Chapter 1

Multiple-Choice Questions
1.
easy
Recording, classifying, and summarizing economic events in a logical manner for the purpose
of providing financial information for decision making is commonly called:
c a. finance.
. auditing.
c. accounting.
d. economics.
!.
easy
"n the audit of historical financial statements, #hich of the follo#ing accounting ases is the
most common$
c a. Regulatory accounting principles.
. Cash asis of accounting.
c. %enerally accepted accounting principles.
d. &i'uidation asis of accounting.
(.
easy
)ny service that re'uires a C*) firm to issue a report aout the reliaility of an assertion that is
made y another party is a+n,:
a. accounting and ookkeeping service.
. attestation service.
c. assurance service.
d. ta- service.
.. /hree common types of attestation services are:
easy a. audits, revie#s, and 0other1 attestation services.
a . audits, verifications, and 0other1 attestation services.
c. revie#s, verifications, and 0other1 attestation services.
d. audits, revie#s, and verifications.
2. +345,
easy
/he organization that is responsile for providing oversight for auditors of pulic companies is
called the 66666666.
d a. )uditing 3tandards 7oard.
. )merican "nstitute of Certified *ulic )ccountants.
c. *ulic 4versight 7oard.
d. *ulic Company )ccounting 4versight 7oard.
8. +345, /he 3aranes-4-ley )ct applies to #hich of the follo#ing companies$
easy a. )ll companies.
c . *rivately held companies.
c. *ulic companies.
d. )ll pulic companies and privately held companies #ith assets greater than 92:: million.
;.
medium
*roviding 'uantitative information that management and others can use to make decisions is the
function of:
d a. management information systems.
. auditing.
c. finance.
d. accounting.
Arens/Elder/Beasley
<. )n audit of historical financial statements most commonly includes the:
medium a. alance sheet, the income statement, and the statement of cash flo#s.
d . income statement, the statement of cash flo#s, and the statement of net #orking capital.
c. statement of cash flo#s, the alance sheet, and the retained earnings statement.
d. alance sheet, the income statement, and the statement of cash flo#s.
=.
medium
/he 66666666666 rate may e defined as appro-imately the rate a ank could earn y investing
in >.3. treasury notes for the same length as the length of a usiness loan.
c a. nominal
. stated
c. risk-free
d. prevailing
1:. /he use of the Certified *ulic )ccountant title is regulated y:
medium a. the federal government.
. state la# through a licensing department or agency of each state.
c. the )merican "nstitute of Certified *ulic )ccountants through the licensing departments
of the ta- and auditing committees.
d. the 3ecurities and ?-change Commission.
11. )n operational audit has as one of its o@ectives to:
medium a. determine #hether the financial statements fairly present the entityAs operations.
c . evaluate the feasiility of attaining the entityAs operational o@ectives.
c. make recommendations for improving performance.
d. report on the entityAs relative success in attaining profit ma-imization.
1!. )n audit of historical financial statements is most often performed to determine #hether the:
medium a. organization is operating efficiently and effectively.
d . entity is follo#ing specific procedures or rules set do#n y some higher authority.
c. management team is fulfilling its fiduciary responsiilities to shareholders.
d. none of these choices.
1(.
medium
)n e-amination of part of an organizationAs procedures and methods for the purpose of
evaluating efficiency and effectiveness is #hat type of audit$
a a. 4perational audit.
. Compliance audit.
c. Binancial statement audit.
d. *roduction audit.
1..
medium
)n audit to determine #hether an entity is follo#ing specific procedures or rules set do#n y
some higher authority is classified as a+n,:
a. audit of financial statements.
. compliance audit.
c. operational audit.
d. production audit.
12. Chich of the follo#ing is a type of audit evidence$
medium a. 4ral responses to the auditor from employees of the company under audit.
d . Critten communications from company employees or outsiders.
c. 4servations made y an auditor.
d. ?vidence may take any of the aove forms.
Arens/Elder/Beasley
18. Chich of the follo#ing services provides the lo#est level of assurance on a financial statement$
medium a. ) revie#.
a . )n audit.
c. Deither service provides assurance on financial statements.
d. ?ach service provides the same level of assurance on financial statements.
1;. /he three re'uirements for ecoming a C*) include all ut #hich of the follo#ing$
medium a. >niform C*) e-amination re'uirement.
c . ?ducational re'uirements.
c. Character re'uirements.
d. ?-perience re'uirement.
1<. "n 0auditing1 financial accounting data, the primary concern is #ith:
medium
a
a. determining #hether recorded information properly reflects the economic events that
occurred during the accounting period.
. determining if fraud has occurred.
c. determining if ta-ale income has een calculated correctly.
d. analyzing the financial information to e sure that it complies #ith government
re'uirements.
1=.
medium
Binancial statement users often receive unreliale financial information from companies. Chich
of the follo#ing is not a common reason for this$
d a. Comple- usiness transactions.
. &arge amounts of data.
c. &ack of firsthand kno#ledge aout the usiness.
d. ?ach of these choices is a common reason for unreliale financial information.
!:. Chich of the follo#ing is not a /rust 3ervices principle as defined y the )"C*) or C"C)$
challenging a. 4nline privacy.
d . )vailaility.
c. *rocessing integrity.
d. 4perational integrity.
!1. Chich one of the follo#ing is more difficult to evaluate o@ectively$
challenging
c
a. *resentation of financial statements in accordance #ith generally accepted accounting
principles.
. Compliance #ith government regulations.
c. ?fficiency and effectiveness of operations.
d. )ll three of the aove are e'ually difficult.
!!. +345,
challenging
/he 3aranes-4-ley )ct prohiits a C*) firm that audits a pulic company from providing
#hich of the follo#ing types of services to that company$
c a. Revie#s of 'uarterly financial statements.
. *reparation of corporate ta- returns.
c. Most consulting services.
d. /a- services.
!(. Chich of the follo#ing audits can e regarded as generally eing a compliance audit$
challenging a. "R3 agentsA e-aminations of ta-payer returns.
a . %)4 auditorAs evaluation of the computer operations of governmental units.
c. )n internal auditorAs revie# of a companyAs payroll authorization procedures.
d. ) C*) firmAs audit of the local school district.
!.. Chich of the follo#ing can e significantly affected y an audit$
challenging a. 7usiness risk.
. "nformation risk.
Arens/Elder/Beasley
c. /he risk-free interest rate.
d. "nherent risk.
!2. /he trait that distinguishes auditors from accountants is the:
challenging a. auditorAs aility to interpret accounting principles generally accepted in the >nited 3tates.
d . auditorAs education eyond the 7achelorAs degree.
c. auditorAs aility to interpret B)37 3tatements.
d. auditorAs accumulation and interpretation of evidence related to a companyAs financial
statements.
!8.
challenging
)ttestation services on information technology include Ce/rust services and 3ys/rust
services. Chich of the follo#ing statements most accurately descries 3ys/rust services$
a. 3ys/rust services provide assurance on usiness processes, transaction integrity and
information processes.
. 3ys/rust services provide assurance on system reliaility in critical areas such as security
and data integrity.
c. ys/rust services provide assurance on internal control over financial reporting.
d. 3ys/rust services provide assurance as to #hether accounting personnel are follo#ing
procedures prescried y the company controller.
?ssay Questions
!;.
easy
Eiscuss the three primary re'uirements for ecoming a C*).
)ns#er:
/he three primary re'uirements for ecoming a C*) are:
Educational requirement. )n undergraduate degree #ith a ma@or in accounting
is re'uired. Most states no# re'uire 12: semester hours for licensure and some states
re'uire 12: semester hours efore taking the C*) e-am.
Uniform CPA examination requirement. /his is a four-part e-am #ith
components on auditing and attestation, financial accounting and reporting,
regulation, and usiness environment and concepts.
Experience requirement. /he e-perience re'uirement varies from state to state
#ith some states re'uiring no e-perience, #hile other states re'uire up to t#o years of
audit e-perience.
!<.
easy
/#o types of attestation services provided y C*) firms are audits and revie#s. Eiscuss the
similarities and differences et#een these t#o types of attestation services. Chich type provides
the least assurance$
)ns#er:
/#o primary types of attestation services are: audits of historical financial statements and
revie#s of historical financial statements. Chile oth services involve the accumulation
and evaluation of evidence regarding assertions made y management in the companyAs
financial statements, a revie# involves a less e-tensive e-amination and provides a lo#er
level of assurance aout the clientAs financial statements than an audit.
Arens/Elder/Beasley
!=.
medium
Eiscuss the differences and similarities et#een the roles of accountants and auditors. Chat
additional e-pertise must an auditor possess eyond that of an accountant$
)ns#er:
/he role of accountants is to record, classify, and summarize economic events in a logical
manner for the purpose of providing financial information for decision making. /o do this,
accountants must have a sound understanding of the principles and rules that provide the
asis for preparing the financial information. "n addition, accountants are responsile for
developing systems to ensure that the entityAs economic events are properly recorded on a
timely asis and at a reasonale cost.
/he role of auditors is to determine #hether the financial information prepared y
accountants properly reflects the economic events that occurred. /o do this, the auditor
must not only understand the principles and rules that provide the asis for preparing
financial information, ut must also possess e-pertise in the accumulation and evaluation
of audit evidence. "t is this latter e-pertise that distinguishes auditors from accountants.
(:.
medium
Eiscuss the similarities and differences et#een financial statement audits, operational audits,
and compliance audits. %ive an e-ample of each type.
)ns#er:
Binancial statement audits, operational audits, and compliance audits are similar in that
each type of audit involves accumulating and evaluating evidence aout information to
ascertain and report on the degree of correspondence et#een the information and
estalished criteria. /he differences et#een each type of audit are the information eing
e-amined and the criteria used to evaluate the information. )n e-ample of a financial
statement audit #ould e the annual audit of "7M Corporation, in #hich the e-ternal
auditors e-amine "7MAs financial statements to determine the degree of correspondence
et#een those financial statements and generally accepted accounting principles. )n
e-ample of an operational audit #ould e an internal auditorAs evaluation of #hether the
companyAs computerized payroll-processing system is operating efficiently and
effectively. )n e-ample of a compliance audit #ould e an "R3 auditorAs e-amination of
an entityAs federal ta- return to determine the degree of compliance #ith the "nternal
Revenue Code.
(1.
medium
Eiscuss the similarities and differences et#een the roles of independent auditors, %)4
auditors, internal revenue agents, and internal auditors.
)ns#er:
/he roles of all four types of auditors are similar in that they involve the accumulation and
evaluation of evidence aout information to ascertain and report on the degree of
correspondence et#een the information and estalished criteria. /he differences in their
roles center around the information audited and the criteria used to evaluate that
information. "ndependent auditors primarily audit companiesA financial statements. %)4
auditorsA primary responsiility is to perform the audit function for Congress. "R3 auditors
are responsile for the enforcement of federal ta- la#s. "nternal auditors primarily perform
operational and compliance audits for their employing company.
Arens/Elder/Beasley
(!. +345,
medium
Chat is an engagement to attest on internal control over financial reporting$
)ns#er:
3ection .:. of the 3aranes-4-ley )ct re'uires pulic companies to report managementAs
assessment of the effectiveness of internal control over financial reporting. /he )ct further
re'uires auditors to attest to the effectiveness of internal control over financial reporting.
/his evaluation, #hich is integrated #ith the audit of financial statements, provides
for#ard-looking information, ecause effective internal controls reduce the likelihood of
future misstatements in the financial statements.
((.
challenging
/o do an audit, it is necessary for information to e in a verifiale form and some criteria y
#hich the auditor can evaluate the information. +), Chat information and criteria #ould an
independent C*) firm use #hen auditing a companyAs historical financial statements$ +7, Chat
information and criteria #ould an "nternal Revenue 3ervice auditor use #hen auditing that same
companyAs ta- return$ +C, Chat information and criteria #ould an internal auditor use #hen
performing an operational audit to evaluate #hether the companyAs computerized payroll
processing system is operating efficiently and effectively$
)ns#er:
+), /he information used y a C*) firm in a financial statement audit is the financial
information in the companyAs financial statements. /he most commonly used criteria are
accounting principles generally accepted in the >nited 3tates.
+7, /he information used y an "R3 auditor is the financial information in the companyAs
federal ta- return. /he criteria are the internal revenue code and interpretations.
+C, /he information used y an internal auditor #hen performing an operational audit of
the payroll system could include various items such as the numer of errors made, costs
incurred y the payroll department, and numer of payroll records processed each month.
/he criteria #ould consist of company standards for departmental efficiency and
effectiveness.
(..
challenging
?-plain #hat is meant y information risk, and discuss the four causes of this risk.
)ns#er:
"nformation risk is the possiility that information upon #hich a usiness decision is made
is inaccurate. Bour causes of information risk are:
remoteness of information,
iases and motives of the provider,
voluminous data, and
comple- e-change transactions.
(2. )ttestation services fall into five categories. Chat are these categories$
challenging )ns#er:
/he five categories of attestation services include:
audits of historical financial statements,
attestation on internal control over financial reporting,
revie#s of historical financial statements,
attestation services on information technology, and
other attestation services that may e applied to a road range of su@ect matter.
Arens/Elder/Beasley
(8.
challenging
Eiscuss four factors that are likely to significantly reduce information risk in the ne-t five to ten
years.
)ns#er:
Bour factors that are likely to significantly reduce information risk in the ne-t five to ten
years are:
technological advances,
more companies #ill go on-line, reducing the risk of investors otaining
outdated information,
ne# accounting and auditing standards, and
auditors #ill find more efficient and effective audit techni'ues.
4ther 4@ective )ns#er Bormat Questions
(;.
easy
a
/he criteria y #hich an auditor evaluates the information under audit may vary #ith the
information eing audited.
a. /rue
. Balse
(<.
easy

/he criteria used y an e-ternal auditor to evaluate pulished financial statements are kno#n as
generally accepted auditing standards.
a. /rue
. Balse
(=. +345,
easy

/he 3aranes-4-ley )ct estalishes standards related to the audits of privately held companies.
a. /rue
. Balse
.:. +345,
easy
a
/he 3aranes-4-ley )ct is #idely vie#ed as having ushered in s#eeping changes to auditing
and financial reporting.
a. /rue
. Balse
.1.
easy

4nly companies that file annual statements #ith the 3ecurities and ?-change Commission are
re'uired to have an annual e-ternal audit.
a. /rue
. Balse
.!.
easy

/he financial statements most commonly audited y e-ternal auditors are the alance sheet, the
income statement, and the statement of changes in retained earnings.
a. /rue
. Balse
.(.
medium

/he primary purpose of a compliance audit is to determine #hether the financial statements are
prepared in compliance #ith generally accepted accounting principles.
a. /rue
. Balse
...
medium
a
Results of compliance audits are typically reported to someone #ithin the organizational unit
eing audited rather than to a road spectrum of outside users.
a. /rue
. Balse
Arens/Elder/Beasley
.2.
medium

/he primary role of the >nited 3tates %eneral )ccounting 4ffice is the enforcement of the
federal ta- la#s as defined y Congress and interpreted y the courts.
a. /rue
. Balse
.8.
medium

C*) firms are never allo#ed to provide ookkeeping services for audit clients.
a. /rue
. Balse
.;. +345,
medium
a
3ection .:. of the 3aranes-4-ley )ct re'uires pulic companies to have an e-ternal auditor
attest to their internal control over financial reporting.
a. /rue
. Balse
.<. +345,
challenging

/he 3aranes-4-ley )ct re'uires a companyAs chairman of the oard of directors, C?4, and
CB4 to certify the companyAs financial statements.
a. /rue
. Balse
.=. +345,
challenging

/he criterion that is most likely to e used as a frame#ork in evaluating a companyAs internal
control over financial reporting under 3ection .:. of the 3aranes-4-ley )ct is the Enterprise
Risk Management frame#ork.
a. /rue
. Balse
2:.
challenging
a
Most pulic companiesA audited financial statements are availale on the 3?CAs ?E%)R
dataase.
a. /rue
. Balse
Chapter 2
Multiple-Choice Questions
1. Chich one of the follo#ing is not one of the three %eneral 3tandards$
easy a. *roper planning and supervision.
a . "ndependence of mental attitude.
c. )de'uate training and proficiency.
d. Eue professional care.
!. Chich one of the follo#ing is not a Bield Cork 3tandard$
easy a. )de'uate planning and supervision.
. Eue professional care.
c. >nderstand the entity and its environment including internal control.
d. 3ufficient appropriate audit evidence.
(. /he %eneral 3tandards stress the importance of:
easy a. evidence accumulation.
. personal 'ualities the auditor should possess.
c. communicating the auditorAs findings to the reader.
d. general supervision of the audit.
Arens/Elder/Beasley
..
easy
/he generally accepted auditing standard that re'uires 0)de'uate technical training and
proficiency1 is normally interpreted as re'uiring the auditor to have:
a a. formal education in auditing and accounting.
. #orked for an entity similar to the entity eing audited.
c. independence in mental attitude
d. a graduate degree in a usiness field.
2. +345, Memers of the *ulic Company )ccounting 4versight 7oard are appointed and overseen y:
easy a. the >.3. Congress.
d . the )merican "nstitute of Certified *ulic )ccountants.
c. the )uditing 3tandards 7oard.
d. the 3ecurities and ?-change Commission.
8.
easy
3tatements on )uditing 3tandards provide auditors of privately held companies #ith 666666
guidance regarding the conduct of financial statement audits.
a. fairly e-tensive
. some limited
c. practically no
d. specific and detailed
Arens/Elder/Beasley
;.
easy
Chich of the follo#ing statements most accurately captures the intent of the standards of field
#ork$
c a. Bield #ork standards are primarily concerned #ith personal attriutes necessary during the
conduct of the audit.
. Bield #ork standards provide e-tensive guidance regarding the conduct of an audit.
c. Bield #ork standards are primarily directed at the auditorAs planning, understanding of
internal control, and evidence accumulation.
d. Bield #ork standards are primarily concerned #ith the conduct of sustantive testing as
opposed to testing of internal controls.
<. +345,
easy
*rior to the passage of the 3aranes-4-ley )ct, #hich of the follo#ing #as responsile for
estalishing auditing standards$
c a. 3ecurities and ?-change Commission
. *ulic Company )ccounting 4versight 7oard
c. )uditing 3tandards 7oard
d. Dational )ssociation of )ccounting
=. +345,
medium
3tandards issued y the *ulic Company )ccounting 4versight 7oard must e follo#ed y
C*)s #ho audit:
a. oth private and pulic companies.
. pulic companies only.
c. private companies, pulic companies, and nonprofit entities.
d. private companies only.
1:. Chich of the follo#ing is the least likely form of usiness for a C*) firm$
medium a. %eneral partnership
. %eneral corporation
c. &imited liaility company
d. &imited liaility partnership
11. /he 3tatements on )uditing 3tandards issued y the )uditing 3tandards 7oard:
medium a. are interpretations of generally accepted auditing standards.
a . are the e'uivalent of la#s for audit practitioners.
c. must e follo#ed in all situations.
d. are optional guidelines #hich an auditor may choose to follo# or not follo# #hen
conducting an audit.
1!. )n auditor need not aide y a particular auditing standard if the auditor elieves that:
medium a. the issue in 'uestion is immaterial in amount.
a . more e-pertise is needed to fulfill the re'uirement.
c. the re'uirement of the standard has not een addressed y the *C)47.
d. any of the aove three are correct.
1(. +345, /he *ulic Company )ccounting 4versight 7oard does not:
medium a. perform inspections of the 'uality controls at audit firms that audit pulic companies.
. estalish auditing standards that must e follo#ed y C*)s on all audits.
c. oversee auditors of pulic companies.
d. perform any of the aove functions.
1..
medium
/he form that must e completed and filed #ith the 3ecurities and ?-change Commission
#henever a company e-periences a significant event that is of interest to pulic investors is the:
a. Borm 3-1.
. Borm <-F.
c. Borm 1:-F.
d. Borm 1:-Q.
Arens/Elder/Beasley
12.
medium
/he form that must e filed #ith the 3ecurities and ?-change Commission #henever a company
plans to issue ne# securities to the pulic is the:
a a. Borm 3-1.
. Borm <-F.
c. Borm 1:-F.
d. Borm 1:-Q.
18.
medium
/he third general standard states that due care is to e e-ercised in the performance of an audit.
/his standard is generally interpreted to re'uire:
c a. o@ective revie# of the ade'uacy of the technical training of firm personnel.
. thorough revie# of the e-isting internal control structure.
c. critical revie# of #ork done at every level of supervision.
d. periodic revie# of a C*) firmAs 'uality control procedures.
1;. +345,
medium
)ssume the *ulic Company )ccounting 4versight 7oard +*C)47, identifies a violation
during its inspection of a registered accounting firm.
d a. /he *C)47 may not enforce some disciplinary action against the accounting firm.
. /he *C)47 may not report the matter to the 3ecurities and ?-change Commission.
c. /he *C)47 may not report the matter to the appropriate state accountancy oard
d. /he *C)47 may not suspend the license to practice of the C*) guilty of the violation.
1<.
medium
Chich of the follo#ing statements est descries the primary purpose of 3tatements on
)uditing 3tandards$
d a. /hey are guides intended to set forth auditing procedures that are applicale to a variety of
situations.
. /hey are procedural outlines that are intended to narro# the areas of inconsistency and
divergence of auditor opinion.
c. /hey are authoritative statements, enforced through the Code of *rofessional Conduct, and
are intended to limit the degree of auditor @udgment.
d. /hey are interpretations that are intended to clarify the meaning of 0generally accepted
auditing standards.1
1=. 3tatements on 3tandards for )ccounting and Revie# 3ervices are issued y the:
medium a. )ccounting and Revie# 3ervices Committee.
a . *rofessional ?thics ?-ecutive Committee.
c. 3ecurities and ?-change Commission.
d. Binancial )ccounting 3tandards 7oard.
!:. Consulting 3tandards are issued y the:
medium a. )ccounting and Revie# 3ervices Committee.
c . 3ecurities and ?-change Commission.
c. Management Consulting 3ervices ?-ecutive Committee.
d. Binancial )ccounting 3tandards 7oard.
!1.
medium
/he auditorAs @udgment concerning the overall fairness of presentation of financial position,
results of operations, and changes in cash flo# is applied #ithin the frame#ork of:
d a. 'uality control.
. generally accepted auditing standards #hich include the concept of materiality.
c. the auditorAs evaluation of the audited companyAs internal control.
d. generally accepted accounting principles.
!!.
medium
) asic o@ective of a C*) firm is to provide professional services to conform to professional
standards. Reasonale assurance of achieving this asic o@ective is provided through:
c a. continuing professional education.
. compliance #ith generally accepted reporting standards.
c. a system of 'uality control.
d. a system of peer revie#.
Arens/Elder/Beasley
!(.
medium
Cithin the conte-t of 'uality control, the primary purpose of continuing professional education
and training activities is to enale a C*) firm to provide its personnel #ith:
c a. technical training that assures proficiency as a valuation e-pert.
. professional education that is re'uired in order to perform #ith due professional care.
c. kno#ledge re'uired to fulfill assigned responsiilities.
d. kno#ledge re'uired to perform a peer revie#.
!..
medium
Cilliams G Co., a memer of the *rivate Companies *ractice 3ection, is to have a 0peer
revie#.1 /he peer revie# can e performed y:
d a. a C*) firm selected y Cilliams G Co.
. a revie# team selected y the state society.
c. internal auditors.
d. either a or .
!2.
medium
a
Hansen CorporationAs stock is listed on a national stock e-change and registered #ith the
3ecurities and ?-change Commission. HansenAs management hires a C*) to perform an
independent audit of HansenAs financial statements. /he primary o@ective of this audit is to
provide assurance to the:
a. investors in Hansen CorporationAs stock.
. stock e-change.
c. 3ecurities and ?-change Commission.
d. management of Hansen Corporation.
!8. Chich of the follo#ing is not an essential component of 'uality control$
medium
a
a. *olicies and procedures to ensure that firm personnel are actively engaged in marketing
strategies.
. *olicies and procedures to ensure that the #ork performed y firm personnel meet
applicale professional standards.
c. *olicies to ensure that personnel maintain their independence in fact and in appearance.
d. *olicies that ensure that monitoring activities are effectively applied.
!;. Chich of the follo#ing is true regarding the )"C*)-approved practice monitoring programs$
challenging a. /he Center for *ulic Company )udit Birms does not offer a peer revie# program.
c . Birms registered #ith the *C)47 must not enroll in an )"C*)-approved practice
monitoring program.
c. *ulic accounting firms must e enrolled in an )"C*)-approved practice monitoring
program for memers in the firm to e eligile for memership in the )"C*).
d. /he )"C*) peer revie# program is administered through the 3?C.
!<.
challenging
c
Chich of the follo#ing statements is true as it relates to limited liaility partnerships$
a. 4nly senior partners are liale for the partnershipAs dets.
. *artners have no liaility in a limited liaility partnership arrangement.
c. *artners are personally liale for the acts of those under their supervision.
d. )ll partners must e )"C*) memers.
!=. +345,
challenging
"f an auditor of a pulic company cannot find guidance issued y the *C)47 on a particular
audit matter, the auditor should generally seek guidance from #hich of the follo#ing sources$
a a. 3tatements on )uditing 3tandards.
. 3tatements on 3tandards for )ccounting and Revie# 3ervices.
c. Regulations issued y the 3ecurities and ?-change Commission.
d. /he )"C*) Code of Professional Conduct.
(:. /he 3?C re'uirements of greatest interest to C*)s are set forth in the 3?CAs:
challenging a. Regulation 3-5 and )ccounting 3eries Releases.
a . 3-1 through 3-18 forms.
c. EirectorAs ne#sletter.
Arens/Elder/Beasley
d. Borms <-F, 1:-F, and 1:-Q.
(1.
challenging
/he )"C*) has authority to estalish standards and rules in all ut #hich of the follo#ing
areas$
d a. )uditing standards applicale to financial statements of private companies.
. Compilation and revie# standards.
c. *rofessional conduct.
d. )uditing standards applicale to financial statements of private and pulic companies.
(!.
challenging
%enerally )ccepted )uditing 3tandards +%))3, and 3tatements on )uditing 3tandards +3)3,
should e looked upon y practitioners as:
c a. ideals to #ork to#ards, ut #hich are not achievale.
. ma-imum standards that denote e-cellent #ork.
c. minimum standards of performance that must e achieved on each audit engagement.
d. enchmarks to e used on all audits, revie#s, and compilations.
((.
challenging
Chich one of the follo#ing is not a re'uirement for elonging to the *rivate Companies
*ractice 3ection of the )merican "nstitute of Certified *ulic )ccountants$
c a. )dherence to 'uality control standards.
. Mandatory peer revie#.
c. *artner rotation after a period of ten consecutive years.
d. Continuing education.
(.. 3tatements on )uditing 3tandards issued y the )"C*)As )uditing 3tandards 7oard are:
challenging

a. part of the generally accepted auditing standards under the )"C*) Code of Professional
Conduct.
. interpretations of generally accepted auditing standards and departures from such
statements must e @ustified.
c. interpretations of generally accepted auditing standards and such standards must e
follo#ed in every engagement.
d. generally accepted auditing procedures that are not covered y the )"C*) Code of
Professional Conduct.
?ssay Questions
(2.
easy
Eistinguish et#een generally accepted auditing standards +%))3, and generally accepted
accounting principles +%))*,. Chat professional organization estalishes %))3$ Chat
professional organization estalishes %))*$
)ns#er:
%enerally accepted auditing standards are general guidelines to help auditors meet their
professional responsiilities in the audit of historical financial statements. /hey are
considered to e the minimum standards of performance for auditors to follo# and are
estalished y the )uditing 3tandards 7oard of the )merican "nstitute of Certified *ulic
)ccountants for private companies and y the *ulic Company )ccounting 4versight
7oard for pulic companies. %enerally accepted accounting principles are the guidelines
#hich an entityAs management normally follo#s #hen preparing historical financial
statements. %))* is estalished y the Binancial )ccounting 3tandards 7oard.
(8.
easy
Eiscuss the relationship et#een 'uality control and generally accepted auditing standards.
)ns#er:
Bor a C*) firm, 'uality control encompasses the methods used to make sure that the firm
meets its professional responsiilities to clients. Quality control is closely related to, ut
Arens/Elder/Beasley
distinct from, %))3. ) C*) firm must make sure that %))3 are follo#ed on every
audit. Quality controls are the procedures used y the C*) firm that help it meet
re'uirements demanded y %))3 on every engagement in a consistent manner.
(;.
easy
Eescrie the various staff levels and responsiilities of a typical pulic accounting firm.
)ns#er:
Staff assistant - 3taff assistants, or staff accountants, perform most of the detailed
audit #ork.
Senior or In-carge auditor - 3eniors coordinate and are responsile for the audit
field #ork, including the supervision and revie# of staff assistantsA #ork.
Manager - Managers assist the senior plan and manage the audit, revie# the
seniorAs #ork, and manages relations #ith the client. ) manager may e responsile
for multiple engagements at the same time.
Partner - *artners revie# the overall audit #ork and they are involved in all
significant audit decisions. )s o#ners of the firm, partners are ultimately responsile
for conducting the audit and serving the client.
(<.
medium
Eiscuss the five elements of 'uality control. Cho estalishes the standards for 'uality control$
)ns#er:
Independence! integrit" and o#$ecti%it" - *ersonnel on engagement should maintain
independence in fact and in appearance, perform all professional responsiilities #ith
integrity and maintain o@ectivity in performing their professional responsiilities.
Personnel management - *olicies and procedures should e estalished to provide
the firm #ith reasonale assurance that all ne# personnel are 'ualified to perform
their #ork, #ork is assigned to personnel #ho have ade'uate training, and personnel
should participate in continuing professional education.
Acceptance and continuation of clients and engagements - *olicies and procedures
should e estalished for deciding #hether to accept or continue a client relationship.
/hese policies should minimize the risk of associating #ith a client #hose
management lacks integrity.
Engagement performance - *olicies and procedures should e-ist to ensure that
engagement personnel perform #ork that meets applicale professional standards and
the firmAs standards of 'uality.
Monitoring - *olicies and procedures should e-ist to ensure that the other four
'uality control elements are eing effectively applied.
Quality control standards are estalished y the )uditing 3tandards 7oard for auditors
of private companies and y the *ulic Company )ccounting 4versight 7oard for
auditors of pulic companies.
(=.
medium
Eescrie the si- organizational structures availale to C*) firms.
)ns#er:
C*) firms can take one of si- organizational forms:
Proprietorsip. /his form is limited to firms #ith only one o#ner.
&eneral partnersip. /his form is similar to a proprietorship, e-cept that it
applies to multiple o#ners.
&eneral corporation. >nlike a general partnership, shareholders in a general
corporation are liale only to the e-tent of their investment in the corporation.
Professional corporation. *rofessional corporations can have one or more
Arens/Elder/Beasley
shareholders. *ersonal liaility protection for shareholders in professional
corporations varies #idely from state to state.
'imited lia#ilit" compan". /his form comines the most favorale attriutes of
a general corporation and a general partnership. &&Cs are ta-ed like a general
partnership, ut its o#ners have limited personal liaility like shareholders of a
general corporation.
'imited lia#ilit" partnersip. )n &&* is structured and ta-ed like a general
partnership. Ho#ever, the personal liaility protection of an &&* is less than that of a
general corporation or an &&C, ut it is greater than a general partnership. Many
accounting firms no# operate as &&*s.
.:.
medium
/here are ten generally accepted auditing standards, divided into three categories. &ist, y
category, each of these ten standards.
)ns#er:
%eneral 3tandards
)de'uate technical training and proficiency.
"ndependence in mental attitude.
Eue professional care.
3tandards of Bield#ork
)de'uate planning and supervision.
>nderstand the entity and its environment including internal control.
3ufficient appropriate audit evidence.
3tandards of Reporting
Chether statements #ere prepared in accordance #ith %))*.
Circumstances #hen %))* #as not consistently follo#ed.
)de'uacy of informative disclosures.
?-pression of opinion on financial statements as a #hole.
.1.
medium
"n the conte-t of auditing, e-plain #hat is meant y an independent mental attitude. Eiscuss
ho# internal auditors can have an independent mental attitude #hen they are employed y the
company they audit.
)ns#er:
"ndependent mental attitude refers to a state of mind in #hich the C*) is totally uniased
#ith respect to the client and the financial information under audit.
)lthough internal auditors are employees of the organization for #hich their audits are
performed, internal auditors should e independent of the function eing e-amined and
should report their findings to a level high enough in the organization to allo# the auditor
to e free from influence y the party, or parties, eing e-amined.
.!. +345,
medium
/he 3aranes-4-ley )ct estalished the *ulic Company )ccounting 4versight 7oard
+*C)47,. Chat are the *C)47As primary functions$ Cho performed these functions prior to
the *C)47$
)ns#er:
/he *C)47 has responsiility for providing oversight auditors of pulic companies,
estalishing auditing and 'uality control standards for pulic company audits and
performing inspections of the 'uality controls at audit firms performing those audits.
/hese functions #ere formerly the responsiility of the )merican "nstitute of Certified
Arens/Elder/Beasley
*ulic )ccountants.
.(.
challenging
Chat are four of the ma@or functions of the )"C*)$
)ns#er:
Ma@or functions of the )"C*) include:
?stalishing standards and rules that practicing C*)s must follo#. /hese
standards consist of auditing standards for auditors of private companies, compilation
and revie# standards, other attestation standards, and the Code of Professional
Conduct.
Research and pulication. )"C*) pulications include the (ournal of
Accountanc", industry audit guides, periodic updates of the Codification of Statements
on Auditing Standards, and the Code of Professional Conduct.
*romoting the accounting profession.
Eeveloping specialist certifications.
Criting and grading the uniform C*) e-amination.
*roviding continuing education seminars for its memers.
...
challenging
Eiscuss the purpose of the 3ecurities and ?-change Commission and its influence on setting
generally accepted accounting principles.
)ns#er:
/he overall purpose of the 3?C is to assist in providing investors #ith reliale information
upon #hich to make investment decisions. )s a result of its authority for specifying
financial reporting re'uirements, the 3?C has considerale influence in setting generally
accepted accounting principles. )lthough the 3?C has taken the position that accounting
principles should e set y the profession +B)37,, the 3?CAs opinion is generally
considered in any ma@or change in %))* proposed y the B)37.
.2.
challenging
/he purpose of the )"C*)As C*) Iision *ro@ect is to help C*)s make sense of our changing
and comple- #orld. /he *ro@ect has identified core values that C*)s must e a#are of in the
future. Chat are the top five core values$
)ns#er:
Continuing education and lifelong learning
Competence
"ntegrity
)ttuned to road usiness issues
4@ectivity
4ther 4@ective )ns#er Bormat Questions
.8.
easy

Memership in the )"C*) is restricted to C*)s #ho are currently practicing as independent
auditors.
a. /rue
. Balse
.;.
easy
Memership in the )"C*) is mandatory for all licensed practicing C*)s.
a. /rue
Arens/Elder/Beasley
. Balse
.<.
easy
a
)ny pulic accounting firm can e a memer of the )"C*) if the firm meets the memership
re'uirements.
a. /rue
. Balse
.=.
easy

3tatements on )uditing 3tandards +3)3s, are issued y the *ulic Company )ccounting
4versight 7oard.
a. /rue
. Balse
2:. +345,
easy

)uditors of pulic companies should, in the asence of guidance issued y the *C)47, follo#
auditing standards issued y the 3?C.
a. /rue
. Balse
21. +345,
medium

/he >.3. Congress has oversight responsiility for the *C)47.

a. /rue
. Balse
2!.
medium

Borm 1:-F must e filed #ith the 3?C #henever a pulic company e-periences a significant
event.
a. /rue
. Balse
2(.
medium

"n a limited liaility partnership, partners are personally liale for liailities arising from
negligent acts of other partners, ut not for liailities arising from acts of other employees.
a. /rue
. Balse
2..
medium
a
&imited liaility companies are structured and ta-ed like a general partnership, ut their o#ners
have limited personal liaility similar to that of a general corporation.
a. /rue
. Balse
22. +345,
medium

)ll C*) firms registered #ith the *C)47 are re'uired to undergo a peer revie# at least once
every t#o years.
a. /rue
. Balse
28.
medium
a
3tatements on )uditing 3tandards +3)3s, are considered to e interpretations of the ten
generally accepted auditing standards.
a. /rue
. Balse
2;. +345,
medium
a
)ny C*) firm that audits more than 1:: pulic companies is re'uired to have an annual
inspection y the *C)47.
a. /rue
. Balse
2<.
medium
a
/he overall purpose of the 3ecurities and ?-change Commission is to assist in providing
investors #ith reliale information upon #hich to make investment decisions.
a. /rue
. Balse
2=. "nternational 3tandards on )uditing are issued y the "nternational )uditing *ractices
Arens/Elder/Beasley
medium
a
Committee.
a. /rue
. Balse
Chapter 3
Multiple-Choice Questions
1. )uditing standards re'uire that the audit report must e titled and that the title must:
easy a. include the #ord 0independent.1
a . indicate if the auditor is a C*).
c. indicate if the auditor is a proprietorship, partnership, or incorporated.
d. indicate the type of audit opinion issued.
!.
Medium
a
/o emphasize the fact that the auditor is independent, a typical addressee of the audit report
could e:
Company Controller 3hareholders 7oard of Eirectors
a. Do Jes Jes
. Do Do Jes
c. Jes Jes Do
d. Jes Do Do
(. /he purpose of the introductory paragraph in the standard un'ualified report is:
easy a. to identify that the type of opinion issued is un'ualified.
. to identify the financial statements audited and the dates and time periods covered y the
report.
c. to indicate the C*) follo#ed applicale audit standards.
d. to indicate all the financial statements are in accordance #ith %))*.
.. /he scope paragraph of the standard un'ualified audit report states that the audit is designed to:
easy a. discover all errors andKor irregularities.
d . discover material errors andKor irregularities.
c. conform to generally accepted accounting principles.
d. otain reasonale assurance #hether the statements are free of material misstatement.
2. /he audit report date on a standard un'ualified report indicates:
easy a. the last day of the fiscal period.
d . the date on #hich the financial statements #ere filed #ith the 3ecurities and ?-change
Commission.
c. the last date on #hich users may institute a la#suit against either client or auditor.
d. the last day of the auditorAs responsiility for the revie# of significant events that
occurred suse'uent to the date of the financial statements.
8.
easy
d
)s a result of managementAs refusal to permit the auditor to physically e-amine inventory, the
auditor has not accumulated sufficient appropriate evidence to conclude #hether financial
statements are stated in accordance #ith %))*. /he auditor must depart from the un'ualified
audit report ecause:
a. the financial statements have not een prepared in accordance #ith %))*.
. the scope of the audit has een restricted y circumstances eyond either the clientAs or
auditorAs control.
c. the auditor has lost independence.
d. the scope of the audit has een restricted.
Arens/Elder/Beasley
;. )n adverse opinion is issued #hen the auditor elieves:
easy a. some parts of the financial statements are materially misstated or misleading.
d . the financial statements #ould e found to e materially misstated if an investigation #ere
performed.
c. the auditor is not independent.
d. the overall financial statements are so materially misstated that they do not present fairly
the financial position or results of operations and cash flo#s in conformity #ith %))*.
<.
easy
"f a misstatement is immaterial to the financial statements of the entity for the current period,
ut is e-pected to have a material effect in future periods, it is appropriate to issue a+n,:
c a. adverse opinion.
. 'ualified opinion.
c. un'ualified opinion.
d. disclaimer of opinion.
=. +*ulic,
easy
Chenever an auditor issues an audit report for a pulic company, the auditor can choose to
issue a report in #hich of the follo#ing forms$
c a. ) comined report on financial statements and internal control over financial reporting.
. 3eparate reports on financial statements and internal control over financial reporting.
c. ?ither a or .
d. Deither a nor .
1:.
easy
Chen determining #hether an e-ception is 0highly material,1 the e-tent to #hich the e-ception
affects different elements of the financial statements must e considered. /his concept is called:
a. materiality.
. pervasiveness.
c. financial analysis.
d. ratio analysis.
11.
medium
)n auditor determines the financial statements include a material departure from %))*.
Chich type of opinion may e issued$
d
Eisclaimer Qualified )dverse
a. Jes Do Do
. Do Jes Do
c. Jes Do Jes
d. Do Jes Jes
1!. +*ulic,
easy
"f an auditor performs an audit of a pulic company, the scope paragraph should make reference
to #hich standards$
c a. )ccounting standards.
. %enerally accepted auditing standards.
c. 3tandards issued y the *C)47 +>.3.,.
d. )ny of the aove standards.
1(.
easy
"f an auditor performs an audit of a private company, the scope paragraph should make
reference to #hich standards$
a. )ccounting standards.
. >.3. generally accepted auditing standards.
c. 3tandards issued y the *C)47 +>.3.,.
d. )ny of the aove standards.
1..
easy
?-amples of un'ualified opinions #hich contain modified #ording +#ithout adding an
e-planatory paragraph, include:
a a. the use of other auditors.
. material uncertainties.
Arens/Elder/Beasley
c. sustantial dout aout the audited company +or the entity, continuing as a going
concern.
d. lack of consistent application of %))*.
12. %))* re'uires that changes in accounting principles e to a:
medium a. more conservative principle.
c . principle #ith e'ual authoritative support.
c. preferale principle.
d. principle detailed in a B)37 pronouncement.
18.
easy
) C*) may #ish to emphasize specific matters regarding the financial statements even though
an un'ualified opinion #ill e issued. Dormally, such e-planatory information is:
c a. included in the scope paragraph.
. included in the opinion paragraph.
c. included in a separate paragraph in the report.
d. included in the introductory paragraph.
1;.
challenging
d
)n auditor #ho issues a 'ualified opinion ecause sufficient appropriate evidence #as not
otained should descrie the limitations in an e-planatory paragraph. /he auditor should also
refer to the limitation in the:
3cope 4pinion Dotes to the
paragraph paragraph financial statements
a. Jes Do Jes
. Do Jes Jes
c. Do Jes Do
d. Jes Jes Do
1<.
medium
Chen the auditor evaluates the effect of a change in accounting principle, the materiality of the
change should e evaluated ased on:
a. the prior years presented.
. the current year effect of the change.
c. guidelines included in %))3.
d. the effect on total assets.
1=.
medium
Conditions re'uiring a departure from an un'ualified audit report include all ut #hich of the
follo#ing$
a. Management refused to allo# the auditor to confirm significant accounts receivale for
#hich there #ere no alternative procedures performed.
. Management decided not to allo# the auditor to confirm significant accounts receivale,
ut the auditor otained sufficient appropriate evidence y e-amining suse'uent cash
receipts.
c. /he audit partnerAs dependent child received a gift of 1:: shares of a clientAs stock for her
irthday from a grandparent.
d. Management has determined that fi-ed assets should e reported in the alance sheet at
their replacement values rather than historical costs. /he auditors do not concur.
!:. /he introductory paragraph of the standard audit report states that the financial statements are:
medium a. the responsiility of the auditor.
. the responsiility of management.
c. the @oint responsiility of management and the auditor.
d. none of the aove.
!1.
medium
/he introductory paragraph of the standard audit report states that the financial statements and
the opinion e-pressed aout those statements are:
d a. the responsiility of the auditor.
Arens/Elder/Beasley
. the responsiility of management.
c. the @oint responsiility of management and the auditor.
d. none of the aove.
!!. /he introductory paragraph of the standard audit report states that the auditor is:
medium a. responsile for the financial statements and the opinion on them.
c . responsile for the financial statements.
c. responsile for the opinion on the financial statements.
d. @ointly responsile for the financial statements #ith management.
!(. +*ulic,
medium
*C)47 )uditing 3tandard Do. ! re'uires the audit of internal control over financial reporting
to e integrated #ith:
a a. the audit of the financial statements.
. the 'uarterly revie# of financial information.
c. the revie# of annual financial statements.
d. none of the aove.
!..
medium
d
/he audit report indicates that +1, management is responsile for the content of the financial
statements and +!, the auditor is responsile for evaluating the appropriateness of the
accounting principles chosen y management. Chich paragraph contains those statements$
a. 7oth are in the introductory paragraph.
. 7oth are in the scope paragraph.
c. 7oth are in the opinion paragraph.
d. Done of the aove are true.
!2.
medium
c
"f the alance sheet of a company is dated Eecemer (1, !::=, the audit report is dated
Beruary <, !:1:, and oth are released on Beruary 12, !:1:, this indicates that the auditor has
searched for suse'uent events that occurred up to:
a. Eecemer (1, !::=.
. Lanuary 1, !:1:
c. Beruary <, !:1:
d. Beruary 12, !:1:.
!8. +*ulic,
medium
) comined report on financial statements and internal control over financial reporting includes
all ut #hich of the follo#ing types of paragraphs$
a. "nherent limitations paragraph.
. Eescription paragraph.
c. 4pinion paragraph.
d. ?ach of the aove paragraphs is included.
!;. Chenever an auditor issues a 'ualified opinion, the implication is that the auditor:
medium a. does not kno# if the financial statements are presented fairly.
d . does not elieve the financial statements are presented fairly.
c. elieves the financial statements are presented fairly.
d. elieves the financial statements are presented fairly 0e-cept for1 a specific aspect of
them.
!<. /he necessity to issue a disclaimer of opinion may arise ecause of:
medium a. a severe limitation on the scope of the audit.
c . a lack of independence et#een the auditor and client.
c. either a or .
d. neither a nor .
!=.
medium
Chen the auditor determines the financial statements are fairly stated and then determines that
the auditor lacks independence, the auditor should issue:
a. an adverse opinion.
. a disclaimer of opinion.
Arens/Elder/Beasley
c. either a 'ualified opinion or an adverse opinion.
d. either a 'ualified opinion or an un'ualified opinion #ith modified #ording.
(:. "f the auditor lacks independence, a disclaimer of opinion must e issued:
medium a. if the client re'uests it.
d . only if it is highly material.
c. only if it is material ut not highly material.
d. in all cases.
(1.
medium
Misstatements must e compared #ith some measurement ase efore a decision can e made
aout materiality. ) commonly accepted measurement ase includes:
d a. net income.
. total assets.
c. #orking capital.
d. all of the aove.
(!.
medium
Chen comparing misstatements #ith a measurement ase, the auditor must consider the
pervasiveness of the misstatement. 4f the follo#ing e-amples, the most pervasive misstatement
is a+n,:
a a. understatement of inventory.
. understatement of retained earnings caused y a miscalculation of dividends payale.
c. misclassification of notes payale as a long-term liaility #hen it should e current.
d. misclassification of salary e-pense as a selling e-pense #hen it should e allocated
e'ually to oth selling and administrative e-pense.
((.
medium
/he dollar amount of some misstatements cannot e accurately measured. Bor e-ample, if the
client #ere un#illing to disclose an e-isting la#suit, the auditor must estimate the likely effect
on:
a. net income.
. users of the financial statements.
c. the auditorAs e-posure to la#suits.
d. managementAs future decisions.
(.. Chenever there is a scope restriction, the appropriate response is to issue a+n,:
medium a. disclaimer of opinion.
d . adverse opinion.
c. 'ualified opinion.
d. un'ualified report, a 'ualification of scope and opinion, or a disclaimer, depending on
materiality.
(2.
medium
Chich of the follo#ing is least likely to cause uncertainty aout the aility of an entity to
continue as a going concern$
a a. ) clientAs la#suit against another company #hich claims the other company has infringed
on its patent.
. &oss of ma@or customers.
c. 3ignificant recurring operating losses.
d. Corking capital deficiencies.
(8.
medium
d
/he client has presented all re'uired financial statements #ith the e-ception of the statement of
cash flo#s. /he auditor has completed the audit and is satisfied that all other statements are
presented fairly. /he auditor:
a. may issue either an un'ualified or a 'ualified opinion.
. must issue an adverse opinion #ith 0e-cept for1 in the opinion paragraph.
c. may issue an un'ualified opinion.
d. must issue a 'ualified opinion #ith 0e-cept for1 in the opinion paragraph.
(;. Chen a disclaimer is issued ecause the auditor lacks independence:
Arens/Elder/Beasley
medium a. no report title is included on the report.
d . a one-paragraph audit report is issued.
c. the only reason cited for issuing the disclaimer is the lack of independence.
d. all of the aove are correct.
(<.
medium
d
Chen a client has not applied %))* consistently from the prior year to the current year, the
auditor does not concur #ith the appropriateness of the change, and the change in %))* has a
material effect on the financial statements, the auditor should issue a+n,:
a. disclaimer.
. adverse opinion.
c. un'ualified opinion.
d. 'ualified opinion.
(=.
medium
Chich of the follo#ing is not a change that affects consistency and, therefore, does not re'uire
an e-planatory paragraph$
c a. Change in accounting principle, such as a change from &"B4 to B"B4.
. Change in reporting entity, such as the inclusion of an additional company in comined
financial statements.
c. Change in an estimate, such as a decrease in the life of an asset for depreciation purposes.
d. Correction of errors y changing from non-%))* to %))*.
.:.
medium
c
"tems that materially affect the comparaility of financial statements generally re'uire
disclosure in the footnotes. "f the client refuses to properly disclose the item, the auditor #ill
most likely issue:
a. a disclaimer.
. an un'ualified opinion.
c. a 'ualified opinion.
d. an adverse opinion.
.1.
medium
)uditors sometimes encounter situations in #hich the outcome of a matter cannot e reasonaly
estimated at the time the financial statements are issued. /hese matters are referred to as:
c a. inestimale matters.
. non se'uiturs.
c. uncertainties.
d. in-suspense matters.
.!.
medium

Chen there is uncertainty aout a companyAs aility to continue as a going concern, the
auditorAs concern is the possiility that the client may not e ale to continue its operations or
meet its oligations for a 0reasonale period of time.1 Bor this purpose, a reasonale period of
time is considered not to e-ceed:
a. si- months from the date of the financial statements.
. one year from the date of the financial statements.
c. si- months from the date of the audit report.
d. one year from the date of the audit report.
.(.
medium
Chen the auditor concludes that there is sustantial dout aout the entityAs aility to continue
as a going concern, the appropriate audit report #ould e:
d a. an un'ualified opinion #ith an e-planatory paragraph.
. a disclaimer of opinion.
c. neither a nor .
d. either a or .
... )n auditor may not issue a 'ualified opinion #hen:
medium a. a scope limitation prevents the auditor from completing an important audit procedure.
c . the auditorAs report refers to the #ork of a specialist.
c. the auditor lacks independence #ith respect to the audited entity.
d. an accounting principle at variance #ith %))* is used.
Arens/Elder/Beasley
.2.
medium
Chen a companyAs financial statements contain a departure from %))* #ith #hich the auditor
concurs, the departure should e e-plained in:
a. the scope paragraph.
. an e-planatory paragraph that appears efore the opinion paragraph.
c. the opinion paragraph.
d. an e-planatory paragraph after the opinion paragraph.
.8.
medium
Chich of the follo#ing representations does an auditor make e-plicitly and #hich implicitly
#hen issuing an un'ualified opinion$
Conformity )de'uacy of
#ith %))* disclosure
a. ?-plicitly ?-plicitly
. ?-plicitly "mplicitly
c. "mplicitly ?-plicitly
d. "mplicitly "mplicitly
.;.
medium
c
Cilliam %regory, C*), is the principal auditor for a multi-national corporation. )nother C*)
has e-amined and reported on the financial statements of a significant susidiary of the
corporation. %regory is satisfied #ith the independence and professional reputation of the other
auditor, as #ell as the 'uality of the other auditorAs e-amination. Cith respect to his report on
the consolidated financial statements, taken as a #hole, %regory:
a. must not refer to the e-amination of the other auditor.
. must refer to the e-amination of the other auditor.
c. may refer to the e-amination of the other auditor.
d. may refer to the e-amination of the other auditor, in #hich case %regory must include in
the auditorAs report on the consolidated financial statements a 'ualified opinion #ith
respect to the e-amination of the other auditor.
.<.
medium
d
) company has changed its method of inventory valuation from an unacceptale one to one in
conformity #ith generally accepted accounting principles. /he auditorAs report on the financial
statements of the year of the change should include:
a. no reference to consistency.
. a reference to a prior period ad@ustment in the opinion paragraph.
c. an e-planatory paragraph that @ustifies the change and e-plains the impact of the change
on reported net income.
d. an e-planatory paragraph e-plaining the change.
.=. +*ulic,
medium
a
3aranes-4-ley re'uires auditors of a pulic company to audit a companyAs financial statements
and attest to managementAs report on the effectiveness of internal control over financial
reporting. Chat type of assurance does the auditor provide in this report$
a. *ositive assurance on the financial statements and on the effectiveness of internal control
over financial reporting.
. *ositive assurance on the financial statements and negative assurance on the effectiveness
of internal control over financial reporting.
c. &imited assurance on the financial statements and on the effectiveness of internal control
over financial reporting.
d. /here is no guidance on #hat level of assurance to provide.
2:.
medium
c
Chenever the client imposes restrictions on the scope of the audit, the auditor should e
concerned that management may e trying to prevent discovery of misstatements. "n such cases,
the auditor #ill likely issue a:
a. disclaimer of opinion in all cases.
. 'ualification of oth scope and opinion in all cases.
c. disclaimer of opinion #henever materiality is in 'uestion.
d. 'ualification of oth scope and opinion #henever materiality is in 'uestion.
Arens/Elder/Beasley
21.
medium
C*)s issue several types of 0special audit reports.1 Chich of the follo#ing circumstances
#ould not re'uire the issuance of a special audit report$
a. /he clientAs financial statements are prepared using the cash asis.
. /he clientAs financial statements are prepared using the accrual asis.
c. /he C*) has een retained to audit only the current assets.
d. /he C*) has een retained to revie# the internal control system, not the financial
statements.
2!. Chen a 'ualified or adverse opinion is issued, the 'ualifying paragraph is inserted:
medium a. et#een the introductory and scope paragraphs.
. et#een the scope and opinion paragraphs.
c. after the opinion paragraph, as a fourth paragraph.
d. immediately after the address, as the first paragraph.
2(. Bor the report containing a disclaimer for lack of independence, the disclaimer is in the:
challenging a. third or opinion paragraph.
c . second or scope paragraph.
c. first and only paragraph.
d. fourth or e-planatory paragraph.
2.. Chich of the follo#ing is not a primary category of attestation report$
challenging a. Compilation report.
a . Revie# report.
c. )udit report.
d. 3pecial audit report ased on a asis of accounting other than %))*.
22.
challenging
Most auditors elieve that financial statements are 0presented fairly1 #hen the statements are in
accordance #ith %))*, and that it is also necessary to:
a. determine that they are not in violation of B)37 statements.
. e-amine the sustance of transactions and alances for possile misinformation.
c. revie# the statements using the accounting principles promulgated y the 3?C.
d. assure investors that net income reported this year #ill e e-ceeded in the future.
28. "n #hich of the follo#ing situations #ould the auditor most likely issue an un'ualified report$
challenging a. /he client valued ending inventory y using the replacement cost method.
d . /he client valued ending inventory y using the De-t-"n-Birst-4ut +D"B4, method.
c. /he client valued ending inventory at selling price rather than historical cost.
d. /he client valued ending inventory y using the Birst-"n-Birst-4ut +B"B4, method, ut
sho#ed the replacement cost of inventory in the Dotes to the Binancial 3tatements.
2;. Chich of the follo#ing statements is true$
challenging
d
a. /he auditor is re'uired to issue a disclaimer of opinion in the event of a material
uncertainty.
. /he auditor is re'uired to issue a disclaimer of opinion in the event of a going concern
prolem.
c. /he auditor is re'uired to issue a disclaimer of opinion for a material uncertainty and for
a going concern prolem.
d. /he auditor has the option, ut is not re'uired, to issue a disclaimer of opinion for a
material uncertainty or for a going concern prolem.
2<.
medium
/he most common case in #hich conditions eyond the clientAs and auditorAs control cause a
scope restriction is an engagement:
a a. agreed upon after the clientAs alance sheet date.
. #here the client #onAt allo# the auditor to confirm receivales for fear of offending its
customers.
c. #here the auditor doesnAt have enough staff to satisfactorily audit all of the clientAs
foreign susidiaries.
Arens/Elder/Beasley
d. #here the client is going through Chapter 11 ankruptcy.
2=.
challenging
Chen the auditor cannot perform procedures and the amounts are so material that a disclaimer
of opinion rather than a 'ualified opinion is re'uired, the:
d a. opinion paragraph #ill state 0does not present fairly.1
. opinion paragraph #ill state 0presents fairly.1
c. scope paragraph #ill e unchanged from the standard un'ualified opinion.
d. scope paragraph #ill e deleted.
8:.
challenging
Chen misstatements are so material that an adverse opinion is issued, a scope paragraph #ould
e:
a. 'ualified.
. unchanged.
c. deleted.
d. e-panded to identify the additional procedures #hich the auditor performed.
81.
challenging
Chen the client fails to make ade'uate disclosure in the ody of the statements or in the related
footnotes, it is the responsiility of the auditor to:
d a. inform the reader that disclosure is not ade'uate, and to issue an adverse opinion.
. inform the reader that disclosure is not ade'uate, and to issue a 'ualified opinion.
c. present the information in the audit report and issue an un'ualified or 'ualified opinion.
d. present the information in the audit report and to issue a 'ualified or an adverse opinion.
8!.
challenging
/he 0un'ualified report #ith e-planatory paragraph1 and the 0un'ualified report #ith modified
#ording1:
c a. arise as a result of an incomplete audit.
. arise #hen the financial statements are not 0presented fairly.1
c. meet the criteria of a complete audit #ith satisfactory results.
d. meet the criteria of a complete audit ut #ith unsatisfactory results.
8(.
medium
Chich of the follo#ing #ill not cause the auditor to issue a standard un'ualified report #ith an
e-planatory paragraph or modified #ording$
c a. ?mphasis of a matter.
. Reports involving other auditors.
c. )uditor disagrees #ith clientAs departure from %))*.
d. &ack of consistent application of %))*.
8..
challenging
Chich of the follo#ing is not one of the principal C*) firmAs alternatives #hen issuing a report
if a different C*) firm performed part of the audit$
a a. "ssue a @oint report signed y oth C*) firms.
. Make no reference to the other C*) firm in the audit report, and issue the standard
un'ualified opinion.
c. Make reference to the other auditor in the report y using modified #ording +a shared
opinion or report,
d. ) 'ualified opinion or disclaimer, depending on materiality, is re'uired if the principal
auditor is not #illing to assume any responsiility for the #ork of the other auditor.
82. Chich of the follo#ing statements is not true$
challenging a. ) one-paragraph report is generally used #hen the auditor is not independent.
c . ) three-paragraph report ordinarily indicates there are no e-ceptions in the audit.
c. More than three paragraphs in the report indicates there must e some type of
'ualification in the audit.
d. )n un'ualified opinion #ith an e-planation or modified #ording #ould re'uire more
than three paragraphs.
Arens/Elder/Beasley
88.
challenging
7ro#n Co.As financial statements ade'uately disclose uncertainties that concern future events,
the outcome of #hich are not reasonaly estimale. /he auditorAs report should include a+n,:
a a. un'ualified opinion.
. disclaimer.
c. 0e-cept for1 'ualified opinion.
d. adverse opinion.
8;. Chich of the follo#ing re'uires recognition in the auditorAs opinion as to consistency$
challenging
c
a. /he correction of an error in the prior yearAs financial statements resulting from a
mathematical mistake in capitalizing interest.
. ) change in the estimate of provisions for #arranty costs.
c. /he change from the cost method to the e'uity method of accounting for investments in
common stock.
d. ) change in depreciation method #hich has no effect on current yearAs financial
statements ut is certain to affect future years.
8<.
challenging
a
Chen an auditor encounters a situation involving more than one of the conditions re'uiring a
departure from a standard un'ualified report, the auditor should modify his or her opinion for
each condition unless one has the effect of neutralizing the others. "n #hich of the follo#ing
situations #ould the auditor not include more than one modification in the report$
a. /here is a material scope limitation, and the auditor is not independent.
. /here is a material %))* violation, and the auditor is not independent.
c. /here is a material scope limitation, and there is sustantial dout aout the companyAs
aility to continue as a going concern.
d. /here is a sustantial dout aout the companyAs aility to continue as a going concern,
and information aout the causes of the uncertainties is not ade'uately disclosed in a
footnote.
8=.
Medium "ndicate #hich changes #ould re'uire an e-planatory paragraph in the audit report.
a
Correction of an error y changing from an
accounting principle that is not generally
acceptale to one that is generally acceptale Change from &"B4 to B"B4
a.
.
c.
d.
Jes
Do
Jes
Do
Jes
Do
Do
Jes
;:.
Medium "ndicate #hich changes #ould re'uire an e-planatory paragraph in the audit report.

Change in the estimated life of an asset

Iariation in the format of the
financial statements
a. Jes
. Do
c. Jes
d. Do
Jes
Do
Do
Jes
Arens/Elder/Beasley
;1.
Medium "ndicate #hich changes #ould re'uire an e-planatory paragraph in the audit report.
a
/he C*) concludes there is sustantial dout
aout the entityAs aility to continue as a
going concern Change from B"B4 to &"B4
a. Jes
. Do
c. Jes
d. Do
Jes
Do
Do
Jes
;!.
Challenging "ndicate #hich changes #ould re'uire an e-planatory paragraph in the audit report.
c
) departure from %))* #hich, due to
unusual circumstances, does not re'uire a
'ualified or adverse opinion.
/he C*) makes reference to the #ork of
another auditor to indicate shared
responsiility in an un'ualified opinion.
a. Jes
. Do
c. Jes
d. Do
Jes
Do
Do
Jes
;(.
?asy "ndicate #hich changes #ould re'uire an e-planatory paragraph in the audit report.
a
Change from &"B4 to B"B4 Change from B"B4 to &"B4
a. Jes
. Do
c. Jes
d. Do
Jes
Do
Do
Jes
;..
Challenging "ndicate #hich changes #ould re'uire an e-planatory paragraph in the audit report.

/he e-istence of related party transactions

"mportant events occurring suse'uent to
the alance sheet date
a. Jes
. Do
c. Jes
d. Do
Jes
Do
Do
Jes
;2.
Medium Chich auditor report #ould re'uire only one paragraph$
c
Eisclaimer due to lack of independence
)dverse opinion due to departure
from %))*
a. Jes
. Do
c. Jes
d. Do
Jes
Do
Do
Jes
Arens/Elder/Beasley
;8.
Medium Chich auditor report #ould re'uire only one paragraph$

Eisclaimer due to scope restriction

Qualified opinion due to scope
restriction
a. Jes
. Do
c. Jes
d. Do
Jes
Do
Do
Jes
;;.
Challenging Chich auditor report must have at least four paragraphs$
d
>n'ualified opinion indicating shared
responsiility #ith another auditor
>n'ualified opinion e-pressing
sustantial dout that the company
is a going concern
a. Jes
. Do
c. Jes
d. Do
Jes
Do
Do
Jes
;<.
Challenging Chich auditor report must have at least four paragraphs$
c
Qualified opinion due to scope restriction
Eisclaimer due to a scope
restriction
a. Jes
. Do
c. Jes
d. Do
Jes
Do
Do
Jes
;=.
Medium Chich auditor report must have at least four paragraphs$
a
Qualified opinion due to departure from
%))*
)dverse opinion due to departure
from %))*
a. Jes
. Do
c. Jes
d. Do
Jes
Do
Do
Jes
<:.
Medium Chich auditor report must have at least four paragraphs$
d
Eisclaimer due to lack of independence
Report re'uired due to omission of
the 3tatement of Cash Blo#s
a. Jes
. Do
c. Jes
d. Do
Jes
Do
Do
Jes
Arens/Elder/Beasley
<1.
Medium ) C*) #ould e-press a 'ualified opinion #ith at least four paragraphs for:
c
)n un@ustified accounting change
) @ustified accounting change,
properly accounted for
a. Jes
. Do
c. Jes
d. Do
Jes
Do
Do
Jes
<!.
Medium ) C*) #ould e-press an un'ualified opinion #ith at least four paragraphs for:
d
)n un@ustified accounting change
) @ustified accounting change, properly
accounted for
a. Jes
. Do
c. Jes
d. Do
Jes
Do
Do
Jes
<(.
Medium /he reasons for e-pressing a 'ualified opinion due to a departure from %))* are e-pressed
in a paragraph

a. preceding the scope paragraph.

. follo#ing the scope paragraph.
c. follo#ing the opinion paragraph.
d. either preceding or follo#ing the opinion paragraph, depending on materiality.
<..
Medium "n #hich situation #ould the auditor e choosing et#een 0e-cept for1 'ualified opinion
and an adverse opinion$
d a. /he auditor lacks independence
. ) client-imposed scope restriction
c. ) circumstance-imposed scope restriction
d. &ack of full disclosure re'uired y footnotes
?ssay Questions
<2.
easy
Eiscuss ho# materiality affects audit reporting decisions.
)ns#er:
Chen determining the appropriate audit report to issue, the auditor considers three
levels of materiality for a given condition. /hese three levels are +1, immaterial, +!,
material #ithout overshado#ing the financial statements as a #hole, and +(, highly
material. Bor conditions involving a %))* violation, the materiality level of the
violation influences #hether an un'ualified, 'ualified, or adverse opinion is issued. Bor
conditions involving a scope restriction, the materiality of the restriction influences
#hether an un'ualified report, a 'ualified scope and opinion report, or a disclaimer of
opinion is issued.
Arens/Elder/Beasley
<8.
medium
/here are five conditions that must e met efore an auditor can issue a standard un'ualified
report for the audit of a private company. *lease discuss each of these five conditions.
)ns#er:
/he five conditions that @ustify issuing a standard un'ualified report are:
)ll statementsMalance sheet, income statement, statement of retained earnings, and
statement of cash flo#sMare included in the financial statements.
/he three general standards of %))3 have een follo#ed in all respects on the
engagement.
3ufficient appropriate audit evidence has een accumulated and the auditor can
conclude that the three field#ork standards have een follo#ed.
/he financial statements are presented in accordance #ith %))*.
/here are no circumstances re'uiring the addition of an e-planatory paragraph or
modification of the #ording of the report.
<;.
medium
/here are three conditions re'uiring a departure from an un'ualified audit report. Eiscuss each
of these three conditions and state the appropriate audit report for each condition.
)ns#er:
/he three conditions re'uiring a departure from an un'ualified report are:
a scope restriction imposed y the client or y circumstances eyond the auditorAs or
clientAs control #hich prevents the auditor from accumulating sufficient evidence to
reach a conclusion regarding #hether financial statements are stated in accordance
#ith %))*. "n this condition, the auditor #ould issue either a 'ualified scope and
opinion report, or a disclaimer of opinion.
the financial statements #ere not prepared in accordance #ith %))*. "n this
condition, the auditor #ould issue a 'ualified opinion if the %))* violation #ere
moderately material, or an adverse opinion if the %))* violation #ere highly
material.
the auditor is not independent. "n this condition, the auditor must issue a disclaimer
of opinion.
Arens/Elder/Beasley
<<.
medium
"n certain circumstances, an auditor #ill issue an un'ualified report, ut the #ording #ill differ
from that of a standard un'ualified report. Eiscuss each of the five circumstances #hen an
auditor #ould issue an un'ualified report #ith an e-planatory paragraph or modified #ording.
)ns#er:
)n un'ualified report #ith an e-planatory paragraph or modified #ording is appropriate in
the follo#ing circumstances:
'ack of consistent application of &AAP. Chen the client has not follo#ed generally
accepted accounting principles consistently in the current period in relation to the
preceding period, an un'ualified opinion #ith an e-planatory paragraph follo#ing the
opinion paragraph is appropriate.
Su#stantial dou#t a#out continuing as a going concern. Chen an auditor concludes
there is sustantial dout aout the clientAs aility to continue as a going concern, an
un'ualified opinion #ith an e-planatory paragraph follo#ing the opinion paragraph
is appropriate. /he auditor also has the option of issuing a disclaimer of opinion.
A departure from &AAP )it )ic te auditor concurs. "f adherence to %))* #ould
result in misleading financial statements, an un'ualified opinion #ith an e-planatory
paragraph is appropriate.
Empasis of a matter. "f the auditor #ants to emphasize specific matters in the audit
report, an e-planatory paragraph discussing those matters may e added to an
un'ualified report.
Reports in%ol%ing oter auditors. Chen an auditor relies upon a different C*) firm to
perform part of the audit, the auditor can indicate that responsiility for the audit is
shared #ith another C*) firm y modifying the #ording of an un'ualified report.
<=.
medium
)n audit report prepared y %arrett and 7ro#n, C*)s, is provided elo#. /he audit for the year
ended Eecemer (1, !::; #as completed on March 1, !::<, and the report #as issued to Lavlin
Corporation, a private company, on March 1(, !::<. &ist any deficiencies in this report. Eo not
re#rite the report.
Ce have e-amined the accompanying financial statements of Ealton Corporation as of
Eecemer (1, !::;. /hese financial statements are the responsiility of the companyAs
management. 4ur responsiility is to e-press an opinion on these statements ased on our audit.
Ce conducted our audit in accordance #ith generally accepted accounting principles.
/hose principles re'uire that #e plan and perform the audit to provide reasonale assurance
aout #hether the financial statements are free of misstatement. )n audit includes e-amining,
on a test asis, evidence supporting the amounts and disclosures in the financial statements. Ce
elieve that our audit provides a reasonale asis for our opinion.
"n our opinion, e-cept for the effects of not capitalizing certain lease oligations that
should e capitalized in order to conform #ith generally accepted accounting principles, the
financial statements referred to aove present accurately the financial position of Laco
Corporation as of Eecemer (1, !::;, in conformity #ith accounting principles generally
accepted in the >nited 3tates of )merica.
%arrett and 7ro#n, C*)s
March, !::<
Arens/Elder/Beasley
)ns#er:
/he audit report contains the follo#ing deficiencies:
/he report title is missing.
/he report is not addressed to anyone and should e addressed to shareholders or the
oard of directors.
/he introductory paragraph should refer to an 0audit,1 not an 0e-amination.1
/he introductory paragraph should list the financial statements that #ere audited.
/he introductory paragraph refers to the #rong company.
/he scope paragraph should state the audit #as conducted in accordance #ith
auditing standards generally accepted in the >nited 3tates of )merica, not generally
accepted accounting principles.
0/hose principles N1 should read 0/hose standards re'uire that #e plan and perform
the audit to o#tain reasonale assurance aout #hether the financial statements are
free of material misstatements.1
/he scope paragraph should contain the follo#ing phrase: 0)n audit also includes
assessing the accounting principles used and significant estimates made y
management, as #ell as evaluating the overall financial statement presentation.1
Bollo#ing the scope paragraph, there should e an e-planatory paragraph that
discusses the %))* violation related to the failure to capitalize certain lease
oligations.
"n the opinion paragraph, the auditor should state that the financial statements present
fairl"N, not present accuratel"N
"n the opinion paragraph, the phrase 0Nin all material respectsN1 should e
included.
"n the opinion paragraph, the phrase 0Nand the results of its operations and its cash
flo#s for the year then endedN1 should e included.
/he audit report should e dated March 1(, !::<.
=:.
medium
Eiscuss the differences regarding ho# matters affecting consistency and matters affecting
comparaility are referred to in the audit report. *rovide t#o e-amples of each type of change.
)ns#er:
/he auditor should disclose a material lack of consistent application of %))* y adding
an e-planatory paragraph after the un'ualified opinion paragraph. /he e-planatory
paragraph should discuss the nature of the change and should refer to the footnote in the
financial statements that discusses the change. Changes that affect comparaility, ut not
consistency, re'uire no such e-planatory paragraph in the audit report, assuming the
change is disclosed in the footnotes.
?-amples of changes affecting consistency include changes in accounting principles,
changes in reporting entities, and correction of errors involving accounting principles.
?-amples of changes affecting comparaility include changes in an estimate, error
corrections not involving accounting principles, variations in the format and
presentation of financial information, and changes ecause of sustantially different
transactions or events.
Arens/Elder/Beasley
=1. +*ulic,
medium
/he follo#ing is a portion of an adverse audit report issued for a pulic company. +Dote: )
separate report #as issued on the effectiveness of internal control over financial reporting.,
Independent Auditors Report
/o the shareholders of Callace Corporation
Ce have audited the accompanying alance sheet of Callace Corporation as of Eecemer
(1, !::;, and the related statements of income, retained earnings, and cash flo#s for the year
then ended. /hese financial statements are the responsiility of the companyAs management.
4ur responsiility is to e-press an opinion on these financial statements ased on our audit.
Ce conducted our audit in accordance #ith the standards of the *ulic Company
)ccounting 4versight 7oard +>nited 3tates,. /hose standards re'uire that #e plan and perform
the audit to otain reasonale assurance aout #hether the financial statements are free of
material misstatement. )n audit includes e-amining, on a test asis, evidence supporting the
amounts and disclosures in the financial statements. )n audit also includes assessing the
accounting principles used and significant estimates made y management, as #ell as evaluating
the overall financial statement presentation. Ce elieve that our audit provides a reasonale
asis for our opinion.
/he company has e-cluded from property and det in the accompanying alance sheet
certain lease oligations that, in our opinion, should e capitalized in order to conform #ith
generally accepted accounting principles. "f these lease oligations #ere capitalized, property
#ould e increased y 91.,2::,:::, long-term det y 91(,!::,:::, and retained earnings y
91,(::,::: as of Eecemer (1, !::;, and net income and earnings per share #ould e increased
y 91,(::,::: and 9!.!2, respectively, for the year then ended.
Required*
Complete the aove adverse audit report y preparing the opinion paragraph. Eo not date or
sign the report.
)ns#er:
"n our opinion, ecause of the effects of the matters discussed in the preceding
paragraph, the financial statements referred to aove do not present fairly, in
conformity #ith generally accepted accounting principles, the financial position of
Callace Corporation as of Eecemer (1, !::;, or the results of its operations and its
cash flo#s for the year then ended.
Arens/Elder/Beasley
=!.
medium
/he follo#ing is a portion of a 'ualified audit report issued for a private company:
Independent Auditors Report
/o the shareholders of /amarak Corporation
Ce have audited the accompanying alance sheet of /amarak Corporation as of 4ctoer
(1, !::;, and the related statements of income, retained earnings, and cash flo#s for the year
then ended. /hese financial statements are the responsiility of the companyAs management.
4ur responsiility is to e-press an opinion on these financial statements ased on our audit.
Ce conducted our audit in accordance #ith auditing standards generally accepted in the
>nited 3tates of )merica. /hose standards re'uire that #e plan and perform the audit to otain
reasonale assurance aout #hether the financial statements are free of material misstatement.
)n audit includes e-amining, on a test asis, evidence supporting the amounts and disclosures
in the financial statements. )n audit also includes assessing the accounting principles used and
significant estimates made y management, as #ell as evaluating the overall financial statement
presentation. Ce elieve that our audit provides a reasonale asis for our opinion.
/he company has included in property and det in the accompanying alance sheet certain
lease oligations that, in our opinion, should e e-pensed in order to conform #ith generally
accepted accounting principles. "f these lease oligations #ere capitalized, property #ould e
decreased y 9.,:::,:::, long-term det y 9!,:::,:::, and retained earnings y 91<:,::: as
of 4ctoer (1, !::2, and net income and earnings per share #ould e decreased y 91<:,:::
and 9.8!, respectively, for the year then ended.
Required*
Complete the aove 'ualified audit report y preparing the opinion paragraph. Eo not date or
sign the report.
)ns#er:
"n our opinion, e-cept for the effects of capitalizing lease oligations, as discussed in the
preceding paragraph, the financial statements referred to aove present fairly, in all
material respects, the financial position of /amarak Corporation as of 4ctoer (1, !::;,
and the results of its operations and its cash flo#s for the year then ended in conformity
#ith generally accepted accounting principles.
Arens/Elder/Beasley
=(. +*ulic,
medium
/he follo#ing is a portion of a 'ualified scope and opinion report due to a scope restriction.
+Dote: ) separate report #as issued on the effectiveness of internal control over financial
reporting.,
Independent Auditors Report
/o the shareholders of Bast /imes Corporation
Ce have audited the accompanying alance sheet of Bast /imes Corporation as of 3eptemer
(:, !::;, and the related statements of income, retained earnings, and cash flo#s for the year
then ended. /hese financial statements are the responsiility of the companyAs management.
4ur responsiility is to e-press an opinion on these financial statements ased on our audit.
?-cept as discussed in the follo#ing paragraph, #e conducted our audit in accordance #ith the
standards of the *ulic Company )ccounting 4versight 7oard +>nited 3tates,. /hose standards
re'uire that #e plan and perform the audit to otain reasonale assurance aout #hether the
financial statements are free of material misstatement. )n audit includes e-amining, on a test
asis, evidence supporting the amounts and disclosures in the financial statements. )n audit also
includes assessing the accounting principles used and significant estimates made y
management, as #ell as evaluating the overall financial statement presentation. Ce elieve that
our audit provides a reasonale asis for our opinion.
Ce #ere unale to otain audited financial statements supporting the companyAs investment in
a foreign affiliate stated at 91,:.:,:::, or its e'uity in earnings of that affiliate of 92:1,:::,
#hich is included in net income, as descried in Dote 1. to the financial statements. 7ecause of
the nature of the companyAs records, #e #ere unale to satisfy ourselves as to the carrying value
of the investment or the e'uity in its earnings y means of other auditing procedures.
Required*
Complete the aove report y preparing the opinion paragraph. Eo not date or sign the report.
)ns#er:
"n our opinion, e-cept for the effects of such ad@ustments, if any, as might have een
determined to e necessary had #e een ale to e-amine evidence regarding the
foreign affiliate investment and earnings, the financial statements referred to aove
present fairly, in all material respects, the financial position of Bast /imes Corporation
as of 3eptemer (:, !::;, and the results of its operations and its cash flo#s for the
year then ended in conformity #ith generally accepted accounting principles.
Arens/Elder/Beasley
=..
medium
Jour C*) firm has completed the field#ork for the !::; audit of 3harp Corporation, a private
company #ith an 4ctoer year-end. Jou #ere preparing to draft a standard, un'ualified audit
report #hen you discovered that the audit manager on the 3harp engagement o#ns 1: shares of
3harpAs common stock. *repare the appropriate report.
)ns#er:
Ce are not independent #ith respect to 3harp Corporation, and the accompanying
alance sheet as of 4ctoer (1, !::;, and the related statements of income, retained
earnings, and cash flo#s for the year then ended #ere not audited y us. )ccordingly,
#e do not e-press an opinion on them.
Note: /here is no report title #hen the auditor issues a disclaimer due to a lack of
independence.
=2.
challenging
Eescrie the standard un'ualified report to e issued for an audit of a private company. 7egin
y specifying the seven parts of the report, and then discuss the contents of each part.
)ns#er:
/he parts of the standard un'ualified report are as follo#s:
Report title. /he title must include the #ord 0independent.1 ?-amples of appropriate
titles are 0independent auditorAs report,1 or 0report of independent accountant.1
Report address. /he report is usually addressed to the companyAs stockholders or
oard of directors. "t should not e addressed to company management.
Introductor" paragrap. /here are three important components of the introductory
paragraph. Birst, it states that an audit #as performed. 3econd, it lists the financial
statements that #ere audited and their dates. /hird, it states that management is
responsile for the financial statements, and that the auditor is responsile for
e-pressing an opinion on those statements ased on an audit.
Scope paragrap. /he scope paragraph is a factual statement aout #hat #as done
during the audit. "t first states that auditing standards generally accepted in the >nited
3tates of )merica #ere follo#ed y the auditor. "t then states that an audit is
designed to otain reasonale assurance aout #hether the statements are free of
material misstatement. "t concludes y stating that the auditor evaluated the
appropriateness of the accounting principles used, and estimates made, y
management, and of the financial statement disclosures and presentations given.
+pinion paragrap. /his paragraph states the auditorAs opinion concerning #hether
the financial statements present fairly the clientAs financial position and results of its
operations and cash flo#s in conformity #ith generally accepted accounting
principles.
,ame of CPA firm. /ypically, the name of the C*) firm, and not the name of an
individual auditor, is used.
Audit report date. /he audit report is normally dated as of the last day of field#ork.
Arens/Elder/Beasley
=8.
challenging
*resented elo# is an independent auditorAs report for a private company prepared y the firm
of Harrington and *erry, &&*.
Auditors Report
/o the president and management
of ?*M, "nc.
Ce have e-amined the accompanying alance sheets and statements of income, retained
earnings, and cash flo#s of ?*M, "nc., as of Eecemer (1, !::; and !::8. Ce performed our
e-amination in accordance #ith auditing standards generally accepted in the >nited 3tates of
)merica and e-amined, on a test asis, evidence supporting the accounting principles used and
estimates made y management.
"n our opinion, the financial statements referred to aove accurately present the financial
position of ?*M, "nc., in conformity #ith generally accepted accounting principles.
Harrington and *erry, &&*
Eecemer (1, !::;
+ter information:
?*M, "nc., is a for-profit corporation and pulishes comparative financial statements for
distriution to shareholders, potential investors, and the general pulic. /he client has a calendar
year-end. Bor the most recent audit, the auditor completed all significant field#ork on March 2,
!::< and issued the audit report on March 18, !::<. Euring !::;, ?*M changed its method of
depreciating long-term assets and properly reflected the effect of the change in the current
yearAs financial statements, restated the prior yearAs financial statements, and properly discussed
the change in a footnote +Dote ., to those statements. /he auditors are satisfied that the change
#as preferale.
Required:
Consider all the facts given and re#rite the complete auditorAs report, including report title,
address, ody of report, name of firm, and audit report date.
Arens/Elder/Beasley
)ns#er:
Independent Auditors Report
/o the shareholders of ?*M, "nc.
Ce have audited the accompanying alance sheets of ?*M, "nc., as of Eecemer (1, !::; and
!::8, and the related statements of income, retained earnings, and cash flo#s for the years then
ended. /hese financial statements are the responsiility of the companyAs management. 4ur
responsiility is to e-press an opinion on these financial statements ased on our audits.
Ce conducted our audits in accordance #ith auditing standards generally accepted in the >nited
3tates of )merica. /hose standards re'uire that #e plan and perform the audit to otain
reasonale assurance aout #hether the financial statements are free of material misstatement.
)n audit includes e-amining, on a test asis, evidence supporting the amounts and disclosures
in the financial statements. )n audit also includes assessing the accounting principles used and
significant estimates made y management, as #ell as evaluating the overall financial statement
presentation. Ce elieve that our audits provide a reasonale asis for our opinion.
"n our opinion, the financial statements referred to aove present fairly, in all material respects,
the financial position of ?*M, "nc., as of Eecemer (1, !::; and !::8, and the results of its
operations and its cash flo#s for the years then ended in conformity #ith generally accepted
accounting principles.
)s discussed in Dote . to the financial statements, ?*M, "nc., changed its method of computing
depreciation in !::;.
Harrington and *erry, &&*
March 2, !::<
Arens/Elder/Beasley
=;.
challenging
4n )pril 1., !::<, your C*) firm completed the field#ork for the audit of 4AMalley
CorporationAs financial statements for the year ended Eecemer (1, !::;. 4AMalley is a
privately held company. &ast year, your firm e-pressed an un'ualified opinion on 4AMalleyAs
!::8 financial statements.
7arrett and 4AConnor, C*)s, performed the audit of the Eecemer (1, !::; and !::8 financial
statements of /omAs 3upply Company, a consolidated susidiary of 4AMalleyAs. 7arrett and
4AConnor completed the field#ork on Beruary !2, !::<, and issued its un'ualified opinion on
/omAs 3upply Company on March !, !::<. /omAs statements reflect total assets of 9=2:,:::
and 9=::,::: as of Eecemer (1, !::; and !::8, respectively, and revenues of 91,<.2,::: and
91,82:,::: for the years then ended.
Euring your audit, you otained the follo#ing information #hich does not appear in the
footnotes to 4AMalleyAs !::; financial statements:
Euring !::;, 4AMalley changed its method of valuing inventory from the Birst-"n-Birst-
4ut method to the &ast-"n-Birst-4ut method. 4AMalleyAs management elieves the change
provides a etter matching of revenues and e-penses, #ith #hich you concur. /he change
reduced ending inventory in !::; y 9!.<,::: and net income y 91!=,:::. /he effect of
the change on !::; is considered material, ut not highly material. /he effect of the
change on prior years is immaterial.
Required*
*repare the shared audit report to accompany 4AMalleyAs !::;-!::8 comparative financial
statements. "nclude the report title, address, ody, date, and your signature.
Arens/Elder/Beasley
)ns#er:
Independent Auditors Report
/o the 7oard of Eirectors of 4AMalley Corporation:
Ce have audited the accompanying consolidated alance sheets of 4AMalley Corporation
as of Eecemer (1, !::; and !::8 and the related consolidated statements of income, retained
earnings, and cash flo#s for the years then ended. /hese financial statements are the
responsiility of the companyAs management. 4ur responsiility is to e-press an opinion on
these financial statements ased on our audit. Ce did not audit the financial statements of
/omAs 3upply Company, a consolidated susidiary, #hich statements reflect total assets of
9=2:,::: and 9=::,::: as of Eecemer (1, !::; and !::8, respectively, and total revenues of
91,<.2,::: and 91,82:,::: for the years then ended. /hose statements #ere audited y other
auditors #hose report has een furnished to us, and our opinion, insofar as it relates to the
amounts included for /omAs 3upply Company, is ased solely on the report of the other
auditors.
Ce conducted our audits in accordance #ith auditing standards generally accepted in the
>nited 3tates of )merica. /hose standards re'uire that #e plan and perform the audit to otain
reasonale assurance aout #hether the financial statements are free of material misstatement.
)n audit includes e-amining, on a test asis, evidence supporting the amounts and disclosures
in the financial statements. )n audit also includes assessing the accounting principles used and
significant estimates made y management, as #ell as evaluating the overall financial statement
presentation. Ce elieve that our audits and the report of other auditors provide a reasonale
asis for our opinion.
Euring the year, 4AMalley changed its method of valuing inventory from the first-in, first-
out method to the last-in, first-out method. /his change #as made ecause management
elieves the change provides a etter matching of revenues and e-penses. /he change reduced
inventory at Eecemer (1, !::;, y 9!.<,::: and net income for !::; y 91!=,:::. /he effect
of the change on prior years is immaterial. "n our opinion, disclosure of this change is re'uired
to conform #ith generally accepted accounting principles.
"n our opinion, ased on our audits and the report of other auditors, e-cept for not
disclosing the change in inventory valuation methods discussed in the preceding paragraph, the
financial statements referred to aove present fairly, in all material respects, the financial
position of 4AMalley Corporation as of Eecemer (1, !::; and !::8, and the results of its
operations and its cash flo#s for the years then ended in conformity #ith generally accepted
accounting principles.
)pril 1., !::< +Dame of studentAs C*) firm,
4ther 4@ective )ns#er Bormat Questions
Arens/Elder/Beasley
=<.
medium
)ssume you are the partner in charge of the !::; audit of 7ecker Corporation, a private
company. /he audit report has not yet een prepared. "n each independent situation follo#ing
+1-<,, indicate the appropriate action +a-g, to e taken. /he possile actions are as follo#s:
a. "ssue a standard un'ualified report.
. Qualify oth the scope and opinion paragraphs.
c. Qualify the opinion paragraph.
d. "ssue an un'ualified opinion #ith an e-planatory paragraph.
e. "ssue an un'ualified opinion #ith modified #ording +no e-planatory paragraph,.
f. "ssue an adverse opinion.
g. Eisclaim an opinion.
/he situations are as follo#s:
f 1. 7ecker Corporation carries its property, plant, and e'uipment accounts at current
market values. Current market values e-ceed historical cost y a highly material
amount, and the effects are pervasive throughout the financial statements.
g !. Management of 7ecker Corporation refuses to allo# you to oserve, or make,
any counts of inventory. /he recorded ook value of inventory is highly
material.
Arens/Elder/Beasley
a (. Jou #ere unale to confirm accounts receivale #ith 7eckerAs customers.
Ho#ever, ecause of detailed sales and cash receipts records, you #ere ale to
perform reliale alternative audit procedures.
g .. 4ne #eek efore the end of field#ork, you discover that the audit manager on
the 7ecker engagement o#ns a material amount of 7eckerAs common stock.
e 2. Jou relied upon another C*) firm to perform part of the audit. )lthough you
#ere the principal auditor, the other firm audited a material portion of the
financial statements. Jou #ish to refer to +ut not name, the other firm in your
report.
d or g 8. Jou have sustantial dout aout 7eckerAs aility to continue as a going
concern.
d ;. 7ecker Corporation changed its method of computing depreciation in !::;. Jou
concur #ith the change and the change is properly disclosed in the financial
statement footnotes.
c <. /en days after the alance sheet date, one of 7eckerAs uildings #as destroyed
y a fire. 7ecker refuses to disclose this information in a footnote to the
financial statements, ut you elieve disclosure is re'uired to conform #ith
%))*. /he amount of the uninsured loss #as material, ut not highly material.
==. +*ulic,
easy

)udit reports issued for financial statements of a pulic company should refer to generally
accepted auditing standards in the scope paragraph.
a. /rue
. Balse
1::.
easy
a
)udit reports issued for financial statements of a private company should refer to generally
accepted auditing standards in the scope paragraph.
a. /rue
. Balse
1:1.
easy
a
"f an audit client has not consistently oserved accounting principles in the current period in
relation to the preceding period, the auditor should normally issue an un'ualified report #ith an
e-planatory paragraph #hich e-plains the nature of the change.
a. /rue
. Balse
1:!.
easy

) 'ualified report is issued #hen all auditing conditions have een met, no significant
misstatements have een discovered, and it is the auditorAs opinion that the financial statements
are fairly stated in accordance #ith %))*.
a. /rue
. Balse
1:(.
easy

/he audit report is normally addressed to the companyAs president or chief e-ecutive officer.
a. /rue
. Balse
Arens/Elder/Beasley
1:..
easy
a
/he phrase 0generally accepted accounting principles1 can e found in the opinion paragraph of
a standard un'ualified report.
a. /rue
. Balse
1:2. +*ulic,
medium

)uditors of pulic company financial statements must issue separate reports on internal control
over financial reporting.
a. /rue
. Balse
1:8.
medium

Changes in an estimate, such as a change in the estimated useful life of an asset for depreciation
purposes, affect consistency ut not comparaility, and therefore re'uire an e-planatory
paragraph in the audit report.
a. /rue
. Balse
1:;.
medium

Chen an auditor decides that adherence to %))* #ould result in misleading financial
statements, the auditor has no choice ut to issue a 'ualified audit report.
a. /rue
. Balse
1:<. +*ulic,
medium

/he phrase 0auditing standards generally accepted in the >nited 3tates of )merica1 can e
found in the opinion paragraph of a standard, un'ualified audit report for a pulic company.
a. /rue
. Balse
1:=.
medium

)uditors should issue a disclaimer of opinion #hen there is a highly material scope restriction
caused y the client.
a. /rue
. Balse
11:.
medium
a
Chenever an auditor issues a 'ualified report, he or she must use the term 0e-cept for1 in the
opinion paragraph.
a. /rue
. Balse
111.
medium

Chenever an auditor issues a 'ualified report, he or she must use the term 0su@ect to1 in the
opinion paragraph.
a. /rue
. Balse
11!.
medium

Chenever an auditor discovers a highly material %))* violation in the financial statements
that the client refuses to correct, the auditor should issue a disclaimer of opinion.
a. /rue
. Balse
11(.
medium

Chen there is a scope limitation in an audit, the audit report #ill e un'ualified, 'ualified scope
and opinion, or adverse, depending on the materiality of the scope limitation.
a. /rue
. Balse
Arens/Elder/Beasley
11..
medium

Changes in reporting entities, such as the inclusion of an additional company in comined

financial statements, affect comparaility ut not consistency, and therefore do not re'uire an
e-planatory paragraph in the audit report.
a. /rue
. Balse
112.
medium

Chen a 'ualified opinion is issued, an e-planatory paragraph is added immediately after the
opinion paragraph to e-plain the nature of the 'ualification that affects the opinion.
a. /rue
. Balse
118.
medium
a
"f an audit client has not consistently applied accounting principles, and the auditor does not
concur #ith the appropriateness of the change, either an un'ualified, a 'ualified, or an adverse
opinion should e issued, depending on the materiality level involved.
a. /rue
. Balse
11;.
medium
a
Chen an auditor relies upon a different C*) firm to perform part of the audit and chooses to
issue a shared opinion, the #ording of the report should e modified in all three paragraphs.
a. /rue
. Balse
11<.
medium

)n auditor should issue a 'ualified opinion #ith an e-planatory paragraph #henever there is a
material uncertainty affecting the financial statements.
a. /rue
. Balse
11=.
medium

/he phrase 0/he audit is designed to otain reasonale assurance aout #hether the statements
are free of material misstatements1 is included in the introductory paragraph of an audit report.
a. /rue
. Balse
1!:.
challenging

"f an auditor is not independent and the auditor kno#s that the company has not follo#ed
%))*, the auditor should immediately disclaim an opinion and not mention the departure from
%))* in the audit report.
a. /rue
. Balse
Chapter 4
Multiple-Choice Questions
1. 3ociety has attached a special meaning to the term 0professional.1 ) professional is:
easy a. someone #ho has passed a 'ualifying e-am to enter the @o market.
. a person #ho is e-pected to conduct himself or herself at a higher level than the
re'uirements of societyAs la#s or regulations.
c. any person #ho receives pay for the services performed.
d. someone #ho has oth an education in the trade and on-the-@o e-perience received under
an e-perienced supervisor.
Arens/Elder/Beasley
!. /he underlying reason for a code of professional conduct for any profession is:
easy a. the need for pulic confidence in the 'uality of service of the profession.
a . that it provides a safeguard to keep unscrupulous people out.
c. that it is re'uired y federal legislation.
d. that it allo#s licensing agencies to have a yardstick to measure deficient ehavior.
(. ) challenge associated #ith the ?thical *rinciples stated in the Code of Professional Conduct is:
easy a. the emphasis on positive activities.
c . that they identify ideal conduct.
c. the difficulty of enforcing principles, or general ideals.
d. that there are too many to rememer.
.. Bor #hich of the follo#ing professional services must C*)s e independent$
easy a. Management advisory services.
. )udits of financial statements.
c. *reparation of ta- returns.
d. )ll three of the aove.
2. 0"ndependence1 in auditing means:
easy a. maintaining an indirect financial interest.
c . not eing financially dependent on a client.
c. taking an uniased and o@ective vie#point.
d. eing an advocate for a client.
8. Chen C*)s are ale to maintain their actual independence, it is referred to as independence in:
easy a. conduct.
c . appearance.
c. fact.
d. total.
;. Chich of the follo#ing statements is true$ /he C*) firm #ill lose its independence if:
medium a. a staff auditor providing audit services to the client ac'uires stock in that client.
a . a staff ta- preparer #ho provides 12 hours of non-audit services to the client ac'uires
stock in that client.
c. an audit manager in an office different than the office providing audit services has a
direct, immaterial financial interest in the audit client.
d. a covered memer has an indirect, immaterial financial interest in an audit client.
<.
easy
"nterpretations of Rule 1:1 prohiit covered memers from o#ning any stock or other direct
investment in audit clients. Covered memers include all ut #hich of the follo#ing$
a a. )ll partners in an office that has no responsiility for the engagement.
. /he firm and its employee enefit plans.
c. "ndividuals on the attest engagement.
d. )ll of the aove descrie covered memers.
=.
easy
c
"n some situations, the interpretations of the Rules of Conduct permit former partners to have
relationships #ith a client of the firm #ithout affecting the firmAs independence. Chich of the
follo#ing situations #ould not cause a loss of independence$
a. /he former partner invests in a current client of the firm and receives retirement enefits
from the C*) firm, #hich are dependent upon the firmAs financial performance.
. /he former partner uses the C*) firmAs office space and has significant influence over a
client.
c. /he former partner severs relations #ith the firm and accepts employment #ith the firmAs
client after having een retired for 1< months.
d. /he former partner is held out as an associate of the firm and takes part in the firmAs
usiness activities.
Arens/Elder/Beasley
1:.
easy
/he financial interests of #hich of the follo#ing parties #ould not e included as a 0direct
financial interest1 of the C*)$
d a. 3pouse.
. Eependent child.
c. Relative supported y the C*).
d. 3iling living in the same city as the C*).
11. "nterpretations of the rules regarding independence allo# an auditor to serve as:
easy a. a director or officer of an audit client.
d . an under#riter for the sale of a clientAs securities.
c. a trustee of a clientAs pension fund.
d. an honorary director for a not-for-profit charitale or religious organization.
1!.
easy

Chen the 'uestion arises #hether a C*) firm may do oth ookkeeping and auditing services
for the same pulic company client, the "nterpretations of the )"C*)As Code of *rofessional
Conduct:
a. encourage it.
. prohiit it.
c. allo# it.
d. allo# each firm to determine the ans#er on a case-y-case asis.
1(. /he C*) must not suordinate his or her professional @udgment to that of others in any:
easy a. engagement.
a . audit engagement.
c. engagement e-cluding ta- services.
d. engagement e-cluding management advisory services.
1.. Chich of the follo#ing #ould e a violation of the rule re'uiring 0o@ectivity1 y the C*)$
easy
c
a. /he auditor accepts managementAs opinion regarding the collection of accounts
receivale #ithout an independent evaluation.
. "n preparing a clientAs ta- return, the C*) encourages a client to take a deduction #hich
the C*) elieves is risky, ut unlikely to e found during an "R3 audit.
c. ?ither a or #ould e a violation of the rule.
d. Deither a nor #ould e a violation of the rule.
12.
easy
d
3everal months after an un'ualified audit report #as issued, the auditor discovers the financial
statements #ere materially misstated. /he clientAs C?4 agrees that there are misstatements, ut
refuses to correct them. 3he claims that 0confidentiality1 prevents the C*) from informing
anyone.
a. /he C?4 is correct and the auditor must maintain confidentiality.
. /he C?4 is incorrect, ut ecause the audit report has een issued it is too late.
c. /he C?4 is correct, ut to e ethically correct the auditor should violate the
confidentiality rule and disclose the error.
d. /he C?4 is incorrect, and the auditor has an oligation to issue a revised audit report,
even if the C?4 #ill not correct the financial statements.
18.
medium
) memer in pulic practice may perform for a contingent fee any professional services for a
client for #hom the memer or memerAs firm performs:
a. an audit.
. consulting services.
c. preparation of an original ta- return.
d. preparation of an amended ta- return.
1;. Chich of the follo#ing activities is allo#ed for a C*) firmAs attestation clients$
easy a. Contingent fees ased on savings due to implementation of an information system.
a . Commissions for referring a revie# client to an insurance agency for insurance coverage.
c. *reparation of ta- returns for #hich fees are ased upon client refunds.
Arens/Elder/Beasley
d. ?ach of the aove is allo#ed.
1<.
Medium

) memer in pulic practice shall neither receive from, nor pay to, a client a commission #hen
the memer or memerAs firm also performs certain services for that client. )re commissions
allo#ed if the C*) performs:
) compilation that #ill e used y a
third party
)n audit of prospective financial
information
a. Jes Jes
. Do Do
c. Jes Do
d. Do Jes
1=.
easy
"f the oard of accountancy in the state in #hich a C*) firm is licensed has rules that are
different than the )"C*)As rules, the C*) firm must follo#:
a. #hichever rules are less restrictive.
. #hichever rules are more restrictive.
c. the rules of the )"C*).
d. the rules of the stateAs oard of accountancy.
!:.
easy
?lise, C*), o#ns a pulic accounting firm and #ishes to estalish a separate partnership to
offer data processing services to the pulic and other pulic accountants.
a. ?lise cannot e a partner in any separate partnership that offers data processing services.
. ?lise may form a separate partnership.
c. ?lise may form a separate partnership as long as partners are C*)s.
d. ?lise may form a separate partnership, ut must give up the pulic accounting practice.
!1. +345,
medium
/he 3aranes-4-ley )ct re'uires #hich employees of an accounting firm to rotate off the
engagement every five years$
d
"n-Charge )uditor *artner responsile for concurring revie#
a. Jes Jes
. Do Do
c. Jes Do
d. Do Jes
!!.
medium
/he )"C*)As Code of *rofessional Conduct states that a C*) should maintain integrity and
o@ectivity. /he term 0o@ectivity1 in the Code refers to a C*)As aility to:
d a. choose independently et#een alternate accounting principles and auditing standards.
. distinguish et#een accounting practices that are acceptale and those that are not.
c. e unyielding in all matters dealing #ith auditing procedures.
d. maintain an impartial attitude on matters that come under the C*)As revie#.
!(.
medium
Chich of the follo#ing is re'uired for a firm to designate itself 0Memer of the )merican
"nstitute of Certified *ulic )ccountants1 on its letterhead$
a. )t least one of the partners must e a memer of the )"C*).
. )ll partners must e memers of the )"C*).
c. /he partners #hose names appear in the firm name must e memers of the )"C*).
d. ) ma@ority of the partners must e memers of the )"C*).
!.. C*)s are prohiited from #hich of the follo#ing forms of advertising$
medium a. 3elf-laudatory advertising.
d . Celerity endorsement advertising.
c. >se of trade names, such as 0)#esome )uditors.1
d. >se of phrases, such as 0%uaranteed largest ta- refunds in to#nO1
!2. )nna %reer, a C*) in pulic practice, contacts 7lake 3a#yers, an employee of Lackson G
Arens/Elder/Beasley
medium
d
Lackson, &&*, and makes him an offer of employment #ithout first notifying Lackson G
Lackson, &&*. )ccording to the )"C*)As Code of *rofessional Conduct, )nnaAs ehavior:
a. is a violation of the Code of *rofessional Conduct.
. is a violation only if %reer and 3a#yers are C*)s.
c. is a violation only if Lackson G Lackson &&* is a C*) firm.
d. is not a violation.
!8.
medium

C*)s may provide ookkeeping services to their non-pulic audit clients, ut there are a
numer of conditions that must e met if the auditor is to maintain independence. Chich of the
follo#ing conditions is not necessary$
a. /he C*) must not assume a management role or function.
. /he client must hire an e-ternal C*) to approve all of the @ournal entries prepared y the
auditor.
c. /he auditor must comply #ith %))3 #hen auditing #ork prepared y hisKher firm.
d. /he client must accept responsiility for the financial statements.
!;. Chich of the follo#ing statements is not true #ith respect to audit committees$
medium a. "ndividuals not on a firmAs oard of directors should comprise the audit committee.
d . /he audit committee generally helps in resolving conflicts et#een the auditors and
company management.
c. )ll companies listed on the DJ3? are re'uired to have an audit committee.
d. )udit committees are re'uired for all companies.
!<. /o emphasize auditor independence from management, many corporations:
medium a. appoint a partner of the firm conducting the audit to the corporationAs audit committee.
c . estalish a policy of discouraging social contact et#een employees of the corporation
and the staff of the independent auditor.
c. have the independent auditor report to an audit committee of outside memers of the
oard of directors.
d. re'uest that a representative of the independent auditor e on hand at the annual
stockholdersA meeting.
!=.
medium
Chich of the follo#ing statements is true #hen the C*) has een engaged to perform an audit
of financial statements$
a. /he C*) firm is engaged and paid y the clientP therefore, the firm has primary
responsiility to e an advocate for the client.
. /he C*) firm is engaged and paid y the client, ut the primary eneficiaries of the audit
are those #ho rely on the financial statements.
c. 3hould a situation arise #here there is no convincing authoritative standard availale, and
there is a choice of actions #hich could impact a clientAs financial statements, the C*) is
free to endorse the choice #hich is in the investorsA interests.
d. /he C*) firm has primary responsiility to the B)37.
(:.
medium
Chich of the follo#ing is not one of the four parts of the )"C*)As Code of *rofessional
Conduct$
d a. *rinciples.
. Rules of Conduct.
c. "nterpretations.
d. Eefinitions.
(1.
medium
4ne of the )"C*)As ?thical *rinciples deals #ith the pulic interest. "t states that memers
should accept the oligation to act in a #ay that #ill:
c
Honor the pulic trust 3erve the clientAs interest
a. Jes Jes
. Do Do
c. Jes Do
Arens/Elder/Beasley
d. Do Jes
(!. )ccording to the *rinciples section of the Code of *rofessional Conduct, all memers:
medium a. should e independent in fact and in appearance at all times.
c . in pulic practice should e independent in fact and in appearance at all times.
c. in pulic practice should e independent in fact and in appearance #hen providing
auditing and other attestations services.
d. in pulic practice should e independent in fact and in appearance #hen providing
auditing, ta-, and M)3 services.
((. 4f the various parts of the )"C*)As Code of *rofessional Conduct, the:
medium a. *rinciples are enforceale.
d . ?thical Rulings are enforceale.
c. "nterpretations are enforceale.
d. Rules of Conduct are enforceale.
(..
medium
Chich of the follo#ing statements est descries the enforceaility of the "nterpretations of the
Rules of Conduct$
d a. /he "nterpretations are not enforceale.
. /he "nterpretations are enforceale.
c. /he "nterpretations may e enforceale if they have een revie#ed and approved y the
)"C*)As Eivision of *rofessional ?thics.
d. /he "nterpretations are not enforceale, ut a practitioner must @ustify departure from
them.
(2. 4f the four parts of the )"C*)As Code of *rofessional Conduct, #hich part is enforceale$
medium a. ?thical Rulings.
. Rules of Conduct.
c. *rinciples.
d. "nterpretations.
(8. ?thical Rulings are:
medium a. issued y the )"C*)As 7oard of %overnors.
. e-planations relating to specific factual circumstances.
c. e-planations relating to road hypothetical circumstances.
d. enforceale.
(;. /he )"C*)As Code of *rofessional Conduct re'uires independence for all:
medium a. attestation engagements.
a . services performed y accountants in pulic practice.
c. accounting and auditing services performed.
d. professional #ork performed y C*)s.
(<.
medium
Rules of Conduct contained in the Code of *rofessional Conduct apply to all )"C*) memers
for all services provided, #hether or not the memer is in the practice of pulic accounting:
d a. in all circumstances.
. for non-attestation services.
c. e-cept for the single e-ception of a ta- practice.
d. unless it is specifically stated other#ise in the Code.
(=.
medium
) memer firm of the )"C*) is not only responsile for its compliance #ith the Rules of
Conduct, ut it is also responsile for compliance y its:
a
?mployees 3hareholders
a. Jes Jes
. Do Do
c. Jes Do
Arens/Elder/Beasley
d. Do Jes
.:.
medium
)n e-ample of an 0indirect o#nership interest in a client1 #ould e o#nership of a clientAs
stock y a memerAs:
c a. dependent child.
. spouse.
c. non-dependent grandfather.
d. )ll of the aove are e-amples of indirect o#nership.
.1.
medium
Chen determining #hether independence is impaired ecause of an o#nership interest in a
client company, materiality #ill affect #hether o#nership is a violation of Rule 1:1:
c a. in all circumstances.
. only for direct o#nership.
c. only for indirect o#nership.
d. under no circumstances.
.!.
medium
"nterpretations of Rule 1:1 regarding a 0direct financial interest1 have presumed that a violation
e-ists in #hich of the follo#ing circumstances, unless other circumstances offset such a
presumption$
a a. Chen close relatives such as nondependent children, rothers, and sisters have a
significant financial interest in the client.
. Chen close relatives such as nondependent children, rothers, and sisters have any
financial interest in the client.
c. Chen the C*) o#ns shares in a mutual fund that has an o#nership interest in the client.
d. Chen close relatives such as rother, sister, or in-la#s are employed y client.
.(. Chich of the follo#ing circumstances #ould ordinarily not impair the auditorAs independence$
challenging a. &itigation y a client against an audit firm related to ta- services.
a . &itigation y a client against an audit firm claiming a deficiency in the previous audit.
c. &itigation y an audit firm against a client claiming management fraud or deceit.
d. ClientAs intent to start a la#suit at some future date, after the current audit is completed,
claiming a deficiency in the previous audit.
...
medium
"nterpretations to the Rules of Conduct permit a C*) firm to do oth ookkeeping and auditing
for the same client if three criteria are met. Chich of the follo#ing is not one of those criteria$
a. /he client must accept full responsiility for the financial statements.
. /he client is re'uired to file an annual report, including audited financial statements, #ith
the 3ecurities and ?-change Commission.
c. /he C*) must not assume the role of employee or of manager.
d. /he C*) must follo# applicale auditing standards.
.2.
medium
Chich of the follo#ing services is not prohiited y the 3?C #henever a C*) also audits the
company$
d a. "nternal audit outsourcing.
. &egal services unrelated to the audit.
c. )ppraisal or valuation services.
d. 3ervices related to assessing the effectiveness of internal control over financial reporting.
.8.
medium
Chich of the follo#ing services is not prohiited y the 3?C #henever a C*) also audits the
company$
a. )ctuarial services.
. )ssisting the company in preparing certain 3?C registration statements +e.g., 1:-Q, 1:-
F,.
c. "nvestment anker services.
d. 7ookkeeping services.
.;. /he memers of a clientAs 0audit committee1 should e:
Arens/Elder/Beasley
medium a. memers of management.
. directors #ho are not a part of company management.
c. non-directors and non-managers.
d. directors and managers.
.<.
medium
)n increasing numer of companies re'uire stockholders to approve the selection of a ne# C*)
firm or the continuation of the e-isting C*) firm ecause:
a a. stockholders are presumaly more o@ective than management.
. the 3?C re'uires it.
c. the )"C*) re'uires it.
d. the stockholders are in a etter position to evaluate the performance of previous or
potential auditors.
.=.
medium
d
Rule (:1 of the )"C*)As Code of *rofessional Conduct re'uires C*)s to maintain the
confidentiality of client information. /his rule #ould e violated if a C*) disclosed information
#ithout a clientAs consent as a result of a:
a. supoena or summons.
. peer revie#.
c. complaint filed #ith the trial oard of the "nstitute.
d. re'uest y a clientAs largest stockholder.
2:. Chich one of the follo#ing statements is false$
medium
a
a. /he auditorAs responsiility to follo# *C)47 standards is greater than the responsiility
for confidentiality.
. "nformation that a C*) otains from a client is generally not privileged.
c. Chen a C*) firm conducts an )"C*)-authorized peer revie# of the 'uality controls of
another C*) firm, permission of the client is not needed to e-amine audit documentation.
d. ) C*) firm #hich oserves sustandard audit documentation of another firm can initiate
a complaint of sustandard performance #ith the )"C*) ?thics Eivision trial oard
not#ithstanding the confidentiality rule.
21. ) C*) is allo#ed to accept a referral fee for recommending a client to another C*) if:
medium
/he client pre-approves
the transaction *ayment of the referral fee is disclosed to the client
d Jes Jes
Do Do
Jes Do
Do Jes
2!. Rule 2:2 of the )"C*)As Code of *rofessional Conduct permits C*) firms to organize as:
medium a. proprietorships or partnerships only.
c . proprietorships, partnerships, or professional corporations.
c. proprietorships, general partnerships, general corporations, professional corporations,
limited liaility companies, and limited liaility partnerships if permitted y state la#.
d. single proprietorships, partnerships, professional corporations if permitted y state la#,
or regular corporations.
2(.
medium
)ccording to the professionAs ethical standards, an auditor #ould e considered independent in
#hich of the follo#ing instances$
a a. /he auditorAs checking account, #hich is fully insured y a federal agency, is held at a
client financial institution.
. /he auditor is also an attorney #ho advises the client as its general counsel.
c. )n employee of the auditor serves as treasurer of a charitale organization that is a client.
d. /he client o#es the auditor fees for t#o consecutive annual audits.
2.. "f a nonpulic company asks an accountant to perform a revie# engagement, and the accountant
Arens/Elder/Beasley
medium has an immaterial direct financial interest in the company, the accountant is:
a. independent ecause the financial interest is immaterial and, therefore, may issue a
revie# report.
. not independent and, therefore, may not issue a revie# report.
c. not independent and, therefore, may not e associated #ith the financial statements.
d. not independent and, therefore, may issue a revie# report, ut may not issue an auditorAs
opinion.
22. +345,
medium
/he 3aranes-4-ley )ct re'uires a cooling off period of ho# long efore a memer of an audit
team can #ork for a client in a key management position$
a. ?ighteen months.
. /#elve months.
c. /hirty-si- months.
d. "t is not specifiedP instead it is left to the auditorAs discretion.
28.
medium
"n determining independence #ith respect to any audit engagement, the ultimate decision as to
#hether or not the auditor is independent must e made y the:
a a. auditor.
. client.
c. audit committee.
d. pulic.
2;. ) C*) firm should decline an offer to perform management advisory services engagement if:
medium a. the proposed engagement is not accounting-related.
c . recommendations made y the C*) firm are to e su@ect to revie# y the client.
c. acceptance #ould re'uire the C*) firm to make management decisions for an audit client.
d. any of the aove is true.
2<.
medium
"n #hich of the follo#ing circumstances #ould a C*) e ound y ethics to refrain from
disclosing any confidential information aout a client$
a. /he C*) is issued a summons enforceale y a court order #hich orders the C*) to
present confidential information.
. ) ma@or stockholder of a client company seeks accounting information from the C*) after
management declined to disclose the re'uested information.
c. Confidential client information is made availale as part of a 'uality revie# of the C*)As
practice y a peer revie# team authorized y the )"C*).
d. )n in'uiry y a disciplinary ody of a state C*) society re'uests confidential client
information.
2=.
challenging

Companies are re'uired to disclose in their pro-y statement or annual filings #ith the 3?C the
total amount of audit and non-audit fees paid to the audit firm for the t#o most recent years.
Chich of the follo#ing is not one of the categories of fees that must e disclosed$
a. 0/a- fees1
. 0Consulting fees1
c. 0)udit-related fees1
d. 0)ll other fees1
8:.
challenging
a
Bour of the si- ?thical *rinciples in the )"C*)As Code of Professional Conduct are e'ually
applicale to all memers of the )"C*). Chich of the follo#ing principles applies only to
memers in pulic practice$
a. 3cope and Dature of 3ervices.
. "ntegrity.
c. Eue Care.
d. /he *ulic "nterest.
81. "nterpretations of the AICPA Code of Professional Conduct are dominated y the concept of:
challenging a. independence.
Arens/Elder/Beasley
a . compliance #ith standards.
c. accounting.
d. acts discreditale to the profession.
8!.
challenging
)n audit committee, consisting of memers of the clientAs oard of directors #ho are not a part
of company management, is re'uired for all companies:
c a. that have audits performed y )"C*) memer firms.
. that must file 1:-F reports #ith the 3?C.
c. listed on the De# Jork 3tock ?-change.
d. in all circumstances.
8(.
challenging
/he Code of *rofessional Conduct is estalished y the memership of the )"C*), and the
"nterpretations of the Rules of Conduct are prepared y the:
d a. Binancial )ccounting 3tandards 7oard.
. 3ecurities and ?-change Commission.
c. C*) licensing agencies #ithin each state.
d. *rofessional ?thics ?-ecutive Committee of the )"C*).
8..
challenging
%enerally, loans et#een a C*) firm or its memers and an audit client are prohiited ecause
they create a financial relationship. Chich of the follo#ing is not an e-ception to this rule$
d a. )utomoile loans.
. &oans fully collateralized y cash deposits at the same financial institution.
c. Home mortgages.
d. >npaid credit card alances not e-ceeding 912,:::.
82.
challenging
c
%enerally, loans et#een a C*) firm or its memers and an audit client are prohiited ecause
it is a financial relationship. Chich of the follo#ing, made under normal lending procedures, is
not an e-ception to this rule$
a. "mmaterial loans.
. Home mortgages.
c. Material loans.
d. 3ecured loans.
Arens/Elder/Beasley
88. Rule 1:1 indicates that materiality is a consideration for:
Medium
d ?valuating direct investments made
y the C*) ?valuating indirect o#nership investments
a. Jes Jes
. Do Do
c. Jes Do
d. Do Jes
8;. "t is not a violation of the )"C*)As Code of *rofessional Conduct for a C*) to:
challenging
a
a. charge fees as an e-pert #itness determined y the amount a#arded to the plaintiff,
even though the C*) also performs a compilation for client use .
. ase consulting fees on a percentage of a ond issue, even though the C*) performs
a revie# of the clientAs financial statements.
c. ase fees for a ta- service on the amount of the refund that the client #ill receive.
d. ase consulting fees on a percentage of a ond issue, even though C*) performs an
audit of the clientAs financial statements.
8<.
medium
Chich of the follo#ing is not defined as an act discreditale in either the Rules or the
"nterpretations of the )"C*)As Code of *rofessional Conduct$
d a. /he C*) firm has issued the standard un'ualified audit report after auditing a
governmental agency, although %))3 #as not follo#ed ecause the government
re'uired procedures different from %))3.
. /he C*) firm discriminates in its hiring practices ased on the age of the applicant.
c. /he C*) retains the clientAs ooks and records to enforce past-due payment of the
C*)As ill, even after the client has demanded they e returned.
d. /he C*) firmAs partner-in-charge #as arrested recently on his #ay home from the
firmAs holiday party. He #as a passenger in a car driven y his #ife and she #as
charged #ith 0driving #hile into-icated.1
8=.
challenging
/here are a numer of offenses for #hich a C*) may e e-pelled from memership in the
)"C*). Chich of the follo#ing is not one of these offenses$
c a. /he #illful failure to file any income ta- return that the C*), as an individual
ta-payer, is re'uired y la# to file.
. /he #illful filing of a fraudulent income ta- return on a clientAs ehalf.
c. Conviction of a crime punishale y imprisonment of 8 months.
d. /he #illful aiding in the preparation of a false and fraudulent income ta- return.
;:. Chich of the follo#ing statements regarding professional and regular corporations is not
true$
challenging
a
a. 3hareholders in oth professional corporations and regular corporations are
individually liale in litigation against the C*) firm.
. /he shareholders, officers, and employees must comply #ith all Code of
*rofessional Conduct re'uirements.
c. 3tock in a pulic accounting corporation must e held y only those C*)s #ho are
'ualified to practice.
d. /he firm name must meet the same re'uirements as those for a single proprietorship
and partnership.
Arens/Elder/Beasley
;1.
challenging
"n #hich of the follo#ing instances #ould the independence of the C*) most likely not e
considered to e impaired$ /he C*) has een retained as the auditor of a:
c a. charitale organization in #hich an employee of the C*) serves as treasurer.
. municipality in #hich the C*) o#ns 9!2:,::: of the 9!,2::,::: indetedness of the
municipality.
c. cooperative apartment house in #hich the C*) o#ns an apartment and is not part of the
management.
d. company in #hich the C*)As investment clu o#ns a one-tenth interest.
;!.
challenging
Rule !:1 - %eneral 3tandards re'uires memers to comply #ith certain standards and
interpretations. Chich of the follo#ing is not a standard specifically addressed in Rule !:1$
a a. *rofessional integrity.
. Eue professional care.
c. *lanning and supervision.
d. 3ufficient relevant data.
;(. +345,
challenging
d
Chich of the follo#ing statements is correct$
a. Don-audit services that are not prohiited y 3aranes-4-ley or the 3?C rules must e
approved y management of the client.
. Don-audit services that are not prohiited y 3aranes-4-ley or the 3?C rules must e
approved y staff of the *C)47.
c. Don-audit services that are not prohiited y 3aranes-4-ley or the 3?C rules must e
approved y staff of the *C)47 and the 3?C.
d. Don-audit services that are not prohiited y 3aranes-4-ley or the 3?C rules must e
approved y the companyAs audit committee.
?ssay Questions
;..
easy
?-plain #hy there is a special need for ethical conduct in the auditing profession.
)ns#er:
3ince users +e.g., the general pulic, of services provided y an auditor generally cannot
evaluate the 'uality of the auditorAs performance, it is critical to the auditing profession
that the pulic have a high degree of confidence in the 'uality of the services provided y
the auditor. *ulic confidence in the 'uality of professional services is enhanced #hen the
profession encourages high standards of performance and ethical conduct y all its
memers. "f users of auditing services #ere to lack confidence in the 'uality of those
services, then the value of C*) firmsA audits #ould e diminished, as #ould the demand
for audits.
;2.
medium
Eiscuss the #ays the accounting profession and society encourage C*)s to conduct themselves
in a professional mannerP i.e., the factors that influence the ethical conduct of audit
practitioners.
)ns#er:
/here are many factors that encourage C*)s to conduct themselves at a high level,
including:
%))3 and interpretations.
Code of Professional Conduct.
&egal liaility.
Quality control.
*eer revie#.
Arens/Elder/Beasley
Continuing professional education re'uirements.
C*) e-amination.
3?C.
Eivision of C*) firms.
*ulic Company )ccounting 4versight 7oard.
;8.
medium
"dentify and descrie each of the four parts to the )"C*)As Code of Professional Conduct. )lso
discuss #hich parts are officially enforceale and #hich are not.
)ns#er:
/he four parts to the Code are:
Principles. /hese estalish ideal standards of ethical conduct stated in
philosophical terms. /hey are not officially enforceale.
Rules of conduct. /hese are the minimum standards of ethical conduct stated
as specific rules. /hey are officially enforceale.
Interpretations. "nterpretations of rules are intended to clarify the rules of
conduct. /hey are not officially enforceale, ut a practitioner must @ustify any
departure.
Etical rulings. /hese are ans#ers to specific 'uestions sumitted to the
)"C*) y practitioners. /hey are not enforceale, ut a practitioner must @ustify any
departure.
Arens/Elder/Beasley
;;.
medium
7riefly descrie the advantages and disadvantages of stating a code of conduct using general
statements of ideal conduct as opposed to specific rules that define unacceptale ehavior.
)ns#er:
)dvantages Eisadvantages
%eneral statements ?mphasis on positive Eifficult to enforce.
activities encouraging
a high level of
performance.
3pecific rules ?nforceaility of /endency for rules
minimum ehavior to e regarded as
and performance ma-imum rather
standards. than minimum
standards.
;<.
medium
Chat are the si- ?thical *rinciples stated in the Code of Professional Conduct$ 7riefly discuss
each principle. )re these principles enforceale$
)ns#er:
/he si- ?thical *rinciples of the Code of Professional Conduct are:
1. Responsi#ilities. Memers should e-ercise sensitive professional and moral
@udgments.
!. -e Pu#lic Interest. Memers should demonstrate commitment to
professionalism y serving the pulic interest and honoring the pulic trust.
(. Integrit". Memers should maintain the highest sense of integrity.
.. +#$ecti%it" and Independence. Memers should remain free of conflicts of
interest and #hen providing attestation services e independent in fact and in
appearance.
2. .ue Care. Memers should oserve standards and continually strive to
improve 'uality of services and discharge of responsiilities.
8. Scope and ,ature of Ser%ices. Memers should oserve the *rinciples of the
Code of Professional Conduct in determining the scope and nature of services to e
provided.
/he ?thical *rinciples are not enforceale.
;=.
medium
?ach of the follo#ing situations involves a possile violation of the rule on independence. Bor
each situation, +1, decide #hether the Code of Professional Conduct has een violated, and +!,
riefly e-plain ho# the situation violates +or does not violate, the Code of Professional Conduct.
a. Harry 7ro#n is a partner in the /opeka office of Hedley G Co., C*)s. HarryAs rother is
employed in an audit-sensitive position y Lensen )ppliances, a pulicly held company
in Fansas. Lensen )ppliances is one of Hedley G Co.As audit clients. Deither Harry nor
personnel from the /opeka office is involved in the audit of Lensen .
Iiolation$ Jes Do
?-planation:
)ns#er:
Do violation. )lthough partners in a C*) firm are not allo#ed to have close relatives
employed in a position of significant influence y a client, it is acceptale to have a close
relative employed in an audit-sensitive position +#ith no significant influence,, as long as
Arens/Elder/Beasley
the partner does not participate in the engagement.
Arens/Elder/Beasley
. Lohn Coods is an audit manager #ith Calden G Co., C*)s, a one-office C*) firm. Lohn
o#ns 1:: shares of common stock in one of the firmAs audit clients, ut he does not
provide any audit or non-audit services to the company.
Iiolation$ Jes Do
?-planation:
)ns#er:
Do violation. Lohn is not a covered memer #ith respect to the audit client as he has no
responsiility for the engagement and is not in a position to influence the engagement.
c. /he accounting firm of Bine G Herman, C*)s, provides ookkeeping and ta- services
for Henderson Corporation, a privately held company. Bine G Herman also performs the
annual audit of Henderson Corporation.
Iiolation$ Jes Do
?-planation:
)ns#er:
Do violation. /he )"C*) does not prohiit C*) firms from providing ookkeeping, ta-,
and audit services to the same non-pulic client.
d. 7o 3helton C*), is the auditor of Cafe ?cko. ) couple of #eeks ago, Cafe ?ckoAs
management e-pressed an intention to commence litigation against 7o, alleging he #as
negligent in last yearAs audit. 7o elieves there is a strong possiility that management
#ill proceed #ith the litigation. Ho#ever, Cafe ?cko has not fired 7o as its auditor, and
he is no# #orking on the current yearAs audit.
Iiolation$ Jes Do
?-planation:
)ns#er:
Iiolation. Chen there is a la#suit or intent to start a la#suit et#een a C*) and an audit
clientAs management related to audit services, independence is impaired.
e. Hamilton )ppliance has not paid Faren &in#ood, C*), her audit fee for the past t#o
years. Faren is starting #ork on the current yearAs audit of Hamilton.
Iiolation$ Jes Do
?-planation:
)ns#er:
Iiolation. "ndependence is impaired if fees remain unpaid for services provided more than
one year prior to the date of the report.
<:.
medium
/he follo#ing situations involve a possile violation of the )"C*)As Code of Professional
Conduct. Bor each situation, +1, determine the applicale rule numer or name from the Code, +!,
decide #hether or not the Code has een violated, and +(, riefly e-plain ho# the situation
violates +or does not violate, the Code.
Arens/Elder/Beasley
a. "n !::., Breeman and Lohnson, oth C*)s, decided to form a C*) practice. "n !::;,
Breeman and Lohnson approached 7ill Eelaney, a physician and medical e-pert, and asked
him to assist them #ith their gro#ing medical consulting practice. Eelaney agreed, ut
only after he #as given an o#nership interest in the firm. Eelaney does not intend to 'uit
his private medical practice.
Rule: 6666666666 Iiolation$ Jes Do
?-planation:
)ns#er:
Iiolation of Rule Q2:2-Borm of 4rganization and Dame. Don-C*) o#nership of firms is
allo#ale, ho#ever, a non-C*) o#ner must actively provide services to the firmAs clients
as their principal occupation.
. 7rian Ee*alie has a successful dentistry practice in Charleston. 7rian has
recommended one of his patients to Fatie Calton, C*). /o sho# gratitude for the referral,
Fatie has agreed to pay 7rian a token gift of 92:. Fatie discloses the payment arrangement
to her ne# clients.
Rule: 6666666666 Iiolation$ Jes Do
?-planation:
)ns#er:
Do violation of Rule Q2:(-Commissions and Referral Bees. ) C*) may pay a referral fee
to a non-C*) as long as the payment is disclosed to the client.
c. /he accounting firm of 7ayer G *eng, C*)s, is negotiating a fee #ith a ne# audit
client. /hey agree the client #ill pay 92:,::: if 7ayer G *eng issues a clean, un'ualified
opinion, 9.:,::: if a 'ualified opinion is issued, and only 9!:,::: if an adverse opinion is
issued.
Rule: 6666666666 Iiolation$ Jes Do
?-planation:
)ns#er:
Iiolation of Rule Q(:!-Contingent Bees. /his is a contingent fee agreement and is
prohiited y Rule (:!.
d. Eon 3mith, C*), is a memer of the engagement team that performs the audit of 3ha#
Corporation. EonAs five-year-old daughter, *recious, received ten shares of 3ha#
CorporationAs common stock for her fifth irthday. /he stock #as a gift from *reciousAs
grandmother.
Rule: 6666666666 Iiolation$ Jes Do
?-planation:
)ns#er:
Iiolation of Rule Q1:1-"ndependence. Eon is a covered memer for purposes of Rule 1:1.
7ecause his daughter is a dependent, her o#nership interest in 3ha# is treated as a direct
financial interest of her father.
e. Lennifer Harris, C*), is a partner in the C*) firm that audits )lltech, "nc., a closely
held corporation. LenniferAs sister-in-la# is the chief financial officer at )lltech, "nc.
Rule Q 6666666666 Iiolation$ Jes Do
?-planation:
Arens/Elder/Beasley
)ns#er:
Do violation of Rule Q1:1. )ccording to the Code a close relative is defined as a parent,
siling, or nondependent child. /hus, a sister-in-la# is not considered to e a close
relative.
<1.
medium
/he follo#ing situations involve a possile violation of the )"C*)As Code of Professional
Conduct. Bor each situation, +1, determine the applicale rule from the Code, +!, decide #hether
or not the Code has een violated, and +(, riefly e-plain ho# the situation violates +or does not
violate, the Code.
a. Ho#ard Cunningham G Co., C*)s, designates its firm as 0Memers of the )merican
"nstitute of Certified *ulic )ccountants.1 )ll of the partners of the firm are C*)s.
Ho#ever, one of the partners has recently chosen to allo# her memership to lapse
ecause of personal reasons.
Rule: 6666666666 Iiolation$ Jes Do
?-planation:
)ns#er:
Iiolation of Rule Q2:2-Borm of 4rganization and Dame. ) firm may not designate itself
as 0Memers of the )merican "nstitute of Certified *ulic )ccountants1 unless all of its
o#ners are memers of the "nstitute.
. 7rad &ong, C*), #as traveling from 4rlando to Miami, Blorida #hen he #as pulled
over y a police officer on suspicion of driving under the influence. He #as convicted in
court of driving #hile under the influence of alcohol. 7ecause of past convictions, 7rad
#as sentenced to 2 years in prison.
Rule: 6666666666 Iiolation$ Jes Do
?-planation:
)ns#er:
Iiolation of Rule Q2:1-)cts Eiscreditale. Belonies are considered acts discreditale.
c. Felley 7rent, C*), is a partner in a one-office C*) firm that audits Eane, "nc., a
closely held corporation. FelleyAs sister #as recently appointed as the chief financial
officer for Eane, "nc.
Rule: 6666666666 Iiolation$ Jes Do
?-planation:
)ns#er:
Iiolation of Rule Q1:1-"ndependence. )ccording to the Code, FellyAs sister is a 0close
relative1 and she occupies a key position at an audit client. 7ecause Felly is a partner in
the office that provides the audit services to Eane, the firm is not independent.
d. 3arah Matrin, C*), is a senior auditor in the 3an Brancisco office of Cooper G
Ho#ell, C*)s. 3arahAs father is employed as the controller of &ine ?lectronics, a pulic
company in Eetroit, Michigan. &ine ?lectronics is one of the firmAs audit clients. Deither
3arah nor the 3an Brancisco office is involved in the audit of &ine ?lectronics.
Rule: 6666666666 Iiolation$ Jes Do
?-planation:
Arens/Elder/Beasley
)ns#er:
Do violation of Rule Q1:1-"ndependence. Chile 3arahAs father occupies a key position
#ith an audit client of the firm, there is no independence violation as long as 3arah is not a
memer of the engagement team. /he firm may provide the audit services.
Arens/Elder/Beasley
e. 4n )ugust !:, !::8, Hank )nderson, C*) and partner, #as offered and accepted the
engagement to audit the annual financial statements of Lernigan Corporation for the year
ended Eecemer (1, !::8. *reliminary #ork egan on the audit on 3eptemer 12, !::8
and the engagement ended on March ;, !::;. Lernigan is regulated y the 3?C. Hank
served as controller of Lernigan Corporation from Eecemer 1, !::!, until )pril 1:, !::8,
at #hich time he terminated his employment #ith Lernigan.
Rule: 6666666666 Iiolation$ Jes Do
?-planation:
)ns#er:
Iiolation of Rule Q1:1-"ndependence. 3ince Hank had an employment relationship #ith
the client during part of the period covered y the financial statements, his independence is
impaired.
<!.
medium
Eiscuss the )"C*)As Code of Professional Conduct rule on advertising and solicitation. %ive
t#o e-amples of permitted advertising or solicitation, and t#o e-amples of prohiited
advertising or solicitation.
)ns#er:
/he rule on advertising and solicitation prohiits memers in pulic practice from
advertising in a manner that is false, misleading, or deceptive. "t also prohiits solicitation
y the use of coercion, over-reaching, or harassment.
?-amples of permitted advertising include the use of television, radio, ne#spapers, and
illoards to communicate truthful information aout the C*). ?-amples of prohiited
advertising identified y "nterpretation 2:!-! of the )"C*)As Code of Professional
Conduct include any advertisement that creates a false or un@ustified e-pectation of
favorale results, and any advertisement that contains statements that #ould e likely to
cause a reasonale person to e deceived.
<(.
medium
Eescrie the methods used y the )"C*) and 3tate 7oards of )ccountancy to enforce the rules
of conduct.
)ns#er:
/he )"C*) uses t#o levels of disciplinary action. Bor less serious violations of Rules of
Conduct, remedial or corrective action may e re'uired of the violator. Bor more serious
violations, the violator may e suspended or e-pelled from memership in the )"C*).
Iiolation of a 3tate 7oardsA rules of conduct is punishale y loss of the violatorAs C*)
certificate and license to practice.
<..
challenging
/he !::-level rules of the Code of Professional Conduct +Rules !:1, !:!, and !:(, are kno#n as
the 0technical standards.1 3ummarize each of these three technical standards.
)ns#er:
Rule !:1M%eneral 3tandards re'uires the C*) to comply #ith four standards of conduct:
a. undertake only those services for #hich the C*) has the necessary professional
competence.
. e-ercise due professional care in the performance of professional services.
c. ade'uately plan and supervise the services.
d. otain sufficient relevant data to support conclusions.
Arens/Elder/Beasley
Rule !:!MCompliance #ith 3tandards re'uires C*)s to perform professional services in
compliance #ith standards promulgated y odies designated y the )"C*).
Rule !:(M)ccounting *rinciples re'uires that if a C*) e-presses an opinion that
financial statements are presented in conformity #ith generally accepted accounting
principles, those statements must not contain any departure from an accounting principle
promulgated y odies designated y the )"C*) to estalish such principles.
<2.
challenging
Eescrie an ethical dilemma that an auditor or an accountant might face in his or her usiness
career, then illustrate ho# the auditor or accountant might use the si--step approach presented
in the te-t to resolve that dilemma. 7e specific.
)ns#er:
)lthough studentsA ans#ers #ill vary depending on the dilemma, their ans#er should
list the follo#ing si- steps, along #ith a discussion of ho# each step relates to their
particular dilemma:
1. +#tain te rele%ant facts. 3tudents should list the key facts from their
dilemma.
!. Identif" te etical issues from te facts. 3tudents should identify the key
ethical issue+s, in their dilemma.
(. .etermine )o is affected #" te outcome of te dilemma and o) eac person
or group is affected. 3tudents should identify #ho is involved and ho# each person is
affected y the dilemma.
.. Identif" te alternati%es a%aila#le to te person )o must resol%e te dilemma.
3tudents should list the alternatives availale to the auditor or accountant.
2. Identif" te likel" consequence of eac alternati%e. 3tudents should identify
oth the short- and long-term effects of each alternative.
8. .ecide te appropriate action.
<8.
challenging
Eiscuss Rule (:1MConfidential Client "nformation, including the four e-ceptions to the rule.
)ns#er:
Rule (:1 prohiits a memer from disclosing any confidential client information #ithout
permission from the client. Ho#ever, there are four conditions #hen client permission is
not re'uired:
4ligations related to technical standardsP i.e., #hen Rule !:! or Rule !:(
re'uires the disclosure.
"n response to a valid supoena or summons.
) peer revie# is eing conducted under )"C*), state C*) 3ociety, or 3tate
7oard of )ccountancy authorization.
/he C*) is initiating or responding to an in'uiry from a recognized
investigative ody or the professional ethics division.
4ther 4@ective )ns#er Bormat Questions
<;.
easy
a
)n advantage of specific rules in the Code of Professional Conduct is the enforceaility of
minimum ehavior and performance standards.
a. /rue
. Balse
Arens/Elder/Beasley
<<. +345,
easy

/he 3aranes-4-ley )ct permits the auditor to perform a #ide variety of non-audit services for
audit clients.
a. /rue
. Balse
<=. +345,
easy

) company may purchase internal audit services from their financial statement auditor if they
are approved y the companyAs audit committee.
a. /rue
. Balse
=:.
easy
a
/he audit committee of a private committee need not approve all non-audit services provided y
the companyAs financial statement auditor.
a. /rue
. Balse
=1.
easy

)n advantage of the principles of professional conduct in the Code of Professional Conduct is

that they are more easily enforced than are the specific rules of conduct.
a. /rue
. Balse
=!.
easy
a
Rule 1:1, "ndependence, prohiits a C*) from performing oth audit services and ookkeeping
services for the same pulic company in the same year.
a. /rue
. Balse
=(.
easy

>nder Rule 1:1, "ndependence, independence is considered to e impaired if fees remain

unpaid for professional services provided more than si- months efore the date of the current
yearAs report.
a. /rue
. Balse
=..
easy

"mprisonment for a period of si- months or longer #ill result in automatic e-pulsion from the
)"C*).
a. /rue
. Balse
=2.
easy

Rule 2:2, Borm of 4rganization and Dame, prohiits C*) firms from practicing as limited
liaility partnerships.
a. /rue
. Balse
=8.
easy
a
>nder Rule 2:2, Borm of 4rganization and Dame, a C*) firm may use any name as long as it
is not misleading.
a. /rue
. Balse
=;.
medium

) C*) firm may practice pulic accounting only in a form of organization permitted y federal
la# or regulation #hose characteristics conform to resolutions of Council.
a. /rue
. Balse
=<.
medium

"n the AICPA Code of Professional Conduct, ethical rulings are less specific than rules of
conduct.
a. /rue
. Balse
==. "nterpretations of rules of conduct in the Code of Professional Conduct are not officially
Arens/Elder/Beasley
medium

enforceale and practitioners need not @ustify departure from them.

a. /rue
. Balse
1::. +345,
medium

/he 3aranes-4-ley )ct does not re'uire audit committee approval of all non-audit services
prior to their performance y the companyAs e-ternal auditor.
a. /rue
. Balse
1:1.
medium

"n the AICPA Code of Professional Conduct, interpretations of rules are more specific than
ethical rulings.
a. /rue
. Balse
1:!.
medium

"n the AICPA Code of Professional Conduct, the second principle of professional conduct,
entitled 0/he *ulic "nterest,1 applies only to memers of the )"C*) in pulic practice and not
to memers #ho #ork as accountants in usiness, government, or education.
a. /rue
. Balse
1:(.
medium

"n the AICPA Code of Professional Conduct, the si-th principle of professional conduct, entitled
03cope and Dature of 3ervices,1 applies to memers of the )"C*) #ho #ork in pulic practice,
usiness, government, or education.
a. /rue
. Balse
1:..
medium
a
)uditors are allo#ed to have an indirect financial interest in an audit client, such as o#nership
of stock in a clientAs company y the auditorAs rother, as long as the amount of the financial
interest is immaterial to the rother.
a. /rue
. Balse
1:2.
medium

Rule 1:1, "ndependence, applies to memers of the )"C*) #hen performing any professional
service.
a. /rue
. Balse
1:8.
medium
a
Rule 1:1, "ndependence, applies to covered memers in a position to influence an attest
engagement.
a. /rue
. Balse
1:;.
medium
a
>nder Rule (:1, Confidential Client "nformation, permission is not re'uired from the client to
use the audit documentation relating to that client during an )"C*)-authorized peer revie#
program #ith another C*) firm.
a. /rue
. Balse
1:<.
medium

"nformation otained y a C*) from a client is legally privileged in federal court.

a. /rue
. Balse
Arens/Elder/Beasley
1:=.
medium

Rule 2:!, )dvertising and 4ther Borms of 3olicitation, prohiits memers of the )"C*) in
pulic practice from performing comparative advertising.
a. /rue
. Balse
11:.
medium

>nder Rule 2:2, Borm of 4rganization and Dame, a C*) firm may not designate itself as
0Memers of the )merican "nstitute of Certified *ulic )ccountants1 unless a ma@ority of its
o#ners are memers of the "nstitute.
a. /rue
. Balse
111.
medium

?-pulsion from the )"C*) for failing to follo# the rules of conduct is, y itself, sufficient to
prevent a C*) from practicing pulic accounting.
a. /rue
. Balse
11!.
medium

>nder the AICPA/s Code of Professional Conduct, C*)s are prohiited from offering audit
clients a discount for referring a prospective client even if they are disclosed.
a. /rue
. Balse
11(.
medium

)ll o#ners of a C*) firm must e C*)s #ho are 'ualified to practice.
a. /rue
. Balse
11..
medium
a
/he "ndependence 3tandards 7oard #as formed to provide a conceptual frame#ork for
independence issues related to audits of pulic companies.
a. /rue
. Balse
Chapter 5
Multiple-Choice Questions
1.
easy
d
Chile performing services for their clients, professionals have a duty to provide a level of care
#hich is:
a. free from @udgment errors.
. superior.
c. greater than average.
d. reasonale.
!.
easy

)uditors #ho fail to e-ercise due care in their performance of professional services may e
liale for:
a. punitive liaility.
. reach of contract.
c. e-cess liaility.
d. criminal charges.
(.
easy

Chich of the follo#ing may give rise to a usiness failure$

a. )n erroneous audit opinion is issued.
. Management may make ill-advised usiness decisions.
Arens/Elder/Beasley
c. )uditors may fail to uncover employee fraud.
d. *oorly trained auditors may perform a companyAs audit.
..
easy

)+n, 66666 failure occurs #hen an auditor issues an erroneous opinion as the result of an
underlying failure to comply #ith auditing standards.
a. usiness
. audit
c. ethics
d. process
2.
easy
a
/he standard of due care to #hich the auditor is e-pected to adhere is referred to as the:
a. prudent person concept.
. common la# doctrine.
c. due care concept.
d. vigilant person concept.
8. )uditors may e liale to their clients for:
easy *unitive damages Compensatory damages
a a. Jes Jes
. Do Do
c. Jes Do
d. Do Jes
;.
easy

>nder the la#s of agency, partners of a C*) firm may e liale for the #ork of others on #hom
they rely. /his #ould not include:
a. employees of the C*) firm.
. employees of the audit client.
c. other C*) firms engaged to do part of the audit #ork.
d. specialists employed y the C*) firm to provide technical advice on the audit.
Arens/Elder/Beasley
<.
easy
d
0)sence of reasonale care that can e e-pected of a person in a set of circumstances1 defines:
a. pecuniary negligence.
. gross negligence.
c. e-treme negligence.
d. ordinary negligence.
=.
easy
c
)n e-ample of a reach of contract #ould likely include:
a. an auditorAs refusal to return the clientAs general ledger ook until the client paid last
yearAs audit fees.
. a ankAs claim that an auditor had a duty to uncover material errors in financial
statements that had een relied on in making a loan.
c. a C*) firmAs failure to complete an audit on the agreed-upon date ecause the firm had a
acklog of other #ork #hich #as more lucrative.
d. an auditorAs claim that the client staff is un'ualified.
1:.
easy
c
*rivity of contract e-ists et#een:
a. auditor and the federal government.
. auditor and third parties.
c. auditor and client.
d. auditor and client attorney.
11.
easy

)udit contracts +engagement letters,:

a. may e either oral or #ritten.
. must e #ritten.
c. must e #ritten and notarized.
d. must e #ritten if the client is regulated y the 3ecurities and ?-change Commission.
1!.
easy
d
)n individual #ho is not party to the contract et#een a C*) and the client, ut #ho is kno#n
y oth and is intended to receive certain enefits from the contract is kno#n as:
a. a third party.
. a common la# inheritor.
c. a tort.
d. a third-party eneficiary.
1(.
easy
d
&a#s that have een developed through court decisions rather than y passage through
legislative odies are:
a. statutory la#s.
. @udicial la#s.
c. federal la#s.
d. common la#s.
1..
easy
a
&a#s that have een passed through state legislatures are:
a. statutory la#s.
. @udicial la#s.
c. federal la#s.
d. common la#s.
12.
easy
d
/he assessment against a defendant of the full loss suffered y a plaintiff regardless of other
partiesA liaility in the #rongdoing is called:
a. separate and proportionate liaility.
. shared liaility.
c. unitary liaility.
d. @oint and several liaility.
Arens/Elder/Beasley
18.
easy
c
66666 risk represents the possiility that the auditor concludes after conducting an ade'uate
audit that the financial statements #ere fairly stated #hen they #ere actually misstated.
a. 7usiness
. *rocess
c. )udit
d. Bailure
1;.
easy
a
/he assessment against a defendant of that portion of the damage caused y the defendantAs
negligence is called:
a. separate and proportionate liaility.
. @oint and several liaility.
c. shared liaility.
d. unitary liaility.
1<.
easy
a
"n third-party suits, #hich of the auditorAs defenses contends lack of privity of contract$
a. &ack of duty.
. Don-negligent performance.
c. Contriutory negligence.
d. )sence of causal connections.
1=.
easy
c
Chich of the follo#ing auditorAs defenses usually means non-reliance on the financial
statements y the user$
a. &ack of duty.
. Don-negligent performance.
c. &ack of causal connections.
d. Contriutory negligence.
!:.
easy
a
/here are a numer of things that the )"C*), representing the profession as a #hole, can do to
reduce the C*)As e-posure to la#suits. 4ne of them is to:
a. sanction memers for improper conduct and performance.
. deal only #ith clients possessing integrity.
c. hire 'ualified auditors and train and supervise them.
d. perform 'uality audits.
!1.
easy

"n connection #ith the audit of financial statements, an independent auditor could e
responsile for failure to detect a material fraud if:
a. statistical sampling techni'ues #ere not used on the audit engagement.
. the auditor planned the audit in a negligent manner.
c. accountants performing important parts of the #ork failed to discover a close relationship
et#een the treasurer and the cashier.
d. the fraud #as perpetrated y one employee #ho circumvented the e-isting internal
controls.
!!.
medium

Chich of the follo#ing most accurately descries constructive fraud$

a. )sence of reasonale care.
. &ack of slight care.
c. Fno#ledge and intent to deceive.
d. ?-treme or unusual negligence #ithout the intent to deceive.
!(.
medium
c
Chich of the follo#ing most accurately descries fraud$
a. )sence of reasonale care.
. &ack of slight care.
c. Fno#ledge and intent to deceive.
d. ?-treme or unusual negligence #ithout the intent to deceive.
!.. Chich of the follo#ing is an illustration of liaility to clients under common la#$
Arens/Elder/Beasley
medium
a
a. Client sues auditor for not discovering a theft of assets y an employee.
. 7ank sues auditor for not discovering that orro#erAs financial statements are misstated.
c. Comined group of stockholders sue auditor for not discovering materially misstated
financial statements.
d. Bederal government prosecutes auditor for kno#ingly issuing an incorrect audit report.
!2.
medium
c
Chich of the follo#ing is an illustration of liaility under the federal securities acts$
a. Client sues auditor for not discovering a theft of assets y an employee.
. 7ank sues auditor for not discovering that orro#erAs financial statements are misstated.
c. Comined group of stockholders sue auditor for not discovering materially misstated
financial statements.
d. auditor sues client for not cooperating during engagement.
!8.
medium
c
) third-party eneficiary is one #hich:
a. has failed to estalish legal standing efore the court.
. does not have privity of contract and is unkno#n to the contracting parties.
c. does not have privity of contract, ut is kno#n to the contracting parties and intended to
enefit under the contract.
d. may estalish legal standing efore the court after a contract has een consummated.
!;.
medium
c
"f the C*) negligently failed to properly prepare and file a clientAs ta- return, the C*) may e
liale for:
a. the penalties the client o#es the "R3.
. the penalties and interest the client o#es.
c. the penalties and interest the client o#es, plus the ta- preparation fee the C*) charged.
d. the penalties and interest, the ta- preparation fee, and the amount of ta- that #as
underpaid.
!<.
medium
d
Historically, most ma@or la#suits against C*) firms have dealt #ith:
a. disputes over income ta- preparation services.
. disputes arising in the performance of M)3 contracts.
c. disputes over the accuracy of ookkeeping services.
d. audited and unaudited financial statements.
!=.
medium
c
0*rivileged communication1 et#een client and auditor is:
a. availale in all federal courts.
. not availale in any court.
c. availale in several states.
d. availale for matters involving income ta-es only.
(:.
medium
Chich of the follo#ing statements is true$
a %ross negligence
may constitute
constructive fraud
Braud re'uires the
intent to deceive
)ll fraud should e detected
during audit
a. Jes Jes Do
. Do Jes Jes
c. Jes Do Jes
d. Do Do Do
Arens/Elder/Beasley
(1.
medium

Bailure of a party to meet its oligations, therey causing in@ury to another party to #hom a duty
#as o#ed, is:
a. reach of contract.
. tort action for negligence.
c. constructive fraud.
d. fraud.
(!.
medium
d
/ort actions against C*)s are more common than reach of contract actions ecause:
a. there are more torts than contracts.
. the urden of proof is on the auditor rather than on the person suing.
c. the person suing need prove only negligence.
d. the amounts recoverale are normally larger.
((.
medium
c
/he principal issue to e resolved in cases involving alleged negligence is usually:
a. the amount of the damages suffered y plaintiff.
. #hether to impose punitive damages on defendant.
c. the level of care e-ercised y the C*).
d. #hether defendant #as involved in fraud.
(..
medium
c
"n the auditing environment, failure to meet auditing standards is often:
a. an accepted practice.
. a suggestion of negligence.
c. conclusive evidence of negligence.
d. tantamount to criminal ehavior.
(2.
medium

) common #ay for a C*) firm to demonstrate its lack of duty to perform is y use of a+n,:
a. e-pert #itnessA testimony.
. audit contract, or engagement letter.
c. management representation letter.
d. confirmation letter.
(8.
medium
a
/he prudent person concept estalishes that:
a. the C*) firm is not e-pected to make only perfect @udgments.
. an audit in accordance #ith %))3 is su@ect to limitations and cannot e relied upon for
complete assurance that all errors and irregularities #ill e found.
c. the courts do not re'uire that the auditor ecome the insurer or guarantor of the accuracy
of the statements.
d. all C*)s are considered prudent.
(;.
medium
d
/o succeed in an action against the auditor, the client must e ale to sho# that:
a. the auditor #as fraudulent.
. the auditor #as grossly negligent.
c. there #as a #ritten contract.
d. there is a close causal connection et#een the auditorAs ehavior and the damages
suffered y the client.
(<.
medium
) group typically included as 0third parties1 in common la# is:
a )ctual and potential stockholders ?mployees of client
a. Jes Jes
. Do Do
c. Jes Do
d. Do Jes
Arens/Elder/Beasley
(=.
medium
a
/he ma@or conclusion of the 1=(1 Ultramares case #as that:
a. ordinary negligence is insufficient for liaility to third parties.
. ordinary negligence is sufficient for liaility to third-party eneficiaries.
c. fraud or gross negligence is sufficient for liaility to third parties.
d. auditors have no liailities to third parties.
.:.
medium
>nder common la#, a foreseen user #ould e treated the same as:
a ) primary eneficiary ) kno#n third party
a. Jes Jes
. Do Do
c. Jes Do
d. Do Jes
.1.
medium

) road interpretation of the rights of third-party eneficiaries holds that users that the auditor
should have een ale to foresee as eing likely users of financial statements have the same
rights as those #ith privity of contract. /his is kno#n as the concept of:
a. foreseen users.
. foreseeale users.
c. e-pected users.
d. four-party contracts.
.!.
medium

Chich of the auditorAs defenses is ordinarily not availale #hen la#suits are filed y a third
party$
a. )sence of causal connections.
. Contriutory negligence.
c. Don-negligent performance.
d. &ack of duty.
.(.
medium
c
)ccording to the principle estalished y the Restatement of -orts case, foreseen users must e
memers of:
a. any potential user group.
. a legally protected class.
c. a reasonaly limited and identifiale user group.
d. a reasonaly limited and estalished user group.
...
medium
/he increased litigation under the federal securities la#s has resulted from:
c
/he availaility of
class-action litigation
/he strict liaility
standards imposed on
C*)s y the securities
la#s )n e-cess of attorneys
a. Jes Jes Jes
. Jes Do Do
c. Jes Jes Do
d. Do Do Do
.2.
medium
a
Chich of the follo#ing statements aout the 3ecurities )ct of 1=(( is not true$
a. /he amount of the potential recovery is the original purchase price plus punitive damages.
. "t deals #ith the information in registration statements and prospectuses.
c. "t concerns only the reporting re'uirements for companies issuing ne# securities.
d. /he only parties that can recover from auditors are original purchasers of securities.
Arens/Elder/Beasley
.8.
medium

>nder the 3ecurities )ct of 1=((, the auditorAs responsiility for making sure the financial
statements #ere fairly stated e-tends to:
a. the date of the financial statements.
. the date the registration statement ecomes effective.
c. the date of the audit report.
d. one year eyond the date of the financial statements.
.;.
medium
a
>nder the 3ecurities ?-change )ct of 1=(., #hich type of organizations is re'uired to sumit
audited financial statements to the 3?C$
a. ?very company #ith securities traded on national and over-the-counter e-changes.
. ?very corporation.
c. ?very company issuing ne# securities.
d. ?very corporation #hich is chartered y a state government.
.<.
medium
d
/he 3ecurities and ?-change Commission can impose all ut #hich of the follo#ing sanctions$
a. 3uspend a C*) from auditing 3?C clients.
. *rohiit a C*) from accepting ne# 3?C clients for a period of time.
c. Re'uire a C*) to participate in continuing-education programs and make changes in
their practice.
d. Revoke a C*) license.
.=.
medium

/he Boreign Corrupt *ractices )ct +BC*), of 1=;;:

a. re'uires auditors to revie# and evaluate systems of internal control as a part of an audit.
. re'uires 3?C registrants to maintain a reasonaly complete and accurate set of records
and an ade'uate system of internal control.
c. re'uires auditors to revie# clientAs internal control system in a manner #hich is thorough
enough to @udge #hether client meets the re'uirements of the BC*).
d. re'uires auditors to file a report #ith the 3?C if clientAs internal control system is
inade'uate.
2:. +345,
medium
a
Chile the Boreign Corrupt *ractices )ct of 1=;; remains in effect, it has een largely
superseded y #hich of the follo#ing$
a. /he 3aranes-4-ley )ct of !::!.
. /he Racketeer "nfluenced and Corrupt 4rganization )ct.
c. /he Bederal Balse 3tatements 3tatute.
d. /he Bederal Mail Braud 3tatute.
21.
medium
c
Chich of the follo#ing is not likely a factor in the increase in the numer of la#suits and sizes
of a#ards to plaintiffs related to auditor ehavior$
a. "ncreased a#areness of auditor responsiilities y users of financial statements.
. C*) firms are more #illing to settle la#suits.
c. Eifficulty @udges and @urors have in understanding legal matters.
d. "ncreased consciousness on the part of the 3?C for its responsiility to protect investors.
2!.
medium

Historically, one of the leading case of criminal action against C*)s is the:
a. 11(8 /enants case.
. >nited 3tates v. 3imon case.
c. ?scott et al. v. 7ar Chris case, aka 7ar Chris.
d. >ltramares Corporation v. /ouche case.
2(.
medium
a
) ma@or purpose of federal securities regulations is to:
a. provide sufficient reliale information to the investing pulic #ho purchases securities in
the marketplace.
. estalish the 'ualifications for accountants #ho are memers of the profession.
c. eliminate incompetent attorneys and accountants #ho participate in the registration of
securities to e offered to the pulic.
Arens/Elder/Beasley
d. provide a set of uniform standards and tests for accountants, attorneys, and others #ho
practice efore the 3ecurities and ?-change Commission.
2..
medium
c
) C*) is su@ect to criminal liaility if the C*):
a. refuses to turn over re'uested audit documentation to a client.
. performs an audit in a negligent manner.
c. #illfully omits a material fact from a set of financial statements.
d. #illfully reaches a contract #ith a client.
22.
medium
c
Chich of the follo#ing est descries a trend in litigation involving C*)s$
a. ) C*) cannot render an opinion unless the C*) has audited all affiliates of a company.
. ) C*) may not successfully assert that the C*) had no motive to e part of a fraud.
c. ) C*) may e e-posed to criminal as #ell as civil liaility.
d. ) C*) is primarily responsile for a clientAs footnotes filed #ith the 3?C.
28.
medium
/ort actions can e ased on #hich of the follo#ing$
a 4rdinary negligence %ross negligence
a. Jes Jes
. Do Do
c. Jes Do
d. Do Jes
2;.
medium

/he preferred defense in third-party suits is:

a. lack of duty to perform.
. non-negligent performance.
c. asence of causal connection.
d. client fraud.
2<.
challenging
a
Chich of the follo#ing resulted in a federal la# passed in 1==2 that significantly reduced
potential damages in securities-related litigation$
a. *rivate 3ecurities &itigation Reform )ct.
. *ulic 3ecurities Eamages and 3ettlements )ct.
c. Racketeer "nfluenced and Corrupt 4rganization )ct.
d. >.3. 3ecurities Claims Reform )ct.
2=.
challenging

/he *rivate 3ecurities &itigation Reform )ct of 1==2 reduced potential damages in securities-
related litigation, ut ecause the act applied only to federal courts, attorneys egan taking cases
to state courts. Chich of the follo#ing eliminated this loophole$
a. *rivate 3ecurities &itigation Reform )mendment.
. 3ecurities &itigation >niform 3tandards )ct of 1==<.
c. Racketeer "nfluenced and Corrupt 4rganization )ct.
d. >.3. 3ecurities Claims Reform )ct.
8:.
challenging
c
4ne of the changes in auditing procedure #hich #as rought aout as a result of the 11(8
/enants case #as that auditors #ere encouraged to egin using:
a. letters of representation.
. confirmation letters.
c. engagement letters.
d. illet dou- letters.
81.
challenging
c
/he leading precedent-setting auditing case in third-party liaility is:
a. Escott et al. v. 0ar Cris Construction Corp.
. 1ocfelder v. Ernst 2 Ernst.
c. Ultramares Corporation v. -ouce.
d. United States v. Simon.
Arens/Elder/Beasley
8!.
challenging
d
>nder common la#, an individual or company that +1, does not have a contract #ith an auditor,
+!, is kno#n y the auditor in advance of the audit, and +(, #ill use the auditorAs report to make
decisions aout the client company has:
a. no rights unless an auditor is grossly negligent.
. no rights unless an auditor is fraudulent.
c. no rights against an auditor.
d. the same rights against an auditor as a client.
8(.
challenging
a
/he asic legal concept #hich #as affirmed in the 1=<2 De# Jork case, Credit Alliance, #as
that:
a. the auditorAs defense of privity of contract is still valid against third parties.
. the auditor is liale for ordinary negligence to specifically foreseen third parties.
c. the auditor is liale for ordinary negligence to reasonaly foreseeale third parties.
d. the auditorAs defense of contriutory negligence is no longer valid.
8..
challenging
c
Chich of the follo#ing statements aout the 3ecurities )ct of 1=(( is not true$
a. ) third party that purchased securities descried in the registration statement may sue the
auditor for material misrepresentations or omissions in the audited financial statements.
. ) third-party user does not have the urden of proof that heKshe relied on the financial
statements.
c. ) third-party user has the urden of proof that the auditor #as either negligent or
fraudulent in doing the audit.
d. ) third-party user does not have the urden of proof that the loss #as caused y the
misleading statements.
82.
challenging

/he most significant audit issue that came as a result of the court decision in the ?scott et al. v.
7ar Chris Construction Corporation case in 1=8< #as:
a. the courtAs reaffirmation that the urden of proof #as on the plaintiff to prove the auditor
#as negligent.
. the affirmation of the increased auditorAs responsiility #hen performing an 3-1 revie#, a
revie# of events suse'uent to the alance sheet, for registration statements.
c. the increased auditor responsiility #hen associated #ith unaudited financial statements.
d. the courtAs refusal to allo# the percentage-of-completion method of accounting for
revenues.
88.
challenging
a
>nder the federal securities acts, one significant result occurring directly due to the ?scott et al.
v. 7ar Chris Construction Corporation case #as that 3)3 #as changed to re'uire:
a. greater emphasis on suse'uent events procedures.
. ne# standards for unaudited statements.
c. a roader definition of third-party eneficiaries.
d. more companies to file annual reports #ith the 3?C.
8;.
challenging

>nder the 3ecurities ?-change )ct of 1=(., most of the litigation against the auditor has een
generated ecause of the auditorAs involvement #ith the:
a. <-F form.
. 1:-F form.
c. 1:-Q form.
d. 3-1 form.
8<.
challenging
a
3ection 1: and Rule 1:-2 of the 3ecurities ?-change )ct of 1=(. are often referred to as:
a. the antifraud provisions.
. the ne# issues provisions.
c. the full-employment act for accountants.
d. the R"C4 provisions.
8=.
challenging
"n a leading securities la# and C*) liailities case, the >.3. 3upreme Court ruled in 1=;8 in
1ocfelder v. Ernst 2 Ernst that efore C*)s could e held liale for Rule 1:-2 of the
Arens/Elder/Beasley
c 3ecurities ?-change )ct of 1=(., #hat #ould e re'uired to e sho#n to the court #as the
auditorAs:
a. ordinary negligence.
. gross negligence.
c. kno#ledge and intent to deceive.
d. financial gain at the e-pense of the plaintiff.
;:.
challenging
d
/he similarity that e-ists in oth the United States v. ,atelli case +i.e., the ,ational Student
Marketing case of 1=;2,, and the ESM &o%ernment Securities v. Alexander &rant 2 Co. case of
1=<8 is that in each case:
a. a partner in a national C*) firm served prison time.
. the partners #ere punished for the shoddy #ork of their suordinates.
c. a presidential pardon kept them from serving time in prison and allo#ed them to retain
their C*) licenses.
d. the auditors #ere not convicted for failing to discover the prolem in year 1, ut for failing
to disclose the prolem #hen it #as discovered in year !.
;1.
challenging
c
/he 3ecurities and ?-change Commission has authority to:
a. prescrie specific auditing procedures to detect fraud concerning inventories and
accounts receivale of companies engaged in interstate commerce.
. deny lack of privity as a defense in third-party actions for gross negligence against the
auditors of pulic companies.
c. determine accounting principles for the purpose of financial reporting y companies
offering securities to the pulic.
d. re'uire a change of auditors of governmental entities after a given period of years as a
means of ensuring auditor independence.
;!.
challenging
a
/he partnership of 7ooth G Haynes, C*)s, has een engaged to e-amine the financial
statements of *aul, "nc., in connection #ith the registration of *aulAs securities #ith the
3ecurities and ?-change Commission. >nder these circumstances, #hich of the follo#ing
statements is true$
a. 7ooth G Haynes is assuming much greater third-party liaility than it assumes on
engagements under common la#.
. "f its e-amination is not fraudulent, 7ooth G Haynes may issue an appropriate disclaimer
to the financial statements and therey avoid liaility.
c. 7ooth G Haynes must incorporate if they #ish to practice efore the 3?C.
d. 7ooth G Haynes must e a large interstate firm if they #ish to practice efore the 3?C.
;(.
challenging
d
%regory G Hedrick, a medium-sized C*) firm, employed ?lise as a staff accountant. ?lise #as
negligent #hile auditing several of the firmAs clients. >nder these circumstances, #hich of the
follo#ing statements is true$
a. ?lise #ould have no personal liaility for negligence.
. %regory G Hedrick is not liale for ?liseAs negligence ecause C*)s are generally
considered to e independent contractors.
c. %regory G Hedrick #ould not e liale for ?liseAs negligence if Cinters disoeyed
specific instructions in the performance of the audits.
d. %regory G Hedrick can recover against its insurer on its malpractice policy even if one of
the partners #as also negligent in revie#ing ?liseAs #ork.
;..
challenging

/he Fing 3urety Company #rote a general fidelity ond covering thefts of assets y the
employees of Cilson, "nc. /hereafter, Cooney, an employee of Cilson, emezzled 91;,!:: of
company funds. Chen the activities #ere discovered, Fing paid Cilson the full amount in
accordance #ith the terms of the fidelity ond, and then sought recovery against CilsonAs
auditors, &ynch G Merritt, C*)s. Chich of the follo#ing #ould e &ynch G MerrittAs est
defense$
a. Fing is not in privity of contract.
. /he shortages #ere the result of clever forgeries and collusive fraud #hich #ould not e
Arens/Elder/Beasley
detected y an e-amination made in accordance #ith generally accepted auditing
standards.
c. &ynch G Merritt #ere not guilty either of gross negligence or fraud.
d. &ynch G Merritt #ere not a#are of the Fing-Cilson surety relationship.
;2.
challenging
c
)s a conse'uence of his failure to adhere to generally accepted auditing standards in the course
of his e-amination of the &amp Corp., Harrison, C*), did not detect the emezzlement of a
material amount of funds y the companyAs controller. )s a matter of common la#, to #hat
e-tent #ould Harrison e liale to the &amp Corp. for losses attriutale to the theft$
a. He #ould have no liaility, since the ordinary e-amination cannot e relied upon to detect
thefts of assets y employees.
. He #ould have no liaility ecause privity of contract is lacking.
c. He #ould e liale for losses attriutale to his negligence.
d. He #ould e liale only if it could e proven that he #as grossly negligent.
;8.
challenging

"n connection #ith a pulic offering of first mortgage onds y Henson Corp., the ond
under#riter has asked HensonAs C*) to furnish him #ith a comfort letter giving as much
assurance as possile relative to HensonAs unaudited financial statements for the three months
ended March (1, !::;.
/he C*) had e-pressed an un'ualified opinion on HensonAs financial statements for the year
ended Eecemer (1, !::8 and he has performed a limited revie# of HensonAs financial
statements for the three months ended March (1, !::;. Dothing has come to his attention that
#ould indicate that the March (1, !::; statements are not properly presented. >nder these
circumstances, the C*)As response to the under#riterAs re'uest should e to:
a. furnish to the under#riters an opinion that the March (1, !::; statements are fairly
presented su@ect to year-end audit ad@ustments.
. give negative assurance as to the March (1, !::; financial statements ut disclaim an
opinion on these statements.
c. inform the under#riters that no comfort letter is possile #ithout an audit of the financial
statements for the three months ended March (1, !::;.
d. Burnish to the under#riters an adverse opinion covering financial statements for the three
months ended March (1, !::;.
?ssay Questions
;;.
easy
Eistinguish et#een #hat is meant y usiness failure and audit failure.
)ns#er:
7usiness failure occurs #hen a usiness is unale to repay its dets, the e-treme case of
#hich is filing for ankruptcy. )udit failure occurs #hen the auditor issues an incorrect
audit report as the result of failing to follo# generally accepted auditing standards.
;<.
easy
Eistinguish et#een ordinary negligence and gross negligence.
)ns#er:
4rdinary negligence is the asence of reasonale care, #hereas gross negligence is the
asence of even slight care that can e e-pected of a person in a set of circumstances.
;=.
easy
Eistinguish et#een audit risk and audit failure.
)ns#er:
)udit risk is the risk that the auditor #ill conclude that the financial statements are fairly
stated and issue an un'ualified report #hen, in fact, the financial statements are materially
Arens/Elder/Beasley
misstated. )n audit failure occurs #hen the auditor, as a result of his or her failure to
follo# %))3, issues an erroneous audit report.
<:.
easy
Eiscuss some of the steps individual practicing auditors can take to minimize their legal
liaility.
)ns#er:
/here are many steps individual practitioners can take to minimize legal liaility
including:
Eeal only #ith clients possessing integrity.
Hire 'ualified personnel and train and supervise them properly.
Bollo# the standards of the profession.
Maintain independence.
>nderstand the clientAs usiness.
*erform 'uality audits.
Eocument the #ork properly.
4tain an engagement letter and a representation letter.
Maintain confidential relations.
Carry ade'uate insurance.
3eek legal counsel.
Choose a form of organization #ith limited liaility.
<1.
medium
Eistinguish et#een constructive fraud and fraud.
)ns#er:
Constructive fraud is the e-istence of e-treme or unusual negligence #ith no intent to
deceive or do harm. "n contrast, fraud involves oth kno#ledge and intent to deceive.
<!.
medium
/here are four ma@or sources of an auditorAs legal liaility. 4ne source is liaility to the audit
client under common la#. 7riefly summarize the other three sources.
)ns#er:
/he other three sources of auditorAs legal liaility are:
&iaility to third parties under common la#.
&iaility to shareholders under federal securities acts.
Criminal liaility.
Arens/Elder/Beasley
<(.
medium
Eiscuss three ma@or factors that have contriuted to the recent increase in the numer of
la#suits against auditors and the size of a#ards to plaintiffs.
)ns#er:
Ma@or factors include:
/he gro#ing a#areness of the responsiilities of pulic accountants y users
of financial statements.
)n increased consciousness on the part of the 3ecurities and ?-change
Commission regarding its responsiility for protecting investorsA interests.
"ncreasing comple-ity of auditing and accounting.
&arge civil court @udgments against C*) firms.
Loint and several liaility doctrine #hich encourages plaintiffs to sue auditors
regardless of fault.
/he #illingness of C*) firms to settle out of court to avoid costly legal fees
and adverse pulicity.
/he difficulty courts have in interpreting technical accounting and auditing
matters.
<..
medium
Eistinguish et#een 0@oint and several liaility1 and 0separate and proportionate liaility.1
)ns#er:
>nder @oint and several liaility, the defendant can e assessed the full loss suffered y the
plaintiff, regardless of the e-tent to #hich other parties shared in the #rongdoing. "n
contrast, under separate and proportionate liaility, the defendant is assessed that portion
of the plaintiffAs loss caused y the defendantAs #rongdoing.
<2.
medium
Eiscuss each of the four defenses a C*) firm can normally use #hen facing legal claims y
clients. Chich of these defenses is ordinarily not availale against third-party suits$
)ns#er:
'ack of dut". /he C*) firm could claim that there #as no implied or e-pressed contract to
perform et#een the C*) firm and the client.
,onnegligent performance. /he C*) firm could claim that the audit #as performed in
accordance #ith %))3.
Contri#utor" negligence. /he C*) firm could claim that the clientAs actions either caused
the loss, or interfered #ith the auditorAs aility to discover the cause of the loss. /his
defense is not availale in third-party suits.
A#sence of causal connection. /he C*) firm could claim that the auditorAs sustandard
performance did not cause the damages suffered y the client.
Arens/Elder/Beasley
<8.
medium
Eiscuss some of the steps the )"C*) and the accounting profession as a #hole can and are
taking to reduce the practitionerAs e-posure to la#suits.
)ns#er:
3teps the profession is taking to reduce practitionersA e-posure to la#suits include:
Research in auditing.
3tandard and rule setting and revisions to meet the changing needs of the
profession.
3etting re'uirements to protect auditors.
?stalishing peer revie# re'uirements.
4pposing la#suits.
?ducating investors and other users of financial statements as to the meaning
of the auditorAs report and the nature of the auditorAs #ork.
3anctioning memers for improper conduct.
&oying for changes in la#s.
<;.
medium
Eiscuss the sanctions the 3ecurities and ?-change Commission can impose on auditors.
)ns#er:
/he 3?C has the po#er to suspend, temporarily or permanently, practitioners from doing
audits for 3?C-regulated companies. /he 3?C can also re'uire individual C*)s or C*)
firms to have an e-tensive revie# of their practices y another C*) firm, to participate in
continuing professional education programs, and to make changes in their practice.
<<.
medium
Eiscuss some of the actions that can e taken y individual C*)s to protect themselves from
legal liaility.
)ns#er:
Eeal only #ith clients possessing integrity.
Hire 'ualified personnel and train and supervise them properly.
Bollo# professional standards.
Maintain independence.
>nderstand the clientAs usiness.
*erform 'uality audits.
Eocument the #ork properly.
4tain an engagement letter and a representation letter.
Carry ade'uate insurance.
3eek legal counsel.
Choose a form of organization #ith limited liaility.
?-ercise professional skepticism.
Arens/Elder/Beasley
<=.
medium
?-plain #hat each of the follo#ing terms means:
+1, 7usiness failure.
+!, )udit failure.
+(, )udit risk.
)ns#er:
+1, 7usiness failure occurs #hen a usiness is unale to repay its lenders or meet the
e-pectations of its investors ecause of economic or usiness conditions. /he
e-treme case of usiness failure is filing for ankruptcy.
+!, )udit failure occurs #hen the auditor issues an erroneous audit opinion as the result
of a failure to comply #ith the re'uirements of generally accepted auditing standards.
+(, )udit risk is the risk that the auditor #ill conclude that the financial statements are
fairly stated and an un'ualified opinion can e issued #hen, in fact, they are
materially misstated.
Arens/Elder/Beasley
=:.
challenging
/hree approaches to the application of the foreseen usersA concept are +1, the Credit Alliance
approach, +!, the restatement of torts approach, and +(, the foreseeale user approach.
3ummarize each of these three approaches.
)ns#er:
/he Credit Alliance approach upholds the concept of privity of contract estalished y the
Ultramares Corporation %. -ouce case. >nder this approach, for an auditor to e liale to
third parties, the auditor +1, must kno# and intend that his or her #ork product #ould e
used y the third party for a specific purpose, and +!, the kno#ledge and intent must e
evidenced y the auditorAs conduct.
>nder the restatement of torts approach, foreseen third-party users of the auditorAs #ork
product must e memers of a reasonaly limited and identifiale group of users, even
though those persons #ere not specifically kno#n to the C*) at the time the #ork #as
done.
>nder the foreseeale user approach, any users that the auditor should have reasonaly
een ale to foresee as eing likely users of financial statements have the same rights as
those #ith privity of contract.
4ther 4@ective )ns#er Bormat Questions
=1.
medium
Match seven of the legal terms +a-@, #ith the definitions provided elo# +1-;,:
a. Common la#
. Constructive fraud
c. 7reach of contract
d. Loint and several liaility
e. 4rdinary negligence
f. /hird-party eneficiary
g. %ross negligence
h. 3tatutory la#
i. Braud
@. 3eparate and proportionate liaility
h 1. &a#s that have een passed y the >.3. Congress and other governmental
units.
e !. )sence of reasonale care than can e e-pected of a person in a set of
circumstances.
g (. &ack of even slight care, tantamount to reckless ehavior that can e e-pected
of a person.
@ .. /he assessment against a defendant of the portion of the damage caused y
the defendantAs negligence.
c 2. Bailure of one or oth parties in a contract to fulfill the re'uirements of the
contract.
d 8. /he assessment against a defendant of the full loss suffered y a plaintiff
regardless of the e-tent to #hich other parties shared in the #rongdoing.
;. ?-istence of e-treme or unusual negligence even though there #as no intent to
deceive or do harmP also termed recklessness.
Arens/Elder/Beasley
=!.
medium
Match eight of the follo#ing terms +a-n, #ith the definitions provided elo# +1-<,:
a. Boreign Corrupt *ractices )ct
. 3ecurities ?-change )ct of 1=(.
c. 3ecurities &itigation >niform 3tandards )ct of 1==<
d. 3ecurities )ct of 1=((
e. Ultramares doctrine
f. )udit risk
g. )udit failure
h. 3tandards failure
i. 7usiness failure
@. )sence of causal connection
k. Contriutory negligence
l. &ack of duty to perform
m. *rivate 3ecurities &itigation Reform )ct
n. Donnegligent performance
g 1. ) situation in #hich the auditor issues an erroneous audit opinion as the result
of an underlying failure to comply #ith the re'uirements of generally
accepted auditing standards.
!. ) federal statute dealing #ith companies that trade securities on national and
over-the-counter e-changes. )uditors are involved ecause the annual
reporting re'uirements include audited financial statements.
k (. )n auditorAs legal defense under #hich the auditor claims that the client failed
to perform certain oligations and that it is the clientAs failure to perform those
oligations that rought aout the claimed damages.
a .. ) federal statute that makes it illegal to offer a rie to an official of a foreign
country.
e 2. ) common-la# approach to third-party liaility in #hich ordinary negligence
is insufficient for liaility to third parties, ecause of the lack of privity of
contract et#een the third party and the auditor unless the third party is a
primary eneficiary.
c 8. ) federal statute designed to cause class-action securities la#suits to e
addressed in federal district courts.
n ;. )n auditorAs legal defense under #hich the auditor claims that the audit #as
performed in accordance #ith generally accepted auditing standards.
@ <. )n auditorAs legal defense under #hich the auditor contends that the damages
claimed y the client #ere not rought aout y any act of the auditor.
=(.
easy
a
/he standard of due care to #hich the auditor is e-pected to e held is referred to as the prudent
person concept.
a. /rue
. Balse
Arens/Elder/Beasley
=..
easy

/he *rivate 3ecurities &itigation Reform )ct of 1==2 capped damage a#ards against auditors to
the amount of the audit fees charged.
a. /rue
. Balse
=2.
easy
a
"n a C*) firm operating as a limited liaility partnership +&&*,, the liaility for one partnerAs
actions does not e-tend to another partnerAs personal assets.
a. /rue
. Balse
=8.
easy

"n a C*) firm operating as a limited liaility partnership +&&*,, the liaility for one partnerAs
actions does not e-tend to the firmAs assets.
a. /rue
. Balse
=;.
easy

3tatutory la#s are la#s that have een developed through court decisions rather than through
the >.3. Congress and other governmental units.
a. /rue
. Balse
=<.
medium
a
4ne result from the Escott et al. %. 0ar Cris case #as a greater emphasis eing placed on audit
staff understanding the clientAs usiness and industry.
a. /rue
. Balse
==.
medium

)n e-ample of auditor legal liaility to third parties under common la# #ould e the federal
government prosecuting an auditor for kno#ingly issuing an incorrect audit report.
a. /rue
. Balse
1::.
medium
a
/he doctrine of @oint and several liaility is one factor that has contriuted to the recent increase
in the numer of la#suits against auditors and the size of a#ards to plaintiffs.
a. /rue
. Balse
1:1.
medium

)udit risk is the risk there #ill e an audit failure for a given audit engagement.
a. /rue
. Balse
1:!.
medium

/he term 0audit failure1 refers to the situation #hen the auditor has follo#ed auditing standards
yet still fails to discover that the clientAs financial statements are materially misstated.
a. /rue
. Balse
1:(.
medium

3everal states have statutes that permit privileged communication et#een the client and
auditor, allo#ing a C*) to refuse to testify in state and federal courts.
a. /rue
. Balse
1:..
medium

/he 3345 -enants case #as a criminal case concerning a C*)As failure to uncover fraud during
a financial statement audit.
a. /rue
. Balse
1:2. 4f the three approaches to applying the concept of foreseen users +Credit Alliance approach,
Arens/Elder/Beasley
medium

restatement of torts approach, and foreseeale user approach,, the approach follo#ed y the
most states is the Credit Alliance approach.
a. /rue
. Balse
1:8.
medium
a
/he only parties #ho can recover from auditors under the 3ecurities )ct of 1=(( are original
purchasers of securities.
a. /rue
. Balse
1:;.
medium
a
>nder the 3ecurities )ct of 1=((, a third-party plaintiff does not have the urden of proof that
he or she relied on the financial statements or that the auditor #as negligent or fraudulent in
doing the audit. Rather, the plaintiff need only prove that the audited financial statements
contained a material misrepresentation or omission.
a. /rue
. Balse
1:<.
medium

Companies #ith securities traded on national and over-the-counter e-changes are re'uired to
sumit audited financial statements once every three years to the 3ecurities and ?-change
Commission.
a. /rue
. Balse
1:=.
medium
a
/he same three defenses availale to auditors in common la# suits y third partiesMnon-
negligent performance, lack of duty, and asence of causal connectionMare also availale for
suits under the 3ecurities ?-change )ct of 1=(..
a. /rue
. Balse
11:.
medium

/he >nited 3tates 3upreme Court has ruled that outside professionals such as accountants #ho
donAt help run corrupt usinesses cannot e sued under the provisions of the Boreign Corrupt
*ractices )ct.
a. /rue
. Balse
11!.
medium

/he Boreign Corrupt *ractices )ct of 1=;; allo#s an in@ured party to seek trele +triple,
damages and recovery of legal fees in cases #here it can e demonstrated that the defendant
#as engaged in a pattern of fraudulent activity.
a. /rue
. Balse
11(.
medium

%ross negligence is the e-istence of e-treme or unusual negligence #ith the intent to deceive.
a. /rue
. Balse
11..
challenging

/he preferred defense in third-party suits is asence of causal connection.

a. /rue
. Balse
112.
challenging

/he restatement of torts approach to the concept of foreseen users states that any users that the
auditor should have reasonaly een ale to foresee as eing likely users of financial statements
have the same rights as those #ith privity of contract.
a. /rue
. Balse
118.
challenging
/he Credit Alliance approach to the concept of foreseen users states that to e liale to third
parties, an auditor +1, must kno# and intend that his or her #ork product #ould e used y the
Arens/Elder/Beasley
a third-party plaintiff for a specific purpose, and +!, the kno#ledge and intent must e evidenced
y the auditorAs conduct.
a. /rue
. Balse
11;. +345,
challenging

/he 3aranes-4-ley )ct of !::! makes destruction of audit documentation punishale y up to

1: years in prison.
a. /rue
. Balse
Chapter 6
Multiple-Choice Questions
1. /he o@ective of the ordinary audit of financial statements is the e-pression of an opinion on:
easy a. the fairness of the financial statements.
a . the accuracy of the financial statements.
c. the accuracy of the annual report.
d. the alance sheet and income statement.
!.
easy
"f the auditor elieves that the financial statements are not fairly stated or is unale to reach an
conclusion ecause of insufficient evidence, the auditor:
c a. should #ithdra# from the engagement.
. should re'uest an increase in audit fees so that more resources can e used to conduct the
audit.
c. has the responsiility of notifying financial statement users through the auditorAs report.
d. should notify regulators of the circumstances.
(. )uditors accumulate evidence to:
easy a. defend themselves in the event of a la#suit.
d . @ustify the conclusions they have other#ise reached.
c. satisfy the re'uirements of the 3ecurities )cts of 1=(( and 1=(..
d. enale them to reach conclusions aout the fairness of the financial statements.
..
easy
/he responsiility for adopting sound accounting policies and maintaining ade'uate internal
control rests #ith the:
a. oard of directors.
. company management.
c. financial statement auditor.
d. companyAs internal audit department.
2.
easy
/he auditorAs est defense #hen material misstatements are not uncovered is to have conducted
the audit:
a a. in accordance #ith auditing standards.
. as effectively as reasonaly possile.
c. in a timely manner.
d. only after an ade'uate investigation of the management team.
8.
easy
"f management insists on financial statement disclosures that the auditor finds unacceptale, the
auditor can:
Arens/Elder/Beasley
a "ssue an adverse audit report "ssue a 'ualified audit report
a.
.
c.
d.
Jes
Do
Jes
Do
Jes
Do
Do
Jes
;.
easy
"f management insists on financial statement disclosures that the auditor finds unacceptale, the
auditor can do all ut #hich of the follo#ing$
a. "ssue an adverse audit report.
. "ssue a disclaimer of opinion.
c. Cithdra# from the engagement.
d. "ssue a 'ualified audit report.
Arens/Elder/Beasley
<.
easy
Chich of the follo#ing is not one of the reasons that auditors provide only reasona#le
assurance on the financial statements$
d a. /he auditor commonly e-amines a sample, rather than the entire population of
transactions.
. )ccounting presentations contain comple- estimates #hich involve uncertainty.
c. Braudulently prepared financial statements are often difficult to detect.
d. )uditors elieve that reasonale assurance is sufficient in the vast ma@ority of cases.
=. +*ulic,
challenging
"n certifying their annual financial statements, the C?4 and CB4 of a pulic company certify
that the financial statements comply #ith the re'uirements of:
c a. %))*.
. the 3aranes-4-ley )ct.
c. the 3ecurities ?-change )ct of 1=(..
d. %))3.
1:. Chich of the follo#ing statements is most correct regarding errors and fraud$
easy a. )n error is unintentional, #hereas fraud is intentional.
a . Brauds occur more often than errors in financial statements.
c. ?rrors are al#ays fraud and frauds are al#ays errors.
d. )uditors have more responsiility for finding fraud than errors.
11. +345, Chich of the follo#ing statements is true of a pulic companyAs financial statements$
easy a. 3aranes-4-ley re'uires the C?4 only to certify the financial statements.
c . 3aranes-4-ley re'uires the CB4 only to certify the financial statements.
c. 3aranes-4-ley re'uires the C?4 and CB4 to certify the financial statements.
d. 3aranes-4-ley neither re'uires the C?4 nor the CB4 to certify the financial statements.
1!. Chich of the follo#ing is not one of the three categories of assertions$
easy a. )ssertions aout classes of transactions and events for the period under audit
. )ssertions aout financial statements and correspondence to %))*
c. )ssertions aout account alances at period end
d. )ssertions aout presentation and disclosure
1(.
easy
"f a short-term note payale is included in the accounts payale alance on the financial
statement, there is a violation of the:
d a. completeness assertion.
. e-istence assertion.
c. cutoff assertion.
d. classification and understandaility assertion.
1.. *rofessional skepticism re'uires auditors to possess a+n, 666666 mind.
easy a. introspective
. 'uestioning
c. intelligent
d. unelieving
12.
easy
c
/he auditor has no responsiility to plan and perform the audit to otain reasonale assurance
that misstatements, #hether caused y errors or fraud, that are not 66666666 are detected.
a. important to the financial statements
. statistically significant to the financial statements
c. material to the financial statements
d. identified y the client
Arens/Elder/Beasley
18. Braudulent financial reporting is most likely to e committed y #hom$
easy a. &ine employees of the company.
c . 4utside memers of the companyAs oard of directors.
c. Company management.
d. /he companyAs auditors.
1;. Chich of the follo#ing #ould most likely e deemed a direct-effect illegal act$
easy a. Iiolation of federal employment la#s.
c . Iiolation of federal environmental regulations.
c. Iiolation of federal income ta- la#s.
d. Iiolation of civil rights la#s.
1<. /he concept of reasonale assurance indicates that the auditor is:
easy a. not an insurer of the correctness of the financial statements.
a . not responsile for the fairness of the financial statements.
c. responsile only for issuing an opinion on the financial statements.
d. responsile for finding all misstatements.
1=. /ests of details of alances are specific procedures intended to:
easy a. test for monetary errors in the financial statements.
a . prove that the accounts #ith material alances are classified correctly.
c. prove that the trial alance is in alance.
d. identify the details of the internal control system.
!:. Chich of the follo#ing is the auditor least likely to do #hen a#are of an illegal act$
easy a. Eiscuss the matter #ith the clientAs legal counsel.
c . 4tain evidence aout the potential effect of the illegal act on the financial statements.
c. Contact the local la# enforcement officials regarding potential criminal #rongdoing.
d. Consider the impact of the illegal act on the relationship #ith the companyAs management.
!1.
medium
c
/he auditor gives an audit opinion on the fair presentation of the financial statements and
associates his or her name #ith it #hen, on the asis of ade'uate evidence, the auditor
concludes that the financial statements are unlikely to mislead:
a. investors.
. management.
c. a prudent user.
d. the reader.
!!.
medium
/he responsiility for the preparation of the financial statements and the accompanying
footnotes elongs to:
a. the auditor.
. management.
c. oth management and the auditor e'ually.
d. management for the statements and the auditor for the notes.
!(. Chen engaged to audit the financial statements, it is acceptale for the auditor to draft:
medium
a /he clientAs financial statements /he footnotes to the clientAs financial statements
a. Jes Jes
. Do Do
c. Jes Do
d. Do Jes
!..
medium
/he auditor has considerale responsiility for notifying users as to #hether or not the
statements are properly stated. /his imposes upon the auditor a duty to:
a a. provide reasonale assurance that material misstatements #ill e detected.
. e a guarantor of the fairness in the statements.
Arens/Elder/Beasley
c. e e'ually responsile #ith management for the preparation of the financial statements.
d. e an insurer of the fairness in the statements.
!2.
easy
0/he auditor should not assume that management is dishonest, ut the possiility of dishonesty
must e considered.1 /his is an e-ample of:
a. unprofessional ehavior.
. an attitude of professional skepticism.
c. due diligence.
d. a rule in the )"C*)As Code of *rofessional Conduct.
!8.
medium
"f the auditor #ere responsile for making certain that all of managementAs assertions in the
financial statements #ere asolutely correct:
d a. ankruptcies could no longer occur.
. ankruptcies #ould e reduced to a very small numer.
c. audits #ould e much easier to complete.
d. audits #ould not e economically feasile.
!;.
medium
/he auditorAs est defense #hen e-isting material misstatements in the financial statements are
not uncovered in the audit is:
d a. the audit #as conducted in accordance #ith generally accepted accounting principles.
. the financial statements are the clientAs responsiility.
c. the client is guilty of contriutory negligence.
d. the client is guilty of fraudulent misrepresentation.
!<. Braudulent financial reporting is often called:
medium a. management fraud.
a . theft of assets.
c. defalcation.
d. emezzlement.
!=. Chich of the follo#ing statements is usually true$
challenging a. "t is easier for the auditor to uncover fraud than errors.
c . "t is easier for the auditor to uncover indirect-effect illegal acts than fraud.
c. /he auditorAs responsiility for detecting direct-effect illegal acts is similar to the
responsiility to detect fraud.
d. /he auditorAs responsiility for detecting indirect-effect illegal acts is similar to the
responsiility to detect fraud.
(:.
medium
)uditing standards make 66666 distinction+s, et#een the auditorAs responsiilities for
searching for errors and fraud.
c a. little
. a significant
c. no
d. various
(1.
medium
"n comparing management fraud #ith employee fraud, the auditorAs risk of failing to discover
the fraud is:
a. greater for management fraud ecause managers are inherently more deceptive than
employees.
. greater for management fraud ecause of managementAs aility to override e-isting
internal controls.
c. greater for employee fraud ecause of the higher crime rate among lue collar #orkers.
d. greater for employee fraud ecause of the larger numer of employees in the organization.
(!.
medium
Chich of the follo#ing statements is correct #ith respect to the auditorAs responsiilities
relative to the detection of indirect-effect illegal acts$
a a. /he auditor has no responsiility for searching for indirect-effect illegal acts.
Arens/Elder/Beasley
. /he auditor has the same responsiility for searching for indirect-effect illegal acts as any
other potential misstatement that may occur.
c. )uditors have responsiility for searching for any illegal act, #hether direct-effect or
indirect-effect.
d. Eiscovery of indirect-effect illegal acts is usually easier than discovery of fraud.
((.
medium
Chen comparing the auditorAs responsiility for detecting employee fraud and for detecting
errors, the profession has placed the responsiility:
c a. more on discovering errors than employee fraud.
. more on discovering employee fraud than errors.
c. e'ually on discovering either one.
d. on the senior auditor for detecting errors and on the manager for detecting employee fraud.
(..
medium
"f several employees collude to falsify documents, the chance a normal audit #ould uncover
such acts is:
a a. very lo#.
. very high.
c. zero.
d. none of the aove.
(2.
medium
Chen planning the audit, if the auditor has no reason to elieve that illegal acts e-ist, the
auditor should:
d a. include audit procedures #hich have a strong proaility of detecting illegal acts.
. still include some audit procedures designed specifically to uncover illegalities.
c. ignore the issue.
d. make in'uiries of management regarding their policies for detecting and preventing illegal
acts and regarding their kno#ledge of violations, and then rely on normal audit procedures
to detect errors, irregularities, and illegalities.
(8. Chen the auditor has reason to elieve an illegal act has occurred, the auditor should:
medium a. in'uire of management only at one level elo# those likely to e involved #ith the
illegality.
c . egin communication #ith the B)37 in accordance #ith *C)47 regulations.
c. consider accumulating additional evidence to determine if there is actually an illegal act.
d. #ithdra# from the engagement.
(;. Chen the auditor kno#s that an illegal act has occurred, the auditor must:
medium a. report it to the proper governmental authorities.
. consider the effects on the financial statements, including the ade'uacy of disclosure.
c. #ithdra# from the engagement.
d. issue an adverse opinion.
(<. +*ulic, "f an auditor uncovers an illegal act at a pulic company, the auditor must notify:
medium a. local la# enforcement officials.
c . the *ulic Company )ccounting 4versight 7oard.
c. the 3ecurities and ?-change Commission.
d. all of the aove.
(=. Chy does the auditor divide the financial statements into smaller segments$
medium a. >sing the cycle approach makes the audit more manageale.
a . Most accounts have fe# relationships #ith others and so it is more efficient to reak the
financial statements into smaller pieces.
c. /he cycle approach is used ecause auditing standards re'uire it.
d. )ll of the aove are correct.
.:.
medium
Chy does the auditor divide the financial statements into segments around the financial
statement cycles$
Arens/Elder/Beasley
a. Most auditors are trained to audit cycles as opposed to entire financial statements.
. /he approach aids in the assignment of tasks to different memers of the audit team.
c. /he cycle approach is re'uired y auditing standards.
d. /he cycle approach allo#s the auditor to detect indirect-effect illegal acts.
.1. /he most important general ledger account included in and affecting several cycles is the:
medium a. cash account.
a . inventory account.
c. income ta- e-pense and liaility accounts.
d. retained earnings account.
.!. Management assertions are:
medium
a
a. implied or e-pressed representations aout accounts, transactions, and disclosures in the
financial statements.
. stated in the footnotes to the financial statements.
c. e-plicitly e-pressed representations aout the financial statements.
d. provided to the auditor in the assertions letter, ut are not disclosed on the financial
statements.
.(. Chich of the follo#ing statements is true$
medium a. )udit o@ectives follo# and are closely related to management assertions.
a . ManagementAs assertions follo# and are closely related to the audit o@ectives.
c. /he auditorAs primary responsiility is to find and disclose fraudulent management
assertions.
d. )ssertions aout presentation and disclosure deal #ith #hether the accounts have een
included in the financial statements at appropriate amounts.
...
medium
Chich of the follo#ing statements is true regarding the distinction et#een general audit
o@ectives and specific audit o@ectives for each account alance$
a. /he specific audit o@ectives are applicale to every account alance on the financial
statements.
. /he general audit o@ectives are applicale to every account alance on the financial
statements.
c. /he general audit o@ectives are stated in terms tailored to the engagement.
d. Bor any given class of transactions, usually only one audit o@ective must e met to
conclude the transactions are properly recorded..
.2. Chich of the follo#ing statements aout the e-istence and completeness assertions is not true$
medium a. /he e-istence and completeness assertions emphasize different audit concerns.
c . ?-istence deals #ith overstatements and completeness deals #ith understatements.
c. ?-istence deals #ith understatements and completeness deals #ith overstatements.
d. /he completeness assertion deals #ith unrecorded transactions.
.8. /he occurrence assertion applies to 6666666.
medium a. presentation and disclosure matters
. classes of transactions and events during the period
c. account alances
d. proper classification of income statement accounts
.;.
medium
Chich of the follo#ing management assertions is not associated #ith transaction-related audit
o@ectives$
a. 4ccurrence
. Classification and understandaility
c. )ccuracy
d. Completeness
.<. Chich of the follo#ing statements is not true$
Arens/Elder/Beasley
medium a. 7alance-related audit o@ectives are applied to account alances.
d . /ransaction-related audit o@ectives are applied to classes of transactions.
c. 7alance-related audit o@ectives are applied to the ending alance in alance sheet
accounts.
d. 7alance-related audit o@ectives are applied to oth eginning and ending alances in
alance sheet accounts.
.=. "n testing for cutoff, the o@ective is to determine:
medium a. #hether all of the current periodAs transactions are recorded.
. #hether transactions are recorded in the correct accounting period.
c. the proper cutoff et#een capitalizing and e-pensing e-penditures.
d. the proper cutoff et#een disclosing items in footnotes or in account alances.
2:. /he detail tie-in o@ective is not concerned that the details in the account alance:
medium a. agree #ith related susidiary ledger amounts.
. are properly disclosed in accordance #ith %))*.
c. foot to the total in the account alance.
d. agree #ith the total in the general ledger.
21. /he detail tie-in is part of the6666666 assertion for account alances.
medium a. classification
. valuation and allocation
c. rights and oligations
d. completeness
2!.
medium
Chich of the follo#ing is not a proper match of a transaction-related audit o@ective and
management assertion$
a a. )ccuracy and cutoff.
. Classification and classification.
c. *osting and summarization #ith accuracy.
d. 4ccurrence and occurrence.
2(. Chich of the follo#ing statements is not correct$
medium a. /here are many #ays an auditor can accumulate evidence to meet overall audit o@ectives.
d . 3ufficient appropriate evidence must e accumulated to meet the auditorAs professional
responsiility.
c. "t is appropriate to minimize the cost of accumulating evidence.
d. %athering evidence and minimizing costs are e'ually important considerations that affect
the approach the auditor selects.
2.. /#o overriding considerations affect the many #ays an auditor can accumulate evidence:
medium
a
1. 3ufficient appropriate evidence must e accumulated to meet the auditorAs professional
responsiility.
!. Cost of accumulating evidence should e minimized.
"n evaluating these considerations:
a. the first is more important than the second.
. the second is more important than the first.
c. they are e'ually important.
d. it is impossile to prioritize them.
22.
medium

"f the auditor has otained a reasonale level of assurance aout the fair presentation of the
financial statements through understanding internal control, assessing control risk, testing
controls, and analytical procedures, then the auditor:
a. can issue an un'ualified opinion.
. can significantly reduce other sustantive tests.
c. can #rite the engagement letter.
d. needs to perform additional tests of controls so that the assurance level can e increased.
Arens/Elder/Beasley
28.
medium
d
)fter the auditor has completed all audit procedures, it is necessary to comine the information
otained to reach an overall conclusion as to #hether the financial statements are fairly
presented. /his is a highly su@ective process that relies heavily on:
a. generally accepted auditing standards.
. the )"C*)As Code of *rofessional Conduct.
c. generally accepted accounting principles.
d. the auditorAs professional @udgment.
2;. Chich of the follo#ing cominations is correct$
medium a. ?-istence relates to #hether the amounts in accounts are understated.
c . 4ccurrence relates to #hether alances e-ist.
c. ?-istence relates to #hether amounts included e-ist.
d. 4ccurrence relates to #hether the amounts in accounts occurred in the proper year.
2<.
medium
"f an auditor conducted an audit in accordance #ith auditing standards, #hich of the follo#ing
#ould the auditor likely detect$
a. >nrecorded transactions.
. "ncorrect postings of recorded transactions.
c. Counterfeit signatures on paid checks.
d. Braud involving collusion.
2=.
medium
Chich of the follo#ing statements est descries the auditorAs responsiility #ith respect to
illegal acts that do not have a material effect on the clientAs financial statements$
a a. %enerally, the auditor is under no oligation to notify parties other than personnel #ithin
the clientAs organization.
. %enerally, the auditor is under an oligation to inform the *C)47.
c. %enerally, the auditor is oligated to disclose the relevant facts in the auditorAs report.
d. %enerally, the auditor is e-pected to compel the client to adhere to re'uirements of the
Boreign Corrupt *ractices )ct.
8:.
medium
Chich of the follo#ing statements est descries the auditorAs responsiility regarding the
detection of fraud$
c a. /he auditor is responsile for the failure to detect fraud only #hen such failure clearly
results from nonperformance of audit procedures specifically descried in the engagement
letter.
. /he auditor must e-tend auditing procedures to actively search for evidence of fraud in all
situations.
c. /he auditor must e-tend auditing procedures to actively search for evidence of fraud
#here the e-amination indicates that fraud may e-ist.
d. /he auditor is responsile for the failure to detect fraud only #hen an un'ualified opinion
is issued.
81. /he essence of the attest function is to:
medium a. assure the consistent application of correct accounting procedures.
. determine #hether the clientAs financial statements are fairly stated.
c. e-amine individual transactions so that the auditor may certify as to their validity.
d. detect collusion and fraud.
8!.
medium
/he primary difference et#een an audit of the alance sheet and an audit of the income
statement is that the audit of the income statement deals #ith the verification of:
a a. transactions.
. authorizations.
c. costs.
d. cutoffs.
8(. /he auditorAs evaluation of the likelihood of material employee fraud is normally done initially
Arens/Elder/Beasley
challenging as a part of:
c a. tests of controls.
. tests of transactions.
c. understanding the entityAs internal control.
d. the assessment of #hether to accept the audit engagement.
8..
challenging
Chen using the cycle approach to segmenting the audit, the reason for treating capital
ac'uisition and repayment separately from the ac'uisition of goods and services is that:
c a. the transactions are related to financing a company rather than to its operations.
. most capital ac'uisition and repayment cycle accounts involve fe# transactions, ut each
is often highly material and therefore should e audited e-tensively.
c. oth a and are correct.
d. neither a nor is correct.
82. "llegal acts are defined in 3)3 2. +)>!1;, as:
challenging a. violations of la#s or government regulations.
c . violations of la#s or government regulations other than errors.
c. violations of la#s or government regulations other than fraud.
d. violations of la# #hich #ould result in the arrest of the perpetrator.
88. Most illegal acts affect the financial statements:
challenging a. directly.
. only indirectly.
c. oth directly and indirectly.
d. materially if directP immaterially if indirect.
8;. Cith respect to the detection of illegal acts, auditing standards state that the auditor provides:
challenging a. no assurance that they #ill e detected.
a . the same reasonale assurance provided for other items.
c. assurance that they #ill e detected, if material.
d. assurance that they #ill e detected, if highly material.
8<.
challenging
"n descriing the cycle approach to segmenting an audit, #hich of the follo#ing statements is
not true$
d a. )ll general ledger accounts and @ournals are included at least once.
. 3ome @ournals and general ledger accounts are included in more than one cycle.
c. /he 0capital ac'uisition and repayment1 cycle is closely related to the 0ac'uisition of
goods and services and payment1 cycle.
d. /he 0inventory and #arehousing1 cycle may e audited at any time during the engagement
since it is unrelated to the other cycles.
8=. Chich of the follo#ing @ournals #ould e included most often in the various audit cycles$
challenging a. Cash receipts @ournal.
c . Cash disursements @ournal.
c. %eneral @ournal.
d. 3ales @ournal.
;:. /ransaction cycles egin and end:
challenging a. at the eginning and end of the fiscal period.
d . each start of the annual audit.
c. at Lanuary 1 and Eecemer (1.
d. at the origin and final disposition of the company.
;1.
challenging
)fter general audit o@ectives are understood, specific audit o@ectives for each account alance
on the financial statements can e developed. Chich of the follo#ing statements is true$
a a. /here should e at least one specific o@ective for each relevant general o@ective.
. /here #ill e only one specific o@ective for each relevant general o@ective.
Arens/Elder/Beasley
c. /here #ill e many specific o@ectives developed for each relevant general o@ective.
d. /here must e one specific o@ective for each general o@ective.
;!.
challenging
)n auditor should recognize that the application of auditing procedures may produce evidence
indicating the possiility of errors or fraud and therefore should:
a a. plan and perform the engagement #ith an attitude of professional skepticism.
. not rely on internal controls that are designed to prevent or detect errors or fraud.
c. design audit tests to detect unrecorded transactions.
d. e-tend the #ork to audit most recorded transactions and records of an entity.
?ssay Questions
;(.
easy
Eiscuss the differences et#een errors, frauds, and illegal acts. %ive an e-ample of each.
)ns#er:
/he primary difference et#een errors and frauds is that errors are unintentional
misstatements of the financial statements, #hereas frauds are intentional
misstatements. "llegal acts are violations of la#s or government regulations, other than
frauds. )n e-ample of an error is a mathematical mistake #hen footing the columns in
the sales @ournal. )n e-ample of a fraud is the creation of fictitious accounts
receivale. )n e-ample of an illegal act is the dumping of to-ic #aste in violation of
the federal environmental protection la#s.
Arens/Elder/Beasley
;..
medium
Eiscuss the actions an auditor should take #hen the auditor discovers an illegal act.
)ns#er:
/he auditor should first consider the effects of the illegal act on the financial
statements, including the ade'uacy of disclosures. "f the auditor concludes that
disclosures are inade'uate, the audit report should e modified accordingly. /he
auditor should also consider the effect of the illegal act on its relationship #ith
management, and managementAs trust#orthiness. De-t, the clientAs audit committee or
others of e'uivalent authority should e informed of the illegal act. "f the client does
not deal #ith the illegal act in a satisfactory manner, the auditor should consider
#ithdra#ing from the engagement. Binally, if the client is pulicly held, the auditor
may need to report the matter to the 3?C.
;2.
medium
/here are three road categories of management assertions. "dentify each of these categories.
)ns#er:
)ssertions aout classes of transactions and events for the period under audit.
)ssertions aout account alances at period end.
)ssertions aout presentation and disclosure.
;8.
medium
7riefly e-plain each management assertion related to classes of transactions and events for the
period under audit.
)ns#er:
+ccurrence. /ransactions and events that have een recorded have occurred
and pertain to the entity.
Completeness. )ll transactions and events that should have een recorded
have een recorded.
Accurac". )mounts and other data relating to recorded transactions and events
have een recorded appropriately.
Classification. /ransactions and events have een recorded in the proper
accounts.
Cutoff. /ransactions and events have een recorded in the correct accounting
period.
;;.
medium
7riefly e-plain each management assertion related to account alances at period end.
)ns#er:
Existence. )ssets, liailities, and e'uity interests e-ist.
Completeness. )ll assets, liailities, and e'uity interests that should have een
recorded have een recorded.
6aluation and allocation. )ssets, liailities, and e'uity interests are included
in the financial statements at appropriate amounts and any resulting valuation
ad@ustments are appropriately recorded.
Rigts and o#ligations. /he entity holds or controls the rights to assets, and
liailities are the oligation of the entity.
Arens/Elder/Beasley
;<.
medium
7riefly e-plain each management assertion related to presentation and disclosure.
)ns#er:
+ccurrence and rigts and o#ligations. Eisclosed events and transactions have
occurred and pertain to the entity.
Completeness. )ll disclosures that should have een included in the financial
statements have een included.
Accurac" and %aluation. Binancial and other information are disclosed
appropriately and at appropriate amounts.
Classification and understanda#ilit". Binancial and other information is
appropriately presented and descried and disclosures are clearly e-pressed.
;=.
medium
Eiscuss three reasons #hy auditors are responsile for 0reasonale1 ut not 0asolute1
assurance.
)ns#er:
Most audit evidence results from testing a sample of a population. 3ampling
involves some risk of not uncovering material misstatements.
)ccounting presentations contain comple- estimates, #hich inherently
involve uncertainty and can e affected y future events. )s a result, the auditor has to
rely on evidence that is persuasive ut not convincing.
Braudulently prepared financial statements are often very difficult for the
auditor to detect, especially #hen there is collusion among management.
<:.
medium
Eistinguish et#een managementAs responsiility and the auditorAs responsiility for the
financial statements under audit.
)ns#er:
Management is responsile for adopting appropriate accounting policies, maintaining
ade'uate internal control, and making fair representations in the financial statements.
/he auditorAs responsiility is to perform an audit designed to provide reasonale
assurance of detecting any material misstatements in the financial statements and to
e-press an opinion on those financial statements at the conclusion of the audit.
<1.
medium
"n the conte-t of the audit of sales, distinguish et#een the e-istence and completeness
transaction-related audit o@ectives. 3tate the effect on the sales account +overstatement or
understatement, of a violation of each o@ective.
)ns#er:
Chen testing the e-istence o@ective for sales, the auditorAs focus is on #hether the
sales that have een recorded in the sales @ournal actually occurred. "n contrast, tests of
the completeness o@ective are concerned #ith determining #hether all sales that
actually occurred have een recorded in the sales @ournal. Iiolations of the e-istence
o@ective result in overstatements of salesP violations of the completeness o@ective
result in understatements of sales.
Arens/Elder/Beasley
<!.
challenging
Eiscuss the differences in the auditorAs responsiilities for discovering +1, material errors, +!,
material fraud +(, direct-effect illegal acts, and +., indirect-effect illegal acts.
)ns#er:
)uditing standards make no distinction et#een the auditorRs responsiilities for
searching for errors and fraud. "n either case, the auditor must otain reasonale
assurance aout #hether the statements are free of material misstatements. /he
standards also recognize that fraud is often more difficult to detect ecause
management or the employees perpetrating the fraud attempt to conceal te fraud. 3till,
the difficulty of detection does not change the auditorRs responsiility to properly plan
and perform the audit to detect material misstatements, #hether caused y error or
fraud. /he auditorAs responsiility for uncovering direct-effect illegal acts is the same
as for errors and fraud. Ho#ever, the auditor is not re'uired to search for indirect-
effect illegal acts unless there is reason to elieve they e-ist.
<(.
challenging
) financial statement audit typically consists of four phases. "dentify each of these four phases
of an audit and discuss the ma@or activities performed y the auditor in each phase.
)ns#er:
Pase I* Plan and design an audit approac. "n this phase, the auditor otains an
understanding of the clientAs entity and its environment. "n addition, the auditor otains an
understanding of the clientAs internal control and assesses the risk of material
misstatement.
Pase II* Perform tests of controls and su#stanti%e tests of transactions. "n this phase, the
auditor tests those internal controls heKshe elieves may e effective at preventing or
detecting misstatements. "n addition, the auditor performs sustantive tests of transactions
to verify the monetary amounts of transactions.
Pase III* Perform anal"tical procedures and tests of details of #alances. "n this phase, the
auditor performs analytical procedures to assess the overall reasonaleness of transactions
and alances. "n addition, tests of details of alances are performed to test for monetary
misstatements in the financial statements.
Pase I6* Complete te audit and issue an audit report. "n the last phase of the audit, the
information otained in the previous phases is comined to reach an overall conclusion as
to #hether the financial statements are fairly presented. )n audit report is then issued
ased on this conclusion.
<..
challenging
Eiscuss some precautionary actions an auditor should take #hen there is a moderate or high risk
of management fraud.
)ns#er:
3ome precautionary actions an auditor should take #hen there is a moderate or high
risk of management fraud include:
Critically challenging the clientAs choice of accounting principles.
)ssigning more e-perienced personnel to the engagement.
Eoing more audit #ork at year-end instead of at interim dates.
Closely supervising assistants and other ine-perienced staff.
*erforming additional or more effective audit procedures.
"n e-treme situations, the auditor should consider #ithdra#ing from the
engagement.
Arens/Elder/Beasley
Arens/Elder/Beasley
4ther 4@ective )ns#er Bormat Questions
<2.
medium
Match seven of the terms +a-k, #ith the definitions provided elo# +1-;,:
a. /ests of details of alances
. /ests of controls
c. 3ustantive tests of transactions
d. )nalytical procedures
e. /ransaction-related audit o@ectives
f. Management assertions
g. 7alance-related audit o@ectives
h. Braud
i. "llegal act
@. ?rror
k. Management fraud
h 1. )n intentional misstatement of the financial statements.
e !. ) set of si- audit o@ectives the auditor must meet, including timing, posting and
summarization, and accuracy.
f (. "mplied or e-pressed representations made y the client aout classes of
transactions, account alances and disclosures in the financial statements.
a .. )udit procedures testing for monetary misstatements to determine #hether the
alance-related audit o@ectives have een satisfied for each significant account
alance.
g 2. ) set of nine audit o@ectives the auditor must meet, including completeness,
detail tie-in, and rights and oligations.
8. )udit procedures designed to test the effectiveness of control policies and
procedures.
d ;. >se of comparisons and relationships to assess #hether account alances or
other data appears reasonale.
<8.
challenging
7elo# are five audit procedures, all of #hich are tests of transactions associated #ith the audit of
the sales and collection cycle. )lso elo# are the si- general transaction-related audit o@ectives
and the five management assertions. Bor each audit procedure, indicate +1, its audit o@ective, and
+!, the management assertion eing tested.
)udit 4@ectives )ssertions
). 4ccurrence I. 4ccurrence
7. Completeness C. Completeness
C. )ccuracy 5. )ccuracy
E. *osting and summarization J. Classification
?. Classification S. Cutoff
B. /iming
Arens/Elder/Beasley
1. Iouch recorded sales from the sales @ournal to the file of ills of lading.
) +1, .
I +!, .
!. Compare dates on the ill of lading, sales invoices, and sales @ournal to test for delays in
recording sales transactions.
B +1, .
S +!, .
(. )ccount for the se'uence of prenumered ills of lading and sales invoices.
7 +1, .
C +!, .
.. /race from a sample of prelistings of cash receipts to the cash receipts @ournal, testing for
names, amounts, and dates.
7, C +1, .
C, 5 +!, .
2. ?-amine customer order forms for credit approval y the credit manager.
) +1, .
I +!, .
<;.
challenging
7elo# are five audit procedures, all of #hich are tests of transactions associated #ith the audit of
the ac'uisition and payment cycle. )lso elo# are the si- general transaction-related audit
o@ectives and the five management assertions. Bor each audit procedure, indicate +1, its audit
o@ective, and +!, the management assertion eing tested.
)udit 4@ectives )ssertions
). 4ccurrence I. 4ccurrence
7. Completeness C. Completeness
C. )ccuracy 5. )ccuracy
E. *osting and summarization J. Classification
?. Classification S. Cutoff
B. /iming
1. Boot the purchases @ournal and trace the totals to the related general ledger accounts.
E +1, .
5 +!, .
!. Recompute the cash discounts taken y the client.
C +1, .
5 +!, .
(. Compare dates on cancelled checks #ith the ank cancellation date.
B +1, .
S +!, .
.. /race from a sample of cancelled checks to the cash disursements @ournal.
7 +1, .
C +!, .
Arens/Elder/Beasley
2. ?-amine supporting documentation for a sample of transactions for authorized payee and
amount and to determine services or goods #ere received.
) +1, .
I +!, .
<<.
challenging
7elo# are five audit procedures, all of #hich are tests of alances associated #ith the audit of
accounts receivale. )lso elo# are the eight general alance-related audit o@ectives and the four
management assertions. Bor each audit procedure, indicate +1, its audit o@ective, and +!, the
management assertion eing tested.
)udit 4@ectives )ssertions
). ?-istence I. ?-istence
7. Completeness C. Completeness
C. )ccuracy 5. Ialuation and allocation
E. Classification J. Rights and oligations
?. Cutoff
B. Eetail tie-in
%. Realizale value
H. Rights and oligations
1. 4tain an aged listing of accounts receivale. Bor a sample of individual customers on the
listing, agree the customerAs name, amount, and other information #ith the corresponding
information in the accounts receivale master file.
B +1, .
5 +!, .
!. ?-amine details of sales for five days efore and five days after year-end to determine
#hether sales have een recorded in the proper period.
? +1, .
5 +!, .
(. )ssess the reasonaleness of the alance in the allo#ance for doutful accounts.
% +1, .
5 +!, .
.. "n'uire as to #hether any accounts receivale have een factored or sold during the period.
H +1, .
J +!, .
2. "n'uire as to #hether there are any receivales from related parties.
E +1, .
5 +!, .
<=.
easy

Responsiility for the fair presentation of financial statements rests e'ually #ith management and
the auditor.
a. /rue
. Balse
=:.
easy

?rrors are usually more difficult for an auditor to detect than frauds.
a. /rue
. Balse
Arens/Elder/Beasley
=1.
easy

)uditors have found that the most efficient #ay to conduct audits is to focus primarily on testing
classes of transactions and performing minimal or no tests of ending account alances.
a. /rue
. Balse
=!.
easy
a
Chen an auditor has reduced assessed control risk ased on tests of controls, he or she may then
reduce the e-tent to #hich the accuracy of the financial statement information directly related to
those controls must e supported through the accumulation of evidence using sustantive tests.
a. /rue
. Balse
=(.
easy

/ests of details of alances typically involve the use of comparisons and relationships to assess the
overall reasonaleness of account alances.
a. /rue
. Balse
=..
easy
a
4ther than in'uiring of management aout policies they have estalished to prevent illegal acts and
#hether management kno#s of any la#s or regulations that the company has violated, the auditor
should not search for indirect-effect illegal acts unless there is reason to elieve they may e-ist.
a. /rue
. Balse
=2.
easy
a
Chen an auditor elieves that an illegal act may have occurred, the first step he or she should take
is to in'uire of management at a level aove those likely to e involved in the potential illegal act.
a. /rue
. Balse
=8.
medium

)udits are e-pected to provide a higher degree of assurance for the detection of material frauds than
is provided for an e'ually material error.
a. /rue
. Balse
=;.
medium
a
)uditors have a higher degree of responsiility for detecting direct-effect illegal acts than indirect-
effect illegal acts.
a. /rue
. Balse
=<.
medium

/he auditorAs first course of action #hen an illegal act is uncovered should e to immediately notify
the appropriate authorities, including ut not limited to the police, and for pulicly held companies,
the 3ecurities and ?-change Commission.
a. /rue
. Balse
==.
medium

>nder the cycle approach to segmenting an audit, transactions recorded in different @ournals should
never e comined #ith the general ledger alances that result from those transactions.
a. /rue
. Balse
1::.
medium

%eneral transaction-related audit o@ectives vary from audit to audit, depending on the nature and
characteristics of the clientAs usiness and industry.
a. /rue
. Balse
Arens/Elder/Beasley
1:1.
medium
a
/he audit o@ective of posting and summarization is associated #ith the management assertion of
accuracy.
a. /rue
. Balse
1:!.
medium

7alance-related audit o@ectives are usually applied to the ending alance in income statement
accountsP transaction-related audit o@ectives are usually applied to transactions reflected in alance
sheet accounts.
a. /rue
. Balse
1:(.
medium
a
/he transaction-related audit o@ective of timing is related to the assertion of cutoff.
a. /rue
. Balse
1:..
medium
a
/he effect of a violation of the e-istence transaction-related audit o@ective for the sales account
#ould e an overstatement of that account.
a. /rue
. Balse
1:2.
medium

/he effect of a violation of the completeness transaction-related audit o@ective for cash
disursements transactions #ould e an overstatement of cash disursements.
a. /rue
. Balse
1:8.
medium

/he transaction-related audit o@ective that deals #ith #hether recorded transactions have actually
occurred is the completeness o@ective.
a. /rue
. Balse
1:;.
medium
a
/he general alance-related audit o@ective that deals #ith determining that details in the account
alance agree #ith related master file amounts, foot to the total in the account alance, and agree
#ith the total in the general ledger is the detail tie-in o@ective.
a. /rue
. Balse
1:<.
medium
a
/he cutoff o@ective, 0transactions near the alance sheet date are recorded in the proper period,1 is
a alance-related audit o@ective.
a. /rue
. Balse
1:=.
medium

Bor a private company audit, tests of controls are normally performed only on those internal
controls the auditor elieves have not een operating effectively during the period under audit.
a. /rue
. Balse
11:.
medium
a
)n audit generally provides no assurance that indirect-effect illegal acts #ill e detected.
a. /rue
. Balse
111.
medium
a
Chen an auditor elieves there is a moderate or high risk of management fraud, the auditor #ill
normally do less audit #ork at interim dates instead of at year-end.
a. /rue
. Balse
Arens/Elder/Beasley
11!.
challenging

)n auditor must inform a clientAs audit committee of an illegal act discovered during an audit in
#riting.
a. /rue
. Balse
11(.
challenging

/he o@ective of the audit of financial statements y an independent auditor is to verify that the
financial statements are free of misstatements and accurately represent the companyAs financial
position and results of operations.
a. /rue
. Balse
11..
challenging
a
/he auditorAs responsiility for uncovering direct-effect illegal acts is the same as for fraud.
a. /rue
. Balse
Chapter 7
Multiple-Choice Questions
1.
?asy
c
)uditors must make decisions regarding #hat evidence to gather and ho# much to accumulate.
Chich of the follo#ing is a decision that must e made y auditors related to evidence$
3ample size /iming of audit procedures
a.
.
c.
d.
Jes
Do
Jes
Do
Jes
Do
Do
Jes
!. )udit procedures may e performed:
?asy
a *rior to the fiscal year-end of the client 3use'uent to the fiscal year-end of the client
a.
.
c.
d.
Jes
Do
Jes
Do
Jes
Do
Do
Jes
(. Chich of the follo#ing forms of evidence is most reliale$
easy a. %eneral ledger account alances.
. Confirmation of accounts receivale alance received from a customer.
c. "nternal memo e-plaining the issuance of a credit memo.
d. Copy of month-end ad@usting entries.
.. Chich of the follo#ing is not a characteristic of the reliaility of evidence$
easy a. ?ffectiveness of client internal controls.
. ?ducation of auditor.
c. "ndependence of information provider.
d. /imeliness.
2. Chich of the follo#ing is not a characteristic of the reliaility of evidence$
easy a. Qualification of individual providing information.
c . )uditorAs direct kno#ledge.
c. Eegree of su@ectivity.
Arens/Elder/Beasley
d. Eegree of o@ectivity.
8.
easy
Calculating the gross margin as a percent of sales and comparing it #ith previous periods is
#hat type of evidence$
a. *hysical e-amination.
. )nalytical procedures.
c. 4servation.
d. "n'uiry
;. )udit evidence otained directly y the auditor #ill not e reliale if:
easy a. the auditor lacks the 'ualifications to evaluate the evidence.
a . it is provided y the clientAs attorney.
c. the client denies its veracity.
d. it is impossile for the auditor to otain additional corrooratory evidence.
<. )ppropriateness of evidence is a measure of the:
easy a. 'uantity of evidence.
. 'uality of evidence.
c. sufficiency of evidence.
d. meaning of evidence.
=. Chich of the follo#ing statements regarding the relevance of evidence is correct$
easy a. /o e relevant, evidence must pertain to the audit o@ective of the evidence.
a . /o e relevant, evidence must e persuasive.
c. /o e relevant, evidence must relate to multiple audit o@ectives.
d. /o e relevant, evidence must e derived from a system including effective internal
controls.
1:. /#o determinants of the persuasiveness of evidence are:
easy a. competence and sufficiency.
c . relevance and reliaility.
c. appropriateness and sufficiency.
d. independence and effectiveness.
11.
easy
c
/hree common types of confirmations used y auditors are +1, negative confirmations, +!, lank
form positive confirmations, and +(, positive confirmations #ith information included. *lace the
confirmations in order of reliaility from highest to lo#est.
a. 1, !, (.
. (, !, 1.
c. !, (, 1.
d. (, 1, !.
1!. Chen auditors use documents to support recorded transactions, the process is often called:
easy a. in'uiry.
c . confirmation.
c. vouching.
d. physical e-amination.
1(. )n e-ample of an e-ternal document is:
easy a. employeesA time reports.
. ank statements.
c. purchase order for company purchases.
d. caron copies of checks.
1..
easy
)n e-ample of a document the auditor receives from the client, ut #hich #as prepared y
someone outside the clientAs organization, is a+n,:
c a. confirmation.
Arens/Elder/Beasley
. sales invoice.
c. vendor invoice.
d. ank reconciliation.
12.
easy
a
0?valuations of financial information made y a study of plausile relationships among
financial and nonfinancial data involving comparisons of recorded amounts to e-pectations
developed y the auditor1 is a definition of:
a. analytical procedures.
. tests of transactions.
c. tests of alances.
d. auditing.
18. 4ften, auditor procedures result in significant differences eing discovered y the auditor. /he
auditor should investigate further if:
?asy
a 3ignificant differences are not
e-pected ut do e-ist
3ignificant differences are e-pected ut
do not e-ist
a.
.
c.
d.
Jes
Do
Jes
Do
Jes
Do
Do
Jes
1;. Chich of the follo#ing is not a purpose of analytical procedures$
easy a. >nderstand the clientAs industry.
c . )ssess the clientAs aility to continue as a going concern.
c. ?valuate internal controls.
d. Reduce detailed audit tests.
1<.
medium
Chich of the follo#ing forms of evidence #ould e least persuasive in forming the auditorAs
opinion$
a a. Responses to auditorAs 'uestions y the president and controller regarding the investments
account.
. Correspondence #ith a stockroker regarding the 'uantity of clientAs investments held in
street name y the roker.
c. Minutes of the oard of directors authorizing the purchase of stock as an investment.
d. /he auditorAs count of marketale securities.
1=. Chich of the follo#ing statements is not true$ 0/he evidence-gathering techni'ue of in'uiry:
medium a. cannot e regarded as conclusive.1
c . re'uires the gathering of corroorative evidence.1
c. is the auditorAs principal method of evaluating the clientAs internal control.1
d. does not provide evidence from an independent source.1
!:. +345,
medium
3aranes-4-ley re'uires auditors of pulic companies to maintain audit documentation for #hat
period of time$
c a. Dot less than ( years.
. Dot less than 2 years.
c. Dot less than ; years.
d. /hrough the issuance of the financial statements.
!1. )nalytical procedures must e used during #hich phase+s, of the audit$
medium
/est of Controls *lanning Completion
a. Jes Jes Jes
. Do Jes Jes
c. Jes Do Do
Arens/Elder/Beasley
d. Do Do Do
!!. Chich of the follo#ing statements is not correct$
medium a. "t is possile to vary the sample size from one unit to 1::T of the items in the population.
. /he decision of ho# many items to test should not e influenced y the increased costs of
performing the additional tests.
c. /he decision of ho# many items to test must e made y the auditor for each audit
procedure.
d. /he sample size for any given procedure is likely to vary from audit to audit.
!(. )uditors #ill replace tests of details #ith analytical procedures #hen possile ecause the:
medium a. analytical procedures are more reliale.
. tests of details are more e-pensive.
c. analytical procedures are more persuasive.
d. tests of details are more difficult to interpret.
!.. Chich of the follo#ing statements is not correct$
medium a. *ersuasiveness of evidence is partially determined y the reliaility of evidence.
c . /he 'uantity of evidence otained determines its sufficiency.
c. /he auditor need not consider the independence of an information source #hen otaining
evidence.
d. ?vidence otained directly y the auditor is ordinarily more reliale than evidence
otained from other sources.
!2. Chich one of the follo#ing is not one of the primary purposes of audit documentation$
medium a. ) asis for planning the audit.
d . ) record of the evidence accumulated and the results of the tests.
c. ) asis for revie# y supervisors and partners.
d. ) asis for determining #ork deficiencies y peer revie# teams.
!8. Chich of the follo#ing is the most o@ective type of evidence$
medium a. ) letter #ritten y the clientAs attorney discussing the likely outcome of outstanding
la#suits.
. /he physical count of securities and cash.
c. "n'uiries of the credit manager aout the collectiility of noncurrent accounts receivale.
d. 4servation of co#es on some inventory ins.
!;. Chich of the follo#ing statements regarding documentation is not correct$
medium

a. Eocumentation includes e-amining client records such as general ledgers and supporting
@ournals.
. "nternal documents are documents that are generated #ithin the company and used to
communicate #ith e-ternal parties.
c. ?-ternal documents are documents that are generated outside of the company and are used
to communicate the results of a transaction.
d. ?-ternal documents are considered more reliale than internal documents.
!<.
medium
c
Chen making decisions aout evidence for a given audit, the auditorAs goal is to otain a
sufficient amount of timely, reliale evidence that is relevant to the information eing verified,
and to do so:
a. no matter the cost involved in otaining such evidence.
. at any cost ecause the costs are illed to the client.
c. at the lo#est possile total cost.
d. at the cost suggested in the engagement letter.
!=. 0*hysical e-amination1 is the inspection or count y the auditor of items such as:
medium a. cash, inventory, and payroll timecards.
d . cash, inventory, canceled checks, and sales documents.
Arens/Elder/Beasley
c. cash, inventory, canceled checks, and tangile fi-ed assets.
d. cash, inventory, securities, notes receivale, and tangile fi-ed assets.
(:. Chich items affect the sufficiency of evidence #hen choosing a sample$
medium
c 3electing items #ith a high likelihood of
misstatement
/he randomness of the items
selected
a. Jes Jes
. Do Do
c. Jes Do
d. Do Jes
(1. Chich of the follo#ing is an e-ample of vouching$
medium a. /race inventory purchases from the ac'uisitions @ournal to supporting invoices.
a . /race selected sales invoices to the sales @ournal.
c. /race details of employee paychecks to the payroll @ournal.
d. )ll of the aove are e-amples of vouching.
(!. Chich of the follo#ing statements aout confirmations is true$
medium a. Confirmations are e-pensive and so are often not used.
. Confirmations may inconvenience those asked to supply them, ut they are #idely used.
c. Confirmations are sometimes not reliale and so auditors use them only as necessary.
d. Confirmations are re'uired for several alance sheet accounts ut no income statement
accounts.
((. /raditionally, confirmations are used to verify:
medium a. individual transactions et#een organizations, such as sales transactions.
. ank alances and accounts receivale.
c. fi-ed asset additions.
d. payroll e-penses.
(.. /o e considered reliale evidence, confirmations must e controlled y:
medium a. a client employee responsile for accounts receivale.
. a financial statement auditor.
c. a clientAs internal audit department.
d. a clientAs controller or CB4.
(2.
medium
"ndicate #hether confirmation of accounts receivale and accounts payale is re'uired or
optional:

)ccounts Receivale )ccounts *ayale

a. Re'uired Re'uired
. Re'uired 4ptional
c. 4ptional Re'uired
d. 4ptional 4ptional
(8.
medium
/he )uditing 3tandards 7oard has concluded that analytical procedures are so important that
they are re'uired during:
a. planning and test of control phases.
. planning and completion phases.
c. test of control and completion phases.
d. planning, test of control, and completion phases.
(;. Chich of the follo#ing statements regarding analytical procedures is not correct$
Arens/Elder/Beasley
medium a. )nalytical tests emphasize a comparison of client internal controls to %))*.
a . )nalytical procedures are re'uired on all audits.
c. )nalytical procedures can e used as sustantive tests.
d. Bor certain accounts #ith small alances, analytical procedures alone may e sufficient
evidence.
(<.
medium
) enefit otained from comparing the clientAs data #ith industry averages is that it provides
a+n,:
a a. indication of the likelihood of financial prolems.
. indication #here errors e-ist in the statements.
c. enchmark to e used in evaluating a clientAs udgets.
d. comparison of 0#hat is1 #ith 0#hat should e.1
(=.
medium
a
/he primary purpose of performing analytical procedures in the planning phase of an audit is to:
a. help the auditor otain an understanding of the clientAs industry and usiness.
. assess the going concern assumption.
c. indicate possile misstatements.
d. reduce detailed tests.
.:. Chich of the follo#ing is not a correct comination of terms and related type of audit evidence$
medium a. Boot U reperformance.
d . Compare U documentation.
c. Iouch U documentation.
d. /race U analytical procedures.
.1. Chich of the follo#ing is not a correct comination of terms and related type of audit evidence$
medium a. "n'uire U in'uiries of client.
c . Count U physical e-amination.
c. Recompute U documentation.
d. Read U documentation.
.!. Chich of the follo#ing is not one of the ma@or types of analytical procedures$
medium a. Compare client #ith industry averages.
d . Compare client #ith prior year.
c. Compare client #ith udget.
d. Compare client #ith 3?C averages.
.(. Chat is the overall o@ective of audit documentation$
medium a. Eefend against claims of a deficient audit.
c . *rovide a asis for revie#ing the #ork of suordinates.
c. *rovide reasonale assurance that the audit #as conducted in accordance #ith standards.
d. *rovide additional support of recorded amounts to the client.
... )n important enefit of industry comparisons is as:
medium a. an aid to understanding the clientAs usiness.
a . an indicator of errors.
c. an indicator of fraud.
d. a least-cost indicator for audit procedures.
.2. /he permanent files included as part of audit documentation do not normally include:
medium a. a copy of the current and prior yearsA audit programs.
a . copies of articles of incorporation, yla#s and contracts.
c. information related to the understanding of internal control.
d. results of analytical procedures from prior years.
.8. /hose procedures specifically outlined in an audit program are primarily designed to
medium a. prevent litigation.
Arens/Elder/Beasley
d . detect errors or irregularities.
c. test internal systems.
d. gather evidence.
.;. ?vidence is generally considered appropriate #hen:
medium a. it has een otained y random selection.
c . there is enough of it to afford a reasonale asis for an opinion on financial statements.
c. it has the 'ualities of eing relevant, o@ective, and free from kno#n ias.
d. it consists of #ritten statements made y managers of the enterprise under audit.
.<.
challenging
%iven the economic constraints in #hich auditors collect evidence, the auditor normally gathers
evidence that is:
c a. irrefutale.
. conclusive.
c. persuasive.
d. completely convincing.
.=.
challenging
/he auditor is concerned that a client is failing to ill customers for shipments. )n audit
procedure that #ould gather relevant evidence #ould e to:
a. select a sample of duplicate sales invoices and trace each to related shipping documents.
. trace a sample of shipping documents to related duplicate sales invoices.
c. trace a sample of 3ales Lournal entries to the )ccounts Receivale susidiary ledger.
d. compare the total of the 3chedule of )ccounts Receivale #ith the alance of the
)ccounts Receivale account in the general ledger.
2:. Relevance can e considered only in terms of:
challenging a. general audit o@ectives.
. specific audit o@ectives.
c. transaction audit o@ectives.
d. alance audit o@ectives.
21.
challenging
)udit documentation should possess certain characteristics. Chich of the follo#ing is one of
the characteristics$
c
)udit documentation should e inde-ed
and cross-referenced
)udit documentation should e
organized to enefit the clientAs staff
a.
.
c.
d.
Jes
Do
Jes
Do
Jes
Do
Do
Jes
2!. Chich of the follo#ing statements is not a correct use of the terminology$
medium

a. ?vidence otained from an independent source outside the client organization is more
reliale than that otained from #ithin.
. Eocumentary evidence is more reliale #hen it is received y the auditor indirectly rather
than directly.
c. Eocuments that originate outside the company are considered more reliale than those that
originate #ithin the clientAs organization.
d. ?-ternal evidence, such as communications from anks, is generally regarded as more
reliale than ans#ers otained from in'uiries of the client.
2(. ?vidence is usually more persuasive for alance sheet accounts #hen it is otained:
challenging a. as close to the alance sheet date as possile.
a . only from transactions occurring on the alance sheet date.
c. from various times throughout the clientAs year.
d. from the time period #hen transactions in that account #ere most numerous during the
fiscal period.
Arens/Elder/Beasley
2.. )udit documentation should provide support for:
medium
c /he audit report /he financial statements
a.
.
c.
d.
Jes
Do
Jes
Do
Jes
Do
Do
Jes
Arens/Elder/Beasley
22. Chich of the follo#ing statements is not correct concerning audit documentation$
challenging
a
a. )udit documentation is ac'uired to defend against claims that the auditor performed a
deficient audit.
. /he only time anyone has a legal right to e-amine audit documentation is #hen the
documentation is supoenaed y a court as legal evidence.
c. )udit documentation is the primary frame of reference used y supervisory personnel to
evaluate the sufficiency of evidence.
d. /he auditor may deny re'uests y the client to revie# audit evidence.
28. Chich of the follo#ing statements is not true$
challenging
d
a. ) large sample of highly competent evidence is not persuasive unless it is relevant to the
o@ective eing tested.
. ) large sample of evidence that is neither competent nor timely is not persuasive.
c. ) small sample of only one or t#o pieces of relevant, competent, and timely evidence
lacks persuasiveness.
d. /he persuasiveness of evidence can e evaluated after considering its competence and its
sufficiency.
2;. Chich of the follo#ing statements is not correct$
challenging
d
a. )nalytical procedures are used to isolate accounts or transactions that should e
investigated more e-tensively.
. Bor certain immaterial accounts, analytical procedures may e the only evidence needed.
c. "n some instances, other types of evidence may e reduced #hen analytical procedures
indicate that an account alance appears reasonale.
d. )nalytical procedures use supporting documentation to determine #hich account alances
need additional detailed procedures.
2<. Chich of the follo#ing statements is not correct$
challenging
a
a. /he effectiveness of the clientAs internal control has little effect on the reliaility of most
types of evidence.
. )nalytical procedures may e reliale even if tests of internal controls indicate control
#eaknesses.
c. 7oth physical e-amination and mechanical accuracy are likely to e highly reliale if the
internal control is effective.
d. ) specific type of evidence is rarely sufficient y itself to provide reliale evidence to
satisfy any audit o@ective.
2=.
challenging
a
)udit evidence supporting the financial statements consists of the underlying accounting data
and all corroorating information availale to the auditor. Chich of the follo#ing is an
e-ample of corroorating information$
a. Minutes of meetings.
. %eneral and susidiary ledgers.
c. )ccounting manuals.
d. Corksheets supporting cost allocations.
8:.
challenging
Chich of the follo#ing discoveries through the use of analytical procedures #ould indicate a
relatively high risk of financial failure$
d a. ) decline in gross margin percentages.
. )n increase in the alance in fi-ed assets.
c. )n increase in the ratio of allo#ance for uncollectile accounts to gross accounts
receivale, #hile at the same time accounts receivale turnover also decreased.
d. ) higher than normal ratio of long-term det to net #orth as #ell as a lo#er than average
Arens/Elder/Beasley
ratio of profits to total assets.
81. Chich of the follo#ing statements is correct regarding the costs involved in otaining
evidence$
challenging
d *hysical e-amination is usually the
least e-pensive type of audit
evidence
Cost of otaining evidence may e a factor in
deciding #hether to otain that evidence
a. Jes
. Do
c. Jes
d. Do
Jes
Do
Do
Jes
8!.
challenging
) common comparison occurs #hen the auditor calculates the e-pected alance and compares it
#ith the actual alance. /he auditorAs e-pected account alance may e determined y:
c a. using industry standards.
. using Eun and 7radstreet reports.
c. relating it to some other alance sheet or income statement account or accounts.
d. in'uiry of the client.
8(. /#o analytical procedures availale to the auditor are:
medium Compare current yearAs alances #ith the preceding year.
Compare details of a particular accountAs alance #ith the preceding year.
3hortcomings of these t#o procedures are that:
a. the first ignores effects of tests of controls and the second fails to consider possile
changes in client personnel.
. the first fails to consider gro#th or decline in usiness activity and the second ignores
relationships of data to other data.
c. oth fail to consider gro#th or decline in usiness activity and ignore relationships of data.
d. it is difficult, time consuming, and, therefore, costly to perform these procedures.
8..
challenging
Chich of the follo#ing statements relating to the competence of evidential matter is al#ays
true$
d a. ?vidence from outside an enterprise is al#ays reliale.
. )ccounting data developed under satisfactory conditions of internal control are more
relevant than data developed under unsatisfactory internal control conditions.
c. 4ral representations made y management are not reliale evidence.
d. ?vidence must e oth reliale and relevant to e considered appropriate.
?ssay Questions
82.
easy
4ne purpose of performing analytical procedures in the planning phase of an audit is to assess
the clientAs financial condition. ?-plain ho# the assessment of a clientAs financial condition can
affect the auditorAs decisions concerning evidence accumulation in later phases of the audit.
)ns#er:
)ll things eing e'ual, the #eaker the clientAs financial condition, the more assurance
the auditor #ill re'uire that the financial statements are free of material misstatements. )s
the auditor re'uires greater assurance, he or she can +1, perform detailed testing closer to
the alance sheet date, +!, increase the e-tent of detailed testing, or +(, perform more
reliale procedures. "n e-treme cases, ho#ever, if the auditor elieves the entity is not a
going concern, he or she may #ithdra# from the engagement and perform no additional
Arens/Elder/Beasley
tests.
88.
medium
Eistinguish et#een internal documentation and e-ternal documentation as types of audit
evidence. %ive t#o e-amples of each. Chich type is considered more reliale$
)ns#er:
"nternal documentation involves the auditorAs e-amination of documents that have een
prepared and used #ithin the clientAs organization and are retained #ithout ever going to
an outside party. ?-amples #ould include duplicate sales invoices, employeesA time
reports, and inventory receiving reports.
?-ternal documentation involves the auditorAs e-amination of documents that have een in
the hands of someone outside the clientAs organization. ?-amples include vendorsA
invoices, cancelled checks, cancelled notes payale, and insurance policies.
?-ternal documents are regarded as more reliale evidence than internal documents.
8;.
medium
"dentify the three common types of confirmations used y auditors. "ndicate #hich type is most
reliale and e-plain your ans#er. "n addition, indicate #hich type is least reliale and e-plain
your ans#er.
)ns#er:
"n order of reliaility, the three common types of confirmations used y auditors are:
positive confirmation #ith a re'uest for information to e supplied y the
recipient.
positive confirmation #ith the information to e confirmed included on the
form.
negative confirmation.
/he positive confirmation #ith a re'uest for information to e supplied y the recipient is
the most reliale ecause the recipient must supply the information from his or her
records. "f this information agrees #ith the information in the clientAs records, the
likelihood that the information is correct is high. /he positive confirmation #ith the
information to e confirmed included on the form is not as reliale as the first type
ecause the recipient may sign and return the confirmation #ithout carefully e-amining
the information. /he negative confirmation is the least reliale ecause a nonresponse
could e due to either the recipient agreeing #ith the information or the recipient ignoring
the confirmation re'uest.
Arens/Elder/Beasley
8<.
medium
/here are four important purposes of analytical procedures. "dentify each of these four purposes
and, for each purpose, give a specific e-ample of an analytical procedure that an auditor might
perform.
)ns#er:
Bour important purposes of analytical procedures are:
/o help the auditor understand the clientAs industry and usiness, the auditor
might analyze recent trends in the clientAs gross margin percentages to assess the
effects of competition in the industry.
/o aid in the assessment of the clientAs aility to continue as a going concern,
the auditor might analyze several of the clientAs key ratios including the ratio of long-
term det to net #orth, the ratio of profits to total assets, and the current ratio.
/o indicate the presence of possile misstatements in the financial statements,
the auditor might compare the current yearAs unaudited account alances #ith the
previous yearAs audited alances.
/o reduce the e-tent of detailed tests, the auditor might perform a simple
analytical procedure such as multiplying the clientAs monthly rent times 1! as a test of
the clientAs rent e-pense account. "f the product agrees #ith the alance in rent
e-pense, no additional testing of the account may e necessary.
8=.
medium
Eiscuss ho# each of the follo#ing influences the persuasiveness of evidence.
1. Relevance
!. "ndependence of provider
(. ?ffectiveness of clientAs internal controls
.. )uditorAs direct kno#ledge
2. Eegree of o@ectivity
)ns#er:
1. Relevance U ?vidence must pertain to the audit o@ective if it is to e persuasive.
Relevance must e considered in terms of specific audit o@ectives as evidence may
e relevant to one o@ective and not another.
!. "ndependence of provider U ?vidence otained from a source outside the entity is
more reliale and persuasive than that otained from #ithin.
(. ?ffectiveness of clientAs internal controls U Chen a clientAs internal controls are
effective, evidence otained is more reliale than #hen they are #eak.
.. )uditorAs direct kno#ledge U ?vidence otained directly y the auditor through
physical e-amination, oservation, computation and inspection is more competent
than information otained indirectly.
2. Eegree of o@ectivity U 4@ective evidence is more reliale than evidence that
re'uires considerale @udgment to determine #hether it is correct.
Arens/Elder/Beasley
;:.
medium
%ive t#o e-amples of relatively reliale documentation and t#o e-amples of less reliale
documentation. Chat characteristics distinguish the t#o$
)ns#er:
?-amples of relatively reliale documents include vendorsA statements, cancelled notes
payale, insurance policies, and ank statements. ?-amples of less reliale documents
include duplicate sales invoices, employeesA time reports, inventory receiving reports, and
internal memoranda.
/he primary characteristic that distinguishes the t#o is #hether the document is an
e-ternal document +the document has een in the hands of someone outside the clientAs
organization #ho is a party to the transaction,, or an internal document. ?-ternal
documents are considered to e more reliale than internal documents.
;1. Eiscuss the auditorAs use of documentation as evidence.
medium
)ns#er:
Eocumentation is the auditorAs e-amination of the clientAs documents and records to
sustantiate the information that either is included or should e included in the financial
statements. Eocuments that the auditor e-amines may either e classified as e-ternal
documents or internal documents. ?-ternal documents are those that have een in the
hands of someone outside of the clientAs organization #ho is a party to the transaction
eing documented. "nternal documents are those that have een prepared and used #ithin
the clientAs organization #ithout ever eing in the custody of an e-ternal party. /he
primary determinant of the auditorAs #illingness to accept a document as reliale evidence
is #hether it is internal or e-ternal, and, #hen internal, #hether it #as created and
processed under conditions of effective internal control.
;!.
challenging
/he auditorAs decisions regarding evidence accumulation can e roken into four
sudecisions. 4ne decision relates to determining the nature of the audit
procedure to e used to collect the evidenceP i.e., 0#hich audit procedures to
use.1 "dentify and discuss the remaining three audit evidence decisions that the
auditor makes.
)ns#er:
/he remaining three audit evidence decisions are:
7at sample si8e to select for a gi%en procedure. /his decision relates to the
extent of testing to e performed. 4nce the auditor has identified #hich procedure to
perform, he or she needs to decide the appropriate numer of items in the population
to testMranging from one to all items in the population.
7ic items to select from te population. 4nce the auditor has decided the
appropriate numer of items to test, he or she needs to decide #hich particular items
in the population to e-amine.
7en to perform te procedures. /his decision relates to the timing of the
testing to e performed. )udit procedures related to alance sheet accounts #hich are
Arens/Elder/Beasley
performed close to the alance sheet date are generally considered more reliale than
procedures performed during the interim period.
Arens/Elder/Beasley
;(.
challenging
/he reliaility of evidence refers to the degree to #hich evidence is considered elievale or
trust#orthy. /here are five factors that affect the reliaility of audit evidence. 4ne factor is the
independence of the providerP i.e., evidence otained from a source outside the client company
is more reliale than that otained #ithin. "dentify and discuss the remaining four factors that
affect the reliaility of evidence.
)ns#er:
/he remaining four factors that affect the reliaility of evidence are:
Effecti%eness of client/s internal control. Chen a clientAs internal controls are
effective, evidence otained from the client is more reliale than #hen controls are
#eak.
Auditor/s direct kno)ledge. ?vidence otained directly y the auditor is more
reliale than information otained indirectly.
9ualifications of indi%iduals pro%iding te information. "nformation otained
from persons not familiar #ith the usiness #orld #ould generally not e considered
as reliale as information from an e-pert in a usiness-related field.
.egree of o#$ecti%it". 4@ective evidence is more reliale than evidence that
re'uires considerale @udgment to determine #hether it is correct.
;..
challenging
Eefine the follo#ing terms commonly used in audit procedures:
1. ?-amine
!. 3can
(. Compute
.. Boot
2. Compare
8. Count
;. Iouch
)ns#er:
1. ?-amine U ) reasonaly detailed study of a specific document or record to determine
specific facts aout it.
!. 3can U ) less detailed e-amination of a document or record to determine #hether
there is something unusual #arranting further investigation.
(. Compute U ) calculation done y the auditor independent of the client.
.. Boot U )ddition of a column of numers to determine #hether the total is the same as
the clientAs.
2. Compare U ) comparison of information in t#o different locations.
8. Count U ) determination of assets on hand at a given time. /his is associated #ith
evidence defined as physical e-amination.
;. Iouch U /he use of documents to verify recorded transactions or amounts.
Arens/Elder/Beasley
4ther 4@ective )ns#er Bormat Questions
;2.
medium
7elo# are 1! audit procedures. Classify each procedure according to the follo#ing types of
audit evidence: +1, physical e-amination, +!, confirmation, +(, documentation, +., oservation,
+2, in'uiry of the client, +8, reperformance, and +;, analytical procedure.
/ype of ?vidence
)udit *rocedures
1. Catch client employees count inventory to determine #hether company procedures are
eing follo#ed.
!. Count inventory items and record the amount in the audit files.
(. /race postings from the sales @ournal to the general ledger accounts.
.. Calculate the ratio of cost of goods sold to sales as a test of overall reasonaleness of gross
margin relative to the preceding year.
2. 4tain information aout the clientAs internal controls y asking 'uestions of client
personnel.
8. /race column totals from the cash disursements @ournal to the general ledger.
;. ?-amine a piece of e'uipment to make sure a recent purchase of e'uipment #as actually
received and is in operation.
<. Revie# the total of repairs and maintenance for each month to determine #hether any
monthAs total #as unusually large.
=. Compare vendor names and amounts on purchases invoices #ith entries in the purchases
@ournal.
1:. Boot entries in the sales @ournal to determine #hether they #ere correctly totaled y the
client.
11. Make a surprise count of petty cash to verify that the amount of the petty cash fund is
intact.
1!. 4tain a #ritten statement from the clientAs ank stating the clientAs year-end alance on
deposit.
)ns#er:
1. 4servation
!. *hysical e-amination
(. Reperformance
.. )nalytical procedure
2. "n'uiry of the client
8. Reperformance
;. *hysical e-amination
<. )nalytical procedure
=. Eocumentation
1:. Reperformance
11. *hysical e-amination
1!. Confirmation
Arens/Elder/Beasley
;8.
medium
Match nine of the terms +a-k, #ith the definitions provided elo# +1-=,:
a. Boot
. Compute
c. 3can
d. "n'uire
e. Count
f. /race
g. Recompute
h. Read
i. ?-amine
@. 4serve
k. Compare
1. ) calculation done y the auditor independent of the client.
a !. )ddition of a column of numers to determine if the total is the same as the
clientAs.
k (. ) comparison of information in t#o different locations.
@ .. ) use of the senses to assess certain activities.
f 2. Bollo#ing details of transactions from original documents to @ournals.
c 8. ) less detailed e-amination of a document or record to determine if there is
something unusual #arranting further investigation.
d ;. 4taining information from the client in response to specific 'uestions.
e <. ) determination of assets on hand at a given time.
h =. )n e-amination of #ritten information to determine facts pertinent to the audit.
Arens/Elder/Beasley
;;. Match five of the terms +a-h, #ith the definitions provided elo# +1-2,:
medium
a. )udit documentation
. )udit procedures
c. )udit o@ectives
d. )nalytical procedures
e. 7udgets
f. Reliaility of evidence
g. 3ufficiency of evidence
h. *ersuasiveness of evidence
d 1. >se of comparisons and relationships to assess the reasonaleness of account
alances.
!. Eetailed instructions for the collection of a type of audit evidence.
f (. /he degree to #hich evidence can e considered elievale or trust#orthy.
a .. Contains all the information that the auditor considers necessary to conduct an
ade'uate audit and to provide support for the audit report.
g 2. /his is determined y the amount of evidence otained.
;<.
medium
7elo# are 1: documents typically e-amined during an audit. Classify each document as either
internal or e-ternal.
/ype of
Eocument
Eocuments
1. Canceled checks for payments of accounts payale.
!. *ayroll time cards.
(. Euplicate sales invoices.
.. IendorsA invoices.
2. 7ank statements.
8. Minutes of the oard of directorsA meetings.
;. 3igned lease agreements.
<. Dotes receivale.
=. 3usidiary accounts receivale records.
1:. Remittance advices.
)ns#er:
1. ?-ternal 8. "nternal
!. "nternal ;. ?-ternal
(. "nternal <. ?-ternal
.. ?-ternal =. "nternal
2. ?-ternal 1:. ?-ternal
Arens/Elder/Beasley
;=.
easy

Cost should never e a consideration #hen making decisions aout evidence for a given audit.
a. /rue
. Balse
<:.
easy
a
Confirmations are among the most e-pensive type of evidence to otain.
a. /rue
. Balse
<1.
easy

4servation is normally more reliale than physical e-amination.

a. /rue
. Balse
<!.
easy

"n'uiries of the client are usually sufficient to provide appropriate evidence to satisfy an audit
o@ective.
a. /rue
. Balse
<(.
easy

) canceled check #ritten y the client, made payale to a local supplier and dra#n on the
clientAs ank account is one type of internal document.
a. /rue
. Balse
<..
easy
a
Chenever practical and reasonale, the confirmation of accounts receivale is re'uired of
C*)s.
a. /rue
. Balse
<2.
easy
a
"n'uiries of clients and reperformance normally have a lo# cost associated #ith them.
a. /rue
. Balse
<8.
easy

Chen analytical procedures reveal unusual fluctuations in an account alance, the auditor #ill
proaly perform fe#er tests of details for that account and increase the tests of controls related
to the account.
a. /rue
. Balse
<;.
easy
a
/he type of audit evidence kno#n as in'uiry re'uires the auditor to otain oral information
from the client in response to 'uestions.
a. /rue
. Balse
<<.
medium

4ne of the primary determinants of the reliaility of audit evidence is the 'uantity
of evidence.
a. /rue
. Balse
<=.
medium

)udit documentation is the @oint property of the auditor and the audit client.
a. /rue
. Balse
Arens/Elder/Beasley
=:.
medium
a
4@ective evidence is more reliale, and hence more persuasive, than su@ective evidence.
a. /rue
. Balse
=1.
medium
a
4rdinarily, audit documentation can e provided to someone else only #ith the e-press
permission of the client.
a. /rue
. Balse
=!.
medium
a
)nalytical procedures must e used in the planning and completion phases of the audit.
a. /rue
. Balse
=(.
medium
a
Confirmations are ordinarily used to verify account alances, ut may e used to verify
transactions.
a. /rue
. Balse
=..
medium
a
4f the three common types of confirmations used y auditors, the least reliale type is the
negative confirmation.
a. /rue
. Balse
=2.
medium

)ccounts receivale confirmations must e controlled y the client from the time they are
prepared until the time they are returned to the auditor.
a. /rue
. Balse
=8.
medium
a
Cost is never an ade'uate @ustification for omitting a necessary procedure or not gathering an
ade'uate sample size.
a. /rue
. Balse
=;.
medium

)nalytical procedures can e used to provide reliale sustantive evidence for all alance-
related audit o@ectives.
a. /rue
. Balse
=<.
medium

4ne advantage of using statistical techni'ues #hen performing analytical procedures is that they
eliminate the need for auditor @udgment.
a. /rue
. Balse
==.
medium
a
Relevance of evidence can only e considered in terms of specific audit o@ectives.
a. /rue
. Balse
Chapter <
Multiple-Choice Questions
Arens/Elder/Beasley
1.
easy
Chich of the follo#ing is not one of the three main reasons #hy the auditor should properly
plan engagements$
a a. /o enale proper on-the-@o training of employees.
. /o enale the auditor to otain sufficient appropriate evidence.
c. /o avoid misunderstandings #ith the client.
d. /o help keep audit costs reasonale.
!. )voiding misunderstandings #ith the client is important for:
easy
a %ood client relations Bacilitating high-'uality #ork at a reasonale cost
a.
.
c.
d.
Jes
Do
Jes
Do
Jes
Do
Do
Jes
(.
easy
) measure of ho# #illing the auditor is to accept that the financial statements may e
materially misstated after the audit is completed and an un'ualified opinion has een issued is
the:
a. inherent risk.
. acceptale audit risk.
c. statistical risk.
d. financial risk.
..
easy
) measure of the auditorAs assessment of the likelihood that there are material misstatements in
an account efore considering the effectiveness of the clientAs internal control is called:
d a. control risk.
. acceptale audit risk.
c. statistical risk.
d. inherent risk.
2. Chen inherent risk is high, there #ill need to e:
?asy
d ) lo#er assessment of audit risk More evidence accumulated y the auditor
a.
.
c.
d.
Jes
Do
Jes
Do
Jes
Do
Do
Jes
8. /he auditor is likely to accumulate more evidence #hen the audit is for a company:
easy
a Chich has large amounts of det Chich is to e sold in the near future
a.
.
c.
d.
Jes
Do
Jes
Do
Jes
Do
Do
Jes
;. Chich of the follo#ing is not typically included in initial audit planning$
easy a. Client acceptanceKcontinuation decisions.
d . Eetermination of the purpose of the audit.
c. 4tain an understanding #ith the client.
d. *erform analytical procedures as sustantive tests.
<. "nitial audit planning involves four matters. Chich of the follo#ing is not one of these$
easy a. Eevelop an overall audit strategy.
. Re'uest that ank alances e confirmed.
c. 3chedule engagement staff and audit specialists.
d. "dentify the clientAs reason for the audit.
Arens/Elder/Beasley
=.
easy
Most auditors assess inherent risk as high for related parties and related-party transactions
ecause:
a. of the uni'ue classification of related-party transactions re'uired on the alance sheet.
. of the lack of independence et#een the parties.
c. of the uni'ue classification of related-party transactions re'uired on the income statement.
d. it is re'uired y generally accepted accounting principles.
1:.
easy
Chich of the follo#ing is not correct regarding the communications et#een successor and
predecessor auditors$
a a. /he urden of initiating the communication rests #ith the predecessor auditor.
. /he urden of initiating the communication rests #ith the successor auditor.
c. /he predecessor auditor must receive their former clientAs permission prior to divulging
information to the successor auditor
d. /he predecessor auditor may choose to provide a limited response to a successor auditor.
11. ) successor auditor may perform #hich of the follo#ing for a ne# audit client$
easy
a 3peak to local attorneys, anks
and other usinesses regarding
the companyAs reputation
3peak to the predecessor auditors aout
disagreements they had #ith management
a. Jes Jes
. Do Do
c. Jes Do
d. Do Jes
1!.
medium
Chich of the follo#ing is not a potential effect of an auditorAs decision that a lo#er acceptale
audit risk is appropriate$
a. More evidence is accumulated.
. &ess evidence is accumulated.
c. 3pecial care is re'uired in assigning e-perienced staff.
d. Revie# of audit documentation is performed y personnel not assigned to the engagement.
1(.
medium
"t is easier and more common to implement increased evidence accumulation for inherent risk
than for acceptale audit risk ecause:
a a. inherent risk can usually e isolated to specific accounts.
. inherent risk applies to the entire audit.
c. acceptale audit risk and sample sizes are set statistically.
d. acceptale audit risk does not impact on the amount of evidence #hich must e
accumulated.
1.. +345,
medium
"f an auditor is re'uested to perform nonaudit services for a pulic company audit client, #ho is
responsile for agreeing to those services #ith the audit firm$
d a. /he clientAs management.
. /he clientAs chief e-ecutive officer.
c. /he clientAs chief financial officer.
d. /he clientAs audit committee.
12.
medium
Chich of the follo#ing statements is true regarding communications et#een predecessor and
successor auditors$
a. /he urden of initiating the communication rests #ith the predecessor.
. /he predecessorAs response can e limited to stating that no information #ill e provided.
c. /he predecessor should communicate #ith the successor only if the client is pulic.
d. /here must e communication et#een the predecessor and successor if the successor is to
accept the engagement.
Arens/Elder/Beasley
18.
medium
"nvestigating ne# clients #ith a focus on assessing the auditorAs potential relationship #ith that
ne# client is a critical element in determining:
a. inherent risk.
. acceptale audit risk.
c. statistical risk.
d. financial risk.
1;. /he purpose of an engagement letter is to:
medium

a. document the C*) firmAs responsiility to e-ternal users of the audited financial
statements.
. document the terms of the engagement in #riting to minimize misunderstandings.
c. notify the audit staff of an upcoming engagement so that personnel scheduling can e
facilitated.
d. emphasize managementAs responsiility for approving the audit program.
1<.
medium
4ne means of informing the client that the auditor is not responsile for the discovery of all acts
of fraud is the:
a a. engagement letter.
. representation letter.
c. responsiility letter.
d. client letter.
1=. Chich of the follo#ing normally signs the engagement letter for an audit of a pulic company$
medium a. Corporate treasurer.
d . Chief financial officer.
c. Chairman of the oard of directors.
d. )udit committee.
!:. Chich of the follo#ing normally signs the engagement letter for an audit of a private company$
medium a. Management.
a . 7oard of directors representative.
c. )udit committee representative.
d. Corporate treasurer.
!1.
medium
d
)n understanding of a clientAs usiness and industry and kno#ledge aout operations are
essential for performing an ade'uate audit. Bor a ne# client, most of this information is
otained:
a. from the predecessor auditor.
. from the 3ecurities and ?-change Commission.
c. from the permanent file.
d. at the clientAs premises.
!!. /he least effective method of identifying related parties for a pulic company #ould e a+n,:
medium a. in'uiry of management.
c . revie# of 3?C filings.
c. distriution of the engagement letter to all stockholders.
d. e-amination of stockholdersA listings to identify principal stockholders.
!(.
medium
)n official record of meetings of the oard of directors and stockholders is included in the
corporate:
c a. yla#s.
. charter.
c. minutes.
d. license.
!.. Chich of the follo#ing is not likely to e a related party$
medium a. )ffiliated companies.
Arens/Elder/Beasley
c . ) ma@or stockholder of the company.
c. ) #arehouse employee.
d. /he chief e-ecutive officer.
!2. Chich of the follo#ing is most likely to occur at the eginning of an initial audit engagement$
medium a. *repare a rough draft of the financial statements and of the auditorAs report.
c . 3tudy and evaluate the system of internal administrative control.
c. Eetermine the clientAs reason for an audit.
d. Consult #ith and revie# the #ork of the predecessor auditor prior to discussing the
engagement #ith the client management.
!8. )n auditor should e-amine minutes of the oard of directorsA meetings:
medium a. through the date of the financial statements.
. through the date of the audit report.
c. only at the eginning of the audit.
d. on a test asis.
!;.
medium
/he first standard of field #ork, #hich states that the #ork is to e ade'uately planned and that
assistants, if any, are to e properly supervised, recognizes that:
a a. early appointment of the auditor is advantageous to the auditor and the client.
. acceptance of an audit engagement after the close of the clientAs fiscal year is generally not
permissile.
c. appointment of the auditor suse'uent to the physical count of inventories re'uires a
disclaimer of opinion.
d. performance of sustantial parts of the e-amination is necessary at interim dates.
!<.
medium
/he corporate minutes are the official record of the meetings of the oard of directors and
stockholders. /he minutes typically include authorizations related to:
d
/he C*)As use of outside specialists Management compensation
a.
.
c.
d.
Jes
Do
Jes
Do
Jes
Do
Do
Jes
!=. )n engagement letter sent to an audit client usually #ould not include a+n,:
medium a. reference to the auditorAs responsiility for the detection of errors or irregularities.
c . estimation of the time to e spent on the audit #ork y audit staff and management.
c. statement that management advisory services #ould e made availale upon re'uest.
d. reference to managementAs responsiility for the financial statements.
(:. Chich of the follo#ing is correct #ith respect to a companyAs corporate charter$
medium
c
a. /he corporate charter is granted y the federal government and is re'uired to recognize the
corporation as a separate entity.
. /he corporate charter includes the rules and procedures used to operate a corporation.
c. /he corporate charter includes the e-act name of the corporation, the date of
incorporation, and the types of usiness the corporation is authorized to conduct.
d. /he corporate charter must e annually revie#ed y the *C)47.
(1. Corporate yla#s include:
Medium
d /he types and amounts of capital stock
the corporation is authorized to issue
/he rules and procedures used to
operate the corporation
a.
.
c.
d.
Jes
Do
Jes
Do
Jes
Do
Do
Jes
Arens/Elder/Beasley
(!.
medium

"n #hat order should the follo#ing steps occur$

). )ssess client usiness risk
7. >nderstand the clientAs usiness and industry
C. *erform preliminary analytical procedures
E. )ssess acceptale audit risk
a. E, 7, C, ).
. 7, ), E, C.
c. 7, E, ), C.
d. E, C, 7, ).
((. Chich of the follo#ing statements is not correct #ith respect to analytical procedures$
medium a. )uditing standards emphasize the need for auditors to develop and use e-pectations.
. )nalytical procedures must e performed throughout the audit.
c. )nalytical procedures may e performed at any time during the audit.
d. )nalytical procedures use comparisons and relationships to assess #hether account
alances appear reasonale.
(.. /he most #idely used profitaility ratio is the:
medium a. 'uick ratio.
d . profit margin.
c. return on assets.
d. earnings per share.
(2.
challenging
/he purpose of the re'uirement in 3)3 Do. <. of having communication et#een the
predecessor and successor auditor is to:
a. allo# the predecessor to disclose information #hich #ould other#ise e confidential.
. help the successor auditor to evaluate #hether to accept the engagement.
c. help the client y facilitating the change of auditors.
d. ensure the predecessor collects all unpaid fees prior to a change in auditor.
(8.
challenging
/he predecessor auditor is re'uired to respond to the re'uest of the successor auditor for
information, ut the response can e limited to stating that no information #ill e provided
#hen:
c a. the predecessor auditor has poor relations #ith the successor auditor.
. the client is dissatisfied #ith the predecessorAs #ork.
c. there are actual or potential legal prolems et#een the client and the predecessor.
d. the predecessor elieves that the client lacks integrity.
(;. Chich of the follo#ing is correct #ith respect to the use of analytical procedures$
challenging
d
a. )nalytical procedures may e used in evaluating alances in the testing phase as long as
the auditor also uses them in assessing the going concern assumption.
. )nalytical procedures must e used throughout the audit.
c. )nalytical procedures used in the testing phase of the audit are primarily used to direct an
auditorAs attention so that the auditorAs understanding of the usiness is improved.
d. )nalytical procedures are performed y studying plausile relationships et#een financial
and nonfinancial data.
(<.
challenging
Chich of the follo#ing ratios is est used to assess a companyAs aility to meet its long-term
det oligations$
c a. Quick ratio.
. Return on common e'uity.
c. Eet to e'uity.
d. Current ratio.
(=. Chich of the follo#ing statements is not correct$
challenging a. )nalytical procedures used in the planning phase of the audit are primarily directed at
Arens/Elder/Beasley
understanding the clientAs usiness and directing the auditorAs attention to areas that may
contain possile misstatements.
. )nalytical procedures used in the completion phase are primarily aimed at assessing going
concern and secondarily aimed at directing the auditorAs attention to areas that may
contain possile misstatements.
c. )nalytical procedures must e used in the planning and completion phases of the audit,
and are optional in the testing phase.
d. )nalytical procedures used in the completion phase are primarily aimed at directing the
auditorAs attention to areas that may contain possile misstatements and secondarily aimed
at assessing going concern.
.:. Chich of the follo#ing #ould not likely e classified as a related-party transaction$
medium a. )n advance of one #eekAs salary to an employee.
a . 3ales of merchandise et#een affiliated companies.
c. &oans or credit sales to the principal o#ner of the client company.
d. ?-changes of e'uipment et#een t#o companies o#ned y the same person.
.1. Chich of the follo#ing #ould not e found in the corporate charter$
challenging a. /he kinds and amount of capital stock authorized.
d . /he date of incorporation.
c. /he types of usiness activity that the corporation is allo#ed to conduct.
d. /he rules and procedures adopted y the stockholders.
.!. Chich of the follo#ing #ould not usually e included in the minutes of the oard of directors$
challenging a. /he duties and po#ers of the corporate officers.
a . Eeclaration of dividends.
c. )uthorization of long-term loans.
d. )pproval of e-ecutive onuses.
.(. Chen are auditors likely to encounter @udgment prolems in the use of analytical procedures$
challenging
d
a. Chenever the auditor places reliance on managementAs e-planations for unusual
fluctuations in account alances #ithout first developing independent e-pectations.
. Chenever the auditor allo#s unaudited alances to unduly influence hisKher e-pectations
of current alances.
c. Chenever the auditor fails to consider the pattern reflected y several unusual fluctuations
#hen trying to e-plain #hat caused them.
d. /he auditor is likely to encounter @udgment prolems in each of the aove instances.
... /he ma@or concern #hen using nonfinancial data in analytical procedures is the:
challenging a. accuracy of the nonfinancial data.
a . source of the nonfinancial data.
c. type of nonfinancial data.
d. presence of multiple sources of nonfinancial data.
.2.
challenging
)n auditor searching for related party transactions should otain an understanding of each
susidiaryAs relationship to the total entity ecause:
a. the usiness structure may e delierately designed to oscure related party transactions.
. this may reveal #hether transactions #ould have taken place if the parties had een
unrelated.
c. transactions may have een consummated on terms e'uivalent to armAs-length
transactions.
d. this may permit the audit of intercompany account alances to e performed as of
concurrent dates.
.8.
challenging
/he first standard of field#ork re'uires, in part, that audit #ork e properly planned. *roper
planning as intended y the first standard of field#ork #ould occur #hen the auditor:
a a. physically oserves the movement of securities already counted to guard against the
Arens/Elder/Beasley
sustitution of such securities for others that are not actually on hand.
. uses negative accounts receivale confirmations instead of positive confirmations ecause
the latter re'uire mailing of second re'uests and revie# of suse'uent cash collections.
c. compares all cash as of a particular date to avoid performing time-consuming cash cutoff
procedures.
d. eliminates the possiility of counting inventory items more than once y arranging to
make e-tensive test counts.
.;. ?arly appointment of the independent auditor #ill enale:
challenging a. a more thorough e-amination to e performed.
d . a proper study and evaluation of internal control to e performed.
c. sufficient competent evidential matter to e otained.
d. a more efficient e-amination to e planned.
.<.
medium
Chenever an auditor compares client data to client-prepared udgets, there are t#o special
concerns. "ndicate if the t#o items elo# are concerns.
a
)ssessing #hether the udgets #ere
realistic plans
Client data may have een altered to conform
to the udget
a. ) concern ) concern
. Dot a concern Dot a concern
c. ) concern Dot a concern
d. Dot a concern ) concern
.=.
challenging
)n auditor #ho accepts an audit engagement and does not possess the industry e-pertise of the
usiness entity should:
a. engage financial e-perts familiar #ith the nature of the usiness entity.
. otain a kno#ledge of matters that relate to the nature of the entityAs usiness.
c. refer a sustantial portion of the audit to another C*) #ho #ill act as the principal auditor.
d. first inform management that an un'ualified opinion cannot e issued.
2:. Chich is a li'uidity activity ratio$
medium a. *rofit margin
. "nventory turnover
c. Return on assets
d. /imes interest earned
21. Chich is usually included in an engagement letter$
medium
?stimate of hours re'uired to
complete audit
Eollar estimate of fees to e illed to
the client
d a.
.
c.
d.
Jes
Do
Jes
Do
Jes
Do
Do
Jes
2!. Chich is usually included in an engagement letter$
medium
a ) reference to %))* ) reference to %))3
a. Jes
. Do
c. Jes
d. Do
Jes
Do
Do
Jes
2(. Chich is usually included in an engagement letter$
medium
c /he financial statements are
Arens/Elder/Beasley
the responsiility of the
companyAs management
Ratios to e used y the auditor in the planning
phase
a.
.
c.
d
Jes
Do
Jes
Do
Jes
Do
Do
Jes
2.. Chen may the auditor refer to a specialist in the audit report$
medium
c
4nly if the specialistAs report
results in a modification of the audit
opinion
4nly if the specialist assisted in the audit of an
account material to the financial statements
a.
.
c.
d
Jes
Do
Jes
Do
Jes
Do
Do
Jes
22. Chich is usually included in the engagement letter$
medium
/he pro@ected type of opinion on
the financials statement to e
audited
Dame+s, of the client personnel responsile for
supplying the auditor #ith information
a.
.
c.
d
Jes
Do
Jes
Do
Jes
Do
Do
Jes
28. Chich is usually included in the engagement letter$
medium
&ist of audit procedures to e used
in inventory oservation /he auditorsA assessment of )udit Risk
a.
.
c.
d
Jes
Do
Jes
Do
Jes
Do
Do
Jes
?ssay Questions
2;.
easy
Eiscuss the factors an auditor should consider efore accepting a company as an audit client.
)ns#er:
/he auditor should investigate and consider the prospective clientAs standing in the
usiness community, financial staility, managementAs integrity, and relations #ith its
ankers, attorneys, and previous C*) firm. /he auditor should also determine #hether
he or she possesses the re'uired competence and independence to do the audit.
2<.
easy
Eiscuss the primary purpose of an audit engagement letter. "s an engagement letter re'uired$
)ns#er:
/he purpose of an audit engagement letter is to estalish a clear understanding et#een
Arens/Elder/Beasley
the auditor and the client regarding the terms of the engagement. )n engagement is re'uired for
oth pulic and private company audits.
2=.
easy
Eefine the term 0related party1 and discuss #hy an auditor should identify the clientAs related
parties early in the audit.
)ns#er:
) related party is an affiliated company, principal o#ner of the client company, or any
other party #ith #hich the client deals #here one of the parties can influence the management
or operating policies of the other. )uditors need to e a#are of #ho the clientAs related parties
are early in the audit to enale the auditor to identify related-party transactions, especially those
that have not een disclosed.
8:.
medium
/here are three main reasons #hy an auditor should properly plan audit engagements. Eiscuss
each of these reasons.
)ns#er:
/hree reasons #hy an auditor should properly plan audit engagements are:
/o enale the auditor to otain sufficient competent evidence for the
circumstances. /his is essential for minimizing legal liaility and maintaining a good
profession reputation.
/o help keep audit costs reasonale. %iven the competitive auditing
environment, keeping costs reasonale helps the firm otain and retain clients.
/o avoid misunderstandings #ith the client. /his is important for good client
relations.
81.
medium
Eiscuss the essential activities involved in the initial planning of an audit.
)ns#er:
/here are four essential activities involved in the initial planning of an audit. /hese
are:
1. Client acceptance or continuation. "n the case of a ne# client, the auditor must
determine #hether the client is one #ith #hich +s,he #ishes to e associated. "n the
case of a continuing client, an auditor must determine #hether continuing the
relationship is appropriate and in the firmAs est interest.
!. Eetermine reason for the audit. /he auditor should determine the reason for the audit
as soon as practical. /he remainder of the planning activities may e impacted y the
clientAs reason for re'uesting the audit.
(. 4tain an understanding #ith the client. )n understanding #ith the client should e
otained to avoid misunderstandings. )uditors are re'uired to otain an understanding
#ith their clients. /his understanding must e #ritten.
.. Eevelop an overall audit strategy. /he strategy should consider the reasons for the
audit, including areas #here there is greater risk of significant misstatements. 3etting a
strategy helps the auditor determine the resources re'uired for the engagement.
Arens/Elder/Beasley
8!.
medium
Eiscuss the re'uired communications et#een predecessor and successor auditors as outlined
y 3)3 Do. <..
)ns#er:
)uditing standards re'uire a successor auditor to communicate #ith the predecessor
auditor #henever accepting a client that has een previously audited. /he purpose of the
communication is to help the successor auditor evaluate #hether to accept the
engagement. Chile the urden of initiating the communication rests on the successor
auditor, the predecessor auditor must respond to the re'uest for information. Ho#ever,
ecause of the re'uirements related to confidentiality, the predecessor must otain the
former clientAs permission prior to providing information to the successor.
8(.
medium
Eiscuss several reasons #hy an auditor may not #ish to continue a relationship #ith an e-isting
audit client.
)ns#er:
/here are a numer of reasons an auditor may choose not to continue a relationship
#ith an e-isting client. ?-amples include:
1. *revious conflicts over accounting issues, scope of the audit, type of opinion,
or fees.
!. Management integrity may e deemed to e insufficient.
(. &egal action initiated y either the auditor or client related to prior audit
services.
.. "f fees remain unpaid for services performed more than one year prior to the
date of the current yearAs audit report.
2. /he presence of e-cessive risk.
8..
medium
Eiscuss four of the matters that should e specified in an engagement letter.
)ns#er:
Matters that should e specified in the engagement letter include:
Chether the auditor #ill perform an audit, a revie#, or a compilation, plus
any other services such as ta- returns or management advisory services.
)ny restrictions to e imposed on the auditorAs #ork.
Eeadlines for completing the audit.
)ssistance to e provided y the clientAs personnel in otaining records and
documents, and schedules to e prepared for the auditor.
)greement on fees.
/he letter should state that the auditor is not responsile for the discovery of
all acts of fraud.
82.
medium
Chat documents do auditors routinely otain to aid in their understanding of a clientAs
governance system$ 7riefly discuss each of these documents.
)ns#er:
)uditors commonly otain the clientAs corporate charter, yla#s, and minutes of
meetings of the oard of directors and shareholders. /he corporate charter is issued y
the state in #hich the company is incorporated and specifies the e-act name of the
corporation along #ith the date of incorporation, the kinds and amounts of stock the
corporation is authorized to issue, and the types of usiness that the corporation is
Arens/Elder/Beasley
authorized to conduct. /he yla#s include the rules and procedures adopted y the
stockholders of the corporation. /hey specify the duties and po#ers of corporate
officers, the method of voting for directors, and
the fre'uency of stockholder meetings. /he corporate minutes are the official record of
the meetings of the oard of directors and stockholders. /hey include summaries of the
most important topics discussed and decisions made at the oard meetings.
88.
medium
Chat are three factors that have increased the importance of otaining an understanding of a
clientAs usiness and industry$ Ho# can an auditor otain this understanding$
)ns#er:
Bactors that have increased the importance of otaining an understanding of a clientAs
usiness and industry include:
)dvances in information technology have increased connectivity among
companies, customers, and vendors. )uditors must understand the risks associated
#ith this increased connectivity.
Companies have e-panded operations to have gloal reaches, often through
@oint ventures and strategic alliances.
"nformation technology affects internal control processes, improving the
'uality and timeliness of accounting information.
/he increased importance of human capital and other intangile assets has
increased accounting comple-ity and the importance of management @udgments and
estimates.
)uditors need a etter understanding of the clientAs usiness and industry to
provide additional value-added services.
/he auditor can otain a sound understanding of the clientAs usiness and industry
through several means, including discussions #ith previous auditors and y revie#ing
the permanent files for the clientP conferences #ith the clientAs personnelP studying
)"C*) industry audit guides, te-tooks, technical magazines, and specialized @ournalsP
and y participating in industry associations and training programs.
8;.
medium
/here are three primary reasons for otaining a thorough understanding of the clientAs industry
and e-ternal environment. Chat are these reasons$
)ns#er:
/he three reasons are:
Risks associated #ith specific industries may affect the auditorAs assessment of client
usiness risk and acceptale audit risk.
Certain inherent risks are typically common to all clients in certain industries.
Bamiliarity #ith those risks aids the auditor in assessing their relevance to the client.
Many industries have uni'ue accounting re'uirements that the auditor must
understand to evaluate #hether the clientAs financial statements are in accordance
%))*.
8<.
medium
Eiscuss the four primary purposes of analytical procedures performed during the planning phase
of an audit.
)ns#er:
/he four primary purposes of preliminary analytical procedures are:
to help the auditor understand the clientAs industry and usiness,
to help the auditor assess the going concern assumption,
Arens/Elder/Beasley
to indicate areas of possile misstatements, and
to reduce the e-tent of detailed tests.
8=.
challenging
Eefine usiness risk. &ist several factors that may impact the auditorAs assessment of usiness
risk.
)ns#er:
7usiness risk is the risk that a company #ill fail to achieve its o@ectives.
Bactors that may impact usiness risk include:
%eneral economic conditions,
?-tent of competition #ithin an industry,
Changing regulatory re'uirements,
Competence of management,
)ility to maintain sufficient cash flo#s and secure financing, and
3uccessful implementation of usiness strategies.
;:.
challenging
)uditors routinely conduct analytical procedures in the planning, testing, and completion phases
of the audit. "dentify the primary and secondary purposes of performing analytical procedures
in each phase of the audit.
)ns#er:
*lanning U /he primary purposes are to understand the clientAs usiness and industry
and indicate areas of possile misstatements. /he secondary purposes are to assess
going concern and reduce the e-tent of detailed tests.
/esting U /he primary purpose is to reduce the e-tent of detailed tests, #hile the
secondary purpose is to indicate areas of possile misstatements.
Completion U/he primary purpose is to indicate areas of possile misstatements,
#hile the secondary purpose is to assess going concern.
;1.
challenging
/hree types of legal documents and records that auditors e-amine in the planning phase of an
audit are the corporate charter and yla#s, corporate minutes of meetings of the oard of
directors and stockholders, and contracts. Eiscuss the audit-relevant information contained in
each of these three types of documents that an auditor should e a#are of early in the audit.
)ns#er:
Corporate carter and #"la)s. /his 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. /he yla#s specify such
things as the fiscal year of the corporation, the fre'uency of stockholder meetings, the
method of voting for directors, and the duties and po#ers of the corporate officers.
Minutes of meetings. /here are t#o categories of audit-relevant information contained in
the minutes: authorizations and discussions y the oard of directors affecting inherent
risk. Common authorizations in the minutes include compensation of officers, ne#
contacts and agreements, ac'uisitions of property, loans, and dividend payments.
Contracts. /he auditor should e-amine contracts early in the engagement to gain a etter
perspective of the organization and to ecome familiar #ith potential prolem areas.
Contracts #ill also e e-amined during the tests of individual audit areas.
Arens/Elder/Beasley
4ther 4@ective )ns#er Bormat Questions
;!.
easy
a
Chen an auditor decides there is higher inherent risk for an account, one potential effect is that
more audit evidence #ill e re'uired for that account.
a. /rue
. Balse
;(.
easy
a
)s acceptale audit risk is decreased, the likely cost of conducting an audit increases.
a. /rue
. Balse
;..
easy

7efore accepting a ne# client, most C*) firms investigate the company to determine its
acceptaility. Ho#ever, )"C*) confidentiality re'uirements prohiit C*) firms from
contacting certain partiesMnamely the companyAs attorneys and ankersMduring this
investigation.
a. /rue
. Balse
;2.
easy

Bor prospective clients that have previously een audited y another C*) firm, the predecessor
auditor is re'uired to communicate #ith the successor auditor.
a. /rue
. Balse
;8.
easy

Chen a successor auditor contacts a companyAs previous auditor, the predecessor auditor is
re'uired to respond fully and #ithout limit to the re'uest for information.
a. /rue
. Balse
;;.
easy

) predecessor auditor #ho has een contacted y a successor auditor for information aout the
client does not have to otain permission from the former client efore providing any
confidential information to the successor auditor ecause the confidentiality re'uirement does
not e-tend to former clients.
a. /rue
. Balse
;<.
easy
a
)uditors should otain copies of the clientAs articles of incorporation, yla#s, and minutes of
the meetings of the oard of directors to aid in their understanding of the companyAs
management and governance structure.
a. /rue
. Balse
;=.
easy
a
)n auditor must evaluate a specialistAs professional 'ualifications and understand the o@ectives
of the specialistAs #ork.
a. /rue
. Balse
<:.
medium

/o evaluate a specialistAs #ork the auditor must himselfKherself e considered a specialist.

a. /rue
. Balse
<1.
medium
a
)n engagement letter estalishes a clear understanding of the terms of the engagement et#een
the client and the auditor, ut it is optional for private companies.
a. /rue
. Balse
Arens/Elder/Beasley
<!.
easy

7ecause of the re'uirements of Rule !:1 of the )"C*)As Code of Professional Conduct #hich
state that auditors should 0undertake only those professional services that the memer or the
memerAs firm can reasonaly e-pect to e completed #ith professional competence,1 auditors
are not normally permitted to consult #ith, or rely on the #ork of, outside specialists during an
audit engagement.
a. /rue
. Balse
<(.
medium

)cceptale audit risk is a measure of the auditorAs #illingness to accept that the financial
statements do not contain material misstatements after the audit is completed and a 'ualified
audit report has een issued.
a. /rue
. Balse
<..
medium

"f a prospective client has een audited in the past, the successor auditor #ill typically rely
solely on the representations aout the client y the predecessor auditor.
a. /rue
. Balse
<2.
medium

/#o ma@or factors that affect acceptale audit risk are the likely users of the financial
statements and the likelihood of issuing an un'ualified audit opinion.
a. /rue
. Balse
<8.
medium

) ma@or consideration in assigning staff to an audit engagement is the e-perience levels

re'uired for the #ork, #hile a less important consideration is maintaining staff continuity on the
engagement.
a. /rue
. Balse
<;.
medium

"nherent risks typically vary across industries.

a. /rue
. Balse
<<.
medium
a
/ransactions #ith related parties must e disclosed in the financial statements if they are
deemed to e material.
a. /rue
. Balse
<=.
medium
a
)ll kno#n related parties must e identified and included in the auditorAs permanent files
related to the client.
a. /rue
. Balse
=:.
medium

%enerally, auditors assess inherent risk as moderate for related party transactions ecause they
e-pect clients to e a#are of their scrutiny of such transactions.
a. /rue
. Balse
=1.
medium

/he corporate charter typically estalishes the companyAs fiscal year and fre'uency of
stockholder meetings.
a. /rue
. Balse
Arens/Elder/Beasley
=!.
medium

4rdinarily, the auditor should revie# and astract copies of contracts during the later stages of
an audit.
a. /rue
. Balse
=(.
medium
a
Chen a successor auditor re'uests information from a companyAs previous auditor, and there
are legal prolems or disputes et#een the client and the predecessor auditor, the predecessor
auditorAs response to the ne# auditor may e limited to stating that no information #ill e
provided.
a. /rue
. Balse
=..
medium

4ne purpose of performing preliminary analytical procedures in the planning phase of an audit
is to help the auditor make a preliminary assessment of control risk.
a. /rue
. Balse
=2.
medium

Material transactions et#een the client and the clientAs related parties must e disclosed in the
auditorAs report.
a. /rue
. Balse
=8.
challenging
a
)n engagement letter can affect the C*) firmAs legal responsiilities to the client, ut does not
affect responsiility to e-ternal users of audited financial statements.
a. /rue
. Balse
=;.
challenging

/#o categories of audit-relevant information found in corporate charters and yla#s are
authorizations and discussions of matters affecting inherent risk.
a. /rue
. Balse
Chapter
Multiple-Choice Questions
1.
easy
a
"f it is proale that the @udgment of a reasonale person #ould have een changed or
influenced y the omission or misstatement of information, then that information is, y
definition of B)37 3tatement Do. !:
a. material.
. insignificant.
c. significant.
d. relevant.
!.
easy
/he preliminary @udgment aout materiality is the amount y #hich the auditor
elieves the statements could e misstated and still not affect the decisions of reasonale users.
a. minimum
. ma-imum
c. mean average
d. median average
(. )uditors are responsile for determining #hether financial statements are materially misstated,
Arens/Elder/Beasley
easy so upon discovering a material misstatement they must ring it to the attention of:
d a. regulators.
. the audit firmAs managing partner.
c. no one in particular.
d. the clientAs management.
.. /he B)37 definition of materiality emphasizes #hat class of financial statement users$
easy a. Regulators.
c . "nformed investors.
c. Reasonale persons.
d. *otential investors.
2.
easy
Chen auditors allocate the preliminary @udgment aout materiality to account alances, the
materiality allocated to any given account alance is referred to as:
d a. the materiality range.
. the error range.
c. tolerale materiality.
d. tolerale misstatement.
8. Chy do auditors estalish a preliminary @udgment aout materiality$
easy a. /o determine the appropriate level of audit e-perience re'uired for the #ork.
c . 3o that the client can kno# #hat records to make availale to the auditor.
c. /o plan the appropriate audit evidence to accumulate and develop an overall audit
strategy.
d. /o finalize the assessment of control risk.
;.
easy
)uditors are 66666 to decide on the comined amount of misstatements in the financial
statements that they #ould consider material early in the audit.
a. permitted
. re'uired
c. not allo#ed
d. strongly encouraged
<. "f an auditor estalishes a relatively high level for materiality, then the auditor #ill:
easy a. accumulate more evidence than if a lo#er level had een set.
. accumulate less evidence than if a lo#er level had een set.
c. accumulate appro-imately the same evidence as #ould e the case #ere materiality lo#er.
d. accumulate an undetermined amount of evidence.
=.
easy
/he preliminary @udgment aout materiality and the amount of audit evidence accumulated are
66666 related.
d a. directly
. indirectly
c. not
d. inversely
1:. )fter the preliminary @udgment aout materiality has een estalished, auditors may:
easy a. not ad@ust it.
d . ad@ust it do#n#ard only.
c. ad@ust it up#ard only.
d. ad@ust it either do#n#ard or up#ard.
11. "n an audit area that has a lo#er inherent risk, it #ould e prudent to:
easy a. increase the amount of audit evidence gathered.
c . assign more e-perienced staff to that area.
c. increase the tolerale misstatement for the area.
d. e-pand planning procedures.
Arens/Elder/Beasley
1!.
easy
Chich of the follo#ing is least likely to e appropriate as the asis for determining the
preliminary @udgment aout materiality in the audit of financial statements$
d a. Det income efore ta-es.
. Current assets.
c. 4#nersA e'uity.
d. "nventory.
1(.
easy
)uditing standards 66666 that the asis used to determine the preliminary @udgment aout
materiality e documented in the audit files.
c a. permit
. do not allo#
c. re'uire
d. strongly encourage
1..
easy
)mounts involving fraud are usually considered 66666 important than unintentional errors of
e'ual dollar amounts.
d a. less
. no less
c. no more
d. more
12.
easy
Chich of the follo#ing 'ualitative factors may significantly influence #hether an item is
deemed to e material$
a
Misstatements that are other#ise
minor may e material if there are
possile conse'uences arising from
contractual oligations.
Misstatements that are other#ise immaterial
may e material if they affect a trend in
earnings
a.
.
c.
d.
Jes
Do
Jes
Do
Jes
Do
Do
Jes
18. )uditors generally allocate the preliminary @udgment aout materiality to the:
easy a. alance sheet only.
a . income statement only.
c. income statement and alance sheet.
d. statement of cash flo#s.
1;. Chich of the follo#ing statements regarding inherent risk is correct$
easy
c
a. /he inherent risk assigned in the audit risk model is unaffected y the auditorAs e-perience
#ith clientAs organization.
. Most auditors set a lo# inherent risk in the first year of an audit and increase it if
e-perience sho#s that it #as incorrect.
c. Most auditors set a high inherent risk in the first year of an audit and reduce it in
suse'uent years as they gain e-perience, even #hen there is inherent risk.
d. /he inherent risk assigned in the audit risk model is dependent upon the strengths in
clientAs internal control system.
1<.
easy
)uditors egin their assessments of inherent risk during audit planning. Chich of the follo#ing
#ould not help in assessing inherent risk during the planning phase$
a a. 4taining clientAs agreement on the engagement letter.
. 4taining kno#ledge aout the clientAs usiness and industry.
c. /ouring the clientAs plant and offices.
d. "dentifying related parties.
Arens/Elder/Beasley
1=.
medium

)uditors commonly allocate materiality to alance sheet accounts rather than income statement
accounts ecause most income statement misstatements have a+n, 66666 effect on the alance
sheet.
a. reduced
. e'ual
c. undetermined
d. increased
!:.
medium
Chich of the follo#ing is not a correct statement regarding the allocation of the preliminary
@udgment aout materiality to alance sheet accounts$
a. )uditors e-pect certain accounts to have more misstatements than others.
. /he allocation has virtually no effect on audit costs ecause the auditor must collect
sufficient appropriate audit evidence.
c. )uditors e-pect to identify overstatements as #ell as understatements in the accounts.
d. Relative audit costs affect the allocation.
!1. Chat is the primary means of dealing #ith risk in planning decisions related to audit evidence$
medium a. 3election of more effective tests of details of alances.
. )pplication of the audit risk model.
c. ?stalishing a lo#er preliminary @udgment aout materiality.
d. )llocating materiality @udgment to segments.
!!. /he phrase 0in our opinion1 in the auditorAs report is intended to inform users that auditors:
medium a. guarantee fair presentation of the financial statements.
d . act as insurers of the accuracy of the statements.
c. certify the material presented in the statements y management.
d. ase their conclusions aout the statements on professional @udgment.
!(.
medium
"nherent risk is 6666666 related to detection risk and 6666666 related to the amount of audit
evidence.
d a. directly, inversely
. directly, directly
c. inversely, inversely
d. inversely, directly
!.. /he five steps in applying materiality are listed elo# in random order.
medium 1. ?stimate the comined misstatement.
!. ?stimate the total misstatement in the segment.
(. 3et preliminary @udgment aout materiality.
.. )llocate preliminary @udgment aout materiality to segments.
2. Compare comined estimate #ith preliminary @udgment aout materiality.
/he correct se'uence from start to finish #ould e:
a. 1 ! 2 . (.
. ( . ! 1 2.
c. . ( 1 2 !.
d. 2 1 ( ! ..
!2. Chich of the follo#ing statements is not correct$
medium a. Materiality is a relative rather than an asolute concept.
. /he most important ase used as the criterion for deciding materiality is total assets.
c. Qualitative factors as #ell as 'uantitative factors affect materiality.
d. %iven e'ual dollar amounts, frauds are usually considered more important than errors.
!8.
medium
3ince materiality is relative, it is necessary to have ases for estalishing #hether misstatements
are material. Dormally, the most common ase for deciding materiality is:
a a. net income efore ta-es.
. net #orking capital.
Arens/Elder/Beasley
c. net income after ta-es.
d. total assets.
!;.
medium
Certain types of misstatements are likely to e more important than other types to users, even if
the dollar amounts are the same. Chich of the follo#ing demonstrates this$
a
)mounts involving frauds are
considered more important than
errors of e'ual amount
Misstatements that are other#ise immaterial
may e material if they affect a trend in
earnings.
a.
.
c.
d.
Jes
Do
Jes
Do
Jes
Do
Do
Jes
!<.
medium
)llocating the preliminary @udgment aout materiality to financial statements segments is
necessary ecause:
a. evidence is accumulated for the financial statements as a #hole so materiality does not
apply to them.
. evidence is accumulated y segments rather than for the financial statements as a #hole.
c. it is re'uired y the )"C*)As Code of *rofessional Conduct.
d. it is re'uired y the 3?C.
!=. Chich of the follo#ing statements is not correct$
medium
c
a. ?ither an overstatement of an asset account or an understatement of a liaility account
#ould have the same effect on the income statement.
. ) misclassification in the alance sheet #ill have no effect on operating income.
c. ?ither an overstatement of an asset account or an overstatement of a liaility account
#ould have the same effect on the income statement.
d. ?ither an understatement of an asset account or an overstatement of a liaility account
#ould have the same effect on the income statement.
(:.
medium
Regardless of ho# the preliminary @udgment aout materiality is allocated, the auditor must e
confident that total comined misstatements in all accounts are:
d a. less than the preliminary @udgment.
. e'ual to the preliminary @udgment.
c. more than the preliminary @udgment.
d. less than or e'ual to the preliminary @udgment.
(1.
medium
)uditors fre'uently refer to the terms audit assurance, overall assurance, and level of assurance
to refer to 66666666.
c a. detection risk
. audit report risk
c. acceptale audit risk
d. inherent risk
(!.
medium
66666 misstatements are those #here the auditor can determine the amount of the misstatement
in the account.
c a. *otential
. &ikely
c. Fno#n
d. *ro@ected
((. Chen a different e-tent of evidence is needed for the various cycles, the difference is caused
y:
medium a. errors in the clientAs accounting system.
d . a clientAs need to achieve an un'ualified opinion.
c. an auditorAs need to follo# auditing standards.
d. an auditorAs e-pectations of errors and assessment of internal control.
Arens/Elder/Beasley
(.. "f planned detection risk is reduced, the amount of evidence the auditor accumulates #ill:
medium a. increase.
a . decrease.
c. remain unchanged.
d. e indeterminate.
(2. &ikely misstatements can result from:
Medium
a
Computation of the
sampling error for the
cash account
Eifferences et#een
managementAs and an
auditorAs @udgment aout
account alances
*ro@ections of
misstatements ased on
an auditorAs tests of a
sample from a
population
a. Do Jes Jes
. Jes Jes Do
c. Do Do Jes
d. Jes Do Do
(8. Chen discussing control risk +CR, and the audit risk model, #hich of the follo#ing is !alse$
medium

a. CR is a measure of the auditorAs assessment of the likelihood that misstatements #ill not
e prevented or detected y internal control.
. "f the auditor concludes that internal control is completely ineffective to prevent or detect
errors, heKshe #ould assign a lo# value +e.g., :T, to CR.
c. /he relationship et#een control risk and detection risk is inverse.
d. /he relationship et#een control risk and evidence needed to support account alances is
direct.
(;.
medium
Chich of the follo#ing is not a good indicator of the degree to #hich statements are relied on
y e-ternal users$
d a. ClientAs size, as measured y total assets or total revenue.
. Eistriution of o#nership among the pulic.
c. Dature and amount of liailities.
d. )mount of net income or loss after ta-es.
(<.
medium
"f an auditor elieves the chance of financial failure is high and there is a corresponding
increase in usiness risk for the auditor, acceptale audit risk #ould likely:
a a. e reduced.
. e increased.
c. remain the same.
d. e calculated using a computerized statistical package.
(=.
medium
Chen management has an ade'uate level of integrity for the auditor to accept the engagement
ut cannot e regarded as completely honest in all dealings, auditors normally:
a a. reduce acceptale audit risk and increase inherent risk.
. reduce inherent risk and control risk.
c. increase inherent risk and control risk.
d. increase acceptale audit risk and reduce inherent risk.
.:. 4ne accounting issue that does not re'uire management to use significant @udgments is:
medium a. the allo#ance for doutful accounts.
. the useful life of e'uipment for ta- purposes.
c. osolete inventory.
d. the liaility for #arranty payments.
.1. "nherent risk is often lo# for an account such as:
Arens/Elder/Beasley
medium a. inventory.
d . marketale securities.
c. cash.
d. accounts receivale.
.!. /he auditor typically does not assess control risk and inherent risk for:
medium a. each audit o@ective.
d . each cycle.
c. each account.
d. the overall audit.
.(. +*ulic, /o #hat e-tent do auditors typically rely on internal controls of their pulic company clients$
medium a. ?-tensively
a . 4nly very little
c. "nfre'uently
d. Dever
... )uditors typically rely on internal controls of their private company clients:
medium a. 4nly as needed to complete the audit and satisfy 3aranes-4-ley re'uirements.
. 4nly if the controls are determined to e effective.
c. 4nly if the client asks an auditor to test controls.
d. 4nly if the controls are sufficient to increase Control Risk to an acceptale level.
.2. )cceptale audit risk is ordinarily set y the auditor during planning and:
medium a. held constant for each ma@or cycle and account.
a . held constant for each ma@or cycle ut varies y account.
c. varies y each ma@or cycle and y each account.
d. varies y each ma@or cycle ut is constant y account.
.8.
medium
Chen the auditor is attempting to determine the e-tent to #hich e-ternal users rely on a clientAs
financial statements, they may consider several factors e-cept for:
d a. client size.
. concentration of o#nership.
c. types and amounts of liailities.
d. assessment of detection risk.
.;. ) ma@or difficulty in the application of the audit risk model is:
medium a. defining the terms of the model.
. measuring the components of the model.
c. understanding the effect on other factors in the model #hen one factor is changed.
d. the failure of the )udit 3tandards 7oard to accept it and incorporate it into standards.
.<. Chen setting a preliminary @udgment aout materiality:
medium a. more evidence is re'uired for a lo# dollar amount than for a high dollar amount.
a . less evidence is re'uired for a lo# dollar amount than for a high dollar amount.
c. the same amount of evidence is re'uired for either lo# or high dollar amounts.
d. there is no relationship et#een it and the dollar amount of evidence needed.
.=. Chen allocating materiality, most practitioners choose to allocate to:
challenging a. the income statement accounts ecause they are more important.
. the alance sheet accounts ecause there are fe#er.
c. oth alance sheet and income statement accounts ecause there could e errors on either.
d. all of the financial statements ecause there could e errors on other statements esides the
income statement and alance sheet.
2:. /he risk of material misstatement refers to:
challenging a. control risk and acceptale audit risk.
Arens/Elder/Beasley
c . inherent risk.
c. the comination of inherent risk and control risk.
d. inherent risk and audit risk.
21. )uditors may assess inherent risk and control risk:
medium
a
Lointly to determine the risk of
material misstatement
3eparately and comine their effects in the
audit risk model
a.
.
c.
d.
Jes
Do
Jes
Do
Jes
Do
Do
Jes
2!. Chich one of the follo#ing statements aout the cycle approach to auditing is not correct$
challenging a. /here are differences among cycles in the fre'uency and size of e-pected errors.
c . /here are differences among cycles in the effectiveness of internal controls.
c. /here are differences among cycles on the auditorAs #illingness to accept risk that material
errors e-ist after the auditing is complete.
d. "t is common for auditors to #ant an e'ually lo# likelihood of errors for each cycle after
the auditor is finished.
2(.
challenging
Chen the auditor has the same level of #illingness to risk that material misstatements #ill e-ist
after the audit is finished for all financial statement cycles:
a a. a different e-tent of evidence #ill likely e needed for various cycles.
. the same amount of evidence #ill e gathered for each cycle.
c. the auditor has not follo#ed generally accepted auditing standards.
d. the level for each cycle must e no more than !T so that the entire audit does not e-ceed
1:T.
2.. Chich of the follo#ing statements is not true$
challenging a. "nherent risk is inversely related to detection risk.
. "nherent risk is inversely related to evidence.
c. "nherent risk is the susceptiility of the financial statements to material error, assuming no
internal controls.
d. "nherent risk is the auditorAs assessment of the likelihood that errors e-ceeding a tolerale
amount e-ist in a segment efore considering the effectiveness of internal controls.
22. Chich of the follo#ing is not a primary consideration #hen assessing inherent risk$
challenging a. Dature of clientAs usiness.
c . ?-istence of related parties.
c. Bre'uency and intensity of managementAs revie# of accounting transactions and records.
d. 3usceptiility to defalcation.
28. Chich of the follo#ing is an e-ample of the concept of inherent risk$
challenging
c
a. Humans make more errors than computersP therefore, a manual accounting system is
riskier than a computerized system.
. )ccounting systems #ith vouchers have many more controls uilt in, so the risk that there
#ill e errors on the financial statements is reduced.
c. &oans receivale for a finance company are less likely to e collectile than those of a
ank.
d. )udits #ith larger sample sizes are less risky than those #ith smaller sample sizes.
2;. /olerale misstatement as set y the auditor:
challenging a. decreases acceptale audit risk.
d . increases inherent risk and control risk.
c. affects planned detection risk.
d. does not affect any of the four risks.
Arens/Elder/Beasley
2<.
challenging
Chich of the follo#ing underlies the application of generally accepted auditing standards,
particularly the standards of field#ork and reporting$
a a. /he elements of materiality and relative risk.
. /he element of internal control.
c. /he element of corroorating evidence.
d. /he element of reasonale assurance.
?ssay Questions
2=.
medium
Eiscuss the three main factors that affect an auditorAs preliminary @udgment aout materiality.
)ns#er:
/he three main factors that affect an auditorAs @udgment aout materiality are:
Materialit" is a relati%e rater tan an a#solute concept. ) misstatement of a
given size might e material for a small company, #hereas the same dollar
misstatement could e immaterial for a larger one.
0ases are needed for e%aluating materialit". 3ince materiality is relative, it is
necessary to have ases for estalishing #hether misstatements are material. Det
income efore ta-es is normally the most commonly used ase, ut other possile
ases include current assets, total assets, current liailities, and o#nersA e'uity.
9ualitati%e factors also affect materialit". Certain types of misstatements are
likely to e more important to users than others, even if the dollar amounts are the
same, such as misstatements involving frauds.
Arens/Elder/Beasley
8:.
medium
Eue to 'ualitative factors, certain types of misstatements are likely to e more important to
users than others, even if the dollar amounts are the same. "dentify t#o 'ualitative factors that
might significantly affect an auditorAs materiality @udgment, and give an e-ample of each.
)ns#er:
Qualitative factors that affect an auditorAs materiality @udgment include:
Amounts in%ol%ing fraud. )mounts involving fraud are usually considered
more important than unintentional errors of e'ual dollar amounts ecause fraud
reflects on the honesty and reliaility of the management or other personnel involved.
Bor e-ample, an intentional misstatement of inventory #ould e more important to
users than a clerical error in inventory of the same amount.
Misstatements affecting contractual o#ligations. Misstatements that are
other#ise minor may e material if there are possile conse'uences arising from
contractual oligations. Bor e-ample, if a misstatement causes a re'uired minimum
account alance to e-ceed the minimum, #hen the correct alance is less than the
minimum, this misstatement likely #ould e important to users.
Profit %s. loss. Misstatements that cause a loss to e reported as a profit or
misstatements that affect trends in earnings are likely to e important to users.
81.
medium
?-plain #hy it is necessary to allocate the preliminary @udgment aout materiality to individual
accounts +segments, in the financial statements. )lso e-plain #hy allocating to alance sheet
accounts is more common than allocating to income statement accounts.
)ns#er:
)llocating the preliminary @udgment aout materiality to individual accounts is
necessary ecause evidence is accumulated for accounts rather than for the financial
statements as a #hole. )llocating to accounts estalishes a tolerale misstatement
amount for each account, #hich helps the auditor decide the appropriate audit evidence
to accumulate for each account. Most practitioners allocate materiality to alance sheet
accounts rather than income statement accounts ecause there are fe#er alance sheet
than income statement accounts.
8!.
medium
Chy do most practitioners allocate the preliminary @udgment aout materiality to alance sheet
accounts$
)ns#er:
Most income statement misstatements have an e'ual effect on the alance sheet ecause of
the doule-entry ookkeeping system. 7ecause there are fe#er alance sheet accounts than
income statement accounts in most audits and most audit procedures focus on alance
sheet accounts, allocating materiality to alance sheet accounts is the most appropriate
alternative.
8(.
medium
Eiscuss ho# auditors use the audit risk model #hen planning an audit.
)ns#er:
/he audit risk model is used primarily for planning purposes in deciding ho# much
evidence to accumulate in each cycle. /he auditor decides an acceptale level of audit
risk, assesses inherent risk and control risk, and then uses the relationship depicted in
the follo#ing model to determine an appropriate level for planned detection risk:
*ER V ))R
"R - CR
Arens/Elder/Beasley
8..
medium
Eescrie the audit risk model and each of its components.
)ns#er:
/he planning form of the audit risk model is stated as follo#s:
*ER V ))R
"R - CR
#here: *ER V planned detection risk
))R V acceptale audit risk
"R V inherent risk
CR V control risk
*lanned detection risk is a measure of the risk that audit evidence for an account #ill
fail to detect misstatements e-ceeding a tolerale amount, should such misstatements
e-ist. *lanned detection risk determines the amount of sustantive evidence that the
auditor plans to accumulate.
)cceptale audit risk is a measure of ho# #illing the auditor is to accept that the
financial statements may e materially misstated after the audit is completed and an
un'ualified opinion has een issued. "t is influenced primarily y the degree to #hich
e-ternal users #ill rely on the statements, the likelihood that a client #ill have financial
difficulties after the audit report is issued, and the auditorAs evaluation of
managementAs integrity.
"nherent risk is a measure of the auditorAs assessment of the likelihood that there are
material misstatements in an account efore considering the effectiveness of internal
control.
Control risk is a measure of the auditorAs assessment of the likelihood that
misstatements e-ceeding a tolerale amount in an account #ill not e prevented or
detected y the clientAs internal controls.
82.
medium
/here are several factors that affect an audit firmAs usiness risk and, therefore, acceptale audit
risk. Eiscuss three of these factors.
)ns#er:
7usiness risk and acceptale audit risk are affected y:
-e degree to )ic external users )ill rel" on te statements. Bor large,
pulicly held clients, usiness risk is greater, and acceptale audit risk #ill e less,
than for small, privately held clients, all things eing e'ual.
-e likeliood tat a client )ill a%e financial difficulties after te audit report
is issued. 7usiness risk is greater, and acceptale audit risk #ill e lo#er, #hen the
client is e-periencing financial difficulties.
-e auditor/s e%aluation of management/s integrit". 7usiness risk is greater
and acceptale audit risk #ill e lo#er #hen the clientAs management has
'uestionale integrity.
Arens/Elder/Beasley
88.
challenging
Eiscuss each of the five steps in applying materiality in an audit, and identify the audit phase+s,
in #hich each step is performed. &ist these steps in the order in #hich they occur.
)ns#er:
Step 3. Set preliminar" $udgment a#out materialit". /his is the comined amount of
misstatements in the financial statements that #ould e considered material. /his decision
is made in the planning stage of the audit.
Step :. Allocate preliminar" $udgment a#out materialit" to segments. "n this step, the
auditor normally allocates the preliminary @udgment aout materiality to the alance sheet
accounts. /he amount of materiality allocated to an account is referred to as that accountAs
tolerale misstatement. /his allocation is performed in the audit planning stage.
Step 4. Estimate total misstatement in segment. "n this step, the auditor pro@ects the sample
results to the population. )n allo#ance for sampling risk is also calculated. /his #ould e
performed after the sustantive tests for each account are completed.
Step ;. Estimate te com#ined misstatement. "n this step, the pro@ected errors for each
account are added, along #ith total sampling error, to calculate the comined
misstatement. /his #ould e performed after all sustantive tests have een completed.
Step <. Compare com#ined estimated misstatement )it preliminar" or re%ised $udgment
a#out materialit". "f the comined estimated misstatement is less than or e'ual to the
@udgment aout materiality, then the auditor concludes the financial statements are fairly
presented. /his #ould e performed after all sustantive tests have een completed, in the
final revie# stage of the audit.
4ther 4@ective )ns#er Bormat Questions
8;.
easy
7elo# are four situations that involve the audit risk model as it is used for planning audit
evidence re'uirements in the audit of inventory. Bor each situation, calculate planned detection
risk.
3"/>)/"4D
1 ! ( .
)cceptale audit risk 1T 1:T 1:T 2T
"nherent risk 1::T 1::T 2:T !:T
Control risk 1::T 1::T .:T (:T
*lanned detection risk 666666 666666 666666 666666
)ns#er: 1. 1TP !. 1:TP (. 2:TP .. <(.(T
Arens/Elder/Beasley
8<.
easy
>sing your kno#ledge of the relationships among acceptale audit risk, inherent risk, control
risk, planned detection risk, tolerale misstatement, and planned evidence, state the effect on
planned evidence +increase or decrease, of changing each of the follo#ing factors, #hile the
other factors remain unchanged.
decrease 1. )n increase in acceptale audit risk. .
increase !. )n increase in inherent risk. .
decrease (. ) decrease in control risk. .
decrease .. )n increase in planned detection risk. .
decrease 2. )n increase in tolerale misstatement. .
8=. Match nine of the terms +a-i, #ith the definitions provided elo# +1-=,:
medium
a. 7usiness risk
. *reliminary @udgment aout materiality
c. "nherent risk
d. *lanned detection risk
e. )udit assurance
f. )cceptale audit risk
g. /olerale misstatement
h. Control risk
i. Materiality
d 1. ) measure of the risk that audit evidence for a segment #ill fail to detect
misstatements e-ceeding a tolerale amount, should such misstatements e-ist.
a !. /he risk that the auditor or audit firm #ill suffer harm ecause of a client
relationship, even though the audit report rendered for the client #as correct.
h (. ) measure of the auditorAs assessment of the likelihood that misstatements
e-ceeding a tolerale amount in a segment #ill not e prevented or detected y
the clientAs internal controls.
f .. ) measure of ho# much risk the auditor is #illing to take that the financial
statements may e materially misstated after the audit is completed and an
un'ualified audit opinion has een issued.
g 2. /he materiality allocated to any given account alance.
8. /he ma-imum amount y #hich the auditor elieves that the statements could
e misstated and still not affect the decisions of reasonale users.
e ;. /his term is synonymous #ith acceptale audit risk.
i <. /he magnitude of an omission or misstatement of accounting information that
makes it proale that the @udgment of a reasonale person #ould have een
changed.
c =. ) measure of the auditorAs assessment of the likelihood that there are material
misstatements efore considering the effectiveness of internal control.
Arens/Elder/Beasley
;:.
medium
"n practice, auditors rarely assign numerical proailities to inherent risk, control risk, or
acceptale audit risk. "t is more common to assess these risks as high, medium, or lo#. Bor each
of the four situations elo#, fill in the lanks for planned detection risk and the amount of
evidence you #ould plan to gather +0planned evidence1, using the terms high, medium, or lo#.
3"/>)/"4D
1 ! ( .
)cceptale audit risk &o# &o# High High
"nherent risk High &o# &o# &o#
Control risk High &o# Medium &o#
*lanned detection risk 666666 666666 666666 666666
*lanned evidence 666666 666666 666666 666666
)ns#er: 1. lo#, high
!. medium, medium
(. medium, medium
.. high, lo#
;1.
easy
a
/he auditorAs preliminary @udgment aout materiality is the ma-imum amount y #hich the
auditor elieves the financial statements could e misstated and still not affect the decisions of
reasonale users.
a. /rue
. Balse
;!.
easy
a
/here is no precise definition of materiality in the professional literature.
a. /rue
. Balse
;(.
easy

/he B)37 definition of materiality focuses on potential users of financial statements.

a. /rue
. Balse
;..
easy
a
Det income efore ta-es is normally the most important ase for deciding materiality.
a. /rue
. Balse
;2.
easy

Most practitioners allocate the preliminary @udgment aout materiality to income statement
accounts.
a. /rue
. Balse
;8.
easy
a
/he primary purpose of allocating the preliminary @udgment aout materiality to financial
statement accounts is to help the auditor decide the appropriate evidence to accumulate.
a. /rue
. Balse
Arens/Elder/Beasley
;;.
easy

)uditors cannot use prior year financial statement alances to estalish their preliminary
@udgment aout materiality in planning the current yearAs audit.
a. /rue
. Balse
;<.
easy

"f acceptale audit risk is lo#, and inherent risk and control risk are oth high, then planned
detection risk should e high.
a. /rue
. Balse
;=.
easy
a
"nherent risk and planned detection risk are inversely relatedP i.e., as inherent risk increases,
planned detection risk should decrease, ceteris pari#us.
a. /rue
. Balse
<:.
easy

)cceptale audit risk and planned detection risk are inversely relatedP i.e., as acceptale audit
risk increases, planned detection risk should decrease, ceteris pari#us.
a. /rue
. Balse
<1.
easy

/he most important element of the audit risk model is control risk.
a. /rue
. Balse
<!.
easy

Bor a private company client, auditors are re'uired to test any internal controls they elieve
have not een operating effectively during the period under audit.
a. /rue
. Balse
<(.
easy
a
"f an auditor elieves the client #ill have financial difficulties after the audit report is issued,
and e-ternal users #ill e relying heavily on the financial statements, the auditor #ill proaly
set acceptale audit risk as lo#.
a. /rue
. Balse
<..
medium

)chieved detection risk can e reduced only y accumulating more audit evidence.
a. /rue
. Balse
<2.
medium
a
)uditors have difficulty applying the concept of materiality in practice ecause they often do
not kno# #ho the users of the financial statements are or #hat decisions #ill e made.
a. /rue
. Balse
<8.
medium

/he audit risk model that must e used for planning audit procedures and evaluating audit
results is: )c)R V "R - CR - )cER.
a. /rue
. Balse
Arens/Elder/Beasley
<;.
medium

3tatements on )uditing 3tandards provide detailed, o@ective guidance on ho# auditors are to
estalish a preliminary materiality level, thus eliminating the need for su@ective auditor
@udgment in this task.
a. /rue
. Balse
<<.
medium

"f the preliminary @udgment of materiality increases, the amount of audit evidence re'uired #ill
also increase.
a. /rue
. Balse
<=.
medium

"nsert risk and control risk are normally assessed for the overall audit.
a. /rue
. Balse
=:.
medium

/olerale misstatement is the ma-imum comined total of all misstatements in the financial
statements that the auditor is #illing to allo#, or tolerate, #hen issuing a standard un'ualified
opinion.
a. /rue
. Balse
=1.
medium
a
"f an auditor assigns a tolerale misstatement of 91,::: to accounts payale, he or she #ould
need to otain more audit evidence for that account than if 91::,::: had een assigned.
a. /rue
. Balse
=!.
medium
a
/o ma-imize audit efficiency, the auditor should allocate less tolerale misstatement to
accounts that can e verified y using lo#-cost audit procedures, such as analytical procedures,
than to accounts that are more costly to audit.
a. /rue
. Balse
=(.
medium

/o ma-imize audit effectiveness, the auditor should estalish a high preliminary @udgment
aout materiality and allocate most of the amount to alance sheet accounts.
a. /rue
. Balse
=..
medium
a
)cceptale audit risk and the amount of sustantive evidence re'uired are inversely related.
a. /rue
. Balse
=2.
medium
a
)s control risk increases, the amount of sustantive evidence the auditor plans to accumulate
should increase.
a. /rue
. Balse
=8.
medium

"nherent risk and control risk are directly related.

a. /rue
. Balse
Arens/Elder/Beasley
=;.
medium
a
)n acceptale audit risk assessment of lo# indicates a risky client re'uiring more e-tensive
evidence, assignment of more e-perienced personnel, andKor a more e-tensive revie# of audit
files.
a. /rue
. Balse
=<.
medium
a
?ngagement risk is effectively the audit firmAs usiness risk.
a. /rue
. Balse
==.
medium

)udit assurance is the complement of planned detection risk, that is, one minus planned
detection risk.
a. /rue
. Balse
Chapter 1"
Multiple-Choice Questions
1. Chich of the follo#ing is responsile for estalishing a private companyAs internal control$
easy a. Management.
a . )uditors.
c. Management and auditors.
d. Committee of 3ponsoring 4rganizations.
!. Chich of the follo#ing is not one of the three primary o@ectives of effective internal control$
easy a. Reliaility of financial reporting
d . ?fficiency and effectiveness of operations
c. Compliance #ith la#s and regulations
d. )ssurance of elimination of usiness risk.
(. +*ulic, /he *ulic Company )ccounting 4versight 7oard states that reasona#le assurance allo#s a:
easy a. small likelihood of ineffective internal controls.
. remote likelihood that material misstatements #ill not e prevented or detected y
internal control.
c. likelihood that material misstatements #ill not e prevented or detected y internal
control.
d. high likelihood that material misstatements #ill not e prevented or detected y
internal control.
..
easy
/#o key concepts that underlie managementAs design and implementation of internal control
are:
c a. costs and materiality.
. asolute assurance and costs.
c. inherent limitations and reasonale assurance.
d. collusion and materiality.
2. "nternal controls can never e considered as asolutely effective ecause:
easy a. their effectiveness is limited y the competency and dependaility of employees.
Arens/Elder/Beasley
a . not all organizations have internal audit departments.
c. controls are designed to prevent and detect only material misstatements.
d. internal controls prevent separation of duties.
8. ) ma@or control availale in a small company, #hich might not e feasile in a ig company,
is:
easy a. a #ider segregation of duties.
d . a voucher system.
c. fe#er transactions to process.
d. the o#ner-managerAs personal interest and close relationship #ith personnel.
;. +*ulic, Chich of the follo#ing is responsile for estalishing internal controls for a pulic company$
easy a. Management.
a . /he *C)47.
c. Management and auditors.
d. Committee of 3ponsoring 4rganizations.
<.
medium
Chich of the follo#ing parties provides an assessment of the effectiveness of internal control
over financial reporting for pulic companies$
a
Management Binancial statement auditors
a. Jes Jes
. Do Do
c. Jes Jes
d. Do Do
=. )n act of t#o or more employees to steal assets or misstate records is fre'uently referred to as:
easy a. collusion.
a . a material #eakness.
c. a control deficiency.
d. a significant deficiency.
1:.
easy
Chen the auditor attempts to understand the operation of the accounting system y tracing a
fe# transactions through the accounting system, the auditor is said to e:
c a. tracing.
. vouching.
c. performing a #alk-through.
d. testing controls.
11. +345,
easy
Chich section of the 3aranes-4-ley )ct re'uires management to issue an internal control
report$
c a. !:!
. !:(
c. .:.
d. .:<
1!. +345,
easy
3aranes-4-ley re'uires management to issue an internal control report that includes t#o
specific items. Chich of the follo#ing is one of these t#o re'uirements$
a a. ) statement that management is responsile for estalishing and maintaining an ade'uate
internal control structure and procedures for financial reporting.
. ) statement that management and the oard of directors are @ointly responsile for
estalishing and maintaining an ade'uate internal control structure and procedures for
financial reporting.
c. ) statement that management, the oard of directors, and the e-ternal auditors are @ointly
responsile for estalishing and maintaining an ade'uate internal control structure and
procedures for financial reporting.
Arens/Elder/Beasley
d. ) statement that the e-ternal auditors are solely responsile.
1(. +345,
easy
Chen management is evaluating the design of internal control, management evaluates #hether
the control can do #hich of the follo#ing$
c
Eetect material misstatements Correct material misstatements
a.
.
c.
d.
Jes
Do
Jes
Do
Jes
Do
Do
Jes
1.. +345,
easy

"nternal control reports issued y pulic companies must identify the frame#ork used to
evaluate the effectiveness of internal control. Chich of the follo#ing is the most common
frame#ork in the >.3.$
a. ?ffective "nternal Control Brame#ork - )"C*)
. "nternal Control - "ntegrated Brame#ork - C434
c. ?nterprise "nternal Control - C434
d. ?nterprise "nternal Control - )"C*)
12. +*ulic,
easy
Chen one material #eakness is present at the end of the year, management of a pulic
company must conclude that internal control over financial reporting is:
c a. insufficient.
. inade'uate.
c. ineffective.
d. inefficient.
18. +*ulic,
easy
/he auditorAs tests to understand the clientAs internal controls might include #hich of the
follo#ing types of procedures$
a
4servation of employees "n'uiries of personnel
a. Jes Jes
. Do Do
c. Jes Do
d. Do Jes
1;.
easy
Chich of managementAs concerns #ith respect to implementing internal controls is the auditor
primarily concerned$
a. ?fficiency of operations.
. Reliaility of financial reporting.
c. ?ffectiveness of operations.
d. Compliance #ith applicale la#s and regulations.
1<.
easy
Chich of the follo#ing activities #ould e least likely to strengthen a companyAs internal
control$
a. 3eparating accounting from other financial operations.
. Maintaining insurance for fire and theft.
c. Bi-ing responsiility for the performance of employee duties.
d. Carefully selecting and training employees.
1=. +*ulic, Management must disclose material #eaknesses in internal control:
medium a. #henever the #eakness is deemed significant to a single class of transactions.
c . #henever the #eakness is significant to overall financial reporting o@ectives.
c. if the #eakness e-ists at the end of the year.
d. only if the auditor identifies the #eakness as significant.
!:.
easy
Chen auditing a private company, the auditor should otain an understanding of internal
control sufficient to:
Arens/Elder/Beasley
a. provide reasonale protection against client fraud and defalcations y client employees.
. assess control risk.
c. provide a asis for suggestions to the client for improving the accounting system.
d. provide a method for safeguarding assets, checking the accuracy and reliaility of
accounting data, promoting operational efficiency, and encouraging adherence to
prescried managerial policies.
!1. +*ulic, /he initial presumption in the audit of a pulic company is that control risk is:
medium a. lo#.
a . moderate.
c. high.
d. lo# or moderate, ut not high.
!!. "n the audit of a private company, the auditor #ill test controls #hen control risk is initially
assessed at:
medium
c &o# Moderate High
a. Jes Do Jes
. Do Do Jes
c. Jes Jes Do
d. Do Jes Do
!(. +*ulic, /he auditorAs study of a pulic companyAs internal control is:
medium a. re'uired y %))3.
c . re'uired y the )"C*).
c. re'uired y the 3aranes-4-ley )ct.
d. recommended y the )"C*).
!.. /he auditorAs consideration of a private companyAs internal control is:
medium a. re'uired y %))*.
. re'uired y %))3.
c. re'uired y the "R3.
d. recommended y the 3?C.
!2.
medium
"nternal controls can never e regarded as completely effective. ?ven if company personnel
could design an ideal system, its effectiveness depends on the:
d a. ade'uacy of the computer system.
. proper implementation y management.
c. aility of the internal audit staff to maintain it.
d. competency and dependaility of the people using it.
!8.
medium
?ven #ith the most effectively designed internal control, the auditor must otain audit
evidence, eyond testing the controls, for every:
c a. transaction.
. financial statement account.
c. material financial statement account.
d. financial statement account that #ill e relied upon y third parties.
!;. /he essence of an effectively controlled organization lies in the:
medium a. effectiveness of its independent auditor.
d . effectiveness of its internal auditor.
c. attitude of its employees.
d. attitude of its management.
!<. +*ulic,
medium
/o issue a report on internal control over financial reporting for a pulic company, an auditor
must:
c a. evaluate managementAs assessment process.
Arens/Elder/Beasley
. independently assess the design and operating effectiveness of internal control.
c. evaluate managementAs assessment process and independently assess the design and
operating effectiveness of internal control.
d. test controls over significant account alances.
!=. +*ulic,
medium
Chich of the stock e-changes re'uire listed companies to have an audit committee composed
entirely of independent directors$
a
DJ3? D)3E)Q
a. Jes Jes
. Do Do
c. Jes Do
d. Do Jes
(:. Chich of the follo#ing factors may increase risks to an organization$
Medium
a %eographic dispersion of
company operations *resence of ne# information technologies
a. Jes Jes
. Do Do
c. Jes Do
d. Do Jes
(1. Chich of the follo#ing statements is correct #ith respect to separation of duties$
medium a. ?mployees should not have temporary and permanent custody of assets.
. ?mployees #ho authorize transactions should not have custody of related assets.
c. "t is permissile to allo# an employee to open cash receipts and record those receipts.
d. ?mployees #ho authorize transactions should have recording responsiility for these
transactions.
(!.
medium
)uthorizations can e either general or specific. Chich of the follo#ing is not an e-ample of a
general authorization$
a. )utomatic reorder points for ra# materials inventory.
. ) sales managerAs authorization for a sales return.
c. Credit limits for various classes of customers.
d. ) sales price list for merchandise.
((. /he most important type of protective measure for safeguarding assets is:
medium a. ade'uate separation of duties among personnel.
c . proper authorization of transactions.
c. the use of physical precautions.
d. ade'uate documentation.
(.. Chich of the follo#ing is correct #ith respect to the design and use of usiness documents$
medium a. Dot all documents used for internal purposes need to e prenumered.
a . Eocuments should e designed for single purposes only to avoid confusion in their use.
c. Eocuments should e designed to e understandale only y those #ho use them.
d. Eocuments designed for e-ternal use must e prenumered.
(2. +*ulic,
medium
*C)47 3tandard ! re'uires auditors to evaluate the effectiveness of the audit committeeAs
oversight of the companyAs:
a
?-ternal financial
reporting
?fficiency of
operations
"nternal control over financial
reporting
a. Jes Do Jes
. Do Do Jes
Arens/Elder/Beasley
c. Jes Jes Do
d. Do Jes Do
(8. Chich of the follo#ing is correct$
medium a. )pproval is a policy decision implemented y employees.
c . )pproval occurs as a matter of general policy and includes significant transactions only.
c. )uthorization is a policy decision for either a general class of transactions or specific
transactions.
d. )pproval should e given y the employee responsile for recording the transaction.
(;.
medium
Chich of the follo#ing principles is not necessary for the proper design and use of documents
and records$
a a. Eesigned for a single use to increase efficiency of operations.
. Constructed in a manner that encourages correct preparation.
c. *repared at the time a transaction takes place.
d. Eesigned for multiple uses to increase efficiency of operations.
(<. Darratives, flo#charts, and internal control 'uestionnaires are three common methods of:
medium a. testing the internal controls.
. documenting the auditorAs understanding of internal controls.
c. designing the audit manual and procedures.
d. documenting the auditorAs understanding of a clientAs organizational structure.
(=.
medium
66666 deal #ith ongoing or periodic assessment of the 'uality of internal control y
management.
a. Quality monitoring activities
. Monitoring activities
c. 4versight activities
d. Management activities
.:. +*ulic,
medium
3maller pulic companies face challenges implementing effective internal control due to
666666.
c a. a lack of e-pertise
. reduced importance
c. limited resources
d. limited availale guidance
.1. Chich of the follo#ing is not one of the levels of an asence of internal controls$
medium a. Ma@or deficiency.
a . Material #eakness.
c. 3ignificant deficiency.
d. Control deficiency.
.!. Chich of the follo#ing is the correct definition of 0control deficiency$1
medium
a
a. ) control deficiency e-ists if the design or operation of controls does not permit company
personnel to prevent or detect misstatements on a timely asis.
. ) control deficiency e-ists if one or more deficiencies e-ist that adversely affect a
companyAs aility to prepare e-ternal financial statements relialy.
c. ) control deficiency e-ists if the design or operation of controls results in a more than
remote likelihood that controls #ill not prevent or detect misstatements.
d. ) control deficiency e-ists if the design or operation of controls results in a more than
proale likelihood that controls #ill prevent or detect misstatements.
.(. )+n, 6666666 deficiency e-ists if a necessary control is missing or not properly formulated.
medium a. control
c . significant
c. design
Arens/Elder/Beasley
d. operating
...
medium
/o determine if significant internal control deficiencies are material #eaknesses, they must e
evaluated on their:
a
&ikelihood 3ignificance
a. Jes Jes
. Do Do
c. Jes Do
d. Do Jes
.2. /he purpose of an entityAs accounting information and communication system is to 666666.
medium
d
Monitor
transactions
Record and
process
transactions "nitiate transactions
a. Jes Jes Jes
. Do Do Do
c. Jes Do Do
d. Do Jes Jes
.8.
medium
) procedure that #ould most likely e used y an auditor in performing tests of control
procedures that involve segregation of functions and that leave no transaction trail is:
a. inspection.
. oservation.
c. reperformance.
d. reconciliation.
.;.
medium
"f the results of tests of controls support the design and operations of controls as e-pected, the
auditor uses 6666 control risk as the preliminary assessment.
a. a lo#er
. the same
c. a higher
d. either a lo#er or higher
.<. "nternal controls normally include procedures designed to provide reasonale assurance that:
medium a. employees act #ith integrity #hen performing their assigned tasks.
. transactions are e-ecuted in accordance #ith managementAs authorization.
c. decision processes leading to managementAs authorization of transactions are sound.
d. collusive activities #ould e detected y segregation of employee duties.
.=. Chich of the follo#ing is correct$
medium a. ) significant deficiency is al#ays a material #eakness.
d . ) control deficiency is al#ays a material #eakness.
c. ) material #eakness is less significant that a control deficiency.
d. ) material #eakness is al#ays a significant deficiency.
2:.
medium
Chich of the follo#ing is not a likely procedure to support the operating effectiveness of
internal controls$
d a. "n'uiry of client personnel.
. 4servation of control-related activities.
c. Reperformance of client procedures.
d. Completing an internal control 'uestionnaire.
21. +*ulic,
medium
7efore making the final assessment of internal control at the end of an integrated audit, the
auditor must:
a
Arens/Elder/Beasley
/est controls *erform sustantive tests of details
a. Jes Jes
. Do Do
c. Jes Do
d. Do Jes
2!. +*ulic,
medium
3ignificant deficiencies and material #eaknesses in internal control of a pulic company must
e reported to #hich of the follo#ing$
c a. /he *ulic Company )ccounting 4versight 7oard.
. Memers of management #ho are responsile for the related area of the company.
c. )udit committee of the companyAs oard of directors.
d. /he )"C*).
2(. 4f the follo#ing statements aout internal controls, #hich one is not valid$
medium
d
a. Do one person should e responsile for the custodial responsiility and the recording
responsiility for an asset.
. /ransactions must e properly authorized efore such transactions are processed.
c. 7ecause of the cost-enefit relationship, a client may apply controls on a test asis.
d. Control procedures reasonaly ensure that collusion among employees cannot occur.
2..
medium
Chich of the follo#ing est descries the inherent limitations that should e recognized y an
auditor #hen considering the potential effectiveness of internal control$
a a. *rocedures that depend on segregation of duties can e circumvented y collusion.
. Competent and honest client personnel provide an environment conducive to accounting
control and provide asolute assurance that effective control #ill e achieved.
c. *rocedures designed to assure the e-ecution and recording of transactions in accordance
#ith proper authorizations are effective against irregularities perpetrated y management.
d. /he enefits e-pected to e derived from effective internal accounting control usually do
not e-ceed the costs of such control.
22. Chich of the follo#ing is not one of the sucomponents of the control environment$
medium a. ManagementAs philosophy and operating style.
c . 4rganizational structure.
c. )de'uate separation of duties.
d. Commitment to competence.
28.
medium
"t is important for the C*) to consider the competence of the clientsA personnel ecause their
competence ears directly and importantly upon the:
a. costKenefit relationship of the system of internal control.
. achievement of the o@ectives of internal control.
c. comparison of recorded accountaility #ith assets.
d. timing of the tests to e performed.
2;. )udit evidence concerning proper segregation of duties normally is est otained y:
medium a. direct personal oservation of the employee #ho applies control procedures.
a . making in'uiries of co-#orkers aout the employee #ho applies control procedures.
c. preparation of a flo#chart of duties performed and availale personnel.
d. inspection of third-party documents containing the initials of #ho applied control
procedures.
2<. *roper segregation of functional responsiilities calls for separation of:
medium a. authorization, e-ecution, and payment.
. authorization, recording, and custody.
c. custody, e-ecution, and reporting.
d. authorization, payment, and recording.
2=. "nternal controls are not designed to provide reasonale assurance that:
Arens/Elder/Beasley
medium a. all frauds #ill e eliminated.
a . transactions are e-ecuted in accordance #ith managementAs authorization.
c. access to assets is permitted only in accordance #ith managementAs authorization.
d. company personnel comply #ith applicale rules and regulations.
8:.
medium
Chich of the follo#ing statements aout auditor documentation of the clientAs internal controls
is correct$
d a. Eocumentation must include flo# charts.
. Eocumentation must include procedural #rite-ups.
c. Do documentation is necessary although it is desirale.
d. Do one particular form of documentation is necessary.
81.
medium
3ignificant deficiencies are matters that come to an auditorAs attention and should e
communicated to an entityAs audit committee ecause they represent:
a. material frauds perpetrated y high-level management.
. internal control deficiencies that could adversely affect a companyAs aility to initiate,
record, process, or report e-ternal financial statements relialy.
c. flagrant violations of the entityAs documented conflict-of-interest policies.
d. intentional attempts y client personnel to limit the scope of the auditorAs field #ork.
8!.
medium
Ho# must significant deficiencies and material #eaknesses e communicated to those charged
#ith governance$
c a. ?ither oral or #ritten communication is acceptale.
. 4ral communication is re'uired.
c. Critten communication is re'uired.
d. Critten communication is re'uired for material #eaknesses, ut oral communication is
allo#ed for significant deficiencies.
8(.
challenging
a
Chich of the follo#ing statements, if any, is correct$
a. /he D)3E)Q market re'uires listed companies to have audit committees that have only
independent directors.
. /he D)3E)Q market re'uires listed companies to have audit committees that have a
minority of the positions held y independent directors.
c. /he D)3E)Q market recommends, ut does not re'uire, listed companies to have audit
committees.
d. /he D)3E)Q market recommends, ut does not re'uire, listed companies to have audit
committees that have a minority of the positions held y independent directors.
8.. +345, /he 3aranes-4-ley )ct re'uires:
challenging a. all pulic companies to issue reports on internal controls.
a . all pulic companies to define ade'uate internal controls.
c. the auditor of pulic companies to design effective "CBR.
d. the auditor of pulic companies to provide recommendations to correct material
#eaknesses.
82.
challenging
Chen considering internal control, an auditor should e a#are of the concept of reasonale
assurance, #hich recognizes that the:
d a. segregation of incompatile functions is necessary to ascertain that internal control is
effective.
. employment of competent personnel provides assurance that the o@ectives of internal
control #ill e achieved.
c. estalishment and maintenance of internal control is an important responsiility of the
management and not of the auditor.
d. costs of internal control should not e-ceed the enefits e-pected to e derived from
internal control.
88. /he financial statements are not likely to correctly reflect %))* if the:
Arens/Elder/Beasley
challenging a. controls affecting the reliaility of financial reporting are inade'uate.
a . companyAs controls do not promote efficiency.
c. companyAs controls do not promote effectiveness.
d. companyAs control do not promote compliance #ith applicale rules and regulations.
8;. /he primary emphasis y auditors is on controls over:
challenging a. classes of transactions.
a . account alances.
c. oth a and , ecause they are e'ually important.
d. oth a and , ecause they vary from client to client.
8<.
challenging
Compared to a pulic company, the most important difference in a nonpulic company in
assessing control risk is the aility to assess control risk at 6666666 for any or all control-
related o@ectives.
d a. lo#
. moderately lo#
c. medium
d. high
8=.
challenging
)n auditor should consider t#o key issues #hen otaining an understanding of a clientAs
internal controls. /hese issues are:
c a. the effectiveness and efficiency of the controls.
. the fre'uency and effectiveness of the controls.
c. the design and utilization of the controls.
d. /he implementation and efficiency of the controls.
;:.
challenging
/he independent auditor should ac'uire an understanding of the internal audit function as it
relates to the independent auditorAs study and evaluation of internal control ecause the:
c a. audit programs, #orking papers, and reports of internal auditors can often e used as a
sustitute for the #ork of the independent auditorAs staff.
. procedures performed y the internal audit staff may eliminate the independent auditorAs
need for an e-tensive study and evaluation of internal control.
c. #ork performed y internal auditors may e a factor in determining the nature, timing,
and e-tent of the independent auditorAs procedures.
d. understanding of the internal audit function is an important sustantive test to e
performed y the independent auditor.
;1. /o e effective, an internal audit department must e independent of:
challenging a. operating departments.
c . the accounting department.
c. oth a and .
d. either a or , ut not oth.
;!.
challenging
d
Hanlon Corp. maintains a large internal audit staff that reports directly to the chief financial
officer. )udit reports prepared y the internal auditors indicate that the system is functioning as
it should and that the accounting records are reliale. )n independent auditor #ill proaly:
a. eliminate tests of controls.
. increase the depth of the study and evaluation of administrative controls.
c. avoid duplicating the #ork performed y the internal audit staff.
d. place limited reliance on the #ork performed y the internal audit staff.
;(.
challenging
?-ternal financial statement auditors must otain evidence regarding #hat attriutes of an
internal audit +"), department if the e-ternal auditors intend to rely on ")As #ork$
d a. "ntegrity
. 4@ectivity
c. Competence
d. )ll of the aove
Arens/Elder/Beasley
;.. Chen planning an audit, the auditorAs assessed level of control risk is:
challenging a. determined y using actuarial tales.
c . calculated y using the audit risk model.
c. an economic issue, trading off the costs of testing controls against the cost of testing
alances.
d. calculated y using the formulas provided in the )"C*)As auditing standards.
;2. Chen a compensating control e-ists, the asence of a key control:
challenging
a
a. is no longer a concern ecause there is no longer a significant deficiency or material
#eakness.
. is still a ma@or concern to the auditor.
c. could cause a material loss, so it must e tested using sustantive procedures.
d. is magnified and must e removed from the sampling process and e-amined in its
entirety.
;8.
challenging
)fter considering a clientAs internal controls, an auditor has concluded that it is #ell designed
and is functioning as intended. >nder these circumstances the auditor #ould most likely:
c a. perform tests of controls to the e-tent outlined in the audit program.
. determine the control procedures that should prevent or detect errors and irregularities.
c. not increase the e-tent of predetermined sustantive tests.
d. determine #hether transactions are recorded to permit preparation of financial statements
in conformity #ith generally accepted accounting principles.
;;.
challenging
a
/o otain an understanding of an entityAs control environment, an auditor should concentrate
on the sustance of managementAs policies and procedures rather than their form ecause:
a. management may estalish appropriate policies and procedures ut not act on them.
. the oard of directors may not e a#are of managementAs attitude to#ard the control
environment.
c. the auditor may elieve that the policies and procedures are inappropriate for that
particular entity.
d. the policies and procedures may e so #eak that no reliance is contemplated y the
auditor.
?ssay Questions
;<.
medium
Eescrie each of the three road o@ectives management typically has for internal control. Cith
#hich of these o@ectives is the auditor primarily concerned$
)ns#er:
/he three o@ectives are:
Reliaility of financial reporting. Management has oth a legal and
professional responsiility to e sure that the information is fairly presented in
according #ith reporting re'uirements such as %))*.
?fficiency and effectiveness of operations. Controls #ithin an organization
are meant to encourage efficient and effective use of its resources to optimize the
companyAs goals.
Compliance #ith la#s and regulations. *ulic and non-pulic organizations
are re'uired to follo# many la#s and regulations. 3ome relate to accounting only
indirectly, such as environmental protection and civil rights la#s. 4thers are closely
related to accounting, such as income ta- regulations and fraud.
/he auditor is primarily concerned #ith the o@ective of reliale financial reporting.
Arens/Elder/Beasley
;=.
medium
7riefly descrie the responsiilities of management and e-ternal auditors for internal controls.
)ns#er:
Management is responsile for estalishing and maintaining the entityAs internal controls.
Bor pulic companies, management is also re'uired y 3ection .:. to pulicly report on
the operating effectiveness of those controls. "n contrast, the auditorAs responsiilities
include understanding and testing internal control over Wnancial reporting. Bor pulic
company clients, the auditor is also re'uired y 3ection .:. to issue an audit report on
managementAs assessment of its internal controls, including the auditorAs opinion on the
operating effectiveness of those controls.
<:. +*ulic,
medium
/here are four steps in the auditorAs process of understanding internal control and assessing
control risk for a pulic company. 3tep one is o#tain and document an understanding of internal
control* design and operation. Chat are the remaining three steps$
Arens/Elder/Beasley
)ns#er:
/he remaining three steps are:
)ssess control risk.
Eesign, perform, and evaluate tests of controls.
Eecide planned detection risk and sustantive tests.
<1.
medium
Certain principles dictate the proper design and use of documents and records. 7riefly descrie
several of these principles.
)ns#er:
Eocuments should e prenumered consecutively to facilitate control over missing
documents and as an aid in locating documents #hen they are needed at a later date.
Eocuments and records should e prepared at the time a transaction takes place, or as
soon as possile thereafter, to minimize timing errors.
Eocuments and records should e designed for multiple uses, #hen possile, to
minimize the numer of different forms. Bor e-ample, a properly designed and used
shipping document can e the asis for releasing goods from storage to the shipping
department, informing illing of the 'uantity of goods to ill to the customer and the
appropriate illing date, and updating the perpetual inventory records.
Eocuments and records constructed in a manner that encourages correct preparation.
/his can e done y providing internal checks #ithin the form or record. Bor e-ample,
a document might include instructions for proper routing, lank spaces for
authorizations and approvals, and designated column spaces for numerical data.
<!.
medium
ManagementAs identification and analysis of risk is an ongoing process and is a critical
component of effective internal control. )n important first step is for management to identify
factors that may increase risk. "dentify at least five factors, oservale y management, #hich
may lead to increased risk in a typical usiness organization.
)ns#er:
/here are many factors that may lead to increased risk in an organization. 3ome e-amples
include:
failure to meet prior o@ectives,
decreasing 'uality of personnel,
increasing geographic dispersion of company operations,
increasing significance and comple-ity of core usiness processes,
introduction of ne# information technologies, and
entrance of ne# competitors.
<(.
medium
Euring a financial statement audit of a private company, three steps must e completed y the
auditor efore concluding that control risk is lo#. Chat are these steps$
)ns#er:
/he three steps that must e completed y the auditor efore concluding that control risk is
lo# are:
1. otaining an understanding of the control environment, risk assessment procedures,
accounting information and communication system, and monitoring methods at a
fairly detailed levelP
!. identify specific controls that #ill reduce control risk and make an assessment of
control riskP and
(. test the effectiveness of controls.
Arens/Elder/Beasley
Arens/Elder/Beasley
Arens/Elder/Beasley
<..
medium
Chat are the t#o primary factors that auditors consider in determining if an entity is auditale$
)ns#er:
/he t#o primary factors are the integrity of management and the ade'uacy of accounting
records.
<2.
medium
Eefine the follo#ing terms: control deficiency, significant deficiency, and material #eakness.
)ns#er:
) control deWciency e-ists if the design or operation of controls does not permit
company personnel to prevent or detect misstatements on a timely asis.
) signiWcant deWciency e-ists if one or more control deWciencies e-ist that results in
more than a remote likelihood that a misstatement that is more than inconse'uential
#ill not e prevented or detected.
) material #eakness e-ists if a signiWcant deWciency, y itself, or in comination #ith
other signiWcant deWciencies, results in a more than remote likelihood that internal
control #ill not prevent or detect material Wnancial statement misstatements.
<8.
medium
Eescrie three inherent limitations of internal control.
)ns#er:
/he effectiveness of internal controls depends on the competency and dependaility of the
people using it. "nherent limitations of internal control include:
employee carelessness,
lack of understanding,
management override, and
collusion.
<;.
medium
/he internal control frame#ork developed y C434 includes five so-called 0components1 of
internal control. Eiscuss each of these five components.
)ns#er:
Bive components of internal control are:
-e control en%ironment. /he control environment consists of the actions,
policies, and procedures that reflect the overall attitudes of top management aout
control and its importance to the company.
Risk assessment. /his is managementAs identification and analysis of risks
relevant to the preparation of financial statements in accordance #ith %))*.
Information and communication. /his is the set of manual andKor
computerized procedures that identifies, assemles, classifies, analyzes, records, and
reports a companyAs transactions and maintains accountaility for the related assets.
Control acti%ities. /hese are the policies and procedures that help ensure
necessary actions are taken to address risks in the achievement of the companyAs
o@ectives.
Monitoring. /his is managementAs ongoing and periodic assessment of the
'uality of internal control performance to determine that controls are operating as
intended and modified #hen needed.
Arens/Elder/Beasley
<<.
medium
Eiscuss #hat is meant y the term 0control environment1 and identify four control environment
sucomponents that the auditor should consider.
)ns#er:
/he control environment consists of the actions, policies, and procedures that reflect the
overall attitudes of top management, directors, and o#ners of an entity aout control and
its importance to the entity. 3ucomponents include integrity and ethical values,
commitment to competence, oard of directors or audit committee participation,
managementAs philosophy and operating style, organizational structure, assignment of
authority and responsiility and human resource policies and practices.
<=.
challenging
Eescrie the auditorAs responsiilities related to communications regarding internal control
matters.
)ns#er:
/he auditor must communicate signiWcant deWciencies and material #eaknesses in #riting
to those charged #ith governance as soon as they ecome a#are of their e-istence. /he
communication is usually addressed to the audit committee and to management. /imely
communications may provide management an opportunity to address control deWciencies
efore managementAs report on internal control must e issued. "n some instances,
deWciencies can e corrected sufWciently early such that oth management and the auditor
can conclude that controls are operating effectively as of the alance sheet date.
=:.
challenging
/he te-t suggested a five-step approach to identify deficiencies, significant deficiencies, and
material #eaknesses. Eescrie this approach.
)ns#er:
1. Identif" existing controls. 7ecause deWciencies and material #eaknesses are the
asence of ade'uate controls, the auditor must Wrst kno# #hich controls e-ist.
!. Identif" te a#sence of ke" controls. "nternal control 'uestionnaires, Xo#charts, and
#alkthroughs are useful tools to identify #here controls are lacking and the likelihood
of misstatement is therefore increased.
(. Consider te possi#ilit" of compensating controls. ) compensating control is one
else#here in the system that offsets the asence of a key control. Chen a
compensating control e-ists, there is no longer a signiWcant deWciency or material
#eakness.
.. .ecide )eter tere is a signi=cant de=cienc" or material )eakness. /he likelihood
of misstatements and their materiality are used to evaluate if there are signiWcant
deWciencies or material #eaknesses.
2. .etermine potential misstatements tat could result. /his step is intended to identify
speciWc misstatements that are likely to result ecause of the signiWcant deWciency or
material #eakness. /he importance of a signiWcant deWciency or material #eakness is
directly related to the likelihood and materiality of potential misstatements.
4ther 4@ective )ns#er Bormat Questions
=(. Match seven of the terms +a-i, #ith the definitions provided elo# +1-;,:
medium a. Control environment
. Control activities
c. "ndependent checks on performance
d. "nternal control
e. Monitoring
f. 3eparation of duties
g. %eneral authorization
h. 3pecific authorization
i. Risk assessment
e 1. ManagementAs ongoing and periodic assessment of the 'uality of internal
control performance to determine that controls are operating as intended and
modified #hen needed.
g !. Company-#ide policies for the approval of all transactions #ithin stated
limits.
a (. /he actions, policies, and procedures that reflect the overall attitudes of top
management, directors, and o#ners of an entity aout control and its
importance to the entity.
f .. 3egregation of the follo#ing activities in an organization: custody of assets,
accounting, authorization, and operational responsiility.
Arens/Elder/Beasley
=1.
challenging
)uditing standards related to the audits of private companies specify the e-tent to #hich
auditors can rely on evidence aout internal controls otained in prior years. 7riefly descrie
this guidance.
)ns#er:
Chen auditors plan to use evidence aout the operating effectiveness of internal control
otained in prior audits, 3)3 11: re'uires them to test their effectiveness at least every
third year. "f auditors determine that a key control has een changed since it #as last
tested, they should test it in the current year. Chen there are a numer of controls tested in
prior audits that have not een changed, 3)3 11: re'uires auditors to test some of those
controls each year to ensure there is a rotation of controls testing throughout the three-year
period.
=!.
challenging
)de'uate separation of duties is an important control activity. Eiscuss the four general
guidelines for separation of duties to prevent oth intentional and unintentional misstatements
that are of significance to auditors.
)ns#er:
/he general guidelines are:
Custody of assets should e separated from accounting,
)uthorizing transactions should e separated from custody of related assets,
4perational responsiility should e separated from record-keeping, and
Euties #ithin "/ should e separated.
i 2. ManagementAs identification and analysis of risks relevant to the preparation
of financial statements in accordance #ith generally accepted accounting
principles.
8. *olicies and procedures that help ensure necessary actions are taken to address
risks in the achievement of the entityAs o@ectives.
d ;. ) process designed to provide reasonale assurance regarding the
achievement of managementAs o@ectives in the follo#ing categories: +1,
reliaility of financial reporting, +!, effectiveness and efficiency of operations,
and +(, compliance #ith applicale la#s and regulations.
=..
easy
a
"f, #hen otaining an understanding of control activities of a relatively small client, the auditor
identified no control activities, the auditor #ould proaly set a high assessment of control risk.
a. /rue
. Balse
=2.
easy
a
"f, #hen otaining an understanding of control activities of a relatively small client, the auditor
identified no control activities, the auditor #ould proaly determine the client #ere
unauditale.
a. /rue
. Balse
=8.
easy

Chen internal controls are effective, then sustantive audit tests are more relialeP thus, the
e-tent of sustantive tests should e reduced.
a. /rue
. Balse
=;.
easy

)uditors of private companies may rely on prior periodsA tests of controls for a period not to
e-ceed four years.
a. /rue
. Balse
=<.
easy
a
"n an audit of a non-pulic company, the less control risk there is, the smaller the amount of
planned sustantive evidence that is re'uired.
a. /rue
. Balse
==.
easy

)s a clientAs information system ecomes more comple-, it is likely that an auditor #ill
decrease reliance on controls and increase sustantive tests to support a control risk assessment.
a. /rue
. Balse
1::.
easy

Chen a company designs and implements internal controls, cost of the controls is not a valid
consideration.
a. /rue
. Balse
1:1. +*ulic,
easy
a
*C)47 3tandard ! re'uires auditors to perform #alkthroughs to assist in understanding
internal control.
a. /rue
. Balse
1:!.
easy

Adequate documents and records is a sucomponent of the control en%ironment.

a. /rue
. Balse
Arens/Elder/Beasley
1:(.
easy
a
Bor proper internal control, there should e ade'uate separation of duties. Ho#ever, the e-tent
of separation of duties considered 0ade'uate1 depends heavily on the size of the organization.
a. /rue
. Balse
1:..
medium
a
"n an audit of a non-pulic company, the auditorAs assessment of control risk and the e-tent of
tests of controls are inversely related.
a. /rue
. Balse
1:2.
medium

3maller companies usually have more e-tensive internal controls than larger companies #hich
result in fe#er frauds eing committed at small companies.
a. /rue
. Balse
1:8. +*ulic,
medium
a
/o issue an un'ualified opinion on internal control over financial reporting, there must e no
identified material #eaknesses and no restrictions on the scope of the audit.
a. /rue
. Balse
1:;. +345,
medium
a
/he 3aranes-4-ley )ct of !::! re'uires that pulic companies issue an internal control report.
a. /rue
. Balse
1:<.
medium

/he most important component of internal control is risk assessment.

a. /rue
. Balse
1:=.
medium
a
/he primary emphasis y auditors #hen evaluating and testing internal control is on controls
over classes of transactions rather than controls over account alances.
a. /rue
. Balse
11:.
medium

Chen internal controls over a given financial statement account are assessed as highly effective,
the auditor need not otain audit evidence for that account eyond testing the controls.
a. /rue
. Balse
111.
medium
a
/he chart of accounts is a control and is closely related to the controls related to ade'uate
documents and records.
a. /rue
. Balse
11!.
medium

)uditing standards prohiit reliance on the #ork of internal auditors due to the lack of
independence of the internal auditors.
a. /rue
. Balse
11(.
medium
a
"f an auditor #ishes to rely on the #ork of internal auditors +"),, the auditor must otain
satisfactory evidence related to the ")As competence, integrity, and o@ectivity.
a. /rue
. Balse
Arens/Elder/Beasley
11..
medium
a
*rocedures used to otain an understanding of internal control are normally performed on fe#er
transactions than procedures used to test controls.
a. /rue
. Balse
112.
medium
a
Bor most uses, flo#charts are superior to narratives as a method of communicating the
characteristics of internal control.
a. /rue
. Balse
118.
medium

Chen documenting their understanding of a clientAs internal controls, auditors are re'uired to
use narratives.
a. /rue
. Balse
Chapter 11
Multiple-Choice Questions
1. Chich of the follo#ing est defines fraud in a financial statement auditing conte-t$
easy a. Braud is an unintentional misstatement of the financial statements.
. Braud is an intentional misstatement of the financial statements.
c. Braud is either an intentional or unintentional misstatement of the financial statements,
depending on materiality.
d. Braud is either an intentional or unintentional misstatement of the financial statements,
depending on consistency.
!.
easy
4ne of the earliest frauds occurred at McFesson-Roins. /his company committed fraud y
doing #hich of the follo#ing$
a. Reporting fictitious contriuted capital.
. Reporting fictitious sales and none-istent inventory.
c. Reporting fictitious fi-ed assets and underreporting e-penses.
d. Reporting e-penses as capitalized items.
(. Chich of the follo#ing is a category of fraud$
easy
a Braudulent financial reporting Misappropriation of assets
a. Jes Jes
. Do Do
c. Jes Do
d. Do Jes
.. Cith respect to fraudulent financial reporting, most frauds involve:
easy
d "nventory or li'uid asset theft "ntentional misstatements of amounts
a. Jes Jes
. Do Do
c. Jes Do
d. Do Jes
2. 66666666 is fraud that involves theft of an entityAs assets.
easy a. Braudulent financial reporting
Arens/Elder/Beasley
c . ) 0cookie @ar1 reserve
c. Misappropriation of assets
d. "ncome smoothing
8. 66666666 involves delierate actions taken y management to meet earnings o@ectives.
easy a. ?-penditure management
. ?arnings management
c. /op-line management
d. Management-y-o@ective
;.
easy
66666666 is a form of earnings management in #hich revenues and e-penses are shifted
et#een periods to reduce fluctuations in earnings.
c a. Braudulent financial reporting
. ?-pense smoothing
c. "ncome smoothing
d. ?ach of the aove is correct
<. Chich of the follo#ing is one of the conditions for fraud descried in 3)3 Do. ==$
easy
a )ttitudesKrationalization Risk Bactors 4pportunities
a. Jes Do Jes
. Do Jes Jes
c. Jes Do Do
d. Do Jes Do
=. Braudulent financial reporting may e accomplished through the manipulation of:
easy a. assets.
d . revenues.
c. liailities.
d. all of the aove
1:. Cho is most likely to perpetrate fraudulent financial reporting$
easy a. Memers of the oard of directors
c . *roduction employees
c. Management of the company
d. /he internal auditors
11. Misappropriation of assets is normally perpetrated y:
easy a. memers of the oard of directors.
. employees at lo#er levels of the organization.
c. management of the company.
d. the internal auditors.
1!.
medium
Chich of the follo#ing is not a factor that relates to opportunities to commit fraudulent
financial reporting$
c a. &ack of controls related to the calculation and approval of accounting estimates.
. "neffective oversight of financial reporting y the oard of directors.
c. ManagementAs practice of making overly aggressive forecasts.
d. High turnover of accounting, internal audit, and information technology staff.
1(. /he most common techni'ue used y management to misstate financial information is:
medium a. overstatement of e-penses.
. improper revenue recognition.
c. understatement of liailities.
d. understatement of assets.
1.. Chich of the follo#ing is a factor that relates to incentives or pressures to commit fraudulent
Arens/Elder/Beasley
medium financial reporting$
a. 3ignificant accounting estimates involving su@ective @udgments.
. ?-cessive pressure for management to meet det repayment re'uirements.
c. ManagementAs practice of making overly aggressive forecasts.
d. High turnover of accounting, internal audit, and information technology staff.
12.
medium
Chich of the follo#ing is a factor that relates to attitudes or rationalization to commit
fraudulent financial reporting$
c a. 3ignificant accounting estimates involving su@ective @udgments.
. ?-cessive pressure for management to meet det repayment re'uirements.
c. ManagementAs practice of making overly aggressive forecasts.
d. High turnover of accounting, internal audit and information technology staff.
18.
medium
Chich of the follo#ing statements descries circumstances that underlie employee incentives to
misappropriate assets$
a a. Eissatisfied employees may steal from a sense of entitlement.
. Ceak internal controls encourage employees to take chances.
c. "f management cheats customers and gets a#ay #ith it, then employees elieve they can
do the same to the company.
d. ?mployees have a vested interest in making the companyAs financial statements erroneous.
1;. Chich of the follo#ing is not a factor that relates to opportunities to misappropriate assets$
medium a. "nade'uate internal controls over assets.
d . *resence of large amounts of cash on hand.
c. "nappropriate segregation of duties or independent checks on performance.
d. )dverse relationships et#een management and employees.
1<. Chich of the follo#ing is a factor that relates to incentives to misappropriate assets$
medium a. 3ignificant accounting estimates involving su@ective @udgments.
. 3ignificant personal financial oligations.
c. ManagementAs practice of making overly aggressive forecasts.
d. High turnover of accounting, internal audit and information technology staff.
1=.
medium
Chich of the follo#ing issues is normally part of the 0rainstorming1 session re'uired y 3)3
Do. ==$
a
Ho# assets could e
misappropriated
Chere the entityAs financial statements are susceptile to
material misstatements due to fraud
a. Jes Jes
. Do Do
c. Jes Do
d. Do Jes
!:. "n the fraud triangle, fraudulent financial reporting and misappropriation of assets:
medium a. share little in common.
c . share most of the same risk factors.
c. share the same three conditions.
d. share most of the same conditions.
!1. 3ources of information gathered to assess fraud risks usually do not include:
medium a. analytical procedures.
d . in'uiries of management.
c. communication among audit team memers.
d. revie# of corporate charter and yla#s.
!!.
medium
3)3 Do. == re'uires auditors to document #hich of the follo#ing matters related to the
auditorAs consideration of material misstatements due to fraud$
Arens/Elder/Beasley
a. Reasons supporting a conclusion that there is not a significant risk of material improper
e-pense recognition.
. *rocedures performed to otain information necessary to identify and assess the risks of
material fraud.
c. Results of the internal auditorAs procedures performed to address the risk of management
override of controls.
d. Eiscussions #ith management regarding separation of duties.
!(. >nder 3)3 Do. ==, auditors are to presume that there is a significant risk of:
medium a. overstated assets.
c . understated liailities.
c. improper revenue recognition.
d. overstated e-penses.
!..
medium
)fter fraud risks are identified and documented, the auditor should evaluate factors that 666666
fraud risk efore developing an appropriate response to the risk of fraud.
a. enhance
. reduce
c. increase
d. increase or decrease
!2.
medium
Chich of the follo#ing parties is responsile for implementing internal controls to minimize the
likelihood of fraud$
c a. ?-ternal auditors
. )udit committee memers
c. Management
d. Committee of 3ponsoring 4rganizations
!8. /he most effective #ay to prevent and deter fraud is to:
medium a. implement programs and controls that are ased on core values emraced y the company.
a . hire highly ethical employees.
c. communicate e-pectations to all employees on an annual asis.
d. terminate employees #ho are suspected of committing fraud.
!;. Braud a#areness training should e:
medium a. road and all-encompassing
c . e-tensive and include details for all functional areas
c. specifically related to the employeeAs @o responsiility
d. focused on employees understanding the importance of ethics
!<. )s part of the rainstorming sessions, auditors are directed to emphasize:
medium
a /he need for professional
skepticism
/he audit teamAs response to potential fraud
risks
a. Jes Jes
. Do Do
c. Jes Do
d. Do Jes
!=. )uditor responses to fraud risks include #hich of the follo#ing$
medium
d *erform procedures to result in the
issuance of a 'ualified opinion
*erform procedures to address the risk of
management override of controls
a. Jes Jes
. Do Do
c. Jes Do
d. Do Jes
Arens/Elder/Beasley
(:.
medium
)s part of designing and performing procedures to address management override of controls,
auditors must perform #hich of the follo#ing procedures$
d
?-amine all @ournal entries aove the
level of materiality Revie# accounting estimates for iases
a. Jes Jes
. Do Do
c. Jes Do
d. Do Jes
(1.
medium
Chich of the follo#ing most accurately defines professional skepticism as it is used in auditing
standards$
a. "t either assumes management is honest or slightly dishonest, ut neither all the time.
. "t neither assumes that management is dishonest nor assumes un'uestioned honesty.
c. "t assumes management is honest most of the time.
d. "t assumes that management is dishonest in only rare instances.
(!.
medium
a
)uditors may identify conditions during field#ork that change or support a @udgment aout the
initial assessment of fraud risks. Chich of the follo#ing is not a condition #hich should alert an
auditor that the initial assessment should e changed$
a. /he auditorAs lack of independence
. Eiscrepancies in the accounting records
c. >nusual relationships et#een the auditor and management
d. Missing or conflicting evidence
((. Chich of the follo#ing is least likely to uncover fraud$
medium a. ?-ternal auditors
a . "nternal auditors
c. "nternal controls
d. Management
(..
medium
Bor in'uiry to e effective, auditors need to e skilled at listening and 6666666 an intervie#eeAs
response to 'uestions.
a a. evaluating
. recording
c. transcriing
d. rememering
(2. Chich of the follo#ing is not a likely source of information to assess fraud risks$
challenging a. Communications among audit team memers.
d . "n'uiries of management.
c. )nalytical procedures.
d. Consideration of fraud risks discovered during recent audits of other clients.
(8. Chich of the follo#ing is not a category of in'uiry used y auditors$
challenging a. )ssessment in'uiry
. Eeclarative in'uiry
c. "nterrogative in'uiry
d. "nformational in'uiry
(;.
challenging
66666666666 in'uiry is used #hen the auditor seeks responses from the intervie#ee aout his
or her kno#ledge of an event or circumstance.
c a. )ssessment
. Eeclarative
c. "nterrogative
d. "nformational
Arens/Elder/Beasley
(<. 66666666666 in'uiry is used to otain details aout facts that the auditor does not have.
challenging a. )ssessment
c . Eeclarative
c. "nterrogative
d. "nformational
(=.
challenging
66666666666 in'uiry is used to ascertain #hether information already otained is correct,
factual or truthful.
a a. )ssessment
. Eeclarative
c. "nterrogative
d. "nformational
.:. /his type of in'uiry often elicits 0yes1 or 0no1 responses to the auditorAs 'uestions.
challenging a. )ssessment
c . Eeclarative
c. "nterrogative
d. "nformational
.1. Chich of the follo#ing non-veral cues is a sign of stress$
challenging a. &eaning a#ay from the auditor, usually to#ard the door or #indo#
. )voiding eye contact
c. Crossing oneAs arms or legs
d. ?ach of the aove is a sign of stress
.!.
challenging
Chich party has the primary responsiility to oversee an organizationAs financial reporting and
internal control processes$
a. /he oard of directors
. /he audit committee
c. Management of the company
d. /he financial statement auditors
.(. Chen the auditor suspects that fraud may e present, 3)3 Do. == re'uires the auditor to:
challenging a. terminate the engagement #ith sufficient notice given to the client.
c . issue an adverse opinion or a disclaimer of opinion.
c. otain additional evidence to determine #hether material fraud has occurred.
d. re-issue the engagement letter.
...
challenging
Cith #hom should the auditor communicate #henever he or she determines that senior
management fraud may e present, even if the matter might e considered inconse'uential$
a. *C)47
. )udit committee
c. )n appropriate level of management that is at least one level aove those involved
d. /he internal auditors
.2. Management is responsile for:
medium
a "dentifying and measuring fraud risks /aking steps to mitigate identified risks
a. Jes Jes
. Do Do
c. Jes Do
d. Do Jes
?ssay Questions
Arens/Elder/Beasley
.8.
easy
Eefine fraud and distinguish et#een the t#o main categories of fraud.
)ns#er:
"n the conte-t of financial statement auditing, fraud is defined as an intentional
misstatement of the financial statements.
/he t#o main categories of fraud are fraudulent financial reporting and misappropriation
of assets. Braudulent financial reporting is an intentional misstatement or omission of
amounts or disclosures #ith the intent to deceive users of the financial statement.
Misappropriation of assets involve theft of an entityAs assets.
Arens/Elder/Beasley
.;.
easy
&ist and riefly descrie the three conditions for fraud arising from fraudulent financial
reporting and misappropriation of assets as descried in 3)3 Do. ==.
)ns#er:
"ncentivesKpressures U Management or other employees have incentives or pressures
to commit fraud.
4pportunities U Circumstances provide opportunities for management or employees to
commit fraud.
)ttitudesKRationalization U )n attitude, character, or set of ethical values e-ists that
allo#s management or employees to intentionally commit a dishonest act, or they are
in an environment that imposes sufficient pressure that causes them to rationalize
committing a dishonest act.
.<.
medium
?-plain professional skepticism and the need for maintaining professional skepticism during an
audit.
)ns#er:
3)3 Do. 1 states that, in e-ercising professional skepticism, an auditor 0neither assumes
that management is dishonest nor assumes un'uestioned honesty.1 )uditors need to
maintain their skepticism and a 'uestioning mind throughout the audit so that they can
identify fraud risk and critically evaluate audit evidence.
.=.
medium
7riefly discuss the rainstorming session re'uired y 3)3 Do. ==. 7e sure to include a list of
ideas that should e addressed in the session.
)ns#er:
3)3 Do. == re'uires the audit team to conduct discussions to share insights from more
e-perienced audit team memers and to 0rainstorm1 ideas that address several ideas. /he
ideas that should e discussed are:
Ho# and #here the entityAs financial statements might e susceptile to material
misstatements due to fraud.
Ho# management could perpetrate and conceal fraudulent financial reporting.
Ho# assets of the entity could e misappropriated.
Ho# the auditor might respond to the susceptiility of material misstatements due to
fraud.
2:.
medium
Chat are the three main types of revenue manipulations employed to commit fraudulent
financial reporting$
)ns#er:
/he three main types of revenue manipulation are:
Bictitious revenues,
*remature revenue recognition, and
Manipulation of ad@ustments to revenues.
Arens/Elder/Beasley
21. +*ulic,
challenging
*C)47 3tandard ! re'uires auditors to evaluate the effectiveness of the audit committee as part
of the assessment of the internal control. 7riefly descrie #hat factors auditors might consider
in evaluating the effectiveness of the audit committee.
)ns#er:
)uditors might consider:
the audit committeeAs independence from the management of the company,
the level of understanding aout the audit committeeAs responsiilities et#een
management and the audit committee, and
the level and types of interactions et#een the audit committee and internal auditors
and e-ternal auditors.
2!.
challenging
&ist and riefly descrie e-amples of risk factors for each condition of fraud for fraudulent
financial reporting.
)ns#er:
Incenti%es>Pressures: 1. Binancial staility or profitaility is threatened y economic,
industry, or entity operating conditions. !. ?-cessive pressure for management to meet
det repayment or other det covenant re'uirements. (. Management or the oard of
directorsA personal net #orth is materially threatened y the entityAs financial performance.
+pportunities: 1. 3ignificant accounting estimates involve su@ective @udgments or
uncertainties that are difficult to verify. !. "neffective oard of director or audit committee
oversight over financial reporting. (. High turnover or ineffective accounting, internal
audit, or information technology staff.
Attitudes>Rationali8ation: 1. "nappropriate or ineffective support of the entityAs ethics and
values. !. Fno#n history of violations of la#s and regulations. (. ManagementAs disregard
for the financial reporting process.
2(.
challenging
)uditors are re'uired to perform certain procedures in every audit to address the risk of
management override of internal controls. Chat are these procedures$
)ns#er:
3)3 Do. == re'uires the follo#ing:
?-amine @ournal entries and other ad@ustments for evidence of possile misstatements
due to fraud.
Revie# accounting estimates for ias.
?valuate the usiness rationale for significant unusual transactions.
Arens/Elder/Beasley
2..
challenging
&ist and riefly descrie e-amples of risk factors for each condition of fraud for
misappropriation of assets.
)ns#er:
Incenti%es>Pressures: 1. *ersonal financial oligations create pressure for those #ith access
to cash or other assets susceptile to theft to misappropriate those assets. !. )dverse
relationships et#een management and employees #ith access to assets susceptile to theft
motivate employees to misappropriate those assets.
+pportunities: 1. *resence of large amounts of cash on hand or inventory items that are
small, of high value, or in high demand. !. "nade'uate internal control over assets.
Attitudes>Rationali8ation: 1. Eisregard for the need to monitor misappropriations of assets.
!. Eisregard for internal controls or failing to correct control deficiencies.
22.
challenging
Eescrie the sources of information gathered to assess fraud risks.
)ns#er:
Chen the auditor is assessing fraud risks the follo#ing information sources should e
considered:
"nformation otained from communications among audit team memers aout their
kno#ledge of the company and its industry, including ho# and #here the companyAs
financial statements might e susceptile to material misstatements due to fraud.
Responses to auditor in'uiries of management aout their vie#s of the risks of fraud
and aout e-isting programs and controls to address specific identified fraud risks.
3pecific risk factors in fraudulent financial reporting or misappropriation of assets.
)nalytical procedures results otained during planning that indicate possile
implausile or une-pected analytical relationships.
Fno#ledge otained through other procedures such as client acceptance and retention
decisions, interim revie# of financial statements, and consideration of inherent and
control risks.
28.
challenging
Chat matters related to their consideration of fraud must auditors document according to 3)3
Do. ==$
)ns#er:
/he discussion among engagement team personnel in planning the audit aout the
susceptiility of the entityAs financial statements to material fraud.
*rocedures performed to otain information necessary to identify and assess the risks
of material fraud.
3pecific risks of material fraud that #ere identified, and a description of the auditorAs
response to those risks.
Reasons supporting a conclusion that there is not a significant risk of material
improper revenue recognition.
Results of the procedures performed to address the risk of management override of
controls.
4ther conditions and analytical relationships that indicated that additional auditing
procedures or other responses #ere re'uired, and the actions taken y the auditor.
/he nature of communications aout fraud made to management, the audit committee,
or others.
Arens/Elder/Beasley
2;.
challenging
Management and the oard of directors are responsile for setting the 0tone at the top.1 Chat is
meant y 0tone at the top$1
)ns#er:
Management cannot act one #ay and e-pect others in the company to ehave differently.
/hrough its actions and communications, management can sho# that dishonest or
unethical ehavior is not tolerated, even if the results enefit the company. 3tatements y
management aout the asolute need to meet operating and financial targets create undue
pressures that may lead employees to commit fraud to achieve them. "n contrast,
statements indicating managementAs desire to aggressively pursue entityAs goals and
targets #hile at the same time re'uiring honest and ethical actions to achieve those goals
clearly indicates to employees that integrity is a re'uirement. Chichever course
management pursues, its actions estalish the 0tone at the top.1
2<.
challenging
Chat types of in'uiry techni'ues might an auditor use #hen making in'uiries of client
personnel$ Chat are the uses of each techni'ue$
)ns#er:
/here are three main types of in'uiry availale for use y auditors. /hese are information
in'uiry, assessment in'uiry, and interrogative in'uiry. "nformation in'uiry is used to
otain information aout facts and details that the auditor does not have. )ssessment
in'uiry is used to corroorate or contradict prior information. "nterrogative in'uiry is
often used #hen the auditor seeks responses from an individual aout his or her
kno#ledge of an event or circumstances.
4ther 4@ective )ns#er Bormat Questions
2=.
easy
a
"n the conte-t of financial statement auditing, fraud is defined as an intentional misstatement of
the financial statements.
a. /rue
. Balse
8:.
easy
a
/he t#o main categories of fraud are fraudulent financial reporting and misappropriation of
assets.
a. /rue
. Balse
81.
easy

0Cookie @ar reserves1 are often created y companies #henever their earnings are high to create
reserves for future periods #hen earnings are at or aove current levels.
a. /rue
. Balse
8!.
easy
a
Management and the oard of directors are responsile for setting the 0tone at the top.1
a. /rue
. Balse
8(.
easy

/#o conditions are generally present #hen material misstatements due to fraud occur U
incentives and opportunities.
a. /rue
. Balse
8.. Binancial statements of all companies are potentially su@ect to manipulation.
Arens/Elder/Beasley
easy
a
a. /rue
. Balse
82.
easy

Braud is more prevalent in large usinesses than small usinesses and not-for-profit
organizations.
a. /rue
. Balse
88.
medium
a
/he audit committee is responsile for overseeing an organizationAs financial reporting and
internal control processes.
a. /rue
. Balse
8;.
medium
a
/he same three fraud triangle risk conditions apply to fraudulent financial reporting and
misappropriation of assets.
a. /rue
. Balse
8<.
medium

0)n attitude, character, or set of ethical values e-ist that allo# management or employees to
commit a dishonest act N.1 descries the opportunities condition included in the fraud triangle.
a. /rue
. Balse
8=.
medium

Misappropriation of assets is normally perpetrated at the highest levels of the organization

hierarchy.
a. /rue
. Balse
;:.
medium
a
Braudulent financial reporting usually involves manipulation of amounts rather than disclosures.
a. /rue
. Balse
;1.
medium

)n e-ample of a fraud risk factor descriing incentivesKpressures is 0ineffective oard of

director oversight over financial reporting.1
a. /rue
. Balse
;!.
medium
a
)n e-ample of a fraud risk factor descriing opportunities is 0ineffective oard of director
oversight over financial reporting.1
a. /rue
. Balse
;(. +*ulic,
medium
a
*C)47 3tandard ! indicates that material fraud y senior management is a material #eakness.
a. /rue
. Balse
;..
medium
a
"nformation and idea e-change sessions are re'uired y 3)3 Do. ==.
a. /rue
. Balse
;2.
medium
a
3)3 Do. == does not specifically indicate #hich memers of an audit engagement team must
attend a rainstorming session.
a. /rue
. Balse
;8.
medium
/he presence of fraud risk factors increases the likelihood of fraud and usually suggests that
fraud is present.
Arens/Elder/Beasley
a. /rue
. Balse
;;.
medium

*rofessional skepticism re'uires auditors to 0either assume that management is dishonest or

they have 'uestionale honesty.1
a. /rue
. Balse
;<.
medium
a
)uditors should consider risk factors related to incentives, opportunities, and attitudes #henever
they assess the likelihood of material misstatements due to fraud.
a. /rue
. Balse
;=. +*ulic,
challenging

)uditors must issue a 'ualified opinion on internal control #henever senior management
commits fraud that is considered a material #eakness.
a. /rue
. Balse
<:.
challenging

/he oard of directors has the primary responsiility to assess fraud risks and estalish
corporate governance programs and controls to prevent, deter, and detect fraud.
a. /rue
. Balse
<1.
challenging
a
4ne of the strongest internal corporate governance mechanisms over senior management is the
audit committee of the oard of directors.
a. /rue
. Balse
<!.
challenging
a
7ecause fraud perpetrators are often kno#ledgeale aout audit procedures, 3)3 Do. ==
re'uires auditors to incorporate unpredictaility into the audit plan.
a. /rue
. Balse
<(.
challenging
a
)ll misstatements the auditor finds during the audit should e evaluated for any indication of
fraud.
a. /rue
. Balse
Chapter 12
Multiple-Choice Questions
1.
easy
"/ has several significant effects on an organization. Chich of the follo#ing #ould not e
important from an auditing perspective$
d a. 4rganizational changes.
. /he visiility of information.
c. /he potential for material misstatement.
d. Done of the aoveP i.e., they are all important.
!.
easy
/he audit procedure #hich is least useful in gathering evidence on significant computer
processes is:
a. documentation.
Arens/Elder/Beasley
. oservation.
c. test decks.
d. generalized audit soft#are.
(. Chich of the follo#ing is not a enefit of using "/-ased controls$
easy a. )ility to process large volumes of transactions.
d . )ility to replace manual controls #ith computer-ased controls.
c. Reduction in misstatements due to consistent processing of transactions.
d. 4ver-reliance on computer-generated reports.
..
easy
4ne significant risk related to an automated environment is that auditors may 6666 information
provided y an information system.
a. not place enough reliance on
. place too much reliance on
c. reveal
d. not understand
2. Chich of the follo#ing is not a risk specific to "/ environments$
easy a. Reliance on the functioning capailities of hard#are and soft#are.
. "ncreased human involvement.
c. &oss of data due to insufficient ackup.
d. Reduced segregation of duties.
8.
easy
Chich of the follo#ing is not an enhancement to internal control that #ill occur as a
conse'uence of increased reliance on "/$
d a. Computer controls replace manual controls.
. Higher 'uality information is availale.
c. Computer-ased controls provide opportunities to enhance separation of duties.
d. Manual controls replace automated controls.
;. Chich of the follo#ing is not a risk to "/ systems$
easy a. Deed for "/ e-perienced staff
c . 3eparation of "/ duties from accounting functions
c. "mproved audit trail
d. Hard#are and data vulneraility
<. Chich of the follo#ing is not a category of an application control$
easy a. *rocessing controls.
c . 4utput controls.
c. Hard#are controls.
d. "nput controls.
=. 4ld and ne# systems operating simultaneously in all locations is a test approach kno#n as:
easy a. pilot testing.
d . horizontal testing.
c. integrative testing.
d. parallel testing.
1:.
easy
a
Chen the client uses a computer ut the auditor chooses to use only the non-"/ segment of
internal control to assess control risk, it is referred to as auditing around the computer. Chich
one of the follo#ing conditions need not e present to audit around the computer$
a. Computer programs must e availale in ?nglish.
. /he source documents must e availale in a non-machine language.
c. /he documents must e filed in a manner that makes it possile to locate them.
d. /he output must e listed in sufficient detail to enale the auditor to trace individual
transactions.
Arens/Elder/Beasley
11. Chich of the follo#ing is a category of general controls$
easy a. *rocessing controls.
c . 4utput controls.
c. *hysical and online security.
d. "nput controls.
1!. Chich of the follo#ing statements related to application controls is correct$
easy
d
a. )pplication controls relate to various aspects of the "/ function including soft#are
ac'uisition and the processing of transactions.
. )pplication controls relate to various aspects of the "/ function including physical security
and the processing of transactions in various cycles.
c. )pplication controls relate to all aspects of the "/ function.
d. )pplication controls relate to the processing of individual transactions.
1(. %eneral controls include all of the follo#ing e-cept:
easy a. systems development.
c . online security.
c. processing controls.
d. hard#are controls.
1..
easy
*redesigned formats, such as those used for audit documentation, can e created and saved
using electronic spreadsheets and #ord processors. /hese are called:
a. desktop pulishing.
. templates.
c. macros.
d. #ork files.
12.
easy
666666 involves implementing a ne# system in one part of the organization, #hile other
locations continue to use the current system.
c a. *arallel testing
. 4nline testing
c. *ilot testing
d. Control testing
18. /o determine that user "E and pass#ord controls are functioning, an auditor #ould most likely:
easy a. attempt to sign on to the system using invalid user identifications and pass#ords.
a . #rite a computer program that simulates the logic of the clientAs access control soft#are.
c. e-tract a random sample of processed transactions and ensure that the transactions #ere
appropriately authorized.
d. e-amine statements signed y employees stating that they have not divulged their user
identifications and pass#ords to any other person.
1;.
easy
Chen "/ programs or files can e accessed from terminals, users should e re'uired to enter
a+n,:
d a. echo check.
. parity check.
c. self-diagnosis test.
d. authorized pass#ord.
1<. )n auditorAs flo#chart of a clientAs system is a graphical representation that depicts the
auditorAs:
easy a. program for tests of controls.
. understanding of the system.
c. understanding of the types of errors that are proale given the present system.
d. documentation of the study and evaluation of the system.
1=. Chich of the follo#ing is not a characteristic of an online processing system$
Arens/Elder/Beasley
medium a. 4utput of the data files is availale on re'uest.
d . Master files are updated at the time the entry is made.
c. Eisplay terminals are used for oth input and output purposes.
d. *rogramming is not allo#ed online and must e done separately.
!:. /ypical controls developed for manual systems #hich are still important in "/ systems include:
medium a. proper authorization of transactions.
d . competent and honest personnel.
c. careful and complete preparation of source documents.
d. all of the aove.
!1. 666666 controls prevent and detect errors #hile transaction data are processed.
medium a. 3oft#are
c . )pplication
c. *rocessing
d. /ransaction
!!. ) dataase management system:
medium a. physically stores each element of data only once.
a . stores data on different files for different purposes, ut al#ays kno#s #here they are and
ho# to retrieve them.
c. allo#s 'uick retrieval of data ut at a cost of inefficient use of file space.
d. allo#s 'uick retrieval of data, ut it needs to update files continually.
!(. Chich of the follo#ing is not associated #ith converting from a manual to an "/ system$
medium a. "t usually centralizes data.
d . "t permits higher 'uality and more consistent controls over operations.
c. "t may eliminate the control provided y division of duties of independent persons #ho
perform related functions and compare results.
d. "t may take the recordkeeping function and the document preparation function a#ay from
those #ho have custody of assets and put those functions into the "/ center.
!.. Chich of the follo#ing statements aout general controls is not correct$
medium a. Eisaster recovery plans should identify alternative hard#are to process company data.
d . 3uccessful "/ development efforts re'uire the involvement of "/ and non-"/ personnel.
c. /he chief information officer should report to senior management and the oard.
d. *rogrammers should have access to computer operations to aid users in resolving
prolems.
!2. Chich of the follo#ing statements is correct$
medium a. )uditors should evaluate application controls efore evaluating general controls.
c . )uditors should evaluate application controls and general controls simultaneously.
c. )uditors should evaluate general controls efore evaluating application controls.
d. Done of these statements is correct.
!8. )n important characteristic of "/ is uniformity of processing. /herefore, a risk e-ists that:
medium a. auditors #ill not e ale to access data 'uickly.
c . auditors #ill not e ale to determine if data is processed consistently.
c. erroneous processing can result in the accumulation of a great numer of misstatements in
a short period of time.
d. all of the aove.
!;.
medium
)uditors should evaluate the 66666666 efore evaluating application controls ecause of the
potential for pervasive effects.
d a. input controls
. control environment
c. processing controls
Arens/Elder/Beasley
d. general controls
!<. ) control that relates to all parts of the "/ system is called a+n,:
medium a. general control.
a . systems control.
c. universal control.
d. applications control.
!=. Controls #hich apply to a specific element of the system are called:
medium a. user controls.
d . general controls.
c. systems controls.
d. applications controls.
(:. Chich of the follo#ing is not an e-ample of an applications control$
medium a. )n e'uipment failure causes system do#ntime.
a . /here is a preprocessing authorization of the sales transactions.
c. /here are reasonaleness tests for the unit selling price of a sale.
d. )fter processing, all sales transactions are revie#ed y the sales department.
(1.
medium
Chich of the follo#ing is least likely to e used in otaining an understanding of client general
controls$
c a. ?-amination of system documentation
. "n'uiry of client personnel +e.g., key users,
c. 4servation of transaction processing
d. Revie#s of 'uestionnaires completed y client "/ personnel
(!. Chich of the follo#ing is not a general control$
medium a. Reasonaleness test for unit selling price of a sale.
a . ?'uipment failure causes error messages on monitor.
c. 3eparation of duties et#een programmer and operators.
d. )de'uate program run instructions for operating the computer.
((. Controls #hich are uilt in y the manufacturer to detect e'uipment failure are called:
medium a. input controls.
c . fail-safe controls.
c. hard#are controls.
d. manufacturerAs controls.
(.. )uditors usually evaluate the effectiveness of:
medium a. hard#are controls efore general controls.
c . sales-cycle controls efore application controls.
c. general controls efore applications controls.
d. applications controls efore the control environment.
(2.
medium
Controls #hich are designed to assure that the information processed y the computer is
authorized, complete, and accurate are called:
a a. input controls.
. processing controls.
c. output controls.
d. general controls.
(8. *rogrammers should e allo#ed access to:
medium a. user controls.
d . general controls.
c. systems controls.
d. applications controls.
Arens/Elder/Beasley
(;. *rogrammers should do all ut #hich of the follo#ing$
medium a. /est programs for proper performance.
. ?valuate legitimacy of transaction data input.
c. Eevelop flo#charts for ne# applications.
d. *rogrammers should perform each of the aove.
(<. 666666 tests determines that every field in a record has een completed.
medium a. Ialidation
c . 3e'uence
c. Completeness
d. *rogramming
(=. "n an "/-intensive environment, most processing controls are:
medium a. input controls.
c . operator controls.
c. programmed controls.
d. documentation controls.
.:. Chich of the follo#ing is not a processing control$
medium a. Control totals.
c . &ogic tests.
c. Check digits.
d. Computations tests.
.1. 4utput controls are not designed to assure that data generated y the computer are:
medium a. accurate.
d . distriuted only to authorized people.
c. complete.
d. used appropriately y employees in making decisions.
.!. )uditors usually otain information aout general and application controls through:
medium a. intervie#s #ith "/ personnel.
d . e-amination of systems documentation.
c. reading program change re'uests.
d. all of the aove methods.
.(. Chen auditors consider only non-"/ controls in assessing control risk, it is kno#n as:
medium a. the single-stage audit.
c . the test deck approach.
c. auditing around the computer.
d. generalized audit soft#are +%)3,.
...
medium
/he auditorAs o@ective to determine #hether the clientAs computer programs can correctly
handle valid and invalid transactions as they arise is accomplished through the:
a a. test data approach.
. generalized audit soft#are approach.
c. microcomputer-aided auditing approach.
d. generally accepted auditing standards.
.2.
medium
/he audit approach in #hich the auditor runs his or her o#n program on a controlled asis to
verify the clientAs data recorded in a machine language is:
c a. the test data approach.
. called auditing around the computer.
c. the generalized audit soft#are approach.
d. the microcomputer-aided auditing approach.
.8. Chich of the follo#ing is not one of the three categories of testing strategies #hen auditing
Arens/Elder/Beasley
medium through the computer$
a a. *ilot simulation.
. /est data approach.
c. *arallel simulation.
d. ?medded audit module.
.;.
medium
d
Companies #ith non-comple- "/ environments often rely on microcomputers to perform
accounting system functions. Chich of the follo#ing is not an audit consideration in such an
environment$
a. &imited reliance on automated controls.
. >nauthorized access to master files.
c. Iulneraility to viruses and other risks.
d. ?-cess reliance on automated controls.
.<. "nternal control is ineffective #hen computer personnel:
medium a. participate in computer soft#are ac'uisition decisions.
c . design flo#charts and narratives for computerized systems.
c. originate changes in customer master files.
d. provide physical security over program files.
.=. Chen using the test data approach:
medium a. test data should include only e-ception conditions.
d . application programs tested must e virtually identical to those used y employees.
c. select data may remain in the client system after testing.
d. none of the aove statements is correct.
2:.
medium
7ecause general controls have a 66666 effect on the operating effectiveness of application
controls, auditors must consider general controls.
a. nominal
. pervasive
c. mitigating
d. #orsening
21. ?rrors in data processed in a atch computer system may not e detected immediately ecause:
medium a. transaction trails in a atch system are availale only for a limited period of time.
. there are time delays in processing transactions in a atch system.
c. errors in some transactions cause re@ection of other transactions in the atch.
d. random errors are more likely in a atch system than in an online system.
2!. 666666 link e'uipment in large geographic regions.
medium a. Cosmopolitan area net#orks +C)Ds,
c . &ocal area net#orks +&)Ds,
c. Cide area net#orks +C)Ds,
d. Iirtual area net#orks +I)Ds,
2(.
medium
c
Chich of the follo#ing computer-assisted auditing techni'ues allo#s fictitious and real
transactions to e processed together #ithout client operating personnel eing a#are of the
testing process$
a. *arallel simulation.
. %eneralized audit soft#are programming.
c. "ntegrated test facility.
d. /est data approach.
2.. Bire#alls are used to protect:
medium a. erroneous internal handling of data.
d . against insufficient documentation of transactions.
c. illogical programming commands.
Arens/Elder/Beasley
d. unauthorized use of system resources.
22. "n an "/ system, automated e'uipment controls or hard#are controls are designed to:
medium a. correct errors in the computer programs.
c . monitor and detect errors in source documents.
c. detect and control errors arising from the use of e'uipment.
d. arrange data in a logical se'uential manner for processing purposes.
28.
medium
"f a control total #ere to e computed on each of the follo#ing data items, #hich #ould est e
identified as a hash total for a payroll "/ application$
a. %ross #ages earned.
. ?mployee numers.
c. /otal hours #orked.
d. /otal deit amounts and total credit amounts.
2;. Chat tools do companies use to limit access to sensitive company data$
medium
a ?ncryption techni'ues Eigital signatures Bire#all
a. Jes Jes Jes
. Jes Do Do
c. Do Jes Jes
d. Jes Jes Do
2<.
medium
Rather than maintain an internal "/ center, many companies use 66666666 to perform many
asic functions such as payroll.
a. e-ternal general service providers
. e-ternal application service providers
c. internal control service providers
d. internal auditors
2=.
medium
d
) company uses the account code 88= for maintenance e-pense. Ho#ever, one of the company
clerks often codes maintenance e-pense as ==8. /he highest account code in the system is ;2:.
Chat internal control in the companyAs computer program #ould detect this error$
a. *re-data input check.
. Ialid-character test.
c. 3e'uence check.
d. Ialid-code test.
8:. Chich of the follo#ing is not an application control$
challenging a. *reprocessing authorization of sales transactions.
d . Reasonaleness test for unit selling price of sale.
c. *ost-processing revie# of sales transactions y the sales department.
d. 3eparation of duties et#een computer programmer and operators.
81.
challenging
d
"t is common in "/ systems to have certain types of transactions initiated automatically y the
computer. Chich of the follo#ing activities #ould not e an appropriate candidate for
automatic computer initialization$
a. "n a ank, periodic calculation of interest on customer accounts.
. "n a manufacturing facility ordering inventory at preset order levels.
c. "n a hospital, the ordering of o-ygen #hen pre-specified levels are achieved.
d. "n an investment rokerage firm, the sale of pharmaceutical stocks #hen the Eo#-Lones
"ndustrial )verage falls elo# a certain level.
8!.
challenging
)pplication controls vary across the "/ system. /o gain an understanding of internal control for
a private company, the auditor must evaluate the application controls for every:
d a. every audit area.
. every material audit area.
Arens/Elder/Beasley
c. every audit area in #hich the client uses the computer.
d. every audit area #here the auditor plans to reduce assessed control risk.
8(.
challenging
Many clients have outsourced the "/ functions. /he difficulty the independent auditor faces
#hen a computer service center is used is to:
c a. gain the permission of the service center to revie# their #ork.
. find compatile programs that #ill analyze the service centerAs programs.
c. determine the ade'uacy of the service centerAs internal controls.
d. try to aide y the Code of Professional Conduct to maintain the security and
confidentiality of clientAs data.
8..
challenging
)n auditor #ho is testing "/ controls in a payroll system #ould most likely use test data that
contain conditions such as:
a a. time tickets #ith invalid @o numers.
. overtime not approved y supervisors.
c. deductions not authorized y employees.
d. payroll checks #ith unauthorized signatures.
82. Chich of the follo#ing is not a general control$
challenging a. /he plan of organization and operation of "/ activity.
c . *rocedures for documenting, revie#ing, and approving systems and programs.
c. *rocessing controls.
d. Hard#are controls.
88.
challenging
"n comparing +1, the ade'uacy of the hard#are controls in the system #ith +!, the
organizationAs methods of handling the errors that the computer identifies, the independent
auditor is:
c a. unconcerned #ith oth +1, and +!,.
. e'ually concerned #ith +1, and +!,.
c. less concerned #ith +1, than #ith +!,.
d. more concerned #ith +1, than #ith +!,.
Arens/Elder/Beasley
8;. 3ervice auditors do not issue #hich of the follo#ing types of reports$
challenging a. Report on implemented controls
. Report on controls that have een implemented and tested for design effectiveness
c. Report on controls that have een implemented and tested for operating effectiveness
d. ?ach of the aove is issued.
8<. /he most important output control is:
challenging

a. distriution control, #hich assures that only authorized personnel receive the reports
generated y the system.
. revie# of data for reasonaleness y someone #ho kno#s #hat the output should look
like.
c. control totals, #hich are used to verify that the computerAs results are correct.
d. logic tests, #hich verify that no mistakes #ere made in processing.
?ssay Questions
8=.
easy
7riefly define general controls and application controls.
)ns#er:
%eneral controls are those that relate to all aspects of the "/ function. /hey include
controls related to administration, soft#are ac'uisition and maintenance, physical and
on-line security, ackup and disaster recovery planning, and hard#are controls.
)pplication controls relate to the processing of individual transactions. )pplication
controls are specific to certain soft#are applications and typically do not affect all "/
functions.
;:.
easy
Chat are three specific risks to "/ systems$
)ns#er:
/hree specific risks to "/ systems include risks to hard#are and data, a reduced audit
trail, and the need for "/ e-perience and separation of "/ duties.
;1.
medium
Eiscuss ho# the integration of "/ into accounting systems enhances internal control.
)ns#er:
?nhancements to internal control resulting from the integration of "/ into accounting
systems include:
Computer controls replace manual controls. Replacing manual procedures
#ith programmed controls that apply checks and alances to each processed
transaction and that process information consistently can reduce human error that is
likely to occur in traditional manual environments.
1iger qualit" information is a%aila#le. "/ systems typically provide
management #ith more and higher 'uality information faster than most manual
systems.
Arens/Elder/Beasley
;!
medium
"dentify the three categories of application controls, and give one e-ample of each.
)ns#er:
)pplication controls fall into three categories:
Input controls. Fey verification and check digits are e-amples of input
controls.
Processing controls. 4ne e-ample is a reasonaleness test for the unit selling
price of a sale.
+utput controls. 4ne e-ample is post-processing revie# of sales transactions
y the sales department.
;(.
medium
Eiscuss #hat is meant y the term 0auditing around the computer.1
)ns#er:
0)uditing around the computer1 occurs #hen the auditor considers only the non-"/
controls #hen assessing control risk. >nder this approach, the auditor otains an
understanding of internal control and performs tests of controls, sustantive tests of
transactions, and account alance verification procedures in the same manner as in
manual systems. Ho#ever, there is no attempt to test, or rely on, the clientAs "/
controls.
;..
medium
Eiscuss the circumstances that must e-ist for the auditor to 0audit around the computer.1
)ns#er:
/o 0audit around the computer,1 the follo#ing conditions must e-ist:
/he source documents must e availale in a form readale y a human.
/he documents must e maintained in a manner that makes it possile to
locate them for auditing purposes.
/he output must e listed in sufficient detail to enale the auditor to trace
individual transactions from the source documents to the output and vice versa.
"f any of these conditions does not e-ist, the auditor #ill have to rely on computer-oriented
controls.
;2.
medium
Eescrie three computer auditing techni'ues availale to the auditor.
)ns#er:
Computer auditing techni'ues availale to the auditor are:
-est data approac. >sing this approach, the auditor develops different types
of transactions that are processed under his or her o#n control using the clientAs
computer programs on the clientAs "/ e'uipment.
Parallel simulation. >sing parallel simulation, the auditor #rites a computer
program that replicates some part of the clientAs application system. /he clientAs data
is then processed using the auditorAs computer program. /he auditor then compares
the output generated y his or her program #ith that generated y the clientAs program
to test the correctness of the clientAs program. %eneralized audit soft#are may e
used.
Em#edded audit module. >sing this approach, the auditor inserts an audit
module in the clientAs application system to capture transactions #ith characteristics
that are of interest to the auditor.
Arens/Elder/Beasley
;8.
medium
Chat are the t#o soft#are testing strategies that companies typically use$ Chich strategy is
more e-pensive$
)ns#er:
Companies may use pilot testing and parallel testing to test ne# soft#are. *ilot testing
involves operating the ne# soft#are at a limited numer of facilities, #hile continuing
to operate the old soft#are at all other locations. *arallel testing involves operating the
ne# and old soft#are simultaneously. *arallel testing is more e-pensive than pilot
testing.
;;.
medium
Eiscuss the advantages and enefits of using generalized audit soft#are.
)ns#er:
)dvantages and enefits of using generalized audit soft#are include:
they are developed in such a manner that most of the audit staff can e trained to use
the program even if they have little formal "/ education.
a single program can e applied to a #ide range of tasks #ithout having to incur the
cost or inconvenience of developing individualized programs.
generalize audit soft#are can perform tests much faster and in more detail than using
traditional manual procedures.
;<.
medium
Chy do usinesses use net#orks$ Eescrie a local area net#ork and a #ide area net#ork.
)ns#er:
Det#orks are used to link e'uipment such as microcomputers, midrange computers,
mainframes, #ork stations, servers, and printers. ) local area net#ork links e'uipment
#ithin a single or small cluster of uildings and is used only #ithin a company. ) #ide
area net#ork links e'uipment in larger geographic regions, including gloal operations.
;=.
medium
Eiscuss the four areas of responsiility under the "/ function that should e segregated in large
companies.
)ns#er:
/he responsiilities for "/ management, systems development, operations, and data
control should e separated:
I- Management. 4versight of the "/ function should e segregated from the
systems development, operations, and data control functions. 4versight of "/ should
e the responsiility of the Chief "nformation 4fficer or "/ manager.
S"stems de%elopment. 3ystems analysts are responsile for the overall design
of each application system. *rogrammers develop, test, and document applications
soft#are. *rogrammers and analysts should not have access to input data or computer
operations.
+perations. Computer operators are responsile for the day-to-day operations
of the computer.
.ata control. Eata control personnel independently verify the 'uality of input
and the reasonaleness of output.
Arens/Elder/Beasley
<:.
challenging
Chat types of reports may e issued y a service organization auditor$ Chich of these is likely
to e used y an auditor performing an audit of a pulic company$
)ns#er:
3ervice organization auditors may issue t#o types of reports:
reports on controls that have een implemented, and
reports on controls that have een implemented and tested for operating
effectiveness.
)uditors of a pulic company #ould likely use the latter type of report ecause they have
to provide a report on the internal control over financial reporting.
<1.
challenging
"dentify the si- categories of general controls and give one e-ample of each.
)ns#er:
%eneral controls fall into the follo#ing si- categories:
Administration of te I- function. Bor e-ample, the chief information officer
+C"4, should report to senior management and oard of directors.
Segregation of I- duties. Bor e-ample, there should e separation of duties
et#een the computer programmers, operators, and the data control group.
S"stems de%elopment. >sers, analysts, and programmers develop and test
soft#are.
P"sical and online securit". Bor e-ample, pass#ords should e re'uired for
access to computer systems.
0ackup and contingenc" planning. Critten ackup plans should e prepared
and tested on a regular asis throughout the year.
1ard)are controls. Bor e-ample, uninterruptile po#er supplies should e
used to avoid loss of data in the event of a po#er lackout.
4ther 4@ective )ns#er Bormat Questions
<!.
medium
Match eight of the terms +a-n, #ith the definitions provided elo# +1-<,:
a. )pplication controls
. )uditing around the computer
c. )uditing through the computer
d. ?rror listing
e. %eneral controls
f. %eneralized audit soft#are
g. Hard#are controls
h. "nput controls
i. 4utput controls
@. *arallel simulation
k. *arallel testing
l. *ilot testing
m. *rocessing controls
n. /est data approach
k 1. /he ne# and old systems operate simultaneously in all locations.
Arens/Elder/Beasley
e !. Controls that relate to all parts of the "/ system.
Arens/Elder/Beasley
@ (. "nvolves the use of a computer program #ritten y the auditor that replicates
some part of a clientAs application system.
n .. ) method of auditing "/ systems #hich uses data created y the auditor to
determine #hether the clientAs computer program can correctly process valid
and invalid transactions.
i 2. Controls such as revie# of data for reasonaleness, designed to assure that
data generated y the computer is valid, accurate, complete, and distriuted
only to authorized people.
a 8. Controls that apply to processing of transactions.
l ;. ) ne# system is implemented in one part of the organization #hile other
locations continue to rely on the old system.
h <. Controls such as proper authorization of documents, check digits, and
ade'uate documentation, designed to assure that the information to e
processed y the computer is authorized, complete, and accurate.
Arens/Elder/Beasley
<(.
easy

"nherent risk is often reduced in comple- "/ systems relative to less comple- "/ systems.
a. /rue
. Balse
<..
easy
a
*arallel testing is used #hen old and ne# systems are operated simultaneously in all locations.
a. /rue
. Balse
<2.
easy
a
Bire#alls can protect company data and soft#are programs.
a. /rue
. Balse
<8.
easy
a
*rogrammers should not have access to transaction data.
a. /rue
. Balse
<;.
easy
a
4ne potential disadvantage of "/ systems is the reduction or elimination of source documents,
#hich reduces the visiility of the audit trail.
a. /rue
. Balse
<<.
easy
a
&)Ds link e'uipment #ithin a single or small cluster of uildings and are used only for
intracompany purposes.
a. /rue
. Balse
<=.
medium
a
"n "/ systems, if general controls are effective, it increases the auditorAs aility to rely on
application controls to reduce control risk.
a. /rue
. Balse
=:.
medium
a
*arallel testing is more e-pensive than pilot testing.
a. /rue
. Balse
=1.
medium

/he effectiveness of manual controls depends solely on the competence of the personnel
performing the controls.
a. /rue
. Balse
=!.
medium

/he test data approach re'uires the auditor to insert an audit module in the clientAs application
system to test transaction data specifically identified y the auditor as unusual.
a. /rue
. Balse
=(.
medium
a
%eneral controls in smaller companies are usually less effective than in more comple- "/
environments.
a. /rue
. Balse
=.. +*ulic,
medium

Fno#ledge of oth general and application controls is not particularly crucial for auditors of
pulic companies.
a. /rue
. Balse
=2. &ogic tests and completeness tests are e-amples of general controls.
Arens/Elder/Beasley
medium

a. /rue
. Balse
=8.
medium

Chen the auditor decides to 0audit around the computer,1 there is no need to test the clientAs "/
controls or otain an understanding of the clientAs internal controls related to the "/ system.
a. /rue
. Balse
=;.
medium

)uditors normally link controls and deficiencies in general controls to specific transaction-
related audit o@ectives.
a. /rue
. Balse
=<.
medium
a
4utput controls focus on detecting errors after processing is completed rather than preventing
errors prior to processing.
a. /rue
. Balse
==.
medium
a
/he o@ective of the computer audit techni'ue kno#n as the test data approach is to determine
#hether the clientAs computer programs can correctly process valid and invalid transactions.
a. /rue
. Balse
1::.
medium

*arallel simulation is used primarily to test internal controls over the clientAs "/ systems,
#hereas the test data approach is used primarily for sustantive testing.
a. /rue
. Balse
1:1.
medium
a
*rocessing controls is a category of application controls.
a. /rue
. Balse
1:!.
medium
a
Controls that relate to a specific use of the "/ system, such as the processing of sales or cash
receipts, are called application controls.
a. /rue
. Balse
1:(.
medium

0)uditing around the computer1 is acceptale only if the auditor has access to the clientAs data
in a machine-readale language.
a. /rue
. Balse
1:..
medium

"/ controls are classified as either input controls or output controls.

a. /rue
. Balse
1:2.
medium

4ne common use of generalized audit soft#are is to help the auditor identify #eaknesses in the
clientAs "/ control procedures.
a. /rue
. Balse
1:8.
medium
a
/ests of controls are normally performed only if the auditor elieves the clientAs internal control
may e effective.
a. /rue
. Balse
1:;. 0)uditing around the computer1 is most appropriate #hen the client has not maintained detailed
Arens/Elder/Beasley
medium

output or source documents in a form readale y humans.

a. /rue
. Balse
1:<.
medium

Chen auditing a client #hose information is processed y an outside service provider, it is not
acceptale for the auditor to rely on the audit report of another independent auditor #ho has
previously tested the internal controls of the service provider, rather than testing the service
providerAs controls himself or herself.
a. /rue
. Balse
1:=.
medium
a
Chen a client uses microcomputers for the accounting functions, the auditor should normally
rely only on non-"/ controls or take a sustantive approach to the audit.
a. /rue
. Balse
Chapter 13
Multiple-Choice Questions
1.
easy
) listing of all the things #hich the auditor #ill do to gather sufficient, competent evidence is
the:
a. audit strategy.
. audit program.
c. audit procedure.
d. audit risk model.
!.
easy
3ho#n elo# +1 through 2, are the five types of tests #hich auditors use to determine #hether
financial statements are fairly stated. Chich three are sustantive tests$
1. procedures to otain an understanding of internal control
!. tests of controls
(. tests of transactions
.. analytical procedures
2. tests of details of alances
a. 1, !, and (.
. (, ., and 2.
c. !, (, and 2.
d. !, (, and ..
(.
easy
Collectively, procedures performed to otain an understanding of the entity and its environment,
including internal controls, represent the auditorAs:
c a. audit strategy.
. tests of controls.
c. risk assessment procedures.
d. tests of transactions.
.. Bor efficiency, tests of controls are fre'uently done at the same time as:
easy a. analytical procedures.
c . compliance tests.
c. tests of transactions.
d. tests of details of alances.
2. Chich of the follo#ing procedures are fre'uently performed in response to the auditorAs
Arens/Elder/Beasley
easy assessment of the risk of material misstatement$
c a. Ratio analysis
. /ests of controls
c. /ests of details of alances
d. Risk assessment procedures
8. "n #hich stage+s, of an audit are analytical procedures not performed$
easy a. "n the planning stage.
. "n the test of controls stage.
c. "n the completion stage.
d. "n con@unction #ith tests of transactions and tests of details of alances.
;. /ests of controls may include #hich of the follo#ing types of evidence$
easy
a Reperformance 4servation
a. Jes Jes
. Do Do
c. Jes Do
d. Do Jes
<. /he purpose of tests of controls is to provide reasonale assurance that the:
easy a. accounting treatment of transactions and alances is valid and proper.
. internal control procedures are functioning as intended.
c. entity has complied #ith %))* disclosure re'uirements.
d. entity has complied #ith re'uirements of 'uality control.
=. "n the conte-t of an audit of financial statements, sustantive tests are audit procedures that:
easy a. may e eliminated under certain conditions.
c . are designed to discover significant suse'uent events.
c. may e either tests of transactions, tests of alances, or analytical tests.
d. #ill increase proportionately #ith the auditorAs reliance on internal control.
1:. Chich of the follo#ing is not useful for otaining an understanding of internal controls$
medium a. Make in'uiries of the clientAs personnel.
c . ?-amine documents and records.
c. Read industry trade magazines.
d. 4serve client activities and operations.
11. ) system #alkthrough is used to:
medium a. test alances.
c . test details of transactions.
c. gain an understanding of internal controls.
d. determine acceptance of the client.
1!. +*ulic, *C)47 3tandard ! 6666666 the auditor to perform #alkthroughs of significant processes.
medium a. encourages
. re'uires
c. does not allo#
d. permits
1(. /he most important consideration in developing the audit plan and audit program is the:
medium a. clientAs size.
d . clientAs industry.
c. audit firmAs availale personnel.
d. the audit risk model used in its planning form.
1.. /ests of controls are directed to#ard the controlAs:
Arens/Elder/Beasley
medium a. efficiency.
. effectiveness.
c. efficiency and effectiveness.
d. cost enefit ratio.
12.
medium
Chen the auditor finds that there are missing controls in an area of the accounting system, the
audit program in that area #ould e modified in such a #ay as to:
d a. increase the amount of tests of controls.
. increase the reliance on tests of controls.
c. cause the issuance of a 'ualified or adverse opinion.
d. eliminate the need for a test of controls.
18.
medium
) procedure designed to test for monetary misstatements directly affecting the correctness of
financial statement alances is a:
a. test of controls.
. sustantive test.
c. test of attriutes.
d. monetary-unit sampling test.
1;. Chich of the follo#ing is not appropriate for purposes of testing the effectiveness of controls$
medium a. Make in'uiries of client personnel.
. ?valuate prior e-perience #ith the client.
c. 4serve control-related activities.
d. Reperform client procedures.
1<. Chich of the follo#ing is not a direct result of performing analytical procedures$
medium a. "dentify areas of potential misstatements.
d . Reduce detailed audit tests.
c. >nderstand the clientAs usiness.
d. "dentify specific errors in the accounts.
1=.
medium
"f no material differences are found using analytical procedures and the auditor concludes that
misstatements are not likely to have occurred:
a a. other tests may e reduced.
. it #ill e necessary to increase the tests of alances.
c. it #ill not e necessary to perform tests of alances.
d. it #ill e necessary to increase the tests of transactions.
!:. /he primary emphasis in most tests of details of alances is on the:
medium a. alance sheet accounts.
a . revenue accounts.
c. cash flo# statement accounts.
d. e-pense accounts.
!1. )nalytical procedures are defined in the auditing standards as:
medium a. compliance tests.
. sustantive tests.
c. tests of controls.
d. helpful procedures not possessing the validity of other tests availale to the auditor.
!!. /ests of transactions are used to determine #hether 66666666666 have een satisfied.
medium a. compliance test re'uirements.
c . alance coverage re'uirements.
c. transaction-related audit o@ectives.
d. e-istence assertions
!(. Chich of the follo#ing statements is not true$
Arens/Elder/Beasley
medium a. )nalytical procedures emphasize the overall reasonaleness of transactions and alances.
. /ests of controls are concerned #ith evaluating #hether controls are sufficiently effective
to @ustify reducing control risk and therey reducing analytical revie# procedures.
c. 3ustantive tests of transactions emphasize the verification of transactions recorded in the
@ournals and then posted in the general ledger.
d. /ests of details of alances emphasize the ending alances in the general ledger.
!.. Chich of the follo#ing audit tests is usually the least costly to perform$
medium a. )nalytical procedures.
a . /ests of controls.
c. /ests of alances.
d. 3ustantive tests of transactions.
!2. Chich of the follo#ing audit tests is usually the most costly to perform$
medium a. )nalytical procedures.
c . /ests of controls.
c. /ests of alances.
d. 3ustantive tests of transactions.
!8. )nalytical procedures must e performed in:
medium a. the planning and test of control stages.
c . con@unction #ith tests of transactions and tests of details of alances.
c. the planning and completion stages.
d. the planning, test of control, and completion stages.
!;. Chich of the follo#ing tests commonly occur together$
medium a. 3ustantive tests of transactions and tests of controls.
a . 3ustantive tests of transactions and otaining an understanding of internal controls.
c. )nalytical procedures and tests of controls.
d. /ests of controls and tests of details of alances.
!<. Chich of the follo#ing relationships et#een types of tests and audit evidence is not correct$
medium a. /ests of details and documentation.
c . /ests of controls and oservation.
c. /ests of details and oservation.
d. 3ustantive tests of transactions and reperformance
!=. )n increased e-tent of tests of controls is most likely to occur #hen:
medium a. it is a first-year audit.
c . the auditor is doing a 0fraud audit.1
c. controls are effective and the preliminary control risk assessment is lo#.
d. controls are ineffective and the preliminary control risk assessment is high.
(:. Many auditors perform e-tensive analytical procedures on audits ecause:
medium a. they are re'uired y %))3.
c . they pinpoint errors in accounts.
c. they indicate areas of potential risk and misstatement.
d. they are re'uired for tests of controls.
(1. +*ulic,
medium
Chich of the follo#ing types of procedures #ill e performed in an audit of internal control
over financial reporting$
c
*rocedures to otain an understanding of internal control Ratio analysis
a. Jes Jes
. Do Do
c. Jes Do
d. Do Jes
Arens/Elder/Beasley
(!. /ests of details of alances focus on:
medium a. eginning of the year alances.
. end of the year alances.
c. transaction details for the period under audit.
d. accounting cycles.
((. )uditors #ho test manual controls that rely on "/-generated reports must consider:
medium a. the enefits of relying on "/-generated reports.
c . separation of duties related to the "/-generated reports.
c. the controls related to the accuracy of the information in the report.
d. #hether the manual controls are approved y the audit committee..
(..
medium
Chen an auditor elieves that analytical procedures indicate a reasonale possiility of
misstatement, the auditor usually #ould:
d
*erform additional tests of controls Eecide to modify tests of details of alances
a. Jes Jes
. Do Do
c. Jes Do
d. Do Jes
(2.
medium
"f the results of the tests of controls, sustantive tests of transactions, and analytical procedures
are not consistent #ith the predictions, tests of details of alances #ill e:
d a. eliminated.
. increased.
c. unaffected.
d. changed.
(8.
medium
Chen controls are deemed ineffective and assessed control risk is at the ma-imum for a private
company, there #ill e 666666 emphasis placed on tests of controls.
a a. no
. relatively little
c. moderate
d. heavy
(;. /ests of controls address each of the follo#ing 'uestions e-cept:
medium a. Ho# #ere the procedures performed$
. Chy #ere the procedures performed$
c. Cere the necessary procedures performed$
d. Cho performed the procedures$
(<. Chich of the follo#ing audit tests #ould e regarded as a test of controls$
medium a. Comparison of the inventory pricing to vendorsA invoices.
. /ests of the signatures on canceled checks to oard of directorsA authorizations.
c. /ests of the additions to property, plant, and e'uipment y physical inspections.
d. Revie# of the specific items making up the alance in a given general ledger account.
(=. +*ulic,
medium
Chich of the follo#ing tests form the asis for an auditorAs report on internal control over
financial reporting$
c a. )nalytical procedures
. /ests of transactions
c. /ests of controls
d. /ests of details of alances
.:.
medium
)fter finishing the revie# phase of the study and evaluation of internal control in an audit, the
auditor should perform tests of controls on:
Arens/Elder/Beasley
a a. those controls that the auditor #ants and plans to rely upon.
. those controls in #hich material #eaknesses #ere identified.
c. those controls that have a material effect upon the financial statement alances.
d. a random sample of the controls that #ere revie#ed.
.1. )t #hat point in the audit are tests of details most appropriately designed$
medium a. ?ngagement evaluation.
. *lanning.
c. /esting.
d. Communication of material #eaknesses.
.!. +*ulic, Chich of the follo#ing isKare performed in an audit of internal control over financial reporting$
Medium
*rocedures to otain an
understanding of internal
control /est of details of alances )nalytical *rocedures
a. Jes Jes Do
. Jes Do Do
c. Do Jes Jes
d. Do Do Jes
.(.
medium
/he reliance placed on sustantive tests in relation to the reliance placed on internal control
varies in a relationship that is ordinarily:
a. parallel.
. inverse.
c. direct.
d. e'ual.
...
medium
Chich of the follo#ing is ordinarily designed to detect possile material dollar errors on the
financial statements$
a. /ests of controls.
. )nalytical revie# procedures.
c. Computer controls.
d. Done of the aove.
.2. Chat type of test is used to otain more types of evidence than any other$
challenging a. 3ustantive tests of transactions.
d . /ests of controls.
c. )nalytical procedures.
d. /ests of details.
.8. 4nly 6666666 involve physical e-amination and confirmation.
challenging a. tests of controls
c . tests of transactions
c. tests of alances
d. analytical procedures
.;. Eocumentation is used in every type of test e-cept 66666666.
challenging a. tests of controls
c . tests of transactions
c. analytical procedures
d. tests of details
.<.
challenging
Chich of the follo#ing types of evidence is not availale #hen using sustantive tests of
transactions$
a. Eocumentation.
. Confirmation.
Arens/Elder/Beasley
c. "n'uiries of the client.
d. Reperformance.
.=. )n e-ception in a test of control indicates the 6666666 of misstatements.
challenging a. the amount
. the likelihood
c. the amount, likelihood, and classification
d. the amount and the classification
2:. Chich of the follo#ing is not a valid asis for omitting an audit test$
challenging a. the difficulty and e-pense involved in testing a particular item.
a . the relative risk involved.
c. the degree of reliance on the relevant internal controls.
d. the relationship et#een the cost of otaining evidence and its usefulness.
21.
challenging
Chich of the follo#ing ultimately determines the specific audit procedures necessary to provide
an independent auditor #ith a reasonale asis for the e-pression of an opinion$
a. /he audit program.
. /he auditorAs @udgment.
c. %enerally accepted auditing standards.
d. /he auditorAs #orking papers.
?ssay Questions
2!.
easy
Contrast the circumstances in #hich the auditor #ould choose not to test controls #ith those in
#hich he or she #ould perform tests of controls.
)ns#er:
"f the auditor elieves that controls have not een operating effectively during the period
under audit, or that it #ould not e cost-effective to test controls, then he or she #ould
choose not to test controls. "n contrast, if the auditor elieves that controls have een
operating effectively during the period under audit, and that it #ould e cost-effective to
test controls, the auditor #ill perform tests of controls.
2(.
easy
/hree factors the auditor considers #hen assessing control risk are: the auditorAs elief
concerning the effectiveness of internal controls, the results of tests of controls, and the cost-
effectiveness of a reduced assessed control risk. "dentify the comination of conditions for these
three factors that is re'uired efore a reduction in sustantive testing is permitted.
)ns#er:
) reduction in sustantive testing is permitted #hen +1, the auditor identifies specific
controls he or she elieves have een operating effectively during the period under audit,
+!, the auditor elieves it #ill e cost-effective to test those controls, and +(, the results of
tests of controls indicate that the controls have indeed een operating effectively.
2..
medium
&ist each of the five types of audit tests and list at least t#o types of evidence that may e
otained from each type of test.
)ns#er:
*rocedures to otain an understanding of internal control - documentation,
oservation, in'uiries of the client, and reperformance.
/ests of controls - documentation, oservation, in'uiries of the client, and
reperformance.
3ustantive tests of transactions - documentation, in'uiries of the client, and
Arens/Elder/Beasley
reperformance.
)nalytical procedures - in'uiries of the client and analytical procedures.
/ests of details of alances - physical e-amination, confirmation, documentation,
in'uires of the client, and reperformance.
22.
medium
Must auditors al#ays perform tests of controls$
)ns#er:
)uditors only need to perform tests of controls in the audit of a private company if they
intend to rely on them. )uditors must al#ays perform tests of controls in the audit of a
pulic company.
28.
medium
Eescrie the five types of audit tests. "dentify #hich of the five types are sustantive tests, and
#hich are used to reduce assessed control risk.
)ns#er:
/he five types of audit tests used to determine #hether financial statements are fairly
stated are: procedures to otain an understanding of internal control, tests of controls,
sustantive tests of transactions, analytical procedures, and tests of details of alances.
3ustantive tests of transactions, analytical procedures, and tests of details of alances
are sustantive tests, #hereas procedures to otain an understanding of internal control
and tests of controls are used to reduce assessed control risk.
2;.
medium
Consider the audit risk model and the five types of audit tests. Chich tests provide evidence
pertinent to the various elements of the audit risk model$
)ns#er:
?vidence can e otained aout control risk via procedures to otain an understanding of
internal controls, tests of controls, and sustantive tests of transactions. ?vidence can e
otained aout planned detection risk via sustantive tests of transactions, analytical
procedures, and tests of details of alances.
2<.
medium
Eiscuss the purposes of +1, sustantive tests of transactions, +!, tests of controls, and +(, tests of
details of alances. %ive an e-ample of each.
)ns#er:
/he purpose of sustantive tests of transactions is to determine #hether all si- transaction-
related audit o@ectives have een satisfied for each class of transactions. Bor e-ample, as
part of the auditorAs test of the accuracy o@ective for sales, the auditor #ould compare the
amount recorded in the sales @ournal for a sample of sales transactions #ith the total on the
corresponding sales invoices.
/he purpose of tests of controls is to determine the effectiveness of oth the design and
operations of specific internal controls. Bor e-ample, the auditor might oserve for a
month #hether statements are mailed to all customers.
/he purpose of tests of details of alances is to determine the monetary correctness of the
accounts to #hich they relate. /he confirmation of accounts receivale is an e-ample.
2=.
medium
/here are three stages of the audit in #hich analytical procedures are performed. "dentify each
of these three stages and, for each stage, discuss the purpose of performing analytical
procedures in that stage. )lso indicate in #hich stage+s, analytical procedures are re'uired y
Arens/Elder/Beasley
current professional auditing standards.
)ns#er:
)nalytical procedures are performed in the audit planning stage to help the auditor decide
the other evidence needed to satisfy sufficient competent evidence re'uirements.
)nalytical procedures can also e performed as sustantive tests in the testing phase of the
audit. )nalytical procedures are performed in the audit completion phase as a final test of
reasonaleness. )uditing standards re'uire that analytical procedures e performed in the
planning and completion phases of every audit.
Arens/Elder/Beasley
8:.
medium
Eiscuss the ma@or determinants of the e-tent of tests of details of alances.
)ns#er:
Ma@or determinants of the e-tent of tests of details of alances include: the results of tests
of controls, sustantive tests of transactions, and analytical proceduresP the amount of
tolerale misstatementP and the levels of inherent risk and acceptale audit risk.
81.
challenging
Chat are the four steps auditors follo# #hen they plan to reduce assessed control risk$
)ns#er:
/he steps are as follo#s:
1. )pply transaction-related audit o@ectives to the class of transaction eing tested.
!. "dentify key controls that should reduce control risk for each transaction-related audit
o@ective.
(. Eevelop appropriate tests of controls for all internal controls used to reduce the
preliminary assessment of control risk elo# ma-imum.
.. Bor potential types of misstatements related to each transaction-related audit
o@ectives, design appropriate sustantive tests of transactions, considering
deficiencies in internal control and e-pected results of the tests of controls.
8!.
challenging
Eiscuss the relationship of each of the follo#ing to the e-tent of planned tests of details of
alances: +1, tolerale misstatement, +!, inherent risk, +(, control risk, and +., acceptale audit
risk.
)ns#er:
"nherent risk and control risk are directly related to the e-tent of planned tests of details of
alancesP that is, as inherent risk andKor control risk increase, the e-tent of planned tests of
details of alances also increases. /olerale misstatement and acceptale audit risk are
inversely related to the e-tent of planned tests of details of alancesP that is, as tolerale
misstatement andKor acceptale audit risk increase, the e-tent of planned tests of details of
alances decreases.
8(.
challenging
/here are seven types of audit evidence: physical e-amination, confirmation, documentation,
oservation, in'uiries of the client, reperformance, and analytical procedures. Bor each of the
follo#ing types of audit tests, indicate the type+s, of evidence that can e otained through the
test: +1, tests of controls, +!, sustantive tests of transactions, +(, analytical procedures, and +.,
tests of details of alances.
)ns#er:
1. -ests of controls. Eocumentation, oservation, in'uiries of the client, reperformance.
!. Su#stanti%e tests of transactions. Eocumentation, in'uiries of the client, reperformance.
(. Anal"tical procedures. "n'uiries of the client, analytical procedures.
.. -ests of details of #alances. *hysical e-amination, confirmation, documentation,
in'uiries of the client, reperformance.
Arens/Elder/Beasley
8..
challenging
Eiscuss the ma@or activities and procedures performed y the auditor in each of the four phases
of an audit.
)ns#er:
/he ma@or activities performed in the planning and design phase +*hase ", are: preplan the
engagementP otain ackground information aout the clientP otain information aout the
clientAs legal oligationsP perform preliminary analytical proceduresP set materiality, and
assess acceptale audit risk and inherent riskP otain an understanding of internal control,
and assess control riskP and develop an overall audit plan and audit program.
*hase "" involves tests of controls, sustantive tests of transactions, and an assessment
of the likelihood of misstatements in the financial statements.
*hase """ involves analytical procedures and tests of details of alances.
"n *hase "I, the auditor performs the revie# for contingent liailities, the revie# for
suse'uent events, accumulates final evidence, evaluates results, issues the audit report,
and communicates #ith the clientAs audit committee and management.
4ther 4@ective )ns#er Bormat Questions
82.
easy
a
4ne difference et#een procedures used to otain an understanding of internal control and
procedures used to test controls is that tests of controls are more e-tensive.
a. /rue
. Balse
88.
easy

/ests of controls are generally less e-pensive to perform than analytical procedures.
a. /rue
. Balse
8;.
easy
a
/ests of controls provide evidence aout the potential for misstatements in a clientAs accounting
system.
a. /rue
. Balse
8<.
easy

)uditing standards encourage, ut do not re'uire, a #ritten audit program.

a. /rue
. Balse
8=.
easy

3ustantive tests of transactions are the most e-pensive type of audit test to perform.
a. /rue
. Balse
;:.
easy
a
)n e-ception in a test of control provides only an indication of the likelihood of monetary
misstatements in the financial statements ecause tests of controls do not reveal #hether
monetary misstatements have actually occurred.
a. /rue
. Balse
Arens/Elder/Beasley
;1.
easy

)n e-ception in a sustantive test of transactions provides only an indication of the likelihood

of monetary misstatements in the financial statements ecause sustantive tests of transactions
do not reveal #hether monetary misstatements have actually occurred.
a. /rue
. Balse
;!.
easy
a
)nalytical procedures are the least e-pensive type of audit test.
a. /rue
. Balse
;(.
easy
a
"f inherent risk is decreased from medium to lo#, tests of details of alances can e reduced.
a. /rue
. Balse
;..
easy
a
Chen designing an audit program for tests of details of alances, the auditor should make
assumptions aout inherent risk and control risk, and predictions concerning the outcome of
tests of controls, sustantive tests of transactions, and analytical procedures.
a. /rue
. Balse
;2.
easy
a
/he e-tent of tests of details of alances can e reduced #hen transaction-related audit
o@ectives have een satisfied y tests of controls or sustantive tests of transactions.
a. /rue
. Balse
;8.
easy

/ests of controls and sustantive tests of transactions are rarely, if ever, conducted
simultaneously on the same transactions.
a. /rue
. Balse
;;.
easy

>nder normal circumstances, there should e no variation in the audit evidence mi- from cycle
to cycle for a given audit engagement.
a. /rue
. Balse
;<.
medium
a
)uditing standards recognize that in instances #here a significant amount of audit evidence is in
electronic form, it may not e possile to reduce detection risk to an acceptale level y
performing only sustantive tests.
a. /rue
. Balse
;=.
medium
a
Chen analytical procedures are performed during sustantive testing, they are typically more
focused and e-tensive than #hen performed as part of audit planning.
a. /rue
. Balse
<:.
medium
a
/ests of controls may e performed prior to sustantive tests of transactions.
a. /rue
. Balse
Arens/Elder/Beasley
<1.
medium

/ests of details of alances focus on eginning and ending of the year alances.
a. /rue
. Balse
<!.
medium
a
"f tests of controls reveal that controls are sufficiently effective to @ustify reducing control risk,
the auditor is @ustified in reducing sustantive audit tests.
a. /rue
. Balse
<(.
medium

)nalytical procedures are the most e-pensive type of audit test to perform ecause of the
e-pertise and training re'uired to properly use them.
a. /rue
. Balse
<.. +*ulic,
medium

*C)47 3tandard ! re'uires auditors to test controls every three years.

a. /rue
. Balse
<2.
medium

/he auditor must communicate significant deficiencies in internal control only after the entire
audit is complete to ensure the auditor has a sufficient understanding of the circumstances
surrounding the deficiency.
a. /rue
. Balse
<8.
medium

/he results of tests of controls and tests of details of alances affect the design of sustantive
tests of transactions.
a. /rue
. Balse
<;.
medium

"f the auditorAs preliminary assessment of control risk is decreased from high to medium, tests
of controls can e reduced.
a. /rue
. Balse
<<.
medium

Chen testing details of alances, most audit procedures satisfy only one alance-related
o@ective, ut more than one audit procedure should e used to test each o@ective.
a. /rue
. Balse
<=.
medium

3ustantive tests of transactions and sustantive tests of details of alances are often conducted
simultaneously.
a. /rue
. Balse
=:.
medium

)uditing standards re'uire that tests of controls e performed on every audit engagement.
a. /rue
. Balse
=1. +*ulic,
challenging
a
"n the audit of a pulic company, computer controls must e tested if they are considered to e
key controls for reducing the likelihood of material misstatements in the financial statements.
a. /rue
. Balse
Arens/Elder/Beasley
=!.
challenging
a
*rocedures to otain an understanding of internal control may suffice for tests of controls #hen
the auditor is assessing automated controls.
a. /rue
. Balse
=(.
challenging
a
)nalytical procedures are normally designed at the account level, #hereas tests of controls and
sustantive tests of transactions are normally designed at the transaction-related o@ective level.
a. /rue
. Balse
=..
challenging

*rocedures to otain an understanding of internal control may suffice for tests of controls #hen
the auditor is assessing control risk in a #ell defined transaction cycle that has not contained
material misstatements in prior audits.
a. /rue
. Balse
=2.
challenging
a
)nalytical procedures provide fe#er types of evidence than any other type of audit test.
a. /rue
. Balse
Chapter 14
Multiple-Choice Questions
1. Chich of the follo#ing is not an account affected y the sales and collection cycle$
easy a. Cash
d . )ccounts receivale
c. )llo#ance for doutful accounts
d. %ross margin
!.
easy
Chich of the follo#ing is not one of the five classes of transactions included in the sales and
collection cycle$
d a. 3ales returns and allo#ances
. Charge-off of uncollectile accounts
c. 7ad det e-pense
d. Eepreciation e-pense
(. Chat event initiates a transaction in the sales and collection cycle$
easy a. Receipt of cash.
d . Eelivery of product to a customer.
c. "dentification of a ne# customer.
d. Customer re'uest for goods.
.. ) 666666666 is a document that indicates a re'uest for merchandise y a customer.
easy a. sales invoice
c . vendor invoice
c. customer order
d. sales order
2. ) 666666666 is a document that communicates the description, 'uantity, and related
Arens/Elder/Beasley
easy information for goods ordered y a customer.
a a. sales order
. customer order
c. vendor invoice
d. sales invoice
8. Chat critical event must take place efore goods can e shipped$
easy a. Eetermination of correct delivery address
. Credit approval
c. Receipt of cash
d. Receipt of sales order from the customer
;. 7efore goods are shipped on account, a properly authorized person must:
easy a. prepare the sales invoice.
c . approve the @ournal entry.
c. approve the customerAs credit.
d. verify that the unit price is accurate.
Arens/Elder/Beasley
<. ) document prepared to initiate shipment of the goods sold is the:
easy a. sales order.
. ill of lading.
c. sales invoice.
d. customer order.
=. /he document used to indicate to the customer the amount of a sale and payment due date is
the:
easy a. sales invoice.
a . ill of lading.
c. purchase order.
d. sales order.
1:. )t #hat point in the sales and collection cycle does the company first give up assets$
easy a. 3ales approval
d . Credit approval
c. Cash collection
d. 3hipment of goods
11. Most companies recognize sales revenue #hen:
easy a. sales are invoiced.
c . customer orders are received.
c. goods are shipped.
d. customer orders are approved.
1!. Chich of the follo#ing is not a usiness function #ithin the 03ales1 class of transactions$
easy a. *rocessing customer orders.
c . %ranting credit.
c. *rocessing and recording sales returns and allo#ances.
d. 3hipping goods.
1(. /he total of the individual account alances in the accounts receivale master file e'uals the:
easy a. total sales for the period.
d . alance of the sales account in the general ledger.
c. total sales less the total cash received for the period.
d. alance of the accounts receivale account in the general ledger.
1..
easy
) listing of amounts o#ed y customer #hich sho#s ho# long each component part has een
due is the:
d a. trial alance.
. #orking trial alance.
c. accounts receivale trial alance.
d. aged accounts receivale trial alance.
12.
easy

) document sent to each customer sho#ing his or her eginning accounts receivale alance
and the amount and date of each sale, cash payment received, any deit or credit memo issued,
and the ending alance is the:
a. accounts receivale susidiary ledger.
. monthly statement.
c. remittance advice.
d. sales invoice.
Arens/Elder/Beasley
18. /he document that accompanies the customerAs payment is the:
easy a. credit memo.
. remittance advice.
c. vendor invoice.
d. monthly statement.
1;. /he document that supports reductions in accounts receivale is the:
easy a. ill of lading.
c . sales invoice.
c. credit memo.
d. monthly statement.
1<.
easy
) document that initiates shipment of goods and indicates the description of the merchandise,
the 'uantity shipped, and customer name and address is the:
a a. ill of lading.
. sales invoice.
c. picking ticket.
d. vendor invoice.
1=. Chen designing audit procedures, the direction of tests is a crucial step in satisfying the:
easy a. valuation o@ective.
c . cutoff o@ective.
c. completeness o@ective.
d. classification o@ective.
!:.
easy
Chich of the follo#ing documents is not commonly associated #ith the 0cash receipts1 class of
transactions$
a. Remittance advice.
. 3ales order.
c. *relisting of cash receipts.
d. Cash receipts @ournal or listing.
!1.
easy
/he process #hich postpones entries for the collection of receivales to conceal an e-isting cash
shortage is referred to as:
a. kiting.
. lapping.
c. floating.
d. shorting.
!!.
easy
Chen sales invoices are automatically calculated and posted y a computer, the auditor may e
ale to reduce sustantive tests of transactions for #hich, if any, o@ective$
a a. )ccuracy
. ?-istence
c. Completeness
d. Done of the aove
!(.
easy
/he 666666666666 is a contract et#een a carrier +e.g., a trucking company, and the seller of
goods that dictates the details surrounding the shipment of goods.
a a. ill of lading
. sales invoice
c. picking ticket
d. remittance advice
Arens/Elder/Beasley
!..
easy
3ome companies have customers send payments directly to an address maintained y a ank.
/his is called a+n, 6666666 system.
c a. direct deposit
. funds transfer
c. locko-
d. interank transfer
!2.
medium
"n many audits, no sustantive tests of transactions are made for the 66666666 o@ective on the
grounds that understatement of sales is not a concern.
c a. accuracy
. e-istence
c. completeness
d. none of the aove
!8. /he most important aspects of the illing function include all ut #hich of the follo#ing$
medium a. Making sure that all shipments have een illed.
. Making sure that no shipment has een illed more than t#ice.
c. Making sure that each shipment is illed at the correct amount.
d. Making sure that each shipment is illed to the proper customer.
!;. Bor the most part, the audit of the sales and collection cycle:
medium a. cannot e performed until the audit of cash is completed.
c . must e performed first so that the audit of the other cycles can rely on the data.
c. can e performed independently of the audit of other cycles.
d. must e performed simultaneously #ith the audit of the purchases and disursements
cycle.
!<.
medium

)n audit procedure that compares the name, amount, and dates sho#n on remittance advices
#ith cash receipts @ournal entries and #ith related duplicate deposit slips #ould e effective in
detecting:
a. kiting.
. lapping.
c. illicit #rite-offs of customers as uncollectile accounts.
d. sales #ithout proper credit authorization.
!=. "n #hich of the follo#ing #ill sales return and allo#ances not e recorded$
medium a. 3ales returns and allo#ances transaction file
c . )ccounts receivale master file
c. Cash receipts @ournal
d. 3ales returns and allo#ances #ill e recorded in all of the aove
(:. Bor most firms, the function of indicating credit approval is recorded on the:
medium a. sales order.
a . sales invoice.
c. customer order.
d. remittance advice.
(1.
medium
/he document used as the asis for recording sales transactions and updating the accounts
receivale master file is the:
d a. sales order.
. ill of lading.
c. sales @ournal.
d. sales invoice.
(!. Chen posting items from the sales @ournal, details of the @ournal and @ournal totals are posted to
Arens/Elder/Beasley
medium #hich items$
c
Eetails of the @ournal are posted to Lournal totals are posted to
a. /he sales account /he general ledger
. /he sales account /he accounts receivale susidiary ledger
c. /he accounts receivale master file /he general ledger
d. /he accounts receivale account in
the general ledger
/he sales account in the general ledger
((. Credit memos are normally issued for #hat purpose+s,$
medium a. /o maintain control of returned merchandise.
a . /o assist in the aging of accounts receivale.
c. /o reduce customer frustration and sales losses.
d. /o inform the customer of the alance due.
(.. *roper auditing re'uires that an account receivale must e charged off y the client #hen:
medium a. the customer files for ankruptcy.
d . the account is at least si- months old.
c. a collection agency cannot inspire customer to pay the det.
d. the client company concludes that an amount is no longer collectile.
(2.
medium
Cho is generally responsile for opening receipts #hen a company uses a locko- to speed the
handling of cash receipts$
c a. Company personnel.
. /emporary employees in the to#n #here the locko- is located.
c. 7ank employees.
d. Company controller.
(8. ) document used to indicate authority to #rite off an account receivale as uncollectile is the:
medium a. credit memo.
. uncollectile account authorization form.
c. deit memo.
d. voucher.
(;.
medium
)fter the auditor has identified the key internal controls and deficiencies and assessed control
risk for a private company, it is appropriate to decide #hether:
a a. sustantive tests #ill e reduced sufficiently to @ustify costs of performing tests of
controls.
. sustantive tests #ill e increased sufficiently to @ustify costs of performing tests of
controls.
c. tests of controls #ill e increased sufficiently to @ustify costs of performing sustantive
tests.
d. tests of controls #ill e reduced sufficiently to @ustify costs of performing sustantive
tests.
(<.
medium
ManagementAs assertions for sales and collection activities are 66666 #hen sales are generated
via e-commerce activities.
a a. unchanged
. e-panded
c. mitigated
d. decreased
(=. /o prevent fraud, management should deny cash access to anyone responsile for:
medium
c 4pening mail from
customers
?ntering sales
transactions
?ntering cash receipts
transactions
a. Jes Jes Jes
Arens/Elder/Beasley
. Do Do Jes
c. Do Jes Jes
d. Jes Do Do
.:. 4ne key internal control to prevent fictitious transactions in the sales and collection cycle is:
medium a. to include a list of customer numers in the computer files.
a . to account for the integrity of the numerical se'uence of sales orders.
c. to include the sales price list of all products in the computer files.
d. having ank reconciliations prepared y one #ho is independent of the treasury function.
.!. Chich one of the follo#ing statements is true$ "n deciding on sustantive tests of transactions:
medium a. some procedures are commonly employed on every audit regardless of the circumstances.
a . all procedures are dependent on the ade'uacy of the controls and the results of the tests of
controls.
c. results otained in the prior yearAs audit #ill not affect the procedures used this year.
d. the materiality of the item #ill not influence the choice of procedures used.
.(. /o test for recorded sales for #hich there #ere no actual shipments, the auditor traces from the:
medium a. ill of lading to the sales @ournal.
. sales @ournal to the ill of lading.
c. sales @ournal to the accounts receivale susidiary ledger.
d. ill of lading to the supporting customer order and sales order.
... )n effective procedure to test for unilled shipments is to trace from the:
medium a. sales @ournal to the shipping documents.
. shipping documents to the sales @ournal.
c. sales @ournal to the accounts receivale ledger.
d. sales @ournal to the general ledger sales account.
.2. /he auditor traces items from the source documents to the @ournals to satisfy the:
medium a. e-istence o@ective.
. completeness o@ective.
c. o#nership o@ective.
d. valuation o@ective.
.8.
medium
"n many audits of sales transactions, no sustantive tests of transactions are performed for the
completeness o@ective ecause:
a. understatements of assets and income are a greater concern than overstatements.
. overstatements of assets and income are a greater concern than understatements.
c. it doesnAt matter if income is understated ecause the savings on income ta- offsets the
reduced revenue and net income is correct.
d. the unrecorded sales cause a reduction of accounts receivaleP therefore, the ratios of the
t#o financial statements #ill not e misleading.
Arens/Elder/Beasley
.;.
medium
/o determine that sales are accurately recorded, the unit prices on the duplicate sales invoices
are normally compared #ith:
a. the original invoices.
. an approved price list.
c. the amounts recorded in the sales @ournal for that transaction.
d. the amounts posted to the customerAs account in the accounts receivale master file.
.<. Chich of the follo#ing is a point at #hich the auditor deems authorization to e critical$
medium
a Credit granting *rice authorization 3hipment of goods
a. Jes Jes Jes
. Jes Do Jes
c. Do Jes Do
d. Jes Do Do
.=. *renumered documents are intended to help:
medium
a *revent the failure to ill or record
sales
*revent duplicate illings or recordings of
sales
a. Jes Jes
. Do Do
c. Jes Do
d. Do Jes
2:. *renumered documents #ill only e useful for control purposes if:
medium a. a different numerical se'uence is used for each company.
. the se'uence is accounted for periodically.
c. employees are allo#ed to use documents out of numerical se'uence.
d. the same numerical se'uence is used each accounting period.
21. "t is important that sales e illed and recorded in the @ournal as soon as possile after:
medium a. the order is received.
d . the order is received and credit is approved.
c. credit is approved and it is verified that there is enough inventory to fill the order.
d. the shipment takes place.
2!. 6666666 tests for omitted transactions, #hile 66666 tests for none-istent transactions.
medium a. /racing, vouching
a . Iouching, tracing
c. Ierifying, tracking
d. /racking, verifying
2(. /he audit procedure referred to as proof of cash receipts is useful to test:
medium a. time lags in making deposits.
. #hether all recorded cash receipts have een deposited in the ank.
c. #hether there are cash receipts that have not een recorded in the @ournals.
d. the clientAs reconciliation et#een cash receipts and ank deposits.
2.. Chich of the follo#ing procedures #ould ordinarily e est e-pected to find unrecorded sales$
medium a. Compare shipping documents #ith sales records.
a . )pply gross profit rates to inventory disposed of during the period.
c. /race payments received suse'uent to the alance sheet date.
d. 3end accounts receivale confirmation re'uests.
Arens/Elder/Beasley
Arens/Elder/Beasley
22.
medium
)t #hich point in an ordinary sales transaction #ould a lack of specific authorization e of least
concern to the auditor$
d a. %ranting of credit.
. 3hipment of goods.
c. Eetermination of discounts.
d. 3elling of goods for cash.
28.
medium

3mith Manufacturing CompanyAs accounts receivale clerk has a friend #ho is also a 3mithAs
customer. /he accounts receivale clerk has issued fictitious credit memos to his friend for
goods supposedly returned. /he most effective procedure for preventing this activity is to:
a. prenumer and account for all credit memorandums.
. re'uire receiving reports to support all credit memorandums efore they are approved.
c. have independent sales and accounts receivale departments.
d. mail monthly statements to customers.
2;.
challenging
%enerally, audit evidence gathered from the sales and collection cycle is comined #ith
evidence from other parts of the audit:
a a. as the evidence accumulation process proceeds.
. only #hen all field#ork processes of the engagement are completed.
c. only after the audit of the sales and collection cycle is concluded.
d. after the conclusion of oth the cash cycle and the sales and collection cycle.
2<.
challenging
*roper separation of duties is useful to prevent various types of misstatements. Chich of the
follo#ing is not an essential separation of duties$
a a. *ersons having access to cash should not have access to marketale securities.
. 3eparate the credit-granting function from the sales function.
c. *ersonnel doing internal comparisons should e independent of those entering the original
data.
d. )nyone responsile for inputting sales and cash receipts transactions information into the
computer should e denied access to cash.
2=.
challenging
Chich one of the follo#ing is not an auditorAs concern aout a key authorization point in the
salesKcollection cycle$
a a. /he receiving room must have authorization efore releasing items to inventory control.
. Credit must e authorized efore the sale.
c. %oods must e shipped after the authorization.
d. *rices must e authorized.
8:.
challenging
/ransaction-related audit o@ectives are essentially the same for processing credit memos as for
sales #ith certain differences. Chich of the follo#ing are t#o key differences$
d a. Risk and emphasis on the completeness o@ective.
. Materiality and emphasis on the accuracy o@ective.
c. Risk and emphasis on the classification o@ective.
d. Materiality and emphasis on the occurrence o@ective.
81.
challenging
Cash receipts from sales on account have een misappropriated. Chich of the follo#ing acts
#ould conceal this defalcation and e least likely to e detected y an auditor$
a a. >nderstating the sales @ournal.
. 4verstating the accounts receivale control account.
c. 4verstating the accounts receivale susidiary ledger.
d. >nderstating the cash receipts @ournal.
Arens/Elder/Beasley
8!.
challenging
Chich of the follo#ing #ould e the est protection for a company that #ishes to prevent the
0lapping1 of trade accounts receivale$
c a. 3egregate duties so that the ookkeeper in charge of the general ledger has no access to
incoming mail.
. 3egregate duties so that no employee has access to oth checks from customers and
currency from daily cash receipts.
c. Have customers send payments directly to the companyAs depository ank.
d. Re'uest that customerAs payment checks e made payale to the company and addressed
to the treasurer.
8(.
medium
) proof of cash is not useful in discovering differences in the actual and reported cash alances
due to:
c a. deposits in transit.
. collections on the companyAs ehalf y the ank #hich are deposited directly to the
companyAs account.
c. cash receipts that #ere not recorded in the relevant @ournals.
d. service charges.
8..
challenging

Chen designing sustantive tests of transactions for sales, the auditor is concerned #ith the
possiility of several types of misstatements. Chich of the follo#ing is not one of the types of
these misstatements$
a. 3ales eing included in the @ournal for #hich no shipment #as made.
. 3ales to related parties, such as officers and susidiaries.
c. 3ales recorded more than once.
d. 3hipments eing made to none-istent customers and recorded as sales.
82.
challenging
)n auditor needs to determine #hether all customers of an electric utility company are eing
illed. /he auditor should test from the:
d a. sales register to the accounts receivale ledger.
. sales register to the meter department records.
c. accounts receivale ledger to the sales register.
d. meter department records to the sales register.
88.
challenging
Chich one of the follo#ing #ould the auditor consider to e an incompatile operation if the
cashier receives remittances from the mailroom$
c a. /he cashier prepares the daily deposit.
. /he cashier makes the daily deposit at a local ank.
c. /he cashier posts the receipts to the accounts receivale susidiary ledger cards.
d. /he cashier endorses the checks.
?ssay Questions
8;.
easy
?-plain each of the follo#ing types of documents and indicate the class of transactions in #hich
they are commonly used.
1. Customer order
!. 3hipping document
(. Remittance advice
.. 3ales returns and allo#ance @ournal
2. >ncollectile account authorization form
)ns#er:
1. Customer order U re'uest for merchandise y a customer. )ppears in the 3ales
class of transactions.
!. 3hipping document U document prepared to initiate shipment of goods, indicating
the description of the merchandise, the 'uantity shipped, and other relevant data.
Arens/Elder/Beasley
)ppears in the 3ales class of transactions.
(. Remittance advice U document that accompanies the sales invoice mailed to the
customer and can e returned to the seller #ith payment. )ppears in the Cash receipts
class of transactions.
.. 3ales returns and allo#ance @ournal U @ournal used to record all sales returns and
allo#ances, analogous to the sales @ournal. )ppears in the 3ales returns and allo#ance
class of transactions.
2. >ncollectile account authorization form U document used internally to indicate
authority to #rite off an account receivale. )ppears in the charge off of >ncollectile
accounts class of transactions.
8<.
medium
3tate the five classes of transactions that comprise the sales and collection cycle.
)ns#er:
/he five classes of transactions that comprise the sales and collection cycle are:
3ales +cash and sales on account,
Cash receipts
3ales returns and allo#ances
Charge-off of uncollectile accounts
7ad det e-pense.
8=.
medium
Customer illing is a critical process #hich auditors must understand. Chat are the most
important aspects of illing and #hat are the related o@ectives$
)ns#er:
/he most important aspects of illing are:
/o make sure that all shipments made have een illed +completeness,,
/hat no shipment has een illed more than once +occurrence,, and
/hat each shipment is illed for the proper amount +accuracy,.
Arens/Elder/Beasley
;:.
medium
Chen assessing planned control risk for sales, the auditor is concerned aout proper
authorization at three key points. Eiscuss each of these three points.
)ns#er:
Credit should e properly authorized efore a sale takes placeP goods should e
shipped only after proper authorizationP and prices, ase terms, freight, and discounts
must e properly authorized.
;1.
medium
Chen testing the occurrence o@ective for sales, the auditor is concerned #ith the possiility of
three types of misstatements. 4ne type is sales eing included in the @ournal for #hich no
shipment #as made. Eiscuss the other t#o types of misstatements.
)ns#er:
/he auditor is also concerned #ith the possiility of +1, shipments eing made to
none-istent customers and recorded as sales, and +!, sales eing recorded more than once.
;!.
medium
?-plain #hat lapping means, and discuss the internal control deficiency that allo#s it to occur.
)lso discuss the procedures the auditor can perform to detect lapping.
)ns#er:
&apping, #hich is a common type of defalcation, is the postponement of entries for the
collection of receivales to conceal an e-isting cash shortage. "t involves deferring
recording the cash receipts from one customer and covering the shortages #ith suse'uent
receipts from another customer. "mproper segregation of duties in #hich a person #ho
handles cash receipts is allo#ed to enter those receipts into the accounting records allo#s
lapping to occur. /he auditor can detect lapping y comparing the name, amount, and
dates sho#n on remittance advices #ith cash receipts @ournal entries and related deposit
slips.
;(.
challenging
Eiscuss the four usiness functions that result in sales transactions in a typical sales and
collection cycle and, for each function, state the key documents and records involved.
)ns#er:
/he four usiness functions that result in sales transactions, and related documents and
records, are:
Processing customer orders. Fey documents include customer order and sales
order.
&ranting credit. Customer order or sales order.
Sipping goods. 3hipping document +ill of lading,.
0illing customers and recording sales. 3ales invoice, sales @ournal, summary
sales report, accounts receivale master file, accounts receivale trial alance, and
monthly statements.
Arens/Elder/Beasley
;..
challenging
Chen designing sustantive tests of transaction for 3ales, the auditor is concerned #ith several
types of misstatements. Chat are these types of misstatements and are they intentional or
unintentional$
)ns#er:
/he auditor is concerned #ith sales eing included in the @ournals for #hich no shipment
#as made, sales recorded more than once, and shipments eing made to none-istent
customers and recorded as sales. /he first t#o types of misstatements can e intentional or
unintentional, ut the third type is al#ays intentional.
;2.
challenging
Bor each of the follo#ing potential misstatements, provide one potential audit test that could e
used to detect the misstatement.
Recorded sale for #hich there #as no shipment
3ale recorded more than once
3hipment made to none-istent customers
)ns#er:
/he potential audit tests include the follo#ing:
Recorded sale for )ic tere )as no sipment. Iouch selected entries in the
sales @ournal to related copies of shipping and other supporting documents.
Sale recorded more tan once. Revie# a numerically sorted list of recorded
sales transactions for duplicate numers. /he auditor may also test for proper
cancellation of shipping documents.
Sipment made to nonexistent customers. /race customer information on sales
invoices to the customer master file.
;8.
challenging
"f sales invoices are automatically calculated and posted y a companyAs computer system, can
the auditor reduce sustantive tests of transactions for the accuracy o@ective$
)ns#er:
"f the auditor determines that the computer is programmed accurately and the price list
master file is authorized and correct, detailed invoice computations can e reduced or
eliminated. /he auditor #ould then focus on determining that effective computer
controls e-ist to ensure that the computer system is properly programmed and has not
een altered since it #as last tested y the auditor.
;;.
challenging
/he transaction-related audit o@ectives and the clientAs methods of controlling misstatements
are essentially the same for credit memos as for sales #ith the e-ception of t#o differences.
Chat are the t#o differences from the auditorAs perspective$
)ns#er:
/he first difference is materiality. "n many instances, sales returns and allo#ances are so
immaterial that auditors ignore them. /he second difference is the emphasis on the
occurrence o@ective. Bor sales returns and allo#ances, auditors usually emphasize testing
recorded transactions to uncovering any theft of cash from the collection of accounts
receivale that #as covered up y fictitious sales returns and allo#ances.
Arens/Elder/Beasley
;<.
challenging
Eescrie the three asic steps an auditor should follo# #hen designing tests of controls and
sustantive tests of transactions.
)ns#er:
/he three asic steps in designing tests of controls and sustantive tests of transactions
are:
Eetermine key internal controls for each audit o@ective.
Eesign tests of controls for each control used to support a reduced control
risk.
Eesign sustantive tests of transactions to test for monetary misstatements for
each o@ective.
4ther 4@ective )ns#er Bormat Questions
;=.
medium
Match seven of the terms for documents and records +a-k, #ith the descriptions provided elo#
+1-;,:
a. Customer order form
. 3ales order
c. 7ill of lading
d. 3ales invoice
e. 3ummary sales report
f. )ccounts receivale master file
g. Monthly statement
h. Remittance advice
i. *relisting of cash receipts
@. Credit memo
k. >ncollectile account authorization form
i 1. ) schedule prepared y an independent person #hen cash is received. "t is used
to verify #hether cash received #as recorded and deposited at the correct
amounts and on a timely asis.
@ !. ) document indicating a reduction in the amount due from a customer ecause
of returned goods or an allo#ance granted.
c (. ) document prepared to initiate shipment of goods, indicating the description of
the merchandise, the 'uantity shipped, and other relevant data. "t is a #ritten
contract et#een the carrier and seller of the receipt and shipment of goods.
.. )n internal document for communicating the description, 'uantity, and related
information for goods ordered y a customer. /his is fre'uently used to indicate
credit approval and authorization for shipment.
h 2. ) document that accompanies the sales invoice mailed to the customer and
#hich can e returned to the seller #ith the cash payment.
k 8. ) document used internally to indicate authority to #rite-off an account
receivale as uncollectile.
d ;. ) document indicating the description and 'uantity of goods sold, the price,
freight charges, insurance, terms, and other relevant data.
Arens/Elder/Beasley
<:.
easy

) sales invoice is a document that usually indicates credit approval.

a. /rue
. Balse
<1.
easy

Credit should e approved efore a customerAs order is received.

a. /rue
. Balse
<!.
easy
a
Credit should e approved efore goods are shipped to a customer.
a. /rue
. Balse
<(.
easy
a
/he receipt of a customer order from a customer is the starting point for the entire sales and
collection cycle.
a. /rue
. Balse
<..
easy

/he preparation of a sales invoice is the final step in the sales and collection cycle.
a. /rue
. Balse
<2.
easy
a
Chen auditors evaluate sales returns and allo#ances, a primary emphasis is on the o@ective of
occurrence.
a. /rue
. Balse
<8.
easy

) ill of lading is a special type of sales invoice used #hen goods are shipped interstate.
a. /rue
. Balse
<;.
easy

/he overall o@ective in the audit of the sales and collection cycle is to evaluate #hether the
account alances affected y the cycle are fairly presented in accordance #ith %))3.
a. /rue
. Balse
<<.
easy
a
Bor good internal control, the credit-granting function should e separate from the sales
function.
a. /rue
. Balse
<=.
medium

/he sales and collection cycle involves the transfer of o#nership of goods to customers ut does
not involve the conversion of services into accounts receivale.
a. /rue
. Balse
=:.
medium
a
/he shipping point is critical ecause it is the first point at #hich company assets are released to
another party.
a. /rue
. Balse
Arens/Elder/Beasley
=1.
medium
a
3ales returns and allo#ances are often ignored y auditors ecause they are often immaterial.
a. /rue
. Balse
=!.
medium

) ill of lading is a #ritten contract et#een the seller and the uyer.
a. /rue
. Balse
=(.
medium
a
"n a locko- system, ank employees are responsile for opening cash receipts and maintaining
records of all payments made y customers at the locko- address.
a. /rue
. Balse
=..
medium
a
/he most difficult type of cash emezzlement to detect is #hen it occurs efore the cash is
recorded in the cash receipts @ournal.
a. /rue
. Balse
=2.
medium
a
3ales transactions are the result of the follo#ing four functions in the sales and collection cycle:
processing customer orders, granting credit, shipping goods, illing customers, and recording
sales.
a. /rue
. Balse
=8.
medium
a
/he most important concern in the processing and recording cash receipts function is the
possiility of theft.
a. /rue
. Balse
=;.
medium

/he prelisting of cash receipts should e prepared y the individual #ho has primary
responsiility for the recording of cash receipts.
a. /rue
. Balse
=<.
medium

) credit memo is a document used internally that indicates authority to #rite-off an account
receivale as uncollectile.
a. /rue
. Balse
==.
medium

/esting from source documents to the @ournal is useful for testing none-istent transactions.
a. /rue
. Balse
1::.
medium

Chen a company prepares multi-copy, prenumered sales invoices at the time customer orders
are received, there is a higher likelihood of failure to ill the customers than #hen sales invoices
are prepared only after goods have een shipped.
a. /rue
. Balse
Arens/Elder/Beasley
1:1.
medium

/ests of controls should never e performed using the clientAs computer systemP that is, all tests
of control should e performed either using the auditorAs computers or performed manually y
the auditor.
a. /rue
. Balse
1:!.
medium
a
ManagementAs assertions for sales and collection activities remain the same #hether sales are
generated through traditional or e-commerce activities.
a. /rue
. Balse
1:(.
medium

Misstatements involving the completeness o@ective for sales lead to overstatements of assets
and income.
a. /rue
. Balse
1:..
medium
a
Iiolations of the e-istence o@ective for sales are of greater concern to the auditor than
violations of the completeness o@ective.
a. /rue
. Balse
1:2.
medium

)n effective procedure to test the completeness o@ective for sales is to trace sales @ournal
entries to copies of sales orders, shipping documents, and sales invoices.
a. /rue
. Balse
1:8.
medium

/he auditorAs primary concern aout authorization centers on shipment of goods to customers.
a. /rue
. Balse
1:;.
medium

Chen auditing sales returns and allo#ances, the emphasis is normally on testing the
completeness o@ective.
a. /rue
. Balse
1:<.
challenging

Bor each internal control deficiency identified y the auditor, he or she should design one or
more tests of controls to assess the e-tent of the deficiency and its effect on the financial
statements.
a. /rue
. Balse
1:=.
challenging

Bor effective internal control, it is important that sales e recorded as soon after the customer
order is received as possile to prevent the unintentional omission of transactions from the
records and to make sure that sales are recorded in the proper period.
a. /rue
. Balse
11:.
challenging

Booting the sales @ournal and tracing the totals to the general ledger are tests relating to the
accuracy o@ective for sales.
a. /rue
. Balse
Chapter 15
Arens/Elder/Beasley
Multiple-Choice Questions
1.
easy
) sample in #hich the characteristics of the sample are the same as those of the population is
a+n,:
a. variales sample.
. representative sample.
c. attriutes sample.
d. random sample.
!.
easy
Chen the auditor decides to select less than 1:: percent of the population for testing, the
auditor is said to use:
a a. audit sampling.
. representative sampling.
c. poor @udgment.
d. estimation sampling.
(. "n practice, auditors 666666666 kno# if a sample is truly a representative one.
easy a. sometimes
d . often
c. routinely
d. never
.. /o determine if a sample is truly representative, an auditor must:
easy a. conduct multiple samples of the same population.
c . never use sampling ecause of the e-pense involved.
c. audit the entire population.
d. use systematic sample selection.
2. 4ne of the #ays to eliminate nonsampling risk is through:
easy a. proper supervision and instruction of the clientAs employees.
. proper supervision and instruction of the audit team.
c. the use of attriutes sampling rather than variales sampling.
d. controls #hich ensure that the sample dra#n is random and representative.
8. 4ne cause of nonsampling risk is:
easy a. ineffective use of audit procedures.
a . testing less than the entire population.
c. use of e-tensive tests of controls.
d. the possiility that a properly-selected sample still may not e representative.
;. )n auditor can increase the likelihood that a sample is representative y using care in:
easy
a Eesigning the sampling process Eesigning the sample selection
a. Jes Jes
. Do Do
c. Jes Do
d. Do Jes
<.
easy
Chen the auditor goes through a population and selects items for the sample #ithout regard to
their size, source, or other distinguishing characteristics, it is called:
a. lock sample selection.
. haphazard selection.
c. systematic sample selection.
d. statistical selection.
Arens/Elder/Beasley
=. Chen auditors #ish to evaluate a sample statistically, the only acceptale selection method is:
easy a. proailistic selection.
a . @udgmental selection.
c. haphazard selection.
d. lock sample selection.
1:.
easy
) sample in #hich every possile comination of items in the population has an e'ual chance of
constituting the sample is a:
a a. random sample.
. statistical sample.
c. @udgment sample.
d. representative sample.
11.
easy
/he process #hich re'uires the calculation of an interval and then selects the items ased on the
size of the interval is:
c a. statistical sampling.
. random sample selection.
c. systematic sample selection.
d. computerized sample selection.
1!. 66666666 is the risk that audit tests #ill not uncover e-isting e-ceptions in a sample.
easy a. 3ampling risk.
. Donsampling risk.
c. )udit risk.
d. Eetection risk.
1(.
easy
66666666 is the risk that an auditor #ill reach an incorrect conclusion ecause a sample is not
representative of the population.
a a. 3ampling risk
. Donsampling risk
c. )udit risk
d. Eetection risk
1..
easy
"n systematic sample selection, the population size is divided y the numer of sample items
desired in order to determine the:
a a. sampling interval.
. tolerale e-ception rate.
c. computed upper e-ceptions rate.
d. mean.
12. 3ampling risk may e controlled y:
medium
c )d@usting the sample size )l#ays using random sampling
a. Jes Jes
. Do Do
c. Jes Do
d. Do Jes
18. Chich of the follo#ing occurrences #ould e least likely to attract the auditorAs attention$
easy a. Eeviations from clientAs estalished control procedures.
. Eeviations from clientAs udgeted values.
c. Monetary errors in populations of transaction data.
d. Monetary errors in populations of account alance details.
1;. Chich of the follo#ing statements is correct$
easy
d
a. ) sample of all items of a population #ill eliminate sampling risk, ut increase
nonsampling risk.
Arens/Elder/Beasley
. /he use of an appropriate sample selection techni'ue ensures a representative sample.
c. /he auditorAs failure to recognize an e-ception is a significant cause of sampling risk.
d. /he use of inappropriate audit procedures is a significant cause of nonsampling risk.
1<.
easy
/he risk #hich the auditor is #illing to take in accepting a control as eing effective #hen the
true population e-ception rate is greater than a tolerale rate is the:
c a. finite correction factor.
. tolerale e-ception rate.
c. acceptale risk of assessing control risk too lo#.
d. estimated population e-ception rate.
1=.
easy
/he e-ception rate the auditor #ill permit in the population and still e #illing to reduce the
assessed level of control risk is called the:
a a. tolerale e-ception rate.
. estimated population e-ception rate.
c. acceptale risk of overreliance.
d. sample e-ception rate.
!:.
easy
"f the auditor decides to assess control risk at the ma-imum level in a private company audit,
tests of controls are:
c a. increased in numer.
. reduced in numer.
c. not performed.
d. unchanged from prior planned settings.
!1. Chich of the follo#ing is not one of the asic phases in audit sampling$
easy a. *lanning the sample
d . ?valuating the results of the sample
c. 3electing the sample and performing the tests
d. ?ach of the aove is a phase in audit sampling.
!!.
easy
)ttriutes sampling #ould e an appropriate method to use on #hich one of the follo#ing
procedures in an audit program$
c a. Revie# sales transactions for large and unreasonale amounts.
. 4serve #hether the duties of the accounts receivale clerk are separate from handling
cash.
c. ?-amine a sample of duplicate sales invoices for credit approval y the credit manager.
d. Revie# the aged schedule of accounts receivale to determine if receivales from officers
are included.
Arens/Elder/Beasley
!(.
easy
a
Chen the computed upper e-ception rate is greater than the tolerale e-ception rate, it is
necessary for the auditor to take specific action. Chich of the follo#ing courses of action #ould
e most difficult to defend if the auditor is ever su@ect to revie# y a court$
a. Reduce the tolerale e-ception rate so as to accept the sample results.
. ?-pand the sample size and perform more tests.
c. Revise the assessed control risk.
d. Crite a letter to management #hich outlines the control deficiencies.
!..
easy
Chich of the follo#ing is not generally considered in determining sample size for tests of
controls$
d a. ?-pected population e-ception rate.
. Risk of assessing control risk too lo#.
c. /olerale e-ception rate.
d. *opulation size.
!2. Chich of the follo#ing statement is correct #ith respect to the 'uantification of sampling risk$
easy a. 3ampling risk cannot e 'uantified.
c . 3ampling risk can e 'uantified only #hen non-proailistic selection techni'ues are used
to select the sample.
c. 3ampling risk can e 'uantified only #hen proailistic selection techni'ues are used to
select the sample.
d. Done of the aove.
!8.
easy
/he auditor may use #hich of the follo#ing criteria #hen using the directed sample selection
techni'ue$
d a. "tems most likely to contain misstatements.
. "tems containing selected population characteristics.
c. &arge dollar coverage.
d. )ny of the aove.
!;. Don-sampling errors occur #hen audit tests do not uncover e-isting e-ceptions in the:
medium a. population.
. sample.
c. planning stage.
d. financial statements.
!<. Chich of the follo#ing statements is correct #ith respect to the evaluation of sample results$
medium
c
a. "t is acceptale to make non-proailistic evaluations only #hen proailistic sample
selection is used.
. "t is acceptale to make non-proailistic evaluations only if the auditor cannot 'uantify
sampling risk.
c. "t is never acceptale to evaluate a non-proailistic sample as if it #ere a statistical one.
d. )ll of the aove are correct.
!=. Chich of the follo#ing statements is a valid criticism of non-statistical sampling$
medium
d
a. Many audit tests, such as footing of @ournals, must e performed outside a statistical
sampling conte-t.
. /he cost of performing random selection or testing often e-ceeds the enefits.
c. Don-statistical sampling does not differ sustantially from statistical sampling methods.
d. Conclusions may e dra#n in more precise #ays #hen using statistical sampling methods.
(:.
medium
Chich of the follo#ing methods of sample selection is appropriately used #hen selecting a
random sample$

)uditorAs @udgmental
selection of items
>se of computer-generated
random numers
>se of random numer
tales
Arens/Elder/Beasley
a. Jes Do Jes
. Do Jes Jes
c. Jes Do Do
d. Do Jes Do
(1. Correspondence is estalished et#een the random numer tale and the population y:
medium a. identifying each item in the population #ith a uni'ue numer.
. deciding the numer of digits to use in the random numer tale and their association #ith
the population numering system.
c. defining #hich digits the auditor uses in a column and the method of reading the tale.
d. selecting a random starting point on the tale.
(!. +*ulic,
medium
/he acceptale risk of assessing control risk too lo# #ill normally e assessed at a 6666 level
#hen auditing a pulic company.
c a. higher
. compensating
c. lo#er
d. nominal
((. Chich of the follo#ing statements is not correct$
medium

a. "t is acceptale to pick a starting point on a random numer tale y using a 0lind sta1
method.
. "t is impossile to dra# a si--digit random numer from a tale that is separated into
columns of five digits.
c. /he only reason for selecting a random starting point on a random numer tale is to
eliminate the predictaility of the sample.
d. Chen selecting a three-digit numer from a tale that is separated into columns of five
digits, it is permissile to use the first three digits, the middle three digits, or the last three
digits.
(..
medium
Chich of the follo#ing is not one of the types of computer tools used to generate random
samples$
d a. ?lectronic spreadsheet programs.
. Random numer generators.
c. %eneralized audit soft#are.
d. Random application search soft#are.
(2.
medium
"n using audit sampling for e-ception rates, the auditor is primarily interested in determining the
66666 the e-ception rate might e.
a. lo#est
. highest
c. average range in #hich
d. none of the aove
(8.
medium
/he highest estimated e-ception rate in the population at a particular acceptale risk of
assessing control risk too lo# is:
c a. the upper e-ception rate.
. estimated population e-ception rate.
c. the computed upper e-ception rate.
d. the tolerale e-ception rate.
(;. /he advantage of systematic sample selection is that:
medium a. it is easy to use.
a . there is limited possiility of it eing iased.
c. it is unnecessary to determine if the population is arranged randomly.
d. it automatically selects items material to the financial statements.
Arens/Elder/Beasley
(<.
medium
) statistical method used to estimate the proportion of items in a population containing an
attriute of interest is:
a a. attriutes sampling.
. variales sampling.
c. estimation sampling.
d. population-proportional-to-size sampling.
(=.
medium
/he e-ception rate that the auditor #ill permit in the population and still e #illing to use the
preliminary control risk assessment is called the:
d a. acceptale e-ception rate.
. estimated population e-ception rate.
c. sample e-ception rate.
d. tolerale e-ception rate.
.:. /he auditorAs est estimate of the population e-ception rate is the:
medium a. current yearAs sample e-ception rate.
a . tolerale e-ception rate.
c. prior yearAs sample e-ception rate.
d. computed upper e-ception rate.
.1.
medium
c
*lace the follo#ing steps in their proper order:
1. )nalyze e-ceptions
!. 3elect the sample
(. Eefine attriutes and e-ception conditions
.. 3tate the o@ectives of the audit test
2. 3pecify the tolerale e-ception rate
a. 1,(,!,.,2.
. .,(,1,!,2.
c. .,(,2,!,1.
d. 1,!,(,.,2.
.!.
medium
"f an auditor @udgmentally selects a sample of one hundred items from a population and finds
t#o e-ceptions, the auditor:
a a. can conclude that the sample e-ception rate is !T.
. can conclude that the population e-ception rate is !T.
c. can calculate the highest e-ception rate e-pected in the population.
d. cannot make any conclusions aout either the sample or the population.
Arens/Elder/Beasley
.(. 666666666 represents the auditorAs measure of sampling risk.
medium a. /?R
. )R)CR
c. 3?R
d. ?*?R
... Bor #hich of the follo#ing audit procedures is audit sampling not appropriate$
medium a. Revie# sales transactions for large and unusual amounts.
a . ?-amine a sample of duplicate sales invoices for credit approval.
c. Compare the 'uantity on duplicate sales invoices #ith the 'uantity on related shipping
documents.
d. )udit sampling is appropriate for each of the aove procedures.
.2. Chich of the follo#ing statements aout the process of defining the population is not correct$
medium a. /he auditor can define the population to include the desired data.
d . /he auditor may generalize only aout that population that has een sampled.
c. /he population represents the ody of data aout #hich the auditor #ishes to generalize.
d. /he auditor can randomly sample from any part of the population that she chooses.
.8. Chich of the follo#ing is the e-ception rate that the auditor e-pects to find efore testing$
medium a. 3ample e-ception rate.
. ?stimated population e-ception rate.
c. Computed e-ception rate.
d. /olerale e-ception rate.
.;. Chich of the follo#ing is not determined until after a sample is tested and evaluated$
medium a. 3ample e-ception rate.
c . ?stimated population e-ception rate.
c. Computed e-ception rate.
d. /olerale e-ception rate.
.<. /he relationship of tolerale e-ception rate +/?R, to sample size is:
medium a. direct +larger /?R V larger sample,.
. inverse +larger /?R V smaller sample,.
c. variale +sometimes larger, sometimes smaller,.
d. not determinale.
.=. Chich of the follo#ing must e set prior to testing a sample$
medium a. 3ample e-ception rate.
d . )chieved upper precision limit.
c. Computed e-ception rate.
d. /olerale e-ception rate.
2:. /he relationship of acceptale risk of accessing control risk too lo# +)R)CR, to sample size is:
medium a. variale +sometimes larger, sometimes smaller,.
c . direct +larger )R)CR V larger sample,.
c. inverse +larger )R)CR V smaller sample,.
d. none-istent.
Arens/Elder/Beasley
21.
medium
"n attriutes sampling, an estimate of the e-pected population e-ception rate is necessary to plan
the sample size. /he relationship of e-pected population e-ception rate +?*?R, to sample size
is:
a a. direct +small ?*?R V small sample,.
. inverse +small ?*?R V large sample,.
c. a variale +sometimes small, sometimes large, dependent on other factors present.
d. indeterminate.
2!. /he initial sample size is so called ecause:
medium a. there is al#ays another sample to e done.
d . an auditor must take several samples to ensure randomness.
c. an auditor must take several samples to ensure that the final sample is representative.
d. e-ceptions must e evaluated efore deciding #hether the sample is sufficiently large to
achieve the o@ectives.
2(. /he sample e-ception rate e'uals:
medium a. the numer of e-ceptions in the population divided y the sample size.
c . the numer of items in the population multiplied y the numer of e-ceptions in the
sample.
c. the numer of e-ceptions in the sample divided y the sample size.
d. the numer of e-ceptions in the population divided y the population size.
2..
medium
7efore the population can e considered acceptale ased on the acceptale risk of assessing
control risk too lo#, the computed upper e-ception rate must e:
c a. greater than or e'ual to the tolerale e-ception rate.
. greater than the tolerale e-ception rate.
c. less than or e'ual to the tolerale e-ception rate.
d. less than the tolerale e-ception rate.
22. Chich of the follo#ing statements is not true$
medium a. Random selection is statistical measurement.
a . "t is acceptale to use random selection procedures #ithout dra#ing statistical
conclusions.
c. "t #ould e inappropriate to dra# a statistical conclusion unless the sample #ere
randomly selected.
d. Random selection is a part of statistical sampling.
28. /he acceptale risk of assessing control risk too lo# is:
medium
d /he risk that the auditor is #illing to
take of accepting a control as
ineffective #hen it is effective
/he risk that the auditor is #illing to
take of accepting a control as effective
#hen it is ineffective
a. Jes Jes
. Do Do
c. Jes Do
d. Do Jes
2;. Chen using statistical sampling, the auditor #ould proaly re'uire a smaller sample if the:
medium a. population increases.
. desired reliaility decreases.
c. desired precision interval narro#s.
d. e-pected e-ception rate increases.
2<.
medium
) principal advantage of statistical methods of attriutes sampling over nonstatistical methods
is that they provide a scientific asis for estalishing the:
d a. risk of assessing control risk too lo#.
Arens/Elder/Beasley
. tolerale e-ception rate.
c. e-pected population e-ception rate.
d. sample size.
2=.
medium
"n performing a revie# of a clientAs cash disursements, an auditor uses systematic sample
selection #ith a random start. /he primary disadvantage of this techni'ue is population items:
c a. may occur t#ice in the sample.
. must e reordered in a systematic pattern efore the sample can e dra#n.
c. may occur in a systematic pattern, thus negating the randomness of the sample.
d. must e replaced in the population after sampling to permit valid statistical inference.
8:.
medium
"n estimation sampling for attriutes, #hich one of the follo#ing must e kno#n to evaluate the
sample results$
d a. ?stimated dollar value of the population.
. 3tandard e-ception of the values in the population.
c. )ctual e-ception rate of the attriute in the population.
d. 3ample size.
81.
challenging
Chich of the follo#ing statements is not correct regarding proailistic and non-proailistic
sample selection$
a. "n proailistic selection, every population item has a kno#n chance of eing selected.
. "t is not acceptale to make non-proailistic evaluations using proailistic selection.
c. *roailistic selection is re'uired for all statistical sampling methods.
d. 7oth methods are acceptale and commonly used.
8!. Don-proailistic selection methods are not ased on mathematical proailitiesP therefore:
challenging a. the e-tent to #hich a sample is representative may e difficult to determine.
a . they are discouraged y the )"C*).
c. they are not allo#ed y the 3tatements on )uditing 3tandards.
d. they are not as effective as statistical sampling.
8(. Chich of the follo#ing statements regarding lock sampling is not true$
challenging a. 7lock sampling is the selection of several items in se'uence.
c . "t is acceptale to use lock sampling for tests of transactions only if a reasonale numer
of locks is used.
c. 4nly one lock should e selected to increase the proaility of a representative sample.
d. 4nce the first item in the lock is selected, the remainder of the lock is chosen
automatically.
8.. ) means of reducing the potential ias in systematic sample selection is to:
challenging a. use multiple starts.
a . use a random numer tale.
c. include a large lock of the population.
d. include only the high-dollar-value items.
82. Chen deciding on the acceptale risk of assessing control risk too lo#, the auditor should:
challenging a. rely on hisKher professional @udgment.
a . err on the side of conservatism.
c. consult the professional standards.
d. follo# 3?C guidelines.
88. Chich of the follo#ing statements is true$
challenging
d
a. )udit procedures on the sample item #ill vary as a result of using either statistical or
nonstatistical sampling.
. /he audit procedures #ill e the same for either statistical or nonstatistical sampling ut
they must e performed differently for each.
c. 3tatistical sampling re'uires 'uantitative audit procedures #hereas nonstatistical sampling
Arens/Elder/Beasley
re'uires @udgmental audit procedures.
d. )udit procedures on the sample item #ill not vary as a result of using either statistical or
nonstatistical sampling.
8;.
challenging

Chen audit procedures have een completed for an attriutes sampling application, the auditor
must generalize from the sample to the population. Chich of the follo#ing statements #ould e
incorrect regarding this process$
a. /he auditor #ould use an attriutes sampling tale to determine the computed upper
e-ception rate.
. /he computed upper e-ception rate is the highest e-ception rate in the population that the
auditor is #illing to accept.
c. "t #ould e #rong for the auditor to conclude that the population e-ception rate is e-actly
the same as the sample e-ception rate.
d. "n selecting the tale corresponding to the risk of overreliance, it should e the same as the
)R)CR used for determining the initial sample size.
8<.
challenging
/he difference et#een the tolerale e-ception rate and the estimated population e-ception rate
is called:
c a. accuracy of the initial sample estimate.
. inflation factor of the initial sample estimate.
c. precision of the initial sample estimate.
d. reliaility of the initial sample estimate.
8=.
challenging
"f an auditor, planning to use statistical sampling, is concerned #ith the numer of a clientAs
sales invoices that contain mathematical errors, the auditor #ould most likely utilize:
a. random sampling #ith replacement.
. sampling for attriutes.
c. sampling for variales.
d. stratified random sampling.
;:.
challenging
"f the result otained from a particular sample is critical to the formation of an audit opinion,
#hich of the follo#ing is the most important to the auditor$
a a. )cceptale risk of assessing control risk too lo#.
. ?stimated population e-ception rate.
c. /olerale e-ception rate.
d. 3ize of the population.
;1. /he tolerale rate of e-ceptions for tests of controls is generally:
challenging a. lo#er than the e-pected rate of errors in the related accounting records.
. higher than the e-pected rate of errors in the related accounting records.
c. identical to the e-pected rate of errors in the related accounting records.
d. unrelated to the e-pected rate of errors in the related accounting records.
;!. )n advantage of using statistical sampling techni'ues is that such techni'ues:
challenging a. mathematically measure risk.
a . eliminate the need for @udgmental decisions.
c. define the values of precision and reliaility re'uired to provide audit satisfaction.
d. have een estalished in the courts to e superior to @udgmental sampling.
;(.
challenging
)uditors #ho prefer statistical to nonstatistical sampling elieve that the principal advantage of
statistical sampling flo#s from its uni'ue aility to:
a a. provide a mathematical measurement of uncertainty.
. promote a more legally defensile procedural approach.
c. define the precision re'uired to provide audit satisfaction.
d. estalish conclusive audit evidence #ith decreased audit effort.
;.. Chich of the follo#ing is an advantage of systematic sample selection over random numer
Arens/Elder/Beasley
challenging sampling$
d a. "t provides a stronger asis for statistical conclusions.
. "t enales the auditor to use the more efficient 0sampling #ith replacement1 tales.
c. /here may e correlation et#een the location of items in the population, the feature of
sampling interest, and the sampling interval.
d. "t does not re'uire estalishment of correspondence et#een random numers and items in
the population.
;2.
challenging

Chat is an auditorAs evaluation of a statistical sample for attriutes #hen a test of 1::
documents results in four e-ceptions if the tolerale e-ception rate is 2T, the e-pected
population e-ception rate is (T, and the allo#ance for sampling risk is !T$
a. )ccept the sample results as support for planned reliance on the control ecause the
tolerale rate less the allo#ance for sampling risk e'uals the e-pected population
e-ception rate.
. Modify planned reliance on the control ecause the sample e-ception rate plus the
allo#ance for sampling risk e-ceeds the tolerale rate.
c. Modify planned reliance on the control ecause the tolerale rate plus the allo#ance for
sampling risk e-ceeds the e-pected population e-ception rate.
d. )ccept the sample results as support for planned reliance on the control ecause the
sample deviation rate plus the allo#ance for sampling risk e-ceeds the tolerale rate.
;8.
challenging
a
"n the evaluation of the results of an attriutes sample, the fact that the e-ception rate in the
sample #as !T rather than the estimated population e-ception rate of .T #ould cause the
computed upper e-ception rate to:
a. e less than the tolerale e-ception rate.
. e'ual the tolerale e-ception rate.
c. e-ceed the tolerale e-ception rate.
d. cannot e determined from the information given.
;;.
challenging
"f the size of the sample to e used in a test of attriutes is not determined y using statistical
concepts, ut the sample is chosen in accordance #ith random selection procedures:
c a. no inferences can e dra#n from the sample.
. the auditor has committed a nonsampling error.
c. the auditor may or may not achieve the tolerale e-ception rate at the acceptale risk of
assessing control risk too lo#.
d. the auditor #ill have to evaluate results using the principles of discovery sampling.
?ssay Questions
;<.
easy
7riefly e-plain #hy auditors utilize audit sampling.
)ns#er:
)uditors use sampling techni'ues primarily ecause it is generally impractical to audit
all transactions or alances. Conse'uently, auditors must design strategies to select
items from the population that are likely to e representative of the remaining
unaudited population items. "n addition, auditors often use sampling techni'ues
ecause of economic realities. /hat is, clients generally do not #ant to incur the
sustantial fees associated #ith auditing every transaction or alance.
;=.
easy
Eiscuss #hat is meant y 0sampling risk.1
)ns#er:
3ampling risk occurs #hen the sample is not representative of the populationP that is, the
characteristics of interest in the sample are not the same as those in the population.
Arens/Elder/Beasley
<:.
easy
Eiscuss #hat is meant y 0nonsampling risk.1
)ns#er:
Donsampling risk occurs #hen audit tests do not uncover e-isting e-ceptions in the
sample.
<1.
easy
?-plain the difference et#een sampling #ith replacement and #ithout replacement. Chich
method is more common in audit practice$
)ns#er:
"n replacement sampling, an element in the population can e included in the sample
more than once, #hereas in nonreplacement sampling, an element can e included only
once. Donreplacement sampling is more common in audit practice.
<!.
medium
Eiscuss t#o causes of nonsampling risk. )lso discuss #ays the auditor can control nonsampling
risk.
)ns#er:
/he t#o causes of nonsampling risk are +1, the auditorAs failure to recognize e-ceptions
and +!, inappropriate or ineffective audit procedures. /he auditor can control nonsampling
risk through careful design of audit procedures and through proper instruction,
supervision, and revie#.
<(.
medium
Chat is the key advantage and disadvantage associated #ith systematic sample selection$ Ho#
must auditors address this disadvantage$
)ns#er:
/he key advantage is its ease of use. %enerally, systematic samples are easily dra#n from
the population and supporting documentation is easily developed. /he key disadvantage is
the potential for ias. 4nce the first item in the sample is selected, all other items are
chosen automatically. )uditors should e careful to consider any potential pattern in the
data prior to selecting their sample to ensure that their selection considers the possile
ias.
<..
medium
Eescrie the differences et#een statistical and nonstatistical sampling in terms of +1, the
sample selection methods used, and +!, 'uantification of sampling risk.
)ns#er:
Donstatistical sampling differs from statistical sampling in that non-proailistic sampling
can e used for the former ut not the latter. "n addition, sampling risk can e 'uantified
#hen using statistical sampling ut not #hen using nonstatistical sampling.
Arens/Elder/Beasley
<2.
medium
Eescrie each of the three types of sample selection methods commonly associated #ith
nonstatistical audit sampling.
)ns#er:
/hree types of sample selection methods commonly associated #ith nonstatistical audit
sampling are:
.irected sample selection. ?ach item in the sample is selected on the asis of
some @udgmental criteria estalished y the auditor.
0lock sample selection. 3everal items in the population are selected in
se'uence.
1apa8ard sample selection. 3ample items are selected from the population
#ithout regard to their size, source, or other distinguishing characteristics.
<8.
medium
Eescrie each of the four types of sample selection methods commonly associated #ith
statistical audit sampling.
)ns#er:
Bour types of sample selection methods commonly associated #ith statistical audit
sampling are:
Simple random sample selection. ?very possile comination of elements in
the population has an e'ual chance of constituting the sample.
S"stematic sample selection. ) proailistic method of sampling in #hich the
auditor calculates an interval +the population size divided y the numer of sample
items desired, and selects the items for the sample ased on the size of the interval
and a randomly selected numer et#een zero and the interval size.
Pro#a#ilit" proportional to si8e sample selection. /he proaility of selecting
any individual population item is proportional to its recorded amount.
Stratified sample selection. ) proailistic method of sampling in #hich the
population is divided into supopulations, and su-samples are taken from each of the
supopulations.
<;.
medium
Eirected sample selection is the selection of each item in the sample ased on some @udgment
criteria estalished y the auditor. Eiscuss three commonly used criteria.
)ns#er:
Commonly-used criteria used in directed sample selection are:
"tems most likely to contain misstatementsP for e-ample, unusual or comple-
transactions, overdue receivales.
"tems containing selected population characteristics, such as transactions
selected from each month during the year or from each location.
&arge dollar coverage in #hich the auditor focuses on selecting the relatively
large items in the population for testing.
Arens/Elder/Beasley
<<.
medium
Chat types of e-ceptions are auditors most concerned #ith #hen evaluating populations of
accounting data$
)ns#er:
/here are three types of e-ceptions that auditors are generally concerned #ith #hen
evaluating populations of accounting data. /hey are:
1. Eeviations from clientAs estalished controls.
!. Monetary misstatements in populations of transaction data.
(. Monetary misstatements in populations of account alance details.
<=.
medium
?-plain the effect on sample size of increasing each of the follo#ing: +1, tolerale e-ception
rate, +!, estimated population e-ception rate, +(, acceptale risk of assessing control risk too
lo#, and +., population size.
)ns#er:
/he tolerale e-ception rate and acceptale risk of assessing control risk too lo# are
inversely related to sample sizeP that is, as /?R or )R)CR increase, sample size #ill
decrease. /he estimated population e-ception rate and the population size are directly
related to sample sizeP that is, as ?*?R increases, sample size #ill also increase, and as
population size increases, sample size may slightly increase.
=:.
challenging
/here are 1. steps to attriutes sampling, divided into three sections: plan the sample, select the
sample and perform the audit procedures, and evaluate the results. Eiscuss each of the steps that
comprise the 0evaluate the results1 section.
)ns#er:
/he steps that comprise the 0evaluate the results1 section in attriutes sampling are:
1. &enerali8e from te sample to te population. /ales can e used to determine
the upper precision limit +computed upper e-ception rate, ased on the acceptale risk
of assessing control risk too lo# and the sample e-ception rate.
!. Anal"8e exceptions. "n this step, the auditor should analyze individual
e-ceptions to determine the reakdo#n in the internal controls that caused them.
(. .ecide te accepta#ilit" of te population. "n the final step, the auditor
compares the computed upper e-ception rate #ith the tolerale e-ception rate. "f the
computed upper e-ception rate is less than or e'ual to the tolerale e-ception rate,
then the population is considered acceptale.
=1.
challenging
/here are 1. steps to attriutes sampling, divided into three sections: plan the sample, select the
sample and perform the audit procedures, and evaluate the results. Eiscuss each of the steps that
comprise the 0plan the sample1 section.
Arens/Elder/Beasley
)ns#er:
/he steps that comprise the 0plan the sample1 section in attriutes sampling are:
1. State te o#$ecti%es of te audit test. /ypically, in attriutes sampling, the
overall o@ective is to test the application of controls and determine #hether
transactions contain monetary misstatements.
!. .ecide if audit sampling applies. )udit procedures involving documentation
normally can e performed using sampling, #hereas procedures involving
oservation, in'uiry of the client, and analytical procedures are not suited to audit
sampling.
(. .efine attri#utes and exception conditions. "n this step, the auditor carefully
defines the attriutes of interest and the conditions that constitute e-ceptions or errors.
.. .efine te population. /he population is the ody of data aout #hich the
auditor #ished to generalize, from #hich the sample must e dra#n.
2. .efine te sampling unit. "n attriutes sampling, the sampling unit is normally
a document, identified y document numers, or a transaction recorded in a @ournal.
8. Specif" tolera#le exception rate. /his is the e-ception rate that the auditor #ill
permit in the population and still e #illing to rely on internal controls.
;. Specif" accepta#le risk of assessing control risk too lo). /his is the risk that
the auditor is #illing to take in accepting a control as effective #hen the true
population e-ception rate is greater than the tolerale e-ception rate.
<. Estimate te population exception rate. /his is the e-ception rate the auditor
e-pects to find in the population efore testing egins.
=. .etermine te initial sample si8e. /he initial sample size is determined from
tales, ased on values for the tolerale e-ception rate, acceptale risk of assessing
control risk too lo#, and the estimated e-ception rate.
4ther 4@ective )ns#er Bormat Questions
=!.
medium
Match eight of the terms +a-k, #ith the definitions provided elo# +1-<,:
a. Haphazard selection
. )ttriutes sampling
c. 7lock sample selection
d. Ludgmental sampling
e. Don-proailistic sample selection
f. *roailistic sample selection
g. Random sample
h. Representative sample
i. 3tatistical sampling
@. 3ystematic sample selection
k. 3ampling distriution
i 1. /he use of mathematical measurement techni'ues to calculate formal statistical
results and 'uantify sampling risk.
c !. ) non-proailistic method of sample selection in #hich items are selected in
measured se'uences.
h (. ) sample #hose characteristics are the same as those of the population.
.. ) statistical, proailistic method of sample evaluation that results in an
estimate of the proportion of items in a population containing a characteristic of
interest.
Arens/Elder/Beasley
Arens/Elder/Beasley
a 2. ) non-proailistic method of sample selection in #hich items are chosen
#ithout regard to their size, source, or other distinguishing characteristics.
f 8. )n auditor selects items such that each population item has a kno#n proaility
of eing included in the sample.
k ;. ) fre'uency distriution of the results of all possile samples of a specified size
that could e otained from a population containing some specific parameters.
g <. ) sample in #hich every possile comination of elements in the population has
an e'ual chance of constituting the sample.
=(.
easy

3ampling risk results from the auditorAs failure to recognize e-ceptions in transaction data.
a. /rue
. Balse
=..
easy
a
?ven #hen nonsampling risk is zero, there is al#ays a chance that a sample is not reasonaly
representative.
a. /rue
. Balse
=2.
easy

/he prior yearAs sample e-ception rate is the auditorAs est estimate of the e-ception rate in the
population for the current year.
a. /rue
. Balse
=8.
easy
a
/he tolerale e-ception rate is the rate that the auditor #ill permit in the population and still e
#illing to conclude a control is effective.
a. /rue
. Balse
=;.
medium
a
Chen selecting a sample, random numers may e otained either #ith replacement or #ithout
replacement. )lthough oth selection methods are theoretically sound, auditors rarely use
replacement sampling.
a. /rue
. Balse
=<.
medium
a
"f a particular internal control is not follo#ed y the client e-actly 8T of the time, and the
auditorAs tests of that control find three control violations in a sample of 2:, the sample is
considered to e representative.
a. /rue
. Balse
==.
medium
a
"n practice, auditors do not kno# #hether a sample is representative, even after all testing is
complete.
a. /rue
. Balse
1::.
medium
a
/he only #ay to kno# #ith certainty #hether a sample is representative is to suse'uently audit
the entire population.
a. /rue
. Balse
1:1.
medium
a
4ne #ay to control sampling risk is to increase sample size.
a. /rue
. Balse
Arens/Elder/Beasley
Arens/Elder/Beasley
Arens/Elder/Beasley
1:!.
medium
a
) sample of all items in a population #ill have a zero sampling risk.
a. /rue
. Balse
1:(.
medium
a
"t is virtually impossile to reduce sampling risk to zero.
a. /rue
. Balse
1:..
medium
a
"t is e'ually acceptale under professional auditing standards for auditors to use either statistical
or nonstatistical sampling methods.
a. /rue
. Balse
1:2.
medium

Chen using nonstatistical sampling, the sample must e a proailistic one.

a. /rue
. Balse
1:8.
medium

/he use of haphazard sample selection is encouraged under professional auditing standards.
a. /rue
. Balse
1:;.
medium

)lthough systematic sample selection is easy to use, its primary disadvantage is that it is not a
proailistic sampling method.
a. /rue
. Balse
1:<.
medium

)cceptale risk of assessing control risk too lo# is the risk that the auditor is #illing to take in
accepting a control as effective #hen the true population e-ception rate is greater than the
estimated population e-ception rate.
a. /rue
. Balse
1:=.
medium

Eirected sample selection, lock sample selection, and haphazard sample selection are three
types of proailistic sample selection methods.
a. /rue
. Balse
11:. +*ulic,
medium
a
)R)CR is normally lo#er for a pulic company audit than a private company audit.
a. /rue
. Balse
111.
medium

/he con@oined sample e-ception rate is the auditorAs 0est estimate1 of the actual e-ception rate
in the entire population.
a. /rue
. Balse
11!.
medium
a
Chen the computed upper e-ception rate is greater than the tolerale e-ception rate in attriutes
sampling, one possile appropriate course of action is to increase sample size.
a. /rue
. Balse
11(.
medium
a
/olerale e-ception rate +/?R, is inversely related to sample size.
a. /rue
. Balse
Chapter 16
Multiple-Choice Questions
1.
easy
Chich of the follo#ing is not a alance-related audit o@ective evaluated in the audit of
accounts receivale$
a a. /iming
. Realizale value
c. Completeness
d. )ccuracy
!. /he t#o primary classes of transactions in the sales and collection cycle are:
easy a. sales and sales discounts.
. sales and cash receipts.
c. sales and sales returns.
d. sales and accounts receivale.
(. /he appropriate evidence to e otained from tests of details must e decided on a+n,:
easy a. efficiency asis.
c . effectiveness asis.
c. audit o@ectives asis.
d. none of the aove.
..
easy
Chich of the follo#ing is not a alance-related audit o@ective evaluated in the audit of
accounts receivale$
a a. 4ccurrence
. Completeness
c. Rights
d. )ccuracy
Arens/Elder/Beasley
11..
medium

/he higher the assessed control risk, the lo#er #ill e the acceptale risk of assessing control
risk too lo#.
a. /rue
. Balse
112.
challenging
a
/he auditor may estimate the 0estimated population e-ception rate1 y taking a small
preliminary sample from the current yearAs data or y using the prior yearAs e-perience #ith the
client.
a. /rue
. Balse
118.
challenging

Chen a small preliminary sample is used to estimate the population e-ception rate, it +the
preliminary sample, cannot e included in the ultimate sample.
a. /rue
. Balse
11;.
challenging
a
"n nonstatistical sampling, the calculated sampling error is the difference et#een the tolerale
e-ception rate and the sample e-ception rate.
a. /rue
. Balse
2.
easy
/ests of #hich alance-related audit o@ective are normally performed first in an audit of the
sales and collection$
d a. )ccuracy
. Completeness
c. Rights
d. Eetail tie-in
8.
easy
Bor most audits, inherent risk for accounts receivale is moderate or lo# e-cept for #hich
alance-related audit o@ectives$
d a. /iming and realizale value.
. Completeness and e-istence.
c. ?-istence and accuracy.
d. Realizale value and cutoff.
;.
easy
Chich of the follo#ing types of receivales #ould not deserve the special attention of the
auditor$
d a. )ccounts receivales #ith credit alances.
. )ccounts that have een outstanding for a long time.
c. Receivales from affiliated companies.
d. ?ach of the aove #ould receive special attention.
<.
easy

) listing of the alances in the accounts receivale master file at the alance sheet date, y total
alance outstanding and y the amount of time the component parts have een outstanding, is
the:
a. customer list.
. aged trial alance.
c. accounts receivale ledger.
d. schedule of accounts receivale.
=.
easy
/esting the information on the aged trial alance for detail tie-in is a necessary audit procedure,
#hich #ould normally include:
a
/est-footing the total column
and the columns depicting the
aging
Comparing the total of the aged trial alance #ith
the general ledger accounts receivale account
a. Jes Jes
. Do Do
c. Jes Do
d. Do Jes
1:.
easy
)uditors are often concerned #ith three aspects of internal controls related to the sales and
collection cycle. Chich of the follo#ing is not one of those controls$
c a. Controls that detect or prevent emezzlements.
. Controls over cutoff.
c. Controls over ac'uisitions.
d. Controls related to the allo#ance for doutful accounts.
11. Cutoff misstatements occur #hen:
easy
c /he auditor fails to otain the end-
of-year ank statement directly from
the ank, otaining instead the
statement #hich includes the t#o
succeeding #eeks
3use'uent period
transactions are
recorded in the
current period
Current period
transactions are
recorded in the
suse'uent period
a. Jes Jes Do
. Jes Do Jes
c. Do Jes Jes
Arens/Elder/Beasley
d. Do Jes Do
1!. Cutoff misstatements occur:
easy a. either y error or fraud.
a . y error only.
c. y fraud only.
d. randomly #ithout causes related to errors or fraud.
1(. %enerally accepted accounting principles re'uire that material sales returns and allo#ances e:
easy a. recorded in the period #hen the merchandise is returned.
c . recorded in the period #hen the credit memo is issued.
c. matched #ith related sales.
d. recorded as a deit to the sales account.
1..
easy
Communication addressed to the detor re'uesting him or her to confirm #hether the alance as
stated on the communication is correct or incorrect is a:
d a. representation letter.
. negative confirmation.
c. ank confirmation.
d. positive confirmation.
12. ) type of positive confirmation kno#n as a lank confirmation:
easy a. re'uests the recipient to fill in the amount of the alance.
a . is considered less reliale than the regular positive confirmation.
c. generates as high a response rate as the regular positive confirmation form.
d. is used #hen the auditor is confirming several small alances.
18.
medium
Bor sales, the occurrence transaction-related audit o@ective affects the 666666 alance-related
audit o@ective.
a a. e-istence
. completeness
c. rights
d. detail tie-in
1;.
medium
Bor cash receipts, the occurrence transaction-related audit o@ective affects the 666666 alance-
related audit o@ective.
a. e-istence
. completeness
c. rights
d. detail tie-in
1<.
medium
Chich of the follo#ing is likely to e determined first #hen performing tests of details for
accounts receivale$
a. Recorded accounts receivale e-ist.
. )ccounts receivale in the aged trial alance agree #ith related master file amounts, and
the total is correctly added and agrees #ith the general ledger.
c. )ccounts receivale are o#ned.
d. ?-isting accounts receivale are included.
1=.
medium
)nalytical procedures are sustantive tests and, if the results of the analytical procedures are
favorale, the auditor #ill:
a a. reduce the e-tent of tests of details of alances.
. reduce the e-tent of tests of controls.
c. reduce the tests of transactions.
d. reduce all of the other tests.
!:. /he most effective test of details of accounts receivale is the:
Arens/Elder/Beasley
medium a. detail tie-in of the records.
c . analysis of the allo#ance for doutful accounts.
c. confirmation of accounts receivale.
d. e-amination of sales invoices.
!1. /ests of details of alances are directed to:
medium a. alance sheet accounts for all cycles.
a . income statement accounts for all cycles.
c. alance sheet accounts for some cycles and income statement accounts for other cycles.
d. all general ledger accounts for all cycles.
!!. /he most important test of details of alances for accounts receivale is:
medium a. confirmations.
a . recalculation of the aged receivales and uncollectile accounts.
c. tracing credit memos for returned merchandise to receiving room reports.
d. tracing from shipping documents to @ournals to the accounts receivale ledger.
!(.
medium
/he most important test of details of alances to determine the e-istence of recorded accounts
receivale is:
d a. tracing details of sales invoices to shipping documents.
. tracing the credits in accounts receivale to ank deposits.
c. tracing sales returns entries to credit memos issued and receiving room reports.
d. the confirmation of customersA alances.
!..
medium
Chen should auditors not perform alternative procedures in testing the accounts receivale
alance$
a. Chen customers do not return positive confirmation re'uests.
. Chen customers do not return negative confirmation re'uests.
c. Chen confirmations are deemed to e ineffective as an audit procedure.
d. Chen confirmations are too costly to use.
!2.
medium
7ecause of its central role in auditing of accounts receivale, the 66666666666666 is one of the
first items tested.
c a. accounts receivale master file
. customer file
c. aged trial alance
d. sales register
!8. "f accounts receivale accounts #ith credit alances are significant, they should e:
medium a. #ritten off.
c . moved to the deit side.
c. reclassified as accounts payale.
d. corrected y making ad@usting entries.
!;. Most tests of accounts receivale are ased on #hat schedule, file, or listing$
medium a. 3ales master file.
. )ged accounts receivale trial alance.
c. )ccounts receivale master file.
d. )ccounts receivale general ledger account.
!<.
medium
"f the clientAs internal control for recording sales returns and allo#ances is evaluated as
ineffective:
a a. a larger sample is needed to verify cutoff.
. sampling is not appropriate.
c. all sales returns must e traced to supporting documentation.
d. all sales returns must e confirmed #ith the customer.
!=. ) customer mails and records a check to a client for payment of an unpaid account on
Arens/Elder/Beasley
medium
d
Eecemer (:. /he client receives and records the amount on Lanuary !. /he records of the t#o
organizations #ill e different on Eecemer (1. /his represents
) cutoff misstatement ) timing difference
a. Jes Jes
. Do Do
c. Jes Do
d. Do Jes
(:.
medium
Chich of the follo#ing audit procedures #ould not likely detect a clientAs decision to pledge or
factor accounts receivale$
c a. ) revie# of the minutes of the oard of directorsA meetings.
. Eiscussions #ith the client.
c. Confirmation of receivales.
d. ?-amination of correspondence files.
(1. Chen do most companies record sales returns and allo#ances$
medium a. Euring the month in #hich the sale occurs.
. Euring the accounting period in #hich the return occurs.
c. Chenever the customer contacts the company regarding the credit.
d. Euring the month after the sale occurs.
(!. Cutoff misstatements can occur for:
Medium
a 3ales 3ales returns and allo#ances
a. Jes Jes
. Do Do
c. Jes Do
d. Do Jes
((. /he most important aspect of evaluating the clientAs method of otaining a reliale cutoff is to:
medium a. perform e-tensive detailed testing of cutoff.
. evaluate the clientAs control procedures around cutoff.
c. confirm a sample of transactions near period end #ith customers.
d. confirm transaction #ith customers.
(.. ) positive confirmation is more reliale evidence than a negative confirmation ecause:
medium a. fe#er confirmations can e sent out.
d . the auditor has a document #hich can e used in court.
c. the detorAs lack of response indicates agreement #ith the stated alance.
d. follo#-up procedures are performed if a response is not received from the detor.
(2. /he advantage of using the negative form of confirmations is that:
medium
a
a. larger sample sizes can e used #ithout increasing the costs aove #hat #ould have een
re'uired for positive confirmations.
. a non-response from the customer proves that the alance is correct.
c. follo#-up procedures are scheduled automatically.
d. they provide greater reliance.
(8.
medium
Chich of the follo#ing procedures do most auditors perform #hen auditing the allo#ance for
doutful accounts$
a. 3end positive confirmations.
. "n'uire of the clientAs credit manager.
c. 3end negative confirmations.
d. ?-amine sales invoices.
(;.
medium
Chen positive confirmations are used, auditing standards re'uire follo#-up procedures for
confirmations not returned y the customer. "n such a situation, #hich of the follo#ing #ould
Arens/Elder/Beasley
a not e classified as an alternative procedure$
a. 3end a second confirmation re'uest.
. ?-amine suse'uent cash receipts to determine if the receivale has een paid.
c. ?-amine shipping documents to verify that the merchandise #as shipped.
d. ?-amine customerAs purchase order and the duplicate sales invoice to determine that the
merchandise #as ordered.
(<.
medium
%enerally accepted accounting principles re'uire that sales returns and allo#ances e matched
#ith related sales:
c a. if practical.
. if re'uired y industry practice.
c. if the amounts are material.
d. any of the aove.
(=. Bor #hich of the follo#ing accounts is cutoff least important$
medium a. 3ales
c . 3ales returns and allo#ances
c. Cash collections
d. "nventory
.:.
medium
Chat are the possile disadvantages of evaluating the allo#ance for doutful accounts y
revie#ing individual non-current alances only$
a
Current accounts receivale may
e ignored
"t is difficult to compare results of the current and
prior years
a. Jes Jes
. Do Do
c. Jes Do
d. Do Jes
.1. Chich of the follo#ing most likely #ould e detected y a revie# of a clientAs sales cutoff$
medium a. ?-cessive sales discounts.
. >nrecorded sales for the year.
c. >nauthorized goods returned for credit.
d. &apping of year-end accounts receivale.
.!. /he positive +as opposed to the negative, form of receivales confirmation is preferred #hen:
medium a. internal control surrounding accounts receivale is considered to e effective.
. there is reason to elieve that a sustantial numer of accounts may e in dispute.
c. a large numer of small alances are involved.
d. there is reason to elieve a significant portion of the re'uests #ill e made.
.(.
medium
)n auditor should perform alternative procedures to sustantiate the e-istence of accounts
receivale #hen:
a a. no reply to a positive confirmation re'uest is received.
. no reply to a negative confirmation re'uest is received.
c. collectiility of the receivales is in dout.
d. pledging of the receivales is proale.
... Ho# might the auditor determine #hether a client has limited rights to accounts receivale$
Medium
a Revie# minutes from oard of directors meetings "n'uiries of the client
a. Jes Jes
. Do Do
c. Jes Do
d. Do Jes
Arens/Elder/Beasley
.2. Confirmation of accounts receivale alances normally provides evidence concerning the:
medium a. valuation of the alances.
c . rights of the alances.
c. e-istence of the alances.
d. completeness of the alances.
.8. "f the auditor decides not to confirm accounts receivale, the auditor should:
medium a. al#ays use alternative procedures to audit the accounts receivale.
c . include copies of customer statements in the audit files.
c. document the reasons for such a decision in the audit files.
d. include copies of customer sales invoices in the audit files.
.;. /he understatement of sales and accounts receivale is est uncovered y:
challenging a. confirming receivales.
c . revie#ing the aged trial alance.
c. test of transactions for shipments made ut not recorded.
d. reconciling the accounts receivale general ledger account #ith the schedule of accounts
receivale.
.<.
challenging
a
Jou are revie#ing sales to discover cutoff prolems. "f the clientAs policy is to record sales
#hen title to the merchandise passes to the uyer, then the ooks and records #ould contain
errors if the Eecemer (1 entries #ere for sales recorded:
a. efore the merchandise #as shipped.
. at the time the merchandise #as shipped.
c. several days suse'uent to shipment.
d. at a time after the point at #hich title passed.
.=. ) procedure to test for a cash receipts cutoff error is:
challenging a. reconciling the ank statement.
d . performing a four-column proof-of-cash.
c. oserving the counting of cash at the alance sheet date.
d. tracing recorded cash receipts to ank deposits on the ank statement of a different period.
2:. /he most reliale evidence from confirmations is otained #hen they are sent:
challenging a. as close to the alance sheet date as possile.
a . at various times throughout the year to different segments of the sample, so that the entire
sample is representative of account alances scattered throughout the year.
c. several months efore the year-end, so the auditor #ill have ade'uate time to perform
alternate procedures if they are re'uired.
d. at various times throughout the year to the same group in the sample, so that the sample
#ill not have a time ias.
21.
challenging
Chich of the follo#ing is the least important consideration in determining the sample size of
confirmations$
a a. /he types of confirmations eing sentP that is, positive or negative.
. /he results of related analytical procedures.
c. /otal annual credit sales.
d. /he auditorAs assessment of detection risk.
2!.
challenging
d
)n auditor learns that collections of accounts receivale during the first ten days of Lanuary
#ere deited to cash and credited to accounts receivale as of Eecemer (1. /he effect
generally #ill e to:
a. overstate the current ratio #ith no effect on #orking capital at Eecemer (1.
. overstate oth #orking capital and the current ratio at Eecemer (1.
c. overstate #orking capital #ith no effect on the current ratio at Eecemer (1.
d. leave oth #orking capital and the current ratio unchanged at Eecemer (1.
Arens/Elder/Beasley
2(.
challenging
Bor effective internal control, employees maintaining the accounts receivale susidiary ledger
should not also approve:
c a. employee overtime #ages.
. credit granted to customers.
c. #rite-offs of customer accounts.
d. cash disursements.
2..
challenging
Bor most audits, a proper cash receipts cutoff is less important than the sales cutoff ecause the
improper cutoff of cash:
c a. is detected and correct #hen cash is separately audited.
. is unlikely to have a material impact on the alance sheet or the income statement.
c. affects on the cash and accounts receivale alances on the alance sheet and does not
affect net income.
d. rarely occurs given the control consciousness of most entities.
22.
medium
Degative confirmations of receivales are less effective than positive confirmations of
receivales ecause:
a. they do not produce evidence that is statistically 'uantifiale.
. the auditor cannot infer that all non-respondents have verified their account information.
c. some recipients may report incorrect alances that re'uire e-tensive follo#-up.
d. a ma@ority of recipients usually lack the #illingness to respond o@ectively.
28. )n auditor #ould e least likely to use confirmations in connection #ith the e-amination of:
medium a. inventories.
c . long-term det.
c. property, plant, and e'uipment.
d. stockholdersA e'uity.
2;.
medium
)n auditor selects a sample from the file of shipping documents to determine #hether invoices
#ere prepared. /his test is performed to satisfy the audit o@ective of:
d a. accuracy.
. e-istence.
c. control.
d. completeness.
2<.
challenging
Chen performing tests of controls and tests of transactions for sales, the auditor generally
defines the population as:
a. all accounts receivale transactions for the year.
. all sales invoices for the year.
c. all cash receipts transactions for the year.
d. all sales invoices less sales return credit memos.
?ssay Questions
2=.
easy
)uditing standards re'uire the confirmation of accounts receivale in normal circumstances.
Chat are the three e-ceptions to this re'uirement$
)ns#er:
/he three e-ceptions are:
1. )ccounts receivale are immaterial.
!. /he auditor considers confirmations ineffective evidence ecause response rates #ill
likely e inade'uate or unreliale.
(. /he comined level of inherent risk and control risk is lo# and other sustantive
evidence can e accumulated to provide sufficient evidence.
Arens/Elder/Beasley
8:.
easy
Eescrie the differences et#een positive and negative confirmations. Chich type is generally
vie#ed as more reliale$
)ns#er:
) positive confirmation re'uests the recipient to respond regardless of #hether the alance
as stated on the confirmation is correct or incorrect. "n contrast, a negative confirmation
re'uests the recipient to respond only if the alance as stated on the confirmation is
incorrect. *ositive confirmations are more reliale ecause the auditor can perform follo#-
up procedures if a response is not received from the customer.
81.
medium
) threefold approach is typically follo#ed #hen determining the reasonaleness of cutoff.
7riefly descrie the threefold approach.
)ns#er:
Birst, auditors should decide on the appropriate cutoff criteria. 3econd, they must evaluate
#hether the client has estalished ade'uate procedures to ensure a reasonale cutoff.
Binally, auditors must test #hether a reasonale cutoff #as otained.
8!.
medium
Eiscuss the alternative procedures an auditor can perform to test the e-istence o@ective for
accounts receivale #hen customers do not respond to confirmation re'uests.
)ns#er:
Bor any positive confirmation not returned, the auditor can e-amine the follo#ing to
verify the e-istence of individual sales transactions making up the ending alance in
accounts receivale:
3use'uent cash receiptsMevidence of the receipt of cash after the
confirmation date includes e-amining remittance advices and entries in the cash
receipts records.
Euplicate sales invoices.
3hipping documents.
Correspondence et#een the customer and the client.
8(.
medium
Eescrie ho# the auditor tests the accuracy o@ective for accounts receivale.
)ns#er:
Confirmation of accounts selected from the trial alance is the most common test of details
of alances for the accuracy of accounts receivale. Chen customers do not respond to
confirmation re'uests, auditors e-amine supporting documents in the same #ay as
descried for the e-istence o@ective. )uditors perform tests of the deits and credits to
individual customersA alances y e-amining supporting documentation for shipments and
cash receipts.
8..
medium
Eescrie ho# the auditor tests the classification o@ective for accounts receivale.
)ns#er:
Dormally, auditors can evaluate the classification of accounts receivale relatively easily,
y revie#ing the aged trial alance for material receivales from affiliates, officers,
directors, or other related parties. )uditors should verify that notes receivale or accounts
that should e classified as noncurrent assets are separated from regular accounts, and
Arens/Elder/Beasley
significant credit alances in accounts receivale are reclassified as accounts payale.
82.
medium
Eiscuss the audit procedures performed #hen testing the detail tie-in o@ective for accounts
receivale, and e-plain #hy this o@ective is ordinarily tested efore any other o@ectives for
accounts receivale.
)ns#er:
Chen testing the detail tie-in o@ective for accounts receivale, the total column and
the columns depicting the aging on the aged trial alance are footed, and the total is
compared to the general ledger. "n addition, a sample of individual alances on the
aged trial alance should e traced to supporting documents to verify the customerAs
name, alance, and proper aging. /hese tests are ordinarily done efore any other tests
to assure the auditor that the population eing tested agrees #ith the general ledger and
accounts receivale master file.
88.
medium
)ssuming the clientAs internal controls are ade'uate, descrie ho# the auditor can verify proper
cutoff of sales transactions.
)ns#er:
)ssuming the clientAs internal controls are ade'uate, the auditor can verify proper cutoff of
sales transactions y otaining the shipping document numer for the last shipment made
at the end of the period and comparing this numer #ith current and suse'uent period
recorded sales.
8;.
medium
Eescrie ho# the auditor tests the rights o@ective for accounts receivale.
)ns#er:
/he auditor can test the rights o@ective for accounts receivale through revie#ing the
clientAs minutes, discussions #ith the client, confirmation #ith anks, and the e-amination
of correspondence files to determine #hether receivales may have een pledged as
collateral, assigned to someone else, factored, or sold.
8<.
medium
Eiscuss the advantages and disadvantages of using negative accounts receivale confirmations
rather than positive confirmations.
)ns#er:
/he primary advantage of negative confirmations is that they are less e-pensive than
positive confirmations ecause there are no second re'uests and no follo#-up of
nonresponses. /he primary disadvantage of negative confirmations is that they are less
reliale than positive confirmations ecause a nonresponse must e regarded as a correct
response, even though the detor may have ignored the confirmation re'uest.
8=.
medium
7riefly descrie the circumstances in #hich it is acceptale to use negative confirmation
re'uests.
)ns#er:
"t is acceptale to use negative confirmation re'uests only #hen all of the follo#ing
circumstances are present:
)ccounts receivale is made up of a large numer of small accounts.
Comined assessed control risk and inherent risk is lo#.
/here is no reason to elieve that the recipients of the confirmations are
unlikely to give them consideration.
Arens/Elder/Beasley
;:.
medium
Eescrie each of the follo#ing types of confirmations:
*ositive confirmation
7lank confirmation form
"nvoice confirmation
Degative confirmation
)ns#er:
*ositive confirmations are communications addressed to a detor re'uesting the
recipient to confirm #hether the alance as stated on the confirmation is correct or
incorrect.
7lank confirmation forms do not state the amount, ut re'uests the recipient to fill in
the alance or furnish other information.
"nvoice confirmations re'uest a recipient to confirm an individual invoice rather than
an entire alance.
Degative confirmations are addressed to detor, ut re'uest responses only if the
information is incorrect.
;1.
challenging
Chat are the ma@or factors affecting sample size for confirming accounts receivale$
)ns#er:
/he factors include:
tolerale misstatement,
inherent risk +e.g., relative size of accounts receivale and numer of accounts,,
control risk,
achieved detection risk form other sustantive tests, and
the type of confirmation +e.g., negative normally re'uires a larger sample size,.
;!.
challenging
Chen an auditor uses negative confirmations several factors must e considered. Chat are those
factors$
)ns#er:
/he auditor must carefully consider the follo#ing:
/he effectiveness of the clientAs internal controls
Results of sustantive tests of transactions
/he appropriateness of analytical procedures as evidence on the fairness of accounts
receivale.
Chether a large ma@ority of recipients #ill give careful consideration to the
confirmation.
4ther 4@ective )ns#er Bormat Questions
;(.
medium
Match seven of the terms +a-k, #ith the definitions provided elo# +1-;,:
a. )ccounts receivale alance-related audit o@ectives
. )ged trial alance
c. )lternative procedures
d. 7lank confirmation form
e. Cutoff misstatements
f. ?vidence planning #orksheet
g. Degative confirmation
Arens/Elder/Beasley
h. *ositive confirmation
i. Realizale value of accounts receivale
@. /iming difference in an account receivale confirmation
k. "nvoice confirmation
c 1. /he follo#-up of a positive confirmation not returned y the detor #ith the use
of documentation evidence to determine #hether the recorded receivale e-ists
and is collectile.
h !. ) letter, addressed to the detor, re'uesting that the recipient indicate directly on
the letter #hether the stated account alance is correct or incorrect and, if
incorrect, y #hat amount.
e (. Misstatements that take place as a result of current period transactions eing
recorded in a suse'uent period, or suse'uent period transactions eing
recorded in the current period.
f .. ) form used to help the auditor decide #hether planned detection risk for tests
of details of alances should e lo#, medium, or high for each alance-related
audit o@ective.
g 2. ) letter, addressed to the detor, re'uesting a response only if the recipient
disagrees #ith the amount of the stated account alance.
@ 8. ) reported difference in a confirmation from a detor that is determined to e a
timing difference et#een the clientAs and detorAs records and therefore not a
misstatement.
;. ) listing of the alances in the accounts receivale master file at the alance
sheet date roken do#n according to the amount of time that has passed et#een
the date of sale and the alance sheet date.
;..
easy
a
/ests of details of alances must e designed for each alance-related audit o@ective.
a. /rue
. Balse
;2.
easy
a
Bavorale results from analytical procedures reduce the e-tent to #hich the auditor needs to test
details of alances.
a. /rue
. Balse
;8.
easy

/ests of detail tie-in are normally conducted last in the audit of the sales and collections cycle.
a. /rue
. Balse
;;.
easy
a
/he criterion used y most merchandising and manufacturing clients for determining #hen a
sale takes place is #hether title to the goods has passed.
a. /rue
. Balse
;<.
medium

Bor sales, the completeness transaction-related audit o@ective affects the e-istence alance-
related audit o@ective.
a. /rue
. Balse
;=. Bor cash receipts, the occurrence transaction-related audit o@ective affects the completeness
Arens/Elder/Beasley
medium
a
alance-related audit o@ective.
a. /rue
. Balse
<:.
medium

/he alance-related audit o@ectives of realizale value and rights are affected y assessed
control risk.
a. /rue
. Balse
<1.
medium
a
/ests of the presentation and disclosure-related o@ectives are generally done as part of the
completion phase of the audit.
a. /rue
. Balse
<!.
medium
a
/ests of details of alances focus on testing the year-end alances of alance sheet accounts.
a. /rue
. Balse
<(.
medium
a
Confirmation of accounts receivale provide evidence related to the e-istence, accuracy and
cutoff o@ectives.
a. /rue
. Balse
<..
medium
a
Confirmation is the most common test of details of alances for the accuracy of accounts
receivale.
a. /rue
. Balse
<2.
medium
a
)ccounts receivale need not e confirmed if they are immaterial to the financial statements.
a. /rue
. Balse
<8.
medium

7lank confirmations are considered less reliale than standard positive confirmations.
a. /rue
. Balse
<;.
medium
a
Degative confirmations are less e-pensive, and less reliale, than positive confirmations.
a. /rue
. Balse
<<.
medium

"t is common to use a comination of positive and negative confirmations y sending the latter
to accounts #ith large alances and the former to those #ith small alances.
a. /rue
. Balse
<=.
medium
a
/ests of the realizale value alance-related audit o@ective are for the purpose of evaluating the
allo#ance for doutful accounts.
a. /rue
. Balse
=:.
medium
a
"f auditors consider confirmations of accounts receivale to e ineffective evidence ecause
response rates #ill e very lo#, they need not confirm accounts receivale.
a. /rue
. Balse
=1.
medium
a
/he type of receivales confirmation is a ma@or factor affecting sample size, #ith negative
confirmations normally re'uiring a larger sample than positive confirmations.
a. /rue
Arens/Elder/Beasley
. Balse
=!.
medium
a
Chen sending confirmations during most audits of accounts receivale, the emphasis is often on
confirming larger and older accounts.
a. /rue
. Balse
=(.
medium

Chen a customer disagrees #ith the amount sho#n on an account receivale confirmation, the
auditor should not ask the client to reconcile the difference.
a. /rue
. Balse
=..
medium
a
/he accounts receivale alance-related audit o@ective net realizale value is not affected y
assessed control risk for sales or cash receipts.
a. /rue
. Balse
=2.
medium
a
Bor most audits, a proper cash receipts cutoff is less important than either the sales or the sales
returns and allo#ances cutoff.
a. /rue
. Balse
=8.
medium
a
)uditors must maintain control of confirmations until they are returned from the customer.
a. /rue
. Balse
Arens/Elder/Beasley
=;.
medium
a
Chen a customer does not return an accounts receivale confirmation, it is acceptale, #ithout
performing alternative procedures, to assume the amount is 1::T overstated #hen generalizing
from the sample to the population.
a. /rue
. Balse
Chapter 17
Multiple-Choice Questions
1. 3ampling used for tests of details provides results in terms of:
easy a. e-ception rates.
c . percentages.
c. dollars.
d. e-pectation rates.
!. 7oth sampling and nonsampling risks are associated #ith:
?asy
d /ests of controls. 3ustantive tests of transactions.
a. Jes Jes
. Do Do
c. Jes Do
d. Do Jes
(. /olerale misstatements for overstatements and understatements:
easy a. may e different amounts.
a . must e different amounts.
c. must e set at the same amount.
d. must e e-pressed in percentages.
.. Monetary-unit sampling is most commonly used #hen:
easy a. several e-ceptions are e-pected.
d . a dollar result is desired.
c. the population data are maintained on manual files.
d. the auditor is searching for understatements only.
2. Monetary-unit sampling is not particularly effective at detecting:
easy a. overstatements.
. understatements.
c. errors in current assets.
d. errors in noncurrent assets.
8. /ests for rates of occurrence are appropriately used in all ut #hich of the follo#ing situations$
?asy
c /esting of internal
controls
3ustantive testing of
transactions
3ustantive testing of
details of alances
a. Jes Jes Jes
. Do Jes Jes
c. Jes Jes Do
d. Do Do Jes
;. Chich of the follo#ing is not a type of statistical method that provides results in dollar terms$
Arens/Elder/Beasley
easy a. Iariales sampling.
. )ttriutes sampling.
c. Monetary-unit sampling.
d. 3ampling #ith proaility proportional to size.
<. Chich of the follo#ing is not a term relevant to sampling for tests of details$
easy a. )cceptale risk of incorrect re@ection
d . )nalysis of misstatements
c. ?stimate misstatements in the population
d. Eefine the e-ception conditions
Arens/Elder/Beasley
=. Chen auditors sample for tests of details of alances, the o@ective is to determine #hether the:
easy a. account alance eing audited is fairly stated.
a . transactions eing audited are free of misstatements.
c. controls eing tested are operating effectively.
d. transactions and account alances eing audited are fairly stated.
1:.
easy
/he auditor must consider the possiility that the true population misstatement is greater than
the amount of misstatement that is tolerale #hen the auditor is performing:
d
Donstatistical sampling. Monetary-unit sampling.
a. Jes Jes
. Do Do
c. Jes Do
d. Do Jes
11. Chat is the purpose of applying stratified sampling to a population$
?asy
d /o avoid items that may
contain misstatements
/o emphasize certain items
and deemphasize others
a. Jes Jes
. Do Do
c. Jes Do
d. Do Jes
1!.
medium
"f an auditor desires a greater level of assurance in auditing a alance, the acceptale risk of
incorrect acceptance:
a a. is reduced.
. is increased.
c. is not changed.
d. may e reduced or increased depending upon other circumstances.
1(. Chich of the follo#ing is not a likely item on #hich to apply stratification techni'ues$
medium a. aging of accounts receivale
c . dollar value of accounts receivale
c. customer names of account receivales
d. numer of sales per customer in a period
1..
medium
"n estimating the population misstatement, the first step in pro@ecting from the sample to the
population is to:
a a. make a point estimate.
. revise the upper error ound.
c. calculate the precision interval.
d. determine the population mean.
12. /olerale misstatement is used to:
Medium
cc Eetermine sample size. 3elect the sample. ?valuate results.
a. Jes Jes Do
. Do Jes Do
c. Do Do Jes
d. Jes Do Jes
18. /he relationship et#een re'uired sample size and the acceptale risk of incorrect acceptance
is:
medium a. inverse.
a . direct.
Arens/Elder/Beasley
c. proportional.
d. indeterminate.
1;. /he final step in the evaluation of the audit results is the decision to:
medium a. accept the population as fairly stated or to re'uire further action.
a . determine sampling error and calculate the estimated total population error.
c. pro@ect the point estimate.
d. determine the error in each sample.
1<. /he most commonly used method of statistical sampling for tests of details of alances is:
medium a. attriutes sampling.
d . systematic sampling.
c. discovery sampling.
d. monetary-unit sampling.
1=.
medium
Chich of the follo#ing does not have to e considered in determining the initial sample size of
a test of details$
a. tolerale misstatement
. acceptale risk of incorrect re@ection
c. estimate of misstatements in the population
d. acceptale audit risk
!:.
medium

"f an auditor concludes that internal controls are likely to e effective, the preliminary
assessment of control risk can e reduced, leading to a+n, 666666 the acceptale risk of
incorrect acceptance.
a. reduction in
. increase in
c. elimination of
d. increase or decrease
!1.
medium
Chen using monetary-unit sampling, the recorded dollar population is a definition of all the
items in the:
a a. population.
. population #hich the auditor has included in the sample.
c. population #hich contain errors.
d. sample #hich contain errors.
!!. "f acceptale audit risk is increased, )R") should e:
medium a. increased.
a . reduced.
c. unaffected.
d. modified.
!(. )s the acceptale risk of incorrect acceptance is reduced, the re'uired sample size 666666666.
medium a. increases
a . decreases
c. is unaffected
d. increases or decreases
!.. /he acceptale risk of incorrect acceptance is most related to:
medium a. audit efficiency.
c . audit results.
c. audit effectiveness.
d. audit estimation.
!2.
medium
"n monetary-unit sampling, the relationship et#een tolerale misstatement size and re'uired
sample size is:
Arens/Elder/Beasley
a. direct.
. inverse.
c. varied.
d. indeterminale.
!8.
medium
/he risk the auditor is #illing to take of accepting a alance as correct #hen the true
misstatement in the alance under audit is greater than the tolerale misstatement is:
c a. the upper ound.
. the tolerale risk.
c. the acceptale risk of incorrect acceptance.
d. the lo#er ound.
!;.
medium
)s the amount of misstatements e-pected in the population approaches tolerale misstatement,
the planned sample size #ill:
a. decrease.
. increase.
c. vary ased on characteristics of the population.
d. e unaffected.
!<.
medium
Chich of the follo#ing is the auditor least likely to consider #hen estimating misstatements in
the population$
d a. *rior e-perience #ith the client.
. Results of current year tests of controls.
c. Results of analytical procedures already performed.
d. )cceptale audit risk.
!=.
medium
)n accounts receivale population contains a total of four customers. /he accounts, the
amounts, and the cumulative total are sho#n elo#. Monetary-unit sampling is to e used.
c )ccount Recorded Cumulative
Dame )mount /otal
7lue 9 (2; 9 (2;
7ro#n !<1 8(<
%ray 8: 8=<
%reen 2;. 1,!;!
7ased on the information aove, the population size is:
a. ..
. 2;..
c. 1,!;!.
d. 9!,8<..
(:.
medium
a
)n auditor using nonstatistical sampling cannot formally measure sampling error and therefore
must su@ectively consider the possiility that the true population misstatement e-ceeds a
tolerale amount. Chich of the follo#ing factors should e considered y the auditor in making
this assessment$
/he dollar difference et#een the point
estimate and tolerale misstatement.
/he e-tent to #hich items in the population
have een audited 1:: percent.
a. Jes Jes
. Do Do
c. Jes Do
d. Do Jes
(1.
medium
Chen using systematic selection procedures #ith monetary-unit sampling of accounts
receivale, the interval is determined y:
a. consulting a random numer tale.
. dividing the population size y the desired sample size.
c. dividing the sample size y the account #ith the largest dollar value.
Arens/Elder/Beasley
d. dividing the population size y the account receivale #ith the largest dollar value.
(!.
medium

"n a proaility proportional to size +**3, sample, all population physical audit units #ith an
amount e'ual to or greater than the amount of the interval #ill automatically e included in the
sample if the auditor uses:
a. random selection.
. systematic selection.
c. lock selection.
d. stratified selection.
((. Monetary unit sampling is also referred to as all of the follo#ing e-cept:
medium a. attriute sampling.
a . dollar unit sampling.
c. cumulative monetary amount sampling.
d. sampling #ith proaility proportional to size.
(..
medium
/he appropriate assumption to make regarding the overall percent of error in those population
items containing an error is:
c a. determined using random numer tales.
. set after a 'uantitative analysis of clientAs internal control system.
c. ased on the auditorAs personal @udgment in the circumstances.
d. ased on statistical analysis using confidence limits.
(2. Chen errors are found, a common assumption in practice is to assume:
medium a. a 1::T assumption for all errors.
d . that the population errors are larger than the sample errors.
c. that the population errors are smaller than the sample errors.
d. that the actual sample errors are representative of the population errors.
(8.
medium
Chich of the follo#ing does not need to e considered #hen the auditor generalizes from the
sample to the population$

)cceptale risk of incorrect acceptance. )cceptale risk of incorrect re@ection.

a. Jes Jes
. Do Do
c. Jes Do
d. Do Jes
(;.
medium
d
/he auditor must deal #ith layers of the computed upper deviation rate from the attriutes tale
ecause there are different error assumptions for each error. )ssume a sample of 1:: had found
one error, and the computed upper deviation rate is sho#n in the follo#ing tale:
Dumer >pper *recision
of ?rrors &imit from /ale
: .:!(
1 .:(<
/he precision limit for the layer #ith one error is:
a. !.(T.
. (.<T
c. 8.1T.
d. 1.2T.
(<. Chich alance-related audit o@ective cannot e assessed using monetary unit sampling$
medium a. )ccuracy.
. Completeness.
c. ?-istence.
d. )ll of the aove can e assessed using monetary unit sampling.
(=. /he confidence limits in variales sampling are similar to the monetary-unit samplingAs:
Arens/Elder/Beasley
medium a. point estimate.
. misstatement ounds.
c. standard deviation.
d. standard error of the mean.
.:.
medium
/he method used to measure the estimated total error amount in a population #hen there is oth
a recorded value and an audited value for each item in the sample is:
a a. difference estimation.
. mean-per-unit estimation.
c. ratio estimation.
d. monetary-unit sampling.
.1.
medium
/he variales sampling method #hich generally results in smaller sample sizes than any other
method is:
a. ratio estimation.
. difference estimation.
c. monetary-unit sampling.
d. mean-per-unit estimation.
.!.
medium
/he auditor is concerned #ith the audited value rather than the error amount of each item in the
sample #hen using:
a. difference estimation.
. mean-per-unit estimation.
c. ratio estimation.
d. monetary-unit sampling.
.(. **3 samples can e otained in an efficient manner using all ut #hich of the follo#ing$
medium a. Hand selection y the auditor.
a . Computer soft#are.
c. Random numer tales.
d. 3ystematic sampling techni'ues.
... Chich of the follo#ing items is not needed to apply M>3$
medium
a ) point estimate for misstatements. ) sample size. )n estimated error rate.
a. Do Jes Do
. Jes Do Jes
c. Do Jes Jes
d. Jes Do Do
.2.
medium
a
Chile performing a sustantive test of details during an audit, the auditor determined that the
sample results supported the conclusion that the recorded account alance #as materially
misstated. "t #as, in fact, not materially misstated. /his situation illustrates the risk of:
a. incorrect re@ection.
. incorrect acceptance.
c. assessing control risk too lo#.
d. assessing control risk too high.
Arens/Elder/Beasley
.8.
challenging

Chile performing a sustantive test of details during an audit, the auditor determined that the
sample results supported the conclusion that the recorded account alance #as materially
misstated. Chich of the follo#ing is not likely to e an acceptale reaction to this discovery$
a. *erform e-panded audit tests in the relevant areas
. "ncrease detection risk in the relevant areas
c. "ncrease the sample size
d. /ake no action until tests of other audit areas are completed
.;. Chen selecting a stratified sample, the sample size is:
challenging a. determined for the unstratified population and then apportioned to each stratum.
. determined for each stratum and selected from that stratum.
c. determined for each stratum and selected randomly from the entire unstratified population.
d. al#ays larger than if unstratified sampling had een used.
.<. )n auditor using nonstatistical sampling cannot:
Challenging
c determine a point estimate for the
population.
mathematically measure the precision of
the point estimate.
a. Jes Jes
. Do Do
c. Jes Do
d. Do Jes
.=.
challenging
"n monetary-unit sampling, the values of the estimated likely ma-imum misstatements are
referred to as the:
d a. point estimates.
. precision intervals.
c. confidence intervals.
d. misstatement ounds.
2:.
challenging
Chen using monetary-unit sampling, evaluating the likelihood of unrecorded items in the
population is:
a. unnecessary.
. impossile.
c. possile ut difficult.
d. an automatic outcome of the process.
21.
challenging
)cceptale risk of incorrect re@ection affects auditorsA action only #hen they conclude that a
population is:
c a. fairly stated.
. acceptale.
c. not fairly stated.
d. acceptale after certain ad@ustments.
2!. /he statistical methods used to evaluate monetary-unit samples:
challenging a. neither e-clude nor include units t#ice.
. permit the inclusion of a unit in the sample more than once.
c. do not permit a unit to e included in the sample more than once.
d. ignore the possiility that a unit may e included in a sample more than once.
2(. Chich of the follo#ing is not a prolem #ith monetary-unit selection$
challenging a. *opulation items #ith a zero recorded alance.
. *opulation items that should have a zero alance ut do not.
Arens/Elder/Beasley
c. )ccounts #ith negative alances.
d. )ccounts #ith small recorded alances that are significantly understated.
2..
challenging

/here are many kinds of statistical estimates that an auditor may find useful, ut asically every
accounting estimate is either of a 'uantity or of an error rate. /he statistical terms that roughly
correspond to 0'uantities1 and 0error rate,1 respectively, are:
a. attriutes and variales.
. variales and attriutes.
c. constants and attriutes.
d. constants and variales.
22.
challenging
"f the auditor elieves that there #ill e more than @ust a fe# e-ceptions discovered, and desires
an accurate estimate of the dollar value of the e-ceptions, he or she #ill use:
d a. attriutes sampling.
. monetary-unit sampling.
c. lock sampling.
d. variales sampling.
28.
challenging
Chile acceptale risk of incorrect acceptance is al#ays important, the risk of incorrect re@ection
is important only #hen there is a 6666666 cost to increasing the sample size.
a a. high
. lo#
c. moderate
d. marginal
2;. Chich of the follo#ing is not a disadvantage of monetary-unit-sampling$
challenging a. "t may e difficult to select samples from large population #ithout computer assistance.
. /he total misstatement ounds resulting #hen misstatements are found may e too lo# to
e useful to the auditor.
c. /he total misstatement ounds resulting #hen misstatements are found may e too high to
e useful to the auditor.
d. ?ach of the aove is a disadvantage.
2<.
challenging
Calculating the sample size using monetary-unit-sampling depends on #hich of the follo#ing
factors$
a
assumptions of the average percent of misstatement
for population items that contain misstatements recorded population value
a. Jes Jes
. Do Do
c. Jes Do
d. Do Jes
2=.
challenging
3tratified sampling is applicale to difference, mean-per-unit, and ratio estimation, ut it is most
commonly used #ith:
d a. ratio estimation.
. discovery sampling.
c. difference estimation.
d. mean-per-unit estimation.
8:.
challenging
)n important statistic to consider #hen using a statistical sampling audit plan is the population
variaility. /he population variaility is measured y the:
a. sample mean.
. standard deviation.
c. standard error of the sample mean.
d. estimated population total minus the actual population.
Arens/Elder/Beasley
81.
challenging
Chich of the follo#ing sampling plans #ould e designed to estimate a numerical measurement
of a population, such as a dollar value$
d a. Dumerical sampling.
. Eiscovery sampling.
c. 3ampling for attriutes.
d. 3ampling for variales.
8!.
challenging
>sing statistical sampling to assist in verifying the year-end accounts payale alance, an
auditor has accumulated the follo#ing data:
c 7alance
Dumer of 7ook determined y
accounts alance the auditor
*opulation: .,1:: 92,:::,::: $
3ample: !:: 9 !2:,::: 9(::,:::
>sing the ratio estimation techni'ue, the auditorAs estimate of year-end accounts payale
alance #ould e:
a. 92,:2:,:::.
. 92,1!2,:::.
c. 98,:::,:::.
d. 98,12:,:::.
8(.
challenging
>se of the ratio estimation sampling techni'ue to estimated dollar amounts is inappropriate
#hen:
a. the total ook value is kno#n and corresponds to the sum of all the individual ook values.
. a ook value for each sample item is unkno#n.
c. there are some oserved differences et#een audited values and ook values.
d. the audited values are nearly proportional to the ook values.
8..
challenging
/he ma@or reason that the difference and ratio estimation methods #ould e e-pected to produce
audit efficiency is that the:
a. eta risk may e completely ignored.
. variaility of the populations of differences or ratios is less than that of the populations of
ook values or audited values.
c. numer of memers of the populations of differences or ratios is smaller than the numer
of memers of the population of ook values.
d. calculations re'uired in using difference or ratio estimation are less arduous and fe#er
than those re'uired #hen using direct estimation.
/he follo#ing information applies to the 'uestions elo#:
)n audit partner is developing an office-training program to familiarize his professional staff
#ith statistical decision models applicale to the audit of dollar-value alances. He #ishes to
demonstrate the relationship of sample sizes to population size and variaility and the auditorAs
specifications as to precision and confidence level. /he partner prepared the follo#ing tale to
sho# comparative population characteristics and audit specifications of t#o populations.
)udit specifications of
Characteristics of a sample from population 1
population 1 relative relative to a sample
to population ! from population !
3pecified
3pecified confidence
3ize Iariaility precision level
Case 1 ?'ual ?'ual ?'ual Higher
Case ! ?'ual &arger /ighter ?'ual
Case ( &arger ?'ual /ighter &o#er
Case . 3maller 3maller ?'ual &o#er
Case 2 &arger ?'ual ?'ual Higher
Arens/Elder/Beasley
82.
challenging
a
7ased on the information presented aove, you are to indicate for the specified case from the
tale the re'uired sample size to e selected from population 1 relative to the sample from
population !. "n case 1, the re'uired sample from population 1 is:
a. larger than the re'uired sample size from population !.
. e'ual to the re'uired sample size from population !.
c. smaller than the re'uired sample size from population !.
d. indeterminate relative to the re'uired sample size from population !.
88.
challenging
a
7ased on the information presented aove, you are to indicate for the specified case from the
tale the re'uired sample size to e selected from population 1 relative to the sample from
population !. "n case !, the re'uired sample from population 1 is:
a. larger than the re'uired sample size from population !.
. e'ual to the re'uired sample size from population !.
c. smaller than the re'uired sample size from population !.
d. indeterminate relative to the re'uired sample size from population !.
8;.
challenging
d
7ased on the information presented aove, you are to indicate for the specified case from the
tale the re'uired sample size to e selected from population 1 relative to the sample from
population !. "n case (, the re'uired sample from population 1 is:
a. larger than the re'uired sample size from population !.
. e'ual to the re'uired sample size from population !.
c. smaller than the re'uired sample size from population !.
d. indeterminate relative to the re'uired sample size from population !.
8<.
challenging
c
7ased on the information presented aove, you are to indicate for the specified case from the
tale the re'uired sample size to e selected from population 1 relative to the sample from
population !. "n case ., the re'uired sample from population 1 is:
a. larger than the re'uired sample size from population !.
. e'ual to the re'uired sample size from population !.
c. smaller than the re'uired sample size from population !.
d. indeterminate relative to the re'uired sample size from population !.
8=.
challenging
a
7ased on the information presented aove, you are to indicate for the specified case from the
tale the re'uired sample size to e selected from population 1 relative to the sample from
population !. "n case 2, the re'uired sample from population 1 is:
a. larger than the re'uired sample size from population !.
. e'ual to the re'uired sample size from population !.
c. smaller than the re'uired sample size from population !.
d. indeterminate relative to the re'uired sample size from population !.
;:. Chy do auditors find M>3 appealing$
challenging a. M>3 increases the likelihood of selecting a alance of high and lo# dollar items.
. M>3 is easy to use in the audit environment.
c. M>3 provides a nonstatistical, rather than a statistical, conclusion.
d. Chen misstatements are found, M>3 rarely produces ounds in e-cess of materiality.
;1. Chat is the primary o@ective of using stratified sampling in auditing$
challenging
c
a. /o increase the confidence level at #hich a decision #ill e reached from the results of the
sample selected.
. /o determine the occurrence rate for a given characteristic in the population eing studied.
c. /o decrease the effect of variance in the total population.
d. /o determine the precision range of the sample selected.
;!.
medium
"n the application of statistical techni'ues to the estimation of dollar amounts, a preliminary
sample is usually taken primarily for the purpose of estimating the population:
d a. mode.
. range.
Arens/Elder/Beasley
c. median.
d. variaility.
?ssay Questions
;(.
easy
?-plain the decision rule used in monetary-unit sampling to determine #hether the population is
acceptale.
)ns#er:
/he auditor #ill accept the conclusion that the population +ook value, is not misstated y
a material amount if oth the lo#er misstatement ound and the upper misstatement ound
fall et#een the understatement and overstatement tolerale misstatement amounts.
;..
easy
Chat are the three primary types of sampling methods used for calculating dollar misstatements
in auditing$
)ns#er:
Donstatistical sampling, monetary unit sampling, and variales sampling.
;2.
easy
?-plain #hy monetary-unit sampling, or proaility proportional to size sampling, is not useful
for detecting understatements.
)ns#er:
Monetary-unit sampling is a techni'ue that assigns physical units to an item in the
population ased on the dollar value of the item. &arger dollar items are more likely to e
chosen for the sample than smaller items. 3o, if a client has understated an item there is less
likelihood that the item #ill e selected. Conse'uently, auditors do not commonly use
monetary-unit sampling #hen they are concerned #ith potential understatements.
;8.
medium
/here are 1. steps to audit sampling for details of alances, divided into three sections: plan the
sample, select the sample and perform the audit procedures, and evaluate the results. Eiscuss
each of the steps included in the 0evaluate the results1 section for nonstatistical sampling.
)ns#er:
/he steps included in the 0evaluate the results1 section are:
1. &enerali8e from te sample to te population. /his involves +1, pro@ecting
misstatements found in the sample to the population and +!, allo#ing for sampling
risk.
!. Anal"8e te misstatements. /he auditor should evaluate the nature and cause of
each misstatement found in the sample.
(. .ecide te accepta#ilit" of te population. "f the pro@ected misstatement +point
estimate,, comined #ith the allo#ance for sampling risk, is less than tolerale
misstatement, the auditor #ill accept the population as fairly stated.
;;.
medium
/here are four steps to generalize from the sample to the population using difference estimation
sampling. "dentify each of these four steps.
)ns#er:
/he four steps to generalize from the sample to the population using difference estimation
sampling are:
1. Compute the point estimate of the total misstatement.
!. Compute an estimate of the population standard deviation.
(. Compute the precision interval.
.. Compute the confidence limits.
Arens/Elder/Beasley
;<.
medium
/he most important difference among tests of controls, sustantive tests of transactions, and
tests of details of alances lies in #hat the auditor #ants to measure. ?-plain #hat each type of
test attempts to measure.
)ns#er:
/ests of controls focus on testing the effectiveness of internal controls. "n sustantive tests
of transactions, the auditor is concerned aout oth the effectiveness of internal controls
and the monetary correctness of transactions in the accounting system. "n tests of details of
alances, the concern is determining #hether the dollar amount of an account alance is
materially misstated.
;=.
medium
Eiscuss the advantages and disadvantages of monetary-unit sampling over other sampling
methods.
)ns#er:
)dvantages of monetary-unit sampling:
"t automatically increases the likelihood of selecting high dollar items from
the population eing audited.
"t fre'uently reduces the cost of doing the audit testing ecause several
sample items are tested at once.
"t is appealing to auditors ecause of its ease of application.
"t provides a statistical conclusion rather than a nonstatistical one, #hich aids
auditors in making etter and more defensile conclusions.
Eisadvantages of monetary-unit sampling:
/he total misstatement ounds resulting #hen e-ceptions are found may e
too high to e useful to the auditor.
"t is cumersome to select proaility proportional to size samples from large
populations #ithout computer assistance.
<:.
medium
?-plain the decision rule used #ith difference estimation sampling to determine #hether the
population is acceptale.
)ns#er:
/he auditor #ill decide to accept the population as fairly stated #hen the t#o-sided
confidence interval for the misstatements is completely #ithin the plus and minus
tolerale misstatements. 4ther#ise, the auditor #ill conclude that the ook value is
misstated y a material amount.
<1.
medium
Ho# might auditors include negative alances #hen using monetary-unit sampling to evaluate a
population$
)ns#er:
/here are t#o asic alternatives to testing negative alances #hen using M>3. Birst, the
auditor may choose to ignore negative alances for M>3 selection and test those amounts y
some other means. 3econd, the auditor could treat the negative alances as positive and add
them to the numer of monetary units eing tested.
<!.
challenging
Consider the steps in sampling for tests of details and for tests of controls. ?-plain the
differences in applying sampling to these t#o types of tests.
)ns#er:
Arens/Elder/Beasley
/he differences are as follo#s:
/ests of Eetails /ests of Controls
1. Eefine a misstatement 1. Eefine attriutes and e-ception conditions
!. 3pecify tolerale misstatement !. 3pecify tolerale e-ception rate
(. 3pecify )R") (. 3pecify )R)CR
.. ?stimate misstatements in the population .. ?stimate ?*?R
2. )nalyze misstatements 2. )nalyze e-ceptions
<(.
challenging
?-plain )R") and )R"R #ithin the conte-t of variales sampling.
)ns#er:
)fter an audit test is performed and statistical results are calculated, the auditor must
conclude either that the population is not materially misstated or that it is materially
misstated. )R") is the statistical risk that the auditor has accepted a population that is
actually materially misstated. /his is a serious concern to auditors ecause there are
potential legal implications in concluding that an account alance is fairly stated #hen it is
misstated y a material amount.
)R"R is the statistical risk that the auditor has concluded that a population is materially
misstated #hen it is not. /he only time that )R"R affects the auditorAs actions is #hen an
auditor concludes that a population is not fairly stated. )R"R is important only #hen there
is a high cost to increasing the sample size or performing other tests.
<..
challenging
"dentify each of the seven factors that influence sample size for nonstatistical tests of details of
alances, and state #hether each factor is directly or inversely related to sample size.
)ns#er:
Bactors that influence sample size for nonstatistical tests are:
Control risk. Control risk is directly related to sample sizeP as control risk
increases, sample size also increases.
Risk for oter su#stanti%e tests related to te same assertion. Eirectly related to
sample sizeP as these risks increase, sample size also increases.
Accepta#le audit risk. "nversely related to sample sizeP as ))R increases,
sample size decreases.
-olera#le misstatement. "nversely relatedP as tolerale misstatement increases,
sample size decreases.
Inerent risk. Eirectly relatedP as inherent risk increases, sample size also
increases.
Expected si8e and frequenc" of misstatements. Eirectly relatedP as the size and
fre'uency of e-pected misstatements increase, sample size also increases.
,um#er of items in te population. Eirectly related, ut has only a minor
effect on sample size.
<2.
challenging
/here are 1. steps to audit sampling for details of alances, divided into three sections: plan the
sample, select the sample and perform the audit procedures, and evaluate the results. Eiscuss
each of the steps included in the 0plan the sample1 section for nonstatistical sampling.
)ns#er:
/he steps comprising the 0plan the sample1 section are:
1. State te o#$ecti%e of te audit test. Bor tests of details of alances, the
o@ective is to determine #hether the account alance eing audited is fairly stated.
!. .ecide if audit sampling applies. "n certain situations, the auditor may choose
to test all large items and no small items. "n those situations, the auditor has not
sampled.
Arens/Elder/Beasley
(. .efine misstatement conditions. Misstatement conditions are any conditions
that represent a monetar" misstatement in a sample item.
.. .efine te population. /he recorded ook value of the account eing audited
is the population.
2. .efine te sampling unit. Bor nonstatistical sampling in tests of details of
alances, the sampling unit is almost al#ays the item making up the account alance.
8. Specif" tolera#le misstatement. /his is the amount of materiality allocated to
the account under audit.
;. Specif" te accepta#le risk of incorrect acceptance. /his is the risk that the
auditor is #illing to take of accepting a alance as correct #hen the true misstatement
in the alance is greater than tolerale misstatement.
<. Estimate misstatements in te population.
=. .etermine te initial sample si8e. "n nonstatistical sampling, this is determined
@udgmentally considering the previous eight factors.
<8.
challenging
Chen using nonstatistical sampling, the auditor must su@ectively consider #hether the true
population misstatement e-ceeds a tolerale amount. /his is done y considering five factors.
4ne factor is the difference et#een the point estimate and tolerale misstatement. 3tate the
other four factors the auditor must consider.
)ns#er:
4ther factors the auditor must consider are:
/he e-tent to #hich items in the population have een audited 1::T.
Chether misstatements tend to e offsetting or in only one direction.
/he amounts of individual misstatements.
3ample size.
<;.
challenging
Eiscuss each of the si- possile courses of action the auditor can take #hen he or she has
concluded that the population is misstated y more than a tolerale amount.
)ns#er:
/he si- possile courses of action the auditor can take #hen he or she has concluded
that the population is misstated y more than a tolerale amount are:
-ake no action until tests of oter audit areas are completed. "f offsetting
misstatements are found in other parts of the audit, the auditor may conclude that the
population is acceptale.
Perform expanded audit tests in specific areas.
Increase te sample si8e. )s sample size increases, sampling error is reduced
if the rate of misstatements in the e-panded sample, their dollar amount, and their
direction are similar to those in the original sample. /his may result in the population
eing acceptale.
Ad$ust te account #alance. "n some circumstances, if the client corrects the
misstatements discovered y the auditor, the ook value of the account may ecome
acceptale.
Request te client to correct te entire population.
Refuse to gi%e an unqualified opinion. "f none of the prior courses of action
results in an acceptale population, the auditor #ill have to issue either a 'ualified or
an adverse opinion.
Arens/Elder/Beasley
<<.
challenging
/here are seven steps to calculate ad@usted misstatement ounds #hen oth overstatement and
understatement errors are discovered in monetary-unit sampling. 3tep one is 0Eetermine
misstatement for each sample item, keeping overstatements and understatements separate.1
Eiscuss each of the remaining si- steps.
)ns#er:
/he remaining si- steps are:
Calculate misstatement per dollar unit in each sample item
+misstatementKrecorded value,.
&ayer misstatements per dollar unit from highest to lo#est.
Eetermine upper precision limit from attriutes sampling tale, and calculate
the percent misstatement ound for each misstatement +layer,.
Calculate initial upper and lo#er misstatement ounds for each layer and
total.
Calculate point estimate for overstatements and understatements.
Calculate ad@usted upper and lo#er misstatement ounds.
<=.
challenging
/he nine steps in planning the sample are almost identical for nonstatistical sampling and
difference estimation. Ho#ever, there are three important differences. Eiscuss each of the three
differences.
)ns#er:
/he three differences in the steps in planning the sample for nonstatistical sampling
and difference estimation are:
Chen using difference estimation, in addition to acceptale risk of incorrect
acceptance, the auditor specifies acceptale risk of incorrect re@ection.
Chen using difference estimation, the auditor makes an advance estimate of
the population standard deviation.
Chen using difference estimation, the sample size is calculated using a
formula.
4ther 4@ective )ns#er Bormat Questions
=:.
medium
Match si- of the terms +a-l, #ith the definitions provided elo# +1-8,:
a. )cceptale risk of incorrect acceptance
. )cceptale risk of incorrect re@ection
c. Eifference estimation
d. Misstatement ounds
e. Monetary-unit sampling
f. Mean-per-unit estimation
g. *oint estimate
h. *roaility proportional to size sample selection
i. Ratio estimation
@. 3tatistical inferences
k. 3tratified sampling
l. Iariale sampling
@ 1. Conclusions dra#n from sample results ased on kno#ledge of sampling
distriutions.
l !. 3ampling techni'ues for tests of details that use the statistical inference
Arens/Elder/Beasley
processes.
(. /he risk that the auditor is #illing to take of concluding a alance is materially
misstated #hen it is, in fact, fairly stated.
e .. ) statistical sampling method that provides upper and lo#er misstatement
ounds e-pressed in monetary amounts.
c 2. ) method of variales sampling in #hich the auditor estimates the population
misstatement y multiplying the average misstatement in the sample y the total
numer of population items and also calculates sampling risk.
a 8. /he risk that the auditor is #illing to take of accepting a alance as correct #hen
the true misstatement in the alance is greater than tolerale misstatement.
Arens/Elder/Beasley
=1.
easy

/he primary factor affecting the auditorAs acceptale risk of incorrect acceptance is assessed
inherent risk.
a. /rue
. Balse
=!.
easy

"n evaluating results for tests of details, auditors must evaluate e-ceptions identified.
a. /rue
. Balse
=(.
easy

/he t#o primary types of sampling methods used for calculating dollar misstatements are
attriutale sampling and monetary unit sampling.
a. /rue
. Balse
=..
easy

)cceptale risk of incorrect acceptance is indirectly affected y acceptale audit risk.

a. /rue
. Balse
=2.
easy

"n monetary-unit sampling, the likelihood of high dollar items from the population eing
included in the sample is lo#er than the likelihood for small dollar items.
a. /rue
. Balse
=8.
easy
a
)cceptale risk of incorrect re@ection is the statistical risk that the auditor has concluded that a
population is materially misstated #hen it is not.
a. /rue
. Balse
=;.
easy

Chen auditors apply M>3 to a sample, the sample is selected using random sampling
techni'ues.
a. /rue
. Balse
=<.
medium
a
/olerale misstatement is inversely related to sample size.
a. /rue
. Balse
==.
medium
a
)cceptale risk of incorrect acceptance +)R"), and sample size are inversely relatedP that is, as
)R") increases, sample size decreases.
a. /rue
. Balse
1::.
medium

?stimated misstatement in the population and sample size are inversely relatedP that is, as
estimated misstatement increases, sample size decreases.
a. /rue
. Balse
1:1.
medium
a
/he purpose of stratification is to permit auditors to emphasize certain aspects of a population
and deemphasize others.
a. /rue
. Balse
Arens/Elder/Beasley
1:!.
medium
a
)n auditor using nonstatistical sampling cannot formally measure sampling error.
a. /rue
. Balse
1:(.
medium
a
)ttriutes sampling tales can e used to evaluate results of tests of details #ith )R)CR eing
replaced #ith )R").
a. /rue
. Balse
1:..
medium
a
Chen using nonstatistical sampling, the larger the sample size, the greater the auditorAs
confidence that the point estimate is close to the true population value.
a. /rue
. Balse
1:2.
medium
a
Re'uired sample size increases as the auditorAs tolerale misstatement for an account alance or
class of transactions decreases.
a. /rue
. Balse
1:8.
medium

/he use of monetary-unit sampling is most appropriate #hen the auditor e-pects to find many
errors and #hen a monetary result is desired.
a. /rue
. Balse
1:;.
medium
a
Eifference estimation fre'uently results in smaller sample sizes than any other variales
sampling method.
a. /rue
. Balse
1:<.
medium
a
4verstatement and understatement amounts are dealt #ith separately and then comined #hen
generalizing from the sample to the population #hen applying M>3.
a. /rue
. Balse
1:=.
medium
a
/he sample size is inversely related to the computed precision interval in difference estimationP
that is, as sample size increases, the computed precision interval decreases.
a. /rue
. Balse
11:.
medium
a
"n difference estimation sampling, the confidence limits are calculated y comining the point
estimate of the total misstatements and the computed precision interval at the desired
confidence level.
a. /rue
. Balse
111.
medium

/he primary factor affecting the auditorAs decision aout )R") is assessed inherent risk.
a. /rue
. Balse
11!.
challenging

/he purpose of stratified sampling is to achieve a greater confidence level +lo#er risk of
incorrect acceptance, for a given sample size.
a. /rue
. Balse
Arens/Elder/Beasley
11(.
challenging
a
)cceptale risk of assessing control risk too lo# +)R)CR, and acceptale risk of incorrect
acceptance +)R"), are inversely relatedP that is, a decrease in )R)CR is accompanied y an
increase in )R").
a. /rue
. Balse
11..
challenging

)cceptale audit risk +))R, and acceptale risk of incorrect acceptance +)R"), are inversely
relatedP that is, as ))R increases, )R") decreases.
a. /rue
. Balse
112.
challenging
a
)ccounts #ith zero or negative year-end alances have no chance of eing included in a
standard proaility proportional to size +**3, sample.
a. /rue
. Balse
118.
challenging

/he statistical results #hen M>3 is used are called e-ception ounds.
a. /rue
. Balse
11;.
challenging

)cceptale risk of incorrect acceptance +)R"), is directly related to the computed precision
interval in difference estimationP that is, as )R") increases, the computed precision interval
decreases.
a. /rue
. Balse
11<.
challenging

/he population standard deviation of the misstatements from the sample is inversely related to
the computed precision interval in difference estimationP that is, as the standard deviation
increases, the computed precision interval decreases.
a. /rue
. Balse
Chapter 1
Multiple-Choice Questions
1.
easy
Chich of the follo#ing accounts is associated #ith a transaction cycle other than ac'uisition
and payment$
a a. Common stock.
. *roperty, plant and e'uipment.
c. )ccrued property ta-es.
d. "ncome ta- e-pense.
!. *roperty, plant, and e'uipment are assets that:
easy a. have e-pected lives of more than one year.
d . are used in the usiness.
c. are not ac'uired for resale.
d. meet all of the re'uirements stated aove.
(.
easy
Chich of the follo#ing e-penses is not typically evaluated as part of the audit of the ac'uisition
and payment cycle$
c a. Eepreciation e-pense.
. "nsurance e-pense.
Arens/Elder/Beasley
c. 7ad dets e-pense.
d. *roperty ta- e-pense.
.. Eeits to manufacturing e'uipment arise from #hich cycle+s,$
easy a. 3ales and collection
c . *ayroll
c. )c'uisition and disursement
d. "nventory and #arehousing
2.
easy
"t should ordinarily e unnecessary to e-amine supporting documentation for each addition to
property, plant, and e'uipment, ut it is customary to verify:
d a. all large transactions.
. all unusual transactions.
c. a representative sample of typical additions.
d. all three of the aove.
8. /he auditor must kno# the clientAs capitalization policies to determine #hether ac'uisitions are:
easy
d
Recorded in accordance
#ith %))*
/reated consistently #ith
those of the preceding year
Decessary
a. Jes Jes Jes
. Jes Do Do
c. Do Do Do
d. Jes Jes Do
;. /o e capitalized as part of property, plant and e'uipment, assets must:
easy a. have e-pected useful lives of more than one year.
d . not e ac'uired for resale.
c. e useful in multiple productive capacities #ithin the organization.
d. a and , ut not c.
<. /he primary accounting record for manufacturing e'uipment and other fi-ed assets is the:
easy a. depreciation ledger.
. fi-ed asset master file.
c. asset inventory.
d. e'uipment roster.
=. Chich of the follo#ing statements aout the audit of fi-ed assets is not correct$
easy

a. /he primary accounting record for manufacturing e'uipment and other property, plant
and e'uipment is generally a fi-ed asset master file.
. Manufacturing e'uipment and current assets are normally audited in the same fashion
regardless of the activity #ithin a particular account.
c. /he emphasis on auditing fi-ed assets is on verification of current-period ac'uisitions.
d. Bailure to record the ac'uisition of a fi-ed asset affects the income statement until the
assets is fully depreciated.
1:.
easy
Euring the audit of prepaid insurance, the auditor should keep in mind that the amount in
insurance e-pense is ased on:
d a. the eginning alance in prepaid insurance.
. the payment of premiums during the year.
c. the ending alance in prepaid insurance.
d. all three of the aove.
11.
easy
Chich of the follo#ing is not a category of tests commonly associated #ith the audit of
manufacturing e'uipment$
d a. Ierification of depreciation e-pense.
Arens/Elder/Beasley
. )nalytical procedures.
c. Ierification of current-period disposals.
d. Ierification of the eginning alance in accumulated depreciation.
1!.
easy
/he audit procedure that re'uires an auditor to 0foot the ac'uisition schedule1 relates to #hich
alance-related audit o@ective$
a. Classification.
. Eetail tie-in.
c. ?-istence.
d. Cut-off.
1(.
easy
Chich of the follo#ing audit o@ectives is not typically a ma@or o@ective in the audit of current
year fi-ed asset additions$
c a. Classification.
. Completeness.
c. ?-istence.
d. )ccuracy.
1..
easy
/he e-tent to #hich auditors verify current period ac'uisitions of property, plant and e'uipment
normally depends upon:
c a. assessed control risk for ac'uisitions.
. tolerale misstatement.
c. 7oth a and .
d. Deither a nor .
12.
easy
"nade'uate controls and misstatements discovered through tests of controls and sustantive tests
of transactions are an indication of the likelihood of misstatements in:
d a. the alance sheet.
. the income statement.
c. the cash flo# statement.
d. oth the income statement and the alance sheet.
18.
medium
Bailure to capitalize a fi-ed asset at the correct amount affects 6666666666 until the company
disposes of the asset.
d a. the alance sheet only
. the income statement only
c. the cash flo# statement only
d. oth the income statement and the alance sheet
1;.
medium
Chich of the follo#ing tests are typically not necessary #hen auditing a clientAs schedule of
recorded disposals$
d a. Booting the schedule.
. /racing schedule totals to the general ledger.
c. /racing cost and accumulated depreciation of the disposals to the property master file.
d. )ll of the aove are necessary.
1<. Chich of the follo#ing is not likely to e a test related to the audit of manufacturing
e'uipment$
medium a. Ierify current year additions.
. 4serve current year disposals.
c. Ierify depreciation e-pense.
d. *erform analytical procedures.
1=.
medium
) set of records for each piece of e'uipment that includes descriptive information, date of
ac'uisition, original cost, current year depreciation, and accumulated depreciation is the:
c a. ac'uisitions @ournal.
. depreciation schedule.
Arens/Elder/Beasley
c. fi-ed asset master file.
d. file of purchase re'uisitions.
!:.
medium
"n the audit of property, plant, and e'uipment, it is helpful to separate the tests into all ut #hich
one of the follo#ing categories$
a a. Ierification of the eginning alance.
. Ierification of current year ac'uisitions.
c. Ierification of current year disposals.
d. Ierification of the ending alance.
!1.
medium
Methods used to determine if there are legal encumrances related to fi-ed assets include all ut
#hich of the follo#ing$
d a. Reading terms of loan and credit agreements.
. Revie#ing loan confirmations received from anks.
c. "n'uiring of the client regarding possile legal encumrances.
d. )ll of the aove may e used to identify legal encumrances.
!!.
medium
/he test of details of alances procedure #hich re'uires a 0recalculation of investment credit1
satisfies the audit o@ective of:
d a. classification.
. detail tie-in.
c. e-istence.
d. accuracy.
!(.
medium
a
/he test of details of alances procedure to 0e-amine vendorsA invoices of closely related
accounts such as repairs to uncover items that should e property, plant, and e'uipment1
satisfies the audit o@ective of:
a. classification.
. detail tie-in.
c. cutoff.
d. e-istence.
!.. /he auditorAs starting point for verifying disposals of property, plant, and e'uipment is the:
medium a. e'uipment account in the general ledger.
c . file of shipping documents.
c. clientAs schedule of recorded disposals.
d. e'uipment susidiary ledger.
!2.
medium
Bailure to capitalize a fi-ed asset at the correct amount #ill affect 66666666666 until the asset
is fully depreciated.
d a. the alance sheet
. the income statement
c. the cash flo# statement
d. oth the income statement and the alance sheet
!8.
medium
c
7ecause the failure to record disposals of property, plant, and e'uipment can significantly affect
the financial statements, the search for unrecorded disposals is essential. Chich of the follo#ing
is not a procedure used to verify disposals$
a. Make in'uiries of management and production personnel aout the possiility of the
disposal of assets.
. Revie# #hether ne#ly ac'uired assets replace e-isting assets.
c. /est the valuation of fi-ed assets recorded in prior periods.
d. Revie# plant modifications and changes in product line, ta-es, or insurance coverage.
!;.
medium
"n rare cases, the auditor may elieve it is necessary that a complete physical inventory of fi-ed
assets e taken to make sure they actually e-ist. "f an inventory is taken, the auditor normally:
c a. takes the inventory.
Arens/Elder/Beasley
. re'uires client to take the inventory and provide documentation to the auditor.
c. oserves the count.
d. re'uires that it e done y an outside, independent third party.
!<.
medium

) ma@or consideration in verifying the ending alance in fi-ed assets is the possiility of
e-isting legal encumrances. /ests to identify possile legal encumrances #ould satisfy the
audit o@ective of:
a. e-istence.
. presentation and disclosure.
c. detail tie-in.
d. classification.
!=.
medium
Chen auditing depreciation e-pense, the t#o ma@or concerns related to the accuracy audit
o@ective are:
c a. consistent application of depreciation method and useful lives.
. consistent application of depreciation method and classification of assets.
c. correctness of calculations and consistent application of depreciation method.
d. cost of the fi-ed asset and useful lives.
(:.
medium
Chich type of audit procedure is often sufficient for purposes of auditing prepaid e-penses and
deferred charges$
d a. /ests of controls.
. /ests of transactions.
c. /ests of details of alances.
d. )nalytical procedures.
(1. Eepreciation e-pense is one of the fe# e-pense accounts that is not verified as a part of:
medium a. tests of controls.
d . tests of transactions.
c. test of details of alances.
d. a and , ut not c.
(!.
medium
Changing circumstances may re'uire a change in the useful life of an asset. Chen this occurs, it
involves a change in:
a a. accounting estimate rather than a change in accounting principle.
. accounting principle rather than a change in accounting estimate.
c. oth accounting principle and accounting estimate.
d. neither accounting principle nor accounting estimate.
((.
medium
/he auditor 66666666666 to test the accuracy or classification of fi-ed assets recorded in prior
periods.
c a. normally needs
. never needs
c. normally does not need
d. is re'uired
(..
medium
/he auditor normally does not need to test the accuracy or classification of fi-ed assets recorded
in prior periods ecause:
c a. they are rarely material to the audit.
. they rarely contain misstatements.
c. they are verified in previous audits.
d. they donAt affect the alance sheet.
(2.
medium
"nternal controls for prepaid insurance are typically categorized into all ut #hich of the
follo#ing$
d a. Controls over the ac'uisition and recording of insurance.
. Controls over the insurance register.
Arens/Elder/Beasley
c. Controls over the charge-off of insurance e-pense.
d. )ll of the aove.
(8. ) record of insurance policies in force and the due date of each policy is contained in the:
medium a. voucher register.
. insurance register.
c. insurance e-pense account.
d. prepaid insurance account.
(;. "nsurance e-pense for the period is a function of #hich of the follo#ing$
medium a. /he eginning prepaid alance, current premium payments and the ending prepaid
alance.
a . /he eginning prepaid alance and the current period premium payments.
c. /he current period premium payments.
d. /he current period premium payments and the ending prepaid alance.
(<.
medium
?-pense accounts analysis is closely related to tests of controls and sustantive tests of
transactions. /he ma@or difference is:
a. the difference in the types of underlying documentation #hich is e-amined.
. the degree of concentration on an individual account.
c. the use or nonuse of cutoff tests.
d. that one emphasizes transactions and the other emphasizes amounts.
(=.
medium
"n connection #ith a revie# of the prepaid insurance account, auditors #ould typically not
perform #hich of the follo#ing procedures$
c a. Recompute the portion of the premium that e-pired during the year.
. *repare e-cerpts of insurance policies for audit #orking papers.
c. Confirm premium rates #ith an independent insurance roker.
d. ?-amine support for premium payments.
.:.
medium
Chich of the follo#ing audit procedures #ould e least likely to lead the auditor to find an
unrecorded fi-ed asset disposal$
a. ?-amination of insurance policies.
. Revie# of repairs and maintenance e-pense.
c. Revie# of property ta- files.
d. 3canning of invoices for fi-ed asset additions.
.1.
medium
/o achieve effective internal accounting control over fi-ed asset additions, a company should
estalish procedures that re'uire:
a a. authorization and approval of ma@or fi-ed asset additions.
. capitalization of the cost of fi-ed asset additions in e-cess of a specific dollar amount.
c. classification, as investments, of those fi-ed asset additions that are not used in the
usiness.
d. performance of recurring fi-ed asset maintenance #ork solely y maintenance
department employees.
.!.
medium
Chich of the follo#ing is a customary audit procedure for the verification of the legal
o#nership of real property$
d a. ?-amination of correspondence #ith the corporate counsel concerning ac'uisition
matters.
. ?-amination of o#nership documents registered and on file at a pulic hall of records.
c. ?-amination of corporate minutes and resolutions concerning the approval to ac'uire
property, plant, and e'uipment.
d. ?-amination of deeds and title guaranty policies on hand.
.(.
medium
4nce the initial audit of a ne#ly constructed industrial plant has een performed, #ith respect to
consistency, #hich of the follo#ing is of least concern to the continuing auditor in the follo#ing
Arens/Elder/Beasley
year$
a. *rior yearsA capitalization policy.
. *rior yearsA capitalization costs.
c. *rior yearsA depreciation methods.
d. *rior yearsA depreciale life.
... Controls over the ac'uisition and recording of insurance are a part of the 66666666.
medium a. inventory and #arehousing cycle
d . capitalization cycle
c. treasury cycle
d. ac'uisition and payment cycle
.2. /he approach used to verify manufacturing e'uipment is different than the one used to verify:
challenging a. current assets.
a . patents.
c. copyrights.
d. all other types of property, plant, and e'uipment.
.8. Chich alance-related audit o@ective is not relevant to an audit of prepaid e-penses$
challenging a. Rights.
d . )ccuracy.
c. Eetail tie-in.
d. Realizale value.
.;.
challenging
/he failure to capitalize a permanent asset, or the recording of an asset ac'uisition at the
improper amount, affects the alance sheet:
d a. forever.
. for the current period.
c. for the depreciale life of the asset.
d. until the firm disposes of the asset.
.<.
challenging
/he failure to capitalize a permanent asset, or the recording of an asset ac'uisition at the
improper amount, affects the income statement:
a. for the current period.
. for the depreciale life of the asset.
c. until the firm disposes of the asset.
d. forever.
.=.
challenging
666666666666 oth have the effect of simultaneously verifying alance sheet and income
statement accounts.
a. )nalytical procedures and sustantive tests of transactions
. /ests of controls and sustantive tests of transactions
c. /ests of details of alances and sustantive tests of transactions
d. /ests of controls and analytical procedures
2:.
challenging
d
/he tests of details of alances procedure for fi-ed assets #hich re'uire the auditor to e-amine
vendorsA invoices of closely related accounts such as repairs and maintenance to uncover items
that should e fi-ed assets #ould satisfy the audit o@ective of:
a. accuracy.
. e-istence.
c. detail tie-in.
d. completeness.
21.
challenging
a
/he erroneous inclusion of transactions that should properly e recorded as assets into accounts
such as repairs e-pense, lease e-pense, or supplies is a common client error. /he auditor should
evaluate the likelihood of these types of misclassifications in con@unction #ith:
a. otaining an understanding of internal control.
. the test of controls.
Arens/Elder/Beasley
c. the tests of transactions.
d. the tests of details of alances.
2!.
challenging
"f the client fails to record disposals of property, plant, and e'uipment, oth the original cost of
the asset account and the net ook value #ill e incorrect.
a. 7oth #ill e overstated indefinitely.
. /he original cost #ill e overstated indefinitely, and the net ook value #ill e overstated
until the asset is fully depreciated.
c. /he original cost #ill e overstated indefinitely, and the net ook value #ill e
understated indefinitely.
d. /he original cost #ill e overstated indefinitely, and the net ook value #ill e
understated until the asset is fully depreciated.
2(. "ncome statement accounts resulting from allocations are typically verified as a part of:
challenging a. tests of controls.
c . sustantive tests of transactions.
c. analytical procedures.
d. planning.
2..
challenging
Chich of the follo#ing e-planations might satisfy an auditor #ho discovers significant deits to
an accumulated depreciation account$
a a. ?-traordinary repairs have lengthened the life of an asset.
. *rior yearsA depreciation charges #ere erroneously understated.
c. ) reserve for possile loss on retirement has een recorded.
d. )n asset has een recorded at its fair value.
22. )n auditor #ould e least likely to use confirmations in connection #ith the e-amination of:
challenging a. inventories.
c . long-term det.
c. property, plant, and e'uipment.
d. stockholdersA e'uity.
28.
challenging
Chich of the follo#ing is the most important internal control procedure over ac'uisitions of
property, plant, and e'uipment$
d. Re'uiring ac'uisitions to e made y user departments.
. >sing a udget to forecast and control ac'uisitions and retirements.
c. )nalyzing monthly variances et#een authorized e-penditures and actual costs.
a. ?stalishing a #ritten company policy distinguishing et#een capital and revenue
e-penditures.
2;.
challenging
/he auditor intervie#s the plant manager. /he auditor is most likely to rely upon this intervie#
as primary support for an audit conclusion on:
c a. capitalization vs. e-pensing policy.
. allocation of fi-ed and variale cost.
c. the necessity to record a provision for deferred maintenance costs.
d. the ade'uacy of the depreciation e-pense.
2<.
challenging
/he audit procedures used to verify accrued liailities differ from those employed for the
verification of accounts payale ecause:
d a. accrued liaility alances are less material than accounts payale alances.
. accrued liailities at year end #ill ecome accounts payale during the follo#ing year.
c. evidence supporting accrued liailities is non-e-istent, #hereas evidence supporting
accounts payale is readily availale.
d. accrued liailities usually pertain to services of a continuing nature, #hereas accounts
payale are the result of completed transactions.
Arens/Elder/Beasley
?ssay Questions
2=.
easy
Chich type of audit procedure +tests of controls, tests of transactions, tests of details, or
analytical procedures, is most often sufficient for the audit of prepaid e-penses$
)ns#er:
)nalytical procedures are often sufficient.
8:.
easy
Chy does the auditor not normally test the accuracy or classification of fi-ed assets recorded in
prior periods$
)ns#er:
/hey are presumed to have een verified in prior yearsA audits.
81.
easy
)uditors should e a#are that the life of certain fi-ed assets might e reduced due to various
circumstances. Chat circumstances might give rise to a reduction in the useful life of a fi-ed
asset$
)ns#er:
/he useful life a of fi-ed asset may e reduced y:
a reduction in customer demand for products or services,
une-pected physical deterioration of the asset, or
a modification in operations.
8!.
easy
Eescrie the types of information that should e included in the schedule of prepaid insurance
that is used y the auditor as the asis for auditing prepaid insurance.
)ns#er:
/he schedule should include each insurance policy in force, policy numer, insurance coverage
for each policy, premium amount, premium period, insurance e-pense for the year, and
prepaid insurance at the end of the year.
8(.
easy
Eescrie t#o #ays the verification of e-istence and tests for omissions of the clientAs insurance
policies in force can e performed.
)ns#er:
/he verification of e-istence and tests for omissions of the insurance policies can e tested in
one of t#o #ays: y e-amining insurance invoices and policies in force or y otaining
a confirmation of insurance information from the companyAs insurance agent.
8..
medium
Chat are several analytical procedures used in the audit of prepaid insurance and insurance
e-pense$
)ns#er:
1. Compare total prepaid insurance and insurance e-pense #ith previous years.
!. Compute the ratio of prepaid insurance to insurance e-pense and compare
#ith previous years.
(. Compare the individual insurance policy coverage on the schedule of
insurance otained from the client #ith the preceding yearAs schedule as a test of
elimination of certain policies or a change in insurance coverage.
Arens/Elder/Beasley
.. Compare the computed prepaid insurance alance for the current year on a
policy-y-policy asis #ith that of the preceding year as a test of an error in the
calculation.

82.
medium
) ma@or issue in verifying the ending alance in property, plant and e'uipment is the possiility
of legal encumrances. Eescrie the procedures that auditors may perform to otain evidence
aout e-isting legal encumrances.
)ns#er:
)uditors may otain evidence aout e-isting legal encumrances y:
reading the terms of loan and credit agreements,
mailing loan confirmation re'uests to anks and other lending institutions,
in'uiring of the client, and
sending letters of in'uiry to the clientAs legal counsel.
88.
medium
Eescrie the audit procedures used to verify the accuracy and detail tie-in o@ectives for prepaid
insurance.
)ns#er:
/he accuracy o@ective is tested y verifying the total amount of the insurance premium, the
length of the policy period, and the allocation of the premium to une-pired insurance.
/he amount of the premium for a given policy and its time period can e verified
simultaneously y e-amining the premium invoice or the confirmation from an
insurance agent. 4nce these t#o have een verified, the clientAs calculations of
une-pired insurance can e tested y recalculation. /he schedule of prepaid insurance
can then e footed and the totals traced to the general ledger to complete the detail tie-
in tests.
8;.
medium
Chat are the auditorAs t#o main o@ectives in the audit of the ending alance in accumulated
depreciation$
)ns#er:
1. )ccumulated depreciation as stated in the property master file must agree #ith the
general ledger. /his o@ective can e satisfied y test footing the accumulated
depreciation or the property master file and tracing the total to the general ledger.
!. )ccumulated depreciation in the master file must e correct.
8<.
medium
?-plain allocation and #hy it is important to have accurate allocation #ithin the financial
statements.
)ns#er:
)llocation is the process of assigning a portion of the cost of an asset to a product or a
period. Bor e-ample, calculating and then recording depreciation e-pense is an allocation
process. "t is important to determine #hen an e-penditure is an asset or a current period
e-pense so that the financial statements are fairly stated.
8=.
challenging
*roperty, plant, and e'uipment is normally audited in a different manner than current asset
accounts. 3tate three reasons #hy this is so, and discuss the differences in ho# property, plant,
and e'uipment is audited compared to current assets.
Arens/Elder/Beasley
)ns#er:
/here are usually fe#er current period ac'uisitions of property, plant, and
e'uipment than current assets.
/he amount of any given ac'uisition is often material.
/he e'uipment is likely to e kept and maintained in the accounting records
for several years.
7ecause of these three differences, the emphasis in auditing property, plant, and e'uipment is
on the verification of current period ac'uisitions rather than on the alance in the
account carried for#ard from the preceding year. "n addition, the e-pected life of
assets over one year re'uires depreciation and accumulated depreciation accounts,
#hich are verified as a part of the audit of the assets.
;:.
challenging
3tate each of the seven specific alance-related audit o@ectives for property, plant, and
e'uipment additions and, for each o@ective, descrie one common test of details of alances.
)ns#er:
Current-"ear acquisitions in te acquisitions scedule agree )it related
master file amounts! and te total agrees )it te general ledger ?detail tie-in@. Boot the
ac'uisitions schedule.
Current-"ear acquisitions as listed exist ?existence@. *hysically e-amine assets.
Existing acquisitions are recorded ?completeness@. ?-amine vendorsA invoices
of closely related accounts such as repairs and maintenance to uncover items that
should e property, plant, and e'uipment.
Current-"ear acquisitions as listed are accurate ?accurac"@. ?-amine vendorsA
invoices.
Current-"ear acquisitions as listed are properl" classified ?classification@.
?-amine rent and lease e-pense for capitalizale leases.
Current-"ear acquisitions are recorded in te proper period ?cutoff@. Revie#
transactions near the alance sheet date for proper period.
-e client as rigts to current-"ear acquisitions ?rigts and o#ligations@.
?-amine vendorsA invoices.
;1.
challenging
Eiscuss the key internal controls related to the disposal of property, plant, and e'uipment.
)ns#er:
/he most important internal control over the disposal of property, plant, and e'uipment is the
e-istence of a formal method to inform management of the sale, trade-in,
aandonment, or theft of recorded machinery and e'uipment. )nother important
control to protect assets from unauthorized disposal is a provision for authorization for
the sale or other disposal of property, plant, and e'uipment. Binally, there should e
ade'uate internal verification of recorded disposals to make sure that assets are
correctly removed from the accounting records.
;!.
challenging
Chen auditing disposals of property, plant, and e'uipment, the search for unrecorded disposals
is essential. 3tate the four audit procedures fre'uently used for verifying disposals.
)ns#er:
Revie# #hether ne#ly ac'uired assets replace e-isting assets.
)nalyze gains and losses on the disposal of assets and miscellaneous income
for receipts from the disposal of assets.
Revie# plant modifications and changes in product lines, ta-es, or insurance
Arens/Elder/Beasley
coverage for indications of deletions of e'uipment.
Make in'uiries of management and production personnel aout the possiility
of the disposal of assets.
;(.
challenging
Eiscuss the key internal controls over e-isting fi-ed assets that affect the auditorAs e-tent of
testing of fi-ed assets ac'uired in prior years.
)ns#er:
"mportant controls include the use of a master file for individual fi-ed assets, ade'uate physical
controls over assets that are easily movale, assignment of identification numers to
each plant asset, and periodic physical count of fi-ed assets and their reconciliation y
accounting personnel. ) formal method of informing the accounting department of all
disposals of fi-ed assets is also an important control over the alance of assets carried
for#ard into the current year.
;..
challenging
Eiscuss the key internal controls for prepaid insurance that affect the auditorAs e-tent of testing
of the prepaid insurance account.
)ns#er:
"mportant controls include proper authorization for ne# insurance policies and payment of
insurance premiums consistent #ith the clientAs payment procedures. ) record of
insurance policies in force and the due date of each policy is an essential control to
make sure that the company has ade'uate insurance at all times. /he control should
include a provision for periodic revie# of the ade'uacy of the insurance coverage y
an independent 'ualified person. /he detailed records of the information in the
insurance register should e verified y someone independent of the person preparing
them. ) closely related control is the use of monthly standard @ournal entries for
insurance e-pense.
4ther 4@ective )ns#er Bormat Questions
;2.
easy
a
Chen an audit is a first-year engagement, some additional risk is involved and more audit #ork
is re'uired than in suse'uent years.
a. /rue
. Balse
;8.
easy

4ne of the auditorAs primary o@ectives #hen auditing manufacturing e'uipment is accuracy.
a. /rue
. Balse
;;.
easy
a
Completeness and e-istence are the auditorAs primary o@ectives in auditing manufacturing
e'uipment.
a. /rue
. Balse
;<.
easy

Cages e-pense is normally considered to e associated #ith the ac'uisition and payment cycle.
a. /rue
. Balse
;=.
easy

/he primary characteristic that distinguishes property, plant, and e'uipment from inventory,
prepaid e-penses, and investments is the intention to use property, plant, and e'uipment as a
part of the operations of the clientAs usiness and their e-pected life of appro-imately one year.
a. /rue
Arens/Elder/Beasley
. Balse
<:.
easy

/he emphasis in auditing manufacturing e'uipment is on the verification of current-period

disposals.
a. /rue
. Balse
<1.
easy
a
/he auditor should keep in mind that the amount in insurance e-pense is a residual amount.
a. /rue
. Balse
<!.
easy
a
/he realizale value audit o@ective is not applicale #hen auditing prepaid insurance or
insurance e-pense.
a. /rue
. Balse
<(.
medium
a
/he starting point for the verification of current-year ac'uisitions of property, plant, and
e'uipment is normally a client-prepared schedule of all ac'uisitions recorded in the general
ledger during the year.
a. /rue
. Balse
Arens/Elder/Beasley
<..
medium

/he least common audit test to verify current period ac'uisitions of property, plant, and
e'uipment is e-amining vendorsA invoices and receiving reports.
a. /rue
. Balse
<2.
medium
a
Eepreciation e-pense is normally verified as a part of tests of details of alances rather than as
part of tests of controls or sustantive tests of transactions.
a. /rue
. Balse
<8.
medium
a
/he most important audit o@ective for depreciation e-pense is accuracy.
a. /rue
. Balse
<;.
medium
a
/he audit of insurance e-pense is normally limited to analytical procedures and a rief test of
#hether charges to insurance e-pense arose from credits to prepaid insurance.
a. /rue
. Balse
<<.
medium
a
/ests of the cutoff o@ective for prepaid insurance are rarely performed y auditors.
a. /rue
. Balse
<=.
medium
a
"n auditing the current year ac'uisitions of property, plant and e'uipment, all alance-related
audit o@ectives e-cept realizale value and disclosure are used as a frame of reference.
a. /rue
. Balse
=:.
medium

Chile analytical procedures are commonly used #hen auditing alance sheet accounts, they are
rarely used #hen auditing income statement accounts.
a. /rue
. Balse
=1.
medium
a
/ests of controls provide an indication of the likelihood of misstatements in oth the income
statement and the alance sheet, simultaneously.
a. /rue
. Balse
=!.
medium
a
/he auditorAs revie# of current year ac'uisitionAs cutoff is normally done as part of accounts
payale cutoff tests.
a. /rue
. Balse
=(.
medium
a
/he auditorAs tests for proper cutoff of current year ac'uisitions of property, plant, and
e'uipment are usually done as part of accounts payale cutoff tests.
a. /rue
. Balse
=..
medium

"n deciding the useful life of an asset, the companyAs policy is relatively unimportant.
a. /rue
. Balse
Arens/Elder/Beasley
=2.
medium

/he audit procedure 0foot the schedule of fi-ed assets ac'uisitions and trace the total to the
general ledger1 relates most closely to the accurac" o@ective for fi-ed assets ac'uisitions.
a. /rue
. Balse
=8.
medium

Confirmations are commonly used to verify additions of property, plant, and e'uipment.
a. /rue
. Balse
=;.
medium
a
Chen auditing insurance e-pense, auditors normally rely on analytical procedures and limited
testing of the deits to ensure that they arose from credits to prepaid insurance.
a. /rue
. Balse
=<.
medium
a
4ne very useful method of auditing depreciation is to use an analytical procedure to test for
reasonaleness.
a. /rue
. Balse
==.
challenging

/he approach to auditing patents and copyrights is more similar to that used for current assets
than the approach used for property, plant, and e'uipment accounts.
a. /rue
. Balse
1::.
challenging

Recording an ac'uisition of a fi-ed asset at an improper amount affects the alance sheet until
the company disposes of the asset, ut the income statement is not affected.
a. /rue
. Balse
1:1.
challenging
a
4rdinarily, it is unnecessary to test the accuracy o@ective or the classification o@ective for
fi-ed assets ac'uired in prior years.
a. /rue
. Balse
1:!.
challenging
a
"n the audit of accrued property ta-es, the t#o most important alance-related audit o@ectives
are completeness and accuracy.
a. /rue
. Balse
1:(.
challenging
a
/ypically, analytical procedures are the primary means of verifying income statement accounts
resulting from allocations.
a. /rue
. Balse
1:..
challenging

Chen auditing ac'uisitions of property, plant, and e'uipment, the auditorAs revie# of lease and
rental agreements most closely relates to the cutoff o@ective.
a. /rue
. Balse
Chapter 2"
Arens/Elder/Beasley
Multiple-Choice Questions
1. /he payroll cycle consists of ho# many classes of transactions$
easy a. one
a . t#o
c. three
d. four
!. Chich of the follo#ing statements is !alse$
easy a. /he payroll cycle consists of one class of transactions.
. 7alance sheet accounts related to payroll are generally more significant than related
transactions.
c. "nternal controls over payroll are effective for most companies.
d. 3mall companies usually have effective controls over payroll.
(. Chich of the follo#ing is not correct regarding controls over the processing of payroll$
easy

a. /he person authorized to sign paychecks should not e other#ise involved in the
preparation of the payroll.
. ) check-signing machine should not e used to replace a manual signature.
c. Eistriution of pay checks should e performed y someone #ho is not involved in the
other payroll functions.
d. >nclaimed paychecks should e immediately returned for redeposit.
.. Chich of the follo#ing statements aout the payroll and personnel cycle is correct$
?asy
c /here are three classes of
transactions #ithin the payroll
cycle U salaried employees,
hourly employees, and
commissioned employees.
/ransactions are less
significant than
related alance sheet
accounts.
"nternal controls over
payroll are effective for
almost all companies,
even small ones.
a. Do Do Jes
. Jes Do Jes
c. Jes Jes Do
d. Do Jes Do
2.
easy
Chich of the follo#ing types of audit procedures is ordinarily emphasized the least #hen
auditing payroll$
d a. /ests of controls
. /ests of transactions
c. )nalytical procedures
d. /ests of details of alances
8.
easy
) form issued for each employee summarizing the earnings and income ta- deductions for the
calendar year is the:
d a. rate authorization form.
. summary payroll report.
c. payroll master file.
d. C-! form.
;. /he payroll and personnel cycle egins #ith #hich of the follo#ing events$
easy a. "ntervie#ing @o candidates.
. Hiring a ne# employee.
c. ?-isting employees sumitting re'uests for payment for #ork performed.
d. "ssuance of paychecks.
Arens/Elder/Beasley
<. Most systems of internal control for payroll are:
easy a. loosely structured ut #ell controlled.
c . loosely structured and loosely controlled.
c. highly structured and #ell controlled.
d. highly structured ut loosely controlled.
=. /he payroll and personnel cycle ends #ith #hich of the follo#ing events$
easy a. "ntervie#ing @o candidates.
d . Hiring a ne# employee.
c. ?-isting employees sumitting re'uests for payment for #ork performed.
d. "ssuance of paychecks.
1:.
easy
/he retirement savings deductions, numer of e-emptions for #ithholding allo#ances, union
dues deductions, and other deductions are found on #hat form$
a. /ime cards
. Eeduction authorization form
c. Rate authorization form
d. Lo time ticket
11.
easy
) 666666666666 includes all payroll transactions processed y the accounting system for a
given period of time.
a. payroll @ournal
. payroll transaction file
c. time report
d. payroll summary
1!. )n imprest payroll account ordinarily carries a alance that is:
easy a. larger than the other company ank accounts.
c . larger than the amount of the periodic payroll disursement.
c. small.
d. elo# zero.
1(. Records that include data such as employment date, performance ratings and pay rates are the:
easy a. personnel records.
a . employee screening forms.
c. summary payroll reports.
d. employee folders.
Arens/Elder/Beasley
1..
easy
"n audits of companies in #hich payroll is a significant portion of inventory, the improper
account classification of payroll can:
a
"ncrease asset valuations. Eecrease asset valuations.
a. Jes Jes
. Do Do
c. Jes Do
d. Do Jes
12. /o minimize the opportunity for fraud, unclaimed salary checks should e:
easy a. deposited in a special ank account.
a . kept in the payroll department.
c. left #ith the employeeAs supervisor.
d. held for the employee in the personnel department.
18. Chich of the follo#ing type of employee typically does not complete time cards$
medium a. Hourly employees.
. 3alaried employees.
c. )ll employees must complete time cards.
d. /ime cards are typically completed y salaried employees, ut may also e completed y
hourly employees.
1;. Chen e-amining payroll transactions, an auditor is primarily concerned #ith the possiility of:
medium a. incorrect summaries of employee time records.
. overpayments and unauthorized payments.
c. under #ithholding of amounts re'uired to e #ithheld.
d. posting of gross payroll amounts to incorrect salary e-pense accounts.
1<.
medium
a
Bor #hich of the follo#ing functions is the use of prenumered documents least important$
a. >se of prenumered time cards in the payroll function.
. >se of prenumered sales invoices in the sales function.
c. >se of prenumered receiving reports in the ac'uisitions function.
d. >se of prenumered deposit slips in the cash receipts function.
1=. Chich of the follo#ing statements aout payroll checks is correct$
medium

a. )fter a payroll check is cashed and returned to the employee it is referred to as a

depository check.
. )s soon as a payroll check is signed y an authorized employee, it ecomes an asset.
c. *ayroll checks are #ritten for the amount of gross pay due employees.
d. "t is rare that payroll checks are direct-deposited into employeesA ank accounts.
!:. Chich of the follo#ing is not an advantage of using an imprest payroll account$
medium a. "t limits the companyAs e-posure to payroll fraud.
c . "t allo#s the delegation of payroll check-signing duties.
c. Companies have fe#er anking transactions.
d. "t facilitates cash management.
!1.
medium
Do individual #ith access to time cards, payroll records, or checks should also e permitted
access to:
c a. the computer.
. @o time tickets.
c. personnel records.
d. the canceled check file.
!!.
medium
/he file for recording each payroll transaction for each employee and maintaining total
employee #ages paid for the year to date is the:
Arens/Elder/Beasley
a a. payroll master file.
. summary payroll report.
c. payroll @ournal.
d. @o time ticket.
!(.
medium
Many companies use outside payroll services to process payroll. )uditors 66666 rely on the
internal controls of these outside payroll services.
d a. must
. cannot
c. rarely
d. can often
!.. /he total of the individual employee earnings in the payroll master file e'uals the total:
medium a. alance of gross payroll in general ledger accounts.
a . of the checks dra#n to employees for payroll.
c. gross payroll plus the total contriuted y the employer for payroll ta-es.
d. gross pay for the current #eekAs payroll.
!2.
medium
"f auditors rely on the internal controls of an outside payroll service provider, they #ill receive
a+n, 66666 report.
a. reliance
. 3)3 ;:
c. outsourcerAs
d. 'uality assurance
!8.
medium
Most companies use an imprest account to pay the payroll. Chich of the follo#ing is not an
advantage of such an account$
d a. "t facilitates cash management.
. "t limits the companyAs e-posure to payroll fraud.
c. "t allo#s the delegation of payroll check-signing duties.
d. "t eliminates the re'uirement of keeping a minimum alance in a checking account.
!;.
medium
/he careful and timely preparation of all payroll ta- returns is necessary to avoid penalties and
criminal charges. /he most important control in the timely preparation of these returns is:
a. computerized preparation of ta- returns.
. a #ell-defined set of policies that indicate #hen each form must e filed.
c. independent verification of computer output y a competent individual.
d. a %aant chart.
!<.
medium
Chich of the follo#ing types of audit tests is usually emphasized due to a lack of independent
third-party evidence related to payroll transactions$
c a. )nalytical procedures
. /ests of details of alances
c. /ests of controls
d. ?ach of the aove is emphasized.
!=. /he most important means of verifying account alances in the payroll and personnel cycle are:
medium a. tests of controls and tests of transactions.
a . analytical procedures and tests of controls.
c. analytical procedures and tests of transactions.
d. test of controls and tests of details of alances.
(:. /ests of payroll are usually not e-tensive ecause:
Medium
a employees #ill
likely complain if
underpaid.
payroll transactions
are uniform and
uncomplicated.
payroll transactions are su@ect to
audit y federal and state
governments.
Arens/Elder/Beasley
a. Jes Jes Jes
. Do Jes Do
c. Do Do Jes
d. Jes Do Do
(1.
medium
"f an auditor #ishes to test the completeness transaction-related audit o@ective in the payroll
and personnel cycle, #hich of the follo#ing #ould e a reasonale test of control$
a a. )ccount for a se'uence of payroll checks.
. ?-amine procedures manual and oserve the recording of transactions.
c. ?-amine payroll records for indication of pay rate approval.
d. Reconcile the payroll ank account.
(!. Chich of the follo#ing is a sustantive test of transactions$
medium a. Revie# personnel policies.
c . )ccount for a se'uence of payroll checks.
c. Reconcile the disursements in the payroll @ournal #ith the disursements on the payroll
ank statement.
d. ?-amine printouts of transactions re@ected y the computer as having invalid employee
"Es.
((.
medium
)s a part of the auditorAs responsiility for 666666666666, the auditor should revie# the
preparation of at least one of each type of payroll ta- form the client is responsile for filing.
d a. doing tests of controls.
. doing tests of alances.
c. doing tests of transactions.
d. understanding the clientAs internal controls.
(..
medium
Chich of the follo#ing is not an assertion related to the classes of transactions underlying the
payroll cycle$
c a. Classification
. )ccuracy
c. ?-istence
d. 4ccurrence
(2.
medium
Chich of the follo#ing circumstances #ould not cause an auditor to e-tend payroll procedures
consideraly$
d a. *ayroll significantly affects inventory valuation.
. /here is a possiility of material fraudulent payroll transactions.
c. /here is a #eak internal control structure.
d. /here is a lack of independent third-party evidence, such as confirmations.
(8.
medium
Chen laor is a material factor in inventory valuation, the auditor should place special emphasis
on testing the internal controls concerning:
c a. fictitious employees.
. authorization of #age rates.
c. proper valuation and allocation of alances.
d. completeness of recorded transactions.
(;.
medium
Chich of the follo#ing is not a procedure that can e performed on canceled checks in an effort
to detect defalcations$
d a. Compare the endorsements on checks #ith authorized signatures.
. 3can endorsements for unusual or recurring second endorsements.
c. ?-amine voided checks to e sure they havenAt een used.
d. ?-amine the payroll records in suse'uent periods to determine that terminated employees
are no longer eing paid.
Arens/Elder/Beasley
(<.
medium
Chat potential prolems may arise #hen an auditor considers the relationship et#een payroll
and inventory valuation$
d
"mproper account
classification.
"mproper allocation
to @os or processes.
Don-manufacturing payroll
e-penses charged to inventory.
a. Jes Jes Jes
. Do Jes Do
c. Do Do Jes
d. Jes Do Do
(=. /he primary concern in testing payroll-related liailities is to make sure that:
medium a. accruals are properly valued.
c . transactions are recorded in the proper period.
c. there are no understated or omitted accruals.
d. the accruals are not overstated.
.:.
medium
Chich department should e authorized to add and delete employees from the payroll or change
pay rates and deductions$
c a. /he supervising department.
. /he accounting department.
c. /he human resources department.
d. /he treasurerAs department.
.1. *aychecks should e distriuted y someone:
Medium
c independent of the timekeeping function. #ho reports to the company controller.
a. Jes Jes
. Do Do
c. Jes Do
d. Do Jes
.!.
medium
Ierification of the legitimacy of year-end unpaid onuses to officers and employees can e
accomplished y comparing the recorded accrual to the amount:
c a. in the e-pense account.
. used in the prior period.
c. authorized in the minutes of the oard.
d. paid in the suse'uent period.
.(.
medium
Chich of the follo#ing errors gives the auditor the least concern in auditing payroll
transactions$
d a. )n error that indicates possile fraud.
. Computational errors in formulas #hen a computerized system is used.
c. Classification errors in charging laor to inventory and @o cost accounts.
d. ?ach of the aove gives the auditor significant concern.
... +*ulic,
medium
/he usual audit test for a pulic companyAs officer compensation is to otain the authorized
salary of each officer from the minutes of the oard of directors and compare it #ith:
a
the 3?CAs 1:-F report. the companyAs federal income ta- return.
a. Jes Jes
. Do Do
c. Jes Do
d. Do Jes
.2. )uditors may e-tend their tests of payroll in #hich of the follo#ing circumstances$
Arens/Elder/Beasley
Medium
a *ayroll materially affects the
valuation of inventory.
/he auditor is concerned there may e
none-istent employees on the payroll.
a. Jes Jes
. Do Do
c. Jes Do
d. Do Jes
.8. /o check the accuracy of hours #orked, an auditor #ould ordinarily compare clock cards #ith:
medium a. personnel records.
. @o time tickets.
c. laor variance reports.
d. time recorded in the payroll register.
.;.
medium
) surprise payroll payoff in #hich employees must pick-up and sign for their pay check is one
means of:
c a. identifying employees #ho do not have proper #ork credentials.
. estalishing a tightly controlled, fraud-free #ork environment .
c. testing for none-istent employees.
d. identifying employees #ho have not sumitted proper C-! forms..
.<.
medium
Chich of the follo#ing is the est #ay for an auditor to determine that every name on a
companyAs payroll is that of a ona fide employee presently on the @o$
c a. ?-amine personnel records for accuracy and completeness.
. ?-amine employeesA names listed on payroll ta- returns for agreement #ith payroll
accounting records.
c. Make a surprise oservation of the companyAs regular distriution of paychecks.
d. Iisit the #orking areas and confirm #ith employees their adge or identification numers.
.=. "nherent risk is typically 66666 for alance-related audit o@ectives as they relate to payroll.
medium a. not considered
. lo#
c. moderate
d. high
2:.
medium
"t #ould e appropriate for the payroll department to e responsile for #hich of the follo#ing
functions$
d a. )pproval of employee time records.
. Maintain records of employment, firings, and raises.
c. /emporary retention of unclaimed employee paychecks.
d. *reparation of governmental reports as to employeesA earnings and #ithholding ta-es.
21. Chat are the t#o ma@or alance-related audit o@ectives in testing payroll liailities$
medium a. )ccuracy and detail tie-in
d . Completeness and valuation
c. Completeness and rights and oligations
d. )ccuracy and cutoff
Arens/Elder/Beasley
2!. Chich of the follo#ing est descries proper internal control over payroll$
medium a. /he preparation of the payroll must e under the control of the personnel department.
c . /he confidentiality of employee payroll data should e carefully protected to prevent
fraud.
c. /he duties of hiring, payroll computation, and payment to employees should e
segregated.
d. /he payment of cash to employees should e replaced #ith payment y checks.
2(.
medium
/he periodic payment from the general cash account to the payroll account for net payroll
should e tested for at least one payroll period. /he primary audit procedure is a+n,:
d a. analytical revie# procedure that net pay is reasonale.
. test of controls that an imprest account is eing used for payroll.
c. sustantive test that the correct amount #as transferred for this test period.
d. test of transactions that the check is prepared for the proper amount and deposited efore
payroll checks are handed out.
2..
challenging
4nce the auditor determines that the companyAs policy for accruing #ages is consistent #ith
prior years, the appropriate audit procedure to test for accuracy and cutoff is:
a a. recalculating the clientAs accrual.
. performing e-tensive tests of controls.
c. performing e-tensive tests of details.
d. none of the aove.
22.
challenging
"n auditing payroll, #hich of the follo#ing procedures #ill ordinarily re'uire the least amount
of auditor time under normal circumstances$
d a. /ests of controls.
. 3ustantive tests of transactions.
c. )nalytical procedures.
d. /ests of details of alances.
28.
challenging
a
) #eak internal control system allo#s a department supervisor to 0clock in1 for a fictitious
employee and then approve the employeeAs time card at the end of the pay period. /his fraud
#ould e detected if other controls #ere in place, such as having an independent party:
a. distriute paychecks.
. recompute hours #orked from time cards.
c. foot the payroll @ournal and trace postings to the general ledger and the payroll master file.
d. compare the date of the recorded check in the payroll @ournal #ith the date on the canceled
checks and time cards.
2;.
challenging
/he most important consideration in evaluating the fairness of the amounts accrued for vacation
pay, sick pay, and other enefits is the:
a a. consistent accrual of these liailities relative to those of preceding periods.
. actual e-pense incurred for the prior period.
c. amount e-pended to date in the current period.
d. profitaility of the client #hich #ill enale these liailities to e met.
2<.
challenging
?ffective internal accounting control over unclaimed payroll checks that are kept y the
company #ould include accounting department procedures that re'uire:
d a. effective cancellation and stop payment orders for checks representing unclaimed #ages.
. preparation of a list of unclaimed #ages on a periodic asis.
c. accounting for all unclaimed #ages in a current liaility account.
d. periodic accounting for the actual checks representing unclaimed #ages.
Arens/Elder/Beasley
2=.
challenging
Chich of the follo#ing internal controls in the payroll and personnel cycle is generally least
important to an auditor$
a. Bormal methods of informing payroll personnel of ne# employees.
. Reconciliation of total payroll e-pense in the general ledger #ith the payroll ta- returns
and the C-! forms.
c. )uthorization of changes in pay rates.
d. Dotice of the termination date of employees no longer #orking for the company.
8:. Chich of the follo#ing statements is correct$
challenging
d
a. /he overhead charged to inventory at the alance sheet date can e understated if the
salaries of administrative personnel are inadvertently or intentionally charged to indirect
manufacturing overhead.
. Chen @os are illed on a cost-plus asis, revenue and total e-penses are oth affected y
charging laor to incorrect @os.
c. *ayroll is a significant portion of inventory for retail and service industry companies.
d. /he valuation of inventory is affected if the direct laor cost of individual employees is
improperly charged to the #rong @o or process.
81.
challenging
Chich of the follo#ing is an effective internal accounting control used to prove that production
department employees are properly validating payroll time cards at a time-recording station$
d a. "nternal auditors should make oservations of distriution of paychecks on a surprise
asis.
. /ime cards should e carefully inspected y those persons #ho distriute pay envelopes to
the employees.
c. 4ne person should e responsile for maintaining records of employee time for #hich
salary payment is not to e made.
d. Eaily reports sho#ing time charged to @os should e approved y the supervisor and
compared to the total hours #orked on the employee time cards.
8!.
challenging
a
4nce the auditor has determined the companyAs policy for accruing #ages and kno#s it is
consistent #ith that of previous years, the appropriate audit procedure to test for cutoff and
accuracy is to:
a. recalculate the clientAs accruals.
. compare the ledger alance #ith the @ournal and the ta- form.
c. confirm the amount #ith employees.
d. compare the recorded accrued #ages #ith the amount approved in the minutes of the
7oard.
?ssay Questions
8(.
easy
Chat are t#o possile reasons that internal controls over payroll are effective for most
companies$
)ns#er:
Harsh federal and state penalties encourage effective controls for #ithholding and paying
payroll ta-es. )lso, employee morale prolems can occur if employees are not paid or are
underpaid.
Arens/Elder/Beasley
8..
easy
Chat events initiate and terminate the payroll and personnel cycle$
)ns#er:
/he hiring of an employee initiates the cycle and the payments to employees,
governments, and other organizations terminate the cycle.
82.
easy
Chat types of audit procedures are typically emphasized during the audit of the payroll cycle$
)ns#er:
)uditors typically emphasize tests of controls, tests of transactions and analytical
procedures.
88.
easy
Eiscuss the procedures involved in, and the purpose of, a surprise payroll payoff.
)ns#er:
) surprise payroll payoff is a procedure in #hich each employee must pick up and sign for
his or her check in the presence of a supervisor and the auditor. )ny checks that are not
claimed are su@ect to an e-tensive investigation to determine #hether an unclaimed check
is fraudulent. /he purpose is to test for none-istent employeesP that is, the issuance of
payroll checks to individuals #ho do not #ork for the company.
8;.
medium
Eiscuss three important differences et#een the payroll and personnel cycle and other cycles in
a typical audit.
)ns#er:
/hree important differences et#een the payroll and personnel cycle and other cycles in a
typical audit are:
/here is only one class of transactions for payroll, #hereas most cycles
include at least t#o classes of transactions.
"n the payroll cycle, transactions are far more significant than related alance
sheet accounts.
"nternal controls over payroll are effective for almost all companies, even
small ones. /his is primarily due to severe federal and state penalties for errors in
#ithholding and paying payroll ta-es and employee morale prolems if employees are
not paid or are underpaid.
8<.
medium
Chat key separation of duties should the auditor e-pect to find #ithin the payroll and personnel
cycle$
)ns#er:
/he human resources department should e independent of the payroll function and should
e responsile for hiring and terminating employees, as #ell as changes in pay rates and
deductions. "n additional payroll processing should e separate from the custody of signed
payroll checks.
Arens/Elder/Beasley
8=.
medium
Eiscuss each of the follo#ing primary documents and records used in the personnel and
employment function in the payroll and personnel cycle: personnel records, deduction
authorization form, and the rate authorization form.
)ns#er:
Personnel records. /hese records include employeesA date of employment,
personnel investigations, rates of pay, authorized deductions, performance
evaluations, and termination of employment.
.eduction autori8ation form. /his form authorizes payroll deductions,
including the numer of e-emptions for #ithholding of income ta-es, >.3. savings
onds, and union dues.
Rate autori8ation form. /his form authorizes employeesA rate of pay.
;:.
medium
Eiscuss each of the follo#ing documents and records used in the timekeeping and payroll
preparation function in the payroll and personnel cycle: time card, @o time ticket, summary
payroll report, payroll @ournal and payroll master file.
)ns#er:
/he primary documents and records used in the timekeeping and payroll preparation
function are:
-ime card. /he time card is used to indicate the time the employee started and
stopped #orking each day and the numer of hours the employee #orked.
(o# time ticket. /his document indicates @os on #hich a factory employee
#orked during a given time period. /his form is used only #hen an employee #orks
on different @os or in different departments.
Summar" pa"roll report. /his report summarizes payroll for a period.
Pa"roll $ournal. /his @ournal is used to record payroll checks.
Pa"roll master file. /his file contains each payroll transaction for each
employee, along #ith total employee #ages paid for the year to date.
;1.
medium
Eiscuss each of the follo#ing primary documents and records used in the +1, payment of
payroll function, and +!, preparation of payroll ta- returns and payment of ta-es function in the
payroll and personnel cycle: payroll check, C-! form, and payroll ta- returns.
)ns#er:
/he primary documents and records used in the payment of payroll function and the
preparation of payroll ta- returns and payment of ta-es function are:
Pa"roll ceck. /his is a check #ritten to the employee for services performed.
7-: form. /his form is issued for each employee summarizing the earnings
record for the calendar year.
Pa"roll tax returns. /hese are ta- forms sumitted to local, state, and federal
units of government for the payment of #ithheld ta-es and the employerAs ta-.
;!.
medium
/here are several key internal controls over the payment of payroll function that should e
present. Bor e-ample, the payroll should e distriuted y someone #ho is not involved in the
other payroll functions. Eiscuss other key internal controls over the payment of payroll
function.
Arens/Elder/Beasley
)ns#er:
Controls over payroll checks should include limiting the authorization for signing the
checks to a responsile employee #ho does not have access to timekeeping or the
preparation of the payroll, and the immediate return of unclaimed checks for redeposit. "f a
check-signing machine is used to replace a manual signature, the machine must e
carefully controlled. )n imprest payroll account can e used to prevent the payment of
unauthorized payroll transactions.
;(.
medium
Eiscuss the advantages of using an imprest payroll account.
)ns#er:
/he advantages of an imprest account are that it limits the clientAs e-posure to payroll
fraud, allo#s the delegation of payroll check-signing duties, separates routine payroll
e-penditures from irregular e-penditures, and facilitates cash management. "t also
simplifies the reconciliation of the payroll ank account.
;..
medium
Eiscuss the t#o circumstances under #hich auditors #ould e-tend their procedures
consideraly in the audit of payroll.
)ns#er:
)uditors often e-tend their procedures consideraly in the audit of payroll under the
follo#ing circumstances: +1, #hen payroll significantly affects the valuation of inventory
and +!, #hen the auditor is concerned aout the possiility of material fraudulent payroll
transactions.
;2.
medium
Ho# do auditors commonly verify sales commission e-pense$
)ns#er:
"f all employees receive the same commission rate, then verifying the e-pense is done y
multiplying the commission rate y the amount of the sales. "f there are different
commission rates, then the auditor #ill likely select a sample of employees to e-amine
separately on a monthly or annual asis.
;8.
medium
Chat is one audit procedure that may e used to test for proper handling of terminated
employees$
)ns#er:
) procedure that tests for proper handling of terminated employees is to select several files
from the personnel records for employees #ho #ere terminated in the current year to
determine #hether each received termination pay consistent #ith company policy.
Continuing payments to terminated employees can e tested y e-amining payroll records
in the suse'uent period to verify that the employee is no longer eing paid. Daturally, this
procedure is not effective if the personnel department is not informed of terminations.
Arens/Elder/Beasley
;;.
challenging
/here are several internal controls in the personnel and employment function that are important
from an audit perspective. Bor e-ample, there should e an ade'uate investigation of the
competence and trust#orthiness of ne# employees. Eiscuss other internal controls in the
personnel and employment function that are important from an audit perspective.
)ns#er:
Brom an audit perspective, the most important internal controls in personnel involve
formal methods of informing the timekeeping and payroll preparation personnel of
ne# employees, the authorization of initial and periodic changes in pay rates, and the
termination date of employees no longer #orking for the company. )s part of these
controls, segregation of duties is e-tremely important. Do individual #ith access to
time cards, payroll records, or checks should also e permitted access to personnel
records.
;<.
challenging
/here are several key internal controls over the timekeeping and payroll preparation function
that should e present. Bor e-ample, ade'uate control over the time on employeesA time cards
includes the use of a time clock or other method of making certain that employees are paid for
the numer of hours they #orked. Eiscuss other key internal controls over the timekeeping and
payroll preparation function.
)ns#er:
"nternal controls over the timekeeping and payroll preparation function should include
controls to prevent anyone from checking in for several employees or sumitting a
fraudulent time card. /he summarization and calculation of the payroll can e controlled
y #ell-defined policies for the payroll department, separation of duties to provide
automatic cross-checks, reconciliation of payroll hours #ith independent production
records, and independent internal verification of all important data. Controls over the
preparation of payroll checks include preventing those responsile for preparing the
checks from having access to time cards, signing or distriuting checks, or independently
verifying payroll output. "n addition, the checks should e prenumered and verified
through independent ank reconciliation procedures.
Arens/Elder/Beasley
4ther 4@ective )ns#er Bormat Questions
;=.
medium
Match seven of the terms for documents and records +a-k, used in the payroll and personnel
cycle #ith the descriptions provided elo# +1-;,:
a. *ersonnel records
. Eeduction authorization form
c. Rate authorization form
d. /ime card
e. Lo time ticket
f. 3ummary payroll report
g. *ayroll check
h. C-! form
i. *ayroll ta- returns
@. *ayroll @ournal
k. *ayroll master file
k 1. ) file used for recording payroll transactions for each employee and maintaining
total employee #ages paid for the year to date.
d !. ) document indicating the time the hourly employee stated and stopped
#orking.
g (. ) document #ritten in e-change for services received from an employee.
i .. Borms sumitted to local, state, and federal units of government for the payment
of #ithheld ta-es and the employerAs ta-.
2. ) form authorizing payroll deductions, including the numer of e-emptions for
#ithholding of income ta-es, >.3. savings onds, and union dues.
c 8. ) form used to authorize the amount of pay.
a ;. Records including date of employment, personnel investigations, rates of pay,
etc.
<:.
easy

*ayroll checks do not need to e distriuted y someone independent of the payroll and
timekeeping functions.
a. /rue
. Balse
<1.
easy
a
Hiring personnel initiates the payroll and personnel cycle.
a. /rue
. Balse
<!.
easy

Biring personnel terminates the payroll and personnel cycle.

a. /rue
. Balse
<(.
easy
a
*aying employees for their services ends the payroll and personnel cycle.
a. /rue
. Balse
Arens/Elder/Beasley
<..
easy
a
)uditors seldom e-pect to find misstatements #hen testing payroll transactions.
a. /rue
. Balse
<2.
easy

Most companies, #ith the e-ception of small ones, have effective controls over the payroll
cycle.
a. /rue
. Balse
<8.
easy
a
/he nature, e-tent, and timing of sustantive tests of payroll transactions vary depending, in
part, on assessed control risk.
a. /rue
. Balse
<;.
easy

"nherent risk for payroll-related liailities is normally higher than for accounts receivale.
a. /rue
. Balse
<<.
easy
a
Chile most cycles include at least t#o classes of transactions, the payroll and personnel cycle
includes only one class of transactions.
a. /rue
. Balse
<=.
easy

0*hysical control over assets1 is not a type of control that is applicale to the payroll cycle.
a. /rue
. Balse
=:.
easy

/he deduction authorization form authorizes the rate of pay and the deductions for ta-es, dues,
etc.
a. /rue
. Balse
=1.
easy
a
Chen auditing the payroll and personnel cycle, tests of controls are routinely performed.
a. /rue
. Balse
=!.
easy

Chen laor is a material part of inventory, auditors should emphasize tests of details of
alances.
a. /rue
. Balse
=(.
easy
a
) signed payroll check that has not een cashed is considered an asset to the company that
issued the check.
a. /rue
. Balse
=..
easy
a
Bor proper internal control, the person+s, responsile for signing the payroll checks should not
have access to timekeeping or e other#ise involved in the preparation of payroll.
a. /rue
. Balse
Arens/Elder/Beasley
=2.
easy

/he @o time ticket indicates the starting and stopping times of #ork during the pay period.
a. /rue
. Balse
=8.
easy
a
/he use of an imprest payroll account prevents losses from payment of unauthorized payroll to
no more than the alance in the imprest account.
a. /rue
. Balse
=;.
easy

"mprest accounts usually carry a significant alance.

a. /rue
. Balse
=<.
easy
a
/here is very little opportunity for confirmation from third parties of alance sheet accounts
related to the payroll and personnel cycle.
a. /rue
. Balse
==.
medium
a
Chen a client uses an outside payroll service for processing payroll, professional auditing
standards permit the auditor to rely on the internal controls of the service organization if the
service organizationAs auditor has issued a favorale report on the internal controls of the
service organization.
a. /rue.
. Balse.
1::.
medium

Chen a client uses an outside payroll service for processing payroll, professional auditing
standards re'uire the auditor to rely on the internal controls of the service organization if the
service organizationAs auditor has issued a favorale report on internal controls.
a. /rue.
. Balse.
1:1.
medium
a
Bor good internal control, the payroll function should e independent of the personnel
department.
a. /rue.
. Balse.
1:!. +*ulic,
medium

"f an audit client is a pulic company, the understanding of internal control must e sufficient to
identify opportunities to increase audit effectiveness.
a. /rue
. Balse
1:(.
medium

/ests of controls and tests of details of alances are the auditorAs most important means of
verifying account alances in the payroll and personnel cycle.
a. /rue
. Balse
1:..
medium

7ecause of the cycleAs pervasive nature, audit tests of the payroll cycle are usually e-tensive.
a. /rue
. Balse
Arens/Elder/Beasley
1:2.
medium

/he primary purpose of a surprise payroll payoff is to detect employees #ho have reported
more time than #as actually #orked +fraudulent hours,.
a. /rue
. Balse
1:8.
medium
a
/he t#o ma@or alance-related audit o@ectives in testing payroll liailities are accuracy and
cutoff.
a. /rue
. Balse
1:;.
medium

7ecause of confidentiality re'uirements and potential losses of payroll funds, outside service
center systems are rarely used y companies for payroll-related functions.
a. /rue
. Balse
1:<.
medium
a
"nternal control over payroll is normally highly structured and #ell controlled.
a. /rue
. Balse
1:=.
medium

3upervisory personnel in the functional department responsile for evaluating employees should
e responsile for authorizing the addition and deletion of employees from the payroll.
a. /rue
. Balse
11:.
medium
a
Eespite the large dollar amounts involved in the payroll and personnel cycle, auditors typically
spend less time auditing this cycle than others.
a. /rue
. Balse
111.
medium
a
"t is generally more difficult for the auditor to detect payment of fraudulent hours than payment
of fictitious employees.
a. /rue
. Balse
11!.
medium
a
4ne common sustantive test of payroll transactions for the e-istence o@ective is to compare
canceled payroll checks #ith personnel records.
a. /rue
. Balse
11(.
medium

/he audit procedure 0Recompute hours #orked from time cards1 is normally performed #hen
testing the completeness o@ective for payroll.
a. /rue
. Balse
11..
challenging
a
"n most audits, payroll ta- e-pense is not tested ecause the audit risk does not @ustify the time
re'uired to perform the tests.
a. /rue
. Balse
Chapter 21
Multiple-Choice Questions
Arens/Elder/Beasley
1.
easy

Receipt of ordered materials y the receiving department #ill generate the completion of a form
called the:
a. ill of lading.
. receiving report.
c. materials re'uisition.
d. inventory ac'uisition summary.
Arens/Elder/Beasley
!.
easy
c
/he audit of 666666 is often the most difficult and comple- part of an audit.
a. property, plant and e'uipment
. cash
c. inventory
d. prepaid insurance
(.
easy
d
"nventory is a comple- area to audit for all ut #hich of the follo#ing reasons$
a. "nventory is often in different locations.
. /here are several acceptale valuation methods and some entities use different methods
for different types of inventory.
c. "nventory is often the largest account in #orking capital.
d. "nventory valuation includes fe# estimates.
..
easy

Chen laor is a significant part of inventory, verifying the proper accounting of these costs
should e tested in the:
a. inventory and #arehousing cycle.
. payroll and personnel cycle.
c. ac'uisitions and payments cycle.
d. cash cycle.
2.
easy
a
Bor retail and #holesale usinesses, the most important inventory is:
a. merchandise availale for sale.
. #ork-in-process.
c. ra# materials.
d. inventory held on consignment.
8.
easy

/he audit procedure 0oserve the client taking a physical inventory count and test the count1 is
sufficient to determine all of the follo#ing e-cept:
a. #hether recorded inventory actually e-ists.
. #hether recorded inventory #as properly valued y the client.
c. #hether recorded inventory #as properly counted y the client.
d. #hether client inventory instruction had properly een follo#ed.
;.
easy
d
"n most manufacturing companies, the inventory and #arehousing cycle egins #ith the:
a. receipt of a customerAs order.
. completion of production of a customerAs order.
c. initiation of production of a customerAs order.
d. ac'uisition of ra# materials for production of an order.
<.
easy
c
/he audit tests to verify that the client is using an inventory method #hich is generally accepted
and to verify that physical counts #ere correctly summarized are performed during the audit of
the:
a. ac'uisition and payments cycle.
. payroll and personnel cycle.
c. inventory and #arehousing cycle.
d. sales and collection cycle.
=. Chich of the follo#ing #ould e an appropriate initiation of a purchase re'uisition$
easy
a 4ne initiated ased on a periodic count
of ra# materials.
4ne initiated y stockroom personnel as
ra# materials are needed.
a. Jes Jes
. Do Do
c. Jes Do
d. Do Jes
1:. )lmost all companies need physical controls over their assets to prevent loss. Chich of the
Arens/Elder/Beasley
easy
a
follo#ing is not an e-ample of such a control$
a. *erpetual inventory master files.
. 3egregated, limited-access storage areas.
c. Custody of assets assigned to specific responsile individuals.
d. )pproved prenumered documents for authorizing movement of inventory.
11.
easy
d
Chich department #ithin a manufacturing company is often responsile for the revie# of
production and scrap reports$
a. *urchasing.
. )ccounts *ayale.
c. )ccounting.
d. *roduction.
1!.
easy

Handling the receipt of ordered goods is a part of the 66666666 cycle.

a. purchasing
. ac'uisition and payment
c. inventory
d. inventory and #arehousing
1(.
easy

666666666 accumulate costs y individual @os as material is issued into production and laor
costs are incurred.
a. Lust-in-time production systems
. Lo order cost systems
c. *rocess cost systems
d. Manufacturing systems
1..
easy
c
/here must e a periodic physical count y the client of the inventory items on hand:
a. only if the client uses the &"B4 method.
. only if the client uses a lo#er-of-cost-or-market method.
c. regardless of the clientAs inventory valuation method.
d. only if the client uses either the &"B4 or B"B4 method.
12.
easy
d
Cith regard to the physical count of inventory, necessary control procedures include:
a. proper instructions for the physical count.
. independent third-party verification of the counts.
c. third-party reconciliations of the physical counts #ith perpetual inventory master files.
d. counting the inventory only on the year-end date.
18.
easy
c
"f the auditor concludes that physical controls over inventory are so inade'uate that the
inventory #ill e difficult to count, the auditor should ordinarily:
a. #ithdra# from the engagement.
. issue a 'ualified audit report.
c. conduct e-panded oservation tests of physical inventory.
d. hire a specialist to assist the auditor.
1;.
easy
a
Brom #hich of the follo#ing evidence-gathering audit procedures #ould an auditor otain most
assurance concerning the e-istence of inventories$
a. 4servation of physical inventory counts.
. Critten inventory representations from management.
c. Confirmation of inventories in a pulic #arehouse.
d. )uditorAs recomputation of inventory e-tensions.
1<.
easy
a
Lohnson Co.As physical count of inventories #as lo#er than the inventory 'uantities sho#n in its
perpetual records. /his situation could e the result of the failure to record:
a. sales.
. sales returns.
c. purchases.
Arens/Elder/Beasley
d. purchase discounts.
1=.
easy
d
Chich of the follo#ing is not a function #ithin the inventory and #arehousing cycle$
a. *rocess the goods.
. 3tore ra# materials.
c. 3hip finished goods.
d. *rocess invoices for shipped goods.
!:.
easy

"f an auditor #ere concerned #ith otaining evidence aout the appropriateness of the value of
inventory, #hich of the follo#ing tests #ould e most appropriate$
a. Compilation tests.
. *rice tests.
c. Confirmation of inventory held y outside parties.
d. *hysical e-amination of the inventory.
!1.
easy

Chich of the follo#ing is the est audit procedure for the discovery of damaged merchandise in
a clientAs ending inventory$
a. Compare the physical 'uantities of slo#-moving items #ith corresponding 'uantities of
the prior year.
. 4serve merchandise and ra# materials during the clientRs physical inventory count.
c. Revie# the managementAs inventory representation letter for accuracy.
d. /est overall fairness of inventory values y comparing the companyAs turnover ratio #ith
the industry average.
!!.
medium
c
Chich of the follo#ing controls #ould e appropriate regarding the release of materials from a
stockroom$
a. *roduction employees re'uest materials e delivered to their #ork areas as they need
them.
. 3tockroom employees deliver materials to #ork areas throughout the day to maintain
acceptale levels of safety stock U no #ritten records are maintained.
c. *roduction employees sumit approved re'uisition forms to the stockroom for materials
needed.
d. *roduction employer in need of materials should personally pick up needed materials
from the stockroom.
!(.
medium
d
Cho should maintain the perpetual inventory master files$
a. *roduction personnel.
. "nventory storeroom personnel.
c. "nventory receiving personnel.
d. )ccounting department personnel.
!..
medium
a
/he inventory and #arehousing cycle can e thought of as having t#o separate ut closely
related systems, one involving the actual physical flo# of goods, and the other the:
a. related costs.
. storage of the goods.
c. internal control over those goods.
d. prevention of #aste, osolescence, and theft.
!2.
medium
c
"n any company involved in manufacturing, an ade'uate cost accounting internal control system
is necessary to indicate the relative profitaility of the various products for management
planning and control and to:
a. determine variances from standards.
. determine variances from udgets.
c. value inventories for financial statement purposes.
d. value inventories for audit verification.
!8. Master files, #orksheets, and reports that accumulate material, laor, and overhead as the costs
Arens/Elder/Beasley
medium
c
are incurred are:
a. accounting systems.
. storeroom documents.
c. cost accounting records.
d. finished goods inventory records.
!;.
medium

/he main difference et#een @o order and process costing systems is that:
a. one accumulates costs y materials issued and the other y laor incurred.
. one accumulates costs y individual @os and the other y particular processes.
c. one emphasizes costs accumulated in completed products and the other emphasizes costs
associated #ith #ork-in-process.
d. one emphasizes costs adding value to the product and the other emphasizes costs incurred
ecause of #aste, scrap, and osolescence.
!<.
medium
d
) #ell-designed computerized system of perpetual inventory master files includes information
aout the:
a. units of inventory purchased, sold, and on hand.
. unit costs of inventory purchased, sold, and on hand.
c. units of ra# materials, #ork-in-process, and finished goods.
d. units and unit costs of inventory purchased, sold, and on hand.
!=.
medium
a
Chich of the follo#ing is a significant audit concern related to the transfer of inventory from
one location to another$
a. Recorded transfers occurred.
. /ransfers #ere properly transported.
c. /ransfers #ere properly planned.
d. /ransfers represent efficient movement of assets.
(:. Chen may auditors oserve the physical inventory count$
medium )t an interim date )t year-end
a a. Jes Jes
. Do Do
c. Jes Do
d. Do Jes
(1.
medium
d
Chich of the follo#ing is not an aspect of concern #hen auditing the cost accounting system$
a. >nit cost records.
. *hysical controls over inventory.
c. Eocuments and records for transferring inventory.
d. 3afeguarding the ra# materials from point of receipt to the storeroom.
(!.
medium
a
/he auditorAs tests of the ade'uacy of the physical controls over ra# materials, #ork-in-process,
and finished goods must e restricted to:
a. oservation and in'uiry.
. documentation and oservation.
c. documentation and confirmation.
d. documentation and in'uiry.
((.
medium
a
"t is fre'uently possile to test the physical inventory prior to the alance sheet date #hen:
a. there are accurate perpetual inventory master files.
. year-end sales are small.
c. the internal control system is no etter at year-end than at an earlier point in time.
d. the client counts inventory at interim dates.
(..
medium
/ests of the perpetual inventory master files for the purpose of reducing the tests of physical
inventory or changing their timing are done through the use of:
Arens/Elder/Beasley
d a. in'uiry.
. oservation.
c. confirmation.
d. documentation.
(2.
medium
c
) ma@or difficulty in the verification of inventory cost records is determining reasonaleness of:
a. direct laorAs hourly rate.
. ra# materials per unit cost.
c. cost allocations.
d. numer of direct laor hours applied.
(8.
medium
d
Chen auditing the inventory and #arehousing cycle, the use of analytical procedures is:
a. not important for this cycle.
. less important than for any other cycle.
c. more important than for any other cycle.
d. as important as their use in any other cycle.
(;.
medium
c
Chich one of the follo#ing analytical procedures #ould e most helpful in alerting the auditor
to the possiility of osolete inventory$
a. Compare gross margin percentage #ith previous yearsA.
. Compare unit costs of inventory #ith previous yearsA.
c. Compare inventory turnover ratio #ith previous yearsA.
d. Compare current year manufacturing costs #ith previous yearsA.
(<.
medium
a
Chich of the follo#ing statements is correct regarding the auditorAs responsiility #ith respect
to the year-end inventory procedures of an audit client$
c /he auditor is responsile
for reconciling the physical
count #ith the perpetual
inventory matter files.
/he auditor is
responsile for
taking and compiling
the inventory.
/he auditor is
responsile for
oserving the physical
counting of inventory.
a. Jes Do Do
. Do Do Jes
c. Jes Do Jes
d. Do Jes Do
(=.
medium
a
McFesson G Roins Company is a #ell-kno#n audit case involving auditor responsiility.
Chat occurred at the McFesson G Roins Company to change the #ay in #hich auditors audit
inventory$
a. /he company recorded none-istent inventory.
. /he auditor did not perform any audit tests of the inventory.
c. /he auditor and company colluded to overstate inventory alances.
d. /he company counted inventory three months prior to year-end.
.:.
medium
c
Chen a physical count of inventory is performed at an interim date, the auditor oserves it at
that time and tests the perpetual records for transactions:
a. throughout the year.
. #hich are a representative sample of the period under audit.
c. from the date of the count to year-end.
d. from the date of the count to the end of the audit field #ork.
.1.
medium

Chen there are no perpetual inventory files and inventory is material:

a. an audit cannot e performed, so the auditor must issue a disclaimer.
. a physical inventory should e taken y the client near year-end.
c. the auditor #ill have to perform the inventory count and determine valuation.
d. the auditor need not oserve inventory counts ut must do test counts.
Arens/Elder/Beasley
.!. )uditor tests of physical controls over ra# materials, #ork-in-process, and finished goods are
performed y:
medium ?-amination 4servation "n'uiry
d a. Jes Do Jes
. Do Jes Do
c. Jes Jes Do
d. Do Do Jes
.(.
medium
d
/he most important part of the oservation of inventory is to determine #hether:
a. all counts are accurate.
. the inventory-takers are 'ualified.
c. osolete inventory has een identified.
d. the physical count is eing taken in accordance #ith the clientAs instructions.
...
medium
d
) useful starting point for ecoming familiar #ith the clientAs inventory is for the auditor to:
a. read the )"C*)As "ndustry )udit %uide.
. revie# accounting theory covering special prolems, such as gas and oil accounting, or
lease-purchase agreements.
c. read the clientAs )ccounting Manual.
d. tour the clientAs facility.
.2.
medium
a
) common inventory oservation procedure is to select a random sample of tag numers and
identify the tag #ith that numer attached to the actual inventory item. /he audit o@ective
eing achieved y this procedure is:
a. inventory as recorded on tags actually e-ists +e-istence,.
. e-isting inventory is counted and tagged +completeness,.
c. inventory is counted accurately +accuracy,.
d. inventory is classified correctly +classification,.
.8.
medium
c
"f a client intends to count inventory at an interim date, the auditor should e-pect there to e all
of the follo#ing e-cept:
a. controls over the preparation and maintenance of perpetual inventory records.
. competent personnel assigned to count the inventory.
c. third-party inventory counting specialists.
d. an ade'uately designed plan to count the inventory.
.;.
medium
c
) common inventory oservation procedure is to e alert for items that are damaged, rust- or
dust-covered, or located in inappropriate places. /he alance-related audit o@ective eing
achieved y this procedure is:
a. classification.
. cutoff.
c. realizale value.
d. rights.
.<.
medium
d
/he test of details of alance procedure #hich re'uires the auditor to account for unused
inventory tag numers to make sure none have een deleted is associated #ith the audit
o@ective of:
a. accuracy.
. e-istence.
c. detail tie-in.
d. completeness.
.=.
medium
d
/he test of details of alance procedure #hich re'uires the auditor to perform tests of lo#er-of-
cost-or-market, selling price, and osolescence is an attempt to satisfy the o@ective of:
a. e-istence.
. completeness.
Arens/Elder/Beasley
c. accuracy.
d. realizale value.
2:.
medium
a
Most of the audit testing of the storage of finished goods as #ell as the shipment of merchandise
takes place during the testing of the:
a. sales and collection cycle.
. payroll and personnel cycle.
c. ac'uisitions and payments cycle.
d. inventory and #arehousing cycle.
21.
medium

/he auditorAs main concerns in verifying transfers of inventory do not include #hether:
a. recorded transfers e-ist.
. transfers represent appropriate uses of company resources.
c. all actual transfers are recorded.
d. the details of the transfer are accurately recorded.
2!.
medium
c
)fter accounting for a se'uence of inventory tags, an auditor traces a sample of tags to the
physical inventory listing to otain evidence that all items:
a. included in the listing have een counted.
. represented y inventory tags actually e-ist.
c. represented y inventory tags are included in the listing.
d. included in the listing are represented y inventory tags.
2(.
medium
d
)uditors test the 'uantity of materials charged to #ork-in-process y tracing these 'uantities to:
a. cost ledgers.
. perpetual inventory records.
c. receiving reports.
d. material re'uisitions.
2..
medium
a
Chich of the follo#ing situations #ould most likely re'uire special audit planning$
a. "nventory consists of precious stones.
. 3ome items of factory and office e'uipment do not ear identification numers.
c. Eepreciation methods used on the clientAs ta- return differ from those used on the ooks.
d. )ssets costing less than 92:: are e-pensed even though their e-pected life e-ceeds one
year.
22.
medium
a
Bor several years, a clientAs physical inventory count has een lo#er than #hat #as sho#n on
the ooks at the time of the count so that do#n#ard ad@ustments to the inventory account #ere
re'uired. Contriuting to the inventory prolem could e #eaknesses in internal control that led
to the failure to ad@ust the accounting records for some:
a. purchases returned to vendors.
. sales returns received.
c. sales discounts allo#ed.
d. cash purchases.
28. /he physical counting of inventory may e performed at #hich of the follo#ing times$
medium "nterim dates 4n a cycle asis during the year
a a. Jes Jes
. Do Do
c. Jes Do
d. Do Jes
2;.
medium
c
Chen an auditor oserves that personnel #ho are responsile for physically counting inventory
are not follo#ing the inventory instructions, the auditor should:
a. contact a clientAs supervisor in an attempt to correct the prolem.
. modify the clientAs physical inventory instructions.
Arens/Elder/Beasley
c. not discuss the prolem #ith clientAs supervisor in order to maintain independence.
d. assign audit staff to the inventory count.
2<.
medium

/he auditorAs o@ective during an oservation of a clientAs physical inventory count is to:
a. discover #hether a client has counted a particular inventory item or group of items.
. otain direct kno#ledge that the inventory e-ists and has een properly counted.
c. provide an appraisal of the 'uality of the merchandise on hand on the day of the physical
count.
d. allo# the auditor to supervise the conduct of the count so as to otain assurance that
inventory 'uantities are reasonaly accurate.
2=.
medium
a
/he audit of year-end physical inventories should include steps to verify that the clientAs
purchases and sales cutoffs #ere ade'uate. /he audit steps should e designed to detect #hether
merchandise included in the physical count at year-end #as not recorded as a:
a. sale in the current period.
. sale in the suse'uent period.
c. purchase in the current period.
d. purchase return in the suse'uent period.
8:.
medium

Chich one of the follo#ing procedures #ould not e appropriate for an auditor in discharging
his responsiilities concerning the clientAs physical inventories$
a. Confirmation of goods in the hands of pulic #arehouses.
. 3upervising the taking of the annual physical inventory.
c. Carrying out physical inventory procedures at an interim date.
d. 4taining #ritten representation from the client as to the e-istence, 'uality, and dollar
amount of the inventory.
81.
medium
d
*ricing manufactured inventory is difficult. )uditors must evaluate the method of allocating
manufacturing overhead for all ut #hich of the follo#ing$
a. reasonaleness.
. computational correctness.
c. adherence to B)37 pronouncement
d. consistency.
8!.
medium
c
"f the perpetual inventory master files sho# lo#er 'uantities of inventory than the physical
count, an e-planation of the difference might e unrecorded:
a. sales.
. sales discounts.
c. purchases.
d. purchase discounts.
8(.
easy

Chich of the follo#ing is not a generally recognized inventory method$

a. B"B4
. &4B4
c. &"B4
d. 3pecific identification

8..
medium

Chich of the follo#ing control procedures #ould most likely e used to maintain accurate
perpetual inventory records$
a. "ndependent storeroom count of goods received.
. *eriodic independent comparison of records #ith goods on hand.
c. *eriodic independent reconciliation of control and susidiary records.
d. "ndependent matching of purchase orders, receiving reports, and vendorsA invoices.
82.
challenging
c
Cost accounting controls are those related to the physical inventory and the conse'uent costs
from the point at #hich:
a. materials are ordered for purchase until the finished product is sold.
Arens/Elder/Beasley
. the customerAs order is received until the finished product is shipped.
c. ra# materials are re'uisitioned until the finished product is sent to storage.
d. ra# materials are re'uisitioned until the finished product is completely manufactured.
88.
challenging
d
"n valuing inventory, the auditor must consider all ut #hich of the follo#ing factors$
a. /he valuation method must e in accordance #ith %))*.
. /he valuation method must e applied on a consistent asis.
c. /he inventory must e valued at the lo#er of cost or market.
d. )ll inventory must e valued using the same valuation method under %))*.
8;.
challenging
c
Controls #hich provide a means of ensuring that the physical counts are properly summarized,
priced at the same amount as the unit records, correctly e-tended and totaled, and included in
the general ledger at the proper amount are kno#n as:
a. standard cost controls.
. pricing internal controls.
c. compilation internal controls.
d. count 'uantity internal controls.
8<.
challenging
c
)ssume that the clientAs valuation of an inventory item is 91: per unit for 1,::: units, using
first-in, first-out +B"B4,. "f the most recent ac'uisition of inventory #as for 8:: units at 91: per
unit and the immediately preceding ac'uisition #as for ;:: units at 9= per unit, the inventory
item is in error and it is:
a. understated 9.::.
. understated 9(::.
c. overstated 9.::.
d. overstated 9;::.
8=.
challenging
d
)ssume that the clientAs valuation of an inventory item is 91: per unit for 1,::: units, using
&"B4. "f the most recent ac'uisition of a layer of inventory #as for 8:: units at 91: per unit and
the immediately preceding layer #as for ;:: units at 9= per unit, the inventory item is in error
and it is:
a. understated 9;::.
. understated 9(::.
c. overstated 9.::.
d. overstated 9;::.
;:.
challenging
c
Chen an outside specialist has assumed full responsiility for taking the clientAs physical
inventory, reliance on the specialistAs report is acceptale if:
a. the auditorAs report contains a reference to the assumption of full responsiility.
. the auditor is satisfied through application of appropriate procedures as to the reputation
and competence of the specialist.
c. the auditor conducted the same audit tests and procedures as #ould have een applicale if
the clientAs employees took the physical inventory.
d. circumstances made it impracticale or impossile for the auditor either to do the #ork
personally or oserve the #ork done y the inventory firm.
;1.
challenging

/o est ascertain that a company has properly included merchandise that it o#ns in its ending
inventory, the auditor should revie# and test the:
a. terms of the open purchase orders.
. purchase cutoff procedures.
c. contractual commitments made y the purchasing department.
d. purchase invoices received on or around year-end.
;!.
challenging
a
Hardy Company mass-produces eight different products. /he controller #ho is interested in
strengthening internal controls over the accounting for materials used in production #ould e
most likely to implement a+n,:
a. perpetual inventory system.
. @o order cost accounting system.
Arens/Elder/Beasley
c. economic order 'uantity system.
d. separation of duties among production personnel.
;(.
challenging
d
Chich of the follo#ing is an internal control #eakness for a company #hose inventory of
supplies consists of a large numer of individual items$
a. /he cycle asis is used for physical counts.
. 3upplies of relatively little value are e-pensed #hen purchased.
c. *erpetual inventory records are maintained only for items of significant value.
d. /he storekeeper is responsile for maintenance of perpetual inventory records.
;..
challenging
c
Chen auditing a pulic #arehouse, #hich of the follo#ing is the most important audit
procedure #ith respect to disclosing unrecorded liailities$
a. 4servation of inventory.
. Revie# of outstanding receipts.
c. "nspection of receiving and issuing procedures.
d. Confirmation of negotiale receipts #ith holders.
?ssay Questions
;2.
easy
Chat are t#o factors affecting the comple-ity of the audit of inventory$
)ns#er:
"nventory is often the largest account in the #orking capital.
"nventory is often in different locations.
Eiverse items in inventory are often difficult to value.
"nventory valuation is difficult due to the estimates involved.
/here are several acceptale methods of valuing inventory and some entities use
different methods for different types of inventory.
;8.
easy
/he asis for the auditorAs verification of inventory pricing and compilation is the clientAs
inventory listing. Eescrie the information that should e included in this listing.
)ns#er:
/he inventory listing should include each inventory itemAs description, 'uantity, unit price,
and e-tended value.
;;.
medium
"n pricing inventory, it is necessary to consider #hether replacement cost is lo#er than
historical cost. Chen applying lo#er of cost or market tests, #hat asis should auditors use for
each of the follo#ing categories of inventory:
Ra# materials
Cork-in-process
*urchased finished goods
)ns#er:
Ra# materials U the most recent cost as found on vendor invoices from the period
suse'uent to year-end
Cork-in-process U all manufacturing costs from production records from the period
suse'uent to year-end
*urchased finished goods U the most recent cost as found on vendor invoices from the
period suse'uent to year-end and the sales value of these goods
;<.
medium
Chat must auditors do to meet their oligations under professional auditing standards related to
the oservation of inventory$
Arens/Elder/Beasley
)ns#er:
7e present at the time the client counts their inventory for determining year-end
alances.
4serve the clientAs counting procedures.
Make in'uiries of client personnel aout their counting procedures.
Make their o#n independent tests of the physical counts.
;=.
medium
Eiscuss the auditorAs responsiilities for inventory maintained in pulic #arehouses or #ith
other outside custodians.
)ns#er:
4rdinarily the auditor #ill confirm inventory held y outside custodians. Ho#ever, the
auditor may perform additional procedures if the amounts involved are significant. /hese
additional procedures may include: an investigation of the custodianAs performance,
re'uesting an independent accountantAs report on the custodianAs control procedures over
the custody of goods, and oserving the physical count of goods held y the custodian.
<:.
medium
Eiscuss the four aspects of the audit of cost accounting #ith #hich the auditor is most
concerned.
)ns#er:
/he auditor is most concerned #ith:
P"sical controls o%er in%entor".
.ocuments and records for transferring in%entor". /he auditorAs primary
concerns in verifying the transfer of inventory from one location to another are that
the recorded transfers e-ist, the transfers that have actually taken place are recorded,
and the 'uantity, description, and date of all recorded transfers are accurate.
Perpetual in%entor" master files. /he ade'uacy of perpetual inventory master
files has a ma@or effect on the timing and e-tent of the auditorAs physical e-amination
of inventory.
Unit cost records.
<1.
medium
"dentify three analytical procedures commonly used #hen auditing accounts in the inventory
and #arehousing cycle.
)ns#er:
Common analytical procedures for the inventory and #arehousing cycle include:
Compare gross margin percentage #ith previous yearsA.
Compare inventory turnover ratio #ith previous yearsA.
Compare unit costs of inventory #ith previous yearsA.
Compare e-tended inventory value #ith previous yearsA.
Compare current-year manufacturing costs #ith previous yearsA.
<!.
medium
Eiscuss the methodology for designing tests of details of alances for inventory.
)ns#er:
/he methodology for designing tests of details of alances for inventory is:
1. 3et materiality, and assess acceptale audit risk and inherent risk for the inventory
and #arehousing cycle.
!. )ssess control risk for several cycles. /his risk is assessed for the inventory and
#arehousing cycle, sales and collection cycle, ac'uisition and payment cycle, and
payroll and personnel cycle.
(. Eesign and perform tests of controls and sustantive tests of transactions for
Arens/Elder/Beasley
several cycles.
.. Eesign and perform analytical procedures for the inventory and #arehousing
cycle.
2. Eesign tests of details of inventory to satisfy alance-related audit o@ectives.
Eesign sample size, timing of tests, items to select for testing, and audit procedures to
e performed.
<(.
medium
/he design of tests of details of alances for inventory is affected y audit results from multiple
cycles. "dentify the cycles, other than the inventory and #arehousing cycle that affect the audit
of inventory.
)ns#er:
/ests of details of alances for inventory are affected y the results of tests of controls and
sustantive tests of transactions in the sales and collection cycle, ac'uisition and
payment cycle, and payroll and personnel cycle, as #ell as the inventory and
#arehousing cycle.
Arens/Elder/Beasley
<..
medium
Eiscuss the key control procedures relating to the clientAs physical count of inventory.
)ns#er:
/he key control procedures relating to the clientAs physical count of inventory include proper
instructions for the physical count, supervision y responsile personnel, independent
internal verification of the counts, independent reconciliations of the physical counts
#ith perpetual inventory master files, and ade'uate control over count sheets or tags.
<2.
medium
?-plain #hy the audit of #ork-in-process and finished goods inventory is generally more
comple- than the audit of purchased inventory.
)ns#er:
/he need to verify the cost of ra# materials, direct laor, and manufacturing overhead in
pricing #ork-in-process and finished goods has the effect of making the audit of #ork-in-
process and finished goods inventory more comple- than the audit of purchased inventory.
<8.
medium
Chat types of tests are availale to an auditor #ho #ishes to test the physical control over
inventory$
)ns#er:
/he auditor may either use oservation or in'uiry to otain evidence aout the physical
control over inventory.
<;.
challenging
3tate the si- functions that make up the inventory and #arehousing cycle and, for each function,
identify the related documents andKor records that #ould e used y a manufacturing company.
)ns#er:
/he si- functions are:
Process purcase orders. Related documents are the purchase re'uisition and
the purchase order.
Recei%e ra) materials. Related documents are the receiving report and the
vendorAs invoice.
Store ra) materials. Related record is the ra# materials perpetual inventory
master file.
Process te goods. Related documents and records are the ra# materials
re'uisition and the cost accounting records.
Store finised goods. Related records are the finished goods perpetual
inventory master file and the cost accounting records.
Sip finised goods. Related documents and records are the shipping
document, the finished goods perpetual inventory master file, and the cost accounting
records.
Arens/Elder/Beasley
<<.
challenging
/he audit of the inventory and #arehousing cycle consists of five parts. 3tate the
five parts and, for each part, identify the cycle in #hich that part is tested y the
auditor.
)ns#er:
/he five parts are:
Acquire and record ra) materials! la#or! and o%eread. /his is tested during
the audits of the ac'uisition and payment cycle, and the payroll and personnel cycle.
Internall" transfer assets and costs. /his is tested in the inventory and
#arehousing cycle.
Sip goods! and record re%enue and costs. /his is tested during the audit of the
sales and collection cycle.
P"sicall" o#ser%e in%entor". /his is tested in the inventory and #arehousing
cycle.
Price and compile in%entor". /his is tested in the inventory and #arehousing
cycle.
4ther 4@ective )ns#er Bormat Questions
<=.
easy

)uditors have een re'uired to perform physical oservation tests of inventory since the early
1==:s.
a. /rue
. Balse
=:.
easy

*erpetual inventory records should e maintained y persons have access to inventory.

a. /rue
. Balse
=1.
easy

"nternal controls over the sip finised goods function in the inventory and #arehousing cycle
are not normally tested y the auditor as a part of performing tests of controls and sustantive
tests of transactions in the sales and collection cycle.
a. /rue
. Balse
=!.
easy

"n the audit of inventory, the auditor and client are @ointly responsile for making and recording
the count of physical inventoryP #hile the auditor is responsile for dra#ing conclusions aout
the ade'uacy of the physical inventory.
a. /rue
. Balse
=(.
easy
a
/he audit procedure 0*erform tests of lo#er-of-cost-or-market, selling price, and osolescence1
provides assurance mainly for the realizale value o@ective for inventory pricing and
compilation.
a. /rue
. Balse
=..
easy
"n process costing systems, costs are accumulated y individual @os.
a. /rue
Arens/Elder/Beasley
. Balse
=2.
easy
a
"n @o cost systems, costs are accumulated y individual @os.
a. /rue
. Balse
=8.
easy

)n approved purchase re'uisition form authorizes shipment of goods to customers.

a. /rue
. Balse
=;.
easy
a
/he receipt of ra# materials is a part of the ac'uisition and payment cycle.
a. /rue
. Balse
=<.
easy

Chen finished goods are completed, they are usually stored in the packing area.
a. /rue
. Balse
==.
easy

Chen performing price tests for purchased inventory, the auditor #ould not e concerned #ith
the most recent vendorsA invoices if the client uses the B"B4 valuation method.
a. /rue
. Balse
1::.
easy
a
) comparison of the current yearAs inventory turnover ratio #ith previous yearsA may indicate
the presence of osolete inventory.
a. /rue
. Balse
1:1.
easy
a
/o test for proper sales cutoff, an auditor #ould otain the numer of the last ill of lading
issued during the period under audit and verify that the item shipped had een e-cluded from
the inventory listing.
a. /rue
. Balse
1:!.
easy

"f the perpetual inventory master files sho# lo#er 'uantities of inventory than the physical
count, one e-planation of the difference might e unrecorded sales.
a. /rue
. Balse
1:(.
medium
a
"t is acceptale under generally accepted accounting principles for a company to use different
valuation methods for different parts of its inventory.
a. /rue
. Balse
1:..
medium
a
"nternal controls over the processing of purcase orders function, the receipt of ra) materials
function, and the storage of ra) materials function in the inventory and #arehousing cycle are
normally tested y the auditor as a part of performing tests of controls and sustantive tests of
transactions in the ac'uisition and payment cycle and the payroll and personnel cycle.
a. /rue
. Balse
1:2.
medium
a
/he ma@or considerations in evaluating the reasonaleness of cost allocations are compliance
#ith %))* and consistency #ith prior years.
a. /rue
. Balse
1:8.
medium
Chen verifying the transfer of inventory from one location to another, the audit o@ectives #ith
#hich the auditor is primarily concerned are occurrence of recorded transfers, completeness of
Arens/Elder/Beasley
a recorded transfers, and accurac" of recorded transfers.
a. /rue
. Balse
1:;.
medium

Chen the clientAs perpetual inventory master files are inade'uate, the auditor #ill proaly
choose to test the physical inventory prior to the alance sheet date.
a. /rue
. Balse
1:<.
medium
a
Chen part of the clientAs inventory is in a pulic #arehouse or in the possession of other outside
custodians, the auditor does not need to oserve a physical count of the inventory if a #ritten
confirmation is otained directly from the inventory custodians.
a. /rue
. Balse
1:=.
medium

/he audit procedure 0Boot the inventory listing schedules for ra# materials, #ork-in-process,
and finished goods1 provides assurance mainly for the accuracy o@ective for inventory pricing
and compilation.
a. /rue
. Balse
11:.
medium

/he audit procedure 0)ccount for unused tag numers sho#n in the auditorAs #orking papers to
make sure no tags have een added1 provides assurance mainly for the e-istence o@ective for
inventory pricing and compilation.
a. /rue
. Balse
111.
medium
a
Chen performing audit tests of pricing and compilation for inventory, the clientAs perpetual
inventory master file may e used in place of vendorsA invoices if controls over the perpetual
inventory master file are ade'uate.
a. /rue
. Balse
11!.
medium

*roduction personnel should ordinarily e responsile for maintaining perpetual inventory

records.
a. /rue
. Balse
11(.
medium
a
/he e-tent and timing of an auditorAs physical e-amination of inventory is significantly
influenced y the ade'uacy of the clientAs perpetual inventory records.
a. /rue
. Balse
11..
challenging
a
Chile separate perpetual inventory records are normally kept for ra# materials and finished
goods, most companies do not use perpetuals for #ork-in-process.
a. /rue
. Balse
112.
challenging

"nherent risk is typically assessed at a moderate level for inventory due to the nature of the
asset.
a. /rue
. Balse
Arens/Elder/Beasley
Chapter 22
Multiple-Choice Questions
1.
easy

Chich of the follo#ing statements is correct$

a. 7onds are fre'uently issued y companies in small amounts.
. /here are relatively fe# transactions in the capital ac'uisition and repayment cycle, and each
transaction is typically highly material.
c. ) primary emphasis in auditing det is on e-istence.
d. )udit procedures for Dotes *ayale and "nterest "ncome are often performed simultaneously.
!.
easy
c
/he capital ac'uisition and repayment cycle does not include:
a. payment of interest.
. payment of dividends.
c. payment of vendor invoices.
d. ac'uisition of capital through interest-earing det.
(.
easy

Chich of the follo#ing is not an o@ective of the auditorAs e-amination of notes payale$
a. /o determine #hether internal controls are ade'uate.
. /o determine #hether clientAs financing arrangements are effective and efficient.
c. /o determine #hether transactions regarding the principal and interest of notes are properly
authorized.
d. /o determine #hether the liaility for notes and related interest e-pense and accrued
liailities are properly stated.
..
easy
c
Chich of the follo#ing statements regarding the capital ac'uisition and repayment cycle is true$
a. Relatively fe# transactions affect the cycle, and most are smaller amounts.
. &arge numers of transactions affect the cycle, and most are smaller amounts.
c. Relatively fe# transactions affect the cycle, and most are highly material.
d. &arge numer of transaction affect the cycle, and most are highly material.
2.
easy
a
/he primary focuses of the audit of det are:
a. accuracy and completeness.
. accuracy and e-istence.
c. completeness and valuation.
d. accuracy and valuation.
8.
easy
a
Responsiility for the issuance of ne# notes payale should e vested in the:
a. oard of directors.
. purchasing department.
c. accounting department.
d. accounts payale department.
;.
easy
c
Chich of the follo#ing accounts is not audited #ithin the capital ac'uisition and repayment cycle$
a. Dotes payale.
. "nterest e-pense.
c. )ccounts payale.
d. 7onds payale.
<.
easy
a
/he auditorAs independent estimate of interest e-pense from notes payale uses average interest
rates and:
a. average notes payale outstanding.
. year-end notes payale outstanding.
c. only notes payale aove the level of materiality.
d. only notes payale to ma@or lenders.
Arens/Elder/Beasley
=.
easy
c
/he tests of details of alances procedure #hich re'uires the auditor to trace the totals of the notes
payale list to the general ledger satisfies the o@ective of:
a. accuracy.
. e-istence.
c. detail tie-in.
d. completeness.
1:.
easy

/he audit o@ective to determine that notes payale in the schedule actually e-ist is verified y the
test of details of alances procedure to:
a. foot the notes payale list.
. confirm notes payale.
c. recalculate interest e-pense.
d. e-amine the alance sheet for proper disclosure of noncurrent portions.
11.
easy
c
/olerale misstatement is often set at a+n, 66666 level for notes payale.
a. high
. moderate
c. lo#
d. unkno#n
1!.
easy
c
Chen auditing interest-earing det, the auditor should 666666 verify the related interest e-pense
and interest payale.
a. not
. attempt to
c. simultaneously
d. never
1(.
easy
d
Chich of the follo#ing accounts #ould not normally e seen in the e'uity section of the alance
sheet$
a. Eonated capital
. Eividends declared
c. Common stock
d. )ccrued revenue
1..
medium
a
Chich one of the follo#ing is not a characteristic of the capital ac'uisition and repayment cycle$
a. /he e-clusion of a fe# transactions is rarely material y itself.
. /here is a legal relationship et#een the client and the holder of the e'uity securities.
c. /here is a direct relationship et#een the interest and dividends accounts and det and e'uity.
d. Relatively fe# transactions affect the account alances, ut each transaction is often highly
material in amount.
12.
medium
c
Chich of the follo#ing statements is true$
a. /here is an inverse relationship et#een the interest and dividends accounts and det and
e'uity.
. /here is no relationship et#een the interest and dividends accounts and det and e'uity.
c. /here is a direct relationship et#een the interest and dividends accounts and det and e'uity.
d. Done of the aove is true.
18.
medium
d
)ssessed control risk and results of sustantive tests of transactions are normally unimportant for
designing tests of details of alances for #hich of the follo#ing accounts$
a. )ccounts receivale.
. "nventory.
c. )ccounts payale.
d. Dotes payale.
Arens/Elder/Beasley
1;.
medium

"n the audit of the transactions and amounts in the capital ac'uisitions and repayments cycle, the
auditor must take great care in making sure that the significant legal re'uirements affecting the
financial statements have een properly fulfilled and:
a. any violations are reported to the 3?C.
. are ade'uately disclosed in the financial statements.
c. must issue a disclaimer if they havenAt een fulfilled.
d. any departures from the agreements are made #ith managementAs kno#ledge and consent.
1<.
medium
d
Chich of the follo#ing is an auditor least likely to consider in determining the appropriate tests of
details of alances for notes payale$
a. 7usiness risk.
. "nherent risk.
c. Results of analytical procedures.
d. )cceptale audit risk.
1=.
medium
c
Chich of the follo#ing audit tests #ould provide evidence regarding the alance-related audit
o@ective of e-istence for an audit of notes payale$
a. ?-amine due dates on duplicate copies of notes.
. ?-amine alance sheet for proper presentation and disclosure of notes payale.
c. ?-amine corporate minutes for loan approval.
d. Boot the notes payale list for notes payale and accrued interest.
!:.
medium
a
Chich of the follo#ing alance-related audit o@ectives is not applicale to the audit of notes
payale$
a. Realizale value.
. Eetail tie-in.
c. Cutoff.
d. Classification.
!1.
medium

Chen there are not numerous transactions involving notes payale during the year, the normal
starting point for the audit of notes payale is:
a. a schedule of notes payale and accrued interest prepared y the audit team.
. a schedule of notes payale and accrued interest otained from the client.
c. a schedule of only those notes #ith unpaid alances at the end of the year prepared y the
client.
d. the notes payale account in the general ledger.
!!.
medium
d
Chen there are numerous transactions involving notes payale during the year, the auditor #ill
likely:
a. prepare a schedule of notes payale and accrued interest prepared.
. revie# a schedule of notes payale and accrued interest otained from the client.
c. re'uest the client to prepare a schedule of only those notes #ith unpaid alances at the end of
the year.
d. perform some other procedure.
!(.
medium

/he tests of details of alances procedure #hich re'uires the auditor to e-amine notes paid after year-end to
determine #hether they #ere liailities at the alance sheet date is an attempt to satisfy the audit
o@ective of:
e-istence.
completeness.
accuracy.
classification.
!..
medium
Chich of the follo#ing o#nersA e'uity transactions do corporations not record in their accounting
systems$
Arens/Elder/Beasley
c a. "ssuance of cash dividends.
. "ssuance of preferred stock.
c. 3ale of common stock on the secondary market.
d. ?ach of the aove is recorded.
!2.
medium

/he audit of o#nersA e'uity of pulic and private companies is very different. Chich of the
follo#ing is not one of these differences$
a. /he numer of transactions +private companies have fe#er transactions,.
. *ayment of dividends +pulic companies rarely pay dividends,.
c. Comple-ity of transactions +pulic companies generally have more comple- transactions,.
d. /ype of noncurrent det +pulic companies issue more onds,.
!8.
medium
d
/he audit o@ective that re'uires that e-isting notes payale are included in the notes payale
schedule is satisfied y performing #hich of the follo#ing audit procedures$
a. confirm notes payale.
. trace the total of the notes payale schedule to the general ledger.
c. revie# the notes payale schedule to determine #hether any are related parties.
d. otain confirmations from creditors #ho have held notes from the client in the past and are
not currently included in the notes payale schedule.
!;.
medium
Chich of the follo#ing o#nersA e'uity transactions usually re'uire specific authorization from a
companyAs oard of directors$
a
Repurchase of common
stock "ssuance of common stock Eeclaration of dividends
a. Jes Jes Jes
. Jes Do Jes
c. Do Jes Do
d. Do Do Jes
!<.
medium

Chen a company maintains its o#n records of stock transactions and outstanding stock, internal
controls must e ade'uate to ensure that:
a. actual o#ners are recorded in the yla#s.
. the correct amount of dividends is paid to stockholders o#ning the stock on the dividend
record date.
c. the correct amount of dividends is paid to stockholders o#ning the stock on the declaration
date.
d. actual o#ners are recorded in the minutes.
!=.
medium
d
/he audit o@ective that re'uires the auditor to determine that notes payale on the notes payale
schedule are properly classified can e tested y performing the procedure to:
a. confirm notes payale.
. e-amine corporate minutes for loan approval.
c. e-amine notes, minutes, and ank confirmations for restrictions.
d. revie# the notes to determine #hether any are #ith related parties.
(:.
medium
c
/he amount of time spent verifying o#nersA e'uity is fre'uently minimal for closely held
corporations ecause:
a. these companies are so small that it is not necessary to audit the capital section.
. the fe# o#ners all have access to the ooks so the auditor spends more time on accounts like
liailities, #hich affect outsiders.
c. there are fe# if any transactions during the year for the capital stock accounts, e-cept for
earnings and dividends.
d. there is no pulic interest in these companies.
(1.
medium
Chich of the follo#ing types of o#nersA e'uity transactions #ould not re'uire authorization y the
oard of directors$
Arens/Elder/Beasley
d a. "ssuance of capital stock.
. Repurchase of capital stock.
c. Eeclaration of dividends.
d. Done of the aove.
(!.
medium

/he record of the issuance and repurchase of capital stock for the life of the corporation is
maintained in the:
a. shareholdersA capital stock master file.
. capital stock certificate record.
c. schedule of stock o#ners.
d. corporate directory.
((.
medium
d
/he record of the outstanding shares at any given time is maintained in the:
a. corporate directory.
. stock certificate ooks.
c. schedule of stock o#ners.
d. shareholdersA capital stock master file.
(..
medium
a
Chen a dividend is declared y the oard of directors, the source for determining #ho should
receive dividend checks is the:
a. shareholdersA capital stock master file.
. stock certificate ooks.
c. common stock account in the general ledger.
d. corporate directory.
(2.
medium
d
/he authorization of an issuance of capital stock normally includes all ut #hich of the follo#ing$
a. /ype of stock to e issued.
. Dumer of shares to e issued.
c. Eate shares are to e issued.
d. )mount of dividend to e paid on shares issued.
(8.
medium
d
)ny company #ith stock listed on a securities e-change is re'uired to engage a+n, 666666666.
a. e'uity analyst
. stock transfer agent
c. independent registrar
d. e'uity placement specialist
(;.
medium
c
Chich of the follo#ing audit o@ectives is least important in the audit of capital stock and paid-in-
capital in e-cess of par$
a. Completeness.
. )ccuracy.
c. Rights and oligations.
d. *resentation and disclosure.
(<.
medium
d
/he primary concern in determining #hether retained earnings is correctly disclosed on the alance
sheet is:
a. correct calculation of the net income or loss for the year.
. correct calculation of dividend payments for the year.
c. #hether prior-period ad@ustments have een made correctly.
d. #hether there are any restrictions on the payment of dividends.
(=.
medium
d
)n auditor #ould most likely verify the interest earned on ond investments y:
a. testing the internal controls over cash receipts.
. vouching the receipt and deposit of interest checks.
c. confirming the ond interest rate #ith the issuer of the onds.
d. recomputing the interest earned on the asis of face amount, interest rate, and period held.
Arens/Elder/Beasley
.:.
medium
a
Chat type of audit test #ill auditors use #hen testing to see if e-isting capital stock transactions are
recorded$
/ests of details of alances /ests of transactions /ests of controls
a. Do Jes Jes
. Jes Do Jes
c. Jes Do Do
d. Do Jes Do
.1.
medium
a
Euring the course of an audit, a C*) oserves that the recorded interest e-pense seems to e
e-cessive in relation to the alance in the long-term det account. /his oservation could lead the
auditor to suspect that:
a. long-term det is understated.
. discount on onds payale is overstated.
c. long-term det is overstated.
d. premium on onds payale is understated.
.!.
medium
a
) company issued onds for cash during the year under audit. /o ascertain that this transaction #as
properly recorded, the auditorAs est course of action is to:
a. trace the cash received from the issuance to the accounting records.
. confirm the results of the issuance #ith the under#riter or investment anker.
c. verify that the ne# cash received is credited to an account entitled 07onds *ayale.1
d. re'uest a statement from the ond trustee as to the amount of onds issued and outstanding.
.(.
medium
d
Chat type of audit test #ill auditors use #hen testing to see if the amounts of capital stock
transactions are accurately recorded$
/ests of details of alances /ests of transactions /ests of controls
a. Do Jes Jes
. Jes Do Jes
c. Do Jes Do
d. Jes Do Do
...
medium
c
"f a company employs a capital stock registrar andKor transfer agent, the registrar or agent, or oth,
should e re'uested to confirm directly to the auditor the numer of shares of each class of stock:
a. surrendered and canceled during the year.
. authorized at the alance sheet date.
c. issued and outstanding at the alance sheet date.
d. authorized, issued, and outstanding during the year.
.2.
challenging
a
Chen a company has treasury stock certificates on hand, a year-end count of the certificates y the
auditor is:
a. al#ays re'uired.
. not re'uired if treasury stock is a deduction from stockholdersA e'uity.
c. re'uired #hen the company classifies treasury stock #ith other assets.
d. re'uired #hen the company had treasury stock transactions during the year.
.8.
challenging
d
"n the audit of notes payale, it is common to include tests of principal and interest payments as a
part of the audit of the ac'uisitions and payment cycle ecause the payments are in the cash
disursements @ournal that is eing sampled. "t is also normal to test these transactions as part of the
capital ac'uisitions and repayment cycle ecause:
a. it is not unusual for the auditor to duplicate a process, therey gathering a larger 'uantity of
evidence.
. replicating the evidence #ill provide the auditor #ith a higher level of assurance.
c. the tests done in the ac'uisitions and payments cycle #ill look only at the cash credit side so
the tests done in the capital ac'uisitions and repayment cycle #ill look at the deit side of
the transaction.
Arens/Elder/Beasley
d. due to the infre'uency of these transactions, in many cases no transactions involving notes
payale are included in the sample tests of ac'uisitions and payments.
.;.
challenging
d
"t is normal practice to verify all capital stock transactions:
a. only #hen the client is small.
. that are in e-cess of a material amount.
c. if there arenAt very many during the year.
d. regardless of the controls in e-istence, ecause of their materiality and permanence in the
records.
.<.
challenging

Euring its fiscal year, a company issued, at a discount, a sustantial amount of first-mortgage
onds. Chen performing audit #ork in connection #ith the ond issue, the independent auditor
should:
a. confirm the e-istence of the ondholders.
. revie# the minutes for authorization.
c. trace the net cash received from the issuance to the ond payale account.
d. inspect the records maintained y the ond trustee.
.=.
challenging

"n connection #ith the audit of a current issue of long-term onds payale, the auditor should:
a. decide #hether the ond issue #as made #ithout violating state or local la#.
. ascertain that the client has otained the opinion of counsel on the legality of the issue.
c. calculate the effective interest rate to see if it is sustantially the same as the rates for similar
issues.
d. determine #hether ondholders are persons other than o#ners, directors, or officers of the
company issuing the ond.
2:.
challenging
a
/he auditor can est verify a clientAs ond sinking fund transactions and year-end alance y:
a. confirmation #ith the ond trustee.
. confirmation #ith individual holders of retired onds.
c. e-amination and count of the onds retired during the year.
d. recomputation of interest e-pense, interest payale, and amortization of ond discount or
premium.
Arens/Elder/Beasley
?ssay Questions
21.
easy
Chat is a note payale$
)ns#er:
) note payale is legal oligation to a creditor #hich may e secured or unsecured y
assets and ears interest.
2!.
easy
Chat is the difference et#een an independent registrar and a stock transfer agent$
)ns#er:
Companies #hose shares are listed on a securities e-change are re'uired to enlist the services of
an independent registrar. /he registrar is responsile for making sure that all stock is issued y a
corporation in accordance #ith the corporate charter and is properly authorized y the oard of
directors. /he registrar is also responsile for signing all ne#ly issued shares. ) stock transfer
agent maintains stockholder records, including transfers of stock o#nership. /ransfer agents
may also disurse cash dividends to shareholders.
2(.
easy
Chy are analytical procedures essential for notes payale$
)ns#er:
/hey are essential ecause tests of details for interest e-pense and accrued interest can
often e eliminated if the results from the analytical procedures are favorale.
2..
medium
Chat are t#o important procedures that companies should implement to prevent misstatements in
o#nersA e'uity$
)ns#er:
Companies should develop:
1. #ell-defined policies for preparing stock certificates and recording capital stock
transactions, and
!. independent internal verification of information in the o#nersA e'uity records.
22.
medium
Chat are the t#o most important alance-related audit o@ectives in notes payale$
)ns#er:
?-isting notes payale are included +completeness,.
Dotes payale are accurately recorded +accuracy,.
28.
medium
Eescrie the methodology for designing tests of details of alances for notes payale.
)ns#er:
/he methodology is:
3et materiality and access acceptale audit risk and inherent risk for notes payale.
)ssess control risk for notes payale.
Eesign and perform tests of controls and sustantive tests of transactions for the
ac'uisition and payment, and sales and collection cycle.
Eesign and perform analytical procedures for notes payale alance.
Eesign tests of details of notes payale alance to satisfy alance-related audit
o@ectives. Eecide sample size, items to select for testing, audit procedures, and timing of
procedures.
Arens/Elder/Beasley
2;.
medium
"dentify three analytical procedures commonly performed for notes payale.
)ns#er:
3ome possile analytical procedures for notes payale include:
Recalculate appro-imate interest e-pense on the asis of average interest rates and
overall monthly notes payale.
Compare individual notes outstanding #ith the prior yearAs.
Compare total alance in notes payale, interest e-pense, and accrued interest #ith
prior years.
2<.
medium
/he starting point for the audit of notes payale is a schedule of notes payale and accrued interest.
Eiscuss the information typically included in the schedule.
)ns#er:
/he usual schedule includes detailed information of all transactions that took place during the
entire year for principal and interest, the eginning and ending alances for notes and interest
payale, and descriptive information aout the notes, such as the due date, the interest rate, and
the assets pledged as collateral.
2=.
medium
Chen a company maintains its o#n records of stock transactions and outstanding stock, the internal
controls must e ade'uate to accomplish three purposes. Chat are these$
)ns#er:
/he three purposes are:
)ctual o#ners of the stock are recognized in the corporate records.
/he correct amount of dividends is paid to the stockholders o#ning the stock as of
the dividend record date.
/he potential for misappropriation is minimized.
8:.
challenging
Eiscuss the four characteristics of the capital ac'uisition and repayment cycle that make it uni'ue
from other cycles.
)ns#er:
/he four characteristics are:
Relatively fe# transactions affect the account alances, ut each transaction is often
highly material in amount.
/he e-clusion of a single transaction could e material in itself.
/here is a legal relationship et#een the client entity and the holder of the stock,
ond, or similar o#nership document.
/here is a direct relationship et#een the interest and dividends accounts and det
and e'uity.
Arens/Elder/Beasley
81.
challenging
Eiscuss the four key controls over notes payale.
)ns#er:
/he four key controls over notes payale are:
Proper autori8ation for te issue of ne) notes. Responsiility for the issuance
of ne# notes should e vested in the oard of directors or high-level management
personnel, #ith signatures of t#o authorized officials re'uired for all loan agreements.
Adequate controls o%er te repa"ment of principal and interest. )t the time
notes are issued, the accounting department should receive a copy in the same manner
in #hich it receives vendorsA invoices and receiving reports. /he accounts payale
department should automatically issue checks for the notes #hen they ecome due, in
the same manner in #hich it prepares checks for ac'uisitions of goods and services.
Proper documents and records. /hese include the maintenance of susidiary
records and control over lank and paid notes y a responsile person. *aid notes
should e canceled and retained under the custody of an authorized official.
Periodic independent %erification. /he detailed note records should e
reconciled periodically #ith the general ledger and compared #ith the note holdersA
records y an employee #ho is not responsile for maintaining the detailed records.
8!.
challenging
Eiscuss the internal controls related to o#nersA e'uity that are of concern to the auditor.
)ns#er:
Proper autori8ation of transactions. Material transactions should e approved
y the oard of directors, including issuance of capital stock, repurchase of capital
stock, and declaration of dividends.
Proper recordkeeping and segregation of duties. /his should include #ell-
defined policies for preparing stock certificates and recording capital stock
transactions, and independent internal verification of information in the records. Many
companies use a capital stock certificate ook and a shareholdersA capital stock master
file to improve control over capital stock transactions.
Independent registrar and stock transfer agent. )n independent registrar acts
as a control to prevent the improper issuance of stock certificates. ) stock transfer
agent acts as a control over the stock records.
8(.
challenging
Eiscuss the overall o@ectives of the audit of notes payale.
)ns#er:
/he overall o@ectives of the audit of notes payale are to determine #hether:
/he internal controls over notes payale are ade'uate.
/ransactions for principal and interest involving notes payale are properly
authorized and recorded as defined y the si- transaction-related audit o@ectives.
/he liaility for notes payale and the related interest e-pense and accrued
liaility are properly stated as defined y eight of the nine alance-related audit
o@ectives +realizale value is e-cluded,.
Arens/Elder/Beasley
8..
challenging
3tate the four most important audit o@ectives for capital stock and descrie ho# the auditor
typically verifies each of the four o@ectives.
)ns#er:
/he four most important audit o@ectives for capital stock are:
Existing capital stock transactions are recorded ?completeness@. Confirm #ith
the registrar or transfer agent #hether any capital stock transactions occurred.
Recorded capital stock transactions occurred and are accuratel" recorded
?occurrence and accurac"@. ?-istence can e tested y e-amining the minutes of the
oard of directorsA meetings for proper authorization. )ccuracy can e tested y
confirming the amount #ith the transfer agent and tracing the amount of the recorded
capital stock transactions to the cash receipts @ournal.
Capital stock is accuratel" recorded ?accurac"@. /he ending alance in the
capital stock account is verified y first determining, via confirmation from the
transfer agent, the numer of shares outstanding at the alance sheet date. /he
recorded par value in the capital account can e verified y multiplying the numer of
shares outstanding y the par value of the stock.
Capital stock is properl" presented and disclosed ?presentation and disclosure@.
>sing the corporate charter, the minutes of oard of directorsA meeting and the
auditorAs analysis of capital stock transactions, the auditor should determine that there
is a proper description of each class of stock. /he proper presentation and disclosure
of stock options, stock #arrants, and convertile securities should also e verified y
e-amining legal documents or other evidence of the provisions of these agreements.
82.
challenging
&ist si- accounts in the capital ac'uisition and repayment cycle commonly found on alance
sheets. Chat characteristics do these accounts have in common that distinguish them from other
accounts$
)ns#er:
7alance sheet accounts in the capital ac'uisition and repayment cycle include:
Dotes payale
Contracts payale
Mortgages payale
7onds payale
)ccrued interest
Cash in the ank
Capital stock-common
Capital stock-preferred
*aid-in capital in e-cess of par
Eonated capital
Retained earnings
)ppropriations of retained earnings
/reasury stock
Eividends declared
Eividends payale
#he uni$ue characteristics o! these accounts are%
Relatively fe# transactions affect the account alances, ut each transaction is
often highly material in amount.
/he e-clusion of a single transaction could e material in itself.
/here is a legal relationship et#een the client entity and the holder of the
stock, ond, or similar o#nership document.
/here is a direct relationship et#een the interest and dividends accounts and
det and e'uity.
Arens/Elder/Beasley
4ther 4@ective )ns#er Bormat Questions
88.
medium
Match si- of the terms +a-i, used in the capital ac'uisitions and repayment cycle #ith the
descriptions provided elo# +1-8,:
a. Capital ac'uisition and repayment cycle
. Capital stock certificate ook
c. Closely held corporation
d. "ndependent registrar
e. Dote payale
f. *ulicly held corporation
g. 3tock transfer agent
h. 3chedule of notes payale and accrued interest
i. 3tock maintenance agent
d 1. )n outside person engaged y a corporation to make sure that its stock is issued
in accordance #ith capital stock provisions in the corporate charter and
authorizations y the oard of directors.
h !. /he normal starting point for the audit of notes payaleP includes detailed
information of all transactions related to notes payale that took place during the
year.
(. ) record of the issuance and repurchase of capital stock for the life of the
corporation.
g .. )n outside person engaged y a corporation to maintain the stockholder records,
and often to disurse cash dividends.
f 2. )n entity that is re'uired to engage an independent registrar.
a 8. /he cycle that concerns the ac'uisition of capital resources through interest-
earing det and o#nersA e'uity and repayment of the capital.
8;.
easy
a
4ne uni'ue characteristic of the capital ac'uisition and repayment cycle is that relatively fe#
transactions affect the account alances, ut each transaction is often highly material in amount.
a. /rue
. Balse
8<.
easy
a
/he e-clusion of a single e'uity transaction is often highly material.
a. /rue
. Balse
8=.
easy

Dotes payale are generally for short periods of time.

a. /rue
. Balse
;:.
easy
a
Chen performing analytical procedures for notes payale, if actual interest e-pense is
materially larger than the auditorAs e-pectation, one possile cause #ould e interest payments
on unrecorded notes payale.
a. /rue
. Balse
Arens/Elder/Beasley
;1.
easy

)uditors seldom learn aout the capital ac'uisition and repayment cycle #hen gaining an
understanding of the clientAs usiness and industry.
a. /rue
. Balse
;!.
easy

/he 3ecurities and ?-change Commission re'uires companies to employ stock transfer agents.
a. /rue
. Balse
;(.
easy

*ulic companies #hose stock is listed on a stock e-change must employ a stock transfer agent.
a. /rue
. Balse
;..
easy
a
*ulic companies #hose stock is listed on a stock e-change must employ an independent
registrar.
a. /rue
. Balse
;2.
easy
a
/he shareholdersA capital stock master file is used as the asis for the payment of dividends and
also acts as a check on the accuracy of the common stock alance in the general ledger.
a. /rue
. Balse
;8.
easy

"ndependent registrars commonly disurse cash dividends to shareholders.

a. /rue
. Balse
;;.
easy
a
)ny restrictions on the payment of dividends must e disclosed in the footnotes to the financial
statements.
a. /rue
. Balse
;<.
medium
a
Chen auditing the capital ac'uisition and repayment cycle, it is common to verify each
transaction taking place in the cycle for the entire year as a part of verifying the alance sheet
accounts.
a. /rue
. Balse
;=.
medium

Be# large companies employ stock transfer agents, ut small companies commonly do so.
a. /rue
. Balse
<:.
medium
a
/he alance-related audit o@ective reali8a#le %alue is not applicale #hen auditing notes
payale.
a. /rue
. Balse
<1.
medium

/he three most important alance-related audit o@ectives for notes payale are e-istence,
realizale value, and accuracy.
a. /rue
. Balse
<!.
medium

/he audit procedure 0Boot the notes payale list and trace the totals to the general ledger1 is
performed #hen verifying the accuracy o@ective for notes payale.
a. /rue
. Balse
<(. /he accuracy of a dividend declaration can e audited y recalculating the amount on the asis
Arens/Elder/Beasley
medium
a
of the dividend per share times the numer of shares outstanding.
a. /rue
. Balse
<..
medium

/he audit procedure 0?-amine notes payale, minutes, and ank confirmations for restrictions1
is performed #hen verifying the classification o@ective for notes payale.
a. /rue
. Balse
<2.
medium
a
Bor most companies, the only transactions involving retained earnings are net earnings for the
year and dividends declared.
a. /rue
. Balse
<8.
medium

?-amining the minutes of the oard of directorsA meetings for proper authorization ordinarily
tests the e-istence o@ective for capital stock transactions.
a. /rue
. Balse
<;.
medium
a
?-amining the minutes of the oard of directorsA meetings for proper authorization ordinarily
tests the occurrence o@ective for capital stock transactions.
a. /rue
. Balse
<<.
medium

/he emphasis in the audit of dividends is on the ending alance rather than the transactions.
a. /rue
. Balse
<=.
medium

)ny company that has more than 1: percent of its stock o#ned y one person is considered to
e closely held.
a. /rue
. Balse
=:.
medium

) shareholdersA capital stock master file is a record of the issuance and repurchase of capital
stock over the life of the corporation.
a. /rue
. Balse
=1.
medium

Capital stock represents a legal oligation to a shareholder and ensures a certain return to the
shareholder.
a. /rue
. Balse
=!.
medium
a
/he audit procedure 0?-amine paid notes for cancellation to make sure they are not still
outstanding1 is performed #hen verifying the completeness o@ective for notes payale.
a. /rue
. Balse
Chapter 23
Multiple-Choice Questions
1. Chich of the follo#ing misstatements is most likely to e uncovered during an audit of a
Arens/Elder/Beasley
easy
c
clientAs ank reconciliation$
a. Euplicate payment of a vendorAs invoice.
. 7illing a customer at a lo#er price than indicated y company policy.
c. Bailure to record a collection of a note receivale y the ank on the clientAs ehalf.
d. *ayment to an employee for more than the hours actually #orked.
!.
easy
a
Chich of the follo#ing is the focus of an audit of cash for most companies$
a. %eneral cash account.
. *ayroll cash account.
c. *etty cash account.
d. Money market account.
(.
easy
c
/he test of details of alances procedure that re'uires the auditor to foot the outstanding check
list and deposits in transit is an attempt to satisfy #hich audit o@ective$
a. Cutoff.
. *resentation and disclosure.
c. Eetail tie-in.
d. Completeness.
..
easy

Chich of the follo#ing cycles does not affect cash in ank$

a. Capital ac'uisitions cycle.
. "nventory and #arehousing.
c. *ayroll and personnel cycle.
d. )c'uisitions and disursements.
2.
easy
c
/he audit o@ective of determining that cash in ank, as stated on the reconciliation, foots
correctly and agrees #ith the general ledger can e tested y #hich of the follo#ing
procedures$
a. *erforming tests for kiting.
. Receiving and testing a cutoff ank statement.
c. Booting the outstanding checks list and the list of deposits in transit.
d. ?-amining the minutes of the oard of directors for restrictions on the use of cash.
8.
easy
a
/he test details of alances procedure that re'uires the auditor to trace the ook alance on the
reconciliation to the general ledger is an attempt to satisfy the audit o@ective of:
a. detail tie-in.
. e-istence.
c. completeness.
d. accuracy.
;.
easy
d
Chich of the follo#ing statements is correct$
a. )uditors must otain ank confirmations on every audit.
. )uditors otain ank confirmations at their discretion.
c. )uditing standards do not address specific re'uirements regarding ank confirmations.
d. )uditing standards do not re'uire ank confirmations e-cept #hen there is an unusually
large numer of inactive ank accounts.
<.
easy

Cash is important to auditors primarily ecause of the potential for:

a. errors.
. fraud.
c. li'uidity.
d. e-penditures.
=.
easy
c
) partial-period ank statement and the related canceled checks, duplicate deposit slips, and
other documents included in ank statements, mailed y the ank directly to the C*) firmAs
office, is called:
a. a four-column proof of cash.
Arens/Elder/Beasley
. a year-end ank statement.
c. a cutoff ank statement.
d. a short-period ank statement.
1:.
easy
d
Chen the auditor elieves the year-end ank reconciliation may e intentionally misstated, it is
appropriate to perform e-tended tests of the year-end ank reconciliation. )ssuming the client
has a 4ctoer (1 year-end, these e-tended tests #ould not include:
a. comparing all 3eptemer (: reconciling items #ith canceled checks and other documents
in the 4ctoer ank statement.
. comparing all canceled checks and deposit slips in the 4ctoer ank statement #ith the
4ctoer cash disursements and receipts records.
c. carrying out all proper procedures suse'uent to the end of the year #ith the use of the
ank cutoff statement.
d. determining that all outstanding checks had cleared y the date of the ank cutoff
statement.
11.
easy
c
Chich of the follo#ing statements is correct$
a. 7ank personnel are responsile for providing reasonale assurance that a response to a
ank confirmation is accurate.
. 7ank personnel are responsile for providing complete assurance that a ank
confirmation is complete.
c. 7ank personnel are not responsile for searching their records for ank alances or loans
eyond those included on the ank confirmation.
d. 7ank personnel are not responsile for providing information related to interest on the
ank confirmation.
1!.
easy
/he auditor uses a proof of cash to determine #hether:
a )ll recorded cash disursements #ere
paid y the ank.
)ll amounts that #ere paid y the ank
#ere recorded.
a. Jes Jes
. Do Do
c. Jes Do
d. Do Jes
1(.
easy

Chich of the follo#ing #ould normally not e discovered as part of the audit of the ank
reconciliation$
a. Bailure to ill a customer.
. Bailure to include a deposit in transit on the ank reconciliation.
c. Euplicate payment of a vendorAs invoice.
d. *ayment to an employee for more hours than she #orked.
1..
easy
c
) proof of cash represents:
a. a test of controls and sustantive test of transactions.
. a sustantive test of transactions.
c. a sustantive test of transactions and test of details of alances.
d. a test of details of alances.
12.
easy
a
/o gather evidence regarding the alance per ank in a ank reconciliation, an auditor #ould
e-amine all of the follo#ing e-cept the:
a. general ledger.
. ank confirmation.
c. cutoff ank statement.
d. year-end ank statement.
18.
medium
Chich of the follo#ing alance-related audit o@ectives typically is assessed as having high
inherent risk for cash$
Arens/Elder/Beasley
a a. ?-istence.
. Cutoff.
c. Eetail tie-in.
d. *resentation and disclosure.
1;.
medium
d
Chich of the follo#ing is not a 0cash e'uivalent1$
a. /ime deposits.
. Certificates of deposit.
c. Money market funds.
d. Marketale securities.
1<.
medium

/he general cash account is considered significant in almost all audits:

a. #here the ending alance is material.
. even #hen the ending alance is immaterial.
c. e-cept those of not-for-profit organizations.
d. #here either the eginning or ending alance is material.
1=.
medium
c
Chich of the follo#ing errors #ould e least likely to e discovered during the audit of the
ac'uisitions and payments cycle$
a. Euplicate payment of a vendorAs invoice.
. "mproper payments of officersA personal e-penditures.
c. *ayment of interest to a related party for an amount in e-cess of the going rate.
d. *ayment for ra# materials that #ere not received.
!:.
medium

7ecause cash is the most desirale asset for people to steal, it has a higher:
a. control risk.
. inherent risk.
c. detection risk.
d. li'uidity risk.
!1.
medium
a
/esting the reasonaleness of the cash alance at year-end is less important #hen the year-end
ank reconciliation is verified:
a. on a 1::T asis.
. y someone in clientAs organization #ho is independent of the treasurerAs function.
c. y someone in clientAs organization #ho is independent of the controllerAs function.
d. y the o#nerKmanager.
!!.
medium
d
) ma@or consideration in the audit of the general cash alance is the possiility of fraud. /he
auditor must e-tend his or her procedures in the audit of year-end cash to determine the
possiility of a material fraud #hen there are:
a. large cash alances at the end of the year.
. large cash receipts and disursements during the year.
c. no imprest accounts used for payroll.
d. inade'uate internal controls.
!(.
medium
a
/he starting point for the verification of the alance in the general ank account is to otain:
a. a ank reconciliation from the client.
. the clientAs cash account from the general ledger.
c. a cutoff ank statement directly from the ank.
d. the clientAs year-end ank statement and reconcile it.
!..
medium

)n imprest petty cash fund #ould least likely e used to pay for #hich of the follo#ing items$
a. Minor office supplies
. Monthly interest e-pense
c. 3tamps for small mailings
d. 3mall contriutions to a local charity
Arens/Elder/Beasley
!2.
medium
c
"n an effort to satisfy the completeness o@ective, the auditor could perform #hich of the
follo#ing test of details of alance procedures$
a. /race the ook alance on the reconciliation to the general ledger.
. /race outstanding checks to suse'uent period ank statements.
c. *erform a four-column proof of cash.
d. Revie# financial statements to make sure that material savings accounts and certificates
of deposit are disclosed separately.
!8.
medium
d
/he audit procedure #hich re'uires the auditor to record the last check numer used on the last
day of the year and suse'uently trace to the outstanding checks and the cash disursements
records is performed to satisfy the audit o@ective of:
a. detail tie-in.
. e-istence.
c. completeness.
d. cutoff.
!;.
medium
c
/he direct receipt of a confirmation from every ank #ith #hich the client does usiness is:
a. re'uired y auditing standards for every audit.
. not necessary unless material fraud is suspected.
c. typically done ut not re'uired y auditing standards.
d. necessary for every audit e-cept #hen there are an unusually large numer of active
accounts.
!<.
medium

/he reason for testing the clientAs ank reconciliation is to verify #hether the clientAs recorded
ank alance is the same amount as the actual cash in ank, e-cept for deposits in transit,
checks outstanding, and other reconciling items. /he information needed to complete the tests
of the reconciliation are provided y the:
a. clientAs records and ledgers for the year under audit.
. cutoff ank statement.
c. clientAs records and ledgers for the suse'uent year.
d. canceled checks for the year under audit.
!=.
medium
c
Chich of the follo#ing items #ould not normally appear on ank reconciliations$
a. 7alance per ank
. &ist of deposits in transit
c. 4utstanding deposits
d. 4utstanding checks
(:.
easy

/he concern in a monthly proof of cash is #ith:

a. ad@usting account alances.
. reconciling the amounts per ooks and ank.
c. determining the month-end alance.
d. identifying cash transfers.
(1.
medium
d
) proof of cash is effective at identifying #hich of the follo#ing misstatements$
a. Checks #ritten for incorrect amounts.
. Checks issued to invalid vendors.
c. Braudulent checks.
d. Checks recorded y the ooks for an amount different than the check.
(!.
medium

/he emphasis in verifying petty cash is normally on #hich of the follo#ing$

a. Jear-end alance
. Controls over petty cash
c. /ransactions for the period
d. 7alance sheet classifications
((. /he process of transferring money from one ank account to another and improperly recording
Arens/Elder/Beasley
medium
a
the transaction is referred to as:
a. kiting.
. lapping.
c. scamming.
d. emezzling.
(..
medium
"f a ank does not respond to a ank confirmation re'uest, an auditor may:
a
*erform alternative
procedures
3end a second
re'uest
)sk the client to communicate
#ith the ank to ask them to
complete and return the
confirmation
a. Do Jes Jes
. Do Do Jes
c. Jes Do Jes
d. Jes Jes Do
(2.
medium
/he most important controls for petty cash relate to:
d /he use of a separate ank account /he use of an imprest fund
a. Jes Jes
. Do Do
c. Jes Do
d. Do Jes
(8.
medium

Chich of the follo#ing cash transfers results in a misstatement of cash at Eecemer (1, !::;$
7ank /ransfer 3chedule
Recorded Eisursement Recorded Eate
transfer paid y transfer received
in ooks y ank in ooks y ank
a. 1!K(1K:;1K:.K:< 1!K(1K:; 1!K(1K:;
. 1K:.K:< 1K:2K:< 1!K(1K:; 1K:.K:<
c. 1!K(1K:;1K:2K:< 1!K(1K:; 1K:.K:<
d. 1K:.K:< 1K11K:< 1K:.K:< 1K:.K:<
(;.
medium
c
66666 is cash stolen from an organization efore it is recorded in the accounting records.
a. /heft
. Cash larceny
c. 3kimming
d. Bloating
(<.
medium
d
/he most important alance-related audit o@ectives in the audit of cash include all ut #hich of
the follo#ing$
a. ?-istence
. )ccuracy
c. Completeness
d. 4ccurrence
(=.
medium
d
Euring his e-amination of a Lanuary 1=, !::< cutoff ank statement, an auditor noticed that the
ma@ority of checks listed as outstanding at Eecemer (1, !::;, had not cleared the ank. /his
#ould indicate:
a. a high proaility of kiting.
. a high proaility of lapping.
c. that the !::; cash disursements records had een closed prior to Eecemer (1, !::;.
d. that the !::; cash disursements records had een held open past Eecemer (1, !::;.
/he follo#ing information applies to the 'uestions elo#:
Arens/Elder/Beasley
&isted elo# are four interank cash transfers, indicated y the numers 1, !, (, and ., of a
client for late Eecemer !::; and early Lanuary !::<:
7ank )ccount 4ne 7ank )ccount /#o
Eisursing Eate Receiving Eate
+MonthKEay, +MonthKEay,
*er 7ank *er 7ooks *er 7ank *er 7ooks
1. 1!K(1 1!K(: 1!K(1 1!K(:
!. 1K! 1!K(: 1!K(1 1!K(1
(. 1K( 1!K(1 1K! 1K!
.. 1K( 1!K(1 1K! 1!K(1
.:.
medium
c
7ased on the schedule of interank transfers aove, #hich of the cash transfers indicates an
error in cash cutoff at Eecemer (1, !::;$
a. 1
. !
c. (
d. .
.1.
medium
d
7ased on the schedule of interank transfers aove, #hich of the cash transfers #ould appear as
a deposit in transit on the Eecemer (1, !::; ank reconciliation$
a. 1
. !
c. (
d. .
.!.
medium
a
7ased on the schedule of interank transfers aove, #hich of the cash transfers #ould not
appear as an outstanding check on the Eecemer (1, !::; ank reconciliation$
a. 1
. !
c. (
d. .
.(.
challenging
a
Chich of the follo#ing errors #ould e least likely to e discovered during the tests of the ank
reconciliation$
a. *ayment #as made to an employee for more hours than he #orked.
. Cash received y the client suse'uent to the alance sheet date #as recorded as cash
receipts in the current year.
c. *ayments on notes payale #ere deited directly to the ank alance y the ank #ere
not entered in the clientAs records.
d. Eeposits #ere recorded in the cash receipts records near the end of the year, deposited in
the ank, and #ere included in the ank reconciliation as a deposit in transit.
...
challenging
a
Chen a customer fails to include a remittance advice #ith a payment, it is common practice for
the person opening the mail to prepare one. Conse'uently, mail should e opened y #hich of
the follo#ing four company employees$
a. Receptionist.
. 3ales manager.
c. Credit manager.
d. )ccounts receivale clerk.
.2. Chich of the follo#ing alance-related o@ectives applies to auditing the general cash account$
challenging Rights Classification Realizale value
d a. Jes Do Jes
. Do Jes Do
c. Jes Jes Jes
Arens/Elder/Beasley
d. Do Do Do
.8.
challenging
d
) proof of cash is not an effective procedure for identifying #hich of the follo#ing types of
misstatements$
a. )ll recorded disursements #ere paid y the ank.
. )ll recorded cash receipts #ere deposited.
c. )ll amounts that #ere paid y the ank #ere recorded.
d. 3ome checks #ere #ritten for incorrect amounts.
.;.
challenging
d
/he standard ank confirmation form has een agreed upon y the:
a. 3?C and B)37.
. )"C*) and the 3?C.
c. 3?C and the )merican 7ankersA )ssociation.
d. )"C*) and the )merican 7ankersA )ssociation.
.<.
medium
a
&isting all ank transfers made a fe# days efore and after the alance sheet date and tracing
each to the accounting records for proper recording is a useful approach to test for:
a. kiting.
. lapping.
c. income smoothing.
d. channel stuffing.
.=.
challenging
a
>nder #hich of the follo#ing circumstances #ould an auditor e most likely to intensify an
e-amination of a 92:: imprest petty cash fund$
a. Reimursement occurs t#ice each #eek.
. /he custodian endorses reimursement checks.
c. Reimursement vouchers are not prenumered.
d. /he custodian occasionally uses the cash fund to cash employee checks.
2:.
challenging

Contact #ith anks for the purpose of opening company ank accounts should normally e the
responsiility of the corporate:
a. oard of directors.
. treasurer.
c. controller.
d. e-ecutive committee.
21.
challenging

4n the last day of the fiscal year, the cash disursements clerk dre# a company check on ank
) and deposited the check in the company account in ank 7 to cover a previous theft of cash.
/he disursement has not een recorded. /he auditor #ill est detect this form of kiting y:
a. e-amining the composition of deposits in oth ank ) and ank 7 suse'uent to year-
end.
. e-amining paid checks returned #ith the ank statement of the ne-t account period after
year-end.
c. preparing, from the cash disursements records, a summary of ank transfers for one
#eek prior to and suse'uent to year-end.
d. comparing the detail of cash receipts as sho#n y the clientAs cash receipts records #ith
the detail on the confirmed duplicate deposit tickets for three days prior to and
suse'uent to year-end.
2!.
challenging
d
"f an auditor 0proves1 the ank statement in the month suse'uent to the alance sheet date, it is
primarily a test for:
a. errors.
. omissions.
c. kiting.
d. intentional misstatements.
Arens/Elder/Beasley
?ssay Questions
2(.
easy
Chat is the most important internal control over petty cash$
)ns#er:
/he most important internal control over petty cash is the use of an imprest fund that is the
responsiility of one person.
2..
easy
Eiscuss t#o analytical procedures commonly performed during the audit of the cash account.
)ns#er:
"t is common for auditors to compare the ending alance on the ank reconciliation, deposits in
transit, outstanding checks, and other reconciling items #ith the prior yearAs
reconciliation. 3imilarly, auditors normally compare the ending alance in cash #ith
previous monthsA alances.
22.
easy
?-plain #hat is meant y a cutoff #ank statement! and discuss the purpose of the cutoff ank
statement in the audit of cash.
)ns#er:
) cutoff ank statement is a partial-period ank statement and the related canceled checks,
duplicate deposit slips, and other documents included in ank statements, mailed y the
ank directly to the C*) firmAs office. /he purpose of the cutoff ank statements is to
verify the reconciling items on the clientAs year-end ank reconciliation #ith evidence that
is inaccessile to the client.
28.
easy
Eiscuss the circumstances in #hich an auditor #ould prepare a proof of cash.
)ns#er:
)uditors #ould prepare a proof of cash #hen the client has material #eaknesses in internal
controls over cash.
2;.
easy
Eo companies usually have significant client usiness risks affecting cash alances$
)ns#er:
Do. Ho#ever, client usiness risk may arise from inappropriate cash management
policies or handling of funds held in trust for others.
2<.
medium
Eescrie each of the ma@or types of cash accounts maintained y usiness entities.
)ns#er:
&eneral cas account. /his is the focal point of cash for most organizations
ecause virtually all cash receipts and disursements flo# through this account.
Imprest pa"roll account. )s a means of improving internal control, many
companies estalish a separate imprest ank account for making payroll payments to
employees. "n such an account, a fi-ed alance, such as 91,:::, is maintained.
"mmediately efore each pay period, one check is dra#n on the general cash account
to deposit the total amount of the net payroll in the imprest payroll account.
0ranc #ank account. Bor a company operating in multiple locations, it is
fre'uently desirale to have a separate ank alance at each location. 7ranch ank
Arens/Elder/Beasley
accounts are useful for uilding pulic relations in local communities and permitting
the centralization of operations at the ranch level.
Imprest pett" cas fund. /his fund is used for small cash transactions that can
e paid more conveniently and 'uickly y cash than y check.
Cas equi%alents. ?-cess cash accumulated during certain parts of the
operating cycle that #ill e needed in the reasonaly near future is often invested in
short-term, highly li'uid cash e'uivalents such as time deposits, certificates of
deposit, and money market funds.
2=.
medium
Chat should e audited on an interank transfer schedule$
)ns#er:
1. /he accuracy of the information on the interank transfer schedule should e verified.
!. /he interank transfers must e recorded in oth the receiving and disursing anks.
(. /he date of the recording of the disursements and receipts for each transfer must e
in the same fiscal year.
.. Eisursement on the interank transfer schedule should e correctly included in or
e-cluded from year-end ank reconciliations as outstanding checks.
2. Receipts on the interank transfer schedule should e correctly included in or
e-cluded from year-end ank reconciliations as deposits in transit.
8:.
medium
?-plain kiting, and discuss ho# it is performed.
)ns#er:
Fiting is the transfer of money from one ank to another and improperly recording the
transaction to cover a defalcation of cash or to 0#indo#-dress1 the financial statements.
Dear the alance sheet date, a check is dra#n on one ank account and immediately
deposited in a second account for credit efore the end of the accounting period. "n making
this transfer, the emezzler is careful to make sure that the check is deposited at a late
enough date so that it does not clear the first ank until after the end of the period. "f the
ank transfer is not recorded until after the alance sheet date, the amount of the transfer is
recorded as an asset in oth anks, overstating the kiterAs total cash alance.
Arens/Elder/Beasley
81.
medium
Eiscuss ho# an auditor can test for kiting.
)ns#er:
/o test for kiting, the auditor otains a schedule of interank transfers that lists all ank
transfers made a fe# days efore and after the alance sheet date, and traces each to the
accounting records for proper recording. 3pecific items of interest include:
/he accuracy of the information on the ank transfer schedule should e verified y
reference to the cash disursements and cash receipts records.
/he date of the recording of the disursements and receipts for each transfer
must e in the same fiscal year.
Eisursements on the ank transfer schedule should e correctly included in
or e-cluded from year-end ank reconciliations as outstanding checks.
Receipts on the ank transfer schedule should e correctly included in or
e-cluded from year-end ank reconciliations as deposits in transit.
8!.
challenging
?-plain the purpose of testing the clientAs ank reconciliation, and discuss the ma@or audit
procedures involved.
)ns#er:
/he purpose of testing the clientRs reconciliation is to verify #hether the clientRs recorded ank
alance is the same amount as the actual cash in the ank. *rocedures include:
Ierify that the clientAs ank reconciliation is mathematically accurate.
/race the alance on the cutoff statement to the alance per ank on the ank
reconciliation.
/race checks included #ith the cutoff ank statement to the list of outstanding
checks on the ank reconciliation and to the cash disursements records.
"nvestigate all significant checks included on the outstanding checks list that
have not cleared the ank as of the cutoff statement.
/race deposits in transit to the suse'uent ank statement.
)ccount for other reconciling items on the ank statement and ank
reconciliation.
8(.
challenging
0Bailure to ill a customer1 is an e-ample of an error that results in the failure to receive cash,
ut #ould not e discovered as part of the audit of the ank reconciliation. 3tate three other
e-amples of errors or irregularities that result in the improper payment of, or failure to receive,
cash, ut that #ould not e discovered during the audit of the ank reconciliation. Ho# are
these types of misstatements normally uncovered in the audit$
)ns#er:
7illing a customer at a lo#er price than called for y company policy.
) defalcation of cash y interception of cash receipts from customers efore
they are recordedP the account is charged off as a ad det.
Euplicate payment of a vendorAs invoice.
"mproper payments of officersA personal e-penditures.
*ayment for ra# materials that #ere not received.
*ayment to an employee for more hours than he or she #orked.
*ayment of interest to a related party for an amount in e-cess of the going
rate.
"f these misstatements are to e uncovered in the audit, their discovery must come aout
through tests of controls and sustantive tests of transactions.
Arens/Elder/Beasley
8..
challenging
Many auditors prove the suse'uent period ank statement if a cutoff statement is not received
directly from the ank. Eiscuss the purpose of proving the suse'uent period statement, and
e-plain the audit procedures performed during the proof.
)ns#er:
/he purpose of such a proof is to test #hether the clientAs employees have omitted, added,
or altered any of the documents accompanying the cutoff statement received from the
client. /he audit procedures include footing all the canceled checks, deit memos,
deposits, and credit memosP checking to see that the ank statement alances #hen the
footed totals are usedP and revie#ing the items included in the footings to make sure that
they #ere canceled y the ank in the proper period and do not include any erasures or
alterations.
4ther 4@ective )ns#er Bormat Questions
82.
medium
Match si- of the terms +a-k, #ith the descriptionsKdefinitions provided elo# +1-8,:
a. 7ank reconciliation
. 7ranch cash account
c. Cash e'uivalents
d. Cutoff ank statement
e. %eneral cash account
f. "mprest payroll account
g. "mprest petty cash fund
h. Fiting
i. *roof of cash
@. 3tandard ank confirmation form
k. &apping
g 1. ) fund of cash maintained #ithin the company for small cash ac'uisitions ,
e-penses, or to cash employeesA checks.
@ !. ) form approved y the )"C*) and )merican 7ankersA )ssociation through
#hich the ank responds to the auditor aout ank alance and loan information.
c (. ?-cess cash invested in short-term, highly li'uid investments such as time
deposits, certificates of deposit, and money market funds.
e .. /he primary ank account for most organizations.
h 2. /he transfer of money from one ank account to another and improperly
recording the transfer so that the amount is recorded as an asset in oth
accounts.
a 8. /he document usually prepared y client personnel of the differences et#een
the cash alance recorded in the general ledger and the amount in the ank
account.
88.
easy

/he most important control for petty cash is that t#o individuals maintain @oint custody of the
asset.
a. /rue
. Balse
Arens/Elder/Beasley
8;.
easy

Chile petty cash is often immaterial in amount, the auditor verifies the account primarily
ecause it is easy to do so.
a. /rue
. Balse
8<.
easy
a
"f internal controls over cash-related transactions are ade'uate, the auditor is @ustified in
reducing the audit tests for the year-end ank reconciliation.
a. /rue
. Balse
8=.
easy
a
) proof of cash involves a comination of sustantive tests of transactions and tests of details of
alances.
a. /rue
. Balse
;:.
easy

) proof of cash includes a reconciliation of cash receipts deposited in the ank #ith the cash
disursements records for a given period.
a. /rue
. Balse
;1.
easy

Many of the auditorAs audit procedures in the audit of cash center around the clientAs ank
confirmations.
a. /rue
. Balse
;!.
easy

/ests of the payroll ank reconciliation usually re'uire considerale time if there is an imprest
payroll account in use.
a. /rue
. Balse
;(.
easy
a
/he transfer of money from one ank account to another and improperly recording the transfer
so that the amount is recorded as an asset in oth accounts is referred to as kiting.
a. /rue
. Balse
;..
easy
a
/racing outstanding checks to suse'uent period ank statements tests the cutoff audit
o@ective.
a. /rue
. Balse
;2.
medium

/ests for kiting are performed using only a schedule of intraank transfers.
a. /rue
. Balse
;8.
medium
a
Chen auditing the year-end cash alance, one of the areas of focus is on the accuracy o@ective.
a. /rue
. Balse
;;.
medium

4ne disadvantage of using an imprest ank account is the increased time needed to reconcile
ank accounts.
a. /rue
. Balse
Arens/Elder/Beasley
;<.
medium
a
/he auditor must e-tend the audit procedures in the audit of year-end cash #hen there are
inade'uate internal controls.
a. /rue
. Balse
;=.
medium

/he three most important audit o@ectives for cash are accuracy, e-istence, and classification.
a. /rue
. Balse
<:.
medium

"t is acceptale for petty cash funds to e mingled #ith other receipts if circumstances re'uire it.
a. /rue
. Balse
<1.
medium

Chen auditing the general cash account, receipt of a standard ank confirmation satisfies the
completeness o@ective for unrecorded ank alances and loans from the ank.
a. /rue
. Balse
<!.
medium

/o test the clientAs list of outstanding checks on the ank reconciliation for completeness, the
auditor should trace from the list to the checks included #ith the cutoff ank statement.
a. /rue
. Balse
<(.
medium

/he client may mail the ank confirmation re'uests if the auditor elieves doing so #ill increase
the likelihood that the confirmation #ill e returned promptly.
a. /rue
. Balse
<..
medium
a
) proof of cash helps the auditor determine #hether all recorded cash receipts #ere deposited in
the ank and #hether all recorded cash disursements #ere paid y the ank.
a. /rue
. Balse
<2.
medium
a
Chen the amount in the petty cash account is immaterial, most auditors #ould choose to test the
account for reasons of client e-pectations.
a. /rue
. Balse
<8.
medium
a
Chen auditing petty cash, the emphasis should e on testing controls over petty cash
transactions rather than the ending alance in the account.
a. /rue
. Balse
<;.
medium

)udit tests of the petty cash fund are typically performed on the alance sheet date.
a. /rue
. Balse
<<.
medium

)uditors usually design ank confirmations that address the clientAs specific circumstances.
a. /rue
. Balse
<=.
medium
a
4rdinarily, all deposits-in-transit listed on the year-end ank reconciliation should appear as
deposits on the cutoff ank statement.
a. /rue
. Balse
Arens/Elder/Beasley
=:.
challenging
a
)uditors are not al#ays re'uired to otain ank confirmations.
a. /rue
. Balse
=1.
challenging

?-amples of cash e'uivalents include time deposits, certificates of deposit, and marketale
securities.
a. /rue
. Balse
=!.
challenging
a
) proof of cash receipts is not useful for uncovering the theft of cash receipts or the recording
and deposit of an improper amount of cash.
a. /rue
. Balse
=(.
challenging
a
) proof of cash disursements is not effective for discovering checks #ritten for an improper
amount, fraudulent checks, or misstatements in #hich the dollar amount appearing in the cash
disursements records is incorrect.
a. /rue
. Balse
=..
challenging

"f an unusually large portion of the checks listed as outstanding on the year-end ank
reconciliation have not cleared the ank y the cutoff date, one possile cause could e that
kiting is occurring.
a. /rue
. Balse
Chapter 24
Multiple-Choice Questions
1.
easy
d
Chich of the follo#ing is not a condition for a contingent liaility to e-ist$
a. /here is a potential future payment to an outside party that #ould result from a current
condition.
. /here is uncertainty aout the amount of the future payment.
c. /he outcome of an uncertainty #ill e resolved y some future event.
d. /he amount of the future payment is reasonaly estimale.
!.
easy
d
)uditors often integrate procedures for presentation and disclosure o@ectives #ith:
/ests for planning o@ectives /ests for alance-related o@ectives
a. Jes Jes
. Do Do
c. Jes Do
d. Do Jes
(.
easy

"f a potential loss on a contingent liaility is remote, the liaility usually is:
a. disclosed in footnotes, ut not accrued.
. neither accrued nor disclosed in footnotes.
c. accrued and indicated in the ody of the financial statements.
d. disclosed in the auditorAs report ut not disclosed on the financial statements.
.. Chich of the follo#ing is an incorrect comination of the 0likelihood of occurrence1 and
Arens/Elder/Beasley
easy
c
financial statement treatment$
a. Remote: no disclosure.
. *roale +amount is estimale,: financial statements are ad@usted.
c. Reasonaly possile +amount is estimale,: financial statements are ad@usted.
d. *roale +amount is not estimale,: footnote disclosure is re'uired.
2.
easy
c
4ne of the auditorAs primary concerns relative to presentation and disclosure-related o@ectives
is:
a. accuracy.
. e-istence.
c. completeness.
d. occurrence.
8.
easy
d
)t the completion of the audit, management is asked to make a #ritten statement that it is not
a#are of any undisclosed contingent liailities. /his statement #ould appear in the:
a. management letter.
. letter of in'uiry.
c. letters testamentary.
d. letter of representation.
;.
easy
c
/he responsiility for identifying and deciding the appropriate accounting treatment for
contingent liailities rests #ith a companyAs 66666.
a. auditors.
. legal counsel.
c. management.
d. management and the auditors.
<.
easy
c
3B)3 2 descries 66666 levels of likelihood of occurrence.
a. one
. t#o
c. three
d. four
=.
easy
d
/he auditor has a responsiility to revie# transactions and activities occurring after the year-end
to determine #hether anything occurred that might affect the statements eing audited. /he
procedures re'uired to verify these transactions are commonly referred to as the revie# for:
a. contingent liailities.
. suse'uent yearAs transactions.
c. late unusual occurrences.
d. suse'uent events.
1:.
easy
a
Chich of the follo#ing is not a contingent liaility #ith #hich an auditor is particularly
concerned$
Dotes receivale discounted *roduct #arranties
a. Jes Jes
. Do Do
c. Jes Do
d. Do Jes
11.
easy
d
)udit procedures related to contingent liailities are initially focused on:
a. accuracy.
. completeness.
c. e-istence.
d. occurrence.
1!. Chich type of suse'uent event re'uires consideration y management and evaluation y the
Arens/Elder/Beasley
easy auditor$
a 3use'uent events that have a direct
effect on the financial statements and
re'uire ad@ustment.
3use'uent events that have no direct
effect on the financial statements ut for
#hich disclosure is considered.
a. Jes Jes
. Do Do
c. Jes Do
d. Do Jes
1(.
easy

Chenever suse'uent events are used to evaluate the amounts included in the statements, care
must e taken to distinguish et#een conditions that e-isted at the alance sheet date and those
that come into eing after the end of the year. /he suse'uent information should not e
incorporated directly into the statements if the conditions causing the change in valuation:
a. took place efore year-end.
. did not take place until after year-end.
c. occurred oth efore and after year-end.
d. are reimursale through insurance policies.
1..
easy

)uditors #ill generally send a standard in'uiry letter to:

a. only those attorneys #ho have devoted sustantial time to client matters during the year.
. every attorney that the client has een involved #ith in the current or preceding year, plus
any attorney the client engages on occasion.
c. those attorneys #hom the client relies on for advice related to sustantial legal matters.
d. only the attorney #ho represent the client in proceeding #here the client is defendant.
12.
easy
Cho may identify matters to e included in a letter of in'uiry sent to a clientAs legal counsel$
a )uditors. Company management.
a. Jes Jes
. Do Do
c. Jes Do
d. Do Jes
18.
easy
d
Chich of the follo#ing is not one of the three main reasons #hy it is essential that audit files e
thoroughly revie#ed y another memer of the audit firm at the completion of the audit$
a. /o evaluate the performance of ine-perienced personnel.
. /o counteract the ias that fre'uently enters into the auditorAs @udgment.
c. /o make sure that the audit meets the C*) firmAs standard of performance.
d. /o evaluate the accuracy of the auditing firmAs time udget for the engagement.
1;.
easy

Chich of the follo#ing suse'uent events is most likely to result in an ad@ustment to a

companyAs financial statements$
a. Merger or ac'uisition activities.
. 7ankruptcy +due to deteriorating financial condition, of a customer #ith an outstanding
accounts receivale alance.
c. "ssuance of common stock.
d. )n uninsured loss of inventories due to a fire.
1<.
easy
c
Cith #hich of the follo#ing client personnel #ould it generally not e appropriate to in'uire
aout commitments or contingent liailities$
a. Controller.
. *resident.
c. )ccounts receivale clerk.
d. Iice president of sales.
1=. )t #hat stages of the audit must analytical procedures e used$
Arens/Elder/Beasley
easy
c
a. *lanning and testing.
. /esting and completion.
c. *lanning and completion.
d. *lanning, testing, and completion.
!:.
medium
Chich of the follo#ing procedures and methods are important in assessing a companyAs aility
to continue as a going concern$
c Eiscussions #ith management regarding
future plans related to sales activities,
cost controls, and marketing efforts.
Revie#ing 'uarter on the internal control
'uestionnaire specifically asking the
client to evaluate the aility to continue.
a. Jes Jes
. Do Do
c. Jes Do
d. Do Jes
!1.
medium
"n'uiries of management regarding the possiility of unrecorded contingencies #ill e useful in
uncovering:
ManagementAs intentional failure to
disclose e-isting contingencies.
Chen management does not comprehend
accounting disclosure re'uirements.
a. Jes Jes
. Do Do
c. Jes Do
d. Do Jes
!!.
medium

Chich of the follo#ing procedures might e useful in discovering a contingent liaility for a
la#suit that management is intentionally neglecting to disclose$
a. "n'uiries +orally and in #riting, of management.
. )nalyzing legal e-pense and revie# invoices and statements from outside legal counsel.
c. Revie#ing current and previous yearsA internal revenue agent reports.
d. 4taining a letter of representation from management that it is a#are of no undisclosed
contingent liailities.
!(.
medium
d
Commitments include all ut #hich of the follo#ing$
a. )greements to purchase ra# materials.
. *ension plans.
c. )greements to lease facilities at set prices.
d. ?ach of the aove is a commitment.
!..
medium
d
/he standard letter of in'uiry to the clientAs legal counsel should e prepared on:
a. plain paper +no letterhead, and e unsigned.
. la#yerAs stationery and signed y the la#yer.
c. auditorAs stationery and signed y an audit partner.
d. clientAs stationery and signed y a company official.
!2.
medium
d
Chich of the follo#ing items #ould ordinarily not e included in the standard letter of in'uiry
to the clientAs attorney$
a. ) list, prepared y management, of pending threatened litigation of material amounts.
. ) re'uest that the attorney furnish information or comment aout the likelihood of an
unfavorale outcome of litigation.
c. ) re'uest that the attorney furnish an estimate of the amount or range of the potential
loss.
d. ) re'uest that the attorney confirm the amount of outstanding fees #hich client o#es for
legal services.
!8. /he letter of representation otained from an audit client should e:
Arens/Elder/Beasley
medium

a. dated as of the end of the period under audit.

. dated as of the audit report date.
c. dated as of any date decided upon y the client and auditor.
d. dated as of the issuance of the financial statement.
!;.
medium
c
Chen should auditors generally assess a clientAs aility to continue as a going concern$
a. >pon completion of the audit.
. Euring the planning stages of the audit.
c. /hroughout the entire audit process.
d. Euring testing and completion phases of the audit.
!<.
medium
c
/he audit procedures for the suse'uent events revie# can e divided into t#o categories: +1,
procedures integrated as a part of the verification of year-end account alances, and +!, those
performed specifically for the purpose of discovering suse'uent events. Chich of the
follo#ing procedures is in category 1$
a. "n'uiries of client regarding contingent liailities.
. 4tain a letter of representation #ritten y client.
c. 3use'uent period sales and purchases transactions are e-amined to determine #hether
the cutoff is accurate.
d. Revie# @ournals and ledgers of year ! to determine the e-istence of any transaction
related to year 1.
!=.
medium
a
/he audit procedures for the suse'uent events revie# can e divided into t#o categories: +1,
procedures normally integrated as a part of the verification of year-end account alances, and
+!, those performed specifically for the purpose of discovering suse'uent events. Chich of the
follo#ing procedures is in category !$
a. Correspond #ith attorneys.
. /est the collectaility of accounts receivale y revie#ing suse'uent period cash
receipts.
c. 3use'uent period sales and purchases transactions are e-amined to determine #hether
the cutoff is accurate.
d. Compare the suse'uent-period purchase price of inventory #ith the recorded cost as a
test of lo#er-of-cost-or-market valuation.
(:.
medium
d
Chich of the follo#ing is not a matter that is typically included in the letter of representation
otained from an audit client$
a. )vailaility of all financial records and related data.
. )sence of unrecorded transactions.
c. Compliance #ith aspects of contractual agreements that may affect the financial
statements.
d. )ssessment of managementAs efficiency of decision making.
(1.
medium
c
3)3 Do. 2= re'uires the auditor to evaluate #hether there is a sustantial dout aout a clientAs
aility to continue as a going concern for at least:
a. one 'uarter eyond the alance sheet date.
. one 'uarter eyond the date of the auditorAs report.
c. one year eyond the alance sheet date.
d. one year eyond the date of the auditorAs report.
(!.
medium
a
3)3 Do. 2= re'uires auditors to evaluate #hether there is a sustantial dout aout a clientAs
aility to continue as a going concern. 4ne of the most important types of evidence to assess the
going concern 'uestion is:
a. analytical procedures.
. confirmations of creditors.
c. statistical sampling procedures.
d. in'uiries of client and its legal counsel.
Arens/Elder/Beasley
((.
medium
d
Chich of the follo#ing statements regarding the letter of representation is not correct$
a. "t is prepared on the clientAs letterhead.
. "t is addressed to the C*) firm.
c. "t is signed y high-level corporate officials, usually the president and chief financial
officer.
d. "t is optional, not re'uired, that the auditor otain such a letter from management.
(..
medium
"f an auditor concludes there are contingent liailities, then he or she must evaluate the:
a
Materiality of the potential liaility.
Dature of the disclosure to e included in
the financial statements.
a. Jes Jes
. Do Do
c. Jes Do
d. Do Jes
(2.
medium
a
Refusal y a client to prepare and sign the representation letter #ould re'uire a+n,:
a. 'ualified opinion or a disclaimer.
. adverse opinion or a disclaimer.
c. 'ualified or an adverse opinion.
d. un'ualified opinion #ith an e-planatory paragraph.
(8.
medium
c
) client representation letter is:
a. prepared on the C*)As letterhead.
. addressed to the client.
c. signed y high-level officials +e.g. the president and chief financial officer,.
d. dated as of the clientAs year-end.
(;.
medium
a
Chich of the follo#ing is not a purpose of the client letter of representation$
a. /o impress upon the audit firm its responsiility for the audit.
. /o impress upon management its responsiility for the financial statement assertions.
c. /o remind management of potential misstatements or omissions in the financial
statements.
d. /o document the responses from management to in'uiries aout various aspects of the
audit.
(<.
medium
d
Chich of the follo#ing is not one of the categories of items included in the client letter of
representation$
a. 3use'uent events
. Completeness of information
c. Recognition, measurement, and disclosure
d. Materiality
(=.
medium
d
3)3 Do. == and 3)3 Do. 2. re'uire the auditor to communicate all management frauds and
illegal acts to the audit committee:
a. only if the act is immaterial.
. only if the act is material.
c. only if the act is highly material.
d. regardless of materiality.
.:.
medium
c
/he auditor is responsile for communicating significant internal control deficiencies to the
audit committee, or those charged #ith governance. /his communication:
a. may e oral or #ritten.
. must e oral.
c. must e #ritten.
d. must e oral via direct communication.
Arens/Elder/Beasley
.1.
medium
a
Chich of the follo#ing audit procedures #ould most likely assist an auditor in identifying
conditions and events that may indicate there could e sustantial dout aout an entityAs aility
to continue as a going concern$
a. Revie# compliance #ith the terms of det agreements.
. Confirmation of accounts receivale from principal customers.
c. Reconciliation of interest e-pense #ith det outstanding.
d. Confirmation of ank alances.
.!.
medium
c
Chich of the follo#ing statements is correct$
a. ) letter of representation is documentation of managementAs acceptance of responsiility
for the financial statements and is deemed to e reliale evidence.
. ) letter of representation is not deemed to e reliale evidence ecause of the potential
incompetence of management.
c. ) letter of representation is not deemed to e reliale evidence ecause of the lack of
independence of the preparers.
d. ) letter of representation is documentation of the C*)As acceptance of responsiility for
the audit of the financial statement and is deemed to e reliale.
.(.
medium
a
Chen a client #ill not permit in'uiry of outside legal counsel, the audit report #ill ordinarily
contain a+n,:
a. disclaimer of opinion.
. 'ualified opinion.
c. standard un'ualified opinion.
d. un'ualified opinion #ith a separate e-planatory paragraph.
...
medium
d
Chich of the follo#ing #ould e a suse'uent discovery of facts #hich #ould not re'uire a
response y the auditor$
a. Eiscovery of the inclusion of material none-istent sales.
. Eiscovery of the failure to #rite off material osolete inventory.
c. Eiscovery of the omission of a material footnote.
d. Eecrease in the value of investments.
.2.
medium
c
Chich of the follo#ing auditing procedures is ordinarily performed last$
a. Reading minutes of the oard of directorsA meetings.
. Confirming accounts payale.
c. 4taining a client representation letter.
d. /esting the purchasing function.
.8.
medium
d
Chich of the follo#ing is the most efficient audit procedure for the detection of unrecorded
liailities at the alance sheet date$
a. 4tain an attorneyAs letter from the clientAs attorney.
. Confirm large accounts payale alances at the alance sheet date.
c. ?-amine purchase orders issued for several days prior to the close of the year.
d. Compare cash disursements in the suse'uent period #ith the accounts payale trial
alance at year-end.
.;.
medium
c
)s part of an audit, a C*) often re'uests a representation letter from the client. Chich one of
the follo#ing is not a valid purpose of such a letter$
a. /o provide audit evidence.
. /o emphasize to the client the clientAs responsiility for the correctness of the financial
statements.
c. /o satisfy the C*) y means of other auditing procedures #hen certain customary
auditing procedures are not performed.
d. /o provide possile protection to the C*) against a charge of kno#ledge in cases #here
fraud is suse'uently discovered to have e-isted in the accounts.
.<. "n connection #ith the annual audit, #hich of the follo#ing is not a 0suse'uent events1
Arens/Elder/Beasley
medium
a
procedure$
a. Revie# availale interim financial statements.
. Read availale minutes of meetings of stockholders, directors, and committees and, for
meetings #here minutes are not availale, in'uire aout matters dealt #ith at such
meetings.
c. Make in'uiries #ith respect to the financial statements covered y the auditorAs
previously issued report if ne# information has ecome availale during the current
e-amination that might affect that report.
d. Eiscuss #ith officers the current status of items in the financial statements that #ere
accounted for on the asis of tentative, preliminary, or inconclusive data.
.=.
medium
a
)n auditor performs interim #ork at various times throughout the year. /he auditorAs
suse'uent events #ork should e e-tended to the date of:
a. the auditorAs report.
. a post-dated footnote.
c. the ne-t scheduled interim visit.
d. the final illing for audit services rendered.
2:.
medium
c
Chich event that occurred after the end of the fiscal year under audit ut prior to issuance of the
auditorAs report #ould not re'uire disclosure in the financial statements$
a. 3ale of a ond or capital stock issue.
. &oss of plant or inventories as a result of fire or flood.
c. ) significant decline in the market price of the corporationAs stock.
d. 3ettlement of litigation #hen the event giving rise to the claim took place after the
alance sheet date.
21.
medium
c
Chich of the follo#ing determines the sufficiency of evidence$
a. %enerally )ccepted )uditing 3tandards.
. 3ecurities and ?-change Commission regulations.
c. )uditor @udgment.
d. )dherence to the audit program.
2!.
medium
c
Chich of the follo#ing material events occurring suse'uent to the alance sheet date #ould
re'uire an ad@ustment to the financial statements efore they could e issued$
a. &oss of a plant as a result of a flood.
. 3ale of long-term det or capital stock.
c. 3ettlement of litigation in e-cess of the recorded liaility.
d. Ma@or purchase of a usiness that is e-pected to doule the sales volume.
2(.
medium
c
Chile there is no professional re'uirement to do so on audit engagements, C*)s fre'uently
issue a formal 0management1 letter to clients. /he primary purpose of this letter is to provide:
a. evidence indicating #hether the auditor is reasonaly certain that internal accounting
control is operating as prescried.
. a permanent record of the internal accounting control #ork performed y the auditor
during the course of the engagement.
c. a #ritten record of discussions et#een auditor and client concerning the auditorAs
oservations and suggestions for improvements.
d. a summary of the auditorAs oservations that resulted from the auditorAs special study of
internal control.
2..
challenging
"f the auditor determines that a suse'uent event that affects the current period financial
statements occurred after field#ork #as completed ut efore the audit report #as issued, #hat
date+s, may the auditor use on the report$
/he date of the
original last day of
field#ork only.
/he date of the
suse'uent
event only.
/he date on #hich the last day of
field#ork occurred along #ith the date
of the suse'uent event.
Arens/Elder/Beasley
a. Jes Jes Do
. Jes Do Jes
c. Do Jes Do
d. Do Do Jes
22.
challenging
d
Chy must audit documentation e revie#ed$
a. /o ensure that the audit meets the C*) firmAs standard of performance.
. /o evaluate the performance of ine-perienced personnel.
c. /o counteract ias that often enters into the auditorAs @udgment.
d. )ll of the aove are reasons for revie# of audit documentation.
28.
challenging
d
"f the auditor concludes that there are contingent liailities, he or she must evaluate the
significance of the potential liaility and the nature of the disclosure needed in the financial
statements. Chich of the follo#ing statements is not true$
a. /he potential liaility is sufficiently #ell kno#n in some instances to e included in the
financial statements as an actual liaility.
. Eisclosure may e unnecessary if the contingency is highly remote or immaterial.
c. Bre'uently, the C*) firm otains a separate evaluation of the potential liaility from its
o#n legal counsel rather than relying on management or managementAs attorneys.
d. )ns#ers and c are correct, ut ans#er is not.
2;.
challenging
d
/he auditorAs responsiility for 0revie#ing the suse'uent events1 of a pulic company that is
aout to issue ne# securities is normally limited to the period of time:
a. eginning #ith the alance sheet date and ending #ith the date of the auditorAs report.
. eginning #ith the start of the fiscal year under audit and ending #ith the alance sheet
date.
c. eginning #ith the start of the fiscal year under audit and ending #ith the date of the
auditorAs report
d. eginning #ith the alance sheet date and ending #ith the date the registration statement
ecomes effective.
2<.
challenging

/he process of 0final evidence accumulation1 is al#ays done late in the engagement. Chich one
of the follo#ing #ould e done the earliest in the engagement$
a. Binal analytical procedures.
. 3earch for contingent liailities.
c. ?valuate the going concern assumption.
d. )c'uire the clientAs letter of representation.
2=.
challenging
d
Chich of the follo#ing is not a reason #hy the auditor re'uests that the client provide a letter of
representation$
a. *rofessional auditing standards re'uire the auditor to otain a letter of representation.
. "t impresses upon management its responsiility for the accuracy of the information in
the financial statements.
c. "t provides #ritten documentation of the oral responses already received to in'uiries of
management.
d. "t provides #ritten documentation, #hich is a higher 'uality of evidence than
managementAs oral responses to in'uiries.
8:.
challenging
a
Chich of the follo#ing is not re'uired to e communicated to the audit committee or similarly
designated ody under auditing standards$
a. )ll material frauds and illegal acts of a material nature.
. Eisagreements #ith management aout the scope of the audit, applicaility of accounting
principles, or #ording of the audit report.
c. Eifficulties encountered in performing the audit, such as lack of availaility of client
personnel and failure to provide necessary information.
d. )uditorAs responsiilities under generally accepted auditing standards, including
responsiility for evaluating internal control and the concept of reasonale rather than
Arens/Elder/Beasley
asolute assurance.
81.
challenging

) C*) has received an attorneyAs letter in #hich no significant disagreements #ith the clientAs
assessments of contingent liailities #ere noted. /he resignation of the clientAs la#yer shortly
after receipt of the letter should alert the auditor that:
a. an adverse opinion #ill e necessary.
. undisclosed unasserted claims may have arisen.
c. the auditor must egin a completely ne# e-amination of contingent liailities.
d. the attorney #as unale to form a conclusion #ith respect to the significance of litigation,
claims, and assessments.
8!.
challenging

Management furnishes the independent auditor #ith information concerning litigation, claims,
and assessments. Chich of the follo#ing is the auditorAs primary means of initiating action to
corroorate such information$
a. Re'uest that client la#yers undertake a reconsideration of matters of litigation, claims,
and assessments #ith #hich they #ere consulted during the period under e-amination.
. Re'uest that client management send a letter of in'uiry to those la#yers #ith #hom
management consulted concerning litigation, claims, and assessments.
c. Re'uest that client la#yers provide a legal opinion concerning the policies and
procedures adopted y management to identify, evaluate, and account for litigation,
claims, and assessments.
d. Re'uest that client management engage outside attorneys to suggest #ording for the te-t
of a footnote e-plaining the nature and proale outcome of e-isting litigation, claims,
and assessments.
8(.
challenging
d
)n attorney is responding to an independent auditor as a result of the clientAs letter of in'uiry.
/he attorney may appropriately limit the response to:
a. asserted claims and litigation.
. asserted, overtly threatened, or pending claims and litigation.
c. items #hich have an e-tremely high proaility of eing resolved to the clientAs
detriment.
d. matters to #hich the attorney has given sustantive attention in the form of legal
consultation or representation.
8..
challenging
a
) company guarantees the det of an affiliate. Chich of the follo#ing est descries the audit
procedure that #ould make the auditor a#are of the guarantee$
a. Revie# minutes and resolutions of the oard of directors.
. Revie# prior yearAs audit files #ith respect to such guarantees.
c. Revie# the possiility of such guarantees #ith the chief accountant.
d. Revie# the legal letter returned y the companyAs outside legal counsel.
82.
challenging

?lise-%reer, &&* is an affiliate of the audit client and is audited y another firm of auditors.
Chich of the follo#ing is most likely to e used y the auditor to otain assurance that all
guarantees of the affiliateAs indetedness have een detected$
a. 3end the standard ank confirmation re'uest to all of the clientAs lender anks.
. Revie# client minutes and otain a representation letter.
c. ?-amine supporting documents for all entries in intercompany accounts.
d. 4tain #ritten confirmation of indetedness from the auditor of the affiliate.
88.
challenging
c
)n auditor must otain #ritten client representations that might e signed y all ut #hich of
the follo#ing$
a. /reasurer
. Chief financial officer
c. Iice president of operations
d. Chief e-ecutive officer
8;.
challenging
)n auditor must otain #ritten client representations that normally should e signed y:
a. the treasurer and the internal auditor.
Arens/Elder/Beasley
c . the president and the chairperson of the oard.
c. the chief e-ecutive officer and the chief financial officer.
d. the corporate counsel and the audit committee chairperson.
8<.
challenging

3use'uent events affecting the realization of assets ordinarily #ill re'uire ad@ustments of the
financial statements under e-amination ecause such events typically represent the:
a. culmination of conditions that e-isted at the alance sheet date.
. discovery of ne# conditions occurring in the suse'uent events period.
c. final estimates of losses relating to casualties occurring in the suse'uent events period.
d. preliminary estimate of losses relating to ne# events that occurred suse'uent to the
alance sheet date.
8=.
challenging
a
)n auditorAs decision concerning #hether or not to 0dual date1 the audit report is ased upon
the auditorAs #illingness to:
a. e-tend auditing procedures and assume responsiility for a greater period of time.
. accept responsiility for suse'uent events.
c. permit inclusion of a footnote captioned: event +unaudited, suse'uent to the date of the
auditorAs report.
d. assume responsiility for events suse'uent to the issuance of the auditorAs report.
;:.
challenging
d
)fter an auditor has issued an audit report on a nonpulic entity, there is no oligation to make
any further audit tests or in'uiries #ith respect to the audited financial statements covered y
that report unless:
a. material adverse events occur after the date of the auditorAs report.
. final determination or resolution #as made of a contingency #hich had een disclosed in
the financial statements.
c. final determination or resolution #as made on matters #hich had resulted in a
'ualification in the auditorAs report.
d. ne# information comes to the auditorAs attention concerning an event that occurred prior
to the date of the auditorAs report that may have affected the auditorAs report.
;1.
challenging
c
) client has a calendar year-end. &isted elo# are four events that occurred after Eecemer (1.
Chich one of these suse'uent events might result in ad@ustment of the Eecemer (1 financial
statements$
a. 3ale of a ma@or susidiary.
. )doption of accelerated depreciation methods.
c. Crite-off of a sustantial portion of inventory as osolete.
d. Collection of =:T of the accounts receivale e-isting at Eecemer (1.
;!.
challenging

/he auditorAs responsiility #ith respect to events occurring et#een the alance sheet date and
the end of the audit e-amination is est e-pressed y #hich of the follo#ing statements$
a. /he auditor is fully responsile for events occurring in the suse'uent period and should
e-tend all detailed procedures through the last day of field#ork.
. /he auditor is responsile for determining that a proper cutoff has een made and
performing a general revie# of events occurring in the suse'uent period.
c. /he auditorAs responsiility is to determine that a proper cutoff has een made and that
transactions recorded on or efore the alance sheet date actually occurred.
d. /he auditor has no responsiility for events occurring in the suse'uent period unless
these events affect transactions recorded on or efore the alance sheet date.
?ssay Questions
;(.
easy
Eistinguish et#een contingent liailities and commitments.
)ns#er:
Contingent liailities are future oligations to an outside party for an unkno#n amount
Arens/Elder/Beasley
resulting from activities that have already taken place. Commitments are agreements to
commit the company to a set of fi-ed conditions in the future regardless of #hat happens
to profits or the economy as a #hole.
;..
easy
Eiscuss the purposes of performing analytical procedures during the audit completion phase.
)ns#er:
)nalytical procedures performed during the completion phase are useful as a final revie#
for material misstatements or financial prolems not noted during other testing, and to
help the auditor take a final o@ective look at the financial statements.
;2.
easy
Cith #hat types of contingencies might an auditor e concerned$
)ns#er:
/he auditor is generally concerned #ith contingencies arising from pending litigation for
patent infringement, income ta- disputes, product #arranties, notes receivale
discounted, guarantees of oligations of others, and unused alances of outstanding
letters of credit.
;8.
medium
Chat are the three re'uired conditions for a contingent liaility to e-ist$
)ns#er:
1. /here is potential for future payment to an outside party or the impairment of an asset
that resulted from an e-isting condition.
!. /here is uncertainty aout the amount of the future payment or impairment.
(. /he outcome #ill e resolved y some future event or events.
;;.
medium
&ist four contingent liailities that auditors are concerned aout in most instances.
)ns#er:
*ending litigation for patent infringement, product liaility or other actionsP income ta-
disputesP product #arrantiesP notes receivale discountedP guarantees of oligation of
othersP and unused alances of outstanding letters of credit.
;<.
medium
Characterize the auditorAs role in preparing the financial statements.
)ns#er:
/he auditor acts in the role of advisor #hen preparing the financial statements, ut
management retains the final and ultimate responsiility for approving the issuance of the
statements.
Arens/Elder/Beasley
;=.
medium
3tate the t#o primary types of suse'uent events that re'uire consideration y management and
evaluation y the auditor, and give t#o e-amples of each type.
)ns#er:
?vents that have a direct effect on the financial statements and re'uired
ad@ustment. ?-amples include declaration of ankruptcy y a customer #ith an
outstanding accounts receivale alance due to deteriorating financial conditionP
settlement of litigation at an amount different from the amount recorded on the ooks.
?vents that have no direct effect on the financial statements ut for #hich
disclosure is advisale. ?-amples include a decline in the market value of securities
held for temporary investment or resale during the suse'uent periodP issuance of
onds or e'uity securities during the suse'uent period.
<:.
medium
Eiscuss three audit procedures commonly used to search for contingent liailities.
)ns#er:
"n'uire of management +orally and in #riting, aout the possiility of
unrecorded contingencies.
Revie# current and previous yearsA internal revenue agent reports for income
ta- settlements.
Revie# the minutes of directorsA and stockholdersA meetings for indications
of la#suits or other contingencies.
)nalyze legal e-pense for the period under audit, and revie# invoices and
statements from legal counsel for indications of contingent liailities.
4tain a letter from each ma@or attorney performing legal services for the
client as to the status of pending litigation or other contingent liailities.
Revie# audit files for any information that may indicate a potential
contingency.
?-amine letters of credit in force as of the alance sheet date and otain a
confirmation of the used and unused alance.
<1. +345,
medium
Eiscuss the three matters #hich 3aranes-4-ley re'uires auditors of pulic companies to report
to the audit committee.
)ns#er:
/he three items that must e reported to the audit committee are:
)ll critical accounting policies and practices to e used.
)ll alternative treatments of financial information #ithin generally accepted accounting
principles that have een discussed #ith management, ramifications of the use of such
alternative disclosures and treatments, and the treatment preferred y the auditor, and
4ther material #ritten communications et#een the auditor and management, such as any
management letter or schedule of unad@usted differences.
<!.
medium
3tate the three purposes of the client letter of representation.
)ns#er:
/o impress upon management its responsiility for the assertions in the
financial statements.
/o remind management of potential misstatements or omissions in the
financial statements.
/o document the responses from management to in'uiries aout various
Arens/Elder/Beasley
aspects of the audit.
<(.
medium
&ist four specific matters that should e included in a client representation letter.
)ns#er:
ManagementAs ackno#ledgment of its responsiility for the fair presentation
in the statements of financial position, results of operations, and cash flo#s in
conformity #ith generally accepted accounting principles or other comprehensive
asis of accounting.
)vailaility of all financial records and related data.
Completeness and availaility of all minutes of meetings of stockholders,
directors, and committees of directors.
"nformation concerning related-party transactions and related amounts
receivale or payale.
*lans or intentions that may affect the carrying value or classification of
assets or liailities.
Eisclosure of compensating alances or other arrangements involving
restrictions on cash alances, and disclosure of line-of-credit or similar arrangements.
<.. +*ulic,
medium
*rovide several representations that auditors of pulic companies may seek from management
regarding internal control.
)ns#er:
*ossile representations include:
ManagementAs ackno#ledgement of its responsiilities for estalishing and
maintaining effective internal control over financial reporting.
ManagementAs conclusion aout the effectiveness of internal control over
financial reporting as of the end of the fiscal period.
Eisclosure to the auditor of all deficiencies in the design or operation of
internal control over financial reporting.
ManagementAs kno#ledge of any material fraud or other fraud involving
senior management or other employees #ho have a significant role in the companyAs
internal control over financial reporting.
<2.
challenging
3tate three lists or re'uests that should e included in a standard 0in'uiry of attorney1 letter.
)ns#er:
) list, prepared y management, of +1, pending threatened litigation and +!,
asserted or unasserted claims or assessments #ith #hich the attorney has had
significant involvement. )n alternative is for the letter to re'uest the attorney to
prepare the list.
) re'uest that the attorney furnish information or comment aout the progress
of each item listed, the legal action the client intends to take, the likelihood of an
unfavorale outcome, and an estimate of the amount or range of the potential loss.
) re'uest for the identification of any unlisted pending or threatened legal
actions or a statement that the clientAs list is complete.
) statement y the client informing the attorney of his or her responsiility to
inform management #henever in the attorneyAs @udgment there is a legal matter
re'uiring disclosure in the financial statements. /he letter of in'uiry should also
re'uest the attorney to respond directly to the auditor that he or she understands this
responsiility.
) re'uest that the attorney identifies and descries the nature of any reasons
for any limitations in the response.
Arens/Elder/Beasley
<8.
challenging
7esides the search for contingent liailities and the revie# for suse'uent events, the auditor
has four important final evidence accumulation responsiilities, all of #hich are re'uired y
current professional auditing standards. Eiscuss each of these four responsiilities.
)ns#er:
Binal analytical procedures performed as a final revie# for material
misstatements or financial prolems and to help the auditor take a final o@ective look
at the financial statements.
?valuate the going concern assumption.
4tain a client representation letter documenting managementAs most
important oral representations during the audit.
Read information included in pulished annual reports pertaining directly to
the financial statements.
4ther 4@ective )ns#er Bormat Questions
<;.
medium
/he field#ork for the Eecemer (1, !::; audit of 3chmidt Corporation ended on March 1;,
!::<. /he financial statements and auditorAs report #ere issued and mailed to stockholders on
March !=, !::<. "n each of the material situations +1 through 2, elo#, indicate the appropriate
action +a, , c, d, or e,. /he possile actions are as follo#s:
a. )d@ust the Eecemer (1, !::; financial statements.
. Eisclose the information in a footnote in the Eecemer (1, !::; financial statements.
c. Re'uest the client revise and reissue the Eecemer (1, !::; financial statements. /he
revision should involve an ad@ustment to the Eecemer (1, !::; financial statements.
d. Re'uest the client revise and reissue the Eecemer (1, !::; financial statements. /he
revision should involve the addition of a footnote, ut no ad@ustment, to the Eecemer (1,
!::; financial statements.
e. Do action is re'uired.
/he situations are as follo#s:
d 1. 4n )pril 2, !::<, you discovered that, on Beruary 18, !::<, a flood destroyed
the entire uninsured inventory in one of 3chmidtAs #arehouses.
!. 4n Beruary 1;, !::<, you discovered that, on Beruary 18, !::<, a flood
destroyed the entire uninsured inventory in one of 3chmidtAs #arehouses.
a (. 4n Beruary 1;, !::<, you discovered that, on Dovemer (:, !::;, a flood
destroyed the entire uninsured inventory in one of 3chmidtAs #arehouses.
e .. 4n )pril 2, !::<, you discovered that, on March (:, !::<, a fire destroyed one
of 3chmidtAs 1( plants.
c 2. 4n )pril ;, !::<, you discovered that a detor of 3chmidt #ent ankrupt on
Lanuary 8, !::<, due to gradual declining financial health.
Arens/Elder/Beasley
<<.
challenging
/he field#ork for the Eecemer (1, !::; audit of /rile Corporation ended on March 1;,
!::<. /he financial statements and auditorAs report #ere issued and mailed to stockholders on
March !=, !::<. "n each of the material situations +1 through 2, elo#, indicate the appropriate
action +a, , c, d, or e,. /he possile actions are as follo#s:
a. )d@ust the Eecemer (1, !::; financial statements.
. Eisclose the information in a footnote in the Eecemer (1, !::; financial statements.
c. Re'uest the client revise and reissue the Eecemer (1, !::; financial statements. /he
revision should involve an ad@ustment to the Eecemer (1, !::; financial statements.
d. Re'uest the client revise and reissue the Eecemer (1, !::; financial statements. /he
revision should involve the addition of a footnote, ut no ad@ustment, to the Eecemer (1,
!::; financial statements.
e. Do action is re'uired.
/he situations are as follo#s:
1. 4n Lanuary 18, !::<, a la#suit #as filed against /rile for a patent infringement
action that allegedly took place in early !::2. "n the opinion of /rileAs
attorneys, there is a reasonale +ut not proale, danger of a significant loss to
/rile.
a !. 4n Beruary 1=, !::<, /rile settled a la#suit out of court that had originated in
!::! and is currently listed as a contingent liaility.
e (. 4n March (:, !::<, /rile settled a la#suit out of court that had originated in
!::. and is currently listed as a contingent liaility.
.. 4n Beruary !, !::<, you discovered an uninsured la#suit against /rile that
had originated on )ugust (:, !::;.
d 2. 4n )pril ;, !::<, you discovered that a detor of /rile #ent ankrupt on
Lanuary !!, !::<, due to a ma@or uninsured fire that occurred on Lanuary !, !::<.
Arens/Elder/Beasley
<=.
medium
Match seven of the terms +a-p, #ith the descriptionKdefinitions provided elo# +1-;,:
a. Commitments
. Completing the engagement checklist
c. Contingent liaility
d. Eual-dated audit report
e. Binancial statement disclosure checklist
f. "ndependent revie#
g. "n'uiry of clientAs attorneys
h. &etter of representation
i. 4ther information in annual reports
@. Revie# for suse'uent events
k. 3use'uent events
l. >nad@usted misstatement #orksheet
m. Management letter
n. *ending claim
o. >nasserted claim
p. )udit documentation revie#
f 1. ) revie# of the financial statements and the entire set of audit files y an
independent revie#er to #hom the audit team must @ustify the evidence
accumulated and the conclusions reached.
c !. ) potential future oligation to an outside party for an unkno#n amount
resulting from activities that have already taken place.
h (. ) #ritten communication from the client to the auditor formalizing statements
that the client has made aout matters pertinent to the audit.
o .. ) potential legal claim against a client #here the condition for a claim e-ists ut
no claim has een filed.
k 2. /ransactions that occurred after the alance sheet date, #hich affect the fair
presentation or disclosure of the statements eing audited.
a 8. )greements that the entity #ill hold to a fi-ed set of conditions, such as the
purchase or sale of merchandise at a stated price.
d ;. /he use of one audit report date for normal suse'uent events and a later date
for one or more suse'uent events.
=:.
easy

)n independent revie# must e performed of all audits.

a. /rue
. Balse
=1.
easy
a
) la#suit has een filed against your client. "f, in the opinion of legal counsel, the likelihood
your client #ill lose the la#suit is remote, no financial statement accrual or disclosure of the
potential loss is re'uired.
a. /rue
. Balse
=!.
easy
a
Current professional auditing standards re'uire the performance of analytical procedures during
the planning and completion phases of the audit.
a. /rue
. Balse
Arens/Elder/Beasley
=(.
easy

Current professional auditing standards re'uire the performance of analytical procedures during
the testing phase of the audit.
a. /rue
. Balse
=..
easy
a
"f an auditor discovers that previously issued financial statements are misleading, the most
desirale approach to follo# is to re'uest that the client issue an immediate revision of the
financial statements containing an e-planation of the reasons for the revision.
a. /rue
. Balse
=2.
easy
a
/he issuance of onds y the client suse'uent to year-end #ould re'uire a footnote disclosure
in, ut no ad@ustment to, the financial statements under audit.
a. /rue
. Balse
=8.
medium
a
3)3 2= directs the auditorAs assessment of going-concern issues.
a. /rue
. Balse
=;.
medium

)uditors are not re'uired to evaluate the going concern assumption as part of each audit.
a. /rue
. Balse
=<.
medium
a
)lthough the letter of representation is typed on the clientAs letterhead and signed y the client,
it is common for the auditor to prepare the letter.
a. /rue
. Balse
==. +*ulic,
medium
a
)uditors of pulic companies must otain certain representations from management regarding
internal control over financial reporting.
a. /rue
. Balse
1::.
medium
a
Current professional auditing standards make it clear that management, not the auditor, is
responsile for identifying and deciding the appropriate accounting treatment for contingent
liailities.
a. /rue
. Balse
1:1.
medium

)t the completion of the audit, management is typically asked to make a #ritten statement as a
part of the engagement letter that it is a#are of no undisclosed contingent liailities.
a. /rue
. Balse
1:!.
medium
a
Chen preparing a standard in'uiry of clientAs attorney letter, the clientAs letterhead should e
used, and the letter should e signed y the client companyAs officials.
a. /rue
. Balse
1:(.
medium

"n a standard in'uiry of clientAs attorney letter, the attorney is re'uested to communicate aout
contingencies up to the alance sheet date.
a. /rue
. Balse
Arens/Elder/Beasley
1:..
medium

"f an attorney refuses to provide the auditor #ith information aout material e-isting la#suits or
unasserted claims, current professional standards re'uire that the auditor issue an adverse
opinion to reflect the lack of availale evidence.
a. /rue
. Balse
1:2.
medium

)uditors are re'uired to communicate orally #ith the audit committee aout internal control
#eaknesses.
a. /rue
. Balse
1:8.
medium
a
)uditors must communicate in #riting aout internal control #eaknesses to the audit committee
or those charged #ith governance.
a. /rue
. Balse
1:;.
medium

)uditors are re'uired to otain a letter of representation that descries managementAs planned
solutions to all internal control #eaknesses identified during an audit.
a. /rue
. Balse
1:<.
medium

/he letter of representation is prepared on the C*) firmAs letterhead, addressed to the clientAs
chief e-ecutive officer, and signed y the audit engagement partner.
a. /rue
. Balse
1:=.
medium
a
"f the client refuses to prepare and sign a letter of representation, the auditor #ould e re'uired
to issue either a 'ualified opinion or a disclaimer of opinion.
a. /rue
. Balse
11:.
medium
a
7ecause a client representation letter is a #ritten statement from a non-independent source, it
cannot e regarded as reliale evidence.
a. /rue
. Balse
111.
medium

"f, during the completion phase of the audit, the auditor determines that he or she has not
otained sufficient evidence to dra# a conclusion aout the fairness of the clientAs financial
statements, there are t#o choices: additional evidence must e otained, or either a 'ualified or
an adverse opinion must e issued.
a. /rue
. Balse
11!.
medium
a
Client representation letters are re'uired y professional auditing standards, #hereas
management letters are optional.
a. /rue
. Balse
11(.
medium

3use'uent events #hich re'uire ad@ustment to the financial statements provide additional
information aout significant conditionsKevents #hich did not e-ist at the alance sheet date.
a. /rue
. Balse
Arens/Elder/Beasley
11..
medium

3use'uent events for #hich disclosure, ut no ad@ustment, is re'uired provide information

aout significant eventsKconditions #hich e-isted at the alance sheet date.
a. /rue
. Balse
112.
challenging
a
Chen testing for contingent liailities, the primary o@ective at the initial stage of the tests is to
determine the e-istence of contingencies.
a. /rue
. Balse
118.
challenging

3use'uent discoveries of facts re'uiring the reissuance of financial statements arise from
events occurring after the date of the auditorAs report.
a. /rue
. Balse
Chapter 25
Multiple-Choice Questions
1.
easy
d
/he standards #hich govern the C*)As association #ith unaudited financial statements of
private companies are the:
a. )"C*)As Code of Professional Conduct.
. 3tatements on )uditing 3tandards +3)3s,.
c. 3tatements of 3tandards on )ttestation ?ngagements +33)?s,.
d. 3tatements on 3tandards for )ccounting and Revie# 3ervices +33)R3,.
!.
easy

/he t#o types of services provided in connection #ith the 3tatements on 3tandards for
)ccounting and Revie# 3ervices are:
a. audit and e-amination services.
. compilation and revie# services.
c. e-amination and revie# services.
d. management advisory services and compilations.
(.
easy
c
3tatements on 3tandards for )ttestation ?ngagements are estalished y the:
a. 3ecurities and ?-change Commission.
. *ulic Company )ccounting 4versight 7oard.
c. )uditing 3tandards 7oard.
d. )ccounting and Revie# 3ervices Committee.
..
easy
c
7ecause the same C*) firm does oth the annual audit and the pulic company interim
financial statement revie#, they are referred to as 6666666.
a. ookkeepers
. accountants
c. auditors
d. C*)s
2.
easy

*ractitioners #ho perform revie#s and compilations are referred to in the 33)R3 standards as:
a. ookkeepers.
. accountants.
c. auditors.
d. C*)s.
Arens/Elder/Beasley
8.
easy
c
)+n, 6666666 results in a conclusion that represents positive assurance.
a. revie#
. compilation
c. e-amination
d. agreed upon procedure engagement
;.
easy
a
Compilation reports may e of all ut #hich of the follo#ing types$
a. Compilation #ith limited independence.
. Compilation #ith full disclosure
c. Compilation #ithout independence.
d. Compilation that omits sustantially all disclosures.
<.
easy
c
)n e-amination results in a conclusion that represents 6666666 assurance.
a. limited assurance
. negative
c. positive
d. une'uivocal
=.
easy
d
) C*) firm can issue a compilation report:
a. only if the partners are independent.
. only if all the partners and the staff in the office performing the engagement are
independent.
c. if the partners have no material or direct immaterial interest in client.
d. even if it is not independent.
1:.
easy

Chich of the follo#ing meets the attestation standardsA definition of an e-amination$

a. *reparing a corporationAs annual ta- returns.
. )n audit of the financial statements.
c. ) revie# of the financial statements.
d. ) compilation of the financial statements.
11.
easy
a
Chich of the follo#ing #ould not e included in a C*)As report ased upon a revie# of the
financial statements of a nonpulic entity$
a. ) statement that the revie# #as in accordance #ith generally accepted auditing standards.
. ) statement that all information included in the financial statements is the representation of
management.
c. ) statement descriing the principal procedures performed.
d. ) statement descriing the auditorAs conclusions ased upon the results of the revie#.
1!.
easy
a
/he distriution of #hich of the follo#ing types of reports is unrestricted$
a. ?-aminations and revie#s
. Revie#s and agreed-upon procedures
c. ?-aminations and agreed-upon procedures
d. ?-aminations, revie#s, and agreed-upon procedures
1(.
easy

/he statement that 0Dothing came to our attention #hich #ould indicate that these statements
are not fairly presented1 e-presses #hich of the follo#ing$
a. Eisclaimer of an opinion.
. Degative assurance.
c. Degative confirmation.
d. 3hared opinion.
1.. Bor revie#s, an accountant does #hich of the follo#ing$
easy
d
4tain an understanding
of internal control.
*erform tests of
controls.
*erform tests of
transactions.
Arens/Elder/Beasley
a. Jes Jes Do
. Jes Do Jes
c. Do Jes Jes
d. Do Do Do
12.
easy

)n auditor #ho conducts an e-amination in accordance #ith generally accepted auditing

standards and concludes that the financial statements are fairly presented in accordance #ith a
comprehensive asis of accounting other than %))*, should issue a:
a. revie# report.
. special report.
c. 'ualified opinion.
d. disclaimer of opinion.
18.
medium
d
3pecific attestation standards have een developed in all ut #hich of the follo#ing areas$
a. *ro forma financial information.
. Compliance #ith la#s and regulations.
c. *rospective financial statements.
d. 3tandards have een developed for all of the aove.
1;.
medium
a
Reports on agreed-upon procedures are intended to e distriuted:
a. to only the involved parties, #ho #ould have the re'uisite kno#ledge aout those
procedures and the level of assurance resulting from them.
. to only the involved parties, #ho #ould have the re'uisite kno#ledge aout those
procedures ut not the level of assurance resulting from them.
c. to any party to #hom the client #ishes.
d. only to the stockholders of the client.
1<.
medium
a
Chich of the follo#ing is not an area of emphasis in a revie# conducted under the 33)R3$
a. /ests of internal controls.
. Make in'uiries of management.
c. 4tain kno#ledge of the client.
d. 4tain kno#ledge of the accounting principles and practices of the clientAs industry.
1=.
medium
c
Eistriution of #hich of the follo#ing types of reports is limited$
a. )udit
. Revie#
c. )greed-upon procedures
d. ?-amination
!:.
medium
c
"n #hich type of report #ould you read the follo#ing statement: 0Ce elieve that our
e-amination provides a reasonale asis for our opinion.1$
a. Revie#
. )udit
c. ?-amination
d. )greed-upon procedures
!1.
medium
a
Chich of the follo#ing forms of revie# are permissile under 33)R3$
a. Revie# #ithout positive assurance.
. Revie# on financial statements that omit sustantially all disclosures.
c. Revie#s #ithout C*) independence.
d. Revie# #ithout limited procedures.
!!.
medium
?vidence for a revie# engagement consists primarily of:
a "n'uiries )nalytical procedures /ests of details
a. Do Jes Do
. Jes Jes Do
Arens/Elder/Beasley
c. Do Do Jes
d. Jes Do Jes
!(.
medium
Chich of the follo#ing services is performed under the attestation standards$
a Ce/rust 3ys/rust
a. Jes Jes
. Do Do
c. Jes Do
d. Do Jes
!.. +*ulic,
medium

/he 3ecurities and ?-change Commission re'uires 'uarterly financial information as a part of
the:
a. 1:-F report.
. 1:-Q report.
c. <-F report.
d. auditorAs report.
!2. +*ulic,
medium
d
/he 'uarterly reports sumitted to the 3?C y the client:
a. have to e audited and the C*) firm must e identified.
. do not have to e audited, ut the C*) firm #hich does the year-end audit must e
identified.
c. have to e audited, ut the C*) firm does not have to e identified.
d. do not have to e audited, ut the C*) firm #hich does the year-end audit must revie# the
'uarterly statements efore they are sumitted to the 3?C.
!8.
medium
d
/he Ce/rust service re'uires that a C*) update its testing of the e-commerce aspects of a
entityAs Ce site at least every:
a. ninety days.
. month.
c. si- months.
d. t#elve months.
!;.
medium

Reports on det compliance and similar engagements may e issued as a separate report or as
part of a report that e-presses the auditorAs opinion on the financial statements. Chen they are
issued as a part of the report on the financial statements, it is done y:
a. adding a middle paragraph efore the opinion paragraph.
. adding a paragraph after the opinion paragraph.
c. adding an additional phrase or sentence #ithin the opinion paragraph.
d. adding a paragraph et#een the introductory and scope paragraphs.
!<.
medium
a
)uditors fre'uently audit statements that #ere prepared on a comprehensive asis of accounting
other than %))*. Chen this occurs:
a. generally accepted auditing standards apply to these engagements and the reporting
re'uirements differ.
. generally accepted auditing standards apply to these engagements and the reporting
re'uirements are the same as #ell.
c. generally accepted auditing standards do not apply to these e-aminations and the reporting
re'uirements differ also.
d. generally accepted auditing standards do not apply to this engagement and the reporting
re'uirements remain the same for the C*).
!=.
medium
d
Chich of the follo#ing is not a standard contained in oth the 3tatement on 3tandards for
)ttestation ?ngagements and the 3tatement on )uditing 3tandards$
a. /he e-amination is to e performed y a person having ade'uate technical training.
. )n independence in mental attitude is to e maintained.
c. 3ufficient evidence is to e otained.
Arens/Elder/Beasley
d. /he practitioner must otain a sufficient understanding of the clientAs internal control.
(:.
medium

Chich of the follo#ing is not one of the types of engagements and related forms of conclusions
that are defined y the attestation standards$
a. Revie#s.
. Compilations.
c. ?-aminations.
d. )greed-upon procedures.
(1.
medium
a
Chich of the follo#ing types of engagement reports #ould provide positive assurance$
a. )n e-amination.
. ) revie#.
c. )n agreed-upon procedures engagement.
d. ) compilation.
(!.
medium
d
Chich of the follo#ing is not one of the general types of prospective financial statements
included in the attestation standards$
Borecasts *ro@ections ?arnings estimates
a. Do Do Jes
. Do Jes Do
c. Jes Jes Do
d. Jes Do Jes
((.
medium
c
) report on an e-amination is 6666666 as to the distriution y the client after it is issued.
a. restricted
. limited
c. unrestricted
d. directed
(..
medium
c
Chich are prospective financial statements that present an entityAs e-pected financial position,
results of operations, and cash flo#s, to the est of the responsile partyAs kno#ledge and
elief$
a Borecasts *ro@ections
a. Jes Jes
. Do Do
c. Jes Do
d. Do Jes
(2.
medium
d
Chich are prospective financial statements that present an entityAs financial position, results of
operations, and cash flo#s, to the est of the responsile partyAs kno#ledge and elief, given
one or more hypothetical assumptions$
a Borecasts *ro@ections
a. Jes Jes
. Do Do
c. Jes Do
d. Do Jes
(8.
medium

*rofessional standards prohiit one of the follo#ing types of engagements for prospective
financial statements from eing undertaken.
a. ) compilation.
. ) revie#.
c. )n e-amination.
d. )n agreed-upon procedures engagement.
(;. %eneral use statements are prepared for use y 66666666.
Arens/Elder/Beasley
medium

a. kno#n contractual parties

. any third party
c. regulators
d. internal auditor.
(<.
medium
c
)n agreed-upon procedures engagement is one in #hich:
a. the auditor and management agree that procedures #ill e applied to all accounts and
circumstances.
. the auditor and management agree that procedures #ill not e applied to all accounts and
circumstances.
c. the auditor and management or a third party agree that the engagement #ill e limited to
certain specific procedures.
d. the auditor and management or a (rd party agree that the auditor #ill apply his or her
@udgment to determine procedures to e performed.
(=.
medium
d
3tatements on )ccounting and Revie# 3ervices are issued y the:
a. )uditing 3tandards 7oard.
. 3ecurities and ?-change Commission.
c. *ulic Company )ccounting 4versight 7oard.
d. )ccounting and Revie# 3ervices Committee of the )"C*).
.:.
medium
c
)ssurance provided y a revie# is sustantially less than an audit. Chich of the follo#ing
statements is true regarding these services$
a. ) revie# re'uires more sustantive evidence than an audit.
. )n audit re'uires less evidence related to internal control than a revie#.
c. ) revie# re'uires less evidence than an audit.
d. Done of the aove statements is true.
.1.
medium
c
)n accountant #ho revie#s the financial statements of a nonpulic entity should issue a report
stating that a revie#:
a. is sustantially e'uivalent in scope to an audit.
. is sustantially more in scope than a compilation.
c. is sustantially less in scope than an audit.
d. provides only limited assurance that the financial statements are fairly presented.
.!.
medium
d
Chich of the follo#ing procedures is not included in a revie# engagement of a nonpulic
entity$
a. "n'uiries of management.
. "n'uiries regarding events suse'uent to the alance sheet date.
c. )ny procedures designed to identify relationships among data that appear to e unusual.
d. ) study and evaluation of internal control.
.(.
medium
d
Chen an accountant performs more than one level of service +for e-ample, a compilation and a
revie#, or a compilation and an audit, concerning the financial statements of a nonpulic entity,
the accountant generally should issue the report that is appropriate for:
a. a revie# engagement.
. a compilation engagement.
c. the lo#est level of service rendered.
d. the highest level of service rendered.
... +*ulic,
medium
c
/he title of a revie# report issued for a pulic companyAs 'uarterly financial statements is titled
#ith #hich of the follo#ing$
a. Report of "ndependent *ulic )ccountants.
. Report of "ndependent )uditors.
c. Report of "ndependent Registered *ulic )ccounting Birm.
d. Report of Certified *ulic )ccountant.
Arens/Elder/Beasley
.2.
medium
d
Jou are a C*) retained y the manager of a cooperative retirement village to do 0#rite-up
#ork.1 Jou are e-pected to prepare unaudited financial statements #ith each page marked
0unaudited1 and accompanied y a disclaimer of opinion stating no audit #as performed. "n
performing the #ork, you discover that there are no invoices to support a claim for a 9!2,:::
disursement. /he manager informs you that all the disursements are proper. Chat should you
do$
a. 3umit the e-pected statements ut omit 9!2,::: of unsupported disursements.
. "nclude the unsupported disursements in the statements since you are not e-pected to
make an audit.
c. 4tain from the manager a #ritten statement that you informed him of the missing
invoices and include his assurance that the disursements are proper.
d. Dotify the o#ners that some of the claimed disursements are unsupported and #ithdra#
if the situation is not satisfactorily resolved.
.8.
medium
c
Eet compliance letters are ordinarily addressed to:
a. under#riters of securities.
. the clientAs audit committee.
c. creditor financial institutions.
d. the 3ecurities and ?-change Commission.
.;.
medium
c
Chy do standards prohiit accepting an engagement on a pro@ection for general use$
a. /he C*)As procedures #ould violate 33)R3.
. Reports on pro@ections are not #ell understood y the general pulic.
c. >nderlying hypothetical assumptions are difficult to interpret #ithout otaining additional
information.
d. /he C*) is not 'ualified to report on the use of %))* in the pro@ected financial statement.
.<.
medium

Chich of the follo#ing is not an element of e-amining a forecast$

a. ?valuating the preparation of the prospective financial statements.
. >nderstanding internal controls.
c . ?valuating the support underlying the assumptions.
d. "ssuing an e-amination report.
.=.
medium
a
)n accountant may accept an engagement to apply agreed-upon procedures to prospective
financial statements provided that:
a. distriution of the report is to e restricted to the specified users involved.
. the prospective financial statements are also e-amined.
c . responsiility for the ade'uacy of the procedures performed is taken y the accountant.
d. negative assurance is e-pressed on the prospective financial statements taken as a #hole.
2:.
medium

Don-accounting data included in a long-form report have een su@ected to auditing procedures.
/he auditorAs report should state this fact and should e-plain that the non-accounting data are
presented for analysis purposes. "n addition, the auditorAs report should state #hether the non-
accounting data are:
a. audited, unaudited, or revie#ed on a limited asis.
. fairly stated in all material respects in relation to the asic financial statements taken as a
#hole.
c. eyond the scope of the normal engagement and therefore, not covered y the opinion on
the financial statements.
d. #ithin the frame#ork of generally accepted auditing standards, #hich apply to the
financial statements taken as a #hole.
21.
medium
a
)n auditor has een asked to report on the alance sheet of Fane Company ut not on the other
asic financial statements. /he auditor #ill have access to all information underlying the asic
financial statements. >nder these circumstances, the auditor:
a. may accept the engagement ecause such engagements merely involve limited reporting
Arens/Elder/Beasley
o@ectives.
. may accept the engagement ut should disclaim an opinion ecause of an inaility to
apply the procedures considered necessary.
c. should refuse the engagement ecause there is a client-imposed scope limitation.
d. should refuse the engagement ecause of a departure from generally accepted auditing
standards.
2!.
medium
a
) C*) #ho has een engaged to audit financial statements that #ere prepared on a cash asis:
a. must ascertain that there is proper disclosure of the fact that the cash asis has een used,
the general nature of material items omitted, and the net effect of such omissions.
. may not e associated #ith such statements #hich are not in accordance #ith generally
accepted accounting principles.
c. must render a 'ualified report e-plaining the departure from generally accepted
accounting principles in the opinion paragraph.
d. must restate the financial statements on an accrual asis and then render the standard
+short-form, report.
2(.
challenging

4ne e-ample of a 0special report,1 as defined y 3tatements on )uditing 3tandards, is a report

issued in connection #ith:
a. a feasiility study.
. price-level asis financial statements.
c. a limited revie# of interim financial information.
d. compliance #ith a contractual agreement not related to the financial statements.
2..
challenging
a
"n a revie# service #here the client has failed to follo# %))*, the accountant is:
a. not re'uired to determine the effect of a departure if management has not done so, ut that
fact must e disclosed in the report.
. re'uired to determine the effect of a departure if management has not done so, and that fact
must e disclosed in the report.
c. not re'uired to determine the effect of a departure if management has not done so, and that
fact need not e disclosed in the report.
d. re'uired to determine the effect of a departure if management has not done so, and that fact
need not e disclosed in the report.
22.
challenging
a
Ce/rust engagements should e performed follo#ing guidance provided y the:
a. )"C*) attestation standards.
. )"C*) auditing standards.
c. )"C*) accounting standards.
d. )"C*) revie# standards.
28.
challenging
a
/he engagement and report on det compliance letters should e limited to compliance matters
that the auditor is 'ualified to evaluate. Chich of the follo#ing engagements #ould e
inappropriate for the C*) to attempt to evaluate$
a. Eetermining #hether the client has properly restricted its usiness activities to the
re'uirements of an agreement.
. Eetermining #hether principal and interest payments #ere made #hen due.
c. Eetermining #hether the proper limitations #ere maintained on dividends, #orking capital,
and det ratios.
d. Eetermining #hether the accounting records #ere ade'uate for conducting an ordinary
audit.
2;.
challenging
c
*rospective financial statements are for general use or for limited use. %eneral use refers to use
y any third party, #hereas limited use refers to use y third parties #ith #hich the responsile
party is negotiating directly. Chich of the follo#ing statements is not correct$
a. Borecasts can e provided for general use.
. Borecasts can e provided for limited use.
c. *ro@ections can e provided for general use.
Arens/Elder/Beasley
d. *ro@ections can e provided for limited use.
2<.
challenging

7efore performing a revie# of a nonpulic entityAs financial statements, an accountant should:

a. complete a series of in'uiries concerning the entityAs procedures for recording, classifying,
and summarizing transactions.
. otain a sufficient level of kno#ledge of the accounting principles and practices of the
industry in #hich the entity operates.
c. in'uire #hether management has omitted sustantially all of the disclosures re'uired y
generally accepted accounting principles.
d. apply analytical procedures to provide limited assurance that no material modifications
should e made to the financial statements.
2=.
challenging
d
)n auditor #ho #as engaged to perform an e-amination of the financial statements of a
nonpulic entity has een asked y the client to refrain from performing various audit
procedures and change the nature of the engagement to a revie# of the financial statements in
accordance #ith standards estalished y the )"C*). /he clientAs re'uest #as made ecause
the cost to complete the e-amination #as significant. >nder these circumstances, the auditor
#ould most likely:
a. 'ualify the auditorAs report and refer to the scope limitation.
. vie# the re'uest as an indication of a possile irregularity.
c. complete the e-amination that #as in progress.
d. honor the clientAs re'uest.
8:.
challenging
d
)n accountantAs standard report on a compilation of a pro@ection should not include a:
a. statement that a compilation of a pro@ection is limited in scope.
. separate paragraph that descries the limitations on the presentationAs usefulness.
c. disclaimer of responsiility to update the report for events occurring after the reportAs date.
d. statement that the accountant e-presses only limited assurance that the results may e
achieved.
81.
challenging

)ttestation standards allo# a C*) to perform all ut #hich of the follo#ing services for a
forecast or pro@ection$
a. Compilation
. Revie#
c. ?-amination
d. )greed-upon procedures
8!.
challenging

>nder #hat standards are Ce/rust and 3ys/rust engagements performed$

a. 33)R
. 33)?
c. 3)3
d. 33)R3
8(.
challenging
c
Degative assurance is not permissile in:
a. reports ased upon a revie# engagement.
. letters re'uired y security under#riters for data pertinent to 3?C registration statements.
c. reports ased on an audit of interim financial statements of a closely held usiness entity.
d. reports relating to the results of agreed-upon procedures to one or more specified
elements, accounts, or items of financial statement.
8..
challenging
a
/he auditorAs est course of action #ith respect to 0other financial information1 included in an
annual report containing the auditorAs report is to:
a. read and consider the manner of presentation of the 0other financial information.1
. indicate in the auditorAs report that the 0other financial information1 is unaudited.
c. consider #hether the 0other financial information1 is accurate y performing a limited
revie#.
d. otain #ritten representations from management as to the accuracy of the 0other financial
Arens/Elder/Beasley
information.1
82.
challenging
c
) C*) #ho is not independent and is associated #ith financial statements should disclaim an
opinion #ith respect to those financial statements. /he disclaimer should:
a. clearly state the specific reasons for lack of independence.
. not mention any reason for the disclaimer other than that the C*) #as unale to conduct
the e-amination in accordance #ith generally accepted auditing standards.
c. not descrie the reason for lack of independence ut should state specifically that the C*)
is not independent.
d. include a middle paragraph clearly descriing the C*)As association #ith the client and
e-plaining #hy the C*) #as unale to gather sufficient competent evidential matter to
#arrant the e-pression of an opinion.
?ssay Questions
88.
easy
Eefine forecast and pro@ection.
)ns#er:
Borecasts are prospective financial statements that present an entityAs expected financial
position, results of operations, and cash flo#s, to the #est of the responsile partyAs
kno#ledge and elief.
*ro@ections are prospective financial statements that present an entityAs financial position,
results of operations, and cash flo#s, to the est of the responsile partyAs kno#ledge and
elief, given one or more "potetical assumptions.
8;.
easy
Chat are 33)R3 and #ho issues them$
)ns#er:
33)R3 are 3tatements on 3tandards for )ccounting and Revie# 3ervices. /hey are issued
y the )ccounting and Revie# 3ervices Committee of the )"C*).
8<.
easy
Chat are 33)?s and #ho issues them$
)ns#er:
33)?s are 3tatements on 3tandards for )ttestation ?ngagements. /hey are issued y the
)uditing 3tandards 7oard.
8=.
easy
Cho developed the 7e#-rust service$ 7riefly e-plain this service.
)ns#er:
7e#-rust #as developed @ointly y the )"C*) and the Canadian "nstitute of Chartered
)ccountants. "n a 7e#-rust engagement, a client engages a C*) to provide reasonale
assurance that the clientAs Ce site complies #ith certain -rust Ser%ices principles and
criteria for one or more e-commerce activities. ) site that meets the -rust Ser%ice
principles is eligile to display the 7e#-rust seal on its transaction or order page.
;:.
medium
) financial statement revie# conducted in compliance #ith 33)R3 emphasizes five activities,
one of #hich is to 0perform analytical procedures.1 3tate the other four.
)ns#er:
4tain kno#ledge of the accounting principles and practices of the clientAs
Arens/Elder/Beasley
industry.
4tain kno#ledge of the clientP that is understood, the clientAs usiness
transactions, its accounting records and employees, and the asis, form, and content of
the financial statements.
Make in'uiries of management to determine #hether the financial statements
are fairly presented.
/he accountant is specifically re'uired to otain a letter of representation
from memers of management #ho are kno#ledgeale aout financial matters.
;1.
medium
Eiscuss each of the three types of compilation reports and the circumstances in #hich each
should e used.
)ns#er:
Compilation )it full disclosure. /his report is used #hen the financial
statements include all disclosures re'uired y generally accepted accounting
principles.
Compilation tat omits su#stantiall" all disclosures. /his type of report is used
#hen the financial statements omit sustantially all of the disclosures re'uired y
%))*, and the asence of disclosures is not, to the C*)As kno#ledge, undertaken
#ith the intent to mislead users.
Compilation )itout independence. "f the accountant is not independent #ith
respect to the client, the compilation report should include, as a separate last
paragraph, a statement to that effect.
;!.
medium
3tate four types of assurance services that fall #ithin the auditing standards ut are not audits,
revie#s, or compilations of financial statements in accordance #ith %))*.
)ns#er:
4ther comprehensive asis of accounting.
3pecified elements, accounts, or items.
"nformation accompanying asic financial statements.
Eet compliance letters and similar reports.
;(.
medium
)uditors fre'uently audit statements prepared on ases other than %))*. Eiscuss four
commonly used ases other than %))*.
)ns#er:
Cas or modified cas #asis. Cith the cash asis, receipts and disursements
are recordedP there are no accruals. >nder the modified cash asis, the cash asis is
follo#ed e-cept for certain items, such as recording fi-ed assets and depreciation.
0asis used to compl" )it te requirements of a regulator" agenc".
Income tax #asis. /he same measurement rules used for filing ta- returns are
often used for financial statement preparation, even though this is not in accordance
#ith generally accepted accounting principles.
A definite set of criteria a%ing su#stantial support. Bor e-ample, the price-
level asis of accounting could e applied to all material items in the financial
statements.
;..
medium
7riefly descrie a S"s-rust engagement.
Arens/Elder/Beasley
)ns#er:
) 3ys/rust licensed accountant evaluates a companyAs computer system using -rust
Ser%ices principles and criteria and determines #hether controls over the system e-ist. /he
accountant then performs tests to determine #hether those controls #ere operating
effectively during a specified period. "f the system meets the re'uirements of the -rust
Ser%ices principles and criteria, an e-amination-level un'ualified attestation report is
issued under the )"C*) attestation standards.
;2.
medium
Bre'uently, clients re'uest auditors to include additional information eyond the asis financial
statements in the set of materials prepared for management or outside users. &ist three types of
additional information commonly included in the additional information section.
)ns#er: +students should list three of the five,
Eetailed comparative statements supporting the control totals on the primary
financial statements for accounts such as cost of goods sold, operating e-penses, and
miscellaneous assets.
3upplementary information re'uired y the Binancial )ccounting 3tandards
7oard or 3ecurities and ?-change Commission.
3tatistical data for past years in the form of ratios and trends.
) schedule of insurance coverage.
3pecific comments on the changes that have taken place in the statements.
;8.
challenging
7riefly descrie each of the five -rust Ser%ices principles.
)ns#er:
/he five -rust Ser%ices principles are:
1. 4nline *rivacy U personal information otained as a result of e-commerce is collected,
used, disclosed, and retained as committed or agreed.
!. 3ecurity U the system is protected against unauthorized access +oth physical and
logical access,.
(. *rocessing integrity U system processing is complete, accurate, timely, and
authorized.
.. )vailaility U the system is availale for operation and use as committed or agreed.
2. Confidentiality U information designated as confidential is protected as committed or
agreed.
;;.
challenging
Eraft a report that #ould e appropriate #hen an independent accountant has performed a
compilation of financial statements #ith disclosures in accordance #ith %))*.
)ns#er:
Ce have compiled the accompanying alance sheet of 5JS Company as of Eecemer (1,
!::5, and the related statements of income, retained earnings, and cash flo#s for the year
then ended, in accordance #ith 3tatements on 3tandards for )ccounting and Revie#
3ervices issued y the )merican "nstitute of Certified *ulic )ccountants.
) compilation is limited to presenting in the form of financial statements information that
is the representation of management. Ce have not audited or revie#ed the accompanying
financial statements and, accordingly, do not e-press an opinion or any other form of
assurance on them.
;<.
challenging
Eraft a report that #ould e appropriate #hen an accountant has made a proper revie# of the
accounting records and the financial statements of a nonpulic entity and has concluded they
appear reasonale.
)ns#er:
Arens/Elder/Beasley
Ce have revie#ed the accompanying alance sheet of 5JS Company as of Eecemer (1,
!::5, and the related statements of income, retained earnings, and cash flo#s for the year
then ended, in accordance #ith 3tatements on 3tandards for )ccounting and Revie#
3ervices issued y the )merican "nstitute of Certified *ulic )ccountants. )ll information
included in these financial statements is the representation of the management of 5JS
Company.
) revie# consists principally of in'uiries of company personnel and analytical procedures
applied to financial data. "t is sustantially less in scope than an audit in accordance #ith
generally accepted auditing standards, the o@ective of #hich is the e-pression of an
opinion regarding the financial statements taken as a #hole. )ccordingly, #e do not
e-press such an opinion.
7ased on our revie#, #e are not a#are of any material modifications that should e made
to the accompanying financial statements in order for them to e in conformity #ith
generally accepted accounting principles.
;=.
challenging
Eiscuss the five 33)R3 re'uirements that must e met #hen an accountant is performing a
compilation of financial statements.
)ns#er:
/he preparer of the statements must:
?stalish an understanding #ith the client aout the type and limitations of the services
to e provided and a description of the report, if a report is to e issued.
*ossess kno#ledge aout the accounting principles and practices of the clientAs industry.
Fno# the clientP understand the nature of the clientAs usiness transactions, accounting
records, and employeesP and kno# the content of the financial statements +the
kno#ledge can e less than that for a revie#,.
Make in'uiries to determine #hether the clientAs information is satisfactory.
Read the compiled financial statements and e alert for any ovious omissions or errors
in arithmetic and %))*.
<:.
challenging
Eraft a report that #ould e appropriate #hen an independent accountant has performed a
compilation of financial statements #hich sustantially omit all disclosures and the statement of
cash flo#s re'uired y %))*.
)ns#er:
Ce have compiled the accompanying alance sheet of 5JS Company as of Eecemer (1,
!::5, and the related statements of income, retained earnings, and cash flo#s for the year
then ended, in accordance #ith 3tatements on 3tandards for )ccounting and Revie#
3ervices issued y the )merican "nstitute of Certified *ulic )ccountants.
) compilation is limited to presenting in the form of financial statements information that
is the representation of management. Ce have not audited or revie#ed the accompanying
financial statements and, accordingly, do not e-press an opinion or any other form of
assurance on them.
Management has elected to omit sustantially all of the disclosures and the statement of
cash flo#s re'uired y generally accepted accounting principles. "f the omitted disclosures
#ere included in the financial statements, they might influence the userAs conclusions
aout the companyAs financial position, results of operations, and cash flo#s. )ccordingly,
these financial statements are not designed for those #ho are not informed aout such
matters.
<1.
challenging
Eraft a report that #ould e appropriate #hen an accountant has performed a compilation of
financial statements #ith disclosures in accordance #ith %))*, ut the accountant is not
Arens/Elder/Beasley
independent #ith respect to the client.
)ns#er:
Ce have compiled the accompanying alance sheet of 5JS Company as of Eecemer (1,
!::5, and the related statements of income, retained earnings, and cash flo#s for the year
then ended, in accordance #ith 3tatements on 3tandards for )ccounting and Revie#
3ervices issued y the )merican "nstitute of Certified *ulic )ccountants.
) compilation is limited to presenting in the form of financial statements information that
is the representation of management. Ce have not audited or revie#ed the accompanying
financial statements and, accordingly, do not e-press an opinion or any other form of
assurance on them.
Ce are not independent #ith respect to 5JS Company.
<!.
challenging
/he format and contents of an audit report for specified elements, accounts, or items is similar
to the standard audit report of financial statements in accordance #ith %))*. Ho#ever, it must
also reflect four re'uirements for reporting on specified elements, accounts, or items. 3tate each
of these four re'uirements.
)ns#er:
/he specified elements, accounts, or items must e identified.
/he asis on #hich the specified elements, accounts, or items are presented
and the agreements specifying the asis must e descried.
/he source of significant interpretations made y the client aout the
provisions of a relevant agreement must e indicated and descried.
"f the specified element, account, or item is presented on a asis that is not in
conformity #ith generally accepted accounting principles or another comprehensive
asis of accounting, a paragraph that restricts the distriution of the report to those
#ithin the entity and the parties to the contract or agreement must e added.
4ther 4@ective )ns#er Bormat Questions
<(.
medium
Match the type of engagement +a-g, #ith the source of authoritative support for that engagement
provided elo# +1-;,. 3ources may e used more than once +or not at all,.
a. )uditing standards
. )ccounting and revie# service standards
c. )uditing standards and governmental auditing standards
d. )ttestation standards
e. %overnmental auditing standards
f. Do standards have een set for these engagements
g. 3tandards of the *ulic Company )ccounting 4versight 7oard
1. Compilation of financial statements prepared in accordance #ith %))* for a
nonpulic company.
d !. )ttestation of forecasted financial statements.
f (. 4perational auditing.
g .. Revie# financial statements prepared in accordance #ith %))* for a pulic
company.
Arens/Elder/Beasley
a 2. )udits of financial statements for a nonpulic entity prepared in accordance
#ith %))*.
c 8. %overnmental auditing.
a ;. &imited assurance engagements other than audits, revie#s, or compilations of
historical financial statements prepared in accordance #ith %))*.
<..
easy

Revie# reports are normally dated as of the clientAs alance sheet date.
a. /rue
. Balse
<2.
easy

33)R3 are issued y the 3?C.

a. /rue
. Balse
<8.
easy
a
) primary concern in reporting on a comprehensive asis is to make sure that the statements
clearly indicate that they are prepared on a asis other than %))*.
a. /rue
. Balse
<;.
easy

33)?s are issued y the *C)47.

a. /rue
. Balse
<<.
easy

) nonaudit engagement in #hich the accountant undertakes to present, in the form of financial
statements, information that is the representation of management, #ithout undertaking to
e-press any assurance on the statements is called a revie# engagement.
a. /rue
. Balse
<=.
easy

C*)s must e independent to issue a compilation report.

a. /rue
. Balse
=:.
easy
a
C*)s must e independent to issue a revie# report.
a. /rue
. Balse
=1.
medium
a
Chen an auditor issues an opinion on additional information accompanying the financial
statements, materiality is the same as that used in forming an opinion on the asic financial
statements.
a. /rue
. Balse
=!.
medium

7e#-rust services are performed under the direction of the 33)R3.

a. /rue
. Balse
=(.
medium
a
S"strust services are performed under the direction of the 33)?s.
a. /rue
. Balse
=..
medium

) financial statement revie# conducted in compliance #ith 33)R3 includes otaining an

understanding of internal control.
a. /rue
. Balse
Arens/Elder/Beasley
=2.
medium
a
3tatements on 3tandards for )ccounting and Revie# 3ervices +33)R3, govern the C*)As
association #ith unaudited financial statements of nonpulic +private, companies, ut not pulic
companies.
a. /rue
. Balse
=8.
medium

C*)s can issue a 7e#-rust opinion only on all five -rust Ser%ices principles.
a. /rue
. Balse
=;.
medium
a
Chen performing a revie# +33)R3 revie#, of financial statements, the accountant is re'uired
to otain a letter of representation from management.
a. /rue
. Balse
=<.
medium

/he use of negative assurance is appropriate in audit reports.

a. /rue
. Balse
==.
medium

/he use of positive assurance is appropriate in revie# reports.

a. /rue
. Balse
1::.
medium
a
Chen performing compilation services, the accountant is not re'uired to otain an
understanding of the clientAs internal control.
a. /rue
. Balse
1:1.
medium
a
) C*) firm can issue a compilation report even if it is not independent #ith respect to the
client.
a. /rue
. Balse
1:!. +*ulic,
medium
a
Chen performing a revie# of interim information for a pulic company, the accountant
ordinarily does not perform tests of the accounting records, independent confirmations, or
physical e-aminations.
a. /rue
. Balse
1:(.
medium
a
Chen issuing a det compliance letter, the auditorAs opinion should e in the form of a negative
assurance.
a. /rue
. Balse
1:..
medium

4f the three types of attestation engagements, e-amination engagements provide a higher level
of assurance than agreed-upon procedures engagements ut less than revie# engagements.
a. /rue
. Balse
Arens/Elder/Beasley
1:2.
medium
a
?-amination attestation engagements result in a conclusion that is in a positive form, #hereas
revie# attestation engagements result in a conclusion in the form of a negative assurance.
a. /rue
. Balse
1:8.
medium
a
Current professional standards prohiit accountants from performing engagements to revie#
forecasts or pro@ections.
a. /rue
. Balse
1:;.
medium
a
/he accountantAs report on the e-amination of prospective financial statements should include a
caveat that the prospective results may not e achieved.
a. /rue
. Balse
1:<.
challenging
a
)uditors should provide det compliance letters only for clients for #hom the auditor has done
an audit of the overall financial statements.
a. /rue
. Balse
Chapter 26
Multiple-Choice Questions
1.
easy

/he "") Code of ?thics is ased on all ut #hich of the follo#ing ethical principles$
a. "ntegrity.
. "ndependence.
c. Competency.
d. Confidentiality.
!.
easy
c
3tatements on "nternal )uditing 3tandards are issued y the:
a. )"C*).
. 3?C.
c. "nternal )uditing 3tandards 7oards.
d. )uditing 3tandards 7oards.
(.
easy
c
"nternal auditors are responsile to:
a. the oard of directors.
. management.
c. oth a and .
d. neither a nor .
..
easy
a
Chich of the follo#ing is not a similarity et#een e-ternal and internal auditors$
a. 7oth must e independent of the company.
. 7oth must e competent.
c. 7oth use similar methodologies in performing their #ork.
d. 7oth consider risk and materiality in their #ork.
2.
easy
d
?-ternal auditors consider internal auditors effective if they are:
a. independent of the operating units eing evaluated.
. competent and #ell trained.
c. have performed relevant audit tests of the internal controls and financial statements.
Arens/Elder/Beasley
d. all of the aove.
8.
easy
d
)uditing standards 6666666 e-ternal auditors to use the internal auditors for direct assistance on
the audit.
a. discourage
. prohiit
c. encourage
d. permit
;.
easy

/he primary source of authoritative literature for doing government audits is the:
a. *urple 7ook.
. Jello# 7ook.
c. %reen 7ook.
d. Red 7ook.
Arens/Elder/Beasley
<.
easy
c
Chen a state or local government agency receives federal financial assistance, it is su@ect to
the audit re'uirements of:
a Jello# 7ook 3ingle )udit )ct 4M7 Circular )-1((
a. Jes Jes Do
. Do Do Jes
c. Jes Jes Jes
d. Jes Do Do
=.
easy
c
Chich of the follo#ing is not one of the road categories of operational audits$
a. Bunctional audits.
. 4rganizational audits.
c. 3ingle )udit )ct audits.
d. 3pecial assignment audits.
1:.
easy
d
Chich of the follo#ing groups could not e involved in an operational audit$
a. C*) firms.
. "nternal auditors.
c. %overnment auditors.
d. Done of the aove ans#ers is correctP that is, all of the aove could e involved.
11.
easy

/he "")As professional practice frame#ork +including its code of ethics and "nternational
3tandards for the *rofessional *ractice of "nternal )uditing, is commonly referred to as the:
a. 7lue 7ook.
. Red 7ook.
c. %reen 7ook.
d. Jello# 7ook.
1!.
easy

/he professional organization #hich is responsile for providing guidance for internal auditors
is the:
a. )*).
. "").
c. )7).
d. )").
1(.
easy
d
/he financial auditing standards of the Jello# 7ook are 666666 the 1: %))3 of the )"C*).
a. the same as
. 'uite different from
c. incompatile #ith
d. consistent #ith
1..
easy

Chich of the follo#ing is not one of the three phases in an operational audit$
a. *lanning.
. /raining and supervising employees.
c. ?vidence accumulation and evaluation.
d. Reporting and follo#-up.
12.
medium
a
/he correct title of the Jello# 7ook is:
a. %overnment )uditing 3tandards.
. "") *ractice 3tandards.
c. 3tatement of Responsiilities of "nternal )uditing.
d. 3tatement of 3tandards on )ccounting and Revie# 3ervices.
18. /he Jello# 7ook recognizes that, ecause of the sensitivity of government activities and their
Arens/Elder/Beasley
medium

pulic accountaility, in government audits the thresholds of acceptale audit risk and tolerale
misstatement compared to an audit of a commercial enterprise may e:
a. e'ual.
. lo#er.
c. higher.
d. indeterminale.
1;.
medium

/he 3ingle )udit )ct re'uires that an audit e conducted for recipients #ho receive total federal
funds in any fiscal year of:
a. 91,:::,::: or more.
. 92::,::: or more.
c. 9(::,::: or more.
d. 91::,::: or more.
1<.
medium

)n audit conducted in accordance #ith the Jello# 7ook must include an audit report that states
the audit #as performed in accordance #ith:
a. %))3.
. %)%)3.
c. %)3).
d. 3)3.

1=.
medium
d
)n audit designed to evaluate the efficiency and effectiveness of an organization or some part
of an organization #ould not e called a+n,:
a. performance audit.
. management audit.
c. operational audit.
d. compliance audit.
!:.
medium
c
Chich of the follo#ing is not one of the ma@or differences et#een financial and operational
auditing$
a. /he financial audit is oriented to the past, ut an operational audit concerns performance
for the future.
. /he financial audit report is distriuted to many readers, ut the operational audit report
goes to a fe# managers.
c. Binancial audits deal #ith the information on the financial statements, ut operational
audits are concerned #ith the information in the ledgers.
d. Binancial audits are limited to matters that directly affect the financial statements, ut
operational audits cover any aspect of efficiency and effectiveness.
!1.
medium
d
7efore an operational audit for effectiveness can e performed, there must e:
a. a financial audit y an independent auditor.
. a financial audit y an internal auditor.
c. a revie# performed y either an independent or an internal auditor.
d. specific criteria developed to define effectiveness.
!!.
medium
d
)uditors involved in planning, performing, or reporting on audits under %)%)3 must complete
6666 hours of continuing professional education in each t#o-year period.
a. !:
. .:
c. 8:
d. <:
!(.
medium
Chich of the follo#ing statements regarding types of operational audits is false$
a. ) functional audit has the advantage of permitting specialization y auditors.
Arens/Elder/Beasley
. )n advantage of functional auditing is its aility to evaluate interrelated functions.
c. /he emphasis in an organizational audit is on ho# efficiently and effectively functions
interact.
d. 3pecial operational auditing assignments arise at the re'uest of management.
!..
medium

/he t#o most important 'ualities for an operational auditor are:

a. personality and appearance.
. independence and competence.
c. competence and technical training.
d. academic ackground and sufficient e-perience.
!2.
medium
a
Chich of the follo#ing is not a difference et#een operational auditing and financial auditing$
a. 7oth must e C*)s.
. 4perational audit reports are usually of a restricted distriution #hile financial audit
reports are #idely distriuted.
c. 4perational audits often cover non-financial issues #hile financial audits do not.
d. Done of the aove is a difference.
!8.
medium
c
) typical o@ective of an operational audit is to determine #hether an entityAs:
a. internal control is ade'uately operating as designed.
. financial statements present fairly the results of operations.
c. specific operating units are functioning efficiently and effectively.
. operational information is in accordance #ith generally accepted government auditing
standards.
!;. Chich of the follo#ing can affect the independence of operational auditors$
medium Responsiilities Reporting 3tructure
d a. Jes Do
. Do Do
c. Do Jes
d. Jes Jes
!<.
challenging
d
Chich is not a purpose of an economy and efficiency audit$
a. Chether the entity is ac'uiring, protecting, and using resources economically and
efficiently.
. /he causes of inefficiencies and uneconomical practices.
c. Chether the entity has complied #ith la#s and regulations concerning matters of economy
and efficiency.
d. ?ach of the aove is a purpose.
!=.
challenging
d
)+n, 666666666 audit emphasizes ho# efficiently and effectively functions
interact.
a. operational
. compliance
c. financial
d. organizational
Arens/Elder/Beasley
(:.
challenging

Chich of the follo#ing is not a purpose of a program audit as performed y

government auditors$
a. Eetermination of the e-tent to #hich the desired results estalished y the legislature are
eing achieved.
. Eetermination of the causes of inefficiencies in sponsored programs.
c. Eetermination of the effectiveness of organizations, programs and activities.
d. Eetermination as to #hether the entity has complied #ith la#s and regulations applicale
to the program.
(1.
challenging
c
Chat distinguishes internal control evaluation and testing for financial and operational
auditing$
a. *urpose of the #ork.
. 3cope of the #ork.
c. 7oth a and .
d. Deither a nor .
(!.
challenging
c
4f the many hours of continuing professional education re'uired every t#o years, ho# many
must e in su@ects related to the government environment and government auditing for auditors
involved in planning, performing and reporting on audits under %)%)3$
a. < hours
. 18 hours
c. !. hours
d. (! hours
((. /o e effective, an internal audit department must report to:
Challenging
4perating departments /he accounting department
a. Jes Jes
. Do Do
c. Jes Do
d. Do Jes
(..
challenging
?-ternal financial statement auditors must otain evidence regarding #hat attriutes of an
internal audit department if the e-ternal auditors intend to rely on the internal auditorAs #ork$
d
"ndependence from the )udit Committee Competence
a. Jes Jes
. Do Do
c. Jes Do
d. Do Jes
?ssay Questions
(2.
easy
Chat organization estalishes auditing standards for internal auditors and #hat are those
standards commonly called$
)ns#er:
)uditing standards for internal auditors are estalished y the "nternal )uditing
3tandards 7oard. /hey are commonly kno#n as the 0Red 7ook.1
Arens/Elder/Beasley
(8.
medium
Chat are several similarities et#een internal and e-ternal auditors$
)ns#er:
7oth must e competent as auditors and remain o@ective in performing their #ork and
reporting their results.
7oth follo# a similar methodology in performing their audits, including planning and
performing tests of controls and sustantive tests.
7oth consider risk and materiality in deciding the e-tent of their tests and evaluating
results. Ho#ever, their decisions aout materiality and risks may differ, ecause
e-ternal users may have different needs than management or the oard.
(;.
medium
?-ternal auditors typically consider internal auditors effective if they meet three criteria. Chat
are these criteria$
)ns#er:
?-ternal auditors typically consider internal auditors effective if they are:
"ndependent of the operating units eing evaluated
Competent and #ell-trained
Have performed relevant audit tests of the internal controls and financial statements
(<.
medium
Ho# do the risk and materiality thresholds change in a government audit compared to a
financial statement audit of a pulic company$
)ns#er:
/he Jello# 7ook recognizes that in government audits the thresholds of acceptale audit
risk and materiality may e lo#er than in an audit of a commercial enterprise. /his is
ecause of the sensitivity of government activities and their pulic accountaility.
(=.
medium
Eiscuss each of the three phases of an operational audit.
)ns#er:
Planning. "n the planning phase, the auditor must determine the scope of the
engagement, staff the engagement, otain ackground information aout the
organizational unit, understand internal control, and decide on the appropriate
evidence to accumulate.
E%idence accumulation and e%aluation. "n operational auditing, it is common
to use documentation, client in'uiry, and oservation e-tensively, #hile confirmation
and reperformance are used less e-tensively for most operational audits than for
financial audits.
Reporting and follo)-up. /he audit report is tailored to address the scope of
the audit, findings, and recommendations and is typically sent only to management.
Chen recommendations are made to management, follo#-up is done to determine
#hether the recommended changes #ere made, and if not, #hy.
.:.
medium
/he "nstitute of "nternal )uditors has estalished ?thical *rinciples for its memers. &ist each
of the principles.
Arens/Elder/Beasley
)ns#er:
/he "")As ethical principles are:
"ntegrity.
4@ectivity.
Confidentiality.
Competency.
.1.
medium
Eefine internal auditing.
)ns#er:
)ccording to the ""): 0"nternal auditing is an independent, o@ective assurance and
consulting activity designed to add value and improve an organizationAs operations. "t
helps an organization accomplish its o@ectives y ringing a systematic, disciplined
approach to evaluate and improve the effectiveness of risk management, control, and
governance processes.1
.!.
medium
Eiscuss three ma@or differences et#een operational and financial auditing.
)ns#er:
Purpose of te audit. Binancial auditing emphasizes #hether historical
information #as correctly recorded, #hereas operational auditing emphasizes
effectiveness and efficiency.
.istri#ution of te reports. Bor financial auditing, the report typically goes to
many users of financial statements, such as stockholders and ankers, #hereas
operational audit reports are intended primarily for management.
Inclusion of nonfinancial areas in operational auditing. 4perational audits
cover any aspect of efficiency and effectiveness in an organization, #hereas financial
audits are limited to matters that directly affect the fairness of financial statement
presentations.
.(.
medium
Eiscuss each of the three road categories +types, of operational audits.
)ns#er:
Aunctional. ) functional audit deals #ith auditing one or more functions +e.g.,
purchasing, in an organization.
+rgani8ational. )n organizational audit deals #ith an entire organizational
unit, such as a department, ranch, or susidiary.
Special assignments. 3pecial assignments audits arise at the re'uest of
management #hen there is a need to investigate a particular area, such as
investigating the possiility of fraud in a division, or determining the cause of an
ineffective ?E* system.
...
medium
4perational auditing is the revie# of an organization for efficiency and effectiveness. Eiscuss
#hat is meant y the terms 0effectiveness1 and 0efficiency.1
)ns#er:
?ffectiveness refers to the degree to #hich the organizationAs o@ectives and
goals are accomplished.
Arens/Elder/Beasley
?fficiency refers to the degree to #hich costs are reduced #ithout reducing
effectiveness.
.2.
challenging
)udit tests as re'uired y the 3ingle )udit )ct must meet several specific o@ectives. 4ne
o@ective is to determine 0#hether the amounts reported as e-penditures #ere for allo#ale
services.1 "dentify three other specific o@ectives.
)ns#er:
Chether the records sho# that those #ho received services or enefits #ere
eligile to receive them.
Chether matching re'uirements, levels of effort, and earmarking limitations
#ere met.
Chether federal financial reports and claims for advances and
reimursements contain information that is supported y the ooks and records from
#hich the asic financial statements have een prepared.
Chether amounts claimed or used for matching #ere determined in
accordance #ith 4M7 Circular )-<; and 4M7 Circular )-1:!.
.8.
challenging
/he auditing standards of the Jello# 7ook are consistent #ith the ten generally accepted
auditing standards of the )"C*). /here are, ho#ever, important additionsKmodifications in the
Jello# 7ook. Bor e-ample, the Jello# 7ook recognizes that materiality and risk are lo#er due
to the nature of the government enterprise. Eiscuss the other additionsKmodifications.
)ns#er:
9ualit" control. )uditors of government entities must have an appropriate
system of internal 'uality control and participate in an e-ternal 'uality control revie#
program.
Compliance auditing. /he audit should e designed to provide reasonale
assurance of detecting material misstatements resulting from noncompliance #ith
provisions of contracts or grant agreements that have a material and direct effect on
the financial statements.
Reporting. /he report on financial statements must descrie the scope of the
auditorsA testing of compliance #ith la#s and regulations and internal controls and
present the results of those tests, or refer to a separate report containing that
information.
.;.
challenging
"n addition to an opinion on #hether the financial statements are in accordance #ith %))*,
identify four other reports re'uired y the 4M7 Circular )-1((.
)ns#er:
/he follo#ing reports are re'uired:
)n opinion as to #hether the schedule of federal a#ards is presented fairly in
all material respects in relation to the financial statements as a #hole.
) report on internal control related to the financial statements and ma@or
programs.
) report on compliance #ith la#s, regulations, and the provisions of contracts
or grant agreements, noncompliance #ith #hich could have a material effect on the
financial statements. /his report can e comined #ith the report on internal control.
) schedule of findings and 'uestioned costs.
Arens/Elder/Beasley
4ther 4@ective )ns#er Bormat Questions
.<. Match seven of the terms +a-o, #ith the descriptionsKdefinitions provided elo# +1-;,:
medium
a. Compliance audit
. ?conomy and efficiency audit
c. ?ffectiveness
d. ?fficiency
e. Bunctional audit
f. %overnment )uditing 3tandards
g. %overnment audit
h. "nstitute of "nternal )uditors
i. 4perational auditing
@. 4rganizational audit
k. *rogram audit
l. 3ingle )udit )ct
m. 3pecial assignment
n. "") *ractice 3tandards
o. 3tatements on "nternal )uditing 3tandards
f 1. /he official title of the Jello# 7ook.
m !. ) management re'uest for an operational audit for a specific purpose, such as
investigating the possiility of fraud in a division or making recommendations
for reducing the cost of a manufactured product.
(. ) government audit to determine #hether an entity is ac'uiring, protecting, and
using its resources economically and efficiently and #hether the entity has
complied #ith la#s and regulations concerning such matters.
c .. /he degree to #hich the organizationAs o@ectives are accomplished.
i 2. /he revie# of an organization for efficiency and effectiveness.
l 8. Bederal legislation that provides for a single coordinated audit to satisfy the
audit re'uirements of all federal funding agencies.
o ;. 3tatements issued y the "nternal )uditing 3tandards 7oard of the "") to
provide authoritative interpretation of the "") *ractice 3tandards.
.=.
easy

"ndependence is a fundamental ethical principle for internal auditors.

a. /rue
. Balse
2:.
easy

Current professional auditing standards prohiit e-ternal auditors from using internal auditors
for direct assistance on e-ternal audits.
a. /rue
. Balse
21.
easy

Current professional auditing standards re'uire e-ternal auditors to use internal auditors for
direct assistance on e-ternal audits.
a. /rue
. Balse
Arens/Elder/Beasley
2!.
easy
a
/he o@ectives of internal auditors are consideraly roader than the o@ectives of e-ternal
auditors.
a. /rue
. Balse
2(.
easy
a
Bor financial auditing, the audit report typically goes to many users of financial statements,
#hereas operational audit reports are intended primarily for management.
a. /rue
. Balse
2..
easy
a
"ntegrity is one of the "")As ethical principles.
a. /rue
. Balse
22.
easy

4perational audits are primarily geared to#ard compliance.

a. /rue
. Balse
28.
easy

?ffectiveness refers to the degree to #hich costs are reduced #ithout reducing efficiency.
a. /rue
. Balse
2;.
easy
a
?fficiency refers to the degree to #hich costs are reduced #ithout reducing effectiveness.
a. /rue
. Balse
2<.
easy

"nternal auditing standards are included in the Jello# 7ook.

a. /rue
. Balse
2=.
easy
a
%overnment auditing standards are included in the Jello# 7ook.
a. /rue
. Balse
8:.
easy
a
?ffectiveness is concerned #ith #hether defined goals are achieved, #hereas efficiency is
concerned #ith #hether the goals are achieved #ith a minimum use of resources.
a. /rue
. Balse
81.
easy

4perational audits may e performed y internal auditors and government auditors, ut not y
e-ternal auditors.
a. /rue
. Balse
8!.
easy
a
7enchmarking is one source of evaluation criteria for completing an operational audit.
a. /rue
. Balse
8(.
easy
a
/he t#o most important 'ualities for an internal auditor to possess are independence and
competence.
a. /rue
. Balse
8..
easy

*rogram audits are primarily focused on inefficient uses of federal funds in sponsored
programs.
a. /rue
. Balse
Arens/Elder/Beasley
82.
easy
a
/he formal name of the Jello# 7ook is &o%ernment Auditing Standards.
a. /rue
. Balse
88.
medium
a
*rofessional guidelines for performing internal audits for companies are not as #ell-defined as
for e-ternal audits.
a. /rue
. Balse
8;.
medium

/o help them remain independent of the operations they audit, internal auditors should report
directly to the controller.
a. /rue
. Balse
8<.
medium
a
)n operational auditor may use 0engineered standards1 as evaluation criteria.
a. /rue
. Balse
8=.
medium
a
/he "nternal )uditing 3tandards 7oard issues Statements on Internal Auditing Standards.
a. /rue
. Balse
;:.
medium
a
4perational audits are often categorized as functional, organizational, or special assignments.
a. /rue
. Balse
;1.
medium

"nternal auditors should have the authority to re'uire implementation of suggestions for
improvement.
a. /rue
. Balse
;!.
medium

/he 0Red 7ook1 specifies all auditing standards issued y the >.3. %eneral )ccounting 4ffice.
a. /rue
. Balse
;(.
challenging
a
4ne disadvantage of functional auditing is the failure to evaluate interrelated functions.
a. /rue
. Balse
Arens/Elder/Beasley