169a auditing chapters 1-4

An independent audit adds value to the communication of financial information because the audit

lends credibility to the financial statements.

Which of the following best describes the reason why an independent auditor is often retained to report on financial statements?

Different interests may exist between the entity preparing the statements and the persons using the statements, and thus outside assurance is needed to enhance the credibility of the statements

Which of the following best describes relationships among auditing, attest, and assurance services?

Auditing is a type of assurance service

Which of the following statements relating to attest and assurance services is not correct?

Financial statement auditing is a form of attest service but it is not an assurance service.

For what primary purpose does the auditor obtain an understanding of the entity and its environment?

to plan the audit and determine the nature, timing, and extent of audit procedures to be performed

Which of the following statements best describes how materiality is related to audit evidence in a financial statement audit?

The lower the level at which the auditor assesses materiality, the greater the amount of evidence the auditor must gather.

Which of the following is the most important reason for an auditor to gain an understanding of an audit client’s system of internal control over financial reporting?

Understanding a client’s system of internal control can help the auditor assess risk and identify areas where financial statement misstatements might be more likely.

Preliminary engagement activities include

all options including: determining audit engagement team requirements, understanding the client and the client’s industry, ensuring the independence of the audit team and audit firm.

Which of the following statements best describes what is meant by an unqualified audit opinion?

An unqualified auditor's opinion indicates that in the auditor’s opinion the client’s financial statements are fairly presented in accordance with agreed-upon criteria, with no need for the inclusion of qualifying phrases.

The auditing standards that are used to guide the conduct of the audit are

explicitly referred to in the basis for opinion section of the auditor’s standard report.

You were recently hired by the CPA firm Honson & Hansen. Before you start working, the firm requires that you participate in the first-year staff training course. The instructor asks you to prepare answers for the following questions:

Required:

1. Which of the following provides the best definition of audit evidence?

The underlying accounting data and any additional information available to the auditor, whether originating from the client or externally.

You were recently hired by the CPA firm Honson & Hansen. Before you start working, the firm requires that you participate in the first-year staff training course. The instructor asks you to prepare answers for the following questions: b. Which of the following best describes the relationship between evidence and the management assertions?

Audit evidence helps the auditor determine whether management's assertions are being met

You were recently hired by the CPA firm Honson & Hansen. Before you start working, the firm requires that you participate in the first-year staff training course. The instructor asks you to prepare answers for the following questions: What are the two key characteristics of audit evidence that an auditor must consider when evaluating it?

relevance and reliability

The basic definition of auditing essentially indicates that, overall, auditing is a process to:

objectively obtain and evaluate evidence regarding assertions made by another party.

Assurance services may improve all of the following except:

periodicity

Evidence is reliable if it:

signals the true state of a management assertion.

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

The risk that the auditor will provide an inappropriate opinion on financial statements that are, in fact, materially misstated.

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

obtain a knowledge of matters that relate to the nature of the entity’s business and the industry in which it operates.

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

the audit of internal controls

During the client acceptance/continuance phase of an audit, a CPA most likely would:

evaluate the integrity of management.

In the context of agency theory, information asymmetry refers to the idea that:

management has more information about the entity’s true financial results and position than do the absentee owners (i.e. stockholders).

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

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

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.

Auditing can be defined as a “systematic process of objectively obtaining and evaluating evidence regarding assertions...” What is meant by “systematic process” in this definition?

There should be a well-planned approach for obtaining and evaluating evidence that is relevant and reliable for each particular audit engagement.

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

Materiality is largely a matter of professional judgment and reflects both quantitative and qualitative considerations.

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

make inquiries of the predecessor auditor.

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

any disputes over whether Peres’ financial statements are fairly stated in accordance with GAAP have been settled to the auditor's satisfaction.

During the client acceptance/continuance phase, preliminary engagement activities include:

performing background checks on top management.

The auditor's report is generally addressed to the:

stockholders of the company

An auditor would issue an adverse opinion if:

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

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

If materiality decreases, sample sizes will need to increase.

Which of the following is not a part of the role of internal auditors?

providing reports on the reliability of financial statements to investors and creditors

Operational auditing is oriented primarily towards:

efficiency and future improvements to accomplish the goals of management.

Which of the following would be considered a nonattest assurance service engagement?

1. expressing an opinion about the reliability of an entity’s financial statements

2. reporting that a company’s sustainability metrics are complete and accurate

neither I nor II

Which of the following statements best describes management’s and the external auditor’s respective levels of responsibility for a public company’s financial statements?

Management has the primary responsibility to ensure that the company’s financial statements are prepared in accordance with GAAP, and the auditor provides reasonable assurance that the statements are free of material misstatement.

Which of the following best describes the relationship between business objectives, strategies, processes, controls, and transactions?

To achieve its objectives, a business formulates strategies and implements processes, which are carried out through business transactions. The entity’s information and internal control systems must be designed to ensure that the transactions are properly executed, captured, and processed.

The Public Company Accounting Oversight Board:

is a quasi-governmental organization that has legal authority to set auditing standards for audits of public companies.

Which of the following is correct regarding the types of audits over which the ASB and the PCAOB, respectively, have standard-setting authority in the United States?

	ASB	PCAOB
a.	Public company audits	Public company audits
b.	Nonpublic company audits	Public company audits
c.	Nonpublic company audits	Nonpublic company audits
d.	Public company audits	Nonpublic company audits

option B

The Audit Committee consists of:

members of the board of directors

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

PCAOB

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

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

The authoritative body empowered to promulgate standards concerning a CPA’s association with audited financial statements of an entity that is required to file financial statements with the SEC is the:

Public Company Accounting Oversight Board.

The auditor must be independent of the auditee unless:

none of the above—the auditor cannot lack independence.

The Reporting section of the Principles Underlying an Audit Conducted in Accordance with GAAS requires that the report, “states whether the financial statements are presented fairly, in all material respects, in accordance with the applicable financial reporting framework.” This passage requires:

an opinion by the auditor.

Because of the risk of material misstatement, an audit of financial statements in accordance with generally accepted auditing standards should be planned and performed with an attitude of:

professional skepticism

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

management of the company

Typically, an external auditor first gets supervisory experience at what level of authority?

senior

An “in-charge” auditor typically holds the rank of:

senior

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

make recommendations for improving performance.

External auditors are referred to as “external” because:

they are not employees of the entity being audited.

Which is not an attribute of an external auditor?

auditee advocacy

Which of the following is NOT a requirement of the Sarbanes-Oxley Act?

A certain number of hours, which is based on the size of the company being audited, must be spent on each audit engagement.

Who bears ultimate responsibility for the financial statements?

management of the organization

Due professional care requires auditors to:

exercise professional skepticism during the audit.

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

compilation and bookkeeping services

Which of the following statements regarding the PCAOB is incorrect?

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

Due professional care requires:

auditors to maintain an attitude that includes a questioning mind and a critical assessment of audit evidence.

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

Management is accountable to shareholders and other constituents for the utilization of the entity’s resources.

The existence of audit risk is recognized by the statement in the auditor’s standard report that the auditor:

obtains reasonable assurance about whether the financial statements are free of material misstatement.

Risk of material misstatement refers to a combination of which two components of the audit risk model?

inherent risk and control risk

As lower acceptable levels of both audit risk and materiality are established, the auditor should plan more work on individual accounts to:

find smaller errors

Which of the following characteristics most likely would heighten an auditor’s concern about the risk of intentional manipulation of financial statements?

Management places substantial emphasis on meeting earnings projections.

Which of the following is a misappropriation of assets?

An employee of a consumer electronics store steals 12 CD players.

Auditing standards require auditors to make certain inquiries of management regarding fraud. Which of the following inquiries is required?

whether management has any knowledge of fraud that has been perpetrated on or within the entity

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

Company management falsifies the inventory count, thereby overstating ending inventory and understating cost of sales.

When is a duty to disclose fraud to parties other than the entity’s senior management and its audit committee most likely to exist?

in response to inquiries from a successor auditor

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

Fraud that involves senior management should be reported directly by the auditor to the audit committee regardless of the amount involved.

engagement risk is

the auditor's risk of loss from events arising in connection with financial statements audited and reported upon.

When assessing the risk of material misstatement, auditors evaluate the reasonableness of an entity's accounting estimates. An auditor normally would be concerned about assumptions that are:

susceptible to bias

Which of the following characteristics most likely would heighten an auditor's concern about the risk of intentional manipulation of financial statements?

Management places substantial emphasis on meeting earnings projections.

Which of the following is a factual misstatement?

a fixed asset being recorded at the incorrect cost

The achieved (actual) level of audit risk:

can never be known with certainty.

The risk that an auditor will conclude, based on substantive procedures, that a material error does not exist in an account balance when, in fact, such an error does exist is referred to as:

detection risk

The risk of material misstatement differs from detection risk in that it:

exists independently of the actions of the auditor.

All of the following are inherent risk factors that are pervasive to the financial statements except:

supplies inventory is difficult to count.

When an auditor increases the assessed level of risk of material misstatement because certain control procedures were determined to be ineffective, the auditor would most likely increase the:

extent of substantive tests

On the basis of audit evidence gathered and evaluated, an auditor decides to increase the assessed level of risk of material misstatement from that originally planned. To achieve an overall audit risk level that is substantially the same as the planned audit risk level, the auditor would:

decrease detection risk

The risk of material misstatement includes which of the following?

inherent risk

An auditor learns that a client's employee in control of inventory gets divorced and is responsible for paying a large amount of child support. All of the following for the audit of inventory likely are true except:

detection risk increases

Which of the following audit risk components may be assessed in qualitative terms?

both risk of material misstatement and detection risk

Which of the following procedures would not be used to obtain an understanding of the entity and its environment?

verify proper valuation of inventory subject to technological obsolescence

Which of the following is not an important consideration in an auditor's evaluation of an entity's business risk?

Audit standards require the auditor to evaluate the entity's business risk in order to provide suggestions to improve the entity's profitability.

Which of the following is a source of detection risk?

a non-representative sample

Which of the following circumstances most likely would cause an auditor to believe that material misstatements may exist in an entity's financial statements?

Accounts receivable confirmation requests yield significantly fewer responses than expected.

The primary responsibility for preventing fraud in an organization lies with:

the organization's management.

Which of the following is not a misstatement of the financial statements?

The entity uses different inventory accounting methods for internal and external reporting.

short answer: 3-11: Why is it important for CPA firms to develop policies and procedures for establishing materiality?

Professional standards provide very little specific guidance on how to assess what is material to a reasonable user. As a result, auditing firms should develop policies and procedures to assist their auditors in establishing materiality judgments for clients in order to minimize the variability of such judgments by firm personnel. In other words, firms would prefer to have their auditors establish similar materiality judgments for clients with similar circumstances.

short answer question 4-23: The auditor should consider audit risk when planning and performing an audit of financial statements. Audit risk should also be considered in determining the nature, timing and extent of auditing procedures and in evaluating the results of those procedures. 

Required:

1. A. Define audit risk.

2. B. Describe the components of audit risk. (inherent risk, control risk and detection risk)

3. C. Explain how these components are interrelated.

a.

Audit risk is the risk that the auditor expresses an inappropriate audit opinion when the financial statements are materially misstated.

b.

Inherent risk is the susceptibility of an assertion in an account or disclosure to a misstatement due to error or fraud that could be material, either individually or when aggregated with other misstatements, before consideration of any related controls. Control risk is the risk that a misstatement that could occur in an assertion about an account or disclosure and that could be material, either individually or when aggregated with other misstatements, will not be prevented, or detected and corrected, on a timely basis by the entity’s internal control. Detection risk is the risk that the procedures performed by the auditor will not detect a misstatement that could be material, either individually or when aggregated with other misstatements.

c.

Inherent risk and control risk differ from detection risk in that they exist independently of the audit of financial statements, whereas detection risk relates to the auditor's procedures and can be changed at the auditor's discretion. Detection risk has an inverse relationship to inherent and control risk.

short answer question: Compare and contrast management’s responsibility for the entity’s financial statements with the auditor’s responsibilities for detecting errors and fraud in the financial statements.

4. Management is responsible to prepare financial statements that fairly present the company’s financial condition and operations in accordance with established accounting standards. Note that the auditor’s opinion explicitly states that the financial statements are the responsibility of management. 

The auditor is responsible to issue an opinion in regard to the financial statements prepared by management. In order to issue this opinion, the auditor must plan and perform the audit in accordance with established standards to obtain reasonable assurance that the financial statements are free of material misstatement, whether caused by error or fraud. However, it is important to note that an auditor’s unqualified opinion does not mean that errors or fraud do not exist but rather that there is reasonable assurance that they do not exist in material amounts.