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Auditing & Assurance Services William Messier 11th Edition – Test Bank
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Auditing & Assurance Services: A Systematic Approach, 11e (Messier)
Chapter 2 The Financial Statement Auditing Environment
1) A series of business and related auditing failures led to the passage of the Sarbanes-Oxley Act (2002).
Answer: TRUE
Difficulty: 1 Easy
Topic: A Decade of Challenge and Change for Financial Statement Auditors
Learning Objective: 02-04 Understand the significant changes that have taken place in the auditing profession over the past two decades.
Bloom’s: Remember
AACSB: Communication
AICPA: BB Legal; FN Measurement
2) The primary audit context with which an auditor is concerned is the auditee’s industry or business.
Answer: TRUE
Difficulty: 1 Easy
Topic: A Model of Business
Learning Objective: 02-06 Recognize that an audit is shaped by the auditee’s business, industry, and economic environment and understand the essential components and processes characteristic of most business entities.
Bloom’s: Remember
AACSB: Communication
AICPA: BB Industry; FN Decision Making
3) The audit committee generally includes senior executives of the organization.
Answer: FALSE
Difficulty: 1 Easy
Topic: A Model of Business
Learning Objective: 02-06 Recognize that an audit is shaped by the auditee’s business, industry, and economic environment and understand the essential components and processes characteristic of most business entities.
Bloom’s: Remember
AACSB: Communication
AICPA: BB Industry; FN Reporting
4) A financial statement audit is generally organized based on the five basic business processes or cycles.
Answer: TRUE
Difficulty: 1 Easy
Topic: A Model of Business
Learning Objective: 02-07 Be familiar with a five-component model of business processes used to organize an audit.
Bloom’s: Remember
AACSB: Communication
AICPA: BB Industry; FN Decision Making
5) One of the five basic business processes is the warehousing cycle.
Answer: FALSE
Difficulty: 1 Easy
Topic: A Model of Business
Learning Objective: 02-07 Be familiar with a five-component model of business processes used to organize an audit.
Bloom’s: Remember
AACSB: Communication
AICPA: BB Industry; FN Decision Making
6) The ASB’s auditing standards contain a preface that includes Principles Underlying an Audit Conducted in Accordance with GAAS.
Answer: TRUE
Difficulty: 1 Easy
Topic: Auditing Standards
Learning Objective: 02-09 Understand that auditing standards are established by both U.S. and international standard setters.; 02-10 Be familiar with the “principles underlying an audit conducted in accordance with generally accepted auditing standards.”
Bloom’s: Remember
AACSB: Communication
AICPA: BB Legal; FN Reporting
7) PCAOB auditing standards must be followed on all financial statement audits performed in the U.S.
Answer: FALSE
Difficulty: 1 Easy
Topic: A Model of Business
Learning Objective: 02-08 Identify and be familiar with the major organizations that affect the public accounting profession’s environment.
Bloom’s: Understand
AACSB: Communication
AICPA: BB Legal; FN Reporting
8) A financial statement audit must be conducted based on GAAP.
Answer: FALSE
Difficulty: 1 Easy
Topic: Auditing Standards
Learning Objective: 02-09 Understand that auditing standards are established by both U.S. and international standard setters.; 02-10 Be familiar with the “principles underlying an audit conducted in accordance with generally accepted auditing standards.”
Bloom’s: Understand
AACSB: Communication
AICPA: BB Legal; FN Reporting
9) Generally, the financial statements of U.S. companies must be prepared based on GAAP.
Answer: TRUE
Difficulty: 1 Easy
Topic: Auditing Standards
Learning Objective: 02-09 Understand that auditing standards are established by both U.S. and international standard setters.; 02-10 Be familiar with the “principles underlying an audit conducted in accordance with generally accepted auditing standards.”
Bloom’s: Understand
AACSB: Communication
AICPA: BB Legal; FN Reporting
10) PCAOB auditing standards must be followed on all audits of public companies’ financial statements.
Answer: TRUE
Difficulty: 1 Easy
Topic: A Model of Business
Learning Objective: 02-08 Identify and be familiar with the major organizations that affect the public accounting profession’s environment.
Bloom’s: Remember
AACSB: Communication
AICPA: BB Legal; FN Reporting
11) The Audit Committee consists of:
- A) members of management.
- B) a subcommittee of the AICPA who establish the SAS.
- C) members of the Board of Directors.
- D) appointed government overseers.
Answer: C
Difficulty: 1 Easy
Topic: A Model of Business
Learning Objective: 02-06 Recognize that an audit is shaped by the auditee’s business, industry, and economic environment and understand the essential components and processes characteristic of most business entities.
Bloom’s: Remember
AACSB: Analytical Thinking
AICPA: FN Measurement; BB Critical Thinking
12) What organization is responsible for setting auditing standards for audits of publicly-traded companies in the U.S.?
- A) AICPA.
- B) FASB.
- C) GASB.
- D) PCAOB.
Answer: D
Difficulty: 1 Easy
Topic: A Model of Business
Learning Objective: 02-08 Identify and be familiar with the major organizations that affect the public accounting profession’s environment.
Bloom’s: Remember
AACSB: Communication
AICPA: BB Legal; FN Reporting
13) The Public Company Accounting Oversight Board’s role is to:
- A) conduct the final review of auditors’ work before the auditor’s opinion is issued.
- B) oversee the auditors of public companies in order to protect the interests of investors.
- C) conduct audits of governmental entities.
- D) sanction auditors who fail to follow GAAS.
Answer: B
Difficulty: 1 Easy
Topic: A Model of Business
Learning Objective: 02-08 Identify and be familiar with the major organizations that affect the public accounting profession’s environment.
Bloom’s: Remember
AACSB: Communication
AICPA: BB Legal; FN Reporting
14) The authoritative body designed 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:
- A) financial accounting standards board.
- B) general accounting office.
- C) public company accounting oversight board.
- D) auditing standards board.
Answer: C
Difficulty: 1 Easy
Topic: A Model of Business
Learning Objective: 02-08 Identify and be familiar with the major organizations that affect the public accounting profession’s environment.
Bloom’s: Remember
AACSB: Communication
AICPA: BB Legal; FN Reporting
15) The auditor must be independent of the auditee unless:
- A) the lack of independence does not influence his or her professional judgment.
- B) both parties agree that the independence issue is not a problem.
- C) the lack of independence is insignificant.
- D) none of the above—the auditor cannot lack independence.
Answer: D
Difficulty: 2 Medium
Topic: Auditing Standards
Learning Objective: 02-09 Understand that auditing standards are established by both U.S. and international standard setters.; 02-10 Be familiar with the “principles underlying an audit conducted in accordance with generally accepted auditing standards.”
Bloom’s: Apply
AACSB: Analytical Thinking
AICPA: BB Legal; FN Decision Making
16) 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?
- A) Purpose of an Audit and Premise upon which an Audit is Conducted.
- B) Performance.
- C) Reporting.
- D) Responsibilities.
Answer:B
Difficulty: 1 Easy
Topic: Auditing Standards
Learning Objective: 02-09 Understand that auditing standards are established by both U.S. and international standard setters.; 02-10 Be familiar with the “principles underlying an audit conducted in accordance with generally accepted auditing standards.”
Bloom’s: Remember
AACSB: Analytical Thinking
AICPA: FN Decision Making; BB Resource Management
17) 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?
- A) The purpose and value of a financial statement audit and lays out the responsibilities of management for an effective audit to be possible.
- B) The fundamental responsibilities and characteristics of an auditor.
- C) Auditors’ responsibilities in performing an effective audit.
- D) Auditors provide a written report that expresses their opinion about the financial statements.
Answer: C
Difficulty: 1 Easy
Topic: Auditing Standards; Auditing, Ethics, and the Code of Professional Conduct
Learning Objective: 02-09 Understand that auditing standards are established by both U.S. and international standard setters.; 02-10 Be familiar with the “principles underlying an audit conducted in accordance with generally accepted auditing standards.”; 02-12 Understand that the auditing profession places a premium on ethical behavior and is governed by a Code of Professional Conduct.
Bloom’s: Understand
AACSB: Analytical Thinking
AICPA: BB Legal; FN Decision Making
18) The Responsibilities section of the Principles Underlying an Audit Conducted in Accordance with GAAS states that auditors are responsible for having appropriate competence and:
- A) independence with respect to the financial statements and supplementary disclosures.
- B) exercising professional care as judged by peer reviewers.
- C) capabilities to perform the audit.
- D) objectivity as an auditor as verified by proper supervision.
Answer: C
Difficulty: 1 Easy
Topic: Auditing Standards; Auditing, Ethics, and the Code of Professional Conduct
Learning Objective: 02-09 Understand that auditing standards are established by both U.S. and international standard setters.; 02-10 Be familiar with the “principles underlying an audit conducted in accordance with generally accepted auditing standards.”; 02-12 Understand that the auditing profession places a premium on ethical behavior and is governed by a Code of Professional Conduct.
Bloom’s: Remember
AACSB: Analytical Thinking
AICPA: FN Decision Making; BB Resource Management
19) 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:
- A) a statement of fact by the auditor.
- B) an opinion by the auditor.
- C) an implied measure of fairness.
- D) an objective measure of compliance.
Answer: B
Difficulty: 1 Easy
Topic: Auditing Standards
Learning Objective: 02-09 Understand that auditing standards are established by both U.S. and international standard setters.; 02-10 Be familiar with the “principles underlying an audit conducted in accordance with generally accepted auditing standards.”
Bloom’s: Understand
AACSB: Communication
AICPA: BB Legal; FN Reporting
20) 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:
- A) objective cynicism.
- B) independent differentialism.
- C) professional skepticism.
- D) impartial conservatism.
Answer: C
Difficulty: 2 Medium
Topic: Auditing, Ethics, and the Code of Professional Conduct; Society’s Expectations and the Auditor’s Responsibilities
Learning Objective: 02-12 Understand that the auditing profession places a premium on ethical behavior and is governed by a Code of Professional Conduct.; 02-05 Know that management is primarily responsible for the entity’s financial statements and understand the auditor’s responsibility for detecting errors, material fraud, and illegal acts.
Bloom’s: Apply
AACSB: Analytical Thinking
AICPA: BB Legal; FN Risk Analysis
21) 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:
- A) the stock exchange officials.
- B) the independent auditor.
- C) the company’s management.
- D) the securities and exchange commission.
Answer: C
Difficulty: 1 Easy
Topic: Society’s Expectations and the Auditor’s Responsibilities
Learning Objective: 02-05 Know that management is primarily responsible for the entity’s financial statements and understand the auditor’s responsibility for detecting errors, material fraud, and illegal acts.
Bloom’s: Remember
AACSB: Communication
AICPA: BB Legal; FN Reporting
22) The primary responsibility for the adequacy of disclosures in the financial statements of a publicly held company rests with the:
- A) partner assigned to the audit engagement.
- B) management of the company.
- C) auditor in charge of the fieldwork.
- D) securities and exchange commission.
Answer: B
Difficulty: 1 Easy
Topic: Society’s Expectations and the Auditor’s Responsibilities
Learning Objective: 02-05 Know that management is primarily responsible for the entity’s financial statements and understand the auditor’s responsibility for detecting errors, material fraud, and illegal acts.
Bloom’s: Remember
AACSB: Communication
AICPA: BB Legal; FN Reporting
23) The largest public accounting firms typically are structured as:
- A) subchapter S corporations.
- B) professional corporations.
- C) limited liability partnerships.
- D) limited liability corporations.
Answer: C
Difficulty: 1 Easy
Topic: Accounting Firms and Audit Teams
Learning Objective: 02-03 Understand the organization of public accounting firms and the composition of audit teams.
Bloom’s: Remember
AACSB: Communication
AICPA: BB Legal; FN Research
24) Typically, an external auditor first gets supervisory experience at what level of authority?
- A) Associate.
- B) Senior.
- C) Manager.
- D) Partner.
Answer: B
Difficulty: 1 Easy
Topic: Accounting Firms and Audit Teams
Learning Objective: 02-03 Understand the organization of public accounting firms and the composition of audit teams.
Bloom’s: Remember
AACSB: Communication
AICPA: FN Measurement; BB Resource Management
25) An “in-charge” auditor typically holds the rank of:
- A) associate.
- B) senior.
- C) manager.
- D) partner.
Answer: B
Difficulty: 1 Easy
Topic: Accounting Firms and Audit Teams
Learning Objective: 02-03 Understand the organization of public accounting firms and the composition of audit teams.
Bloom’s: Remember
AACSB: Communication
AICPA: FN Measurement; BB Resource Management
26) Which of the following best describes the concept of risk assessment on which auditors can provide independent assurance?
- A) The risk that financial statements are misstated because of fraud.
- B) The risk that financial statements are misstated because of error or fraud.
- C) Whether management has systems in place to evaluate and effectively manage the entity’s business risks.
- D) Developing client acceptance and continuance practices that minimize the likelihood of lawsuits against the auditor.
Answer: C
Difficulty: 1 Easy
Topic: Types of Other Audit, Attest, and Assurance Services
Learning Objective: 02-02 Be familiar with the various types of audit, attest, and assurance services offered by accounting professionals.
Bloom’s: Apply
AACSB: Analytical Thinking
AICPA: BB Critical Thinking; FN Risk Analysis
27) Forensic audits include all of the following except:
- A) criminal investigations.
- B) manufacturers’ assertions about product quality.
- C) employee fraud.
- D) management fraud.
Answer: B
Difficulty: 1 Easy
Topic: Types of Other Audit, Attest, and Assurance Services
Learning Objective: 02-02 Be familiar with the various types of audit, attest, and assurance services offered by accounting professionals.
Bloom’s: Understand
AACSB: Communication
AICPA: BB Industry; FN Leveraging Technology
28) A typical objective of an operational audit is for the auditor to:
- A) determine whether the financial statements present fairly the entity’s operations.
- B) evaluate the feasibility of attaining the entity’s operational objectives.
- C) make recommendations for improving performance.
- D) report on the entity’s relative success in attaining profit maximization.
Answer: C
Difficulty: 1 Easy
Topic: Types of Other Audit, Attest, and Assurance Services
Learning Objective: 02-02 Be familiar with the various types of audit, attest, and assurance services offered by accounting professionals.
Bloom’s: Remember
AACSB: Communication
AICPA: BB Industry; FN Leveraging Technology
29) 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:
- A) monetary stimulus.
- B) evaluation.
- C) accuracy.
- D) compliance.
Answer: D
Difficulty: 1 Easy
Topic: Types of Other Audit, Attest, and Assurance Services
Learning Objective: 02-02 Be familiar with the various types of audit, attest, and assurance services offered by accounting professionals.
Bloom’s: Remember
AACSB: Communication
AICPA: BB Industry; FN Leveraging Technology
30) External auditors are referred to as “external” because:
- A) they report to users outside of the audited entity.
- B) they are paid by parties outside of the audited entity.
- C) they are not employees of the entity being audited.
- D) their offices are not at the entity’s place of business.
Answer: C
Difficulty: 1 Easy
Topic: Types of Auditors
Learning Objective: 02-01 Be familiar with the different types of auditors.
Bloom’s: Understand
AACSB: Communication
AICPA: BB Industry; FN Decision Making
31) Which is NOT an attribute of an external auditor?
- A) Independence.
- B) Auditee advocacy.
- C) Objectivity.
- D) Concern for the public interest.
Answer: B
Difficulty: 1 Easy
Topic: Types of Auditors
Learning Objective: 02-01 Be familiar with the different types of auditors.
Bloom’s: Remember
AACSB: Communication
AICPA: BB Industry; FN Decision Making
32) What is the general character of the work conducted in performing a forensic audit for a company?
- A) Providing assurance that the financial statements are not materially misstated.
- B) Detecting or deterring fraudulent activity.
- C) Offering an opinion on the reliability of the specific assertions made by management.
- D) Identifying the causes of an entity’s financial difficulties.
Answer: B
Difficulty: 1 Easy
Topic: Types of Other Audit, Attest, and Assurance Services
Learning Objective: 02-02 Be familiar with the various types of audit, attest, and assurance services offered by accounting professionals.
Bloom’s: Understand
AACSB: Communication
AICPA: BB Industry; FN Leveraging Technology
33) Which of the following is NOT a requirement of the Sarbanes-Oxley Act?
- A) Audit firms cannot provide most types of nonaudit services to their public company auditees.
- B) Audit firms are required to rotate audit partners off audit engagements every five years for public company audits.
- C) Firms that audit public companies are subject to inspection by the PCAOB.
- D) A certain number of hours, which is based on the size of the company being audited, must be spent on each audit engagement.
Answer: D
Difficulty: 2 Medium
Topic: A Decade of Challenge and Change for Financial Statement Auditors; A Model of Business
Learning Objective: 02-04 Understand the significant changes that have taken place in the auditing profession over the past two decades.; 02-08 Identify and be familiar with the major organizations that affect the public accounting profession’s environment.
Bloom’s: Remember
AACSB: Communication
AICPA: BB Legal; FN Reporting
34) 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:
- A) the nature of the CPA’s report qualification.
- B) the scope of the CPA’s auditing procedures.
- C) requirements for the review of the entity and its environment.
- D) whether the CPA should undertake an audit engagement.
Answer: D
Difficulty: 2 Medium
Topic: A Model of Business; Auditing Standards
Learning Objective: 02-06 Recognize that an audit is shaped by the auditee’s business, industry, and economic environment and understand the essential components and processes characteristic of most business entities.; 02-09 Understand that auditing standards are established by both U.S. and international standard setters.; 02-10 Be familiar with the “principles underlying an audit conducted in accordance with generally accepted auditing standards.”
Bloom’s: Apply
AACSB: Communication
AICPA: BB Legal; FN Decision Making
35) Who bears ultimate responsibility for the financial statements?
- A) Management of the organization, equally with the external auditor that audits the statements.
- B) Management and the shareholders of the organization.
- C) The external auditor that audits the statements.
- D) Management of the organization.
Answer: D
Difficulty: 1 Easy
Topic: Society’s Expectations and the Auditor’s Responsibilities
Learning Objective: 02-05 Know that management is primarily responsible for the entity’s financial statements and understand the auditor’s responsibility for detecting errors, material fraud, and illegal acts.
Bloom’s: Remember
AACSB: Analytical Thinking
AICPA: BB Legal; FN Measurement
36) The Responsibilities section of the Principles Underlying an Audit Conducted in Accordance with GAAS is concerned with:
- A) proper planning and supervision, appropriate materiality levels, and sufficient appropriate audit evidence.
- B) 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.
- C) whether the auditor has unrestricted access to those within the entity from whom the auditor needs to obtain audit evidence.
- D) complying with ethical requirement, appropriate competence and maintaining professional skepticism.
Answer: D
Difficulty: 2 Medium
Topic: Auditing Standards
Learning Objective: 02-09 Understand that auditing standards are established by both U.S. and international standard setters.; 02-10 Be familiar with the “principles underlying an audit conducted in accordance with generally accepted auditing standards.”
Bloom’s: Remember
AACSB: Communication
AICPA: BB Legal; FN Measurement
37) 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:
- A) business and finance courses.
- B) quality control and peer review.
- C) education and experience in auditing.
- D) supervision and review skills.
Answer: C
Difficulty: 2 Medium
Topic: Auditing Standards
Learning Objective: 02-09 Understand that auditing standards are established by both U.S. and international standard setters.; 02-10 Be familiar with the “principles underlying an audit conducted in accordance with generally accepted auditing standards.”
Bloom’s: Understand
AACSB: Diversity
AICPA: FN Decision Making; BB Marketing
38) The main difference between SAS and AU is:
- A) they are the same except that SAS are organized chronologically and the AU are organized by topical area.
- B) SAS are issued by the ASB and AU are issued by the PCAOB.
- C) SAS are issued by the PCAOB and AU are issued by the ASB.
- D) SAS define minimum standards of performance for auditors while AU define financial accounting principles that must be followed according to GAAP.
Answer: A
Difficulty: 2 Medium
Topic: Auditing Standards
Learning Objective: 02-11 Understand the nature of auditing standards.
Bloom’s: Analyze
AACSB: Communication
AICPA: FN Decision Making; BB Resource Management
39) The AICPA’s Statements on Auditing Standards can be described as:
- A) providing very specific guidance about the specific activities an auditor must perform on each engagement.
- B) similar to financial accounting standards in that they are developed by the government.
- C) tend to be general in nature and require a great deal of professional judgment.
- D) providing assurance that an auditor will not issue an incorrect opinion.
Answer: C
Difficulty: 2 Medium
Topic: Auditing Standards
Learning Objective: 02-11 Understand the nature of auditing standards.
Bloom’s: Understand
AACSB: Communication
AICPA: BB Legal; FN Measurement
40) Due professional care requires auditors to:
- A) obtain independent, third party (non-auditee) documentation as evidence for all information presented in the financial statements.
- B) exercise professional skepticism during the audit.
- C) disregard any evidence generated by the auditee during the audit.
- D) find every error contained in the financial statements prepared by management.
Answer: B
Difficulty: 2 Medium
Topic: Society’s Expectations and the Auditor’s Responsibilities
Learning Objective: 02-05 Know that management is primarily responsible for the entity’s financial statements and understand the auditor’s responsibility for detecting errors, material fraud, and illegal acts.
Bloom’s: Understand
AACSB: Communication
AICPA: BB Legal; FN Decision Making
41) 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:
- A) an opinion statement of whether the financial statements present fairly.
- B) an opinion statement of whether the financials are free of material misstatements.
- C) an opinion statement of whether the financials are in accordance with an applicable financial reporting framework.
- D) an opinion statement of whether the financial statements between periods are not materially affected by changes in accounting principles that are not disclosed.
Answer: D
Difficulty: 2 Medium
Topic: Auditing Standards
Learning Objective: 02-09 Understand that auditing standards are established by both U.S. and international standard setters.; 02-10 Be familiar with the “principles underlying an audit conducted in accordance with generally accepted auditing standards.”
Bloom’s: Understand
AACSB: Analytical Thinking
AICPA: BB Legal; FN Measurement
42) An internal auditor is likely to be more concerned with ________ than the external auditor.
- A) internal administrative procedures
- B) cost accounting procedures
- C) the efficiency of operations
- D) internal control
Answer: C
Difficulty: 2 Medium
Topic: Types of Other Audit, Attest, and Assurance Services; Types of Auditors
Learning Objective: 02-02 Be familiar with the various types of audit, attest, and assurance services offered by accounting professionals.; 02-01 Be familiar with the different types of auditors.
Bloom’s: Apply
AACSB: Analytical Thinking
AICPA: BB Industry; FN Risk Analysis
43) Which of the following is NOT included in the broad category of assurance services?
- A) Operational audit.
- B) Reporting on internal control.
- C) Accounting or review services.
- D) Evaluation of the auditee’s risk management framework.
Answer: C
Difficulty: 2 Medium
Topic: Types of Other Audit, Attest, and Assurance Services
Learning Objective: 02-02 Be familiar with the various types of audit, attest, and assurance services offered by accounting professionals.
Bloom’s: Apply
AACSB: Communication
AICPA: BB Industry; FN Reporting
44) Which of the following is NOT explicitly a part of the IIA’s definition of internal auditing?
- A) Internal auditing is an objective assurance activity.
- B) Internal auditing is a consulting activity.
- C) Internal auditing should help an organization accomplish its objectives.
- D) Internal auditors should help external auditors complete the annual financial statement audit.
Answer: D
Difficulty: 1 Easy
Topic: Types of Auditors
Learning Objective: 02-01 Be familiar with the different types of auditors.
Bloom’s: Remember
AACSB: Communication
AICPA: BB Industry; FN Research
45) Which of the following statements regarding the PCAOB is incorrect?
- A) It is a public-sector, nonprofit corporation.
- B) It is overseen by the SEC.
- C) It sets standards for public company audits.
- D) It has delegated all of its standard-setting authority to the AICPA.
Answer: D
Difficulty: 2 Medium
Topic: A Model of Business
Learning Objective: 02-08 Identify and be familiar with the major organizations that affect the public accounting profession’s environment.
Bloom’s: Remember
AACSB: Communication
AICPA: BB Legal; FN Decision Making
46) Due professional care requires:
- A) auditors to maintain an attitude that includes a questioning mind and a critical assessment of audit evidence.
- B) the examination of all available corroborating evidence.
- C) the exercise of error-free judgment.
- D) a study and review of internal controls that includes tests of controls.
Answer: A
Difficulty: 1 Easy
Topic: Society’s Expectations and the Auditor’s Responsibilities
Learning Objective: 02-05 Know that management is primarily responsible for the entity’s financial statements and understand the auditor’s responsibility for detecting errors, material fraud, and illegal acts.
Bloom’s: Remember
AACSB: Ethics
AICPA: FN Decision Making; BB Critical Thinking
47) Which of the following best describes the role of corporate governance?
- A) Management decides which accounting principles are the most appropriate.
- B) Shareholders vote to decide who should be members of the board of directors.
- C) Holding the management team accountable to shareholders and other constituents for the utilization of the entity’s resources.
- D) Management often is compensated based on the company’s profitability.
Answer: C
Difficulty: 3 Hard
Topic: A Model of Business
Learning Objective: 02-06 Recognize that an audit is shaped by the auditee’s business, industry, and economic environment and understand the essential components and processes characteristic of most business entities.
Bloom’s: Understand
AACSB: Communication
AICPA: BB Industry; FN Decision Making
48) The Performance section of Principles Underlying an Audit Conducted in Accordance with GAAS states that the auditor is unable to obtain absolute assurance that the financials are free of material misstatements because of inherent limitations which arise from all of the following except:
- A) the presentation of the financial statements based on GAAS.
- B) the nature of financial reporting.
- C) the nature of audit procedures.
- D) the need for the audit to be conducted within a reasonable period of time and so as to achieve a balance between benefit and cost.
Answer: A
Difficulty: 2 Medium
Topic: Auditing Standards
Learning Objective: 02-09 Understand that auditing standards are established by both U.S. and international standard setters.; 02-10 Be familiar with the “principles underlying an audit conducted in accordance with generally accepted auditing standards.”
Bloom’s: Understand
AACSB: Analytical Thinking
AICPA: BB Legal; FN Decision Making
49) Which of the following best describes what is meant by generally accepted auditing standards?
- A) Audit assertions generally determined on audit engagements.
- B) Acts to be performed by the auditor.
- C) Standards of quality for the auditor’s performance.
- D) Procedures to be used to gather evidence to support financial statements.
Answer: C
Difficulty: 3 Hard
Topic: Auditing Standards
Learning Objective: 02-09 Understand that auditing standards are established by both U.S. and international standard setters.; 02-10 Be familiar with the “principles underlying an audit conducted in accordance with generally accepted auditing standards.”
Bloom’s: Understand
AACSB: Analytical Thinking
AICPA: BB Legal; FN Measurement
50) 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:
- A) the preparation and fair presentation of the financial statement in accordance with the applicable financial reporting framework.
- B) the design, implementation, and maintenance of internal control.
- C) providing financial statement users with an opinion on whether the financial statements present fairly.
- D) ensuring that the financial statements are free from material misstatement, whether due to error or fraud.
Answer: C
Difficulty: 3 Hard
Topic: Auditing Standards
Learning Objective: 02-09 Understand that auditing standards are established by both U.S. and international standard setters.; 02-10 Be familiar with the “principles underlying an audit conducted in accordance with generally accepted auditing standards.”
Bloom’s: Understand
AACSB: Communication
AICPA: BB Legal; FN Reporting
51) 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:
- A) make sure all audit team members have adequate training.
- B) obtain sufficient appropriate audit evidence.
- C) identify and assess risks of material misstatement.
- D) determine and apply appropriate materiality levels.
Answer: A
Difficulty: 3 Hard
Topic: Auditing Standards
Learning Objective: 02-09 Understand that auditing standards are established by both U.S. and international standard setters.; 02-10 Be familiar with the “principles underlying an audit conducted in accordance with generally accepted auditing standards.”
Bloom’s: Remember
AACSB: Communication
AICPA: BB Legal; FN Reporting
52) 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:
- A) an auditor from reporting on one basic financial statement and not the others.
- B) an auditor from expressing different opinions on each of the basic financial statements.
- C) management from reducing its final responsibility for the basic financial statements.
- D) misinterpretations regarding the degree of responsibility the auditor is assuming.
Answer: D
Difficulty: 3 Hard
Topic: Auditing Standards
Learning Objective: 02-09 Understand that auditing standards are established by both U.S. and international standard setters.; 02-10 Be familiar with the “principles underlying an audit conducted in accordance with generally accepted auditing standards.”
Bloom’s: Understand
AACSB: Communication
AICPA: BB Legal; FN Reporting
53) The Performance section of the “Principles Underlying an Audit” is concerned with:
- A) proper planning and supervision, appropriate materiality levels, and sufficient appropriate audit evidence.
- B) 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.
- C) whether the auditor has unrestricted access to those within the entity from whom the auditor needs to obtain audit evidence.
- D) complying with ethical requirement, appropriate competence and maintaining professional skepticism.
Answer: A
Difficulty: 2 Medium
Topic: Auditing Standards
Learning Objective: 02-09 Understand that auditing standards are established by both U.S. and international standard setters.; 02-10 Be familiar with the “principles underlying an audit conducted in accordance with generally accepted auditing standards.”
Bloom’s: Remember
AACSB: Communication
AICPA: BB Legal; FN Research
54) The Reporting section of the “Principles Underlying an Audit” is concerned with:
- A) proper planning and supervision, appropriate materiality levels, and sufficient appropriate audit evidence.
- B) 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.
- C) whether the auditor has unrestricted access to those within the entity from whom the auditor needs to obtain audit evidence.
- D) complying with ethical requirements, appropriate competence and maintaining professional skepticism.
Answer: B
Difficulty: 2 Medium
Topic: Auditing Standards
Learning Objective: 02-09 Understand that auditing standards are established by both U.S. and international standard setters.; 02-10 Be familiar with the “principles underlying an audit conducted in accordance with generally accepted auditing standards.”
Bloom’s: Remember
AACSB: Communication
AICPA: BB Legal; FN Research
55) The IAASB and the ASB have collaborated on the principles underlying an audit conducted in accordance with generally accepted auditing standards. These principles are grouped into four categories. What are the four categories?
Answer: The four categories of principles are:
- Purpose and premise of an audit;
- Personal responsibilities of the auditor;
- Auditor actions in performing the audit; and
- Reporting.
Difficulty: 1 Easy
Topic: Auditing Standards
Learning Objective: 02-09 Understand that auditing standards are established by both U.S. and international standard setters.; 02-10 Be familiar with the “principles underlying an audit conducted in accordance with generally accepted auditing standards.”
Bloom’s: Remember
AACSB: Communication
AICPA: BB Legal; FN Reporting
56) The principles underlying an audit conducted in accordance with generally accepted auditing standards are grouped into four categories. The second category is that of “personal responsibility of the auditor.” Generally explain what is intended by this principle.
Answer: Auditors are responsible for having appropriate competence and capabilities to perform the audit; complying with relevant ethical requirements; and maintaining professional skepticism and exercising professional judgment, throughout the planning and performance of the audit.
Difficulty: 2 Medium
Topic: Auditing Standards
Learning Objective: 02-09 Understand that auditing standards are established by both U.S. and international standard setters.; 02-10 Be familiar with the “principles underlying an audit conducted in accordance with generally accepted auditing standards.”
Bloom’s: Understand
AACSB: Communication
AICPA: BB Legal; FN Reporting
57) You are the owner of a small grocery store, Corner Marketplace. Explain the five process categories and how they apply to your business.
Answer:
Financing: The financing process involves loans or shareholder capital financing for assets such as land, buildings, and equipment. Corner Marketplace may have a bank loan or lease for its store. It may also have solicited other means of financing, such as additional owner funds. Purchasing: Businesses acquire goods and services to support the sale of their own goods or services through the purchasing process. Corner Marketplace would purchase food inventory to sell to customers. It might also need to purchase display cases, freezers, etc. to store and display the inventory.
Human Resource Management: Business organizations hire personnel to perform various functions in accordance with the enterprise’s mission and strategy. Corner Marketplace should have established policies for hiring, training, evaluating, counseling, promoting, compensating, and terminating employees.
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.
Revenue: Corner Marketplace would generate revenue through sales of food to customers and would collect the proceeds of those sales. Typically, a small grocery store would not have accounts receivables from customers, as customers would pay immediately. However, the revenue cycle includes cash receipts and credit card transactions.
Difficulty: 3 Hard
Topic: A Model of Business
Learning Objective: 02-06 Recognize that an audit is shaped by the auditee’s business, industry, and economic environment and understand the essential components and processes characteristic of most business entities.; 02-07 Be familiar with a five-component model of business processes used to organize an audit.
Bloom’s: Apply
AACSB: Analytical Thinking
AICPA: FN Measurement; BB Industry
58) Define corporate governance, the board of directors, and the audit committee and explain how they relate to each other.
Answer:Corporategovernance is all the people, processes, and activities in place to help ensure proper stewardship over an entity’s assets. The boardofdirectors is the body primarily responsible for management oversight in corporations. The auditcommittee oversees internal and external audit work done for an entity.
The board of directors plays a part in ensuring proper corporate governance by holding management responsible for the usage of the entity’s assets. The audit committee is made up of members of the board of directors. The audit committee enhances corporate governance by holding management accountable for its activities through audits of its work.
Difficulty: 2 Medium
Topic: A Model of Business
Learning Objective: 02-06 Recognize that an audit is shaped by the auditee’s business, industry, and economic environment and understand the essential components and processes characteristic of most business entities.
Bloom’s: Understand
AACSB: Analytical Thinking
AICPA: FN Measurement; BB Critical Thinking
59) Describe the organizations involved in standard setting for auditors in the United States and what their respective roles are in setting current auditing standards for companies in the United States.
Answer: Most auditing standards were developed by the AICPA’s Accounting Standards Board (ASB). At that time, the profession was self-regulated. However, the Sarbanes-Oxley Act of 2002 transferred the authority to set auditing standards for public company audits to the Public Company Accounting Oversight Board (PCAOB), which is overseen by the Securities and Exchange Commission (SEC). However, the PCAOB adopted the ASB’s auditing standards on an interim basis. CPAs must still abide by the AICPA’s Code of Professional Conduct at all times. They must also follow auditing standards set by the ASB when performing audits of private companies and other nonpublic entities. The ASB has replaced the 10 GAAS with a more comprehensive and coherent description of the principles underlying an audit conducted in accordance with generally accepted auditing standards.
Difficulty: 3 Hard
Topic: A Decade of Challenge and Change for Financial Statement Auditors; A Model of Business; Auditing Standards
Learning Objective: 02-04 Understand the significant changes that have taken place in the auditing profession over the past two decades.; 02-09 Understand that auditing standards are established by both U.S. and international standard setters.; 02-10 Be familiar with the “principles underlying an audit conducted in accordance with generally accepted auditing standards.”; 02-08 Identify and be familiar with the major organizations that affect the public accounting profession’s environment.
Bloom’s: Understand
AACSB: Ethics
AICPA: BB Legal; FN Decision Making
60) 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?
Answer:
– Plans the work and properly supervises any assistants.
– Determines and applies appropriate materiality level or levels throughout the audit.
– Identifies and assesses risks of material misstatement, whether due to fraud or error, based on an understanding of the entity and its environment, including the entity’s internal control.
– Obtains sufficient appropriate audit evidence about whether material misstatements exist, through designing and implementing appropriate responses to the assessed risks.
Difficulty: 1 Easy
Topic: Auditing Standards
Learning Objective: 02-09 Understand that auditing standards are established by both U.S. and international standard setters.; 02-10 Be familiar with the “principles underlying an audit conducted in accordance with generally accepted auditing standards.”
Bloom’s: Apply
AACSB: Communication
AICPA: BB Legal; FN Measurement
61) Jane Goodperson performed an audit on the Quagmire Corporation and issued an unqualified opinion. Jane performed the audit with due professional care and in accordance with generally accepted auditing standards. Two months after the report is issued, Jane discovers on the news that the CEO of Quagmire, Johnny Best, had been stealing small amounts of inventory. The amount, however, is immaterial compared to the overall inventory of the corporation. Jane soon receives a call from Quagmire’s CFO, Mark Beastly. Mark wants Jane to refund her audit fees. Mark thinks Jane did not properly perform the audit, as she did not discover this fraud. Further, he feels that now Quagmire’s financial statements are not fairly stated because of Jane. How should Jane respond to this claim?
Answer: Jane should tell Mark that her responsibility was to plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether caused by error or fraud. She had no responsibility to plan and perform the audit to obtain reasonable assurance that misstatements, whether caused by errors or fraud, which are not material to the financial statements will be detected. Quagmire’s management, not Jane, has responsibility for the financial statements. In fact, because of the Sarbanes-Oxley Act of 2002, Mark had to assume explicit responsibility for the financial statements by “certifying” that he, as CFO, is responsible for establishing and maintaining internal control and that the financial statements fairly present the entity’s financial conditions and operations. This statement is probably still true, since the amount stolen was immaterial.
Difficulty: 2 Medium
Topic: Society’s Expectations and the Auditor’s Responsibilities
Learning Objective: 02-05 Know that management is primarily responsible for the entity’s financial statements and understand the auditor’s responsibility for detecting errors, material fraud, and illegal acts.
Bloom’s: Apply
AACSB: Communication
AICPA: BB Legal; FN Risk Analysis
62) Mike has just graduated from State University with a bachelor’s degree in accounting. He would like to pursue a career in auditing. What options does Mike have? Describe three auditing career options, including a description of the organization Mike would work for.
Answer:
External: Mike could become an external auditor. He would work for a CPA firm providing independent audits to nonpublic or public companies. Mike would need to pass the Uniform CPA Examination monitored by the American Institute of Certified Public Accountants. His state may have other requirements, such as 150 credit hours and experience.
Internal: Mike could also be an internal auditor. He would be directly employed by the entity for which he is performing audits. Internal auditors may conduct financial, internal control, compliance, operational, and forensic audits within their organization. Internal auditors are supported by the Institute of Internal Auditors.
Governmental: Another option for Mike is governmental auditing. This is essentially a form of internal auditing and Mike could be employed by federal (such as the Government Accountability Office or the Internal Revenue Service), state, or local agencies.
Forensic: Mike could also be a forensic auditor. Forensic auditors are employed by corporations, government agencies, public accounting firms, and consulting and investigative services firms. They are trained in detecting, investigating, and deterring fraud and white-collar crime and are supported by the Association of Certified Fraud Examiners.
Difficulty: 2 Medium
Topic: Types of Auditors
Learning Objective: 02-01 Be familiar with the different types of auditors.
Bloom’s: Remember
AACSB: Communication
AICPA: BB Industry; FN Decision Making
63) With respect to an entity’s financial statements, describe both the responsibility of management and that of the auditor.
Answer: The financial statements are the responsibility of management. 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.
Difficulty: 1 Easy
Topic: Society’s Expectations and the Auditor’s Responsibilities
Learning Objective: 02-05 Know that management is primarily responsible for the entity’s financial statements and understand the auditor’s responsibility for detecting errors, material fraud, and illegal acts.
Bloom’s: Understand
AACSB: Communication
AICPA: FN Decision Making; BB Critical Thinking
64) What auditing standards are used to conduct an audit for a privately-held corporation? What auditing standards are used to conduct an audit for a publicly-traded corporation? What organization is responsible for setting each of these sets of standards?
Answer: Auditing standards developed by the AICPA’s Auditing Standards Board (ASB) are used to conduct an audit for a privately-held corporation or other entities that are nonpublic companies. This includes the principles underlying an audit conducted in accordance with generally accepted auditing standards and the ASB’s Statements on Auditing Standards (SAS).
Auditing standards developed by the Public Company Accounting Oversight Board (PCAOB) must be used to conduct an audit for a publicly-traded corporation. These standards include all those issued by the ASB through 2003, which were codified by the PCAOB, and any new standards issued by the PCAOB after that point.
Difficulty: 2 Medium
Topic: Auditing Standards
Learning Objective: 02-09 Understand that auditing standards are established by both U.S. and international standard setters.; 02-10 Be familiar with the “principles underlying an audit conducted in accordance with generally accepted auditing standards.”
Bloom’s: Remember
AACSB: Communication
AICPA: BB Legal; FN Reporting
65) There are several types of audit services that are provided by auditors. Identify and define three of these types of audits.
Answer: Financial Statement Audit: Auditors test the transactions, balances, and disclosures in a set of financial statements to determine if they are materially correct.
Internal Control Audit: Auditors test the internal controls of a company to determine whether the control system is functioning effectively (i.e., preventing, or detecting and correcting, misstatements in the financial statements).
Compliance Audit: Auditors test the extent to which rules, policies, laws, covenants, or government regulations are followed by the entity.
Operational Audit: Auditors review part or all of an organization’s activities to evaluate whether resources are being used effectively and efficiently. The auditor assesses the entity’s performance, identifies areas for improvement, and develops recommendations.
Forensic Audit: Auditors conduct forensic audits to detect or deter fraudulent activities.
Difficulty: 2 Medium
Topic: Types of Other Audit, Attest, and Assurance Services
Learning Objective: 02-02 Be familiar with the various types of audit, attest, and assurance services offered by accounting professionals.
Bloom’s: Remember
AACSB: Communication
AICPA: BB Industry; FN Reporting
Chapter 4 Risk Assessment
1) Audit risk is the auditor’s exposure to loss or injury of his or her reputation from events arising in connection with financial statements audited.
Answer: FALSE
Difficulty: 1 Easy
Topic: Audit Risk
Learning Objective: 04-01 Understand the concept of audit risk.
Bloom’s: Remember
AACSB: Communication
AICPA: BB Legal; FN Risk Analysis
2) Engagement risk is the auditor’s exposure to loss or injury of his or her reputation from events arising in connection with financial statements audited.
Answer: TRUE
Difficulty: 1 Easy
Topic: Audit Risk
Learning Objective: 04-02 Learn the form and components of the audit risk model.
Bloom’s: Remember
AACSB: Communication
AICPA: BB Legal; FN Risk Analysis
3) The components of the audit risk model include inherent risk, control risk, and detection risk.
Answer: TRUE
Difficulty: 1 Easy
Topic: Audit Risk
Learning Objective: 04-02 Learn the form and components of the audit risk model.
Bloom’s: Remember
AACSB: Communication
AICPA: BB Legal; FN Risk Analysis
4) Inherent risk is the susceptibility of an assertion to material misstatement, assuming no related controls.
Answer: TRUE
Difficulty: 1 Easy
Topic: Audit Risk
Learning Objective: 04-02 Learn the form and components of the audit risk model.
Bloom’s: Remember
AACSB: Communication
AICPA: BB Legal; FN Risk Analysis
5) Professional judgment must be used when evaluating business risk.
Answer: TRUE
Difficulty: 1 Easy
Topic: Audit Risk
Learning Objective: 04-04 Understand the auditor’s risk assessment process.
Bloom’s: Understand
AACSB: Communication
AICPA: BB Legal; FN Risk Analysis
6) The risk of a material misstatement includes inherent risk and sampling risk.
Answer: FALSE
Difficulty: 1 Easy
Topic: Audit Risk
Learning Objective: 04-02 Learn the form and components of the audit risk model.
Bloom’s: Remember
AACSB: Communication
AICPA: BB Legal; FN Risk Analysis
7) The combination of inherent risk and control risk is referred to as client risk.
Answer: TRUE
Difficulty: 1 Easy
Topic: Audit Risk
Learning Objective: 04-02 Learn the form and components of the audit risk model.
Bloom’s: Understand
AACSB: Communication
AICPA: BB Legal; FN Risk Analysis
8) Inherent risk includes sampling risk and detection risk.
Answer: FALSE
Difficulty: 1 Easy
Topic: Audit Risk
Learning Objective: 04-02 Learn the form and components of the audit risk model.
Bloom’s: Understand
AACSB: Communication
AICPA: BB Legal; FN Risk Analysis
9) Engagement risk is:
- A) the risk of issuing an incorrect audit opinion.
- B) the auditor’s risk of loss from events arising in connection with financial statements audited and reported upon.
- C) the overall risk of material misstatement.
- D) the risk of the entity’s financial failure.
Answer: B
Difficulty: 1 Easy
Topic: Audit Risk
Learning Objective: 04-02 Learn the form and components of the audit risk model.
Bloom’s: Understand
AACSB: Communication
AICPA: BB Legal; FN Risk Analysis
10) Client risk as defined in the text is:
- A) the auditor’s risk of loss from events arising in connection with financial statements audited and reported upon.
- B) the overall risk of material misstatement.
- C) the risk that audit procedures will fail to detect material misstatements.
- D) the risk of the entity’s financial failure.
Answer: B
Difficulty: 1 Easy
Topic: Audit Risk
Learning Objective: 04-02 Learn the form and components of the audit risk model.
Bloom’s: Remember
AACSB: Communication
AICPA: BB Legal; FN Risk Analysis
11) Under Auditing Standards, which of the following would be classified as an error?
- A) Misappropriation of assets for the benefit of management.
- B) Misinterpretation by management of facts that existed when the financial statements were prepared.
- C) Preparation of records by employees to cover a fraudulent scheme.
- D) Intentional omission of the recording of a transaction to benefit a third party.
Answer: B
Difficulty: 1 Easy
Topic: Assessing the Risk of Material Misstatement
Learning Objective: 04-06 Understand the fraud risk assessment process.
Bloom’s: Apply
AACSB: Ethics
AICPA: BB Legal; FN Decision Making
12) 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:
- A) susceptible to bias.
- B) consistent with prior periods.
- C) insensitive to variations.
- D) similar to industry guidelines.
Answer: A
Difficulty: 1 Easy
Topic: The Auditor’s Risk Assessment Process
Learning Objective: 04-04 Understand the auditor’s risk assessment process.
Bloom’s: Apply
AACSB: Analytical Thinking
AICPA: FN Risk Analysis; BB Critical Thinking
13) Which of the following characteristics most likely would heighten an auditor’s concern about the risk of intentional manipulation of financial statements?
- A) Turnover of senior accounting personnel is low.
- B) Insiders recently purchased additional shares of the entity’s stock.
- C) Management places substantial emphasis on meeting earnings projections.
- D) The rate of change in the entity’s industry is slow.
Answer: C
Difficulty: 1 Easy
Topic: Assessing the Risk of Material Misstatement
Learning Objective: 04-06 Understand the fraud risk assessment process.
Bloom’s: Apply
AACSB: Analytical Thinking
AICPA: FN Risk Analysis; BB Critical Thinking
14) Which of the following is a factual misstatement?
- A) A management estimate that is outside the range of reasonable outcomes determined by the auditor.
- B) A fixed asset being recorded at the incorrect cost.
- C) A projected misstatement resulting from errors found during sampling.
- D) Difference in judgment between the auditor and management.
Answer: B
Difficulty: 2 Medium
Topic: Assessing the Risk of Material Misstatement
Learning Objective: 04-05 Learn how the auditor assesses the risk of material misstatement.
Bloom’s: Remember
AACSB: Analytical Thinking
AICPA: BB Critical Thinking; FN Measurement
15) Engagement risk can be eliminated by:
- A) establishing policies for client acceptance and continuance.
- B) lowering audit risk.
- C) lowering materiality.
- D) Engagement risk cannot be eliminated.
Answer: D
Difficulty: 2 Medium
Topic: Audit Risk
Learning Objective: 04-02 Learn the form and components of the audit risk model.
Bloom’s: Analyze
AACSB: Communication
AICPA: BB Legal; FN Risk Analysis
16) The achieved (actual) level of audit risk:
- A) can always be accurately assessed by the auditor.
- B) should be greater than or equal to acceptable audit risk.
- C) can never be known with certainty.
- D) is the same for all audit engagements.
Answer: C
Difficulty: 2 Medium
Topic: Audit Risk
Learning Objective: 04-02 Learn the form and components of the audit risk model.
Bloom’s: Understand
AACSB: Analytical Thinking
AICPA: FN Risk Analysis; BB Critical Thinking
17) An auditor knows that an audit client operating in an industry in which common stock is valued based on the price-earnings ratio will soon make an initial public offering. All of the following are true except:
- A) materiality should be reduced.
- B) risk of material misstatement should increase.
- C) detection risk should decrease.
- D) audit risk should increase.
Answer: D
Difficulty: 3 Hard
Topic: Audit Risk; Assessing the Risk of Material Misstatement
Learning Objective: 04-02 Learn the form and components of the audit risk model.; 04-05 Learn how the auditor assesses the risk of material misstatement.; 04-03 Understand how to use the audit risk model.
Bloom’s: Analyze
AACSB: Analytical Thinking
AICPA: FN Risk Analysis; BB Industry
18) 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:
- A) sampling risk.
- B) detection risk.
- C) nonsampling risk.
- D) inherent risk.
Answer: B
Difficulty: 2 Medium
Topic: Audit Risk
Learning Objective: 04-02 Learn the form and components of the audit risk model.; 04-03 Understand how to use the audit risk model.
Bloom’s: Understand
AACSB: Analytical Thinking
AICPA: FN Risk Analysis; BB Critical Thinking
19) The risk of material misstatement differs from detection risk in that it:
- A) arises from the misapplication of auditing procedures.
- B) may be assessed in either quantitative or qualitative terms.
- C) exists independently of the actions of the auditor.
- D) can be changed at the auditor’s discretion.
Answer: C
Difficulty: 2 Medium
Topic: Audit Risk
Learning Objective: 04-02 Learn the form and components of the audit risk model.; 04-03 Understand how to use the audit risk model.
Bloom’s: Understand
AACSB: Analytical Thinking
AICPA: FN Risk Analysis; BB Critical Thinking
20) All of the following are inherent risk factors that are pervasive to the financial statements except:
- A) highly complex significant transactions.
- B) non-routine transactions.
- C) classes of transactions are not processed systematically.
- D) supplies inventory is difficult to count.
Answer: D
Difficulty: 2 Medium
Topic: Audit Risk
Learning Objective: 04-02 Learn the form and components of the audit risk model.; 04-03 Understand how to use the audit risk model.
Bloom’s: Analyze
AACSB: Analytical Thinking
AICPA: FN Risk Analysis; BB Industry
21) 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:
- A) extent of tests of controls.
- B) level of detection risk.
- C) extent of substantive tests.
- D) level of inherent risk.
Answer: C
Difficulty: 3 Hard
Topic: Audit Risk
Learning Objective: 04-02 Learn the form and components of the audit risk model.; 04-03 Understand how to use the audit risk model.
Bloom’s: Analyze
AACSB: Analytical Thinking
AICPA: FN Risk Analysis; BB Industry
22) 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:
- A) decrease amount of substantive testing.
- B) decrease detection risk.
- C) increase detection risk.
- D) increase materiality levels.
Answer: B
Difficulty: 3 Hard
Topic: Audit Risk
Learning Objective: 04-02 Learn the form and components of the audit risk model.; 04-03 Understand how to use the audit risk model.
Bloom’s: Analyze
AACSB: Analytical Thinking
AICPA: FN Risk Analysis; BB Critical Thinking
23) The risk of material misstatement includes which of the following?
- A) Detection risk
- B) Audit risk
- C) Inherent risk
- D) Nonsampling risk
Answer: C
Difficulty: 1 Easy
Topic: Audit Risk
Learning Objective: 04-02 Learn the form and components of the audit risk model.
Bloom’s: Remember
AACSB: Analytical Thinking
AICPA: FN Risk Analysis; BB Critical Thinking
24) 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:
- A) fraud risk increases.
- B) the risk of misappropriation of assets increases.
- C) risk of material misstatement increases.
- D) detection risk increases.
Answer: D
Difficulty: 2 Medium
Topic: Audit Risk; Assessing the Risk of Material Misstatement
Learning Objective: 04-02 Learn the form and components of the audit risk model.; 04-06 Understand the fraud risk assessment process.; 04-03 Understand how to use the audit risk model.
Bloom’s: Apply
AACSB: Analytical Thinking
AICPA: FN Risk Analysis; BB Industry
25) Which of the following audit risk components may be assessed in qualitative terms?
- A) Risk of material misstatement.
- B) Detection risk.
- C) Neither risk of material misstatement nor detection risk.
- D) Both risk of material misstatement and detection risk.
Answer: D
Difficulty: 2 Medium
Topic: Audit Risk
Learning Objective: 04-03 Understand how to use the audit risk model.
Bloom’s: Remember
AACSB: Analytical Thinking
AICPA: FN Risk Analysis; BB Critical Thinking
26) When an entity moves into a significant new line of business, all of the following increase except:
- A) client risk.
- B) acceptable audit risk.
- C) risk of material misstatement.
- D) entity business risk.
Answer: B
Difficulty: 2 Medium
Topic: Audit Risk; The Auditor’s Risk Assessment Process
Learning Objective: 04-02 Learn the form and components of the audit risk model.; 04-04 Understand the auditor’s risk assessment process.
Bloom’s: Apply
AACSB: Analytical Thinking
AICPA: FN Risk Analysis; BB Industry
27) Which of the following procedures would not be used to obtain an understanding of the entity and its environment?
- A) Observe entity operations.
- B) Reperform entity processes.
- C) Verify proper valuation of inventory subject to technological obsolescence.
- D) Review prior year’s audit documentation.
Answer: C
Difficulty: 2 Medium
Topic: The Auditor’s Risk Assessment Process
Learning Objective: 04-04 Understand the auditor’s risk assessment process.
Bloom’s: Understand
AACSB: Communication
AICPA: FN Decision Making; BB Industry
28) Which of the following is not an important consideration in an auditor’s evaluation of an entity’s business risk?
- A) The specific business risks an entity faces that may result in financial statement errors and fraud.
- B) Business risk factors that impact the ability of the entity to be profitable and survive.
- C) Audit standards include many entity business risk factors that identify circumstances that increase the likelihood of material misstatements.
- D) Audit standards require the auditor to evaluate the entity’s business risk in order to provide suggestions to improve the entity’s profitability.
Answer: D
Difficulty: 1 Easy
Topic: The Auditor’s Risk Assessment Process
Learning Objective: 04-04 Understand the auditor’s risk assessment process.
Bloom’s: Remember
AACSB: Analytical Thinking
AICPA: FN Risk Analysis; BB Critical Thinking
29) Which of the following is a source of detection risk?
- A) Unstable business environment.
- B) Poor client controls.
- C) A nonrepresentative sample.
- D) Inherent risk assessed too high.
Answer: C
Difficulty: 2 Medium
Topic: Audit Risk
Learning Objective: 04-02 Learn the form and components of the audit risk model.
Bloom’s: Analyze
AACSB: Analytical Thinking
AICPA: FN Risk Analysis; BB Critical Thinking
30) In general, material frauds perpetrated by which of the following are most difficult to detect?
- A) Internal audit function.
- B) Keypunch operator.
- C) Cashier.
- D) Controller.
Answer: D
Difficulty: 2 Medium
Topic: Assessing the Risk of Material Misstatement
Learning Objective: 04-06 Understand the fraud risk assessment process.
Bloom’s: Apply
AACSB: Analytical Thinking
AICPA: FN Risk Analysis; BB Critical Thinking
31) Which of the following circumstances most likely would cause an auditor to believe that material misstatements may exist in an entity’s financial statements?
- A) Accounts receivable confirmation requests yield significantly fewer responses than expected.
- B) Audit trails of computer-generated transactions exist only for a short time.
- C) The chief financial officer does not sign the management representation letter until the last day of the auditor’s fieldwork.
- D) Management consults with other accountants about significant accounting matters.
Answer: A
Difficulty: 3 Hard
Topic: Assessing the Risk of Material Misstatement; Evaluation of Audit Test Results; Responding to Risk Assessment Results
Learning Objective: 04-05 Learn how the auditor assesses the risk of material misstatement.; 04-07 Learn how to respond to the results of the risk assessments.; 04-08 Learn how to evaluate the results of the audit tests.
Bloom’s: Analyze
AACSB: Analytical Thinking
AICPA: FN Risk Analysis; BB Critical Thinking
32) The primary responsibility for preventing fraud in an organization lies with:
- A) the audit committee of the board of directors.
- B) the internal audit function.
- C) the external auditor.
- D) the organization’s management.
Answer: D
Difficulty: 2 Medium
Topic: Assessing the Risk of Material Misstatement; The Auditor’s Risk Assessment Process
Learning Objective: 04-06 Understand the fraud risk assessment process.; 04-04 Understand the auditor’s risk assessment process.
Bloom’s: Understand
AACSB: Communication
AICPA: FN Decision Making; BB Industry
33) Which of the following is not a misstatement of the financial statements?
- A) The entity uses different inventory accounting methods for internal and external reporting.
- B) A departure from GAAP.
- C) The footnote for pensions is omitted.
- D) A clerk incorrectly based the allowance for doubtful accounts on 31% of sales as opposed to 13% of sales as determined by the controller.
Answer: A
Difficulty: 2 Medium
Topic: Assessing the Risk of Material Misstatement; Responding to Risk Assessment Results
Learning Objective: 04-05 Learn how the auditor assesses the risk of material misstatement.; 04-07 Learn how to respond to the results of the risk assessments.
Bloom’s: Analyze
AACSB: Analytical Thinking
AICPA: FN Decision Making; BB Critical Thinking
34) All of the following represent an increased opportunity for management to commit fraud except:
- A) significant related party transactions.
- B) the auditor’s relationship with management is strained.
- C) management is dominated by a single person.
- D) the financial statements include highly subjective estimates.
Answer: B
Difficulty: 2 Medium
Topic: Assessing the Risk of Material Misstatement
Learning Objective: 04-06 Understand the fraud risk assessment process.; 04-05 Learn how the auditor assesses the risk of material misstatement.
Bloom’s: Apply
AACSB: Analytical Thinking
AICPA: FN Risk Analysis; BB Critical Thinking
35) The auditor can respond to an increased risk of fraud by doing all of the following except:
- A) evaluating whether the accounting policies selected may be indicative of fraudulent financial reporting through earnings management.
- B) assigning more experienced personnel to the audit.
- C) increasing detection risk.
- D) taking steps to obtain more reliable evidence.
Answer: C
Difficulty: 2 Medium
Topic: Audit Risk; Responding to Risk Assessment Results
Learning Objective: 04-02 Learn the form and components of the audit risk model.; 04-07 Learn how to respond to the results of the risk assessments.
Bloom’s: Apply
AACSB: Analytical Thinking
AICPA: FN Risk Analysis; BB Critical Thinking
36) An auditor discovers a likely fraud during an audit but concludes that the overall effect of the fraud is not sufficiently material to affect the audit opinion. The auditor should probably:
- A) disclose the fraud to the appropriate level of the client’s management.
- B) disclose the fraud to appropriate authorities external to the client.
- C) discuss with the client the additional audit procedures that will be needed to identify the exact amount of the fraud.
- D) modify the audit program to include tests specifically designed to identify the fraud and its impact on the financial statements.
Answer: A
Difficulty: 3 Hard
Topic: Evaluation of Audit Test Results
Learning Objective: 04-08 Learn how to evaluate the results of the audit tests.
Bloom’s: Analyze
AACSB: Communication
AICPA: FN Decision Making; BB Critical Thinking
37) The acceptable level of detection risk is inversely related to the:
- A) extent of the substantive procedures.
- B) risk of misapplying auditing procedures.
- C) overall materiality.
- D) risk of failing to discover material misstatements.
Answer: A
Difficulty: 3 Hard
Topic: Audit Risk
Learning Objective: 04-02 Learn the form and components of the audit risk model.; 04-03 Understand how to use the audit risk model.
Bloom’s: Analyze
AACSB: Analytical Thinking
AICPA: FN Risk Analysis; BB Critical Thinking
38) As the acceptable level of detection risk decreases, an auditor may change the:
- A) timing of tests of controls by performing them at an interim date rather than at year-end.
- B) nature of substantive procedures from less effective to more effective procedures.
- C) timing of tests of controls by performing them at several dates rather than at one time.
- D) assessed level of risk of material misstatement to a higher amount.
Answer: B
Difficulty: 3 Hard
Topic: Audit Risk
Learning Objective: 04-02 Learn the form and components of the audit risk model.; 04-03 Understand how to use the audit risk model.
Bloom’s: Analyze
AACSB: Analytical Thinking
AICPA: FN Risk Analysis; BB Critical Thinking
39) As the acceptable level of detection risk decreases, the assurance directly provided from:
- A) substantive procedures should increase.
- B) substantive procedures should decrease.
- C) tests of controls should increase.
- D) tests of controls should decrease.
Answer: A
Difficulty: 2 Medium
Topic: Audit Risk
Learning Objective: 04-02 Learn the form and components of the audit risk model.; 04-03 Understand how to use the audit risk model.
Bloom’s: Understand
AACSB: Analytical Thinking
AICPA: FN Risk Analysis; BB Critical Thinking
40) Increased fraud risk could result in all of the following except:
- A) lower detection risk.
- B) higher inherent risk.
- C) lower control risk.
- D) higher client risk.
Answer: C
Difficulty: 3 Hard
Topic: Audit Risk; Assessing the Risk of Material Misstatement
Learning Objective: 04-02 Learn the form and components of the audit risk model.; 04-06 Understand the fraud risk assessment process.
Bloom’s: Evaluate
AACSB: Analytical Thinking
AICPA: FN Risk Analysis; BB Critical Thinking
41) The objectives of the engagement partner’s communication with the audit team include:
- A) maintaining an adversarial atmosphere between the auditor and management.
- B) complying with SEC rules.
- C) complying with FASB rules.
- D) emphasizing the importance of professional skepticism.
Answer: D
Difficulty: 2 Medium
Topic: Assessing the Risk of Material Misstatement
Learning Objective: 04-06 Understand the fraud risk assessment process.
Bloom’s: Apply
AACSB: Communication
AICPA: FN Decision Making; BB Resource Management
42) The auditor is most likely to presume that a high risk of a fraud relating to the misappropriation of assets exists if:
- A) the entity is a multinational company that does business in numerous foreign countries.
- B) the entity does business with several related parties.
- C) inadequate segregation of duties places an employee in a position to perpetrate and conceal theft.
- D) inadequate employee training results in lengthy EDP exception reports each month.
Answer: C
Difficulty: 2 Medium
Topic: Assessing the Risk of Material Misstatement
Learning Objective: 04-06 Understand the fraud risk assessment process.
Bloom’s: Analyze
AACSB: Analytical Thinking
AICPA: FN Risk Analysis; BB Industry
43) Which of the following factors most likely would heighten an auditor’s concern about the risk of fraudulent financial reporting?
- A) Inability to generate cash flows from operations while reporting substantial earnings growth.
- B) Management’s lack of interest in increasing the entity’s earnings trend.
- C) Large amounts of liquid assets that are easily converted into cash.
- D) Inability to borrow necessary capital without granting debt covenants.
Answer: A
Difficulty: 3 Hard
Topic: Assessing the Risk of Material Misstatement; Evaluation of Audit Test Results; Responding to Risk Assessment Results
Learning Objective: 04-06 Understand the fraud risk assessment process.; 04-07 Learn how to respond to the results of the risk assessments.; 04-08 Learn how to evaluate the results of the audit tests.
Bloom’s: Evaluate
AACSB: Analytical Thinking
AICPA: FN Risk Analysis; BB Industry
44) A properly planned and performed audit may fail to detect a material misstatement resulting from fraud because:
- A) audit procedures that are otherwise effective may be ineffective for fraud that is concealed through collusion.
- B) an audit is planned and performed to provide reasonable assurance of detecting material misstatements caused by errors but not by fraud.
- C) the factors considered in assessing control risk indicated an increased risk of error but only a low risk of fraud in the financial statements.
- D) the auditor did not consider factors influencing audit risk for account balances that have effects pervasive to the financial statements taken as a whole.
Answer: A
Difficulty: 3 Hard
Topic: Assessing the Risk of Material Misstatement; The Auditor’s Risk Assessment Process
Learning Objective: 04-06 Understand the fraud risk assessment process.; 04-04 Understand the auditor’s risk assessment process.
Bloom’s: Analyze
AACSB: Analytical Thinking
AICPA: FN Risk Analysis; BB Critical Thinking
45) Which of the following is correct concerning required auditor communications about fraud?
- A) Fraud that involves senior management should be reported directly by the auditor to the audit committee regardless of the amount involved.
- B) Fraud with a material effect on the financial statements should be reported directly by the auditor to the Securities and Exchange Commission.
- C) Any requirement to disclose fraud outside the entity is the responsibility of management and not that of the auditor.
- D) The professional standards provide no requirements related to the communication of fraud, but the auditor should use professional judgment in determining communication responsibilities.
Answer: A
Difficulty: 2 Medium
Topic: Auditor’s Communication Requirements
Learning Objective: 04-10 Learn the auditor’s communication requirements about fraud to management, the audit committee, and others.
Bloom’s: Understand
AACSB: Communication
AICPA: FN Risk Analysis; BB Industry
46) Using the audit risk model, identify the relationship between the following elements. For each of the items below, highlight whether the two elements have an inverse relationship, a direct relationship, or no relationship. When considering each item, assume that the other components of the risk model remain constant.
Answer:
| a. | Engagement Risk and Acceptable Audit Risk | Inverse | Direct | No Relationship |
| b. | Assessed Inherent Risk and Planned Detection Risk | Inverse | Direct | No Relationship |
| c. | Materiality and Amount of substantive evidence needed | Inverse | Direct | No Relationship |
| d. | Assessed Inherent Risk and Assessed Control Risk | Inverse | Direct | No Relationship |
| e. | Acceptable Audit Risk and Assessed Control Risk | Inverse | Direct | No Relationship |
| f. | Amount of substantive evidence collected and Achieved
Detection Risk |
Inverse | Direct | No Relationship |
| g. | Actual Inherent Risk and Actual Control Risk | Inverse | Direct | No Relationship |
| h. | Achieved Detection Risk and Achieved Audit Risk | Inverse | Direct | No Relationship |
Difficulty: 3 Hard
Topic: Audit Risk
Learning Objective: 04-02 Learn the form and components of the audit risk model.; 04-03 Understand how to use the audit risk model.
Bloom’s: Analyze
AACSB: Analytical Thinking
AICPA: FN Risk Analysis; BB Critical Thinking
47) What is the difference between audit risk and engagement risk?
Answer: Audit risk is the risk that the auditor may unknowingly fail to appropriately modify the opinion on financial statements that are materially misstated. It can be directly controlled by the scope of the auditor’s test procedures. Engagement risk, on the other hand, is the auditor’s exposure to loss or injury to professional practice from litigation, adverse publicity, or other events arising in connection with financial statements audited and reported on. It cannot be directly controlled by the auditor, but some control can be exercised through the careful acceptance and continuance of clients.
Difficulty: 1 Easy
Topic: Audit Risk
Learning Objective: 04-01 Understand the concept of audit risk.; 04-02 Learn the form and components of the audit risk model.
Bloom’s: Remember
AACSB: Analytical Thinking
AICPA: FN Risk Analysis; BB Critical Thinking
48) You are teaching a class of new hires at your international accounting firm. Explain the audit risk model using a mathematical formula.
AR = RMM × DR
AR = Audit risk
RMM = Risk of material misstatement
DR = Detection risk
Answer: Audit risk consists of:
- The risk that the balance or class and related assertions contain misstatements that could be material to the financial statements when aggregated with misstatements in other balances or classes. These risks exist independently of the audit.
- The risk that the auditor will not detect such misstatements (detection risk). This risk can be controlled by the auditor through the scope of the audit procedures performed.
Difficulty: 1 Easy
Topic: Audit Risk
Learning Objective: 04-02 Learn the form and components of the audit risk model.; 04-03 Understand how to use the audit risk model.
Bloom’s: Understand
AACSB: Communication
AICPA: FN Risk Analysis; BB Critical Thinking
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