Chapter 8 Final

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Chapter 8

Multiple-Choice Questions

1. 1. easy easy

Which of the following is

Which of the following is notnot one of the three main reasons why the auditor should properlyone of the three main reasons why the auditor should properly plan engagement

plan engagements?s?

aa aa.. TTo o eennaabblle e pprrooppeer r oonn--tthhee--jjoob b ttrraaiinniinng g oof f eemmppllooyyeeeess.. b.

b. To enable the auditor to obtain To enable the auditor to obtain sufficient apprsufficient appropriate evidence.opriate evidence. c.

c. To To avoavoid id mismisundunderserstantandindings gs wiwith th the the cliclientent.. d.

d. To To hehelp klp keeeep aup audidit cot coststs rs reaeasosonanablble.e. 2

2.. AAvvooiiddiinng g mmiissuunnddeerrssttaannddiinnggs s wwiitth h tthhe e cclliieennt t iis s iimmppoorrttaannt t ffoorr:: easy

easy

aa GGooood d cclliieennt t rreellaattiioonnss FFaacciilliittaattiinng g hhiigghh--qquuaalliitty y wwoorrk k aat t a a rreeaassoonnaabblle e ccoosstt a. a. b. b. c. c. d. d. Yes Yes No No Yes Yes No No Yes Yes No No No No Yes Yes 3. 3. easy easy A

A meameasursure e of of how willhow willing the ing the audauditoitor r is is to to acaccepcept t thathat t the finathe financincial al ststateatemenments ts may bemay be materially misstated after the audit is completed and an unqualified opinion has been issued is materially misstated after the audit is completed and an unqualified opinion has been issued is the:

the: b

b a.a. inherent risk.inherent risk. b.

b. acceptable audit risk.acceptable audit risk. cc.. ssttaattiissttiiccaal rl riisskk.. d

d.. ffiinnaanncciiaal rl riisskk.. 4.

4. easy easy

A measure of the

A measure of the auditor’s assessment of the likelihood that there are auditor’s assessment of the likelihood that there are material misstatemmaterial misstatements inents in an account before considering the effectiveness of the

an account before considering the effectiveness of the client’s internal control is called:client’s internal control is called: d

d aa.. ccoonnttrrool l rriisskk.. b.

d.. iinnhheerreennt t rriisskk.. 5

5.. WWhheen n iinnhheerreennt t rriissk k iis s hhiigghh, , tthheerre e wwiilll l nneeeed d tto o bbee:: Easy

Easy

d

d A A lloowweer r aasssseessssmmeennt t oof f aauuddiit t rriisskk MMoorre e eevviiddeenncce e aaccccuummuullaatteed d bby y tthhe e aauuddiittoor r a. a. b. b. c. c. d. d. Yes Yes No No Yes Yes No No Yes Yes No No No No Yes Yes 6

6.. TThhe e aauuddiittoor r iis s lliikkeelly ty to o aaccccuummuullaatte me moorre ee evviiddeenncce we whheen n tthhe e aauuddiit t iis s ffoor a r a ccoommppaannyy:: easy

easy

aa WWhhiicch h hhaas s llaarrgge e aammoouunntts s oof f ddeebbtt WWhhiicch h iis s tto o bbe e ssoolld d iin n tthhe e nneeaar r ffuuttuurree a. a. b. b. c. c. d. d. Yes Yes No No Yes Yes No No Yes Yes No No No No Yes Yes 7

7.. WWhhiicch h oof f tthhe e ffoolllloowwiinng g iiss notnottypically included in initial audit typically included in initial audit planning?planning? eeaassyy aa.. CClliieennt t aacccceeppttaannccee//ccoonnttiinnuuaattiioon n ddeecciissiioonnss..

d

d bb.. DDeetteerrmmiinnaattiioon n oof f tthhe e ppuurrppoosse e oof f tthhe e aauuddiitt.. c.

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d.

d. PerPerforform anam analylytictical pral proceocedurdures as ses as subsubstantantivtive tee testssts.. 8

8.. IInniittiiaal al auuddiit t ppllaannnniinng ig innvvoollvvees fs foouur r mmaatttteerrss. W. Whhiicch h oof tf thhe fe foolllloowwiinng g iis s nnoot t oonne e oof tf thheessee?? eeaassyy aa.. DDeevveelloop p aan n oovveerraalll l aauuddiit t ssttrraatteeggyy..

b

b b.b. Request that baRequest that bank balances be confink balances be confirmed.rmed. c.

c. SchScheduedule ele engangagegemenment stt staff aff and and audaudit it spespeciacialislists.ts. d.

d. IdeIdentintify fy the the cliclientent’s ’s reareason son for for the the audaudit.it. 9.

9. easy easy

Most auditors assess inherent risk as high for related parties and related-party transactions Most auditors assess inherent risk as high for related parties and related-party transactions because:

because: b

b a.a. of the unique classification of rof the unique classification of related-party traelated-party transactions requirensactions required on the balance shed on the balance sheet.et. b.

b. of the lack of independence betweeof the lack of independence between the parties.n the parties. c.

c. of the uof the unique nique clasclassifisificatication of reon of relatelated-pard-party traty transactnsactions reions requirequired on the id on the income ncome statstatemenement.t. d.

d. it is rit is requequireired by gend by generaerally aclly accepcepted acted accoucountinting pring princincipleples.s. 10.

10. easy easy

Which of the following is not correct regarding the communications between successor and Which of the following is not correct regarding the communications between successor and predecessor auditor

predecessor auditors?s?

aa aa.. TThhe e bbuurrddeen n oof f iinniittiiaattiinng g tthhe e ccoommmmuunniiccaattiioon n rreesstts s wwiitth h tthhe e pprreeddeecceessssoor r aauuddiittoorr.. b.

b. The burden of initiating the comThe burden of initiating the communication restmunication rests with the sucs with the successor auditor.cessor auditor. c.

c. The prThe predecedecessor aessor auditouditor musr must recet receive theive their forir former cmer clientlient’s per’s permissimission prion prior to dior to divulgvulginging information to the successor auditor

information to the successor auditor d.

d. The prThe predecedecessor aessor auditouditor may cr may choose hoose to proto provide a lvide a limitimited resed response tponse to a suco a successcessor audior auditor.tor. 1

111.. A A ssuucccceessssoor r aauuddiittoor r mmaay y ppeerrffoorrm m wwhhiicch h oof f tthhe e ffoolllloowwiinng g ffoor r a a nneew w aauuddiit t cclliieenntt?? easy

easy

aa SSppeeaak k tto o llooccaal l aattttoorrnneeyyss, , bbaannkkss and other businesses regarding and other businesses regarding the company’s reputation the company’s reputation

Speak to the predecessor auditors about Speak to the predecessor auditors about disagreements they had with

disagreements they had with managementmanagement

aa.. YYeess YYeess

b. b. NoNo NoNo cc.. YYeess NNoo d d.. NNoo YYeess 12. 12. medium medium

Which of the following is not a potential effect of an auditor’s decision that a lower acceptable Which of the following is not a potential effect of an auditor’s decision that a lower acceptable audit risk is

audit risk is appropriate?appropriate? b

b a.a. More evidence is More evidence is accumulated.accumulated. b.

b. Less evidence is accumulated.Less evidence is accumulated. c.

c. SpeSpeciacial carl care is re is requequireired in asd in assigsigninning expg experieriencenced sted staffaff.. d.

d. ReviReview of aew of audit dudit documeocumentatintation is pon is perfoerformed by rmed by persopersonnel nonnel not assit assigned tgned to the eno the engagegagement.ment. 13.

13. medium medium

It is easier and more common to implement increased evidence accumulation for inherent risk It is easier and more common to implement increased evidence accumulation for inherent risk than for acceptable audit risk because:

than for acceptable audit risk because:

aa aa.. iinnhheerreennt t rriissk k ccaan n uussuuaalllly y bbe e iissoollaatteed d tto o ssppeecciiffiic c aaccccoouunnttss.. b.

b. inherent risk applies to the entinherent risk applies to the entire audit.ire audit. c.

c. accaccepteptablable audie audit rist risk and sak and sampmple sile sizes azes are set sre set stattatististicaicallylly.. d.

d. acacceceptptabable le auaudidit t ririsk doesk does s nonot t imimpapact ct on the on the amamouount of nt of evevididenence whice which musch must t bebe accumulated. accumulated. 14. (SOX) 14. (SOX) medium medium If an auditor is

If an auditor is requested to perform nonaudit services for a requested to perform nonaudit services for a public company audit client, who ispublic company audit client, who is responsible for agreeing to those services with the

responsible for agreeing to those services with the audit firm?audit firm? d

d aa.. TThhe e cclliieenntt’’s s mmaannaaggeemmeenntt.. b.

b. The client’s chief executive ofThe client’s chief executive officer.ficer. c.

c. ThThe cle clieientnt’s c’s chihief fef fininanancicial oal offfficicerer.. d.

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15. 15. medium medium

Which of the following statements is true regarding communications between predecessor and Which of the following statements is true regarding communications between predecessor and successor auditors?

successor auditors? b

b a.a. The burden of initiating the comThe burden of initiating the communication restmunication rests with the prs with the predecessor.edecessor. b.

b. The predecessor’s response can be lThe predecessor’s response can be limited to staimited to stating that no inforting that no information will mation will be provided.be provided. c.

c. The pThe prederedecessocessor shour should cold communmmunicaticate wite with the h the succsuccessor essor only only if thif the clie client ient is publs public.ic. d.

d. TherThere muse must be cot be communimmunicatication beton between tween the prhe predecedecessor essor and suand succesccessor if sor if the sthe succeuccessor issor is tos to accept the engagement.

accept the engagement. 16.

16. medium medium

Investigating new clients with a focus

Investigating new clients with a focus on assessing the auditor’s potential relationship with thaton assessing the auditor’s potential relationship with that new client is a critical element in

new client is a critical element in determining:determining: b

b a.a. inherent risk.inherent risk. b.

d.. ffiinnaanncciiaal rl riisskk.. 1

177.. TThhe e ppuurrppoosse e oof f aan n eennggaaggeemmeennt t lleetttteer r iis s ttoo:: medium

medium b

b

a.

a. dodocucumement nt ththe e CPCPA A fifirmrm’s ’s rerespspononsisibibilility ty to exteto externrnal al ususerers s of the of the auaudiditeted d fifinanancnciaiall statements.

statements. b.

b. document the terms of the engagdocument the terms of the engagement in writinement in writing to minimize mg to minimize misunderstandings.isunderstandings. c.

c. notnotifify the audy the audit stait staff of an upcff of an upcomioming engng engageagemenment so that pet so that persorsonnennel schel schedulduling caing can ben be facilitated.

facilitated. d.

d. emphaemphasize size manamanagemegement’s nt’s resporesponsibinsibility lity for for approapproving ving the the audiaudit prt prograogram.m. 18.

18. medium medium

One means of informing the client that the auditor is not responsible for the discovery of all acts One means of informing the client that the auditor is not responsible for the discovery of all acts of fraud is the:

of fraud is the:

aa aa.. eennggaaggeemmeennt t lleetttteerr.. b.

b. representation letter.representation letter. cc.. rerespspoonsnsibibililiity lety lettteter.r. d

d.. cclliieennt t lleetttteerr.. 1

199.. WWhhiicch oh of f tthhe e ffoolllloowwiinng g nnoorrmmaalllly y ssiiggnns ts thhe e eennggaaggeemmeennt lt leetttteer fr foor r aan an auuddiit t oof f a a ppuubblliic c ccoommppaanyny?? m

meeddiiuumm aa.. CCoorrppoorraatte e ttrreeaassuurreerr.. d

d bb.. CChhiieef f ffiinnaanncciiaal l ooffffiicceerr.. c.

c. ChChaiairmrman an of of ththe be boaoard rd of of didirerectctorors.s. d

d.. AAuuddiit t ccoommmmiitttteeee.. 2

200.. WWhhiicch oh of f tthhe e ffoolllloowwiinng g nnoorrmmaalllly y ssiiggnns ts thhe e eennggaaggeemmeennt lt leetttteer fr foor r aan an auuddiit t oof f a a pprriivvaatte ce coommppaannyy?? m

meeddiiuumm aa.. MMaannaaggeemmeenntt..

aa bb.. BBooaarrd d oof f ddiirreeccttoorrs s rreepprreesseennttaattiivvee.. c.

c. AuAudidit t cocommmmitittetee re repepreresesentntatativive.e. d.

d. CoCorprpoorarate te trtreaeasusurrerer.. 21. 21. medium medium d d

An understanding of a client’s business and industry and knowledge about operations are An understanding of a client’s business and industry and knowledge about operations are esse

essential for performntial for performing an ing an adeqadequate audit. For a uate audit. For a new client, most of new client, most of this inforthis informatimation on isis obtained:

obtained: a.

a. frfrom tom the phe prerededececessssor aor aududititoror.. b.

b. from the Securfrom the Securities and Exchaities and Exchange Commission.nge Commission. cc.. frfrom om tthe he pperermamanenent nt ffililee..

d.

d. at at ththe ce clilienent’t’s ps preremimiseses.s. 2

222.. TThhe e lleeaasst t eeffffeeccttiivve me meetthhood od of f iiddeennttiiffyyiing ng rreellaatteed pd paarrttiiees fs foor r a pa puubblliic c ccoommppaanny y wwoouulld d bbe e aa((nn)):: m

meeddiiuumm aa.. iinnqquuiirry y oof f mmaannaaggeemmeenntt.. cc bb.. rreevviieew w oof f SSEEC C ffiilliinnggss..

c.

c. disdistritributbution oion of the ef the engangagegemenment lett letter tter to all so all stoctockhokholdelders.rs. d.

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An official record of meetings of the board of directors and stockholders is included in the An official record of meetings of the board of directors and stockholders is included in the corporate: corporate: cc aa.. bbyyllaawwss.. b. b. charter.charter. cc.. mmiinnuutteess.. d d.. lliicceennssee.. 2

244.. WWhhiicch h oof f tthhe e ffoolllloowwiinng g iis s nnoot t lliikkeelly y tto o bbe e a a rreellaatteed d ppaarrttyy?? m

meeddiiuumm aa.. AAffffiilliiaatteed d ccoommppaanniieess..

cc bb.. A A mmaajjoor r ssttoocckkhhoollddeer r oof f tthhe e ccoommppaannyy.. cc.. A wA wararehehououse se eemmplployoyeeee..

d.

d. ThThe che chieief ef exexecucutitive ove offfficicerer.. 2

255.. WWhhiicch oh of f tthhe e ffoolllloowwiinng g iis s mmoosst t lliikkeelly y tto oo occccuur ar at t tthhe e bbeeggiinnnniinng og of f aan n iinniittiiaal l aauuddiit t eennggaaggememeenntt?? m

meeddiiuumm aa.. PPrreeppaarre e a a rroouuggh dh drraafft t oof f tthhe e ffiinnaanncciiaal l ssttaatteemmeenntts s aannd d oof f tthhe e aauuddiittoorr’’s s rreeppoorrtt.. cc bb.. SSttuuddy y aannd d eevvaalluuaatte e tthhe e ssyysstteem m oof f iinntteerrnnaal l aaddmmiinniissttrraattiivve e ccoonnttrrooll..

c.

c. DetDetermermine ine the the clclienient’s t’s rereasoason fn for or an an audaudit.it. d.

d. ConConsulsult with ant with and revid review the woew the work of the prerk of the predecdecessessor audior auditor prtor prior to disior to discuscussinsing theg the engagement with the client management.

engagement with the client management. 2

266.. AAn n aauuddiittoor r sshhoouulld d eexxaammiinne e mmiinnuuttees s oof f tthhe e bbooaarrd d oof f ddiirreeccttoorrss’ ’ mmeeeettiinnggss:: m

meeddiiuumm aa.. tthhrroouuggh h tthhe e ddaatte e oof f tthhe e ffiinnaanncciiaal l ssttaatteemmeennttss.. b

b b.b. through the date othrough the date of the audit reporf the audit report.t. c.

c. ononly ly at at ththe be begegininnining ng of of ththe e auaudidit.t. d d.. oon n a a tteesst t bbaassiiss.. 27. 27. medium medium

The first standard of field work, which states that the work is to be adequately planned and that The first standard of field work, which states that the work is to be adequately planned and that assistants, if any, are to be

assistants, if any, are to be properly supervised, recognizes that:properly supervised, recognizes that:

aa aa.. eeaarrlly y aappppooiinnttmmeennt t oof f tthhe e aauuddiittoor r iis s aaddvvaannttaaggeeoouus s tto o tthhe e aauuddiittoor r aannd d tthhe e cclliieenntt.. b.

b. acceptance of an audit engagement afacceptance of an audit engagement after the close of ter the close of the client’s fthe client’s fiscal year is iscal year is generally notgenerally not permissible.

permissible. c.

c. appappoinointmetment of the audint of the auditor sutor subsebsequequent to the phynt to the physicsical counal count of invent of inventortories reies requiquires ares a disclaimer of opinion.

disclaimer of opinion. d.

d. perfperformaormance of nce of substsubstantiantial paal parts orts of the f the examexaminatiination is on is necenecessary ssary at inat interiterim datm dates.es. 28.

28. medium medium

The corporate minutes are the official record of the meetings of the board of directors and The corporate minutes are the official record of the meetings of the board of directors and stockholders.

stockholders. The minutes typiThe minutes typically include authorizationcally include authorizations related to:s related to: d

d

T

Thhe e CCPPAA’’s s uusse e oof f oouuttssiidde e ssppeecciiaalliissttss MMaannaaggeemmeennt t ccoommppeennssaattiioonn a. a. b. b. c. c. d. d. Yes Yes No No Yes Yes No No Yes Yes No No No No Yes Yes 2

299.. AAn n eennggaaggeemmeennt t lleetttteer r sseennt t tto o aan n aauuddiit t cclliieennt t uussuuaalllly y wwoouulld d nnoot t iinncclluudde e aa((nn)):: me

medidiumum aa.. rerefferereencnce e tto o tthe he aaududititoror’’s s rreespspononsisibibilliity ty ffor or tthe he dedetetectctioion n of of eerrrorors rs oor r irirrregegululararititieies.s. cc bb.. eessttiimmaattiioon n oof f tthhe e ttiimme e tto o bbe e ssppeennt t oon n tthhe e aauuddiit t wwoorrk k bby y aauuddiit t ssttaafff f aannd d mmaannaaggeemmeenntt..

c.

c. statestatement ment that that manamanagemegement advnt advisory isory serviservices wces would bould be mae made avade availabilable upole upon reqn requestuest.. d.

d. refereference rence to mto manageanagementment’s re’s responssponsibiliibility fty for tor the fihe financnancial ial statestatementsments.. 3

300.. WWhhiicch h oof f tthhe e ffoolllloowwiinng g iis s ccoorrrreecct t wwiitth h rreessppeecct tt to o a a ccoommppaannyy’’s cs coorrppoorraatte e cchhaarrtteerr?? medium

medium cc

a.

a. The cThe corpororporate chate chartearter is gr is granteranted by the d by the fedefederal gral governovernment ament and is rnd is requirequired to red to recogecognize tnize thehe corporation as a

corporation as a separate entity.separate entity. b.

b. The corporate charter includes thThe corporate charter includes the rules and proce rules and procedures used to operedures used to operate a corporation.ate a corporation. c.

c. ThThe e cocorprpororatate e chchararteter r ininclclududes es ththe e exexacact t naname me of of ththe e cocorprpororatatioion, n, ththe e dadate te of of incorporation, and the types of business the

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d.

d. The cThe corporporaorate chte chartarter muer must be ast be annunnuallally revy reviewiewed by ted by the PChe PCAOAOB.B. 3

311.. CCoorrppoorraatte e bbyyllaawws s iinncclluuddee:: Medium

Medium d

d TThhe e ttyyppees s aannd d aammoouunntts s oof f ccaappiittaal l ssttoocck k the corporation is authorized to issue the corporation is authorized to issue

The rules and procedures used to The rules and procedures used to

operate the corporation operate the corporation a. a. b. b. c. c. d. d. Yes Yes No No Yes Yes No No Yes Yes No No No No Yes Yes 32. 32. medium medium b b

In what order should the

In what order should the following steps occur?following steps occur? A. Assess client business risk

A. Assess client business risk

B. Understand the client’s business and industry B. Understand the client’s business and industry C. Perform preliminary analytical procedures C. Perform preliminary analytical procedures D. Assess acceptable audit risk

D. Assess acceptable audit risk aa.. DD, , BB, , CC, , AA.. b. b. B, A, D, B, A, D, C.C. cc.. BB, , DD, , AA, , CC.. d d.. DD, , CC, , BB, , AA.. 3

333.. WWhhiicch h oof f tthhe e ffoolllloowwiinng g ssttaatteemmeenntts s iis s nnoot t ccoorrrreecct t wwiitth h rreessppeecct t tto o aannaallyyttiiccaal l pprroocceedduurreess?? m

meeddiiuumm aa.. AAuuddiittiinng sg sttaannddaarrdds es emmpphhaassiizze te thhe ne neeeed fd foor ar auuddiittoorrs ts to do deevveelloop ap annd ud usse ee expxpeeccttaattiioonnss.. b

b b.b. Analytical procAnalytical procedures must be peredures must be performed throughout tformed throughout the audit.he audit. c.

c. AnalyAnalytical tical procprocedureedures may s may be pbe perfoerformed rmed at aat any tny time ime duriduring tng the ahe audit.udit. d.

d. AnaAnalylytictical procal proceduedures use compres use compariarisonsons s and reland relatiationsonshiphips to s to assassess wheess whethether r accaccounountt balances appear re

balances appear reasonable.asonable. 3

344.. TThhe e mmoosst t wwiiddeelly y uusseed d pprrooffiittaabbiilliitty y rraattiio o iis s tthhee:: m

meeddiiuumm aa.. qquuiicck k rraattiioo.. d

d bb.. pprrooffiit t mmaarrggiinn.. cc.. rreettuurrn n oon n aasssseettss.. d

d.. eeaarrnniinnggs ps peer sr shhaarree.. 35.

35.

challenging challenging

The

The purpurpospose e of of the the rerequiquireremenment t in in SASAS S No. No. 84 84 of of havhaving ing comcommunmunicaicatiotion n betbetweeween n thethe predecessor and succ

predecessor and successor auditor is essor auditor is to:to: b

b a.a. allow the predeallow the predecessor to disclose cessor to disclose information winformation which would otherhich would otherwise be confidewise be confidential.ntial. b.

b. help the successor auditor to evalhelp the successor auditor to evaluate whether to uate whether to accept the engagaccept the engagement.ement. c.

c. helhelp thp the cle clienient by ft by faciacilitlitatiating tng the che chanhange oge of auf auditditorsors.. d.

d. ensurensure the pe the prederedecesscessor color collectlects all s all unpaiunpaid feed fees pris prior to or to a chaa change in nge in auditauditor.or. 36.

36.

The predecessor auditor is required to respond to the request of the successor auditor for The predecessor auditor is required to respond to the request of the successor auditor for information, but the response can be limited to stating that no information will be provided information, but the response can be limited to stating that no information will be provided when:

when:

cc aa.. tthhe e pprreeddeecceessssoor r aauuddiittoor r hhaas s ppoooor r rreellaattiioonns s wwiitth h tthhe e ssuucccceessssoor r aauuddiittoorr.. b.

b. the client is dissatisfied wthe client is dissatisfied with the predecesith the predecessor’s work.sor’s work. c.

c. therthere are e are actuaactual or pl or potentotential lial legal pegal problroblems bems betweetween the en the clieclient annt and the d the predepredecesscessor.or. d.

d. the pthe predredeceecessossor belr believieves thes that that the clie client lent lackacks ints integregrityity.. 3

377.. WWhhiicch oh of f tthhe e ffoolllloowwiinng g iis s ccoorrrreecct wt wiitth h rreessppeecct tt to o tthhe e uusse oe of f aannaallyyttiiccaal pl prroocceedduurreess?? challenging

challenging d

d

a.

a. AnalyAnalytical tical procprocedureedures may bs may be usee used in ed in evaluavaluating ting balanbalances ices in the n the testitesting phang phase as lse as long asong as the auditor also uses them in

the auditor also uses them in assessing the going concern assumption.assessing the going concern assumption. b.

b. Analytical procedures must be used Analytical procedures must be used throughout the authroughout the audit.dit. c.

c. AnalyAnalytical ptical procedrocedures useures used in the d in the testtesting phaing phase of tse of the audihe audit are prt are primarimarily usily used to died to direct rect anan auditor’s attention so that the auditor’s understanding of the business is

auditor’s attention so that the auditor’s understanding of the business is improved.improved. d.

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and nonfinancial data. and nonfinancial data. 38.

38.

Which of the following ratios is best used to assess a company’s ability to meet its long-term Which of the following ratios is best used to assess a company’s ability to meet its long-term debt obligations?

debt obligations? cc aa.. QQuuiicck k rraattiioo..

b.

b. Return on common equity.Return on common equity. cc.. DDeebbt t tto o eeqquuiittyy..

d

d.. CCuurrrreennt t rraattiioo.. 3

399.. WWhhiicch h oof f tthhe e ffoolllloowwiinng g ssttaatteemmeenntts s iis s nnoot t ccoorrrreecctt?? challenging

challenging b

b

a.

a. AnaAnalylytictical procal proceduedures useres used in the plannd in the planning phaing phase of the audise of the audit are primt are primariarily direly directected d atat understanding the client’s business and directing the auditor’s attention to areas that may understanding the client’s business and directing the auditor’s attention to areas that may contain possible

contain possible misstatements.misstatements. b.

b. Analytical procedures used in the completion phase are primAnalytical procedures used in the completion phase are primarily aimed at assessiarily aimed at assessing goingng going conce

concern rn and secondarand secondarily aimed ily aimed at directinat directing g the auditor’the auditor’s s atteattention to ntion to areaareas s that maythat may contain possible

contain possible misstatements.misstatements. c.

c. AnaAnalylytictical proal procecedurdures muses must be used in the plt be used in the plannanning aning and compd completletion phion phaseases of the audis of the audit,t, and are optional in the

and are optional in the testing phase.testing phase. d.

d. AnalyAnalytical ptical procerocedures udures used in tsed in the comhe completpletion phaion phase are pse are primarimarily arily aimed aimed at diret directincting theg the auditor’s attention to areas that may contain possible misstatements and secondarily aimed auditor’s attention to areas that may contain possible misstatements and secondarily aimed at assessing going concern.

at assessing going concern. 4

400.. WWhhiicch h oof f tthhe e ffoolllloowwiinng g wwoouulld d nnoot t lliikkeely ly bbe e ccllaassssiiffiieed d aas s a a rreellaatteedd--ppaarrty ty ttrraannssaaccttiioonn?? m

meeddiiuumm aa.. AAn n aaddvvaanncce e oof f oonne e wweeeekk’’s s ssaallaarry y tto o aan n eemmppllooyyeeee.. aa bb.. SSaallees s oof f mmeerrcchhaannddiisse e bbeettwweeeen n aaffffiilliiaatteed d ccoommppaanniieess..

c.

c. LoanLoans or s or credcredit sit sales ales to to the the prinprincipal cipal owneowner of r of the the clieclient cnt compaompany.ny. d.

d. ExchaExchanges nges of eof equipmquipment ent betwbetween teen two cwo compaompanies nies owneowned by d by the sthe same ame persoperson.n. 4

411.. WWhhiicch oh of f tthhe e ffoolllloowwiinng g wwoouulld d nnoot t bbe e ffoouunnd id in n tthhe e ccoorrppoorraatte ce chhaarrtteerr?? cchhaalllleennggiinngg aa.. TThhe e kkiinndds s aannd d aammoouunnt t oof f ccaappiittaal l ssttoocck k aauutthhoorriizezedd..

d

d bb.. TThhe e ddaatte e oof f iinnccoorrppoorraattiioonn.. c.

c. The tThe types ypes of buof businesiness acss activittivity thy that tat the cohe corporarporation tion is ais allowellowed to d to conduconduct.ct. d.

d. The rThe ruleules ans and prod procedcedureures ados adoptepted by thd by the ste stockockholholderders.s. 4

422.. WWhhiicch oh of f tthhe e ffoolllloowwiinng g wwoouulld d nnoot t uussuuaalllly y bbe e iinncclluuddeed id in tn thhe me miinnuuttees s oof f tthhe be booaarrd d oof df diirreeccttoorrss?? cchhaalllleennggiinngg aa.. TThhe de duuttiiees as annd pd poowweerrs os of tf thhe ce coorrppoorraatte oe offffiicceerrss..

aa bb.. DDeeccllaarraattiioon n oof f ddiivviiddeennddss.. c.

c. AuAuththororizizatatioion on of lf lonong-g-teterm rm loloanans.s. d.

d. ApApprprovoval al of of exexececututivive e bobonunuseses.s. 4

433.. WWhheen an arre ae auuddiittoorrs ls liikkeelly y tto o eennccoouunntteer jr juuddggmmeennt pt prroobblleemms s iin n tthhe e uusse oe of f aannaallyyttiiccaal pl prroocceedduurreess?? challenging

challenging d

d

a.

a. WhWhenenevever er ththe e auaudiditotor r plplacaces es rerelilianance ce on on mamananagegemementnt’s ’s exexplplananatatioions ns fofor r ununususuauall fluctuations in account balances without

fluctuations in account balances without first developing independent expectations.first developing independent expectations. b.

b. Whenever the auditor allows unaudited balances to Whenever the auditor allows unaudited balances to unduly influence his/her expectationsunduly influence his/her expectations of current balances.

of current balances. c.

c. WheneWhenever thver the audie auditor ftor fails tails to conso consider ider the pathe patterttern refn reflectlected by seed by severaveral unusul unusual flal fluctuauctuationstions when trying to explain what caused

when trying to explain what caused them.them. d.

d. The aThe auditouditor is r is likelikely to ly to encouencounter jnter judgmeudgment pront problemblems in es in each of ach of the athe above ibove instanstances.nces. 4

444.. TThhe e mmaajjoor r ccoonncceerrn wn whheen n uussiinng g nnoonnffiinnaanncciiaal l ddaatta a iin n aannaallyyttiiccaal l pprroocceedduurrees is is s tthhee:: cchhaalllleennggiinngg aa.. aaccccuurraaccy y oof f tthhe e nnoonnffiinnaanncciiaal l ddaattaa..

aa bb.. ssoouurrcce e oof f tthhe e nnoonnffiinnaanncciiaal l ddaattaa.. c.

c. tytype pe of of nononfnfininanancicial al dadatata.. d.

d. prepresensence oce of muf multiltiple ple sousourcerces of ns of nonfonfinainancincial daal data.ta. 4

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ch

chalallelengnginingg susubsbsididiaiaryry’s ’s rerelalatitiononshship ip to to ththe te tototal al enentitity ty bebecacaususe:e: b

b a.a. the business structure may be delithe business structure may be deliberately designeberately designed to obscure related to obscure related party transacd party transactions.tions. b.

b. this this may may reveal reveal whether whether transactions transactions would would have have taken taken place place if if the the parties parties had had beenbeen unrelated.

unrelated. c.

c. trtranansasactctioions ns mamay y hahave ve bebeen en coconsnsumummamateted d on on tetermrms s eqequiuivavalelent nt to to ararm’m’s-s-lelengngthth transactions.

transactions. d.

d. ththis may peris may permimit t ththe e auaudidit t of intof interercocompmpanany y acaccocoununt t babalalancnces to es to be perbe perfoformrmed as ed as of of concurrent dates. concurrent dates. 46. 46. challenging challenging

The first standard of fieldwork requires, in part, that audit work be properly planned. Proper The first standard of fieldwork requires, in part, that audit work be properly planned. Proper planning as inte

planning as intended by the first nded by the first standard of fiestandard of fieldwork would occldwork would occur when the auditorur when the auditor::

aa aa.. pphhyyssiiccaalllly oy obbsseerrvvees ts thhe me moovveemmeennt ot of sf seeccuurriittiiees as allrreeaaddy cy coouunntteed td to go guuaarrd ad aggaaiinnsst tt thhee substitution of such securities for others that are not

substitution of such securities for others that are not actually on hand.actually on hand. b.

b. uses negative accounts ruses negative accounts receivable confirmateceivable confirmations instead of positive cions instead of positive confirmations becaonfirmations becauseuse the latter require mailing of second requests and

the latter require mailing of second requests and review of subsequent cash collections.review of subsequent cash collections. c.

c. compacompares alres all casl cash as of a ph as of a partiarticulacular date tr date to avoio avoid perd performforming tiing time-come-consuminsuming casng cash cutoh cutoff ff procedures.

procedures. d.

d. elieliminminateates the possis the possibilbility of couity of countinting inveng inventontory itery items morms more than once than once by e by arrarranganging toing to make extensive test counts.

make extensive test counts. 4

477. . EEaarrlly y aappppooiinnttmmeennt t oof f tthhe e iinnddeeppeennddeennt t aauuddiittoor r wwiilll l eennaabbllee:: cchhaalllleennggiinngg aa.. a a mmoorre e tthhoorroouuggh h eexxaammiinnaattiioon n tto o bbe e ppeerrffoorrmmeedd.. d

d bb.. a a pprrooppeer r ssttuuddy y aannd d eevvaalluuaattiioon n oof f iinntteerrnnaal l ccoonnttrrool l tto o bbe e ppeerrffoorrmmeedd.. c.

c. sufsufficficienient comt competpetent ent evievidendentiatial matl matter tter to be oo be obtabtaineined.d. d.

d. a ma more ore effefficiicient ent exaexaminminatiation on to to be be plaplannenned.d. 48.

48. medium medium

Whenever an auditor compares client data to client-prepared budgets, there are two special Whenever an auditor compares client data to client-prepared budgets, there are two special concerns. Indicate if the two items below are concerns.

concerns. Indicate if the two items below are concerns. aa

Assessing whether the budgets were Assessing whether the budgets were

realistic plans realistic plans

Client data may have been altered to

Client data may have been altered to conformconform to the budget

to the budget aa.. AAccoonncceerrnn AAccoonncceerrnn b.

b. Not a concerNot a concernn Not a conceNot a concernrn cc.. AAccoonncceerrnn NoNottaaccoonncceerrnn d

d.. NNoottaaccoonncceerrnn AAccoonncceerrnn 49.

49.

An auditor who accepts an audit engagement and does not possess the industry expertise of the An auditor who accepts an audit engagement and does not possess the industry expertise of the business entity

business entity should:should: b

b a.a. engage financial engage financial experts familexperts familiar with the naiar with the nature of the businture of the business entity.ess entity. b.

b. obtain a knowledge of matters tobtain a knowledge of matters that relate to hat relate to the nature of the the nature of the entity’s busineentity’s business.ss. c.

c. referefer a substr a substantiaantial portl portion of ion of the authe audit to dit to anothanother CPer CPA who A who will awill act as thct as the prie principancipal audil auditor.tor. d.

d. firsfirst inft inform orm manamanagemegement thnt that aat an unqn unqualifualified oied opinipinion caon cannot nnot be isbe issued.sued. 5

500.. WWhhiicch h iis s a a lliiqquuiiddiitty y aaccttiivviitty y rraattiioo?? m

meeddiiuumm aa.. PPrrooffiit t mmaarrggiinn b

b b.b. Inventory turnover Inventory turnover cc.. RReettuurrn n oon n aasssseettss d

d.. TTiimmees s iinntteerreesst t eeaarrnneedd 5

511.. WWhhiicch h iis s uussuuaalllly y iinncclluuddeed d iin n aan n eennggaaggeemmeennt t lleetttteerr??

medium medium

Estimate of hours required to Estimate of hours required to

complete audit complete audit

Dollar estimate of fees to be billed to Dollar estimate of fees to be billed to

the client the client d d a.a. b. b. c. c. Yes Yes No No Yes Yes Yes Yes No No No No

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d

d.. NNoo YYeess

5

522.. WWhhiicch h iis s uussuuaalllly y iinncclluuddeed d iin n aan n eennggaaggeemmeennt t lleetttteerr?? medium

medium

aa A A rreeffeerreenncce e tto o GGAAAAPP A A rreeffeerreenncce e tto o GGAAAASS aa.. YYeess b. b. NoNo cc.. YYeess d d.. NNoo Yes Yes No No No No Yes Yes 5

533.. WWhhiicch h iis s uussuuaalllly y iinncclluuddeed d iin n aan n eennggaaggeemmeennt t lleetttteerr?? medium

medium

cc TThhe e ffiinnaanncciiaal l ssttaatteemmeenntts s aarree the responsibility of the the responsibility of the company’s management company’s management

Ratios to be used by the auditor in the planning Ratios to be used by the auditor in the planning

phase phase a. a. b. b. c. c. d d Yes Yes No No Yes Yes No No Yes Yes No No No No Yes Yes 5

544.. WWhheen n mmaay y tthhe e aauuddiittoor r rreeffeer r tto o a a ssppeecciiaalliisst t iin n tthhe e aauuddiit t rreeppoorrtt?? medium

medium cc

Only if the specialist’s report Only if the specialist’s report results in a modification of the audit results in a modification of the audit

opinion opinion

Only if the specialist assisted in the audit of Only if the specialist assisted in the audit of anan

account material to the

account material to the financial statementsfinancial statements a. a. b. b. c. c. d d Yes Yes No No Yes Yes No No Yes Yes No No No No Yes Yes 5

555.. WWhhiicch h iis s uussuuaalllly y iinncclluuddeed d iin n tthhe e eennggaaggeemmeennt t lleetttteerr?? medium

medium b

b The projectThe projected type of opinion oned type of opinion on the financials statement to be the financials statement to be

audited audited

Name(s) of th

Name(s) of the client personnee client personnel responsible for l responsible for supplying the auditor with

supplying the auditor with informationinformation a. a. b. b. c. c. d d Yes Yes No No Yes Yes No No Yes Yes No No No No Yes Yes 5

566.. WWhhiicch h iis s uussuuaalllly y iinncclluuddeed d iin n tthhe e eennggaaggeemmeennt t lleetttteerr?? medium

medium b

b List of audit List of audit procedures to be procedures to be usedused

iin n iinnvveennttoorry y oobbsseerrvvaattiioonn TThhe e aauuddiittoorrss’ ’ aasssseessssmmeennt t oof f AAuuddiit t RRiissk k a. a. b. b. c. c. d d Yes Yes No No Yes Yes No No Yes Yes No No No No Yes Yes

Essay Questions

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57. 57. easy easy

Discuss the factors an auditor should consider before accepting a

Discuss the factors an auditor should consider before accepting a company as an audit client.company as an audit client. Answer:

Answer: The

The audiauditor tor shoulshould d inveinvestigstigate ate and consider the and consider the prospprospectiective ve clieclient’s standing in nt’s standing in thethe business

business communitycommunity, , financial financial stability, stability, management’s management’s integrity, integrity, and and relations relations with with itsits bankers, attorneys, and previous CPA firm. The auditor should

bankers, attorneys, and previous CPA firm. The auditor should also determine whether healso determine whether he or she possesses the

or she possesses the required competence and independence to do the required competence and independence to do the audit.audit.

58. 58. easy easy

Discuss the primary purpose of an

Discuss the primary purpose of an audit engagement letter. Is an engagement letter required?audit engagement letter. Is an engagement letter required? Answer:

Answer:

The purpose of an

The purpose of an audit engagement letter is to establish a clear audit engagement letter is to establish a clear understanding betweenunderstanding between the auditor and the client regarding the

the auditor and the client regarding the terms of the engagement. An engagement is required for terms of the engagement. An engagement is required for both public and pr

both public and private company auditivate company audits.s.

59. 59. easy easy

Define the term “related party” and discuss why an auditor should identify the client’s related Define the term “related party” and discuss why an auditor should identify the client’s related parties early in

parties early in the audit.the audit. Answer:

Answer:

A related party is an

A related party is an affiliated company, principal owner of the client company, or anyaffiliated company, principal owner of the client company, or any other party with which the client deals where one of the parties can influence the management other party with which the client deals where one of the parties can influence the management or operating policies of the other. Auditors need to be aware of who the client’s related parties or operating policies of the other. Auditors need to be aware of who the client’s related parties are early in the

are early in the audit to enable the audit to enable the auditor to identify related-party transactions, especially thoseauditor to identify related-party transactions, especially those that have not been

that have not been disclosed.disclosed.

There are three main reasons why an auditor should properly plan audit engagements. Discuss There are three main reasons why an auditor should properly plan audit engagements. Discuss each of these reasons.

each of these reasons. Answer:

Answer:

Three reasons why an auditor should

Three reasons why an auditor should properly plan audit engagements are:properly plan audit engagements are:

•

• To enaTo enable ble the the audauditoitor r to to obtobtain ain sufsufficficienient t comcompetpetent ent evievidendence ce for for thethe

circumstances. This is essential for minimizing legal liability and maintaining a good circumstances. This is essential for minimizing legal liability and maintaining a good profession reputa

profession reputation.tion.

•

• To helTo help p keekeep p audaudit it coscosts ts rereasoasonabnable. le. GivGiven en the the comcompetpetititive ive audaudititinging

environment, keeping costs reasonable helps the firm obtain and retain clients. environment, keeping costs reasonable helps the firm obtain and retain clients.

•

• To avoid misunderstandings with the client. This is important for good clientTo avoid misunderstandings with the client. This is important for good client

relations. relations. 61. 61. medium medium

Discuss the essential activities involved in the initial planning of an Discuss the essential activities involved in the initial planning of an audit.audit. Answer:

Answer: Ther

There e are four are four esseessential activintial activities involvties involved ed in the in the initinitial planning of ial planning of an an audiaudit. Theset. These are:

are:

1.

CliClient ent accaccepteptancance e or or concontintinuatuationion. . In In the case the case of of a a new cliennew client, t, the auditthe auditor or musmustt determine whether the client is one with which (s)he wishes to be associated. In the determine whether the client is one with which (s)he wishes to be associated. In the cas

case e of of a a concontintinuinuing g cliclientent, , an an audauditoitor r musmust t detdetermermine ine whewhethether r concontintinuinuing g thethe relationship is appropriate and in the firm’s best interest.

relationship is appropriate and in the firm’s best interest.

2.

Determine reason for the audit. The auditor should determine the reason for the auditDetermine reason for the audit. The auditor should determine the reason for the audit as soon as practical. The remainder of the planning activities may be impacted by the as soon as practical. The remainder of the planning activities may be impacted by the

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client’s reason for requesting the audit. client’s reason for requesting the audit.

3.

Obtain an understanding with the client. An understanding with the client should beObtain an understanding with the client. An understanding with the client should be obtained to avoid misunderstandin

obtained to avoid misunderstandings. gs. Auditors are required to obtain an understandAuditors are required to obtain an understandinging with their clients. This understanding must

with their clients. This understanding must be written.be written.

4.

Develop an overall audit strategy. The strategy should consider the reasons for theDevelop an overall audit strategy. The strategy should consider the reasons for the audit, including areas where there

audit, including areas where there is greater risk of is greater risk of significant misstatemesignificant misstatements. Setting ants. Setting a strategy helps the auditor determine the resources required for the

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Discuss the required communications between predecessor and successor auditors as outlined Discuss the required communications between predecessor and successor auditors as outlined by SAS No.

by SAS No. 84.84. Answer:

Answer: Audit

Auditing ing standstandards require a ards require a succsuccessor auditor to essor auditor to commcommunicaunicate te with the with the predpredecessecessor or auditor whenever accepting a client that has been previously audited. The purpose of the auditor whenever accepting a client that has been previously audited. The purpose of the co

commmmununicicatatioion n is is to to hehelp lp ththe e susuccccesessosor r auaudiditotor r evevalaluauate te whwhetetheher r to to acaccecept pt ththee engagement. While the burden of initiating the communication rests on the successor engagement. While the burden of initiating the communication rests on the successor auditor, the predecessor auditor must respond to the request for information. However, auditor, the predecessor auditor must respond to the request for information. However, because

because of of the the requirements requirements related related to to confidentialityconfidentiality, , the the predecessor predecessor must must obtain obtain thethe former client’s permission prior to

former client’s permission prior to providing information to the providing information to the successor.successor.

Discuss several reasons why an auditor may

Discuss several reasons why an auditor may notnotwish to continue a wish to continue a relationship with an existingrelationship with an existing audit client.

audit client. Answer: Answer:

There are a number of reasons an auditor may choose not to continue a relationship with There are a number of reasons an auditor may choose not to continue a relationship with an existing

an existing client. client. Examples iExamples include:nclude: 1.

1. PrevPrevious conious conflicflicts over acts over accountcounting issuing issues, scoes, scope of the aupe of the audit, tydit, type of opinipe of opinion, or on, or fees.

fees. 2.

2. ManagemenManagement intt integriegrity maty may be y be deemdeemed to ed to be inbe insuffsufficieicient.nt. 3.

3. LeLegagal l acactition on ininititiaiateted d by by eieithther the er the auaudiditotor r or clieor client nt rerelalateted d to prito prior or auaudiditt services.

services. 4.

4. If feeIf fees remais remain unpaid fn unpaid for servor services perices performformed more thed more than one yan one year prior tear prior to the dato the datee of the current year’s audit report.

of the current year’s audit report. 5.

5. ThThe pree presesencnce of exe of excecessssivive rie risksk..

Discuss four of the matters that should

Discuss four of the matters that should be specified in an engagement letter.be specified in an engagement letter. Answer:

Answer:

Matters that should be specified in the

Matters that should be specified in the engagement letter include:engagement letter include:

•

• Whether Whether the auditor will perform an the auditor will perform an auditaudit, , a a revireview, or ew, or a a compicompilatilation, pluson, plus

any other services such as

any other services such as tax returns or management advisory services.tax returns or management advisory services.

•

• Any restrictions to be imposed on the Any restrictions to be imposed on the auditor’s work.auditor’s work. •

• Deadlines for completing the audit.Deadlines for completing the audit. •

• Assistance to be provided by the client’s personnel in obtaining records andAssistance to be provided by the client’s personnel in obtaining records and

documents, and schedules to be prepared for

documents, and schedules to be prepared for the auditor.the auditor.

•

• Agreement on fees.Agreement on fees. •

• The letter should state that the auditor is not responsible for the discovery of The letter should state that the auditor is not responsible for the discovery of

all acts of fraud. all acts of fraud.

Wha

What t docdocumeuments nts do do audauditoitors rs rouroutintinely ely obtobtain ain to to aid aid in in thetheir ir undunderserstantandinding g of of a a cliclientent’s’s governance system?

governance system? Briefly discuss eaBriefly discuss each of these documents.ch of these documents. Answer:

Answer:

Auditors commonly obtain the client’s corporate charter,

Auditors commonly obtain the client’s corporate charter, bylaws, and minutes of bylaws, and minutes of meetingsmeetings of the board of directors and shareholders. The corporate charter is issued by the state in of the board of directors and shareholders. The corporate charter is issued by the state in which the company is incorporated and specifies the exact name of the corporation along which the company is incorporated and specifies the exact name of the corporation along wit

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authorized to issue, and the types of business that the corporation is authorized to conduct. authorized to issue, and the types of business that the corporation is authorized to conduct. The

The bybylawlaws s incincludlude e the the rulrules es and and proprocecedurdures es adoadoptepted d by by the the stostockhckholdolders ers of of thethe corporation. They specify the duties and powers of corporate officers, the method of corporation. They specify the duties and powers of corporate officers, the method of voting for directors, and

voting for directors, and

the frequency of stockholde

the frequency of stockholder meetings. r meetings. The corporate minutThe corporate minutes are the official recores are the official record of d of the meetings of the board of directors and stockholders. They include summaries of the the meetings of the board of directors and stockholders. They include summaries of the most important topics discussed and decisions made at the

most important topics discussed and decisions made at the board meetings.board meetings.

What are three factors that have increased the importance of obtaining an understanding of a What are three factors that have increased the importance of obtaining an understanding of a client’s business and industry? How can an

client’s business and industry? How can an auditor obtain this understanding?auditor obtain this understanding? Answer:

Answer:

Factors that have increased the importance of obtaining an understanding of a client’s Factors that have increased the importance of obtaining an understanding of a client’s business and industry

business and industry include:include:

•

• Advances Advances in in inforinformatimation on techntechnology ology have have increincreased ased conneconnectivctivity ity amonamongg

companies, customers, and vendors. Auditors must understand the risks associated companies, customers, and vendors. Auditors must understand the risks associated with this increased

with this increased connectivity.connectivity.

•

• Companies have expanded operations to have global reaches, often throughCompanies have expanded operations to have global reaches, often through

joint ventures

joint ventures and strategic alland strategic alliances.iances.

•

• InformatInformation ion techntechnology ology affeaffects cts inteinternal rnal contrcontrol ol procprocesseesses, s, imprimproving oving thethe

quality and timeliness of

quality and timeliness of accounting information.accounting information.

•

• The increased importance of human capital and other intangible assets hasThe increased importance of human capital and other intangible assets has

increased accounting complexity and the importance of management judgments and increased accounting complexity and the importance of management judgments and estimates.

estimates.

•

• Auditors need a better understanding of the client’s business and industry toAuditors need a better understanding of the client’s business and industry to

provide additiona

provide additional value-added serl value-added services.vices. The auditor can obtain a

The auditor can obtain a sound understanding of the client’s business and sound understanding of the client’s business and industry throughindustry through sev

severaeral l meameans, ns, incincludluding ing disdiscuscussiosions ns witwith h prepreviovious us audauditoitors rs and and by by rerevieviewinwing g thethe permanent

permanent files files for for the the client; client; conferences conferences with with the the client’s client’s personnel; personnel; studying studying AICPAAICPA industry audit guides, textbooks, technical magazines, and specialized journals; and by industry audit guides, textbooks, technical magazines, and specialized journals; and by participating i

participating in industry associan industry associations and training tions and training programs.programs.

There are three primary reasons for obtaining a thorough understanding of the client’s industry There are three primary reasons for obtaining a thorough understanding of the client’s industry and external environment. What are these reasons?

and external environment. What are these reasons? Answer:

Answer:

The three reasons are: The three reasons are:

•

• Risks associated with specific industries may affect the auditor’s assessment of clientRisks associated with specific industries may affect the auditor’s assessment of client

business risk a

business risk and acceptable audit rnd acceptable audit risk.isk.

•

• CerCertaitain n inhinhereerent nt risrisks ks arare e tytypicpicallally y comcommon mon to to all all cliclientents s in in cercertaitain n indindustustriries.es.

Familiarity with those risks aids the auditor in assessing their relevance to the Familiarity with those risks aids the auditor in assessing their relevance to the client.client.

•

• ManMany y indindustustrieries s havhave e uniunique que accaccounountinting g reqrequiruiremeements nts thathat t the the audaudititor or musmustt

understand to evaluate whether the client’s financial statements are in accordance understand to evaluate whether the client’s financial statements are in accordance GAAP. GAAP. 68. 68. medium medium

Discuss the four primary purposes of analytical procedures performed during the planning phase Discuss the four primary purposes of analytical procedures performed during the planning phase of an audit.

of an audit. Answer: Answer:

The four primary purposes of preliminary analytical procedures are: The four primary purposes of preliminary analytical procedures are:

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•

• to help the auditor understand the to help the auditor understand the client’s industry and business,client’s industry and business, •

• to help the auditor assess the to help the auditor assess the going concern assumption,going concern assumption, •

• to indicate areas of possible misstatements, andto indicate areas of possible misstatements, and •

• to reduce the extent of to reduce the extent of detailed tests.detailed tests.

69. 69.

Define business risk.

Define business risk. List several factorList several factors that may impact the auditor’s assessment of businesss that may impact the auditor’s assessment of business risk.

risk. Answer: Answer:

Business risk is the risk that

Business risk is the risk that a company will fail to achieve a company will fail to achieve its objectives.its objectives. Factors that may impact business risk include:

Factors that may impact business risk include:

•

• General economic conditions,General economic conditions, •

• Extent of competition within an Extent of competition within an industry,industry, •

• Changing regulatory requirements,Changing regulatory requirements, •

• Competence of management,Competence of management, •

• Ability to maintain sufficient cash flows and secure financing, andAbility to maintain sufficient cash flows and secure financing, and •

• Successful implementation of business strategies.Successful implementation of business strategies.

70. 70.

Auditors routinely conduct analytical procedures in the planning, testing, and completion phases Auditors routinely conduct analytical procedures in the planning, testing, and completion phases of the audit.

of the audit. Identify the primary and secondaIdentify the primary and secondary purposes of performing analytiry purposes of performing analytical procedurescal procedures in each phase of the audit.

in each phase of the audit. Answer:

Answer:

•

• Planning – The primary purposes are to understand the client’s business and industryPlanning – The primary purposes are to understand the client’s business and industry

and indicate areas

and indicate areas of of possipossible misstatble misstatemenements. The ts. The seconsecondary purposes are dary purposes are to to asseassessss going concern and reduce the

going concern and reduce the extent of detailed tests.extent of detailed tests.

•

• Testing – The primary purpose is to reduce the extent of detailed tests, while theTesting – The primary purpose is to reduce the extent of detailed tests, while the

secondary purpose is to indicate areas of

secondary purpose is to indicate areas of possible misstatemenpossible misstatements.ts.

•

• Completion –The primary purpose is to indicate areas of possible misstatements,Completion –The primary purpose is to indicate areas of possible misstatements,

while the secondary purpose is to

while the secondary purpose is to assess going concern.assess going concern. 71.

71.

Three types of legal documents and records that auditors examine in the planning phase of an Three types of legal documents and records that auditors examine in the planning phase of an audit are the corporate charter and bylaws, corporate minutes of meetings of the board of audit are the corporate charter and bylaws, corporate minutes of meetings of the board of directors and stockholders, and contracts. Discuss the audit-relevant information contained in directors and stockholders, and contracts. Discuss the audit-relevant information contained in each of these three types of documents that an auditor should be aware of early in the audit. each of these three types of documents that an auditor should be aware of early in the audit. Answer:

Answer:

Corporate charter and bylaws.

Corporate charter and bylaws. This includes the amounts of capital stock the corporationThis includes the amounts of capital stock the corporation is authorized to issue, its par

is authorized to issue, its par or stated value, preferences and conditions for dividends, andor stated value, preferences and conditions for dividends, and information concerning voting rights of each class of stock. The bylaws specify such information concerning voting rights of each class of stock. The bylaws specify such things as the fiscal year of the corporation, the frequency of stockholder meetings, the things as the fiscal year of the corporation, the frequency of stockholder meetings, the method of voting for directors, and the

method of voting for directors, and the duties and powers of the duties and powers of the corporate officers.corporate officers. Minutes of

Minutes of meetingsmeetings. There are two categories of audit-relevant information contained in. There are two categories of audit-relevant information contained in the

the minuminutes: authoriztes: authorizationations s and and discdiscussioussions ns by by the the board of board of direcdirectors affectintors affecting g inheinherentrent risk. Common authoriz

risk. Common authorizationations s in in the the minutminutes es incluinclude de compecompensatinsation on of of offiofficerscers, , newnew contacts and agreements, acquisitions of

contacts and agreements, acquisitions of property, loans, and dividend property, loans, and dividend payments.payments. Contracts

Contracts. The auditor should examine contracts early in the engagement to gain a better . The auditor should examine contracts early in the engagement to gain a better perspective

perspective of of the the organization organization and and to to become become familiar familiar with with potential potential problem problem areas.areas. Contracts will also be examined during the tests of

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Chapter 8 Final

Chapter 8

Chapter 8

Multiple-Choice Questions

Multiple-Choice Questions

Essay Questions

Essay Questions

1.

1.

2.

2.

3.

3.

4.

4.

Other Objective Answer Format Questions

Other Objective Answer Format Questions