Auditing Ch 8

Net income before taxes is the normal base used to determine materiality for a not-for-profit organization. T/F

False

Amounts involving fraud are not usually considered qualitative factors affecting the preliminary materiality judgment. T/F

False

In which of the following circumstances would an auditor of an issuer be least likely to reevaluate established materiality​ levels?

a. Significant new contractual arrangements draw attention to a particular aspect of a​ client's business that is separately disclosed in the financial statements.

b. The materiality level was established based on preliminary financial statement amounts that differ significantly from actual amounts.

c. The client released​ third-quarter results before the​ SEC-prescribed deadline.

d. The client disposed of a major portion of the​ client's business.

c. The client released​ third-quarter results before the​ SEC-prescribed deadline.

Which of the following procedures would a CPA least likely perform during the planning stage of the​ audit?

a. Take a tour of the​ client's facilities

b. Determine the effect of information technology on the audit

c. Perform inquiries of outside legal counsel regarding pending litigation

d. Determine the timing of testing

c. Perform inquiries of outside legal counsel regarding pending litigation

A successor​ auditor's inquiries of the predecessor auditor should include questions regarding

a. the assessment of the objectivity of the​ client's internal audit function.

b. the number of engagement personnel the predecessor assigned to the engagement.

c. the response rate for confirmations of accounts receivable.

d. communications to management and those charged with governance regarding significant deficiencies in the system of internal control.

d. communications to management and those charged with governance regarding significant deficiencies in the system of internal control.

Likely misstatements can result from:

a. projections of misstatements based on an auditor’s tests of a sample from a population

b. computation of the sampling error for the cash account

c. differences between​ management's and an​ auditor's judgment about account balances & projections of misstatements based on an auditor’s tests of a sample from a population

d. computation of the sampling error for the cash account & differences between​ management's and an​ auditor's judgment about account balances

c. differences between​ management's and an​ auditor's judgment about account balances & projections of misstatements based on an auditor’s tests of a sample from a population

Which of the following are major difficulties auditors face when allocating materiality to balance sheet​ accounts?

a. only overstatements need be considered

b. certain accounts contain more misstatements than others & audit costs can affect allocation

c. certain accounts contain more misstatements than others & only overstatements need be considered & audit costs can affect allocation

d. certain accounts contain more misstatements than others & only overstatements need be considered

b. certain accounts contain more misstatements than others & audit costs can affect allocation

If the preliminary judgment of materiality​ increases, the amount of audit evidence required will decrease. T/F

True

Which of the following statements is not​ correct?

a. Given equal dollar​ amounts, frauds are usually considered more important than errors.

b. Qualitative factors as well as quantitative factors affect materiality.

c. The most important base used as the criterion for deciding materiality is total assets.

d. Materiality is a relative rather than an absolute concept.

c. The most important base used as the criterion for deciding materiality is total assets.

If an auditor establishes a relatively high level for​ materiality, then the auditor will

a. accumulate approximately the same evidence as would be the case were materiality lower.

b. accumulate more evidence than if a lower level had been set.

c. accumulate less evidence than if a lower level had been set.

d. accumulate an undetermined amount of evidence

c. accumulate less evidence than if a lower level had been set.

Audit standards require the auditor to consider materiality early in the audit. Which​ statement(s) regarding preliminary materiality is​ (are) true?

I. Preliminary materiality may change during the engagement.

II. Preliminary materiality is the maximum amount by which the auditor believes the financials could be misstated and still not affect the decisions of reasonable users.

a. I only

b. II only

c. both I & II

d. neither I & II

c. both I & II

__ materiality is materiality for segments of the audit.

a. financial statement

b. segment

c. individual

d. performance

d. performance

Auditing standards define​ ________ as the magnitude of​ misstatements, including​ omissions, that​ individually, or when aggregated with other​ misstatements, could reasonably be expected to influence the judgment made by a reasonable user of the financial statements.

a. fraud

b. significant

c. inherent risk

d. materiality

d. materiality

Which of the following is not an example of the use of data visualization to perform risk​ assessment?

a. Reviewing inventory balance trends by product line or geographic location.

b. Selecting general ledger accounts for further detailed analysis.

c. Examining trends in general ledger account balances from year to year.

d. Selecting a sample of accounts receivable to send positive confirmation to.

d. Selecting a sample of accounts receivable to send positive confirmation to.

Which of the following is a correct statement regarding analytical​ procedures?

a. In order to look for a misstatement in the allowance for bad​ debts, the auditor should divide gross sales by sales returns and allowances.

b. Common-size financial statements display all items as a percentage change from a base year.

c. A major strength in using industry ratios for auditing is the difference between the nature of the​ client's financial information and that of the firms making up the industry totals.

d. In identifying areas of specific​ risk, the auditor is likely to focus on the liquidity activity ratios.

d. In identifying areas of specific​ risk, the auditor is likely to focus on the liquidity activity ratios.

The auditor should read the corporate minutes to obtain authorizations and other information that is relevant to performing the audit. T/F

True

Which of the following would most likely not be classified as a related-party transaction?

a. exchanges of equipment between two companies owned by the same person

b. loans or credit sales to the principal owner of the client company

c. an advance of one​ week's salary to an employee

d. sales of merchandise between affiliated companies

c. an advance of one​ week's salary to an employee

A related party transaction may be indicated when another company

a. purchases its securities at their fair value.

b. has had a distributor relationship with the company for 10 years.

c. subsidizes certain operating expenses of the company.

d. loans to the company at market rates.

c. subsidizes certain operating expenses of the company.

Which is usually included in the engagement​ letter?

a. List of audit procedures to be used in inventory observation

b. The auditors’ assessment of audit risk

c. Neither a nor b

d. Both a & b

c. Neither a nor b

Which of the following is not true regarding the​ auditor's use of a​ specialist?

a. There is no need for the auditor to evaluate the​ specialist's objectivity as long as they have the required expertise.

b. The auditor should understand the objectives and the scope of the​ specialist's work.

c. The auditor should evaluate the​ specialist's professional qualifications.

d. There is a need for the auditor to refer to the​ specialist's report if the auditor modified the audit opinion as a result of the​ specialist's report.

a. There is no need for the auditor to evaluate the​ specialist's objectivity as long as they have the required expertise.

For public​ companies, the​ __ is responsible for hiring the auditor as required by the Sarbanes-Oxley Act.

a. ​client's management

b. ​client's chief financial officer

c. ​client's audit committee

d. ​client's chief executive officer

c. ​client's audit committee

The auditor is likely to accumulate more evidence when the audit is for a company

a. which is to be sold in the near future

b. which has large amounts of debt

c. both a & b

d. neither a nor b

c. both a & b

Client business risk includes the auditor identifying declines in economic conditions that adversely affect sales and the collectability of accounts receivable. T/F

True

__ is the risk that the financial statements contain a material misstatement due to fraud or error prior to the audit.

a. Client business risk

b. Risk of material misstatement

c. Inherent risk

d. Acceptable audit risk

b. Risk of material misstatement

A measure of how willing the auditor is to accept that the financial statements may be materially misstated after the audit is completed and an unqualified opinion has been issued is the

a. inherent risk

b. statistical risk

c. financial risk

d. acceptable audit risk

d. acceptable audit risk

The auditor uses knowledge gained from the understanding of the client's business and industry to assess

a. client business risk

b. control risk

c. inherent risk

d. audit risk

a. client business risk

As acceptable audit risk is decreased, the likely cost of conducting an audit increases. T/F

True - b/c lower AAR = more evidence needed = more expensive

The preliminary judgment on materiality is compared to the total estimated misstatement amount to determine if the balance is materially misstated. T/F

True

Auditors should understand client objectives related to

a. reliability of financial reporting.

b. effectiveness and efficiency of operations.

c. compliance with laws and regulations.

d. all of the above

d. all of the above

Amounts involving fraud are usually considered more important than unintentional errors of equal dollar amounts. T/F

True

Auditing standards __ that the basis used to determine the preliminary judgment about materiality be documented in the audit files.

a. permit

b. do not allow

c. require

d. strongly encourage

c. require

What are potential basis in establishing planning materiality?

net income (profitable company), revenue (losses/non-profit), net assets (losses/non-profit)

What are percentage ranges for each base?

Net Income: 5-10%, Revenues & Net Assets: 1-3%

Would you pick a higher or lower materiality for a company with a net loss?

lower b/c loss indicates that significant proportion of fina missstmts could have material impact on financial health

If company investors apply pressure, would you pick a higher or lower materiality?

lower b/c pressure could lead to intentional misstatements

If a company has maintained a strong focus on its core values of its company culture, such as integrity, ethical business practices, and sustainability, would you pick a higher or lower materiality?

higher b/c maintaining good company culture indicates the risk of material misstmt is lower so less evidence needed