Audit Exam 2

What should the auditor conclude given the results of the following analytical procedures? Note that “Difference” is the absolute difference between the auditor’s expectation and the client’s book value.

Planning phase: Difference < Overall Materiality

Conclusion:

Conclusion: IR = Low

What should the auditor conclude given the results of the following analytical procedures? Note that “Difference” is the absolute difference between the auditor’s expectation and the client’s book value.

Planning phase: Difference ≥ Overall Materiality

Conclusion:

Conclusion: IR = High

What should the auditor conclude given the results of the following analytical procedures? Note that “Difference” is the absolute difference between the auditor’s expectation and the client’s book value.

Substantive test: Difference < Tolerable Misstatement

Conclusion:

Conclusion: Account is fairly stated

What should the auditor conclude given the results of the following analytical procedures? Note that “Difference” is the absolute difference between the auditor’s expectation and the client’s book value.

Substantive test: Difference > Tolerable Misstatement

Conclusion:

Conclusion: Collect more substantive testing

Describe the audit risk model. Which risks exist independently of the audit?

AR = IR x CR x DR

Inverse relationship between IR x CR and DR

RMM = IR x CR

IR and CR are independent of the audit

In what order do the three categories of audit procedures (risk assessment, controls testing, and substantive testing) usually occur?

Risk Assessment → Control Testing → Substantive Testing

Describe reliance and substantive strategies for internal controls. For each strategy, include the level of CR, and nature, extent, and timing (NET) of substantive testing. To link these strategies to the audit risk model, also include the level of DR associated with each strategy.

CR:

• Reliance Strategy: Low or moderate, supported by control testing

• Substantive Strategy: High CR

Describe reliance and substantive strategies for internal controls. For each strategy, include the level of CR, and nature, extent, and timing (NET) of substantive testing. To link these strategies to the audit risk model, also include the level of DR associated with each strategy.

Nature:

• Reliance Strategy: Less reliable substantive evidence

• Substantive Strategy: More reliable substantive evidence

Describe reliance and substantive strategies for internal controls. For each strategy, include the level of CR, and nature, extent, and timing (NET) of substantive testing. To link these strategies to the audit risk model, also include the level of DR associated with each strategy.

Extent:

• Reliance Strategy: Less substantive testing

• Substantive Strategy: More substantive testing

Describe reliance and substantive strategies for internal controls. For each strategy, include the level of CR, and nature, extent, and timing (NET) of substantive testing. To link these strategies to the audit risk model, also include the level of DR associated with each strategy.

Timing:

• Reliance Strategy: Year-end + Interim

• Substantive Strategy: Year-end

Describe reliance and substantive strategies for internal controls. For each strategy, include the level of CR, and nature, extent, and timing (NET) of substantive testing. To link these strategies to the audit risk model, also include the level of DR associated with each strategy.

DR:

• Reliance Strategy: High

• Substantive Strategy: Low

What does NET stand for?

Nature, Extent, and Timing

The reliability of evidence each provides: Inquiry

a. Low reliability

b. Moderate reliability

c. High reliability

A.

The reliability of evidence each provides: Observation

a. Low reliability

b. Moderate reliability

c. High reliability

A.

The reliability of evidence each provides: Confirmation

a. Low reliability

b. Moderate reliability

c. High reliability

B.

The reliability of evidence each provides: Analytics

a. Low reliability

b. Moderate reliability

c. High reliability

B.

The reliability of evidence each provides: Inspect Documents

a. Low reliability

b. Moderate reliability

c. High reliability

B.

The reliability of evidence each provides: Inspect Assets

a. Low reliability

b. Moderate reliability

c. High reliability

C.

The reliability of evidence each provides: Recalculation

a. Low reliability

b. Moderate reliability

c. High reliability

C.

The reliability of evidence each provides: Reperformance

a. Low reliability

b. Moderate reliability

c. High reliability

C.

Categorize the eight audit procedures we discussed by the three categories of testing (risk assessment, controls testing, and substantive testing)

Risk assessment:

Inspect Documents, Inquiry, Analytical Procedures, Observation

Categorize the eight audit procedures we discussed by the three categories of testing (risk assessment, controls testing, and substantive testing)

Controls Testing:

Inspect Documents, Inquiry, Observation, Reperformance

Categorize the eight audit procedures we discussed by the three categories of testing (risk assessment, controls testing, and substantive testing)

Substantive Testing:

Inspect Documents, Inquiry, Analytical Procedures, Confirmations, Recalculation, and Inspect Assets

Which of the following audit procedures can be used to test controls?

a. Analytical procedures and observation

b. Confirmation and reperformance

c. Inspect assets and recalculation

d. Inspect documents and inquiry

D.

Which statement is FALSE about the client’s audit committee (AC)?

a. Each AC member is also a director

b. The AC approves non-audit services

c. The AC cannot include executives such as the CEO and CFO

d. The AC hires the audit firm, but does not agree to audit fees

e. The AC should establish a process for addressing accounting problem

D.

Which of the following items relate to the competence of the internal auditor?

a. Ask the internal audit director “who do you report to?”

b. Certifications and degrees held by the internal audit staff

c. Recalculate depreciation schedules prepared by the client controller

d. The organizational chart

B.

Assume: (1) overall materiality is $900; (2) the only outstanding misstatement at the end of the audit is a $1,500 understatement of cost of sales; and (3) the client booked an adjusting entry to reduce this misstatement to $899. Which opinion should the auditor provide?

a. Unqualified (clean)

b. A different opinion that informs users the auditor believes there is a material misstatement

**Note that overall materiality is also called planning materiality**

A.

Tolerable misstatement for a high-risk group of accounts should be ___ of overall materiality.

a. 2%

b. 5%

c. 50%

d. 75%

C.

Typical range is 50-75%. So for higher risk, we’ll go with 50%.

A misstatement is qualitatively material if the amount of the misstatement

a. Exceeds 5% of pretax earnings

b. Is less than quantitative materiality

c. Is less than quantitative materiality and impacts a key performance metric

d. Is generated by an omission of liabilities and expenses only

C.

The risk of material misstatement without considering controls is ___ risk.

a. Audit

b. Inherent

c. Detection

d. Pre-Control

B.

Your client competes in a rapidly changing industry, which

a. Decreases control risk

b. Decreases inherent risk

c. Increases detection risk

d. Increases inherent risk

D.

Your client’s controls are much worse this year compared to last year, which

a. Does not affect inherent risk, increases control risk, and decreases detection risk

b. Does not affect inherent risk, increases control risk, and increases detection risk

c. Increases inherent risk, does not affect control risk, and increases detection risk

d. Increases inherent risk, increases control risk, and decreases detection risk

A.

Controls are much worse, so CR increases, which leads to DR decreasing

Your client experienced a large increase in the volume of sales transactions this year compared to last year. How should you adjust the audit risk model?

a. Increase inherent risk, control risk does not change, and decrease detection risk

b. Decrease inherent risk, control risk does not change, and increase detection risk

c. Inherent risk does not change, increase control risk, and decrease detection risk

d. Increase inherent risk, increase control risk, and detection risk does not change

A.

A lot of sales transactions

_____ testing occurs during the fiscal year under audit.

a. Year-end

b. Interim

c. None of the above – the auditor cannot perform any procedures until after the end of the fiscal year under audit

B.

If detection risk is low, the plan for substantive testing should be:

a. Set the timing of testing to year-end only and collect less evidence

b. Set the timing of some tests to interim dates and collect less evidence

c. Set the timing of testing to year-end only and collect more evidence

d. Set the timing of some tests to interim dates and collect more evidence

C.

AR = IR x CR x DR

IR x CR (increasing), DR (decreasing)

Means we’ll perform all testing at the end

If audit risk does not change, inherent risk increases, and control risk does not change, what is the effect on detection risk?

a. Decreases

b. Does not change

c. Increases

A.

Which of the following factors relate to the appropriateness of evidence?

a. Relevance

b. Reliability

c. Risk of material misstatement

d. The effectiveness of internal controls

e. Relevance and Reliability

E.

Which assertion is violated or threatened when a fake sale is recorded?

a. Existence

b. Completeness

c. Occurrence

d. Cutoff

C.

Vouching involves moving from ____, and tests which assertion?

a. Journals/ledgers to source documents; Completeness

b. Journals/ledgers to source documents; Occurrence

c. Source documents to journals/ledgers; Completeness

d. Source documents to journals/ledgers; Occurrence

B.

Recording a sales journal entry when the supporting invoice did not use the correct price from the master price list violates which assertion?

a. Completeness

b. Existence

c. Occurrence

d. None of the above

D.

Accuracy!

Which of the following procedures provides the MOST reliable substantive evidence for the existence of accounts receivable?

a. Inquiry of the credit manager

b. Inspecting documents to determine if recorded sales shipped to customers

c. Recalculating price times quantity for each invoice in a selected sample

d. Vouching account receivable subsidiary ledger entries to subsequent cash receipts

D.

subsidiary ledger entries to subsequent cash receipts since it’s A/R

Which of the following procedures provides the LEAST reliable substantive evidence for the accuracy of depreciation expense?

a. Inspect capital purchase contracts to evaluate useful lives

b. Inquiry of the controller to ask about sales of fixed assets

c. Recalculate client depreciation schedules

d. Reperform controls related to purchasing fixed assets

B.

The permanent audit documentation file includes

a. A list of adjusting entries the client recorded at the end of the fiscal year

b. The audit plan for substantive testing

c. The chart of accounts

d. Unaudited financial statements for the fiscal year under audit

C.

A reliance approach is used when control risk is ____ and results in a relatively ____ extent of substantive testing.

a. High; small

b. High; large

c. Low or moderate; small

d. Low or moderate; large

C.

An auditor initially assessed control risk as high, and the results of controls testing indicate that control risk should be low. The auditor should

a. Reduce the planned extent of substantive testing

b. None of the options listed here are correct

c. Set the timing of substantive procedures as year-end only

d. Use a substantive approach

A.

CR (increase) & DR (decrease) and vice versa

substantive testing

Client management must disclose its evaluation of internal controls

a. In 10-Q filings

b. To the auditor and audit committee if it identifies significant or material deficiencies

c. To other members of management only

d. None of the above – only the external auditor discloses a summary of internal control evaluation

B.

If your audit client outsources a process, you should

a. Claim a scope limitation on internal controls testing for that process

b. Obtain a SOC 1 report from the outsourced service provider’s auditor

c. Trust the client’s verbal assurances that the controls surrounding the outsourced process are effective

d. Visit the service provider to evaluate the controls surrounding the outsourced process

B.

A control problem has a reasonable possibility of a misstatement that is not material but significant. This represents which category of deficiency?

a. Control deficiency

b. Severe deficiency

c. Significant deficiency

d. Material weakness

C.

not material but significant

You discover three significant deficiencies that are material in aggregate. The client did not correct them during the audit period. You should report this to

a. The client’s audit committee

b. The client’s management

c. The public by issuing an adverse opinion on the effectiveness of internal controls

d. All of the above

e. A & B only

D.

audit committee

management

the public

You suspect your client has booked sales to fake customers. Which of the following tests would have the best chance of detecting these misstatements?

a. Inquiry of the sales manager

b. Observe controls over the sales process

c. Trace invoices and related shipping documents to the sales journal and A/R subsidiary ledger

d. Vouch entries in the sales journal and A/R subsidiary ledger to invoices and related shipping documents

D.

Trace → Completeness

Vouch → Occurence

Suspecting book sales, so we vouch backwards

A negative confirmation

a. Is considered audit evidence only if the recipient returns it

b. Is considered audit evidence even if the recipient does not return it

c. Should be used to collect evidence when accounts receivable is material

d. Provides the most reliable audit evidence of any confirmation type

B.

If two attempts at positive confirmations are not returned, the auditor should

a. Declare a scope limitation for accounts receivable

b. Inform the client sales manager that the company should stop making credit sales

c. Vouch from individual account receivable subsidiary ledgers to shipping documents

d. Trace from shipping documents to individual account receivable subsidiary ledgers

C.

Vouch → testing occurrence → test sale → evidence for existence → A/R

Trace → completeness → Are there other accounts not included that should be included?

Which of the following procedures provides the MOST reliable audit evidence for the cutoff assertion for revenue?

a. Recalculate price times quantity on a sample of invoices.

b. Send confirmations to client customers

c. Vouch a sample of sales journal entries dated just before and after year end to the supporting invoices, shipping documents, and customer purchase orders.

d. Trace a sample of invoices dated just before and after year end – and the related shipping documents and customer purchase orders – to sales journal entries.

D.

cutoff assertion for revenue

The engagement letter:

a.

b.

c.

d.

e.

f.

g.

a. Contract between audit and client

b. Required by auditing standards

c. Defines responsibilities of auditor + client

d. Addresses audit-audit committee communications

e. Can provide some legal protection for auditor

f. Identifies any additional services to be provided

g. Includes fee estimate

The risk that the procedures performed by the auditor will not detect a misstatement that exists and that could be material, either individually or when aggregated with other misstatements.

a. Audit Risk

b. Inherent Risk

c. Control Risk

d. Detection Risk

D.

risk that the procedures performed by the auditor

The risk that a misstatement 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, or detected and corrected, on a timely basis by the entity’s internal control.

a. Audit Risk

b. Inherent Risk

c. Control Risk

d. Detection Risk

C.

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

a. Audit Risk

b. Inherent Risk

c. Control Risk

d. Detection Risk

A.

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 related controls.

a. Audit Risk

b. Inherent Risk

c. Control Risk

d. Detection Ris

B.

______________ is seeking information of knowledgeable persons, both financial and

nonfinancial, within the entity or outside.

A) Observation
B) Inquiry
C) Inspection
D) Vouching

B.

______________ is watching a process or procedure being performed by others.
A) Inquiry
B) Reperformance
C) Observation
D) Tracing

C.

______________ refers to selecting an item for testing from the accounting journals or ledgers than examining the underlying source document.
A) Tracing
B) Vouching
C) Inspection
D) Recalculation

B.

______________ are evaluations of financial information made through analysis of plausible relationships among both financial and nonfinancial data.
A) Analytical Procedures
B) Recalculation
C) Reperformance
D) Overall Materiality

A.

______________ refers to whether the type of evidence can be relied on to signal the true state of the assertion.
A) Relevance of evidence
B) Appropriateness of evidence
C) Reliability of evidence
D) Sufficiency of evidence

C.

______________ is the maximum amount by which the auditor believes the financial statements could be misstated and still not affect the decisions of users.
A) Tolerable Misstatement
B) Overall Materiality
C) Risk of Material Misstatement
D) Sufficiency of evidence

B.

______________ refers to selecting a source document and testing that it is included in the accounting journal or ledger.
A) Vouching
B) Reperformance
C) Inspection
D) Tracing

D.

______________is the measure of the quantity of audit evidence. The quantity of audit evidence necessary is affected by the auditor’s assessment of the risks of material misstatement and the quality of the audit evidence obtained.
A) Sufficiency of evidence
B) Appropriateness of evidence
C) Relevance of evidence
D) Reliability of evidence

A.

______________ refers to the examination of internal or external records or documents that are in paper form, electronic form, or other media.
A) Observation
B) Tracing
C) Inspection
D) Analytical Procedures

C.

_____________ refers to the auditor’s checking the mathematical accuracy of documents or records either manually or electronically.
A) Reperformance
B) Recalculation
C) Analytical Procedures
D) Inspection

B.

______________ refers to the auditor’s independent execution of procedures or controls that were originally performed as part of the entity’s internal control, either manually or through the use of computer-assisted audit techniques.
A) Recalculation
B) Observation
C) Tracing
D) Reperformance

D.

______________ is equal to IR × CR
A) Risk of Material Misstatement
B) Overall Materiality
C) Tolerable Misstatement
D) Appropriateness of evidence

A.

______________ refers to the measure of the quality of audit evidence; that is, its relevance and reliability in providing support for the conclusions on which the auditor’s opinion is based.
A) Sufficiency of evidence
B) Relevance of evidence
C) Appropriateness of evidence
D) Reliability of evidence

C.

_______________ refers to the risk that financial statements are materially misstated prior to the audit.
A) Tolerable Misstatement
B) Risk of Material Misstatement
C) Overall Materiality
D) Sufficiency of evidence

B.

_______________ refers to the amount of the overall materiality that is used to establish a scope for the audit procedures for the individual account balance or disclosures.
A) Overall Materiality
B) Risk of Material Misstatement
C) Tolerable Misstatement
D) Appropriateness of evidence

C.

_______________ refers to its relationship to the assertion or to the objective of the control being tested.
A) Reliability of evidence
B) Appropriateness of evidence
C) Sufficiency of evidence
D) Relevance of evidence

D.

Your client's controller and CFO both left the company during the year under audit. Your audit partner does not believe the new controller and new CFO are qualified for their jobs. This situation

 

A. Does not affect the audit risk model

B. Increases detection risk

C. Increases inherent risk

D. Decreases control risk

C.

Audit tests (procedures) used during risk assessment include

 

A. Confirmation and recalculation

B. Reperformance and observation

C. Reperformance and analytical procedures

D. Analytical procedures and inquiry

D.

A misstatement with an amount less than the quantitative material threshold but allows the client to meet its EPS forecast is 

 

A. Tolerable misstatement

B. Quantitatively material

C. Qualitatively material

D. Not material

C.

Controls testing can involve inquiry, reperformance, inspection of documents, and 

 

A. Recalculation

B. Inspection of assets

C. Observation

D. Confirmation

E. Analytical procedures

C.

The audit committee

 

A. Can hire the audit firm, but cannot be involved in determining the audit fee

B. Is not involved in the audit process after the audit firm is hired

C. Approves audit and non-audit services provided by the audit firm

D. All of the answer choices listed here are correct

C.

Which components of the audit risk model exist independently of the audit?

 

A. Inherent risk and control risk

B. Inherent risk and detection risk

C. Control risk and detection risk

D. None of the answer choices listed here are correct

A.

Assume detection risk is low. The extent of substantive testing should be ___.

 

A. High

B. Providing more reliable evidence

C. Low

D. Providing less reliable evidence

A.

Your client installed a new accounting system during the year under audit. This situation

 

A. Increases inherent risk

B. Decreases inherent risk

C. Decreases detection risk

D. Decreases control risk

C.

Assume detection risk is high. The timing of substantive testing should occur at 

 

A. Year end only

B. Interim dates only

C. Year end and interim dates

C.

Which of the following is an entity-level control? 

 

A. Bank reconciliation

B. Matching purchase orders, invoices, and receiving reports before paying vendors

C. Audit committee

D. Requiring both the CEO and CFO to authorize checks greater than $100,000

C.

A substantive strategy is used when 

A. Control risk is moderate or at its highest level

B. Control risk is at its lowest level

C. Control risk is at its highest level

D. Control risk is moderate

C.

Which of the following best tests the occurrence of sales?

A. Send confirmations to client vendors

B. Vouch from the sales journal to invoices, shipping documents, and customer orders

C. Send confirmations to client customers

D. Trace from invoices, shipping documents, and customer orders to the sales journal

B.

Which of the following tests provides the most reliable evidence for auditing internal controls?

 

A. Confirmation

B. Recalculation

C. Inspect assets

D. Observation

D.

Analytical procedures 

 

A. Are required during audit planning

B. Are typically used as a controls test

C. Are required as a substantive test

D. Involve corresponding with third-parties who conduct business with the client

A.

Your client outsourced its purchasing process to Purchase Experts, Inc. How should you audit the controls over your client's purchasing process?

 

A. Document the situation as a scope limitation

B. Go to Purchase Experts' headquarters and audit their controls

C. Issue an unqualified opinion for controls

D. Obtain a SOC1 report from Purchase Experts' external auditor

D.

Which of the following best tests the completeness of accounts receivable?

 

A. Send confirmations to client customers

B. Trace from subsequent cash receipts to individual account receivable subsidiary ledgers

C. Recalculate balances within individual customer account receivable subsidiary ledgers

D. Count inventory

B.

Which of the following is found in the current documentation file?

 

A. The client's corporate charter

B. The 12/31 trial balance for the year under audit

C. The client's chart of accounts

D. None of the answer choices listed here are correct

B.

As of the end of the fiscal year you are auditing, your client had two significant control deficiencies that are material in aggregate. Which opinion should you issue for the audit of controls?

 

A. Unqualified (clean)

B. Qualified

C. Disclaimer of opinion

D. Adverse

D.

Which of the following procedures provides the least reliable substantive evidence?

 

A. Inspect assets

B. Confirmation

C. Observation

D. Recalculation

C.

What happens if a firm accepts a client but lacks industry expertise?

Risk of audit failure or need to hire specialists

What factors do external auditors consider when deciding whether to rely on the work of internal audit?

Completeness & Objectivity

What technique provides the strongest evidence?

a. Inquiry

b. Observation

c. Inspection

d. Reperformance

D.

It’s reperformance since it’s the most direct evidence of whether a control works

Who controls IR and CR?

a. the client or business

b. the auditor

A.

If IR and CR are both HIGH, what must happen to DR to keep AR low?

a. DR must be very low - meaning much more extensive testing

b. DR must be moderate

c. DR must be very high - not much more extensive testing

a.

Who owns audit documentation?

A) The Client

B) The Auditor

C) The Audit Committee

D) The Public Company Accounting Oversight Board (PCAOB)

B.

Minimum documentation retention period in the US?

A) 3 years

B) 5 years

C) 7 years

D) 10 years

C.