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Accounting 408 Name __________________________

Exam 2, Chapters 3, 4, 5, 6, E, F

Spring 2017 Row _______

Multiple Choice Questions. (2 points each, 100 points total) Read each question carefully and indicate the one

best answer to each question by placing a mark in the appropriate space on the answer sheet.

1. The scope and nature of an auditor’s contractual obligation to a client is ordinarily set forth in the

a. Management representation letter.

b. Scope paragraph of the auditor’s report.

c. Engagement letter.

d. Introductory paragraph of the auditor’s report.

2. Which of the following conditions most likely would pose the greatest risk in accepting a new audit

engagement?

a. Staff will need to be rescheduled to cover this new client.

b. There will be a client-imposed scope limitation.

c. The firm will have to hire a specialist in one audit area.

d. The client’s financial reporting system has been in place for 10 years.

3. Before accepting an engagement to audit a new client, an auditor is required to

a. make inquiries of the predecessor auditor after obtaining the consent of the prospective client.

b. obtain a copy of the client’s financial statements.

c. prepare a memorandum setting forth the staffing requirements and documenting the preliminary audit

plan.

d. discuss the management representation letter with the prospective client’s audit committee.

4. Which of the following statements is true about the auditor’s use of the work of a specialist?

a. The specialist should not have an understanding of the auditor’s use of the specialist’s findings.

b. The auditor is required to perform substantive procedures to verify the specialist’s assumptions and

findings.

c. The client should not have an understanding of the nature of the work to be performed by the

specialist.

d. The auditor should obtain an understanding of the methods and assumptions used by the specialist.

5. Madison Corporation has a few large accounts receivable that total $1,000,000. Nassau Corporation has a

great number of small accounts receivable that also total $1,000,000. The importance of a misstatement in

any one account is therefore greater for Madison than for Nassau. This is an example of the auditor’s

concept of

a. materiality.

b. comparative analysis.

c. reasonable assurance.

d. audit risk.

6. In assessing the risk of material misstatement for purchases, an auditor vouches a sample of entries in the

voucher register to the supporting documents. Which assertion would this test of controls most likely

support?

a. Completeness.

b. Occurrence.

c. Accuracy.

d. Classification.

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7. Tracing bills of lading (shipping documents) to sales invoices provides evidence that

a. shipments to customers were invoiced.

b. shipments to customers were recorded in the sales journal.

c. recorded sales were shipped.

d. invoiced sales were recorded in the sales journal.

8. Some account balances, such as those for pensions or leases, are the results of complex calculations. The

susceptibility to material misstatements in these types of accounts is defined as

a. audit risk.

b. detection risk.

c. sampling risk.

d. inherent risk.

9. As the acceptable level of detection risk decreases, an auditor may change the

a. timing of substantive tests by performing them at an interim date rather than at year end.

b. nature of substantive tests from a less effective to a more effective procedure.

c. timing of tests of controls by performing them at several dates rather than at one time.

d. assessed level of inherent risk to a higher amount.

10. Which of the following statements reflects an auditor’s responsibility for detecting fraud?

a. An auditor is responsible for detecting employee errors and simple fraud, but not for discovering

fraudulent acts involving employee collusion or management override.

b. An auditor should plan the audit to detect fraud caused by departures from GAAP.

c. An auditor is not responsible for detecting fraud unless the application of auditing standards would

result in such detection.

d. An auditor should design the audit to provide reasonable assurance of detecting errors and fraud that

are material to the financial statements.

11. The risk that an auditor’s procedures will lead to the conclusion that a material misstatement does not exist

in an account balance when, in fact, such misstatement does exist is

a. audit risk.

b. inherent risk.

c. control risk.

d. detection risk.

12. The ultimate purpose of understanding the entity and its environment and assessing inherent risk and

control risk is to contribute to the auditor’s assessment of the risk that

a. tests of controls may fail to identify procedures relevant to assertions.

b. material misstatements may exist in the financial statements.

c. specified controls requiring separation of duties may be circumvented by collusion.

d. entity policies may be inappropriately overridden by senior management.

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13. AICPA auditing standards give a formula for audit risk relationships. Overall allowable audit risk (AR) is

the risk that monetary misstatements equal to tolerable misstatement may remain undetected. The risk of

material misstatement (RMM) is the combined assessments of inherent and control risk. In the audit risk

formula, AP is the auditor’s assessment of the risk that substantive analytical procedures and other relevant

substantive tests related to the same assertion will fail to detect material misstatements not detected by the

relevant controls. TD is the allowable risk of incorrect acceptance for a test of details given that material

misstatements occur in an assertion and are not detected by internal control or by analytical procedures and

other substantive tests. Which model represents the allowable risk of incorrect acceptance (TD)?

a. TD = AR ÷ (RMM × AP).

b. TD = RMM ÷ (AR × AP).

c. TD = AP ÷ (RMM × AR).

d. TD = RMM × AP × AR.

Use this information for questions 14 – 17.

Two auditors, Steve and Laurie, independently assessed the risks associated with their client's accounts

receivable. They both decide to hold audit risk at .04. Both agree that inherent risk should be set at .5 and no

analytical procedures will be performed. However, Steve evaluates the control risk as moderate (.40) while

Laurie assesses it a little higher (.50). Using the audit risk model, answer the following questions.

14. What is detection risk for Steve?

a. .50

b. .25

c. .20

d. .02

e. some other amount

15. What is detection risk for Laurie?

a. .50

b. .25

c. .20

d. .16

e. some other amount

16. If audit risk was changed to .06 (instead of .04) and all other factors remain unchanged except detection

risk, then detection risk for each auditor would

a. decrease.

b. increase.

c. remain unchanged.

d. cannot be determined with the information given.

17. Which auditor, Steve or Laurie, will have to collect the most substantive testing evidence?

a. An audit would not be conducted because audits are illegal.

b. Evidence is never collected in an audit.

c. Steve.

d. Laurie.

18. The objective of performing analytical procedures in planning an audit is to identify the existence of

a. unusual transactions and events.

b. illegal acts that went undetected because of internal control weaknesses.

c. related party transactions.

d. recorded transactions that were not properly authorized.

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19. Analytical procedures used in planning an audit should focus on

a. evaluating the adequacy of evidence gathered concerning unusual balances.

b. testing individual account balances that depend on accounting estimates.

c. enhancing the auditor’s understanding of the client’s business.

d. identifying material weaknesses in internal control.

20. For all audits of financial statements made in accordance with auditing standards, the use of analytical

procedures is required to some extent

In the As a In the Final

Planning Substantive Review

Stage Test Stage

a. Yes No Yes

b. No Yes No

c. No Yes Yes

d. Yes No No

21. When an auditor obtains an understanding of the entity and its environment, which of the following is the

most likely order of performing the steps A through C below?

A = Tests of controls

B = Preparation of a flowchart documenting the understanding of the client’s internal control

C = Substantive tests

a. ABC.

b. ACB.

c. BAC.

d. BCA.

22. Which of the following statements is true concerning analytical procedures used as risk assessment

procedures?

a. Analytical procedures usually involve comparisons of ratios developed from recorded amounts with

expectations developed by management.

b. Analytical procedures used in planning an audit ordinarily use data aggregated at a high level.

c. Analytical procedures can replace tests of controls in gathering evidence to support the assessed level

of control risk.

d. Analytical procedures are more effective, but not more efficient, than tests of details and transactions.

23. The primary reason to establish internal control is to

a. safeguard the resources of the organization.

b. provide reasonable assurance that the objectives of the organization are achieved.

c. encourage compliance with organizational objectives.

d. guarantee the accuracy, reliability, and timeliness of information.

24. The PCAOB auditing standards state that internal controls may be preventive or detective. Which of the

following controls is preventive?

a. Requiring two persons to open mail.

b. Reconciling the accounts receivable subsidiary file with the control account.

c. Using batch totals.

d. Preparing bank reconciliations.

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25. The design or operation of a control may not allow management or employees, in the normal course of

performing their assigned functions, to prevent or detect misstatements on a timely basis. According to

auditing standards, the result is a

a. material weakness.

b. significant deficiency.

c. control deficiency.

d. critical deficiency.

26. Which of the following most likely would not be considered an inherent limitation of the potential

effectiveness of a large entity’s internal control?

a. Incompatible duties.

b. Management override.

c. Mistakes in judgment.

d. Collusion among employees.

27. Internal control can provide only reasonable assurance of achieving entity objectives. One factor limiting

the likelihood of achieving those objectives in a small entity is that

a. the auditor’s primary responsibility is the detection of fraud.

b. the board of directors is active and independent.

c. effective separation of duties may not be feasible.

d. management monitors internal control.

28. Which of the following are considered control environment factors?

Detection Human Resources

Risk Policies and Practices

a. Yes Yes

b. Yes No

c. No Yes

d. No No

29. As part of understanding internal control in planning an audit of a nonissuer, an auditor does not need to

a. consider factors that affect the risk of material misstatement.

b. ascertain whether controls have been implemented.

c. identify the types of potential misstatements that can occur.

d. obtain knowledge about the operating effectiveness of internal control.

30. After obtaining a sufficient understanding of the entity, its environment, and internal control in an audit of

the financial statements, the auditor assesses

a. the need to apply auditing standards.

b. detection risk to determine the acceptable level of inherent risk.

c. detection risk and inherent risk to determine the acceptable level of control risk.

d. control risk and inherent risk to determine the acceptable level of detection risk.

31. In the audit of a nonissuer, the auditor should perform tests of control when the auditor’s risk assessment

includes an expectation

a. of a low level of inherent risk.

b. of relying on the operating effectiveness of internal control.

c. that the controls are not suitably designed.

d. that the controls are not being applied.

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32. A CPA’s understanding of internal control in a financial statement audit of a nonissuer

a. is usually more limited than that made in an examination of internal control integrated with an audit of

financial statements.

b. is usually more extensive than that made in an examination of internal control integrated with an audit

of financial statements.

c. will usually be identical to that made in an examination of internal control integrated with an audit of

financial statements.

d. will usually result in a report on the effectiveness of internal control.

33. Three conditions are generally present in the client’s organization when fraud occurs. Those conditions

include each of the following except a(n)

a. incentive or pressure to commit fraud.

b. professional skepticism about the likelihood of fraud.

c. opportunity to commit fraud.

d. attitude or rationalization about the act of fraud.

34. Which of the following circumstances would an auditor most likely consider a risk factor relating to

misstatements arising from fraudulent financial reporting?

a. Several members of management have recently purchased additional shares of the entity’s stock.

b. Several members of management have recently sold shares of the entity’s stock.

c. Management is interested in maintaining the entity’s earnings trend by using aggressive accounting

practices.

d. The entity distributes financial forecasts to financial analysts that predict conservative operating

results.

35. Which of the following circumstances is most likely to cause an auditor to change an assessment of the risk

of material misstatement of the financial statements due to fraud?

a. Property and equipment are usually sold at a loss before being fully depreciated.

b. Unusual discrepancies between the entity’s records and confirmation replies.

c. Monthly bank reconciliations usually include several in-transit items.

d. Clerical errors are listed on a computer-generated exception report.

36. Based on the video shown in class, the ZZZZ Best fraud

a. involved an employee that hid stolen money in the walls of his house.

b. involved a bookkeeper for a small business located in Lincoln, Nebraska.

c. resulted in a long jail sentence for an employee in an insurance agency.

d. was perpetrated by an individual that started a carpet cleaning business as a teenager.

37. Most frauds are discovered by

a. tips.

b. independent audits.

d. law enforcement investigations.

d. governmental regulatory agencies.

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38. Based on our classroom discussion of framing effects, which statement is not true?

a. Framing effects are most likely to occur when dealing with decision contexts that are ambiguous or

lack feedback.

b. Framing effects occur whenever a person is influenced in either thought or behavior by the way in

which information is presented or described.

c. The effect of framing was illustrated in the Simply Steam and Easy Clean cases.

d. Auditors should consider the impact of framing during inquiry with client personnel and consider it a

significant indicator of fraud.

39. AICPA auditing standards identify two general approaches to audit sampling. They are

a. random and nonrandom.

b. statistical and nonstatistical.

c. precision and reliability.

d. risk and nonrisk.

40. Each time an auditor draws a conclusion based on evidence from a sample, an additional risk, sampling

risk, is introduced. An example of sampling risk is

a. projecting the results of sampling beyond the population tested.

b. properly applying an improper audit procedure to sample data.

c. reaching an erroneous conclusion from sample data.

d. improperly applying a proper audit procedure to sample data.

41. The auditor failed to recognize a deviation included in a sample intended to test controls related to a

transaction process. This failure best illustrates

a. statistical risk.

b. sampling risk.

c. audit risk.

d. nonsampling risk.

42. Which of the following sampling methods is used to estimate a numerical measurement of a population,

such as a dollar value?

a. Attribute sampling.

b. Stop-or-go sampling.

c. Variables sampling.

d. Random-number sampling.

43. In performing tests of controls over authorization of cash disbursements, which of the following statistical

sampling methods is most appropriate?

a. Attribute.

b. Ratio.

c. Stratified.

d. Variables.

44. A distinguishing characteristic of random number sample selection is that

a. each item is selected from a stratum having minimum variability.

b. each item’s chance for selection is proportional to its dollar value.

c. each item in the population has a known and nonzero chance of being selected.

d. each stratum in the population has an equal number of items selected.

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45. An auditor plans to examine a sample of 20 purchase orders for proper approvals as prescribed by the

client’s internal control. One of the purchase orders in the chosen sample of 20 cannot be found, and the

auditor is unable to use alternative procedures to test whether that purchase order was properly approved.

The auditor should

a. choose another purchase order to replace the missing purchase order in the sample.

b. consider this test of controls invalid and proceed with substantive tests because internal control is

ineffective.

c. treat the missing purchase order as a deviation for the purpose of evaluating the sample.

d. select a completely new set of 20 purchase orders.

46. For which of the following audit tests will an auditor most likely use attribute sampling?

a. Inspecting employee time cards for proper approval by supervisors.

b. Selecting accounts receivable for confirmation of account balances.

c. Examining invoices in support of the valuation of fixed asset additions.

d. Making an independent estimate of the amount of a LIFO inventory.

47. In testing payroll transactions, an auditor discovers that four out of a statistical sample of 100 selected time

cards were not signed by the appropriate supervisor. To evaluate the materiality or significance of this

control deficiency, the auditor should

a. compare the tolerable deviation rate with the expected deviation rate.

b. compute an upper precision limit and compare with the tolerable deviation rate.

c. evaluate the dollar amount of the four time cards in relation to the financial statements.

d. report the deviations and let management assess the significance because they are in the best position

to know.

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Use the following information for questions 48 – 50.

Answer the following questions assuming an independent attribute sampling application is followed. Use the

sample size shown in the table and round (if necessary) the sample size when you determine the upper limit.

Round in the most appropriate way.

Case: A B C

Risk of Overreliance (Risk of

Assessing Control Risk Too Low)

5%

5%

10%

Tolerable Deviation Rate

7%

15%

5%

Expected Deviation Rate

1%

4%

0%

Actual Number of Deviations

Found

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48. The sample size for Case A is

a. 25

b. 40

c. 45

d. 66

49. The computed upper limit (UEL) for Case B is (assume the number of items examined was equal to the

actual computed sample)

a. 15.0

b. 4.6

c. 4.2

d. 3.8

50. The computed upper limit (UEL) for Case C is (assume the number of items examined was equal to the

actual computed sample)

a. 10.2

b. 8.4

c. 6.5

d. 5.0

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Que. No. Answer Que. No. Answer

1 c 26 a

2 b 27 c

3 a 28 c

4 d 29 d

5 a 30 d

6 b 31 b

7 a 32 a

8 d 33 b

9 b 34 c

10 d 35 b

11 d 36 d

12 b 37 a

13 a 38 d

14 c 39 b

15 d 40 c

16 b 41 d

17 d 42 c

18 a 43 a

19 c 44 c

20 a 45 c

21 c 46 a

22 b 47 b

23 b 48 d

24 a 49 a

25 c 50 d