesresultfromunintentionalbiasorintentionalattemptstomisstatethefinancialstatements. C. The possibility that management fraud, defalcations, and the misappropriation of assets may indicate the existence of illegal acts.
D. The risk that mistakes, falsifications, and omissions may cause the financial statements to contain material misstatements.
Correct Answer: D
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "d" is correct. The most important factor concerning an auditor's responsibility to detect errors and fraud is the risk that mistakes, falsifications, and omissions may cause the financial statements to contain material misstatements.
Choice "a" is incorrect. The susceptibility of the accounting records to intentional manipulations, alterations, and the misapplication of accounting principles is something the auditor must consider, but it does not describe the auditor's responsibility to detect errors and fraud. Choice "b" is incorrect. The probability that unreasonable accounting estimates result from unintentional bias or intentional attempts to misstate the financial statements is something the auditor must consider, but it does not describe the auditor's responsibility to detect errors and fraud.
Choice "c" is incorrect. The possibility that management fraud, defalcations, and the misappropriation of assets may indicate the existence of illegal acts is something the auditor must consider, but it does not describe the auditor's responsibility to detect errors and fraud.
QUESTION 505
Disclosure of fraud to parties other than a client's senior management, those charged with governance, or its board of directors ordinarily is not part of an auditor's responsibility. However, to which of the following outside parties may a duty to disclose irregularities exist?
A. Option A B. OptionB C. Option C D. Option D
Correct Answer: D
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "d" is correct. The accountant may have a duty to disclose irregularities to all of the following outside parties:
Yes - The SEC when the client reports an auditor change. Yes - A successor auditor when the successor makes appropriate inquiries. Yes - A government funding agency from which the client receives financial assistance. Choices "a", "b", and "c" are incorrect, based on the above explanation.
QUESTION 506
Which of the following statements describes why a properly designed and executed audit may not detect a material misstatement due to fraud?
A. Auditproceduresthatareeffectivefordetectinganunintentionalmisstatementmaybeineffectiveforanintentionalmisstatementthatisconcealedthrough collusion.
B. Anauditisdesignedtoprovidereasonableassuranceofdetectingmaterialerrors,butthereisnosimilarresponsibilityconcerningmaterialmisstatementdueto fraud.
C. The factors considered in assessing control risk indicated an increased risk of intentional misstatements, but only a low risk of unintentional errors in the financial statements.
D. The auditor didn't consider factors influencing audit risk for account balances that have effects pervasive to financial statements taken whole.
Correct Answer: A
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "a" is correct. A properly designed and executed audit may not detect a material misstatement that is concealed through collusion. The auditor's responsibility is to design audit procedures that can reasonably be expected to detect material misstatements (errors and fraud) in the financial statements. Intentional misstatements that are concealed through collusion, however, are very difficult to detect, and generally the auditor is not responsible to discover them. Choice "b" is incorrect. An audit is designed to provide reasonable assurance of detecting material misstatements (both errors and fraud).
Choice "c" is incorrect. If the factors considered in assessing control risk indicated an increased risk of intentional misstatements, a properly designed and executed audit would have taken the increased risk into consideration with additional audit procedures. Choice "d" is incorrect. In a properly designed and executed audit, the auditor would consider factors influencing audit risk for account balances that have effects pervasive to the financial statements taken as a whole.
QUESTION 507
Which of the following circumstances most likely would cause an auditor to consider whether material misstatements exist in an entity's financial statements?
A. Supportingrecordsthatshouldbereadilyavailablearefrequentlynotproducedwhenrequested. B. Significantdeficienciesininternalcontrolpreviouslycommunicatedhavenotbeencorrected.
C. Clerical errors are listed on a monthly computer-generated exception report.
D. Differences are discovered during the client's annual physical inventory count.
Correct Answer: A
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "a" is correct. Supporting records that should be readily available but are frequently not produced when requested would cause an auditor to consider whether material misstatements exist.
Choice "b" is incorrect. Failure to correct significant deficiencies in internal control may represent a conscious decision by management to accept that degree of risk because of cost or other considerations.
Although this is a fraud risk factor, the auditor is more likely to be concerned about missing audit evidence.
Choice "c" is incorrect. Clerical errors listed on a monthly computer-generated exception report would be a control over data processing that would tend to minimize the risk of material misstatement.
Choice "d" is incorrect. Differences being discovered during the client's annual physical inventory count is a common occurrence at most companies and would not necessarily indicate that a material misstatement exists.
QUESTION 508
The most likely explanation why the auditor's examination cannot reasonably be expected to bring all illegal acts by the client to the auditor's attention is that:
A. Illegalactsareperpetratedbymanagementoverrideofinternalaccountingcontrols.
B. Illegalactsbyclientsoftenrelatetooperatingaspectsratherthanaccountingaspects.
C. The client's system of internal accounting control may be so strong that the auditor performs only minimal substantive testing.
D. Illegal acts may be perpetrated by the only person in the client's organization with access to both assets and the accounting records.
Correct Answer: B
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "b" is correct. The audit should be designed to identify material misstatements due to illegal acts, but illegal acts that relate to operating aspects rather than accounting aspects may not directly affect the financial statements, and therefore they may be less likely to be discovered by the auditor.
Choice "a" is incorrect. The audit should be designed to identify material misstatements due to illegal acts, even if they are caused by management override of (its own) internal control. Choice "c" is incorrect. The audit should be designed to identify material misstatements due to illegal acts, even when minimal substantive testing is performed by the auditor due to a very strong system of internal control.
Choice "d" is incorrect. The audit should be designed to identify material misstatements due to illegal acts, even when those illegal acts were perpetrated by the only person with access to both assets and the accounting records.
QUESTION 509
An auditor of a manufacturer would most likely question whether that client has committed illegal acts if the client has:
A. Beenforcedtodiscontinueoperationsinaforeigncountry.
B. Beenanannualdonortoalocalpoliticalcandidate.
C. Failed to correct material weaknesses in internal accounting control that were reported after the prior year's audit. D. Disclosed several subsequent events involving foreign operations in the notes to the financial statements.
Correct Answer: A
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "a" is correct. Being forced to discontinue operations in a foreign country would cause the auditor of the manufacturer to question whether that client has
committed an illegal act. Choice "b" is incorrect. Making political contributions to local politicians is not illegal. (Bribes are illegal.) Choice "c" is incorrect. Failure to correct material weaknesses in internal accounting control may represent a conscious decision by management to accept that degree of risk because of cost or other considerations. Choice "d" is incorrect. Disclosure of subsequent events is not indicative of an illegal act.
QUESTION 510
If specific information comes to an auditor's attention that implies the existence of possible illegal acts that could have a material, but indirect effect on the financial statements, the auditor should next:
A. Applyauditproceduresspecificallydirectedtoascertainingwhetheranillegalacthasoccurred.
B. Seektheadviceofaninformedexpertqualifiedtopracticelawastopossiblecontingentliabilities. C. Report the matter to an appropriate level of management at least one level above those involved. D. Discuss the evidence with those charged with governance.
Correct Answer: A
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "a" is correct. If specific information comes to an auditor's attention that implies the existence of possible illegal acts that could have a material, but indirect effect on the financial statements, the auditor should next apply audit procedures specifically directed to ascertaining whether an illegal act has occurred. The auditor should obtain an understanding of the situation, inquire of management (at a level above those involved), consult legal counsel, and consider applying additional audit procedures if necessary.
Choice "b" is incorrect. The auditor would consult with the client's legal counsel after obtaining an understanding of the situation and inquiring of management. Choice "c" is incorrect. The auditor would inquire of management at a level above those involved after obtaining an understanding of the situation. Choice "d" is incorrect. The auditor would only communicate with those charged with governance regarding detected illegal acts, not possible illegal acts.
QUESTION 511
When an auditor becomes aware of a possible illegal act by a client, the auditor should obtain an understanding of the nature of the act to:
A. Evaluatetheeffectonthefinancialstatements.
B. Determinethereliabilityofmanagement'srepresentations.
C. Consider whether other similar acts may have occurred.
D. Recommend remedial actions to those charged with governance.
Correct Answer: A
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "a" is correct. When an auditor becomes aware of a possible client illegal act, the auditor should next obtain an understanding of the nature of the act in order to evaluate the effect on the financial statements.
Choices "b", "c", and "d" are incorrect. After evaluating the effect of the illegal act on the financial statements, the auditor may also determine the reliability of management's representations, consider whether other similar acts may have occurred, or recommend remedial actions to those charged with governance.
QUESTION 512
The auditor should obtain sufficient knowledge of the client's information and communication system relevant to financial reporting to understand all of the following, except:
A. Classesoftransactionsintheentity'soperationsthataresignificanttothefinancialstatements,andhowthosetransactionsareprocessed,frominitiationto inclusion in the financial statements.
B. Thefinancialreportingprocess,includingdevelopmentofsignificantaccountingestimatesandinclusionofappropriatedisclosures.
C. The means the entity uses to communicate roles, responsibilities, and significant matters relating to financial reporting.
D. Control activities related to each account balance, transaction class, and disclosure component in the financial statements or to every assertion relevant to them.
Correct Answer: D
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "d" is correct. Ordinarily, audit planning does not require an understanding of the control activities related to each account balance, transaction class, and disclosure component in the FS or to every assertion relevant to them.
Choice "a" is incorrect. The auditor is required to understand significant classes of transactions and how they are processed.
Choice "b" is incorrect. The auditor is required to understand the financial reporting process. Choice "c" is incorrect. The auditor is required to understand the methods used by the entity to communicate matters relevant to financial reporting.
QUESTION 513
Which of the following information discovered during an audit most likely would raise a question concerning possible illegal acts?
A. Relatedpartytransactions,althoughproperlydisclosed,werepervasiveduringtheyear.
B. Theentitypreparedseverallargecheckspayabletocashduringtheyear.
C. Material internal control weaknesses previously reported to management were not corrected. D. The entity was a campaign contributor to several local political candidates during the year.
Correct Answer: B
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "b" is correct. Information that may raise a question concerning possible illegal acts include unusually large payments made to:
· Cash
· Bearer
· Purchase cashiers checks
· Transfer funds to numbered accounts
Choice "a" is incorrect. Related party transactions may provide an indication of fraud, particularly if not made in the ordinary course of business, but they are generally not indicative of illegal acts.
Choice "c" is incorrect. Failure to correct material internal control weaknesses may represent a conscious decision by management to accept that degree of risk because of cost or other considerations.
Choice "d" is incorrect. Contributions to local political candidates are legal and generally would not raise a question about possible illegal acts.
QUESTION 514
Which of the following is not a control environment factor?
A. Participationofthosechargedwithgovernance. B. Hiringandadvancementpolicies.
C. Management's approach toward business risks. D. Proper segregation of duties.
Correct Answer: D
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "d" is correct. Policies and procedures involving segregation of duties are control activities, not control environment factors.
Choice "a" is incorrect. Participation of those charged with governance is a control environment factor. Choice "b" is incorrect. Hiring and advancement policies are part of human resource policies and practices, which are control environment factors. Choice "c" is incorrect. Management's approach toward business risks is part of its philosophy and operating style, which is a control environment factor.
QUESTION 515
An auditor who discovers that a client's employees have paid small bribes to public officials most likely would withdraw from the engagement if the:
A. Clientreceivesfinancialassistancefromafederalgovernmentagency.
B. Auditevidencethatisnecessarytoprovethattheillegalactswerecommitteddoesnotexist. C. Employees' actions affect the auditor's ability to rely on management's representations.
D. Notes to the financial statements fail to disclose the employees' actions.
Correct Answer: C
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "c" is correct. When an auditor cannot rely on management's representations, he or she should withdraw from the engagement.
Choice "a" is incorrect. As long as the client takes appropriate remedial action, the auditor would not need to withdraw from the engagement simply because the client receives federal financial assistance.
However, the auditor would be subject to a variety of reporting requirements related to this discovery.
Choice "b" is incorrect. If there is no evidence that an illegal act was committed, management may be unable to take remedial action against the related employees. As long as the illegal act is immaterial and the auditor is satisfied that management's response is appropriate in the circumstances, there would be no reason for the auditor to withdraw. Choice "d" is incorrect. The auditor should evaluate the adequacy of disclosure in the financial statements with respect to the potential effects of an illegal act. If the auditor concludes that disclosure is inadequate, he or she should express a qualified or adverse opinion, but would not necessarily need to withdraw from the engagement (unless the client refused to accept the modified report).
QUESTION 516
Which of the following statements is true regarding the risk assessment component of internal control?
A. Anauditorevaluatesanentity'sriskassessmentbecauseitisacomponentofoverallauditriskinafinancialstatementaudit.
B. Anauditor'sevaluationofanentity'sriskassessmentmaynotbeapplicabletotheauditofeveryentity.
C. An auditor evaluates an entity's risk assessment to understand how management addresses risks relevant to financial reporting.
D. An auditor need not consider an entity's risk assessment because he or she is primarily concerned with audit risk in a financial statement audit.
Correct Answer: C
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "c" is correct. The auditor needs to understand how management addresses risks relevant to financial reporting in order to properly plan the audit. Choice
"a" is incorrect. An entity's risk assessment differs from an auditor's assessment of audit risk.
The entity is concerned with managing risks that affect entity objectives (financial reporting, operations, and compliance) whereas the auditor is concerned with the risk that material misstatements could occur in the financial statements. Choice "b" is incorrect. The five components of internal control are applicable to the audit of every entity.
Choice "d" is incorrect. The auditor needs to understand how management addresses risks relevant to financial reporting in order to properly plan the audit.
QUESTION 517
Before applying principal substantive tests to the details of accounts at an interim date prior to the balance sheet date, an auditor should:
A. Assesscontrolriskatalowlevelfortheassertionsembodiedintheaccountsselectedforinterimtesting.
B. Determinethattheaccountsselectedforinterimtestingarenotmaterialtothefinancialstatementstakenasawhole. C. Consider whether the amounts of the year-end balances selected for interim testing are reasonably predictable.
D. Obtain written representations from management that all financial records and related data will be made available.
Correct Answer: C
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "c" is correct. Before performing substantive tests at an interim date, an auditor should consider whether the amounts of the year-end balances selected for interim testing are reasonably predictable with respect to amount, relative significance and composition. Choice "a" is incorrect. It is not necessary for control risk to be assessed at a low level level for the assertions relating to the accounts that will be substantively tested at an interim date. It may simply be more efficient to perform a substantive audit. As long as the balances tested at interim are reasonably predictable with respect to amount, relative significance and composition, the account may be tested at interim.
Choice "b" is incorrect. Material account balances, such as accounts receivable and inventory, are commonly tested at an interim date.
Choice "d" is incorrect. The written representation letter will not be obtained until after year-end.
QUESTION 518
Which of the following is not true with respect to the control activities of an entity?
A. Controlactivitiesarethepoliciesandproceduresthathelpensurethatmanagementdirectivesarecarriedout.
B. Controlactivitiesarethepoliciesandproceduresthathelpensurethatthefinancialstatementsarefairlypresentedinconformitywithgenerallyaccepted accounting principles.
C. An understanding of control activities may be obtained while the auditor is obtaining an understanding of the other components of internal control.
D. An understanding of control activities does not require an understanding of control activities related to each account balance included in the financial statements.
Correct Answer: B
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "b" is correct. Control activities are the policies and procedures that help ensure that management directives are carried out. These policies and procedures may relate to any of the three objectives (financial reporting, operations, and compliance), not strictly to the financial reporting objective.
Choice "a" is incorrect. Control activities are defined as the policies and procedures that help ensure that management directives are carried out.
Choice "c" is incorrect. As an auditor obtains an understanding about the other components of internal control, he or she is also likely to obtain some knowledge about control activities. Choice "d" is incorrect. Ordinarily, audit planning does not require an understanding of control activities related to each account balance, transaction class, and disclosure component.
QUESTION 519
Before applying substantive tests to the details of asset accounts at an interim date, an auditor should assess:
A. Controlriskatalowlevel.
B. Inherentriskatahighlevel.
C. The difficulty in controlling the incremental audit risk. D. Materiality for the accounts tested as insignificant.
Correct Answer: C
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "c" is correct. Before performing substantive tests at an interim date, the auditor must assess the difficulty in controlling the incremental audit risk from the interim date (on which the substantive procedures are performed) to the year-end date (on which an opinion is rendered). Choice "a" is incorrect. The auditor would not have to assess control risk at a low level in order to perform substantive tests at interim. It may simply be more efficient to perform a substantive audit. As long as the balances tested at interim are reasonably predictable with respect to amount, relative significance and composition, the account may be tested at interim. Choice "b" is incorrect. Generally, inherent risk should be low in order to test substantively at interim.
Choice "d" is incorrect. If the materiality level for those accounts to be tested is insignificant, then the auditor probably would not perform any substantive testing, since it is unlikely that a material error exists in an insignificant balance.
QUESTION 520
Which of the following statements best describes how a detailed audit plan of a CPA who is engaged to audit the financial statements of a large publicly held company compares with the audit client's comprehensive internal audit program?
A. ThecomprehensiveinternalauditplanissubstantiallyidenticaltotheauditplanusedbytheCPAbecausebothcoversubstantiallyidenticalareas.
B. ThecomprehensiveinternalauditplanislessdetailedandcoversfewerareasthanwouldnormallybecoveredbytheCPA.
C. The comprehensive internal audit plan is more detailed and covers areas that would normally not be covered by the CPA.
D. The comprehensive internal audit plan is more detailed although it covers fewer areas than would normally be covered by the CPA.
Correct Answer: C
Section: Auditing and Attestation (I) (Volume C) Explanation
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Choice "c" is correct. "Internal auditors" are part of the system of internal control. Their audits would cover more areas in greater depth than those of the "independent auditors," whose concerns are limited to areas materially affecting the "financial statements taken as a whole." Choices "a", "b", and "d" are incorrect, as described above.
QUESTION 521
When assessing an internal auditor's objectivity, an independent auditor should:
A. Evaluatetheadequacyoftheinternalauditor'sauditplans.
B. Inquireabouttheinternalauditor'seducationalbackgroundandprofessionalcertification. C. Consider the organizational level to which the internal auditor reports.
D. Review the internal auditor's audit documentation.
Correct Answer: C
Section: Auditing and Attestation (I) (Volume C) Explanation
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Explanation
Choice "c" is correct. When assessing an internal auditor's objectivity, an independent auditor should consider the organizational level to which the internal auditor reports. Choice "a" is incorrect. Evaluating the adequacy of the internal auditor's audit plans would be performed when assessing an internal auditor's competence. Choice "b" is incorrect. Inquiring about the internal auditor's educational background and professional certification would be performed when assessing an internal auditor's competence. Choice "d" is incorrect. Reviewing the internal auditor's audit documentation (to determine the quality of the reports and recommendations) would be performed when assessing an internal auditor's competence.
QUESTION 522
Before accepting an audit engagement, a successor auditor should make specific inquiries of the predecessor auditor regarding: A. Disagreementsthepredecessorhadwiththeclientconcerningauditingproceduresandaccountingprinciples.
B. Thepredecessor'sevaluationofmattersofcontinuingaccountingsignificance.
C. The degree of cooperation the predecessor received concerning the inquiry of the client's lawyer. D. The predecessor's assessments of inherent risk and judgments about materiality.
Correct Answer: A
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "a" is correct. Before accepting an audit engagement, a successor auditor should make specific inquiries of the predecessor auditor regarding disagreements the predecessor had with the client concerning auditing procedures and accounting principles. Choice "b" is incorrect. The successor auditor may make specific inquiries of the predecessor auditor regarding the predecessor's evaluation of matters of continuing accounting significance, but this would occur after accepting the engagement. Choice "c" is incorrect. The successor auditor may make specific inquiries of the predecessor auditor regarding the degree of cooperation the predecessor received concerning the inquiry of the client's lawyer, but this would occur after accepting the engagement. Choice "d" is incorrect. The successor auditor would generally come to his or her own conclusions regarding assessments of inherent risk and judgments about materiality without consulting the predecessor auditor.
QUESTION 523
Ordinarily, the predecessor auditor permits the successor auditor to review the predecessor's audit documentation relating to:
A. Option A B. OptionB C. Option C D. Option D
Correct Answer: A
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "a" is correct. Ordinarily, the predecessor auditor permits the successor auditor to review the predecessor's audit documentation relating to matters of continuing accounting and auditing significance, including both contingencies and balance sheet accounts. Contingencies have continuing significance as they may continue to affect the current year financial statements (either by remaining as contingencies or by being resolved); balance sheet accounts from the prior year-end have continuing significance since they are the opening balances for the current year. Choices "b", "c", and "d" are incorrect, per above explanation.
QUESTION 524
The understanding with a client of an auditor's contractual obligation ordinarily is set forth in the:
A. Managementletter.
B. Scopeparagraphoftheauditor'sreport.
C. Engagement letter.
D. Introductory paragraph of the auditor's report.
Correct Answer: C
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "c" is correct. An engagement letter, which is a presumptively mandatory requirement, sets forth the scope and nature of an auditor's contractual obligation to a client. Choice "a" is incorrect. A management letter (also known as a letter of recommendations, or a constructive services letter) is usually delivered by the auditor at the end of the audit. It identifies areas of weakness and provides recommended solutions. Choices "b" and "d" are incorrect. The scope and introductory paragraphs of the auditor's report do provide some information regarding the work performed by the auditor, but they do not express the auditor's understanding with the client as completely as does an engagement letter.
QUESTION 525
An auditor should obtain knowledge of a client's information and communication system in order to understand each of the following, except:
A. Howtransactionsareinitiated,processed,andreported.
B. Theprocessusedtopreparefinancialstatements.
C. The means used by an entity to communicate financial reporting roles to its staff. D. The means used by an entity to ensure that management directives are carried out.
Correct Answer: D
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "d" is correct. Control activities (not the information and communication system) are the policies and procedures that help ensure that management directives are carried out. Choices "a", "b", and "c" are incorrect. The auditor obtains an understanding of an entity's information and communication system to understand how transactions are initiated, processed, and reported, the financial reporting process, and the means used by an entity to communicate financial reporting roles and responsibilities.
QUESTION 526
The monitoring component of internal control excludes:
A. Assessinginformationderivedfromexternalparties.
B. Assessingthequalityofinternalcontrolperformanceovertime. C. Improving controls that are not operating effectively.
D. Eliminating controls that are not operating effectively.
Correct Answer: D
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "d" is correct. Monitoring is the process of assessing the quality of internal control performance over time and taking necessary corrective actions. Eliminating a control that is not operating effectively would not be an appropriate corrective action. Choice "a" is incorrect. Information derived from external parties (such as customer complaints and regulator comments) may be useful in identifying problems with the internal control structure.
Choices "b" and "c" are incorrect. Assessing the quality of internal control performance over time and improving controls that are not operating effectively are part of the monitoring process.
QUESTION 527
In planning an audit of a new client, an auditor most likely would consider the methods used to process accounting information because such methods:
A. Influencethedesignofinternalcontrol.
B. Affecttheauditor'spreliminaryjudgmentaboutmaterialitylevels. C. Assist in evaluating the planned audit objectives.
D. Determine the auditor's acceptable level of audit risk.
Correct Answer: A
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "a" is correct. The auditor would consider the methods used to process accounting information in planning an audit of a new client, because such methods influence the design of internal control. The auditor is required to obtain an understanding of the design of internal control in order to plan the audit and determine the nature, timing, and extent of tests to be performed.
Choice "b" is incorrect. The auditor's judgment about materiality levels is based upon the auditor's perception of the needs of a reasonable person who will rely on the financial statements, not on the methods used to process accounting information. Choice "c" is incorrect. The planned audit objectives are based upon the auditor's desire to render an opinion on the fairness of the financial statements. This end goal is not influenced by the methods used by the client to process accounting information. Choice "d" is incorrect. Audit risk is the risk that the auditor may unknowingly fail to appropriately modify his or her opinion on financial statements that are materially misstated. The auditor's only acceptable level of audit risk is low, and this is not affected by the client's methods used to process accounting information.
QUESTION 528
Dunn, CPA, is auditing the financial statements of Taft Co. Taft uses Quick Service Center (QSC) to process its payroll. Price, CPA, is expressing an opinion on a description of the controls placed in operation at QSC regarding the processing of its customers' payroll transactions. Dunn expects to consider the effects of Price's report on the Taft engagement.
Price's report should contain a (an):
A. DescriptionofthescopeandnatureofPrice'sprocedures.
B. StatementthatDunnmayassesscontrolriskbasedonPrice'sreport.
C. AssertionthatPriceassumesnoresponsibilitytodeterminewhetherQSC'scontrolsaresuitablydesigned. D. Opinion on the operating effectiveness of QSC's internal controls.
Correct Answer: A
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "a" is correct. Price, CPA (the "service auditor") should include in his or her report a description of the scope and nature of the procedures performed. Choices "b" and "d" are incorrect. A report on controls placed in operation does not provide an opinion on operating effectiveness, and therefore may not be used to assess control risk. Choice "c" is incorrect. A report on controls placed in operation includes a statement that, "our examination included procedures to obtain reasonable assurance about whether the controls were suitably designed."
Which of the following is not part of obtaining an understanding of internal control?
A. Consideringthetypesofmisstatementsthatmayoccurinanentity'sfinancialstatements. B. Determiningwhetherinternalcontrolsareoperatingeffectively.
C. Considering knowledge obtained from previous audits.
D. Determining the extent to which internal controls are computerized.
Correct Answer: B
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "b" is correct. The auditor is not required to obtain knowledge about operating effectiveness as part of the understanding of internal control. This knowledge is obtained later, for specific controls on which the auditor plans to rely. Choices "a", "c", and "d" are incorrect. During the planning phase of the audit, the auditor obtains an understanding of the internal control system by considering:
· The types of misstatements that may occur.
· The risk that misstatements may occur.
· Factors that influence the design of tests of controls and substantive tests.
· The assessment of inherent risk.
· Judgments about materiality.
· The complexity and sophistication of the entity's operations and systems. · The use of manual vs. computerized control procedures. Such knowledge may be obtained by appropriate inquiry, inspection, or observation. Knowledge may also be obtained based on previous experience with the client and/or an understanding of the industry in which the entity operates.
QUESTION 496
Audit evidence concerning segregation of duties ordinarily is best obtained by:
A. Performingtestsoftransactionsthatcorroboratemanagement'sfinancialstatementassertions. B. Observingtheemployeesastheyapplycontrolprocedures.
C. Obtaining a flowchart of activities performed by available personnel.
D. Developing audit objectives that reduce control risk.
Correct Answer: B
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "b" is correct. Audit evidence concerning segregation of duties ordinarily is best obtained by the auditor observing the employees as they apply control procedures. Generally the auditor's direct, personal knowledge obtained through observation, inspection and physical examination is more persuasive than indirect
information.
Choice "a" is incorrect. Performing tests of transactions that corroborate management's financial statement assertions would provide little audit evidence concerning segregation of duties. Choice "c" is incorrect. Obtaining a flowchart of activities performed by available personnel may assist the auditor in understanding the design of the internal control system, but it provides no audit evidence regarding whether the segregation of duties is actually functioning as designed. Choice "d" is incorrect. Developing audit objectives that reduce control risk provides no audit evidence regarding the segregation of duties.
QUESTION 497
After testing a client's internal control activities, an auditor discovers a number of significant deficiencies in the operation of a client's internal controls. Under these circumstances the auditor most likely would:
A. Issueadisclaimerofopinionabouttheinternalcontrolsaspartoftheauditor'sreport. B. Increasetheassessmentofcontrolriskandincreasetheextentofsubstantivetests. C. Issue a qualified opinion of this finding as part of the auditor's report.
D. Withdraw from the audit because the internal controls are ineffective.
Correct Answer: B
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "b" is correct. The auditor uses tests of controls to evaluate control risk. In situations where there are a number of significant deficiencies in the operation of the client's internal controls, the auditor would increase the assessment of control risk (and the risk of material misstatement) and revise substantive testing accordingly (for example, by increasing the extent of substantive tests).
Choice "a" is incorrect. An auditor is required to communicate significant deficiencies to management and those charged with governance, and a disclaimer of opinion on the effectiveness of controls would be included in this communication. However, such disclaimer would not be part of the auditor's report on the financial statements. Choice "c" is incorrect. Since the auditor's report provides an opinion on the financial statements (and not on internal control), significant deficiencies in internal control do not result in a qualified opinion.
Choice "d" is incorrect. The auditor need not withdraw from an audit simply because internal controls are ineffective, but rather would increase the assessment of control risk and revise substantive testing accordingly.
QUESTION 498
In which of the following circumstances is substantive testing of accounts receivable before the balance sheet date most appropriate?
A. Theclienthasanewsalesincentiveprograminplace.
B. Internalcontrolsduringtheremainingperiodareeffective. C. There is a high turnover of senior management.
D. It is a first engagement of a new client.
Correct Answer: B
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "b" is correct. The higher the auditor's risk assessment, the closer to period end substantive procedures should be performed. Conversely, effective controls reduce control risk and reduce the risk of material misstatement, allowing more interim testing to occur. Choice "a" is incorrect. A new sales incentive program results in an increase in the risk of material misstatement, making it less likely that interim testing will be performed. Choice "c" is incorrect. High turnover of senior management results in an increase in the risk of material misstatement, making it less likely that interim testing will be performed. Choice "d" is incorrect. In the first engagement of a new client, the auditor will have less knowledge of the client and therefore would be less inclined to utilize interim testing, which increases audit risk.
QUESTION 499
What is the most likely course of action that an auditor would take after determining that performing substantive tests on inventory will take less time than performing tests of controls?
A. Assesscontrolriskatalowlevel.
B. Performbothtestsofcontrolsandsubstantivetestsoninventory. C. Perform only substantive tests on inventory.
D. Perform only tests of controls on inventory.
Correct Answer: C
Section: Auditing and Attestation (I) (Volume C)
Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "c" is correct. If it would take less time to perform substantive tests than it would to perform tests of controls, and if there is no other reason to test controls (i.e., if there is not a high degree of electronic processing), the auditor would not be likely to test controls. Choice "a" is incorrect. In order to assess control risk at a low level, tests of controls would need to be performed. However, if it is more efficient to perform substantive tests, the auditor would not be likely to test controls. Choice "b" is incorrect. If it would take less time to perform substantive tests than it would to perform tests of controls, and if there is no other reason to test controls (i.e., if there is not a high degree of electronic processing), the auditor would not be likely to test controls. Choice "d" is incorrect. Substantive procedures are always be necessary for all assertions relevant to material transaction classes, account balances, and disclosures. Assuming inventory is material, tests of controls alone would not be sufficient.
QUESTION 500
Which of the following procedures would an auditor least likely perform before the balance sheet date?
A. Confirmationofaccountspayable.
B. Observationofmerchandiseinventory.
C. Assessment of the risk of material misstatement. D. Identification of related parties.
Correct Answer: A
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "a" is correct. The auditor should consider whether the year-end balances of the particular asset or liability accounts that might be selected for interim examination are reasonably predictable with respect to amount, relative significance, and composition. Accounts payable is relatively difficult to predict because it may fluctuate at management's discretion. Choice "b" is incorrect. The auditor should consider whether the year-end balances of the particular asset or liability accounts that might be selected for interim examination are reasonably predictable with respect to amount, relative significance, and composition. Inventory is relatively predictable with respect to amount, composition and relative significance. Choice "c" is incorrect. During planning, the auditor is required to obtain an understanding of the entity and its environment, including its internal control, and to assess risk. Such preliminary planning is often conducted prior to the balance sheet date. Choice "d" is incorrect. Audit testing at interim dates may permit early consideration of significant matters affecting the year-end financial statements, such as the identification of related parties.
Supplemental Questions
QUESTION 501
Which of the following factors are included in an entity's control environment?
A. Option A B. OptionB C. Option C D. Option D
Correct Answer: D
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "d" is correct. Yes - Yes - Yes. An entity's control environment includes participation of those charged with governance, management's philosophy, and the organizational structure.
QUESTION 502
Which of the following are considered control environment factors?
A. Option A B. OptionB C. Option C D. Option D
Correct Answer: C
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "c" is correct. Yes - No - Yes. Control environment factors include:
1. Communication and enforcement of integrity and ethical values. 2. Commitment to competence.
3. Participation of those charged with governance.
4. Management's philosophy and operating style.
5. Organizational structure.
6. Assignment of authority, responsibility, and accountability. 7. Human resource policies and practices.
Choice "a" is incorrect. Detection risk is the risk that an auditor's procedures will lead to the conclusion that a material error does not exist in an account balance when, in fact, such error does exist.
Choices "b" and "d" are incorrect, per the above.
QUESTION 503
Which of the following circumstances would most likely cause an auditor to suspect that material misstatements arising from fraud exist in a client's financial statements?
A. Propertyandequipmentareusuallysoldatalossbeforebeingfullydepreciated. B. Significantlyfewerresponsestoconfirmationrequestsarereceivedthanexpected. C. Monthly bank reconciliations usually include several in-transit items.
D. Clerical errors are listed on an EDP-generated exception report.
Correct Answer: B
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "b" is correct. Material fraud ("intentional" misstatements or omissions) may result from large amounts of fictitious accounts receivable. Receiving significantly fewer confirmation responses than expected implies some accounts receivable may be fictitious. Choice "a" is incorrect. Selling property and equipment at a loss from book value is not unusual and would not necessarily be indicative of fraud.
Choice "c" is incorrect. Bank reconciliations typically include in-transit items (e.g., deposits in transit and outstanding checks), and this would not necessarily be indicative of fraud. Choice "d" is incorrect. Clerical errors listed on an exception report would be a control over data processing that would tend to minimize the risk of material misstatement.
QUESTION 504
Which of the following factors is most important concerning an auditor's responsibility to detect errors and fraud?
A. Thesusceptibilityoftheaccountingrecordstointentionalmanipulations,alterations,andthemisapplicationofaccountingprinciples.
B. Theprobabilitythatunreasonableaccountingestimatesresultfromunintentionalbiasorintentionalattemptstomisstatethefinancialstatements. C. The possibility that management fraud, defalcations, and the misappropriation of assets may indicate the existence of illegal acts.
D. The risk that mistakes, falsifications, and omissions may cause the financial statements to contain material misstatements.
Correct Answer: D
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "d" is correct. The most important factor concerning an auditor's responsibility to detect errors and fraud is the risk that mistakes, falsifications, and omissions may cause the financial statements to contain material misstatements.
Choice "a" is incorrect. The susceptibility of the accounting records to intentional manipulations, alterations, and the misapplication of accounting principles is something the auditor must consider, but it does not describe the auditor's responsibility to detect errors and fraud. Choice "b" is incorrect. The probability that unreasonable accounting estimates result from unintentional bias or intentional attempts to misstate the financial statements is something the auditor must consider, but it does not describe the auditor's responsibility to detect errors and fraud.
Choice "c" is incorrect. The possibility that management fraud, defalcations, and the misappropriation of assets may indicate the existence of illegal acts is something the auditor must consider, but it does not describe the auditor's responsibility to detect errors and fraud.
QUESTION 505
Disclosure of fraud to parties other than a client's senior management, those charged with governance, or its board of directors ordinarily is not part of an auditor's responsibility. However, to which of the following outside parties may a duty to disclose irregularities exist?
A. Option A B. OptionB C. Option C D. Option D
Correct Answer: D
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "d" is correct. The accountant may have a duty to disclose irregularities to all of the following outside parties:
Yes - The SEC when the client reports an auditor change. Yes - A successor auditor when the successor makes appropriate inquiries. Yes - A government funding agency from which the client receives financial assistance. Choices "a", "b", and "c" are incorrect, based on the above explanation.
QUESTION 506
Which of the following statements describes why a properly designed and executed audit may not detect a material misstatement due to fraud?
A. Auditproceduresthatareeffectivefordetectinganunintentionalmisstatementmaybeineffectiveforanintentionalmisstatementthatisconcealedthrough collusion.
B. Anauditisdesignedtoprovidereasonableassuranceofdetectingmaterialerrors,butthereisnosimilarresponsibilityconcerningmaterialmisstatementdueto fraud.
C. The factors considered in assessing control risk indicated an increased risk of intentional misstatements, but only a low risk of unintentional errors in the financial statements.
D. The auditor didn't consider factors influencing audit risk for account balances that have effects pervasive to financial statements taken whole.
Correct Answer: A
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "a" is correct. A properly designed and executed audit may not detect a material misstatement that is concealed through collusion. The auditor's responsibility is to design audit procedures that can reasonably be expected to detect material misstatements (errors and fraud) in the financial statements. Intentional misstatements that are concealed through collusion, however, are very difficult to detect, and generally the auditor is not responsible to discover them. Choice "b" is incorrect. An audit is designed to provide reasonable assurance of detecting material misstatements (both errors and fraud).
Choice "c" is incorrect. If the factors considered in assessing control risk indicated an increased risk of intentional misstatements, a properly designed and executed audit would have taken the increased risk into consideration with additional audit procedures. Choice "d" is incorrect. In a properly designed and executed audit, the auditor would consider factors influencing audit risk for account balances that have effects pervasive to the financial statements taken as a whole.
QUESTION 507
Which of the following circumstances most likely would cause an auditor to consider whether material misstatements exist in an entity's financial statements?
A. Supportingrecordsthatshouldbereadilyavailablearefrequentlynotproducedwhenrequested. B. Significantdeficienciesininternalcontrolpreviouslycommunicatedhavenotbeencorrected.
C. Clerical errors are listed on a monthly computer-generated exception report.
D. Differences are discovered during the client's annual physical inventory count.
Correct Answer: A
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "a" is correct. Supporting records that should be readily available but are frequently not produced when requested would cause an auditor to consider whether material misstatements exist.
Choice "b" is incorrect. Failure to correct significant deficiencies in internal control may represent a conscious decision by management to accept that degree of risk because of cost or other considerations.
Although this is a fraud risk factor, the auditor is more likely to be concerned about missing audit evidence.
Choice "c" is incorrect. Clerical errors listed on a monthly computer-generated exception report would be a control over data processing that would tend to minimize the risk of material misstatement.
Choice "d" is incorrect. Differences being discovered during the client's annual physical inventory count is a common occurrence at most companies and would not necessarily indicate that a material misstatement exists.
QUESTION 508
The most likely explanation why the auditor's examination cannot reasonably be expected to bring all illegal acts by the client to the auditor's attention is that:
A. Illegalactsareperpetratedbymanagementoverrideofinternalaccountingcontrols.
B. Illegalactsbyclientsoftenrelatetooperatingaspectsratherthanaccountingaspects.
C. The client's system of internal accounting control may be so strong that the auditor performs only minimal substantive testing.
D. Illegal acts may be perpetrated by the only person in the client's organization with access to both assets and the accounting records.
Correct Answer: B
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "b" is correct. The audit should be designed to identify material misstatements due to illegal acts, but illegal acts that relate to operating aspects rather than accounting aspects may not directly affect the financial statements, and therefore they may be less likely to be discovered by the auditor.
Choice "a" is incorrect. The audit should be designed to identify material misstatements due to illegal acts, even if they are caused by management override of (its own) internal control. Choice "c" is incorrect. The audit should be designed to identify material misstatements due to illegal acts, even when minimal substantive testing is performed by the auditor due to a very strong system of internal control.
Choice "d" is incorrect. The audit should be designed to identify material misstatements due to illegal acts, even when those illegal acts were perpetrated by the only person with access to both assets and the accounting records.
QUESTION 509
An auditor of a manufacturer would most likely question whether that client has committed illegal acts if the client has:
A. Beenforcedtodiscontinueoperationsinaforeigncountry.
B. Beenanannualdonortoalocalpoliticalcandidate.
C. Failed to correct material weaknesses in internal accounting control that were reported after the prior year's audit. D. Disclosed several subsequent events involving foreign operations in the notes to the financial statements.
Correct Answer: A
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "a" is correct. Being forced to discontinue operations in a foreign country would cause the auditor of the manufacturer to question whether that client has
committed an illegal act. Choice "b" is incorrect. Making political contributions to local politicians is not illegal. (Bribes are illegal.) Choice "c" is incorrect. Failure to correct material weaknesses in internal accounting control may represent a conscious decision by management to accept that degree of risk because of cost or other considerations. Choice "d" is incorrect. Disclosure of subsequent events is not indicative of an illegal act.
QUESTION 510
If specific information comes to an auditor's attention that implies the existence of possible illegal acts that could have a material, but indirect effect on the financial statements, the auditor should next:
A. Applyauditproceduresspecificallydirectedtoascertainingwhetheranillegalacthasoccurred.
B. Seektheadviceofaninformedexpertqualifiedtopracticelawastopossiblecontingentliabilities. C. Report the matter to an appropriate level of management at least one level above those involved. D. Discuss the evidence with those charged with governance.
Correct Answer: A
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "a" is correct. If specific information comes to an auditor's attention that implies the existence of possible illegal acts that could have a material, but indirect effect on the financial statements, the auditor should next apply audit procedures specifically directed to ascertaining whether an illegal act has occurred. The auditor should obtain an understanding of the situation, inquire of management (at a level above those involved), consult legal counsel, and consider applying additional audit procedures if necessary.
Choice "b" is incorrect. The auditor would consult with the client's legal counsel after obtaining an understanding of the situation and inquiring of management. Choice "c" is incorrect. The auditor would inquire of management at a level above those involved after obtaining an understanding of the situation. Choice "d" is incorrect. The auditor would only communicate with those charged with governance regarding detected illegal acts, not possible illegal acts.
QUESTION 511
When an auditor becomes aware of a possible illegal act by a client, the auditor should obtain an understanding of the nature of the act to:
A. Evaluatetheeffectonthefinancialstatements.
B. Determinethereliabilityofmanagement'srepresentations.
C. Consider whether other similar acts may have occurred.
D. Recommend remedial actions to those charged with governance.
Correct Answer: A
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "a" is correct. When an auditor becomes aware of a possible client illegal act, the auditor should next obtain an understanding of the nature of the act in order to evaluate the effect on the financial statements.
Choices "b", "c", and "d" are incorrect. After evaluating the effect of the illegal act on the financial statements, the auditor may also determine the reliability of management's representations, consider whether other similar acts may have occurred, or recommend remedial actions to those charged with governance.
QUESTION 512
The auditor should obtain sufficient knowledge of the client's information and communication system relevant to financial reporting to understand all of the following, except:
A. Classesoftransactionsintheentity'soperationsthataresignificanttothefinancialstatements,andhowthosetransactionsareprocessed,frominitiationto inclusion in the financial statements.
B. Thefinancialreportingprocess,includingdevelopmentofsignificantaccountingestimatesandinclusionofappropriatedisclosures.
C. The means the entity uses to communicate roles, responsibilities, and significant matters relating to financial reporting.
D. Control activities related to each account balance, transaction class, and disclosure component in the financial statements or to every assertion relevant to them.
Correct Answer: D
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "d" is correct. Ordinarily, audit planning does not require an understanding of the control activities related to each account balance, transaction class, and disclosure component in the FS or to every assertion relevant to them.
Choice "a" is incorrect. The auditor is required to understand significant classes of transactions and how they are processed.
Choice "b" is incorrect. The auditor is required to understand the financial reporting process. Choice "c" is incorrect. The auditor is required to understand the methods used by the entity to communicate matters relevant to financial reporting.
QUESTION 513
Which of the following information discovered during an audit most likely would raise a question concerning possible illegal acts?
A. Relatedpartytransactions,althoughproperlydisclosed,werepervasiveduringtheyear.
B. Theentitypreparedseverallargecheckspayabletocashduringtheyear.
C. Material internal control weaknesses previously reported to management were not corrected. D. The entity was a campaign contributor to several local political candidates during the year.
Correct Answer: B
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "b" is correct. Information that may raise a question concerning possible illegal acts include unusually large payments made to:
· Cash
· Bearer
· Purchase cashiers checks
· Transfer funds to numbered accounts
Choice "a" is incorrect. Related party transactions may provide an indication of fraud, particularly if not made in the ordinary course of business, but they are generally not indicative of illegal acts.
Choice "c" is incorrect. Failure to correct material internal control weaknesses may represent a conscious decision by management to accept that degree of risk because of cost or other considerations.
Choice "d" is incorrect. Contributions to local political candidates are legal and generally would not raise a question about possible illegal acts.
QUESTION 514
Which of the following is not a control environment factor?
A. Participationofthosechargedwithgovernance. B. Hiringandadvancementpolicies.
C. Management's approach toward business risks. D. Proper segregation of duties.
Correct Answer: D
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "d" is correct. Policies and procedures involving segregation of duties are control activities, not control environment factors.
Choice "a" is incorrect. Participation of those charged with governance is a control environment factor. Choice "b" is incorrect. Hiring and advancement policies are part of human resource policies and practices, which are control environment factors. Choice "c" is incorrect. Management's approach toward business risks is part of its philosophy and operating style, which is a control environment factor.
QUESTION 515
An auditor who discovers that a client's employees have paid small bribes to public officials most likely would withdraw from the engagement if the:
A. Clientreceivesfinancialassistancefromafederalgovernmentagency.
B. Auditevidencethatisnecessarytoprovethattheillegalactswerecommitteddoesnotexist. C. Employees' actions affect the auditor's ability to rely on management's representations.
D. Notes to the financial statements fail to disclose the employees' actions.
Correct Answer: C
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "c" is correct. When an auditor cannot rely on management's representations, he or she should withdraw from the engagement.
Choice "a" is incorrect. As long as the client takes appropriate remedial action, the auditor would not need to withdraw from the engagement simply because the client receives federal financial assistance.
However, the auditor would be subject to a variety of reporting requirements related to this discovery.
Choice "b" is incorrect. If there is no evidence that an illegal act was committed, management may be unable to take remedial action against the related employees. As long as the illegal act is immaterial and the auditor is satisfied that management's response is appropriate in the circumstances, there would be no reason for the auditor to withdraw. Choice "d" is incorrect. The auditor should evaluate the adequacy of disclosure in the financial statements with respect to the potential effects of an illegal act. If the auditor concludes that disclosure is inadequate, he or she should express a qualified or adverse opinion, but would not necessarily need to withdraw from the engagement (unless the client refused to accept the modified report).
QUESTION 516
Which of the following statements is true regarding the risk assessment component of internal control?
A. Anauditorevaluatesanentity'sriskassessmentbecauseitisacomponentofoverallauditriskinafinancialstatementaudit.
B. Anauditor'sevaluationofanentity'sriskassessmentmaynotbeapplicabletotheauditofeveryentity.
C. An auditor evaluates an entity's risk assessment to understand how management addresses risks relevant to financial reporting.
D. An auditor need not consider an entity's risk assessment because he or she is primarily concerned with audit risk in a financial statement audit.
Correct Answer: C
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "c" is correct. The auditor needs to understand how management addresses risks relevant to financial reporting in order to properly plan the audit. Choice
"a" is incorrect. An entity's risk assessment differs from an auditor's assessment of audit risk.
The entity is concerned with managing risks that affect entity objectives (financial reporting, operations, and compliance) whereas the auditor is concerned with the risk that material misstatements could occur in the financial statements. Choice "b" is incorrect. The five components of internal control are applicable to the audit of every entity.
Choice "d" is incorrect. The auditor needs to understand how management addresses risks relevant to financial reporting in order to properly plan the audit.
QUESTION 517
Before applying principal substantive tests to the details of accounts at an interim date prior to the balance sheet date, an auditor should:
A. Assesscontrolriskatalowlevelfortheassertionsembodiedintheaccountsselectedforinterimtesting.
B. Determinethattheaccountsselectedforinterimtestingarenotmaterialtothefinancialstatementstakenasawhole. C. Consider whether the amounts of the year-end balances selected for interim testing are reasonably predictable.
D. Obtain written representations from management that all financial records and related data will be made available.
Correct Answer: C
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "c" is correct. Before performing substantive tests at an interim date, an auditor should consider whether the amounts of the year-end balances selected for interim testing are reasonably predictable with respect to amount, relative significance and composition. Choice "a" is incorrect. It is not necessary for control risk to be assessed at a low level level for the assertions relating to the accounts that will be substantively tested at an interim date. It may simply be more efficient to perform a substantive audit. As long as the balances tested at interim are reasonably predictable with respect to amount, relative significance and composition, the account may be tested at interim.
Choice "b" is incorrect. Material account balances, such as accounts receivable and inventory, are commonly tested at an interim date.
Choice "d" is incorrect. The written representation letter will not be obtained until after year-end.
QUESTION 518
Which of the following is not true with respect to the control activities of an entity?
A. Controlactivitiesarethepoliciesandproceduresthathelpensurethatmanagementdirectivesarecarriedout.
B. Controlactivitiesarethepoliciesandproceduresthathelpensurethatthefinancialstatementsarefairlypresentedinconformitywithgenerallyaccepted accounting principles.
C. An understanding of control activities may be obtained while the auditor is obtaining an understanding of the other components of internal control.
D. An understanding of control activities does not require an understanding of control activities related to each account balance included in the financial statements.
Correct Answer: B
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "b" is correct. Control activities are the policies and procedures that help ensure that management directives are carried out. These policies and procedures may relate to any of the three objectives (financial reporting, operations, and compliance), not strictly to the financial reporting objective.
Choice "a" is incorrect. Control activities are defined as the policies and procedures that help ensure that management directives are carried out.
Choice "c" is incorrect. As an auditor obtains an understanding about the other components of internal control, he or she is also likely to obtain some knowledge about control activities. Choice "d" is incorrect. Ordinarily, audit planning does not require an understanding of control activities related to each account balance, transaction class, and disclosure component.
QUESTION 519
Before applying substantive tests to the details of asset accounts at an interim date, an auditor should assess:
A. Controlriskatalowlevel.
B. Inherentriskatahighlevel.
C. The difficulty in controlling the incremental audit risk. D. Materiality for the accounts tested as insignificant.
Correct Answer: C
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "c" is correct. Before performing substantive tests at an interim date, the auditor must assess the difficulty in controlling the incremental audit risk from the interim date (on which the substantive procedures are performed) to the year-end date (on which an opinion is rendered). Choice "a" is incorrect. The auditor would not have to assess control risk at a low level in order to perform substantive tests at interim. It may simply be more efficient to perform a substantive audit. As long as the balances tested at interim are reasonably predictable with respect to amount, relative significance and composition, the account may be tested at interim. Choice "b" is incorrect. Generally, inherent risk should be low in order to test substantively at interim.
Choice "d" is incorrect. If the materiality level for those accounts to be tested is insignificant, then the auditor probably would not perform any substantive testing, since it is unlikely that a material error exists in an insignificant balance.
QUESTION 520
Which of the following statements best describes how a detailed audit plan of a CPA who is engaged to audit the financial statements of a large publicly held company compares with the audit client's comprehensive internal audit program?
A. ThecomprehensiveinternalauditplanissubstantiallyidenticaltotheauditplanusedbytheCPAbecausebothcoversubstantiallyidenticalareas.
B. ThecomprehensiveinternalauditplanislessdetailedandcoversfewerareasthanwouldnormallybecoveredbytheCPA.
C. The comprehensive internal audit plan is more detailed and covers areas that would normally not be covered by the CPA.
D. The comprehensive internal audit plan is more detailed although it covers fewer areas than would normally be covered by the CPA.
Correct Answer: C
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "c" is correct. "Internal auditors" are part of the system of internal control. Their audits would cover more areas in greater depth than those of the "independent auditors," whose concerns are limited to areas materially affecting the "financial statements taken as a whole." Choices "a", "b", and "d" are incorrect, as described above.
QUESTION 521
When assessing an internal auditor's objectivity, an independent auditor should:
A. Evaluatetheadequacyoftheinternalauditor'sauditplans.
B. Inquireabouttheinternalauditor'seducationalbackgroundandprofessionalcertification. C. Consider the organizational level to which the internal auditor reports.
D. Review the internal auditor's audit documentation.
Correct Answer: C
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "c" is correct. When assessing an internal auditor's objectivity, an independent auditor should consider the organizational level to which the internal auditor reports. Choice "a" is incorrect. Evaluating the adequacy of the internal auditor's audit plans would be performed when assessing an internal auditor's competence. Choice "b" is incorrect. Inquiring about the internal auditor's educational background and professional certification would be performed when assessing an internal auditor's competence. Choice "d" is incorrect. Reviewing the internal auditor's audit documentation (to determine the quality of the reports and recommendations) would be performed when assessing an internal auditor's competence.
QUESTION 522
Before accepting an audit engagement, a successor auditor should make specific inquiries of the predecessor auditor regarding: A. Disagreementsthepredecessorhadwiththeclientconcerningauditingproceduresandaccountingprinciples.
B. Thepredecessor'sevaluationofmattersofcontinuingaccountingsignificance.
C. The degree of cooperation the predecessor received concerning the inquiry of the client's lawyer. D. The predecessor's assessments of inherent risk and judgments about materiality.
Correct Answer: A
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "a" is correct. Before accepting an audit engagement, a successor auditor should make specific inquiries of the predecessor auditor regarding disagreements the predecessor had with the client concerning auditing procedures and accounting principles. Choice "b" is incorrect. The successor auditor may make specific inquiries of the predecessor auditor regarding the predecessor's evaluation of matters of continuing accounting significance, but this would occur after accepting the engagement. Choice "c" is incorrect. The successor auditor may make specific inquiries of the predecessor auditor regarding the degree of cooperation the predecessor received concerning the inquiry of the client's lawyer, but this would occur after accepting the engagement. Choice "d" is incorrect. The successor auditor would generally come to his or her own conclusions regarding assessments of inherent risk and judgments about materiality without consulting the predecessor auditor.
QUESTION 523
Ordinarily, the predecessor auditor permits the successor auditor to review the predecessor's audit documentation relating to:
A. Option A B. OptionB C. Option C D. Option D
Correct Answer: A
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "a" is correct. Ordinarily, the predecessor auditor permits the successor auditor to review the predecessor's audit documentation relating to matters of continuing accounting and auditing significance, including both contingencies and balance sheet accounts. Contingencies have continuing significance as they may continue to affect the current year financial statements (either by remaining as contingencies or by being resolved); balance sheet accounts from the prior year-end have continuing significance since they are the opening balances for the current year. Choices "b", "c", and "d" are incorrect, per above explanation.
QUESTION 524
The understanding with a client of an auditor's contractual obligation ordinarily is set forth in the:
A. Managementletter.
B. Scopeparagraphoftheauditor'sreport.
C. Engagement letter.
D. Introductory paragraph of the auditor's report.
Correct Answer: C
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "c" is correct. An engagement letter, which is a presumptively mandatory requirement, sets forth the scope and nature of an auditor's contractual obligation to a client. Choice "a" is incorrect. A management letter (also known as a letter of recommendations, or a constructive services letter) is usually delivered by the auditor at the end of the audit. It identifies areas of weakness and provides recommended solutions. Choices "b" and "d" are incorrect. The scope and introductory paragraphs of the auditor's report do provide some information regarding the work performed by the auditor, but they do not express the auditor's understanding with the client as completely as does an engagement letter.
QUESTION 525
An auditor should obtain knowledge of a client's information and communication system in order to understand each of the following, except:
A. Howtransactionsareinitiated,processed,andreported.
B. Theprocessusedtopreparefinancialstatements.
C. The means used by an entity to communicate financial reporting roles to its staff. D. The means used by an entity to ensure that management directives are carried out.
Correct Answer: D
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "d" is correct. Control activities (not the information and communication system) are the policies and procedures that help ensure that management directives are carried out. Choices "a", "b", and "c" are incorrect. The auditor obtains an understanding of an entity's information and communication system to understand how transactions are initiated, processed, and reported, the financial reporting process, and the means used by an entity to communicate financial reporting roles and responsibilities.
QUESTION 526
The monitoring component of internal control excludes:
A. Assessinginformationderivedfromexternalparties.
B. Assessingthequalityofinternalcontrolperformanceovertime. C. Improving controls that are not operating effectively.
D. Eliminating controls that are not operating effectively.
Correct Answer: D
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "d" is correct. Monitoring is the process of assessing the quality of internal control performance over time and taking necessary corrective actions. Eliminating a control that is not operating effectively would not be an appropriate corrective action. Choice "a" is incorrect. Information derived from external parties (such as customer complaints and regulator comments) may be useful in identifying problems with the internal control structure.
Choices "b" and "c" are incorrect. Assessing the quality of internal control performance over time and improving controls that are not operating effectively are part of the monitoring process.
QUESTION 527
In planning an audit of a new client, an auditor most likely would consider the methods used to process accounting information because such methods:
A. Influencethedesignofinternalcontrol.
B. Affecttheauditor'spreliminaryjudgmentaboutmaterialitylevels. C. Assist in evaluating the planned audit objectives.
D. Determine the auditor's acceptable level of audit risk.
Correct Answer: A
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "a" is correct. The auditor would consider the methods used to process accounting information in planning an audit of a new client, because such methods influence the design of internal control. The auditor is required to obtain an understanding of the design of internal control in order to plan the audit and determine the nature, timing, and extent of tests to be performed.
Choice "b" is incorrect. The auditor's judgment about materiality levels is based upon the auditor's perception of the needs of a reasonable person who will rely on the financial statements, not on the methods used to process accounting information. Choice "c" is incorrect. The planned audit objectives are based upon the auditor's desire to render an opinion on the fairness of the financial statements. This end goal is not influenced by the methods used by the client to process accounting information. Choice "d" is incorrect. Audit risk is the risk that the auditor may unknowingly fail to appropriately modify his or her opinion on financial statements that are materially misstated. The auditor's only acceptable level of audit risk is low, and this is not affected by the client's methods used to process accounting information.
QUESTION 528
Dunn, CPA, is auditing the financial statements of Taft Co. Taft uses Quick Service Center (QSC) to process its payroll. Price, CPA, is expressing an opinion on a description of the controls placed in operation at QSC regarding the processing of its customers' payroll transactions. Dunn expects to consider the effects of Price's report on the Taft engagement.
Price's report should contain a (an):
A. DescriptionofthescopeandnatureofPrice'sprocedures.
B. StatementthatDunnmayassesscontrolriskbasedonPrice'sreport.
C. AssertionthatPriceassumesnoresponsibilitytodeterminewhetherQSC'scontrolsaresuitablydesigned. D. Opinion on the operating effectiveness of QSC's internal controls.
Correct Answer: A
Section: Auditing and Attestation (I) (Volume C) Explanation
Explanation/Reference:
Explanation:
Explanation
Choice "a" is correct. Price, CPA (the "service auditor") should include in his or her report a description of the scope and nature of the procedures performed. Choices "b" and "d" are incorrect. A report on controls placed in operation does not provide an opinion on operating effectiveness, and therefore may not be used to assess control risk. Choice "c" is incorrect. A report on controls placed in operation includes a statement that, "our examination included procedures to obtain reasonable assurance about whether the controls were suitably designed."