Final Exam Review- Acc 5370

Short Answer: A standard, unqualified auditor's report for a public company contains three sections. Provide a brief (one or two sentences) description for each section.

1. Opinion (Opinion on the Financial Statements)
This section states the auditor’s conclusion that the financial statements are presented fairly, in all material respects, in accordance with the applicable financial reporting framework (e.g., GAAP).

2. Basis for Opinion
This section explains the foundation for the auditor’s opinion, including that the audit was conducted in accordance with auditing standards and that sufficient, appropriate evidence was obtained.

3. Responsibilities (Management’s and Auditor’s Responsibilities)
This section outlines management’s responsibility for preparing the financial statements and maintaining internal controls, as well as the auditor’s responsibility to obtain reasonable assurance and issue an opinion.

Evidence is reliable if it:

signals the true state of a management assertion.

True or False: Information asymmetry seldom occurs.

False

Testing all transactions that occurred during the period is cost prohibitive.

True

When obtaining an understanding of the entity and its environment, the auditor should obtain an understanding of internal controls primarily to:

identify areas of relatively high risk of misstatement and plan the audit accordingly.

The basic definition of auditing states it is a process to:

objectively obtain and evaluate evidence regarding assertions.

Which of the following statements best describes a relationship between sample size and other elements of auditing?

If materiality decreases, sample size will need to increase.

Which of the following is not a benefit of emerging audit technologies?

Remove the challenge of junior auditor work and make that work less interesting.

Short Answer: Sally Thompson's company, Sally's Shoes, is a successful shoe retail business with one store. Sally would like to expand to two locations, but the bank has asked for an independent audit before it will provide financing. Sally hires her brother-in-law, George Thompson, to perform the audit. George has experience in auditing non-profit organizations and he decides to perform the audit the same way as his other audits. After completing all the steps of the audit process, George issues an unqualified opinion indicating that he is certain that the company's financial statements contain no misstatements. Comment on any potential problems with George's audit of Sally's Shoes.

First, independence is impaired because George is Sally’s brother-in-law. Auditors must be independent both in fact and appearance, and a close family relationship creates a clear conflict of interest.

Second, George may lack appropriate industry expertise, since auditing a retail business is different from auditing non-profit organizations. This could affect the quality of the audit.

Third, his statement that he is “certain” there are no misstatements is inappropriate. Auditors provide reasonable assurance, not absolute certainty.

Overall, due to the lack of independence, potential lack of competence, and improper wording of the opinion, the audit would not be considered reliable.

Short Answer: Why must an auditor assess materiality?

An auditor must assess materiality to determine the significance of potential misstatements and to focus the audit on areas that could influence users’ decisions. It helps guide the nature, timing, and extent of audit procedures and ensures that sufficient appropriate evidence is obtained.

Short Answer: You are a new employee at the accounting firm Murray & Murray, CPAs. Before you are assigned to your first audit, your supervisor tests your knowledge and asks you to explain the term "scope" in the context of a financial statement audit.

 

Required:

A. Provide a definition of scope.

B. Describe what influences an auditor's determination of scope.

A. Definition of scope:
Scope refers to the nature, timing, and extent of the audit procedures that the auditor performs to obtain sufficient appropriate evidence.

B. What influences scope:
The auditor’s determination of scope is influenced by factors such as the assessed risk of material misstatement, materiality levels, the effectiveness of internal controls, and the size and complexity of the client’s operations.

An auditor would issue an adverse opinion if:

the statements taken as a whole do not fairly present the financial condition and results of operations of the company.

Auditing is defined as a "systematic process of objectively obtaining and evaluating evidence regarding assertions..." What is meant by "systematic process"?

There should be a well-planned approach for obtaining and evaluating evidence.

Short Answer: The textbook presented the concept of auditing through an analogy that involved buying a house and hiring a house inspector.

Name three desirable qualities of a house inspector or an auditor and discuss how those qualities apply to an auditor and why those qualities are important for an auditor to possess.

Independence means the auditor is unbiased and not influenced by the client, which is important because users of financial statements rely on the auditor’s opinion to be objective and trustworthy.
Competence refers to having the necessary knowledge and skills to perform the audit properly, ensuring that the auditor can identify issues and apply appropriate procedures.
Professional skepticism means maintaining a questioning mindset and not simply accepting information at face value, which helps the auditor detect errors or potential fraud.

Which of the following best describes the concept of audit risk?

The risk that the auditor will provide a "clean" opinion on financial statements that are, in fact, materially misstated.

Discuss an overview of the financial statement audit process using the terms "assertion," "evidence," and "report."

In a financial statement audit, management first makes assertions about the company’s financial information (such as that balances are accurate, complete, and properly valued). The auditor then gathers and evaluates evidence to test whether those assertions are reasonable and free of material misstatement. Based on this evidence, the auditor issues a report expressing an opinion on whether the financial statements are fairly presented.

True or False: Auditing focuses on rules, techniques, and computations required to prepare and analyze financial information.

False

Which of the following is true with respect to the auditor's report?

The report indicates that the company's financial statements were audited in accordance with applicable auditing standards.

Which of the following would best be described as an assurance service?

Offering an opinion concerning the accuracy of statements made on an entity's website relating to its online privacy policies.

True or False: Decision makers demand reliable information that is provided by accountants.

True

Short Answer: Define "information asymmetry" and discuss it in the context of the financial markets. Include in your discussion how information asymmetry is reduced.

Information asymmetry occurs when one party (typically management) has more or better information about a company than other parties (such as investors or creditors). In financial markets, this creates risk because decision makers may rely on incomplete or biased information when making investment or lending decisions.

Information asymmetry is reduced through financial reporting, regulations, and independent audits. Auditors help by examining financial statements and providing assurance that they are fairly presented, which increases the reliability and credibility of the information available to external users.

The auditor's report is generally addressed to the:

stockholders of the company.

True or False: Conflicts of interest often occur between absentee owners and managers.

False

Assurance services may improve all of the following except:

periodicity.

Before accepting an engagement to audit a new entity, an auditor is required to:

make inquiries of the predecessor auditor.

Short Answer: Explain the relationship between audit, attest and assurance services.

Assurance services are the broadest category—they include any service that improves the quality or reliability of information for decision-makers.

Within assurance services are attest services, where a CPA issues a report on the reliability of a specific subject matter (like financial statements or internal controls).

Auditing is a specific type of attest service—it involves examining a company’s financial statements and providing an opinion on whether they are fairly presented in accordance with accounting standards.

Which of the following statements is not true with respect to assurance, attest, and audit services?

These services are applied only to financial statements and financial statement accounts.

Which of the following best describes the fundamental, underlying reason for why there is demand for an independent auditor to report on financial statements?

Different interests may exist between the company preparing the statements and the parties using the statements.

An investor is reading the financial statements of the Stankey Corporation and observes that the statements are accompanied by an auditor's unqualified report. From this, the investor may conclude that:

any disputes over significant accounting issues have been settled to the auditor's satisfaction.

True or False: Auditing is a type of attest service.

True

Which of the following statements about the study of auditing is NOT true?

The study of auditing focuses on learning the rules, techniques, and computations required to analyze financial statements.

Which of the following best describes why an independent auditor is asked to express an opinion on the fair presentation of financial statements?

The opinion of an independent party is needed because a company is not likely to be considered objective with respect to its own financial statements.

Which of the following is not a concept that is included in the scope paragraph of the auditor's report?

The conformance of the financial statements with generally accepted accounting principles.

Which of the following best describes why publicly-traded corporations follow the practice of having the external auditor appointed by the board of directors or elected by the stockholders?

To enhance auditor independence from the management of the corporation.

During the first phase of an audit, a CPA most likely would:

evaluate the integrity of management.

For publicly-held companies, which of the following is integrated into the audit of financial statements?

The audit of internal controls.

Why do auditors generally use a sampling approach to evidence gathering?

Auditors must balance the cost of the audit with the need for precision.

Which one of the following statements best describes the concept of materiality?

Materiality is largely a matter of professional judgment.

Preliminary engagement activities include:

performing background checks on top management.

True or False: Auditing services and attestation services are the same.

False

Short Answer: The cost of capital can be generally defined as the rate of return expected by anyone who provides capital to a company (e.g. an investor or a bank). How can a financial statement audit reduce the cost of capital for a company?

A financial statement audit can reduce a company’s cost of capital by increasing the credibility and reliability of its financial information. When investors and lenders trust that the financial statements are fairly presented, they perceive less risk associated with the company. As a result, they are willing to accept a lower required rate of return, which lowers the company’s cost of capital.

An auditor who accepts an audit engagement and does not possess expertise with respect to the business entity's industry, should:

obtain a knowledge of matters that relate to the nature of the entity's business.

Which of the following is not included in the broad category of assurance services?

Accounting or review services.

True or False: A financial statement audit must be conducted based on GAAP.

False

True or False: One of the five basic business processes is the warehousing cycle.

False

The Responsibilities section of Principles Underlying an Audit Conducted in Accordance with GAAS recognizes that regardless of how capable an individual may be in other fields, the individual cannot meet the requirements of the auditing standards without the proper:

education and experience in auditing.

Which of the following best describes the concept of risk assessment on which auditors can provide independent assurance?

Whether management has systems in place to evaluate and effectively manage the entity's business risks.

Which of the following best describes the role of corporate governance?

Holding the management team accountable to shareholders and other constituents for the utilization of the entity's resources.

Short Answer: What are the four things required of an auditor to obtain reasonable assurance that are outlined in the Performance section of the Principles Underlying an Audit Conducted in Accordance with GAAS?

• 
  Plan and properly supervise the audit.

• Determine and apply appropriate materiality levels.

• Identify and assess risks of material misstatement due to error or fraud.

• Obtain sufficient appropriate audit evidence to support the audit opinion.

True or False: The audit committee generally includes senior executives of the organization.

False

The Responsibilities section of the Principles Underlying an Audit Conducted in Accordance with GAAS is concerned with:

complying with ethical requirement, appropriate competence and maintaining professional skepticisim.

Which of the following statements regarding the PCAOB is incorrect?

It has delegated all of its standard-setting authority to the AICPA.

External auditors are referred to as "external" because:

they are not employees of the entity being audited.

You are the owner of a small grocery store, Corner Marketplace. Explain the five process categories and how they apply to your business.

• Financing Cycle – This involves obtaining and managing funds to operate the business, such as taking out loans, repaying debt, or managing owner investments and withdrawals.

• Human Resources/Payroll Cycle – This includes hiring employees (cashiers, stockers), tracking hours worked, and paying wages. It also involves managing employee benefits and scheduling.

• Inventory Management: A grocery store would have significant inventory to manage, which it accomplishes as part of the inventory management process. The store would need to allocate proper costs to inventory and would need to account for produce, etc. that is expired.ling.

• Revenue Cycle – This involves selling groceries to customers and collecting cash or card payments. It includes scanning items, processing transactions, and recording daily sales.

Governmental auditing often extends beyond examinations leading to the expression of an opinion on the fairness of financial presentation and includes audits of efficiency, effectiveness, and:

compliance.

The 'Purpose of an Audit and Premise upon which an Audit is Conducted’ section of Principles Underlying an Audit Conducted in Accordance with GAAS states that management is responsible for all the following except for:

providing financial statement users with an opinion on whether the financial statements present fairly.

The Performance section of Principles Underlying an Audit Conducted in Accordance with GAAS states that for auditors to obtain reasonable assurance, they need to do all of the following except for:

make sure all audit team members have adequate training.

Due professional care requires auditors to:

exercise professional skepticism during the audit.

True or False: A series of business and related auditing failures led to the passage of the Sarbanes-Oxley Act (2002)

True

Short Answer: There are several types of audit services that are provided by auditors. Identify and define three of these types of audits.

• Financial Statement Audit: Auditors test the transactions, balances, and disclosures in a set of financial statements to determine if they are materially correct.

• Forensic Audit: Auditors conduct forensic audits to detect or deter fraudulent activities.

• Compliance Audit: Auditors test the extent to which rules, policies, laws, covenants, or government regulations are followed by the entity.

The accuracy of information included in footnotes accompanying the audited financial statements issued by a company whose shares are traded on a stock exchange is the primary responsibility of:

the company's management.

The objectives of the Reporting section of Principles Underlying an Audit Conducted in Accordance with GAAS are to provide assurance and include all of the following except for:

an opinion statement of whether the financial statements between periods are not materially affected by changes in accounting principles that are not disclosed.

The Reporting section of Principles Underlying an Audit Conducted in Accordance with GAAS requires the auditor's report to contain either an expression of opinion regarding the financial statements taken as a whole or an assertion to the effect that an opinion cannot be expressed. The objective of this requirement is to prevent:

misinterpretations regarding the degree of responsibility the auditor is assuming.

What organization is responsible for setting auditing standards for audits of publicly-traded companies in the U.S.?

PCAOB.

The auditor must be independent of the auditee unless:

none of the above—the auditor cannot lack independence.

An "in-charge" auditor typically holds the rank of:

senior.

The Public Company Accounting Oversight Board's role is to:

oversee the auditors of public companies in order to protect the interests of investors.

Which principle of the Principles Underlying an Audit Conducted in Accordance with GAAS describes where auditors are required to plan the work and properly supervise any assistants?

Performance.

What is the general character of the work conducted in performing a forensic audit for a company?

Detecting or deterring fraudulent activity.

True or False: A financial statement audit is generally organized based on the five basic business processes or cycles.

True

True or False: Generally, the financial statements of U.S. companies must be prepared based on GAAP.

True

Forensic audits include all of the following except:

manufacturers' assertions about product quality.

Short Answer: Define corporate governance, the board of directors, and the audit committee and explain how they relate to each other.

• Corporate governance is the system of rules, processes, and structures used to direct and control a company, ensuring accountability, transparency, and protection of shareholders’ interests.

• The board of directors is a group elected by shareholders to oversee management, set strategic direction, and ensure the company is being run in the best interest of stakeholders.

• The audit committee is a subcommittee of the board of directors responsible for overseeing financial reporting, internal controls, and the audit process, including working with external auditors.

Which of the following best describes the general character of the three principles that are listed in the Performance section of the Principles Underlying an Audit Conducted in Accordance with GAAS?

Auditors’ responsibilities in performing an effective audit.

A CPA is most likely to refer to one or more of the items listed in the Responsibilities section of the Principles Underlying an Audit Conducted in Accordance with GAAS in determining:

whether the CPA should undertake an audit engagement.

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

management of the company.

A typical objective of an operational audit is for the auditor to:

make recommendations for improving performance.

True or False: PCAOB auditing standards must be followed on all audits of public companies' financial statements.

True

Which of the following is not explicitly a part of the IIA's definition of internal auditing?

Internal auditors should help external auditors complete the annual financial statement audit.

The Performance section of the "Principles Underlying an Audit" is concerned with:

proper planning and supervision, appropriate materiality levels, and sufficient appropriate audit evidence.

The Reporting section of the "Principles Underlying an Audit" is concerned with:

the auditor expressing an audit opinion in accordance with the auditor’s findings, whether the financials are presented fairly, and whether the financial are in accordance with the applicable financial reporting framework.

Short Answer: With respect to an entity's financial statements, describe both the responsibility of management and that of the auditor.

• Management is responsible to ensure that the financial statements fairly present the entity's financial conditions and operations. Management is responsible for establishing and maintaining internal control.

• The auditor's responsibility is to express an opinion on the financial statements based on the audit. The auditor is responsible to provide reasonable assurance with respect to errors, fraud, and illegal acts.

An internal auditor is likely to be more concerned with __________ than the external auditor.

the efficiency of operations

Which of the following factors most likely would cause a CPA to decide not to accept a new audit engagement?

Management's disregard of its responsibility to maintain an adequate control environment.

Which of the following relatively small misstatements most likely would have a material effect on an entity's financial statements?

An illegal payment to a foreign official that was not recorded.

True or False: The audit committee is directly responsible for the appointment, compensation, and oversight of the work of any accounting firm employed by a public company.

True

A written understanding between the auditor and the client concerning the auditor's responsibility for the discovery of illegal acts is usually set forth in a(n):

engagement letter.

During the initial planning phase of an audit, a CPA most likely would:

discuss the timing of the audit procedures with the client's management.

Short Answer: BDK Accounting is auditing a new client, A La Carte Catering. BDK could save audit time by using work from A La Carte's internal audit staff. The staff consists of three accountants with public accounting experience and certification. A La Carte requires every member of its accounting department to spend two out of every five years on the internal audit staff. Then, the employee is rotated back into the accounting department for a couple of years. What factors should BDK consider when determining whether or not it can use work of the internal audit staff? In this case, what should BDK decide?

BDK should consider the internal auditors’ objectivity, competence, and work quality.

Although they are competent, their objectivity is impaired because employees rotate between accounting and internal audit, creating a self-review threat.

Therefore, BDK should not rely on their work and should perform its own audit procedures.

An independent auditor might consider the procedures performed by the internal audit function because:

they are employees whose work might be relied upon.

Which of the following is not a qualitative factor that may affect an auditor's establishment of materiality?

Firm policy sets materiality at 4% of pretax income.

True or False: Materiality significantly impacts the auditor's decisions about how much and what kind of evidence to gather.

True

True or False: All companies must have an audit committee.

False

An auditor obtains knowledge about a new client's business and its industry in order to:

understand the events and transactions that may have an effect on the client's financial statements.

Which of the following is the most important qualitative factor that auditors should consider when making materiality judgments?

The misstatement will cause the client to fail to meet an earnings forecast.

Evaluating a prospective client requires which of the following steps?

Communicate with the predecessor auditor.

True or False: When the prospective client has previously been audited, auditing standards require that the successor auditor make certain inquiries of the predecessor auditor before accepting the engagement.

True

Short Answer: Often in an audit, total combined tolerable misstatement is greater than overall materiality. Why is this the case?

Total tolerable misstatement across accounts can exceed overall materiality because it is unlikely that all accounts will be misstated by their full tolerable amounts at the same time. This approach provides a safety margin while still keeping the overall risk of material misstatement within acceptable limits.

Short Answer: Name and describe three supervisory activities that should be performed by the engagement partner and other engagement team members performing supervisory activities.

• Review of work performed – Supervisors review audit workpapers to ensure procedures were properly performed and conclusions are supported by sufficient evidence.

• Providing guidance and direction – They instruct team members on audit objectives, procedures, and address any issues or questions during the audit.

• Resolving significant issues – Supervisors evaluate and resolve accounting or auditing issues, including disagreements and unusual findings, ensuring appropriate conclusions are reached.

In the context of an audit of financial statements, substantive procedures are audit procedures that:

may be either tests of details of transactions, tests of details of account balances, or analytical procedures.