Accounting 408 Name __________________________

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

Summer 2017 Row _______

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

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

1. Which of the following characteristics most likely will heighten an auditor’s concern about the risk of

material misstatements due to fraud in an entity’s financial statements?

a. Employees who handle cash receipts are not bonded.

b. Internal auditors have direct access to the board of directors and the entity’s management.

c. The audit committee is active in overseeing the entity’s financial reporting policies.

d. The entity’s industry is experiencing declining customer demand.

2. Which procedure must be performed during the planning stage of the audit concerning potential fraud?

a. Document the results of procedures used to address the risk of fraud.

b. Consider the characteristics of journal entries, particularly those made near year end.

c. Consider whether estimates prepared and recorded by management could indicate a bias in reporting.

d. Conduct discussions among the engagement personnel regarding the risks of material misstatement due

to error or fraud.

3. Based on the video shown in class, the White Electric Supply Company fraud

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

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

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

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

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

include each of the following except a(n)

a. incentive or pressure to commit fraud.

b. professional skepticism about the likelihood of fraud.

c. opportunity to commit fraud.

d. attitude or rationalization about the act of fraud.

5. Moor, CPA, discovers a likely fraud during an audit but concludes that its effects, if any, could not be so

material as to affect the opinion. Moor should

a. notify the proper external authorities.

b. perform additional audit procedures to establish that fraud has occurred.

c. confer with the client about the additional audit procedures necessary to establish that fraud has

occurred.

d. report the finding to the appropriate representatives of the client with the recommendation that it be

pursued to a conclusion.

6. Which of the following certifications shows expertise in fraud auditing?

a. CFE

b. CIA

c. CMA

d. CPA

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

a. management representation letter.

b. scope paragraph of the auditor’s report.

c. engagement letter.

d. introductory paragraph of the auditor’s report.

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

engagement?

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

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

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

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

9. Early appointment of the auditor enables preliminary work to be performed by the auditor that benefits the

client because it permits the audit to be performed in

a. a more efficient manner.

b. a more thorough manner.

c. accordance with quality control standards.

d. accordance with generally accepted auditing standards.

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

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

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

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

plan.

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

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

procedures?

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

expectations developed by management.

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

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

of control risk.

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

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

a. unusual transactions and events.

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

c. related party transactions.

d. recorded transactions that were not properly authorized.

13. If the independent auditors decide that it is efficient to consider how the work performed by the internal

auditors may affect the nature, timing, and extent of audit procedures, they should assess the internal

auditors’

a. efficiency and experience.

b. independence and review skills.

c. training and supervisory skills.

d. competence and objectivity.

14. The section of the auditor’s audit documentation called the permanent file usually contains the

a. confirmation received from the bank.

b. engagement letter.

c. organization chart.

d. audit plan.

15. Which of the following would an auditor most likely use in determining the auditor’s preliminary judgment

about materiality?

a. The anticipated sample size of the planned substantive tests.

b. The entity’s annualized interim financial statements.

c. The results of the internal control questionnaire.

d. The contents of the representation letter.

16. Vouching sales invoices to shipping documents provides evidence that

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

b. invoiced sales were recorded in the sales journal.

c. shipments to customers were invoiced.

d. recorded sales were shipped.

17. The acceptable level of detection risk is inversely related to the

a. assurance provided by substantive tests.

b. risk of misapplying auditing procedures.

c. preliminary judgment about materiality levels.

d. risk of failing to discover material misstatements.

18. Which of the following audit risk components may be assessed in nonquantitative terms?

Control Detection Inherent

Risk Risk Risk

a. Yes Yes Yes

b. No Yes Yes

c. Yes Yes No

d. Yes No Yes

19. Audit risk at the account balance, transaction class, or disclosure level consists of inherent risk, control risk,

and detection risk. Which of the following statements is true?

a. Cash is more susceptible to theft than an inventory of coal because it has a greater inherent risk.

b. The risk that material misstatement will not be prevented or detected on a timely basis by internal

control can be reduced to zero by effective controls.

c. Detection risk is a function of the efficiency of an auditing procedure.

d. The existing levels of inherent risk, control risk, and detection risk can be changed at the discretion of

the auditor.

20. Which of the following is a step in an auditor’s decision to rely on the internal controls?

a. Apply analytical procedures to both financial data and nonfinancial information to detect conditions

that may indicate weak controls.

b. Perform tests of details of transactions and account balances to identify potential errors and fraud.

c. Identify specific controls that are likely to detect or prevent material misstatements and perform tests

of controls.

d. Document that the additional audit effort to perform tests of controls exceeds the potential reduction in

substantive testing.

21. Regardless of the assessed risk of material misstatement, an auditor of a nonissuer would perform some

a. tests of controls to determine their effectiveness.

b. analytical procedures to verify the design of controls.

c. substantive procedures to restrict detection risk for significant transaction classes.

d. dual-purpose tests to evaluate both the risk of monetary misstatement and preliminary control risk.

22. Which of the following statements about the auditor’s response to assessed risks in a financial statement

audit is true?

a. Risk assessment procedures performed to obtain an understanding of an entity’s internal control also

may serve as tests of controls.

b. When the risk of material misstatement is high, an auditor should reduce the amount of substantive

testing.

c. Reliance on internal control may be sufficient to allow the auditor to eliminate substantive testing for

significant transaction classes.

d. When assessing the risk of material misstatement, an auditor should not consider evidence obtained in

prior audits about the operation of controls.

23. According to auditing standards about audit risk and materiality in conducting an audit, the concepts of

audit risk and materiality are interrelated and must be considered together by the auditor. Which of the

following is true?

a. Material fraud but not material errors cause financial statements to be materially misstated.

b. If misstatements are not important individually but are important in the aggregate, the concept of

materiality does not apply.

c. Audit risk is the risk that the auditor may unknowingly express a modified opinion when in fact the

financial statements are fairly stated.

d. The phrase in the auditor’s standard report “present fairly, in all material respects, in conformity with

generally accepted accounting principles” indicates the auditor’s belief that the financial statements

taken as a whole are not materially misstated.

24. The auditing standards gives a formula for risk relationships. Overall allowable audit risk (AR) is the risk

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

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

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

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

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

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

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

a. TD = AR ÷ (RMM × AP).

b. TD = RMM ÷ (AR × AP).

c. TD = AP ÷ (RMM × AR).

d. TD = RMM × AP × AR.

Use this information for questions 25 – 28.

Two auditors, Mark and Molly, independently assessed the risks associated with their client's accounts

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

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

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

25. What is detection risk for Mark?

a. .50

b. .25

c. .20

d. .16

26. What is detection risk for Molly?

a. .50

b. .25

c. .20

d. .16

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

risk, then detection risk for each auditor would

a. decrease.

b. increase.

c. remain unchanged.

d. cannot be determined with the information given.

28. Which auditor, Mark or Molly, will have to collect the most substantive testing evidence?

a. Mark.

b. Molly.

c. Evidence is never collected in an audit.

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

29. The auditor should perform tests of controls when the auditor’s risk assessment includes an expectation of

the operating effectiveness of internal control or when

a. substantive procedures alone do not provide sufficient appropriate audit evidence at the relevant

assertion level.

b. tests of details and substantive analytical procedures provide sufficient appropriate audit evidence to

support the assertion being evaluated.

c. the auditor is not able to obtain an understanding of internal controls.

d. the owner-manager performs virtually all the functions of internal control.

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

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

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

b. material misstatements may exist in the financial statements.

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

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

31. When assessing the risk of material misstatement at a low level, an auditor is required to document the

auditor’s

Understanding of Overall

the Entity's Control Responses to

Environment Assessed Risks

a. Yes No

b. No Yes

c. Yes Yes

d. No No

32. The Sarbanes-Oxley Act of 2002 (SOX) requires management of issuers to do all of the following except

a. establish and document internal control procedures and to include in their annual reports a report on

the company’s internal control over financial reporting.

b. provide a report to include a statement of management’s responsibility for and assessment of internal

control.

c. provide an identification of the framework used to evaluate the effectiveness of internal control.

d. provide a statement that the board approves changes in internal control procedures.

33. During the audit of internal controls for an issuer, the auditor discovered a material weakness in internal

control. The auditor would most likely express a(n)

a. adverse opinion on internal control.

b. qualified opinion on internal control.

c. unqualified opinion on internal control.

d. disclaimer of opinion on internal control.

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

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

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

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

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

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

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

A = Tests of controls

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

C. = Substantive tests

a. ABC.

b. ACB.

c. BAC.

d. BCA.

36. The auditor should perform tests of control when the auditor’s risk assessment includes an expectation

a. of a low level of inherent risk.

b. that the controls are not being applied.

c. that the controls are not suitably designed.

d. of the operating effectiveness of internal control.

37. An auditor wishes to evaluate the design and perform tests of controls over a client’s cash disbursements

procedures. If the controls leave no audit trail of documentary evidence, the auditor most likely will test

the procedures by

a. confirmation and observation.

b. observation and inquiry.

c. analytical procedures and confirmation.

d. inquiry and analytical procedures.

38. Which of the following audit procedures most likely would provide an auditor with the most assurance

about the effectiveness of the operation of a client's internal control?

a. Substantive tests of control procedures.

b. Reperformance of client’s control procedures.

c. Inquiry of client personnel about control procedures.

d. Confirmation with outside parties about the control procedures.

39. After auditors assess RMM at a high level, they will tend to

a. perform a great deal of risk assessment procedures.

b. perform a great deal of walkthroughs.

c. perform a great deal of tests of controls.

d. perform a great deal of substantive tests.

40. The most important component of an entity’s internal control is the

a. risk assessment function.

b. monitoring element.

c. information and communication system.

d. control environment.

41. In a sampling application, the group of items about which the auditor wants to estimate some characteristic

is called the

a. population.

b. attribute of interest.

c. sample.

d. sampling unit.

42. The probability that an auditor’s conclusion based on a sample might be different from the conclusion

based on an audit of the entire population is the concept of

a. sampling risk.

b. the confidence level.

c. statistical sampling.

d. the tolerable rate.

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

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

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

The auditor should

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

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

ineffective.

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

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

44. Statistical sampling usually may be applied in tests of controls when the client’s controls

a. permit detection of material misstatements in the accounting records.

b. leave an audit trail.

c. are described in accounting manuals.

d. depend primarily on separation of duties.

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

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

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

c. Selecting accounts receivable for confirmation of account balances.

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

46. As a result of sampling procedures applied as tests of controls, an auditor incorrectly assesses control risk

too low. The most likely explanation for this situation is that the

a. deviation rates of both the auditor’s sample and the population exceed the tolerable rate.

b. deviation rates of both the auditor’s sample and the population are less than the tolerable rate.

c. deviation rate in the auditor’s sample is less than the tolerable rate, but the deviation rate in the

population exceeds the tolerable rate.

d. deviation rate in the auditor’s sample exceeds the tolerable rate, but the deviation rate in the population

is less than the tolerable rate.

47. If systematic selection is used with a starting point of 10, a population size of 100, and a necessary sample

size of 20, the first three items selected for examination would be

a. 10, 110, 210.

b. 110, 210, 310.

c. 10, 15, 20.

d. 15, 20, 25.

Use the following information for questions 48 – 50.

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

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

Round in the most appropriate way.

Case: A B C

Risk of Overreliance (Risk of

Assessing Control Risk Too Low)

5%

5%

10%

Tolerable Deviation Rate

7%

15%

5%

Expected Deviation Rate

1%

4%

0%

Actual Number of Deviations

Found

0

2

0

48. The sample size for Case A is

a. 22

b. 42

c. 66

d. 93

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

actual computed sample)

a. 3.8

b. 4.2

c. 4.6

d. 15.0

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

actual computed sample)

a. 11.4

b. 8.4

c. 6.5

d. 5.0

Que. No. Answer Que. No. Answer

1 d 26 c

2 d 27 b

3 b 28 a

4 b 29 a

5 d 30 b

6 a 31 c

7 c 32 d

8 b 33 a

9 a 34 b

10 b 35 c

11 b 36 d

12 a 37 b

13 d 38 b

14 c 39 d

15 b 40 d

16 d 41 a

17 a 42 a

18 a 43 c

19 a 44 b

20 c 45 d

21 c 46 c

22 a 47 c

23 d 48 c

24 a 49 c

25 d 50 d