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In planning an engagement, the internal auditor should establish objectives and procedures to address the risk associated with the activity. Risk is defined as
a. The possibility that the balance or class of transactions and related assertions contains misstatements that could be material to the financial statements
b. The uncertainty of the occurrence of an event that could affect the achievement of objectives
c. The failure to adhere to organizational policies, plans and procedures or to comply with relevant laws and regulations
d. The failure to accomplish established objectives and goals for operations or programs
b. suppression or omission of the effects of transactions from records or documents
The reliance placed on substantive tests in relation to the reliance placed on internal control varies in a relationship that is ordinarily
a. Parallel
b. Inverse
c. Direct
d. Equal
b. Inverse
After performing a study and evaluation of the client’s system of internal control an auditor has concluded that the system is well designed and is functioning as anticipated. Under these circumstances the audit would most likely
a. Cease to perform further substantive tests
b. Not increase the extent of predetermined substantive tests
c. Increase the extent of an anticipated analytical review procedures
d. Perform all compliance tests to the extent outlined in the preplanned audit program
b. Not increase the extent of predetermined substantive tests
With respect to the auditor’s planning of a year-end examination, which of the following statements is always true?
a. An engagement should not be accepted after the fiscal year ends
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
d. It is an acceptable practice to carry out substantial parts of the examination at interim dates
At interim dates, an auditor evaluates a client’s internal accounting control procedures and finds them to be effective. The auditor performs a substantial part of the audit engagement in a continuous basis throughout the year. At a minimum, the auditor’s year-end audit procedures must include
a. Determination that the client’s internal accounting control procedures are still effective at yearend
b. Confirmation of those year-end accounts that were examined at interim dates
c. Tests of compliance with internal control in the same manner as those tests made at the interim dates
d. Comparison of the responses to the auditor’s internal control questionnaire with a detailed flowchart at year-end
a. Determination that the client’s internal accounting control procedures are still effective at yearend
Which of the following statements is not correct?
a. Materiality is relative rather than an absolute concept
b. Normally, the most important base used as the criterion for deciding materiality is Net Income
c. Qualitative factors as well as quantitative factors affect materiality
d. Given equal peso amounts, irregularities are usually considered more important than errors
b. Normally, the most important base used as the criterion for deciding materiality is Net Income
Regardless of how the allocation of the preliminary judgment about materiality was done, when the audit is completed the auditor must be confident that the combined errors in all accounts are
a. Less than the preliminary judgment
b. Equal to the preliminary judgment
c. More than the preliminary judgment
d. Less than or equal to the preliminary judgment
d. Less than or equal to the preliminary judgment
Which of the following statements about the cycle approach to auditing is not correct?
a. There are differences among cycles in the frequency and size of expected errors
b. There are differences among cycles in the effectiveness of the internal control structure
c. There are differences among cycles on the auditor’s willingness that material errors exist after auditing is completed
d. It is common for auditors to want an equally low likelihood of errors for each cycle after the auditor is finished
c. There are differences among cycles on the auditor’s willingness that material errors exist after auditing is completed
When a different extent of evidence is needed for various cycles, the difference is caused by
a. Errors in the client’s accounting system
b. Client’s need to achieve an unqualified opinion
c. The auditor’s need to follow PSAs.
d. The auditor’s expectations of errors and assessment of the control structure
d. The auditor’s expectations of errors and assessment of the control structure
Which one of the following factors is not a good indicator of potential financial failure?
a. Client is constantly short of cash and working capital
b. Client’s retained earnings were reduced by half as a result of a large dividend payout
c. Client relies heavily on debt financing, especially by financing permanent assets with shortterm loans
d. Client has had increasing net losses for several years
b. Client’s retained earnings were reduced by half as a result of a large dividend payout
Which of the following is not a consideration when auditor is attempting to assess the inherent risk?
a. Nature of the client’s business
b. Existence of related parties
c. Frequency and intensity of top management’s review of the accounting transactions and records
d. Susceptibility to defalcation
c. Frequency and intensity of top management’s review of the accounting transactions and records
Which of the following discoveries by the auditor would not raise the red flag of increased inherent risk?
a. Management bonuses are based on percentage of net income
b. A bond indenture requires a current ratio of at least three to one
c. Client makes extensive use of notes receivable and notes payable rather than buying and selling an open account
d. Client is a parent company subsidiary
c. Client makes extensive use of notes receivable and notes payable rather than buying and selling an open account
The auditor sets both control risk and inherent risk. On a typical engagement, the author would not set both of these for
a. The overall audit
b. Each cycle
c. Each account
d. Each objective
a. The overall audit
After obtaining and understanding of an entity’s internal control structure and assessing control risk, an auditor may next
a. Perform tests of controls to verify management’s assertions that are embodied in the financial statements
b. Consider whether evidential matter is available to support a further reduction in the assessed level of control risk
c. Apply analytical procedures as substantive tests to validate the assessed level of control risk
d. Evaluate whether the internal control structure policies and procedures detected material misstatements in the financial statements
a. Perform tests of controls to verify management’s assertions that are embodied in the financial statements
When conducting an audit that arouse suspicion of fraud should be given greater attention than other errors. This is an example of applying the criterion of
a. Reliability of evidence
b. Materiality
c. Risk
d. Dual-purpose testing
c. Risk
The audit risk against which the auditor requires reasonable protection is a combination of two separate risks. The first of these is that material errors will occur in the accounting process by which the financial statements are developed, and the second is that
a. A company’s system of internal control is not adequate to detect errors and irregularities
b. Those errors that occur will not be detected in the auditor’s examination
c. Management may possess an attitude that lacks integrity
d. Evidential matter is not competent enough for the auditor to form an opinion based on reasonable assurance
b. Those errors that occur will not be detected in the auditor’s examination
Which of the following procedures is not performed as part of planning an audit engagement?
a. Reviewing the working papers of the prior year
b. Performing analytical procedures
c. Tests of controls
d. Designing an audit program
c. Tests of controls
Which of the following is not generally considered a financial statement audit risk factor?
a. Top management dominates management operating and financing decisions
b. A new client with no prior audit history
c. Rate of change in the entity’s industry is rapid
d. Profitability of the entity relative to its industry is inconsistent
a. Top management dominates management operating and financing decisions
Which of the following statements is correct regarding the auditor’s determination of materiality?
a. The planning level of materiality will normally be the larger of the amount considered for the balance sheet vs. the income statement
b. The auditor’s planning level of materiality may be disaggregated into smaller “tolerable misstatements” for the various accounts
c. Auditors may use various rules of thumb to arrive at an evaluation level of materiality, but not for determining the planning level of materiality
d. The amount used for the planning will equal that used for evaluation
b. The auditor’s planning level of materiality may be disaggregated into smaller “tolerable misstatements” for the various accounts
The system approach to an audit is least likely to be appropriate for
a. Clients with weak internal control
b. Clients that is large in size
c. Clients in specialized industries
d. Clients that are publicly held
a. Clients with weak internal control
Which of the following income statements is least likely to be verified in conjunction with the audit of a balance sheet account?
a. Depreciation expense
b. Interest revenue
c. Travel and entertainment
d. Uncollectible accounts expense
c. Travel and entertainment
Materiality should be considered by the auditor when
a. Determining the nature, timing and extent of auditor’s procedures
b. Evaluating the effect of misstatements
c. Both a and b
d. Neither a nor b
c. Both a and b
The type of transactions that ordinarily have a high inherent risk because they involve management judgments or assumptions are referred to as
a. estimation transactions
b. non-routine transactions
c. routine transactions
d. related-party transactions
a. estimation transactions
Which of the following descriptions best describes inherent risk?
a. Auditors fail to discover a material misstatement in the course of their audit and do not modify their audit opinion
b. A company’s internal control fails to identify a material misstatements in a timely fashion
c. Auditing procedures fail to find a material misstatement
d. The possibility that a material misstatement will occur in any given account before considering internal control
d. The possibility that a material misstatement will occur in any given account before considering internal control
While performing an audit, Manuel decides to restrict then risk of misstatement to 3%. What must the acceptable level of detection risk be if inherent risk is 25% and control risk is 40%?
a. 0.3%
b. 30%
c. 12%
d. 33.3%
b. 30%
How frequently must an auditor test operating effectiveness of controls that appear to function as they have in past years and on which the auditor wishes to rely in the current year?
a. Monthly
b. Each audit
c. At least every second audit
d. At least every third audit
d. At least every third audit
An auditor may decide to assess control risk at the maximum level for certain assertions because the auditor believes
a. Control policies and procedures are unlikely to pertain to the assertions
b. The entity’s control environment, accounting system, and control procedures are interrelated
c. Sufficient evidential matter to support the assertions is likely to be available
d. More emphasis on tests of controls than substantive tests is warranted
a. Control policies and procedures are unlikely to pertain to the assertions
The auditor faces a risk that the examination will not detect material errors which occur in the accounting process. In regard to minimizing this risk, the auditor primarily relies on
a. Substantive tests
b. Compliance tests
c. Internal control
d. Statistical analysis
a. Substantive tests
The auditor uses the assessed level of control risk (together with the assessed level of inherent risk) to determine the acceptable level of detection risk for financial statement assertions. As the acceptable level of detection risk decreases, the auditor may do one or more of the following, except change the
a. Nature of substantive tests to more effective procedures
b. Timing of substantive tests, such as performing them at year-end rather than at an interim date
c. Extent of substantive tests, such as using larger sample sizes
d. Assurances provided by substantive tests to a lower level
d. Assurances provided by substantive tests to a lower level
The auditor should perform which of the following as risk assessment procedures?
a. Analytical procedures
b. Confirmation
c. Recalculation
d. Reperformance
a. Analytical procedures
The concepts of audit risk and materiality are interrelated and must be considered together by the auditor. Which of the following is true?
a. Audit risk is the risk that the auditor may unknowingly express a modified opinion when in fact the financial statements are fairly stated
b. The phrase in the auditor’s standard report “present fairly, in all material respects, in conformity with generally accepted accounting principles” indicates the auditor’s belief that the financial statements taken as a whole are not materially misstated
c. If misstatements are not important individually but are important in the aggregate, the concept of materiality does not apply
d. Material fraud but not material errors cause financial statements to be materially misstated
b. The phrase in the auditor’s standard report “present fairly, in all material respects, in conformity with generally accepted accounting principles” indicates the auditor’s belief that the financial statements taken as a whole are not materially misstated
In financial statement audit, inherent risk represents the
a. Susceptibility of an account balance to error that could be material
b. Risk that error could occur and not be prevented or detected by the internal control structure
c. Risk that error could occur and not be detected by the auditor’s procedures
d. Risk that the auditor fails to modify materiality misstated financial statements
a. Susceptibility of an account balance to error that could be material
Which of the following statements about internal control is correct?
a. Properly maintained internal controls reasonably assure that collusion among employees cannot occur
b. Establishing and maintaining internal control is the internal auditor’s responsibility
c. Exceptionally strong control allows the auditor to eliminate substantive tests of details
d. The cost-benefit relationship should be considered in designing internal controls
d. The cost-benefit relationship should be considered in designing internal controls
When an organization has strong internal control, management can expect various benefits. The benefit least likely to occur is
a. Reduced cost of an external audit
b. Elimination of employee fraud
c. Improvement in the reliability and integrity of information for decision-making purposes
d. Some assurance of compliance with governmental regulations
b. Elimination of employee fraud
A potential business risk created by regulatory requirement may most likely include
a. Increased product liability
b. Increased legal exposure
c. The entity does not have the personnel or expertise to deal with the changes in the industry
d. Loss of financing due to the entity’s inability to meet financing requirements
b. Increased legal exposure
Which of the following conditions and events may least likely indicate the existence of risks of material misstatements?
a. Significant transactions with related parties
b. Entities or business segments likely to be sold
c. Significant amount of routine or systematic transactions
d. Changes in key personnel including departure of key executives
c. Significant amount of routine or systematic transactions
The auditor should determine overall responses to address the risks of material misstatement at the financial statement level. Such responses most likely include
a. Assigning less experienced staff
b. Emphasizing to the audit team the need to maintain professional skepticism in gathering and evaluating audit evidence
c. Performing predictable further audit procedures
d. Performing substantive procedures at an interim date instead of at period end
b. Emphasizing to the audit team the need to maintain professional skepticism in gathering and evaluating audit evidence
An independent auditor should perform tests of controls or those internal accounting controls:
a. That materially affects financial statement balances
b. That he plans to rely upon
c. Where instance of noncompliance were noted
d. That he relied on the prior year’s audit
b. That he plans to rely upon
The probability that an auditor will give an inappropriate opinion on financial statements is
a. Audit risk
b. Inherent risk
c. Control risk
d. Detection risk
a. Audit risk
Auditors would appear not to exhibit due audit care if there was a
a. high audit risk
b. low detection risk
c. high inherent risk
d. low control risk
a. high audit risk
An auditor who believes that a material irregularity may exist should initially
a. Withdraw from the engagement
b. Discuss the matter with higher level of management
c. Discuss the matter with those believed to be involved in the perpetration of the material irregularity
d. Consult legal counsel
c. Discuss the matter with those believed to be involved in the perpetration of the material irregularity
Investigation of new clients and reevaluation of existing ones is an essential part of deciding
a. inherent risk
b. acceptable audit risk
c. statistical risk
d. financial risk
b. acceptable audit risk
An extensive understanding of the client’s business and industry and knowledge about the company’s operations are essential for doing an adequate audit. For a new client, most of this information is obtained
a. from the predecessor auditor
b. from the Securities and Exchange Commission
c. from the permanent file
d. at the client’s premises
d. at the client’s premises
Research has indicated several factors which affect business risk and therefore acceptable risk. Which of the following does not affect business risk?
a. The degree to which external users rely on the statements
b. The likelihood that client will have financial difficulties after the audit report is issued
c. The integrity of management
d. Weaknesses in client’s internal control structure
d. Weaknesses in client’s internal control structure
The audit risk against which the auditor requires reasonable protection is a combination of two separate risks. The first of these is that material errors will occur in the accounting process by which the financial statements are developed, and the second is that
a. a company’s system of internal control is not adequate to detect errors and irregularities
b. those errors that occur will not be detected in the auditor’s examination
c. management may possess an attitude that lacks integrity
d. evidential matter is not competent enough for the auditor to form an opinion based on reasonable assurance
b. those errors that occur will not be detected in the auditor’s examination
Which of the following statements concerning materiality thresholds is incorrect?
a. Aggregate materiality thresholds are a function of the auditor’s preliminary judgment concerning audit risk
b. In general, the more misstatements the auditor expects, the higher should be the aggregate materiality threshold
c. The smallest aggregate level of errors or fraud that could be considered material to any of the financial statements is referred to as a “materiality threshold”
d. Materiality thresholds may change between the planning and review stages of the audit. These changes may be due to quantitative and/or qualitative factors
b. In general, the more misstatements the auditor expects, the higher should be the aggregate materiality threshold
Which of the following factors best describe the materiality of audit risk?
1. Volume of transactions
2. Degree of system integration
3. Years since last audit
4. Significant management turnover
5. Value of assets at risk
6. Average value per transaction
7. Results of last audit
a. 1 through 7
b. 2, 4 and 7
c. 1, 5 and 6
d. 3, 4 and 6
c. 1, 5 and 6
Which of the following concepts about materiality is incorrect?
a. Materiality is directly related to the acceptable level of detection risk
b. Materiality does not apply if internal control is highly effective
c. Materiality is a matter of professional audit judgment
d. Materiality is more closely related to fieldwork and reporting standards than to general standards
b. Materiality does not apply if internal control is highly effective
Which type of audit risk does the management of a company have the most control over in the short term?
a. Inherent risk
b. Control risk
c. Detection risk
d. Sufficiency risk
b. Control risk
Auditors would perform the following steps in which order?
a. Determine audit risk; assess control risk; determine detection risk; set materiality
b. Set materiality; determine audit risk; assess control risk; determine detection risk
c. Set materiality; assess control risk; determine detection risk; determine audit risk
d. Determine audit risk; set materiality; assess control risk; determine detection risk
b. Set materiality; determine audit risk; assess control risk; determine detection risk
As the audit progresses and additional information about the client is obtained, the acceptable level of audit risk
a. may be modified
b. may not be reduced because it would become statistically invalid, but it may be increased
c. may not be increased because it would become statistically invalid, but it may be reduced
d. may not be modified
a. may be modified
Which of the following is not a consideration when the auditor is attempting to assess the inherent risk?
a. Nature of client’s business
b. Existence of related parties
c. Frequency and intensity of top management’s review of the accounting transactions and records
d. Susceptibility to defalcation
c. Frequency and intensity of top management’s review of the accounting transactions and records
Which of the following is an example of the concept of inherent risk?
a. Humans make more errors than computers, therefore a manual accounting system is riskier than a computerized system
b. Accounting systems with vouchers have many more controls built in, so the risk that there will be errors on the financial statements is reduced
c. Loans receivable for a finance company are less likely to be collectible than those of a bank
d. Audits with larger sample sizes are less risky than those with smaller sizes
c. Loans receivable for a finance company are less likely to be collectible than those of a bank
Which of the following discoveries by the auditor would not raise the red flag of increased inherent risk?
a. Management bonuses are based on a percentage of net income
b. A bond indenture requires a current ratio of at least three to one
c. Client makes extensive use of notes receivable and notes payable rather than buying and selling on open account
d. Client is a parent company with a subsidiary
c. Client makes extensive use of notes receivable and notes payable rather than buying and selling on open account
Inherent risk is reduced where the likelihood of defalcation is low. This would be true for an account such as
a. Inventory
b. Marketable securities
c. Cash
d. Accounts receivable
a. Inventory
Both control risk and inherent risk are set by the auditor. On a typical engagement, the auditor would not set both of these for
a. the overall audit
b. each cycle
c. each account
d. each objective
a. the overall audit
Because control risk and inherent risk vary from cycle to cycle, account to account or objective to objective,
a. acceptable audit risk must remain a constant
b. detection risk and required audit evidence will also vary
c. detection risk will vary but audit evidence will remain constant
d. detection risk will remain constant but audit evidence will vary
b. detection risk and required audit evidence will also vary
After obtaining an understanding of an entity’s internal control structure and assessing control risk, an auditor may next
a. perform tests of controls to verify management’s assertions that are embodied in the financial statements
b. consider whether evidential matter is available to support a further reduction in the assessed level of control risk
c. apply analytical procedures as substantive tests to validate the assessed level of control risk
d. evaluate whether the internal control structure policies and procedures detected material misstatements in the financial statements
a. perform tests of controls to verify management’s assertions that are embodied in the financial statements
An auditor may compensate for a weakness in the internal control by increasing the
a. level of detection risk
b. extent of tests of controls (compliance tests)
c. preliminary judgment about audit risk
d. extent of analytical procedures
a. level of detection risk
When conducting an audit, errors that arouse suspicion of fraud should be given greater attention than other errors. This is an example of applying the criterion of
a. reliability of evidence
b. materiality
c. risk
d. dual-purpose testing
c. risk
When an independent auditor’s examination of financial statement discloses special circumstances that make the auditor suspect that material errors and irregularities may exist, the auditor’s initial course of action should be to
a. recommend that the client pursue the suspected fraud to a conclusion that is agreeable to the auditor
b. extend normal audit procedures in an attempt to detect the full extent of the suspected fraud
c. reach an understanding with the proper client representative as to whether the auditor or the client is to make the investigation necessary to determine if a fraud has in fact occurred
d. decide whether the fraud, if in fact it should exist, might be of such a magnitude as to affect the auditor’s report on the financial statements
d. decide whether the fraud, if in fact it should exist, might be of such a magnitude as to affect the auditor’s report on the financial statements
The audit risk against which the auditor requires reasonable protection is a combination of two separate risks. The first of these is that material errors will occur in the accounting process by which the financial statements are developed, and the second is that
a. a company’s system of internal control is not adequate to detect errors and irregularities
b. those errors that occur will not be detected in the auditor’s examination
c. management may possess an attitude that lacks integrity
d. evidential matter is not competent enough for the auditor to form an opinion based on reasonable assurance
b. those errors that occur will not be detected in the auditor’s examination
A CPA may reduce the audit work on a first-time audit by reviewing the working papers of the predecessor auditor. The predecessor should permit the successor to review working papers relating to matters of continuing accounting significance such as those that relate to
a. extent of reliance on the work of specialists
b. fee arrangement and summaries of payments
c. analysis of contingencies
d. staff hours required to compete the engagement
c. analysis of contingencies
Which of the following procedures is not performed as a part of planning an audit engagement?
a. Reviewing the working papers of the prior year
b. Performing analytical procedures
c. Tests of controls
d. Designing an audit program
c. Tests of controls
The risk of a material misstatement occurring in an account, assuming an absence of internal control, is referred to as:
a. Account risk
b. Control risk
c. Detection risk
d. Inherent risk
d. Inherent risk
Which of the following is not generally considered a financial statement audit risk factor?
a. Management operating and financing decisions are dominated by top management
b. A new client with no prior audit history
c. Rate of change in the entity’s industry is rapid
d. Profitability of the entity relative to its industry is inconsistent
a. Management operating and financing decisions are dominated by top management
The risk that the auditor’s procedures will lead them to conclude that a material misstatement does not exist in an account balance when in fact such a misstatement does exist is referred to as :
a. Account risk
b. Control risk
c. Detection risk
d. Inherent risk
c. Detection risk
Which of the following statements is correct regarding the auditor’s determination of materiality?
a. The planning level of materiality will normally be the larger of the amount considered for the balance sheet vs. the income statement
b. The auditor’s planning level of materiality may be disaggregated into smaller “tolerable misstatements” for the various accounts
c. Auditors may use various rules of thumb to arrive at an evaluation level of materiality, but not for determining the planning level of materiality
d. The amount used for the planning will equal that used for evaluation
b. The auditor’s planning level of materiality may be disaggregated into smaller “tolerable misstatements” for the various accounts
The auditors must consider materiality in planning an audit engagement. Materiality for planning purpose is:
a. The auditor’s preliminary estimate of the largest amount of error that would be material to any one of the client’s financial statements
b. The auditor’s preliminary estimate of the smallest amount of error that would be material to any one of the client’s financial statements
c. The auditor’s preliminary estimate of the amount of error that would be material to the client’s balance sheet
d. An amount that cannot be quantitatively stated since it depends on the nature of the item
b. The auditor’s preliminary estimate of the smallest amount of error that would be material to any one of the client’s financial statements
Research has indicated several factors which affect business risk and therefore acceptable risk. Which of the following does not affect business risk?
a. The degree to which external users rely on the statements
b. The likelihood that client will have financial difficulties after the audit report is issued
c. The integrity of management
d. Weaknesses in client’s internal control structure.
d. Weaknesses in client’s internal control structure.
