Auditing Theory - WILEY

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Question: ENPL2-0001

The Sarbanes-Oxley Act of 2002 authorized creation of the Answers

A: Auditing Standards Board.

B: Public Company Accounting Oversight Board. C: Financial Accounting Standards Center. D: Corporate Governance Institute. Answer Explanations

A. Answer A is incorrect because the Auditing Standards Board has been involved with auditing standards for many years and was not established by the Act.

B. Answer B is correct in that the Act authorized creation of the Public Company Accounting Oversight Board. C. Answer C is incorrect in that the Act did not establish a

Financial Accounting Standards Center.

D. Answer D is incorrect because while there are several “Corporate Governance Institutes,” none were established by the Act.

Hint

The Act increased governmental involvement. Question: ENPL2-0002

Which of the following has the lowest authoritative status but may be useful in assisting the auditor in applying the SASs? Answers

A: Statements on Auditing Standards. B: Auditing Statements of Position. C: Journal of Accountancy articles. D: Auditing Interpretations. Answer Explanations

A. Answer A is incorrect. SASs have the highest level of authority.

B. Answer B is incorrect. Statements of Position have the authority of interpretative guidance.

C. Answer C is correct. Journal of Accountancy articles have no authoritative status but may be useful in applying SASs. D. Answer D is incorrect. Auditing Interpretations have the status of interpretive guidance.

Hint

Which of the publications have no authoritative status? Question: ENPL2-0003

Early appointment of the independent auditor will enable Answers

A: A more thorough examination to be performed.

B: A proper consideration of internal control to be performed. C: Sufficient competent evidential matter to be obtained. D: A more efficient audit to be planned.

Answer Explanations

A. Answer A is incorrect because the overall scope of the audit must remain the same regardless of appointment date. B. Answer B is incorrect because a proper consideration of internal control may be performed even without early appointment.

C. Answer C is incorrect because sufficient competent evidential matter must be obtained regardless of the

appointment date.

D. Answer D is correct because the early appointment of the independent auditor enables the auditor to plan his/her work so that it may be done expeditiously and to determine the extent to which it can be done before the balance sheet date. Such preliminary work by the auditor permits the audit to be performed in a more efficient manner and to be completed at an early date after the year-end.

Hint

Planning enhances efficiency. Question: ENPL2-0004

When establishing an understanding with an audit client, that understanding should be documented

Answers

A: Through use of an engagement letter.

B: Through a written communication with the client. C: Either orally or in writing witht the client.

D: In a manner completely based on the auditor's seasoned professional judgment.

A. Answer A is incorrect. While an engagement letter is frequently used, it is not required.

B. Answer B is correct. The professional standards require a written communication.

C. Answer C is incorrect. The understanding must be written not oral.

D. Answer D is incorrect. The professional standards allow only limited auditor use of professional judgment here in that a written communication is required.

Hint

Only limited flexibility exists here. Question: ENPL2-0005

An understanding with the client must include the objectives of the engagement, management’s responsibilities, and

The auditor’s responsibilities Limitations of the audit A. Yes Yes B. Yes No C. No Yes D. No No Answers A: A. B: B. C: C. D: D. Answer Explanations

A. Answer A is correct. The professional standards require that both the auditor’s responsibilities and limitations of the audit be communicated.

B. Answer B is incorrect. Limitations of the audit must be communicated.

C. Answer C is incorrect. The auditor’s responsibilities must be communicated.

D. Answer D is incorrect. Both the auditor’s responsibilities and limitations of the audit must be communicated. Hint

What needs to be communicated to reduce the likelihood of misunderstandings?

The primary responsibility for the adequacy of disclosure in the financial statements of a publicly held company rests with the Answers

A: Partner assigned to the audit engagement. B: Management of the company.

C: Auditor in charge of the fieldwork. D: Securities and Exchange Commission. Answer Explanations

A. Answer A is incorrect because his/her responsibility is limited to expressing an opinion as to the fairness of the financial statements.

B. Answer B is correct because financial statements are the representations of management, and they have the responsibility for producing proper financial statements. C. Answer C is incorrect because his/her responsibility is to gather audit evidence regarding the fairness of the financial statements.

D. Answer D is incorrect because its responsibility for enforcing disclosure requirements in financial statements of publicly held companies is secondary to management's primary responsibility for the representations included in the financial statements.

Hint

Who makes the representations in the financial statements? Question: ENPL2-0007

Which of the following statements best describes the phrase "generally accepted auditing standards" as it relates to an audit of a nonpublic company?

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Answers

A: They identify the policies and procedures for the conduct of the audit.

B: They define the nature and extent of the auditor’s responsibilities.

C: They provide guidance to the auditor with respect to planning the audit and writing the audit report.

D: They set forth a measure of the quality of the performance of audit procedures.

A. Answer A is incorrect because generally accepted auditing standards give only limited guidance as to specific policies and procedures for the conduct of the audit. B. Answer B is incorrect because generally accepted auditing standards give only limited guidance as to the nature and extent of the auditor's responsibilities.

C. Answer C is incorrect because it only relates to the standard concerned with planning the audit and writing the audit report and not to the other standards.

D. Answer D is correct because generally accepted auditing standards (GAAS) deal with measures of the quality of the performance of audit procedures. Auditing standards relate not only to the auditor's professional qualities but also to the judgment exercised by the auditor in the performance of the audit.

Hint

GAAS is a measure of performance. Question: ENPL2-0008

Which of the following underlies the application of generally accepted auditing standards, particularly the standards of fieldwork and reporting?

Answers

A: The elements of materiality and audit risk. B: The element of internal control.

C: The element of corroborating evidence. D: The element of reasonable assurance. Answer Explanations

A. Answer A is correct because the elements of materiality and audit risk underlie the application of all the standards, particularly the standards of fieldwork and reporting. B. Answer B is incorrect because internal control does not underlie all GAAS but rather deals specifically with the second fieldwork standard.

C. Answer C is incorrect because corroborating evidence is required to be gathered but does not underlie all GAAS.

Corroborating evidence addresses the third fieldwork standard directly.

D. Answer D is incorrect because reasonable assurance is a basic concept of internal control which recognizes that the cost of internal control should not exceed the benefits expected to be derived.

Hint

Which of the following do not underlie the application of all the standards?

Which of the following publications does not qualify as a source of generally accepted accounting principles?

Answers

A: Accounting interpretations issued by the FASB. B: AICPA Concepts Statements.

C: AICPA Practice Bulletins.

D: Statements of Financial Standards issued by the FASB. Answer Explanations

A. Answer A is incorrect because interpretations issued by the FASB are considered as sources of GAAP (AU 411). B. Answer B is correct because the AICPA has not issued concepts statements. The concepts statements issued by the FASB are considered "other accounting literatures" and are not sources of generally accepted accounting principles. C. Answer C is incorrect because Practice Bulletins are considered as sources of GAAP (AU 411).

D. Answer D is incorrect because FASB statements are considered sources of GAAP (AU 411).

Hint

The AICPA has not issued concepts statements. Question: ENPL2-0010

In developing an overall audit strategy, an auditor should consider

Answers

A: Whether the allowance for sampling risk exceeds the achieved upper precision limit.

B: Findings from substantive tests performed at interim dates. C: Whether the inquiry of the client’s attorney identifies any litigation, claims, or assessments not disclosed in the financial statements.

D: Reporting objectives of the engagement. Answer Explanations

A. Answer A is incorrect. Any information on the achieved upper precision limit will generally be obtained after the overall audit strategy has been developed.

B. Answer B is incorrect. Any information on interim substantive tests will generally be obtained after the overall audit strategy has been developed.

C. Answer C is incorrect. Any information pertaining to attorney's letters will generally be obtained after the overall audit strategy has been developed.

D. Answer D is correct. An overall audit strategy involves (1) determining the scope of the audit, (2) determining the reporting objectives, and (3) considering various other important factors.

Hint

The preliminary audit strategy occurs very early in the engagement.

Inherent risk and control risk differ from detection risk in that inherent risk and control risk are

Answers

A: Elements of audit risk while detection risk is not.

B: Changed at the auditor’s discretion while detection risk is not. C: Considered at the individual account-balance level while detection risk is not.

D: Functions of the client and its environment while detection risk is not.

A. Answer A is incorrect. Inherent risk, control risk and detection risk are all components of audit risk.

B. Answer B is incorrect. Detection risk, not inherent risk and control risk, may be changed at the auditor's discretion. C. Answer C is incorrect. Auditors consider all of the component risks at the account level.

D. Answer D is correct. Inherent risk and control risk exist independently of the audit of financial statements as functions of the client and its environment, whereas detection risk relates to the auditor's procedures and can be changed at his or her discretion.

Hint

An auditor may change the level of detection risk. Question: ENPL2-0012

As the acceptable level of detection risk decreases, the assurance directly provided from

Answers

A: Substantive procedures should increase. B: Substantive procedures should decrease. C: Tests of controls should increase.

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D: Tests of controls should decrease. Answer Explanations

A. Answer A is correct. Detection risk is restricted by the auditor's substantive procedures. As the acceptable level of detection risk decreases, assurance provided by substantive procedures must increase. Increased assurance can be obtained by modifying the nature, timing and/or extent of the substantive procedures.

This answer is incorrect. Refer to the correct answer explanation. C. Answer C is incorrect. The acceptable level of detection

risk is based largely on the assessed levels of control risk and inherent risk. Accordingly, any tests of controls will already have been performed.

D. Answer D is incorrect. The acceptable level of detection risk is based largely on the assessed levels of control risk and inherent risk. Accordingly, any tests of controls will already have been performed.

Hint

There is an inverse relationship between detection risk and substantive procedures.

Holding all other factors constant, decreasing the extent of substantive audit procedures for accounts payable ordinarily has what effect on audit risk?

Answers A: Increases. B: Decreases. C: No effect. D: Indeterminate. Answer Explanations

A. Answer A is correct because decreasing the extent of substantive audit procedures increases detection risk, and this will increase audit risk when all other factors remain constant. This answer is incorrect. Refer to the correct answer explanation. This answer is incorrect. Refer to the correct answer explanation. This answer is incorrect. Refer to the correct answer explanation. Hint

Identify the effect of decreasing the extent of substantive procedures on audit risk.

Which of the following audit risk components may be assessed in nonquantitative terms? Inherent risk Control risk Detection risk A. Yes Yes No B. Yes No Yes C. No Yes Yes

D. Yes Yes Yes

Answers A: A. B: B. C: C. D: D. Answer Explanations

This answer is incorrect. Refer to the correct answer explanation. This answer is incorrect. Refer to the correct answer explanation. This answer is incorrect. Refer to the correct answer explanation. D. Answer D is correct because all of these risks may be assessed in quantitative terms such as percentages. They may also be assessed in nonquantitative terms such as a range from a minimum to a maximum.

Hint

No tricks here.

Use the audit risk model to calculate audit risk (to the closest percent) in the following circumstance:

Control risk 40% Inherent risk 40% Detection risk 40% Answers A: 1%. B: 6%. C: 13%. D: 40%. Answer Explanations

This answer is incorrect. Refer to the correct answer explanation. B. Answer B is correct. The requirement is to use the audit

risk model to mathematically calculate audit risk (to the nearest percent). AU 312 discusses the three components of the audit risk model presented in this problem which may be viewed as

Audit risk

= Inherent risk x Control risk x Detection risk in this problem Audit risk = .40 x .40 x .40 = 6.4%

Note that a quantitative approach such as this is largely for demonstrative purposes and few would directly incorporate it into practice.

This answer is incorrect. Refer to the correct answer explanation. This answer is incorrect. Refer to the correct answer explanation. Hint

AR = IR x DR x CR Question: ENPL2-0016

The risk that an auditor will conclude, based on substantive procedures, that a material misstatement does not exist in an account balance when, in fact, such error does exist is referred to as Answers A: Sampling risk. B: Detection risk. C: Nonsampling risk. D: Inherent risk. Answer Explanations

A. Answer A is incorrect. Sampling risk arises from the possibility that, when a test of controls or a substantive test is restricted to a sample, the auditor's conclusions may be different from the conclusions he or she would reach if the procedures were applied in the same way to all items in the account balance or class of transactions.

B. Answer B is correct. Detection risk is the risk that the auditor will not detect a material misstatement that exists in an assertion.

C. Answer C is incorrect. Nonsampling risk includes only those aspects of audit risk that are not due to sampling. D. Answer D is incorrect. Inherent risk is the susceptibility of an assertion to a material misstatement, assuming that there are no related controls.

Hint

No tricks here.

As a lower acceptable level of materiality is established, the auditor should plan more work on individual accounts to Answers

A: Find smaller misstatements. B: Find larger misstatements.

C: Increase the tolerable misstatement in the accounts. D: Decrease the risk of assessing control risk too low. Answer Explanations

A. Answer A is correct. A decrease in acceptable levels of materiality requires the auditor to do one or more of the following: (1) select a more effective auditing procedure, (2) perform auditing procedures closer to the balance sheet date, or

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(3) increase the extent of a particular auditing procedure. By increasing the extent of a procedure concerning an individual account and/or selecting a more effective procedure, the auditor will find the smaller misstatements that in aggregate might exceed his preliminary judgments about materiality. The auditor, therefore, must plan to find smaller misstatements as a lower acceptable level of materiality is established.

B. Answer B is incorrect. Larger misstatements must be discovered in any sampling plan regardless of materiality levels. C. Answer C is incorrect. A decrease in materiality will lead to a decrease in tolerable misstatement for an account, not an increase. Tolerable misstatement is a planning concept and is related to the auditor's preliminary estimates of materiality levels in such a way that tolerable misstatement combined for the entire audit plan, does not exceed those estimates.

D. Answer D is incorrect. Lower levels of materiality do not require a reduction in the risk of assessing control risk too low. The risk of assessing control risk too low pertains to the planned reliance on specific internal control policies and procedures, not work on individual accounts.

Hint

As the level of materiality decreases, the amount of evidence needed increases.

Which of the following statements is not correct about materiality?

Answers

A: The concept of materiality recognizes that some matters are important for fair presentation of financial statements in conformity with GAAP, while other matters are not important. B: An auditor considers materiality for planning purposes in terms of the largest aggregate level of misstatements that could be material to any one of the financial statements.

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

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

A. Answer A is incorrect. Materiality does recognize that some matters are important for fair presentation in conformity with GAAP.

B. Answer B is correct because the auditor considers materiality for planning purposes in terms of the smallest, not the largest, aggregate amount of misstatement that could be material to any one of the financial statements.

C. Answer C is incorrect as materiality is a judgment assessed in quantitative and qualitative terms.

D. Answer D is incorrect because materiality is a function of the auditor's perception of user needs. Hint

What is the definition of materiality? Question: ENPL2-0019

In considering materiality for planning purposes, an auditor believes that misstatements aggregating $10,000 would have a material effect on an entity's income statement, but that misstatements would have to aggregate $20,000 to materially affect the balance sheet. Ordinarily, it would be appropriate to design auditing procedures that would be expected to detect misstatements that aggregate

Answers A: $10,000 B: $15,000 C: $20,000 D: $30,000 Answer Explanations

A. Answer A is correct because it will ordinarily be difficult to anticipate during the planning stage of an audit whether all misstatements will affect only one financial statement. The auditor therefore generally is required to use the lower financial statement figure for most portions of planning. This answer is incorrect. Refer to the correct answer explanation. This answer is incorrect. Refer to the correct answer explanation. This answer is incorrect. Refer to the correct answer explanation. Hint

In the planning stage, the auditor typically makes a conservative assessment of materiality.

Following the Professional Standards which of the following is not one of the assertions made by management for account balances?

Answers A: Completeness. B: Existence.

C: Valuation and allocation. D: Relevance and reliability. Answer Explanations

A. Answer A is incorrect. Completeness is an account balance assertion.

B. Answer B is incorrect. Existence is an account balance assertion.

C. Answer C is incorrect. Presentation and disclosure is an account balance assertion.

D. Answer D is correct. Relevance and reliability is not included in the professional standards as an account balance assertion. AU 326 presents as assertions: (1) Existence, (2) Rights and obligations, (3) Completeness, and (4) Valuation and allocation.

Hint

No tricks here.

Which of the following, if material, would be fraud as defined in Statements on Auditing Standards?

Answers

A: Errors in the application of accounting principles. B: Errors in the accounting data underlying the financial statements.

C: Misinterpretation of facts that existed when the financial statements were prepared.

D: Misappropriation of assets. Answer Explanations

A. Answer A is incorrect because an error in the application of accounting principles is an example of "errors" as defined by Statements on Auditing Standards. An error refers to an unintentional mistake.

B. Answer B is incorrect because an error in accounting data is an example of "errors" as defined by Statements on Auditing Standards. An error refers to an unintentional mistake. C. Answer C is incorrect because a misinterpretation of facts is an example of "errors" as defined by Statements on Auditing Standards. An error refers to an unintentional mistake. D. Answer D is correct because the term "fraud" refers to intentional distortions of financial statements such as deliberate misrepresentations.

Hint

Fraud is an intentional distortion of the financial statements. Question: ENPL2-0022

Which of the following factors is most important concerning an auditor's responsibility to detect errors and fraud?

Answers

A: The susceptibility of the accounting records to intentional manipulations, alterations, and the misapplication of accounting principles.

B: The probability that unreasonable accounting estimates result from unintentional bias or intentional attempts to misstate the financial statements.

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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. Answer Explanations

A. Answer A is incorrect. The susceptibility of the accounting records to intentional manipulations, alterations, and the misapplication of accounting principles are examples of factors that may influence the auditor's consideration of risk of material misstatement. This answer is incorrect because it is incomplete.

B. Answer B is incorrect. The probability that unreasonable accounting estimates result from unintentional bias or intentional attempts to misstate the financial statements is an example of a factor that may influence the auditor's consideration of risk of material misstatements in the financial statements. This answer is incorrect because it is incomplete. C. Answer C is incorrect. The possibility that management fraud, defalcations, and the misappropriation of assets indicating the existence of illegal acts is one factor the auditor can use to assess the risk of management

misrepresentation in the financial statements. Answer C is incorrect because it is incomplete.

D. Answer D is correct. The auditor should assess the risk that errors and fraud (which include mistakes, falsifications and omissions) may cause the financial statements to contain material misstatements.

Hint

Three of these answers are incorrect because they are incomplete. The correct answer is the broadest in scope. Question: ENPL2-0023

What assurance does the auditor provide that errors, fraud, and direct effect illegal acts that are material to the financial statements will be detected?

Errors Fraud

Direct effect illegal acts

A. Limited Negative Limited

B. Limited Limited Reasonable

C. Reasonable Limited Limited

D. Reasonable Reasonable Reasonable

Answers A: A. B: B. C: C. D: D. Answer Explanations

This answer is incorrect. Refer to the correct answer explanation. This answer is incorrect. Refer to the correct answer explanation. This answer is incorrect. Refer to the correct answer explanation. D. Answer D is correct. AU 316 requires the auditor to design the audit to provide reasonable assurance of detecting material errors, fraud and direct effect illegal acts.

Hint

Direct effect illegal acts require the same assurance as errors and fraud.

The independent auditor's plan for an examination in accordance with generally accepted auditing standards is influenced by the possibility of material misstatements. The auditor will therefore conduct the examination with an attitude of Answers A: Professional skepticism. B: Subjective mistrust. C: Objective indifference. D: Professional responsiveness. Answer Explanations

A. Answer A is correct because the auditor should plan and perform the audit with an attitude of professional skepticism, recognizing that the application of auditing procedures may produce evidential matter indicating the possibility of errors or fraud.

This answer is incorrect. Refer to the correct answer explanation. This answer is incorrect. Refer to the correct answer explanation. This answer is incorrect. Refer to the correct answer explanation. Hint

Controlled doubt increases the likelihood of detecting material misstatements due to errors and fraud.

Which of the following statements best describes the auditor's responsibility regarding the detection of material errors and fraud?

Answers

A: The auditor is responsible for the failure to detect material errors and fraud only when such failure results from the nonapplication of generally accepted accounting principles. B: Auditing procedures may or may not need to be extended if the auditor’s analysis indicates the existence of fraud risk factors.

C: The auditor is responsible for the failure to detect material errors and fraud only when the auditor fails to confirm receivables or observe inventories.

D: Extended auditing procedures are required to detect unrecorded transactions even if there is no evidence that material errors and fraud may exist.

A. Answer A is incorrect. The auditor should design the audit to provide reasonable assurance of detecting errors and fraud that is material to the financial statements. This responsibility for detection is not limited to circumstances arising from the nonapplication of generally accepted accounting principles.

B. Answer B is correct. When fraud risk factors exist, the auditor should consider whether already designed procedures adequately consider the existence of fraud. When they do not, audit procedures must be extended.

C. Answer C is incorrect. The auditor may be held responsible for failures to detect misstatements due to errors and fraud because of inadequate planning, performance or judgment. Not confirming receivables or not observing inventories are only two of the many possible situations in which the auditor may be held responsible for a failure to detect associated errors and fraud.

D. Answer D is incorrect. The extended auditing procedures are necessary when normal procedures indicate evidence that misstatements due to errors and fraud may exist, not when there is no such evidence.

Hint

An existing material misstatement due to error or fraud suggests that other such misstatements may exist.

Which of the following is an example of fraudulent financial reporting?

Answers

A: Company management improperly records as revenue the proceeds of a loan.

B: The treasurer diverts customer payments to his personal use, concealing his actions by debiting an expense account, thus overstating expenses.

C: An employee steals inventory and the "shrinkage" is recorded in cost of goods sold.

D: An employee bills his company for products not received, using the name of a fictitious supplier.

A. Answer A is correct because fraudulent financial reporting involves intentional misstatements or omissions of

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amounts or disclosures in financial statements to deceive financial statement users and improperly recording the revenue results in such misstatements.

Differentiate between fraudulent financial reporting and misappropriation of assets.

Which of the following is correct concerning a "fraud risk factor?"

Answers

A: Its presence indicates that the risk of fraud is high. B: It has been observed in circumstances where frauds have occurred.

C: It requires modification of planned audit procedures. D: It is also a material weakness in internal control. Answer Explanations

A. Answer A is incorrect because the risk of fraud may or may not be high when a risk factor is present.

B. Answer B is correct because AU 316 suggests that while fraud risk factors do not necessarily indicate the existence of fraud, they often have been observed in circumstances where frauds have occurred.

C. Answer C is incorrect because the current audit program may in many circumstances appropriately address a fraud risk factor.

D. Answer D is incorrect because a fraud risk factor may or may not represent a material weakness in internal control; see AU 325 for information on reportable conditions and material weaknesses in internal control.

Hint

Fraud risk factors are present in most audits. Question: ENPL2-0028

Which of the following is correct concerning requirements about auditor communications about fraud?

Answers

A: All fraud that causes a material misstatement of the financial statements should be reported directly to the audit committee. B: Fraud that causes an immaterial misstatement of the financial statements need not be reported to the audit committee. C: Fraud with a material effect on the financial statements should be reported directly by the auditor to the Securities and Exchange Commission.

D: The auditor has no responsibility to disclose fraud outside the entity under any circumstances.

A. Answer A is correct because all fraud involving senior management and all other material fraud should be reported directly to the audit committee.

B. Answer B is incorrect because fraud resulting in an immaterial misstatement of the financial statements with which management is involved must be communicated to the audit committee.

C. Answer C is incorrect because auditors are only required to report fraud to the Securities and Exchange Commission under particular circumstances.

D. Answer D is incorrect because under certain circumstances auditors must disclose fraud outside the entity. AU 316 provides information on the CPA's responsibility relating to fraud.

Hint

What party do CPAs frequently report significant matters to? Question: ENPL2-0029

Which of the following is not required when considering fraud in a financial statement audit?

Answers

A: Conduct a continuing assessment of the risks of material misstatment due to fraud throughout the audit.

B: Conduct an audit team discussion of the risk of material misstatment due to fraud.

C: Conduct the audit with professional skepticism, which includes an attitude that assumes balances are incorrect until documented by the auditor.

D: Inquire of the audit committee as to their views about the risks of fraud and their knowledge of any fraud or suspected fraud.

A. Answer A is incorrect because an assessment of the risks of material misstatement of fraud is required by AU 316. B. Answer B is incorrect because such a staff discussion is required by AU 316.

C. Answer C is correct because professional skepticism is an attitude that includes a questioning mind and a critical assessment of audit evidence—it does not assume that balances are incorrect until documented by the auditor. AU 316 provides guidance on considering fraud during a financial statement audit. D. Answer D is incorrect because such inquiries of an audit committee are required by AU 316.

Hint

What are the major requirements of SAS 99? Question: ENPL2-0030

Which of the following need not be documented in relation to the auditor's consideration of fraud?

Answers

A: Nature of communications about fraud made to management. B: Procedures performed to obtain information to identify and assess risks of material misstatement due to fraud.

C: Specific risks of material misstatment due to fraud that were identified.

D: The assessed level of the risk of management override of controls.

A. Answer A is incorrect because AU 316 requires such communications.

B. Answer B is incorrect because AU 316 requires such communications.

C. Answer C is incorrect because AU 316 requires such communications.

D. Answer D is correct because while auditors must consider the risk of management override of controls, no such assessment need be made as part of an audit.

Hint

Think about an auditor's overall approach to considering fraud. Question: ENPL2-0031

Which of the following is most likely to be an overall response to fraud risks identified in an audit?

Answers

A: Supervise members of the audit team less closely and rely more upon judgment.

B: Increase consideration of management's selection and application of accounting principles.

C: Use only accountants with multiple years of experience on the engagement.

D: Increase emphasis on the audit of transactions in all areas of the audit.

A. Answer A is incorrect because closer supervision, not less close supervision, is more likely to be appropriate. B. Answer B is correct because AU 316 indicates that overall responses to the risk of material misstatement due to fraud include (1) assigning personnel with particular skills relating to the area and considering the necessary extent of supervision to the audit, (2) increasing the consideration of management’s selection and application of accounting principles, and (3) making audit procedures less predictable. C. Answer C is incorrect because no such requirement for experience of all staff members exists.

D. Answer D is incorrect because it is unlikely that increased emphasis on transactions in all areas of the audit will be necessary.

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Hint

Think about an approach that will make identifying misstatements more likely.

Individuals who commit fraud are ordinarily able to rationalize the act and have

Incentive Professional skepticism

A. Yes Yes B. Yes No C. No Yes D. No No Answers A: A. B: B. C: C. D: D. Answer Explanations

A. Answer A is incorrect because professional skepticism is not ordinarily necessary.

B. Answer B is correct because AU 316 suggests that the three conditions generally present when fraud occurs are that individuals have an (1) incentive or pressure, (2) opportunity, and (3) ability to rationalize.

C. Answer C is incorrect because an incentive is ordinarily necessary and professional skepticism is not. D. Answer D is incorrect because an incentive is ordinarily necessary.

Hint

Consider whether the options seem to relate to committing as opposed to detecting fraud.

An auditor gathers information necessary to identify risks of material misstatement due to fraud by

Inquiry of management

Considering fraud risk factors

A. Yes Yes B. Yes No C. No Yes D. No No Answers A: A. B: B. C: C. D: D. Answer Explanations

A. Answer A is correct because, when obtaining information needed to identify risks of material misstatement due to fraud, AU 316 requires inquiries of management, consideration of results of analytical procedures, consideration of fraud risk factors, and consideration of certain other information. In addition, a discussion among engagement personnel regarding the risks of material misstatement due to fraud is required.

B. Answer B is incorrect because it states that a consideration of fraud risk factors is unnecessary.

C. Answer C is incorrect because it states that inquiry of management is unnecessary.

D. Answer D is incorrect because it states that neither inquiry of management nor a consideration of fraud risk factors is necessary.

Hint

Think about various approaches to detecting fraud, none of which are perfect.

Professional skepticism, when exercised during the consideration of the risk of misstatement due to fraud Answers

A: Should only be exercised during the planning stage of the audit.

B: Is based on the notion that the client is dishonest. C: Is an attitude that includes a questioning mind. D: Ordinarily includes the use of an outside expert in most audits.

A. Answer A is incorrect because professional skepticism is exercised during all stages of the audit. B. Answer B is incorrect because the auditor does not assume that the client is either honest or dishonest.

C. Answer C is correct because AU 230 defines professional skepticism as an attitude that includes a questioning mind and a critical assessment of audit evidence. D. Answer D is incorrect because no outside expert is ordinarily consulted relating to the professional skepticism requirement.

Hint

Define professional skepticism. Question: ENPL2-0035

Which of the following is not a likely response when an auditor has determined that a misstatement is, or may be, the result of fraud, and has determined that the effect on the financial statements may be material?

Answers

A: Consider the implications for other aspects of the audit. B: Discuss the matter and approach to further investigation with an appropriate level of management.

C: Attempt to obtain additional evidential matter to determine whether material fraud has occurred or is likely to have occurred.

D: Suggest that the client contact a local law enforcement authority to report the possible fraud.

This answer is incorrect. Refer to the correct answer explanation. This answer is incorrect. Refer to the correct answer explanation. This answer is incorrect. Refer to the correct answer explanation. D. Answer D is correct because in most circumstances of fraud it is unlikely that a CPA would suggest to a client that a local law enforcement authority be contacted.

Hint

When considering material implications of fraud, whom is the auditor least likely to suggest the client contact?

In which of the following circumstances is it least likely that the auditor will have a responsibility to disclose a fraudulent act to parties other than the client's senior management and its audit committee?

Answers

A: In response to a successor auditor.

B: To comply with legal and regulatory requirements.

C: In response to question raised by an analyst who follows the stock of the company.

D: To a funding agency in accordance with requirement for audit of entities that receive governmental financial assistance. Answer Explanations

This answer is incorrect. Refer to the correct answer explanation. This answer is incorrect. Refer to the correct answer explanation. C. Answer C is correct because an auditor will not ordinarily disclose a fraudulent act in response to a question raised by an analyst.

This answer is incorrect. Refer to the correct answer explanation. Hint

An auditor is responsible to disclose information to successor auditors, legal and regulatory agencies, and funding agencies. Question: ENPL2-0037

Which of the following is a risk factor relating to the misappropriation of assets?

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A: Large amounts of cash on hand. B: High turnover of legal counsel.

C: Inability to generate positive cash flows from operations. D: Overly complex organizational structure involving numerous legal entities.

A. Answer A is correct because the existence of large amounts of cash on hand may lead to the misappropriation of assets.

Think in terms of assets on the balance sheet. Question: ENPL2-0038

Which of the following is not typically a characteristic of fraud? Answers A: Collusion. B: Concealment. C: Falsified documentation. D: Unintentional. Answer Explanations

This answer is incorrect. Refer to the correct answer explanation. This answer is incorrect. Refer to the correct answer explanation. This answer is incorrect. Refer to the correct answer explanation. D. Answer D is correct because fraud is intentional, not unintentional.

Hint

No tricks here.

Which of the following statements is correct concerning fraud risk factors that an auditor considers when performing a financial statement audit?

Answers

A: They can easily be ranked in order of importance. B: They must be considered individually, and not in combination, when conducting an audit.

C: They must be combined into models before they are effective in identifying the existence of fraud.

D: Their existence in an audit does not necessarily indicate the existence of fraud.

This answer is incorrect. Refer to the correct answer explanation. This answer is incorrect. Refer to the correct answer explanation. This answer is incorrect. Refer to the correct answer explanation.

D. Answer D is correct because AU 316 makes clear that while fraud risk factors do not necessarily indicate the existence of fraud, they often have been observed in circumstances where frauds have occurred.

Hint

Does a sample necessarily represent the population as a whole? Question: ENPL2-0040

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

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

B: Management's lack of interest in increasing the entity's stock trend.

C: Large amounts of liquid assets that are easily convertible into cash.

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

A. Answer A is correct because the inability to generate cash flows from operations while reporting earnings and growth is explicitly included as a risk factor in AU 316; such a situation causes one to question whether the earnings being reported are proper.

B. Answer B is incorrect because while many managements share an interest in increasing the entity’s stock trend (e.g., increase price), the lack of such an interest does not indicate particularly high risk of fraudulent financial reporting. C. Answer C is incorrect because large amounts of liquid assets are often relatively easily to audit, and not indicative of fraudulent financial reporting.

D. Answer D is incorrect because the granting of debt covenants is often necessary and appropriate when obtaining debt financing.

Hint

Which seems the most risky? Question: ENPL2-0041

When an auditor becomes aware of a possible client illegal act, the auditor should obtain an understanding of the nature of the act to

Answers

A: Increase the assessed level of control risk.

B: Recommend remedial actions to the audit committee. C: Evaluate the effect on the financial statements.

D: Determine the reliability of management’s representations. Answer Explanations

A. Answer A is incorrect. Discovery of an illegal act will not necessarily increase the assessed level of control risk. B. Answer B is incorrect. While the occurrence of illegal acts will be communicated to the audit committee, the auditor will not necessarily recommend remedial actions.

C. Answer C is correct. When an auditor becomes aware of information concerning a possible illegal act, he or she should obtain an understanding of the nature of the act, the circumstances in which it occurred, and sufficient other information to evaluate its effect on the financial statements. D. Answer D is incorrect. Obtaining an understanding of the nature of the act will not necessarily affect the reliability of management's representations.

Hint

Illegal acts are communicated to the audit committee after their effects are evaluated.

Which of the following is not a procedure performed primarily for the purpose of expressing an opinion on the financial statements, but may bring possible illegal acts to the auditor's attention?

Answers

A: Obtain an understanding of internal control.

B: Review of policies concerning effectiveness of management decision making policies.

C: Tests of transactions. D: Tests of balances. Answer Explanations

A. Answer A is incorrect because obtaining an understanding of internal control is performed to lead to the expression of an opinion on the financial statements. B. Answer B is correct because the review of effectiveness of decision making policies is not a procedure when expressing an opinion on the financial statements. External auditors are primarily concerned with internal controls that affect recording, processing, summarizing, and reporting financial data.

C. Answer C is incorrect because tests of transactions (substantive tests) are performed for the purpose of expressing an opinion on the financial statements.

D. Answer D is incorrect because tests of balances (substantive tests) are performed for the purpose of expressing an opinion on the financial statements.

Hint

An auditor must obtain an understanding of the internal control and perform substantive procedures.

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An auditor of a manufacturer would most likely question whether that client has committed illegal acts if the client has Answers

A: Been forced to discontinue operations in a foreign country. B: Been an annual donor to a local political candidate. C: Failed to correct material weaknesses in internal 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. Answer Explanations

A. Answer A is correct because being forced to discontinue operations in a foreign country is consistent with the existence of an illegal act, although other conditions may have forced such discontinuance.

B. Answer B is incorrect because such political contributions made by companies are generally not illegal. C. Answer C is incorrect because failure to correct a material weakness is not necessarily indicative of violation of a law (e.g., the Foreign Corrupt Practices Act).

D. Answer D is incorrect because disclosure of subsequent events, whether involving foreign operations or other information, is a normal acceptable disclosure which need not directly relate to illegal acts.

Hint

A forced dismissal from a country is often due to the company's conduct.

An auditor who finds that the client has committed an illegal act would be most likely to withdraw from the engagement when the

Answers

A: Illegal act affects the auditor’s ability to rely on management representations.

B: Illegal act has material financial statement implication. C: Illegal act has received widespread publicity.

D: Auditor can not reasonably estimate the effect of the illegal act on the financial statements.

A. Answer A is correct. The requirement is to determine the circumstances under which an auditor's discovery of an illegal act would be most likely to result in withdrawal from the engagement. The auditor must consider the effects of illegal acts on his/her ability to rely on management's representations and the possible effects of continuing his/her association with the client.

B. Answer B is incorrect because a material illegal act need not always result in resignation.

C. Answer C is incorrect because according to the professional standards (AU 328), publicity is not directly related to a decision to withdraw.

D. Answer D is incorrect because while an inability to estimate the effect of an illegal act may lead to report modification, it need not lead to withdrawal. Hint

The FS are the representations of management. The auditor does not want to be associated with a client that lacks integrity. Question: ENPL2-0045

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

Answers

A: Adequacy of the preplanned audit program.

B: Ability to establish consistency in application of accounting principles between years.

C: Apparent scope limitation. D: Integrity of management. Answer Explanations

A. Answer A is incorrect since such a program will not exist before the prospective client is accepted.

B. Answer B is incorrect because the availability of prior year financial statements and accounting records normally provides sufficient evidence concerning consistency. C. Answer C is incorrect since the potential successor has not yet accepted the prospective client.

D. Answer D is correct since obtaining evidence relative to the integrity of management is one of the objectives to be accomplished during such a review.

Hint

Why might management refuse the communication? Question: ENPL2-0046

When a CPA is approached to perform an audit for the first time, the CPA should make inquiries of the predecessor auditor. This is a necessary procedure because the predecessor may be able to provide the successor with information that will assist the successor in determining

Answers

A: Whether the predecessor’s work should be utilized. B: Whether the company follows the policy of rotating its auditors.

C: Whether in the predecessor’s opinion internal control of the company has been satisfactory.

D: Whether the engagement should be accepted. Answer Explanations

A. Answer A is incorrect because the auditor may review the predecessor auditor's work papers only to help isolate matters of continuing accounting significance.

B. Answer B is incorrect because the requirement that the successor auditor communicate with the predecessor auditor discourages the process of rotating auditors, especially due to client-auditor disagreements about accounting principles and audit procedures.

C. Answer C is incorrect because the predecessor's opinion of the client's internal control is not relevant to the successor auditor.

D. Answer D is correct because the successor auditor is required to communicate with the predecessor auditor to obtain information concerning the client to help determine whether the engagement should be accepted.

Hint

Think about the questions asked by a successor auditor. Question: ENPL2-0047

What is the responsibility of a successor auditor with respect to communicating with the predecessor auditor in connection with a prospective new audit client?

Answers

A: The successor auditor has no responsibility to contact the predecessor auditor.

B: The successor auditor should obtain permission from the prospective client to contact the predecessor auditor. C: The successor auditor should contact the predecessor regardless of whether the prospective client authorizes contact. D: The successor auditor need not contact the predecessor if the successor is aware of all available relevant facts.

A. Answer A is incorrect because the successor auditor must attempt to communicate with the predecessor auditor after permission from the prospective client is obtained.

B. Answer B is correct because permission must be obtained from the prospective client before contact with the predecessor is attempted. The successor auditor must attempt to communicate with the predecessor auditor after permission from the prospective client is received.

C. Answer C is incorrect because the successor auditor must receive permission from the prospective client before contact with the predecessor auditor is permitted.

D. Answer D is incorrect because the successor auditor must attempt to communicate with the predecessor auditor after permission from the prospective client is obtained.

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The successor auditor should attempt to communicate with the predecessor auditor.

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

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

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

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

D: Management has a reputation for consulting with several accounting firms about significant accounting issues. Answer Explanations

A. Answer A is incorrect because an auditor may be able to modify the timing of performance of audit procedures to when such details of recorded transactions are available. B. Answer B is incorrect because in many circumstances controls are subject to management override and an auditor may still be able to form an opinion on the financial statements. C. Answer C is correct because the objective of an audit of financial statements is the expression of an opinion on the financial statements; accordingly, when sufficient competent evidence is not available it is unlikely that an audit will be performed.

D. Answer D is incorrect because such “shopping for principles” will not necessarily lead to rejection of a potential audit engagement; see AU 625 for information on requirements for reporting on the application of accounting principles. Hint

What is the objective of an audit? Question: ENPL2-0049

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

A: Engage financial experts familiar with the nature of the business entity.

B: Obtain a knowledge of matters that relate to the nature of the entity’s business.

C: Refer a substantial portion of the audit to another CPA who will act as the principal auditor.

D: First inform management that an unqualified opinion cannot be issued.

A. Answer A is incorrect because audit expertise rather than financial expertise is required. Presumably, the auditor will

be able to obtain competence with respect to the industry of the business entity.

B. Answer B is correct because an auditor who accepts an engagement and does not possess sufficient industry expertise should attempt to obtain knowledge of the matters that relate to the nature of the entity's business organization and its operating characteristics.

C. Answer C is incorrect because there is no requirement to refer a substantial portion of the audit to another auditor. D. Answer D is incorrect because audit opinions are not qualified or disclaimed due to lack of capability of the auditor. If the auditor does not have the competence to undertake the engagement, the auditor should decline the engagement. Hint

Important to an effective audit is an understanding of the information being audited.

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

A: Obtaining a written representation letter from the client’s management.

B: Examining documents to detect illegal acts having a material effect on the financial statements.

C: Considering whether the client’s accounting estimates are reasonable in the circumstances.

D: Determining the extent of involvement of the client’s internal auditors.

A. Answer A is incorrect because auditors obtain a written representation letter near the conclusion of an audit. B. Answer B is incorrect because examination of documents related to illegal acts, if available at all, will occur subsequent to the planning of the audit.

C. Answer C is incorrect because considering the reasonableness of accounting estimates will also occur subsequent to the planning of the audit.

D. Answer D is correct because SAS 108, which lists various planning procedures, includes determining the extent of involvement of the client's internal auditors.

Hint

The auditor would use such information in designing the nature, extent, and timing of later testing.

The element of the audit planning process most likely to be agreed upon with the client before implementation of the audit strategy is the determination of the

Answers

A: Timing of inventory observation procedures to be performed. B: Evidence to be gathered to provide a sufficient basis for the auditor’s opinion.

C: Procedures to be undertaken to discover litigation, claims, and assessments.

D: Pending legal matters to be included in the inquiry of the client’s attorney.

A. Answer A is correct because the auditor will normally wish to observe the counting of inventory and there is therefore a need for coordination of timing between the auditor and the client.

B. Answer B is incorrect because the client will not determine the evidence to be gathered to provide a sufficient basis for the auditor's opinion.

C. Answer C is incorrect because procedures relating to discovery of litigation, claims, and assessments will be determined subsequent to implementation of the audit strategy. D. Answer D is incorrect because procedures relating to the discovery of pending legal matters will be determined subsequent to implementation of the audit strategy. Hint

An auditor must coordinate client assistance prior to the audit. Question: ENPL2-0052

Which of the following procedures is least likely to be performed as a part of obtaining an understanding during an audit engagement of a new audit client previously audited by another CPA?

Answers

A: Communication with the predecessor auditor. B: Performing analytical procedures.

C: Obtaining confirmation of cash balances. D: Considering internal control.

A. Answer A is incorrect. A successor auditor should attempt communication with the predecessor auditor while obtaining an understanding of the client.

B. Answer B is incorrect. Analytical procedures must be performed while obtaining an understanding of the client. C. Answer C is correct. Confirmation of cash balances is a

substantive audit procedure which will be performed during the audit.

D. Answer D is incorrect because a tentative audit program will be designed while obtaining an understanding of the client.

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Identify the least likely procedure to be performed very early during the audit.

If, during an audit, the successor auditor becomes aware of information that may indicate that financial statements reported on by the predecessor auditor may require revision, the successor auditor should

Answers

A: Ask the client to arrange a meeting among the three parties to discuss the information and attempt to resolve the matter. B: Notify the client and the predecessor auditor of the matter and ask them to attempt to resolve it.

C: Notify the predecessor auditor who may be required to revise the previously issued financial statements and auditor’s report. D: Ask the predecessor auditor to arrange a meeting with the client to discuss and resolve the matter.

A. Answer A is correct because the auditor should not contact the predecessor auditor directly due to the confidential relationship with the client.

B. Answer B is incorrect because the auditor should not contact the predecessor auditor without the client's permission. C. Answer C is incorrect because this communication should not occur without the client's permission.

D. Answer D is incorrect because the auditor should not communicate with the predecessor auditor without the client's permission.

Hint

A confidential relationship exists between a client and auditor. Question: ENPL2-0054

A predecessor auditor Answers

A: Must attempt communication with a successor auditor prior to accepting the engagement.

B: Must attempt communication with a successor auditor after the engagement has been accepted.

C: Must attempt communication with a successor auditor prior to acceptance of the engagement and may choose to attempt communication after the engagement has been accepted. D: Is not required to attempt communication with a successor since this is the successor’s responsibility.

A. Answer A is incorrect because the successor auditor must attempt communication with a predecessor prior to accepting the engagement.

B. Answer B is incorrect because no communication is required after the engagement has been accepted.

C. Answer C is incorrect because no communication is required after the engagement has been accepted.

D. Answer D is correct because the successor auditor must attempt communication with the predecessor auditor either prior to accepting the engagement, or after the engagement has been accepted, or both. It is the successor's responsibility, not the predecessor auditor's responsibility.

Hint

Determine who must attempt communication between the predecessor and successor auditors.

The audit work performed by each assistant should be reviewed to determine whether it was adequately performed and to evaluate whether the

Answers

A: Audit has been performed by persons having adequate technical training and proficiency as auditors.

B: Auditor’s system of quality control has been maintained at a high level.

C: Results are consistent with the conclusions to be presented in the auditor’s report.

D: Audit procedures performed are approved in the professional standards.

A. Answer A is incorrect because while determining that the audit has been performed by persons having adequate technical training and proficiency as auditors is important, this is accomplished by numerous procedures in addition to reviewing audit work.

B. Answer B is incorrect because CPA firms, not individual auditors within the firms, have systems of quality control.

C. Answer C is correct because AU 311 suggests that the work performed by each assistant should be reviewed to determine whether it was adequately performed and to evaluate whether the results are consistent with the conclusions to be presented in the auditor's report.

D. Answer D is incorrect because the professional standards do not in general approve certain audit procedures. Hint

Differences of opinion among audit personnel must be resolved prior to the issuance of an opinion.

With respect to planning of a year-end audit, which of the following statements is always true?

Answers

A: An engagement should not be accepted after the fiscal year-end.

B: An inventory count must be observed at the balance sheet date.

C: The client’s audit committee should not be told of the specific audit procedures which will be performed.

D: It is an acceptable practice to carry out substantial parts of the examination at interim dates.

A. Answer A is incorrect because an audit may be accepted after the fiscal year-end. However, the auditor should ascertain whether circumstances are likely to permit an adequate audit and expression of an unqualified opinion.

B. Answer B is incorrect because the inventory count need not be observed if it is impracticable; however, the auditor must bear in mind that s/he has the burden of justifying the use of alternate procedures. It is also incorrect because the auditor's observation procedures may be performed either during or after the end of the period under audit in cases of well-kept perpetual inventory records.

C. Answer C is incorrect because in certain

circumstances the audit committee may be told of specific audit procedures.

D. Answer D is correct because it is an acceptable practice for the auditor to carry out substantial parts of the examination at interim dates.

Hint

To lessen an auditor's seasonal workload, procedures may be performed before the balance sheet date.

Which of the following is least likely to be included in the auditor’s risk assessment process to identify and assess the risks of material misstatement?

Answers A: Identify risks.

B: Relate risks to what can go wrong at the relevant assertion level.

C: Consider whether risks are of a magnitude that could result in a misstatement that could be material.

D: Consider the likelihood that risks could result in misstatements of an amount which is less than material. Answer Explanations

A. Answer A is incorrect. The risk assessment includes identification of risks.

B. Answer B is incorrect. An auditor should relate risks to what can go wrong at the relevant assertion level.