Multiple-Choice Questions - CPA Diary



Chapter 8

Multiple-Choice Questions

|1. |Which of the following is not one of the three main reasons why the auditor should properly plan engagements? |

|easy | |

|a |a. To enable proper on-the-job training of employees. |

| |b. To enable the auditor to obtain sufficient appropriate evidence. |

| |c. To avoid misunderstandings with the client. |

| |d. To help keep audit costs reasonable. |

| | |

|2. |Avoiding misunderstandings with the client is important for: |

|easy | | | |

|a |Good client relations | |Facilitating high-quality work at a reasonable cost |

| |a. |Yes |Yes |

| |b. |No |No |

| |c. |Yes |No |

| |d. |No |Yes |

| | | | |

|3. |A measure of how willing the auditor is to accept that the financial statements may be materially misstated after the|

|easy |audit is completed and an unqualified opinion has been issued is the: |

|b |a. inherent risk. |

| |b. acceptable audit risk. |

| |c. statistical risk. |

| |d. financial risk. |

| | |

|4. |A measure of the auditor’s assessment of the likelihood that there are material misstatements in an account before |

|easy |considering the effectiveness of the client’s internal control is called: |

|d |a. control risk. |

| |b. acceptable audit risk. |

| |c. statistical risk. |

| |d. inherent risk. |

| | |

|5. |When inherent risk is high, there will need to be: |

|Easy | | |

|d |A lower assessment of audit risk | |More evidence accumulated by the auditor |

| |a. |Yes |Yes |

| |b. |No |No |

| |c. |Yes |No |

| |d. |No |Yes |

| | |

|6. |The auditor is likely to accumulate more evidence when the audit is for a company: |

|easy | |

|a |Which has large amounts of debt | |Which is to be sold in the near future |

| |a. |Yes |Yes |

| |b. |No |No |

| |c. |Yes |No |

| |d. |No |Yes |

| | |

|7. |Which of the following is not typically included in initial audit planning? |

|easy |a. Client acceptance/continuation decisions. |

|d |b. Determination of the purpose of the audit. |

| |c. Obtain an understanding with the client. |

| |d. Perform analytical procedures as substantive tests. |

| | |

|8. |Initial audit planning involves four matters. Which of the following is not one of these? |

|easy |a. Develop an overall audit strategy. |

|b |b. Request that bank balances be confirmed. |

| |c. Schedule engagement staff and audit specialists. |

| |d. Identify the client’s reason for the audit. |

| | |

|9. |Most auditors assess inherent risk as high for related parties and related-party transactions because: |

|easy | |

|b |a. of the unique classification of related-party transactions required on the balance sheet. |

| |b. of the lack of independence between the parties. |

| |c. of the unique classification of related-party transactions required on the income statement. |

| |d. it is required by generally accepted accounting principles. |

| | |

|10. |Which of the following is not correct regarding the communications between successor and predecessor auditors? |

|easy | |

|a |a. The burden of initiating the communication rests with the predecessor auditor. |

| |b. The burden of initiating the communication rests with the successor auditor. |

| |c. The predecessor auditor must receive their former client’s permission prior to divulging information to the |

| |successor auditor |

| |d. The predecessor auditor may choose to provide a limited response to a successor auditor. |

| | |

|11. |A successor auditor may perform which of the following for a new audit client? |

|easy | | | |

|a |Speak to local attorneys, banks and | | |

| |other businesses regarding the | |Speak to the predecessor auditors about disagreements they had|

| |company’s reputation | |with management |

| |a. |Yes | |Yes |

| |b. |No | |No |

| |c. |Yes | |No |

| |d. |No | |Yes |

| | | | |

| | |

|12. |Which of the following is not a potential effect of an auditor’s decision that a lower acceptable audit risk is |

|medium |appropriate? |

|b |a. More evidence is accumulated. |

| |b. Less evidence is accumulated. |

| |c. Special care is required in assigning experienced staff. |

| |d. Review of audit documentation is performed by personnel not assigned to the engagement. |

| | |

|13. |It is easier and more common to implement increased evidence accumulation for inherent risk than for acceptable audit|

|medium |risk because: |

|a |a. inherent risk can usually be isolated to specific accounts. |

| |b. inherent risk applies to the entire audit. |

| |c. acceptable audit risk and sample sizes are set statistically. |

| |d. acceptable audit risk does not impact on the amount of evidence which must be accumulated. |

| | |

|14. (SOX) |If an auditor is requested to perform nonaudit services for a public company audit client, who is responsible for |

|medium |agreeing to those services with the audit firm? |

|d |a. The client’s management. |

| |b. The client’s chief executive officer. |

| |c. The client’s chief financial officer. |

| |d. The client’s audit committee. |

| | |

|15. |Which of the following statements is true regarding communications between predecessor and successor auditors? |

|medium | |

|b |a. The burden of initiating the communication rests with the predecessor. |

| |b. The predecessor’s response can be limited to stating that no information will be provided. |

| |c. The predecessor should communicate with the successor only if the client is public. |

| |d. There must be communication between the predecessor and successor if the successor is to accept the engagement. |

| | |

|16. |Investigating new clients with a focus on assessing the auditor’s potential relationship with that new client is a |

|medium |critical element in determining: |

|b |a. inherent risk. |

| |b. acceptable audit risk. |

| |c. statistical risk. |

| |d. financial risk. |

| | |

|17. |The purpose of an engagement letter is to: |

|medium |a. document the CPA firm’s responsibility to external users of the audited financial statements. |

|b | |

| |b. document the terms of the engagement in writing to minimize misunderstandings. |

| |c. notify the audit staff of an upcoming engagement so that personnel scheduling can be facilitated. |

| |d. emphasize management’s responsibility for approving the audit program. |

| | |

|18. |One means of informing the client that the auditor is not responsible for the discovery of all acts of fraud is the: |

|medium | |

|a |a. engagement letter. |

| |b. representation letter. |

| |c. responsibility letter. |

| |d. client letter. |

| | |

|19. |Which of the following normally signs the engagement letter for an audit of a public company? |

|medium |a. Corporate treasurer. |

|d |b. Chief financial officer. |

| |c. Chairman of the board of directors. |

| |d. Audit committee. |

| | |

|20. |Which of the following normally signs the engagement letter for an audit of a private company? |

|medium |a. Management. |

|a |b. Board of directors representative. |

| |c. Audit committee representative. |

| |d. Corporate treasurer. |

| | |

|21. |An understanding of a client’s business and industry and knowledge about operations are essential for performing an |

|medium |adequate audit. For a new client, most of this information is obtained: |

|d | |

| |a. from the predecessor auditor. |

| |b. from the Securities and Exchange Commission. |

| |c. from the permanent file. |

| |d. at the client’s premises. |

| | |

|22. |The least effective method of identifying related parties for a public company would be a(n): |

|medium |a. inquiry of management. |

|c |b. review of SEC filings. |

| |c. distribution of the engagement letter to all stockholders. |

| |d. examination of stockholders’ listings to identify principal stockholders. |

| | |

|23. |An official record of meetings of the board of directors and stockholders is included in the corporate: |

|medium | |

|c |a. bylaws. |

| |b. charter. |

| |c. minutes. |

| |d. license. |

| | |

|24. |Which of the following is not likely to be a related party? |

|medium |a. Affiliated companies. |

|c |b. A major stockholder of the company. |

| |c. A warehouse employee. |

| |d. The chief executive officer. |

| | |

|25. |Which of the following is most likely to occur at the beginning of an initial audit engagement? |

|medium |a. Prepare a rough draft of the financial statements and of the auditor’s report. |

|c |b. Study and evaluate the system of internal administrative control. |

| |c. Determine the client’s reason for an audit. |

| |d. Consult with and review the work of the predecessor auditor prior to discussing the engagement with the client |

| |management. |

| | |

|26. |An auditor should examine minutes of the board of directors’ meetings: |

|medium |a. through the date of the financial statements. |

|b |b. through the date of the audit report. |

| |c. only at the beginning of the audit. |

| |d. on a test basis. |

| | |

|27. |The first standard of field work, which states that the work is to be adequately planned and that assistants, if any,|

|medium |are to be properly supervised, recognizes that: |

|a |a. early appointment of the auditor is advantageous to the auditor and the client. |

| |b. acceptance of an audit engagement after the close of the client’s fiscal year is generally not permissible. |

| |c. appointment of the auditor subsequent to the physical count of inventories requires a disclaimer of opinion. |

| |d. performance of substantial parts of the examination is necessary at interim dates. |

| | |

|28. |The corporate minutes are the official record of the meetings of the board of directors and stockholders. The |

|medium |minutes typically include authorizations related to: |

|d | |

| |The CPA’s use of outside specialists | |Management compensation |

| |a. |Yes |Yes |

| |b. |No |No |

| |c. |Yes |No |

| |d. |No |Yes |

| | |

|29. |An engagement letter sent to an audit client usually would not include a(n): |

|medium |a. reference to the auditor’s responsibility for the detection of errors or irregularities. |

|c |b. estimation of the time to be spent on the audit work by audit staff and management. |

| |c. statement that management advisory services would be made available upon request. |

| |d. reference to management’s responsibility for the financial statements. |

| | |

|30. |Which of the following is correct with respect to a company’s corporate charter? |

|medium |a. The corporate charter is granted by the federal government and is required to recognize the corporation as a |

|c |separate entity. |

| |b. The corporate charter includes the rules and procedures used to operate a corporation. |

| |c. The corporate charter includes the exact name of the corporation, the date of incorporation, and the types of |

| |business the corporation is authorized to conduct. |

| |d. The corporate charter must be annually reviewed by the PCAOB. |

| | |

|31. |Corporate bylaws include: |

|Medium | | | |

|d |The types and amounts of capital stock the | |The rules and procedures used to operate the |

| |corporation is authorized to issue | |corporation |

| |a. |Yes |Yes |

| |b. |No |No |

| |c. |Yes |No |

| |d. |No |Yes |

| | |

|32. |In what order should the following steps occur? |

|medium |A. Assess client business risk |

|b |B. Understand the client’s business and industry |

| |C. Perform preliminary analytical procedures |

| |D. Assess acceptable audit risk |

| |a. D, B, C, A. |

| |b. B, A, D, C. |

| |c. B, D, A, C. |

| |d. D, C, B, A. |

| | |

|33. |Which of the following statements is not correct with respect to analytical procedures? |

|medium |a. Auditing standards emphasize the need for auditors to develop and use expectations. |

|b |b. Analytical procedures must be performed throughout the audit. |

| |c. Analytical procedures may be performed at any time during the audit. |

| |d. Analytical procedures use comparisons and relationships to assess whether account balances appear reasonable. |

| | |

|34. |The most widely used profitability ratio is the: |

|medium |a. quick ratio. |

|d |b. profit margin. |

| |c. return on assets. |

| |d. earnings per share. |

| | |

|35. |The purpose of the requirement in SAS No. 84 of having communication between the predecessor and successor auditor is|

|challenging |to: |

|b |a. allow the predecessor to disclose information which would otherwise be confidential. |

| |b. help the successor auditor to evaluate whether to accept the engagement. |

| |c. help the client by facilitating the change of auditors. |

| |d. ensure the predecessor collects all unpaid fees prior to a change in auditor. |

| | |

|36. |The predecessor auditor is required to respond to the request of the successor auditor for information, but the |

|challenging |response can be limited to stating that no information will be provided when: |

|c |a. the predecessor auditor has poor relations with the successor auditor. |

| |b. the client is dissatisfied with the predecessor’s work. |

| |c. there are actual or potential legal problems between the client and the predecessor. |

| |d. the predecessor believes that the client lacks integrity. |

| | |

|37. |Which of the following is correct with respect to the use of analytical procedures? |

|challenging |a. Analytical procedures may be used in evaluating balances in the testing phase as long as the auditor also uses |

|d |them in assessing the going concern assumption. |

| |b. Analytical procedures must be used throughout the audit. |

| |c. Analytical procedures used in the testing phase of the audit are primarily used to direct an auditor’s attention |

| |so that the auditor’s understanding of the business is improved. |

| |d. Analytical procedures are performed by studying plausible relationships between financial and nonfinancial data. |

| | |

|38. |Which of the following ratios is best used to assess a company’s ability to meet its long-term debt obligations? |

|challenging | |

|c |a. Quick ratio. |

| |b. Return on common equity. |

| |c. Debt to equity. |

| |d. Current ratio. |

| | |

|39. |Which of the following statements is not correct? |

|challenging |a. Analytical procedures used in the planning phase of the audit are primarily directed at understanding the |

|b |client’s business and directing the auditor’s attention to areas that may contain possible misstatements. |

| |b. Analytical procedures used in the completion phase are primarily aimed at assessing going concern and secondarily|

| |aimed at directing the auditor’s attention to areas that may contain possible misstatements. |

| |c. Analytical procedures must be used in the planning and completion phases of the audit, and are optional in the |

| |testing phase. |

| |d. Analytical procedures used in the completion phase are primarily aimed at directing the auditor’s attention to |

| |areas that may contain possible misstatements and secondarily aimed at assessing going concern. |

| | |

|40. |Which of the following would not likely be classified as a related-party transaction? |

|medium |a. An advance of one week’s salary to an employee. |

|a |b. Sales of merchandise between affiliated companies. |

| |c. Loans or credit sales to the principal owner of the client company. |

| |d. Exchanges of equipment between two companies owned by the same person. |

| | |

|41. |Which of the following would not be found in the corporate charter? |

|challenging |a. The kinds and amount of capital stock authorized. |

|d |b. The date of incorporation. |

| |c. The types of business activity that the corporation is allowed to conduct. |

| |d. The rules and procedures adopted by the stockholders. |

| | |

|42. |Which of the following would not usually be included in the minutes of the board of directors? |

|challenging |a. The duties and powers of the corporate officers. |

|a |b. Declaration of dividends. |

| |c. Authorization of long-term loans. |

| |d. Approval of executive bonuses. |

| | |

|43. |When are auditors likely to encounter judgment problems in the use of analytical procedures? |

|challenging |a. Whenever the auditor places reliance on management’s explanations for unusual fluctuations in account balances |

|d |without first developing independent expectations. |

| |b. Whenever the auditor allows unaudited balances to unduly influence his/her expectations of current balances. |

| |c. Whenever the auditor fails to consider the pattern reflected by several unusual fluctuations when trying to |

| |explain what caused them. |

| |d. The auditor is likely to encounter judgment problems in each of the above instances. |

| | |

|44. |The major concern when using nonfinancial data in analytical procedures is the: |

|challenging |a. accuracy of the nonfinancial data. |

|a |b. source of the nonfinancial data. |

| |c. type of nonfinancial data. |

| |d. presence of multiple sources of nonfinancial data. |

| | |

|45. |An auditor searching for related party transactions should obtain an understanding of each subsidiary’s relationship |

|challenging |to the total entity because: |

|b |a. the business structure may be deliberately designed to obscure related party transactions. |

| |b. this may reveal whether transactions would have taken place if the parties had been unrelated. |

| |c. transactions may have been consummated on terms equivalent to arm’s-length transactions. |

| |d. this may permit the audit of intercompany account balances to be performed as of concurrent dates. |

| | |

|46. |The first standard of fieldwork requires, in part, that audit work be properly planned. Proper planning as intended |

|challenging |by the first standard of fieldwork would occur when the auditor: |

|a |a. physically observes the movement of securities already counted to guard against the substitution of such |

| |securities for others that are not actually on hand. |

| |b. uses negative accounts receivable confirmations instead of positive confirmations because the latter require |

| |mailing of second requests and review of subsequent cash collections. |

| |c. compares all cash as of a particular date to avoid performing time-consuming cash cutoff procedures. |

| |d. eliminates the possibility of counting inventory items more than once by arranging to make extensive test counts.|

| | |

|47. | Early appointment of the independent auditor will enable: |

|challenging |a. a more thorough examination to be performed. |

|d |b. a proper study and evaluation of internal control to be performed. |

| |c. sufficient competent evidential matter to be obtained. |

| |d. a more efficient examination to be planned. |

| | |

|48. |Whenever an auditor compares client data to client-prepared budgets, there are two special concerns. Indicate if the |

|medium |two items below are concerns. |

|a | | | |

| |Assessing whether the budgets were realistic | |Client data may have been altered to conform to the |

| |plans | |budget |

| |a. |A concern | |A concern |

| |b. |Not a concern | |Not a concern |

| |c. |A concern | |Not a concern |

| |d. |Not a concern | |A concern |

| | |

|49. |An auditor who accepts an audit engagement and does not possess the industry expertise of the business entity should: |

|challenging | |

|b |a. engage financial experts familiar with the nature of the business entity. |

| |b. obtain a knowledge of matters that relate to the nature of the entity’s business. |

| |c. refer a substantial portion of the audit to another CPA who will act as the principal auditor. |

| |d. first inform management that an unqualified opinion cannot be issued. |

| | |

|50. |Which is a liquidity activity ratio? |

|medium |a. Profit margin |

|b |b. Inventory turnover |

| |c. Return on assets |

| |d. Times interest earned |

| | |

|51. |Which is usually included in an engagement letter? |

| | |

| |Estimate of hours required to complete | |Dollar estimate of fees to be billed to the |

|medium |audit | |client |

|d |a. |Yes | |Yes |

| |b. |No | |No |

| |c. |Yes | |No |

| |d. |No | |Yes |

| | | | |

|52. |Which is usually included in an engagement letter? |

|medium | | | |

|a |A reference to GAAP | |A reference to GAAS |

| |a. Yes | |Yes |

| |b. No | |No |

| |c. Yes | |No |

| |d. No | |Yes |

| | | | |

|53. |Which is usually included in an engagement letter? |

|medium | | | |

|c |The financial statements are the | | |

| |responsibility of the company’s | |Ratios to be used by the auditor in the planning phase |

| |management | | |

| |a. |Yes | |Yes |

| |b. |No | |No |

| |c. |Yes | |No |

| |d |No | |Yes |

| | | | | |

|54. |When may the auditor refer to a specialist in the audit report? |

|medium | | | | |

|c | | | |

| |Only if the specialist’s report results in a | | |

| |modification of the audit opinion | |Only if the specialist assisted in the audit of an account |

| | | |material to the financial statements |

| |a. |Yes | |Yes |

| |b. |No | |No |

| |c. |Yes | |No |

| |d |No | |Yes |

| | | | | |

|55. |Which is usually included in the engagement letter? |

|medium | | | | |

|b |The projected type of opinion on the | | |

| |financials statement to be audited | |Name(s) of the client personnel responsible for supplying the|

| | | |auditor with information |

| |a. |Yes | |Yes |

| |b. |No | |No |

| |c. |Yes | |No |

| |d |No | |Yes |

| | | | | |

|56. |Which is usually included in the engagement letter? |

|medium | | | | |

|b |List of audit procedures to be used in | | |

| |inventory observation | |The auditors’ assessment of Audit Risk |

| |a. |Yes | |Yes |

| |b. |No | |No |

| |c. |Yes | |No |

| |d |No | |Yes |

| | | | | |

| | | | | |

Essay Questions

|57. |Discuss the factors an auditor should consider before accepting a company as an audit client. |

|easy | |

| |Answer: |

| |The auditor should investigate and consider the prospective client’s standing in the business community, financial |

| |stability, management’s integrity, and relations with its bankers, attorneys, and previous CPA firm. The auditor |

| |should also determine whether he or she possesses the required competence and independence to do the audit. |

| | |

|58. |Discuss the primary purpose of an audit engagement letter. Is an engagement letter required? |

|easy | |

| |Answer: |

| |The purpose of an audit engagement letter is to establish a clear understanding between the auditor and the client |

| |regarding the terms of the engagement. An engagement is required for both public and private company audits. |

| | |

|59. |Define the term “related party” and discuss why an auditor should identify the client’s related parties early in the |

|easy |audit. |

| |Answer: |

| |A related party is an affiliated company, principal owner of the client company, or any other party with which the |

| |client deals where one of the parties can influence the management or operating policies of the other. Auditors need |

| |to be aware of who the client’s related parties are early in the audit to enable the auditor to identify |

| |related-party transactions, especially those that have not been disclosed. |

| | |

|60. |There are three main reasons why an auditor should properly plan audit engagements. Discuss each of these reasons. |

|medium | |

| |Answer: |

| |Three reasons why an auditor should properly plan audit engagements are: |

| |To enable the auditor to obtain sufficient competent evidence for the circumstances. This is essential for minimizing|

| |legal liability and maintaining a good profession reputation. |

| |To help keep audit costs reasonable. Given the competitive auditing environment, keeping costs reasonable helps the |

| |firm obtain and retain clients. |

| |To avoid misunderstandings with the client. This is important for good client relations. |

| | |

|61. |Discuss the essential activities involved in the initial planning of an audit. |

|medium | |

| |Answer: |

| |There are four essential activities involved in the initial planning of an audit. These are: |

| |Client acceptance or continuation. In the case of a new client, the auditor must determine whether the client is one |

| |with which (s)he wishes to be associated. In the case of a continuing client, an auditor must determine whether |

| |continuing the relationship is appropriate and in the firm’s best interest. |

| |Determine reason for the audit. The auditor should determine the reason for the audit as soon as practical. The |

| |remainder of the planning activities may be impacted by the client’s reason for requesting the audit. |

| |Obtain an understanding with the client. An understanding with the client should be obtained to avoid |

| |misunderstandings. Auditors are required to obtain an understanding with their clients. This understanding must be |

| |written. |

| |Develop an overall audit strategy. The strategy should consider the reasons for the audit, including areas where |

| |there is greater risk of significant misstatements. Setting a strategy helps the auditor determine the resources |

| |required for the engagement. |

|62. |Discuss the required communications between predecessor and successor auditors as outlined by SAS No. 84. |

|medium | |

| |Answer: |

| |Auditing standards require a successor auditor to communicate with the predecessor auditor whenever accepting a |

| |client that has been previously audited. The purpose of the communication is to help the successor auditor evaluate |

| |whether to accept the engagement. While the burden of initiating the communication rests on the successor auditor, |

| |the predecessor auditor must respond to the request for information. However, because of the requirements related to |

| |confidentiality, the predecessor must obtain the former client’s permission prior to providing information to the |

| |successor. |

| | |

|63. |Discuss several reasons why an auditor may not wish to continue a relationship with an existing audit client. |

|medium | |

| |Answer: |

| |There are a number of reasons an auditor may choose not to continue a relationship with an existing client. Examples|

| |include: |

| | |

| |Previous conflicts over accounting issues, scope of the audit, type of opinion, or fees. |

| |Management integrity may be deemed to be insufficient. |

| |Legal action initiated by either the auditor or client related to prior audit services. |

| |If fees remain unpaid for services performed more than one year prior to the date of the current year’s audit report.|

| |The presence of excessive risk. |

| | |

|64. |Discuss four of the matters that should be specified in an engagement letter. |

|medium | |

| |Answer: |

| |Matters that should be specified in the engagement letter include: |

| |Whether the auditor will perform an audit, a review, or a compilation, plus any other services such as tax returns or|

| |management advisory services. |

| |Any restrictions to be imposed on the auditor’s work. |

| |Deadlines for completing the audit. |

| |Assistance to be provided by the client’s personnel in obtaining records and documents, and schedules to be prepared |

| |for the auditor. |

| |Agreement on fees. |

| |The letter should state that the auditor is not responsible for the discovery of all acts of fraud. |

| | |

|65. |What documents do auditors routinely obtain to aid in their understanding of a client’s governance system? Briefly |

|medium |discuss each of these documents. |

| |Answer: |

| |Auditors commonly obtain the client’s corporate charter, bylaws, and minutes of meetings of the board of directors |

| |and shareholders. The corporate charter is issued by the state in which the company is incorporated and specifies the|

| |exact name of the corporation along with the date of incorporation, the kinds and amounts of stock the corporation is|

| |authorized to issue, and the types of business that the corporation is authorized to conduct. The bylaws include the |

| |rules and procedures adopted by the stockholders of the corporation. They specify the duties and powers of corporate |

| |officers, the method of voting for directors, and |

| | |

| | |

| |the frequency of stockholder meetings. The corporate minutes are the official record of the meetings of the board of|

| |directors and stockholders. They include summaries of the most important topics discussed and decisions made at the |

| |board meetings. |

| | |

|66. |What are three factors that have increased the importance of obtaining an understanding of a client’s business and |

|medium |industry? How can an auditor obtain this understanding? |

| |Answer: |

| |Factors that have increased the importance of obtaining an understanding of a client’s business and industry include:|

| |Advances in information technology have increased connectivity among companies, customers, and vendors. Auditors must|

| |understand the risks associated with this increased connectivity. |

| |Companies have expanded operations to have global reaches, often through joint ventures and strategic alliances. |

| |Information technology affects internal control processes, improving the quality and timeliness of accounting |

| |information. |

| |The increased importance of human capital and other intangible assets has increased accounting complexity and the |

| |importance of management judgments and estimates. |

| |Auditors need a better understanding of the client’s business and industry to provide additional value-added |

| |services. |

| | |

| |The auditor can obtain a sound understanding of the client’s business and industry through several means, including |

| |discussions with previous auditors and by reviewing the permanent files for the client; conferences with the client’s|

| |personnel; studying AICPA industry audit guides, textbooks, technical magazines, and specialized journals; and by |

| |participating in industry associations and training programs. |

| | |

|67. |There are three primary reasons for obtaining a thorough understanding of the client’s industry and external |

|medium |environment. What are these reasons? |

| |Answer: |

| |The three reasons are: |

| |Risks associated with specific industries may affect the auditor’s assessment of client business risk and acceptable |

| |audit risk. |

| |Certain inherent risks are typically common to all clients in certain industries. Familiarity with those risks aids |

| |the auditor in assessing their relevance to the client. |

| |Many industries have unique accounting requirements that the auditor must understand to evaluate whether the client’s|

| |financial statements are in accordance GAAP. |

| | |

|68. |Discuss the four primary purposes of analytical procedures performed during the planning phase of an audit. |

|medium | |

| |Answer: |

| |The four primary purposes of preliminary analytical procedures are: |

| |to help the auditor understand the client’s industry and business, |

| |to help the auditor assess the going concern assumption, |

| |to indicate areas of possible misstatements, and |

| |to reduce the extent of detailed tests. |

| | |

|69. |Define business risk. List several factors that may impact the auditor’s assessment of business risk. |

|challenging | |

| |Answer: |

| |Business risk is the risk that a company will fail to achieve its objectives. |

| |Factors that may impact business risk include: |

| |General economic conditions, |

| |Extent of competition within an industry, |

| |Changing regulatory requirements, |

| |Competence of management, |

| |Ability to maintain sufficient cash flows and secure financing, and |

| |Successful implementation of business strategies. |

|70. |Auditors routinely conduct analytical procedures in the planning, testing, and completion phases of the audit. |

|challenging |Identify the primary and secondary purposes of performing analytical procedures in each phase of the audit. |

| |Answer: |

| |Planning – The primary purposes are to understand the client’s business and industry and indicate areas of possible |

| |misstatements. The secondary purposes are to assess going concern and reduce the extent of detailed tests. |

| |Testing – The primary purpose is to reduce the extent of detailed tests, while the secondary purpose is to indicate |

| |areas of possible misstatements. |

| |Completion –The primary purpose is to indicate areas of possible misstatements, while the secondary purpose is to |

| |assess going concern. |

|71. |Three types of legal documents and records that auditors examine in the planning phase of an audit are the corporate |

|challenging |charter and bylaws, corporate minutes of meetings of the board of directors and stockholders, and contracts. Discuss |

| |the audit-relevant information contained in each of these three types of documents that an auditor should be aware of|

| |early in the audit. |

| |Answer: |

| |Corporate charter and bylaws. This includes the amounts of capital stock the corporation is authorized to issue, its |

| |par or stated value, preferences and conditions for dividends, and information concerning voting rights of each class|

| |of stock. The bylaws specify such things as the fiscal year of the corporation, the frequency of stockholder |

| |meetings, the method of voting for directors, and the duties and powers of the corporate officers. |

| |Minutes of meetings. There are two categories of audit-relevant information contained in the minutes: authorizations |

| |and discussions by the board of directors affecting inherent risk. Common authorizations in the minutes include |

| |compensation of officers, new contacts and agreements, acquisitions of property, loans, and dividend payments. |

| |Contracts. The auditor should examine contracts early in the engagement to gain a better perspective of the |

| |organization and to become familiar with potential problem areas. Contracts will also be examined during the tests of|

| |individual audit areas. |

| | |

Other Objective Answer Format Questions

|72. |When an auditor decides there is higher inherent risk for an account, one potential effect is that more audit |

|easy |evidence will be required for that account. |

|a |a. True |

| |b. False |

|73. |As acceptable audit risk is decreased, the likely cost of conducting an audit increases. |

|easy |a. True |

|a |b. False |

|74. |Before accepting a new client, most CPA firms investigate the company to determine its acceptability. However, AICPA |

|easy |confidentiality requirements prohibit CPA firms from contacting certain parties—namely the company’s attorneys and |

|b |bankers—during this investigation. |

| |a. True |

| |b. False |

|75. |For prospective clients that have previously been audited by another CPA firm, the predecessor auditor is required to|

|easy |communicate with the successor auditor. |

|b |a. True |

| |b. False |

|76. |When a successor auditor contacts a company’s previous auditor, the predecessor auditor is required to respond fully |

|easy |and without limit to the request for information. |

|b |a. True |

| |b. False |

|77. |A predecessor auditor who has been contacted by a successor auditor for information about the client does not have to|

|easy |obtain permission from the former client before providing any confidential information to the successor auditor |

|b |because the confidentiality requirement does not extend to former clients. |

| |a. True |

| |b. False |

|78. |Auditors should obtain copies of the client’s articles of incorporation, bylaws, and minutes of the meetings of the |

|easy |board of directors to aid in their understanding of the company’s management and governance structure. |

|a |a. True |

| |b. False |

|79. |An auditor must evaluate a specialist’s professional qualifications and understand the objectives of the specialist’s|

|easy |work. |

|a |a. True |

| |b. False |

|80. |To evaluate a specialist’s work the auditor must himself/herself be considered a specialist. |

|medium |a. True |

|b |b. False |

|81. |An engagement letter establishes a clear understanding of the terms of the engagement between the client and the |

|medium |auditor, but it is optional for private companies. |

|a |a. True |

| |b. False |

|82. |Because of the requirements of Rule 201 of the AICPA’s Code of Professional Conduct which state that auditors should |

|easy |“undertake only those professional services that the member or the member’s firm can reasonably expect to be |

|b |completed with professional competence,” auditors are not normally permitted to consult with, or rely on the work of,|

| |outside specialists during an audit engagement. |

| |a. True |

| |b. False |

|83. |Acceptable audit risk is a measure of the auditor’s willingness to accept that the financial statements do not |

|medium |contain material misstatements after the audit is completed and a qualified audit report has been issued. |

|b |a. True |

| |b. False |

|84. |If a prospective client has been audited in the past, the successor auditor will typically rely solely on the |

|medium |representations about the client by the predecessor auditor. |

|b |a. True |

| |b. False |

|85. |Two major factors that affect acceptable audit risk are the likely users of the financial statements and the |

|medium |likelihood of issuing an unqualified audit opinion. |

|b |a. True |

| |b. False |

|86. |A major consideration in assigning staff to an audit engagement is the experience levels required for the work, while|

|medium |a less important consideration is maintaining staff continuity on the engagement. |

|b |a. True |

| |b. False |

|87. |Inherent risks typically vary across industries. |

|medium |a. True |

|b |b. False |

|88. |Transactions with related parties must be disclosed in the financial statements if they are deemed to be material. |

|medium |a. True |

|a |b. False |

|89. |All known related parties must be identified and included in the auditor’s permanent files related to the client. |

|medium |a. True |

|a |b. False |

|90. |Generally, auditors assess inherent risk as moderate for related party transactions because they expect clients to be|

|medium |aware of their scrutiny of such transactions. |

|b |a. True |

| |b. False |

|91. |The corporate charter typically establishes the company’s fiscal year and frequency of stockholder meetings. |

|medium |a. True |

|b |b. False |

|92. |Ordinarily, the auditor should review and abstract copies of contracts during the later stages of an audit. |

|medium |a. True |

|b |b. False |

|93. |When a successor auditor requests information from a company’s previous auditor, and there are legal problems or |

|medium |disputes between the client and the predecessor auditor, the predecessor auditor’s response to the new auditor may be|

|a |limited to stating that no information will be provided. |

| |a. True |

| |b. False |

|94. |One purpose of performing preliminary analytical procedures in the planning phase of an audit is to help the auditor |

|medium |make a preliminary assessment of control risk. |

|b |a. True |

| |b. False |

|95. |Material transactions between the client and the client’s related parties must be disclosed in the auditor’s report. |

|medium |a. True |

|b |b. False |

|96. |An engagement letter can affect the CPA firm’s legal responsibilities to the client, but does not affect |

|challenging |responsibility to external users of audited financial statements. |

|a |a. True |

| |b. False |

|97. |Two categories of audit-relevant information found in corporate charters and bylaws are authorizations and |

|challenging |discussions of matters affecting inherent risk. |

|b |a. True |

| |b. False |

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