Deck 6: Planning, Understanding the Entity and Evaluating Business Risk

Question 1

During preliminary audit planning:

A) the auditor considers the possibility of business failure.
B) the auditor designs the audit to search for evidence to support the company's continued existence.
C) the auditor does not need to consider the possibility of business failure because that is a procedure performed during the overall evaluation at the end of the audit.
D) the auditor inquires of the company's legal advisers concerning the possibility of going concern problems.

Answer 1

A

Question 2

The scope and nature of an auditor's contractual obligation to a client ordinarily is established in the:

A) engagement letter.
B) Corporations Act 2001.
C) management letter.
D) client's constitution.

Answer 2

A

Question 3

An audit program should be designed for each individual audit and should include audit steps and procedures to:

A) ensure that only material items are audited.
B) detect all fraud.
C) identify all internal control weaknesses.
D) ensure an efficient and effective audit.

Answer 3

D

Question 4

Because of the risk of material misstatement, an audit of a financial report in accordance with the auditing standards should be planned and performed with an attitude of:

A) objective judgment.
B) independent integrity.
C) professional scepticism.
D) impartial conservatism.

Question 5

When an auditor is approached to perform an audit for the first time, the auditor should make inquiries of the previous auditor. This is a necessary procedure because the predecessor may be able to provide the successor with information that will assist the successor in determining:

A) whether the predecessor's work should be utilised.
B) whether the company follows the policy of rotating its auditors.
C) whether the predecessor's assessment of control risk has been high.
D) whether the engagement should be accepted.

Question 6

An auditor who finds that the client has committed an illegal act would be most likely to withdraw from the engagement when the:

A) illegal act affects the auditor's ability to rely on management representations.
B) illegal act has material financial report implications.
C) illegal act has received widespread publicity.
D) auditor cannot reasonably estimate the effect of the illegal act on the financial report.

Question 7

Time budgets on audit engagements are not used for which of the following reasons?

A) Monitor actual audit hours worked by staff on an engagement.
B) Ensure that adequate time is allocated to significant areas of the audit.
C) Estimate an appropriate fee for the engagement.
D) To ensure that audit staff working on the engagement are paid the correct amount.

Question 8

Which of the following factors most likely would cause an auditor to not accept a new audit engagement?

A) An inadequate understanding of the entity's internal control.
B) The close proximity to the end of the entity's fiscal year.
C) The conclusion that the entity's management probably lacks integrity.
D) An inability to perform preliminary analytical procedures before assessing control risk.

Question 9

To ascertain the exact name of the corporate client, the auditor relies primarily on:

A) corporate minutes.
B) by-laws.
C) company constitution.
D) tax returns.

Question 10

A prospective client's refusal to give permission to communicate with the previous auditor and review certain portions of the previous auditor's working papers will bear directly on the auditor's decision concerning the:

A) ability to establish consistency in application of accounting principles.
B) apparent scope limitation.
C) integrity of management.
D) adequacy of the planned audit program.

Question 11

What is the responsibility of an auditor with respect to communicating with the previous auditor in connection with a prospective new audit client?

A) The auditor has no responsibility to contact the previous auditor.
B) The auditor should contact the previous auditor regardless of whether the prospective client authorises contact.
C) The auditor need not contact the previous auditor if the successor is aware of all available facts.
D) The auditor should obtain permission from the prospective client to contact the previous auditor.

Question 12

An audit firm's quality control procedures pertaining to the acceptance of a prospective audit client would most likely include:

A) inquiry of management as to whether disagreements between the previous auditor and the prospective client were resolved satisfactorily.
B) consideration of whether sufficient appropriate audit evidence may be obtained to afford a reasonable basis for an opinion.
C) inquiry of third parties, such as the prospective client's bankers and solicitors, about information regarding the prospective client and its management.
D) consideration of whether the internal control is sufficiently effective to permit a reduction in the extent of required substantive tests.

Question 13

An auditor obtains knowledge about a new client's business and its industry in order to:

A) make constructive suggestions concerning improvements to the client's internal control.
B) develop an attitude of professional scepticism concerning management's financial report assertions.
C) evaluate whether the aggregation of known misstatements causes the financial report taken as a whole to be materially misstated.
D) understand the events and transactions that may have an effect on the client's financial report.

Question 14

Engagement letters include all of the following except:

A) a list of additional services that will be provided.
B) a list of adjusting journal entries.
C) information about the audit fee.
D) arrangements involving the use of experts.

Question 15

An auditor searching for related-party transactions should obtain an understanding of each subsidiary's relationship to the total entity because:

A) intercompany transactions may have been consummated on terms equivalent to arm's length transactions.
B) this might reveal whether particular transactions would have taken place if the parties had not been related.
C) the business structure may be deliberately designed to obscure related-party transactions.
D) this might permit the audit of intercompany account balances to be performed as of concurrent dates.

Question 16

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 the prospective client's signature on the engagement letter.
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.

Question 17

Which of the following should an auditor obtain from the previous auditor prior to accepting an audit engagement?

A) Analysis of statement of financial position accounts.
B) Analysis of income statement accounts.
C) All matters of continuing accounting significance.
D) Facts that might bear on the integrity of management.

Question 18

Inquiry of the previous auditor is:

A) required about matters that have a bearing on acceptance of the client.
B) required after acceptance of a new client regarding matters the successor believes may affect the conduct of his or her audit.
C) helpful to the successor and may facilitate the successor's audit, but is not required either before or after acceptance of the client.
D) required only if the change in auditors resulted from a disagreement between the client and previous auditors.

Question 19

Which of the following situations would most likely require special audit planning by the auditor?

A) Some items of factory and office equipment do not bear identification numbers.
B) Depreciation methods used on the client's tax return differ from those used on the books.
C) Assets costing less than $500 are expensed even though the expected life exceeds one year.
D) Inventory is comprised of precious gemstones.

Question 20

Prior to the acceptance of an audit engagement with a client who has terminated the services of the previous auditor, the proposed auditor should:

A) contact the previous auditor without advising the prospective client and request a complete report of the
Circumstances leading to the termination with the understanding that all information disclosed will be kept confidential.
B) accept the engagement without contacting the previous auditor, since the proposed auditor can include audit procedures to verify the reason given by the client for the termination.
C) not communicate with the previous auditor, because this would in effect be asking the auditor to violate the confidential relationship between auditor and client.
D) advise the client of the intention to contact the previous auditor and request permission for the contact.

Question 21

Analytical procedures are:

A) never required.
B) required for planning, substantive testing and overall review of the financial report.
C) required for planning and overall review of the financial report.
D) required during planning only.

Question 22

In applying analytical procedures, the identification of the relationships and types of data used, as well as conclusions reached when recorded amounts are compared to expectations, requires:

A) judgment by the auditor.
B) participation by senior audit team members.
C) understanding of complex models.
D) advanced training in plausibility formulation.

Question 23

Which of the following is the most likely first step that an auditor will perform after accepting an initial audit engagement?

A) Prepare a rough draft of the financial report and of the auditor's report.
B) Assess control risk for the assertions embodied in the financial report.
C) Tour the client's facilities and review the general records.
D) Consult with and review the work of the previous auditor prior to discussing the engagement with the client management.

Question 24

Which of the following is not a benefit of analytical procedures?

A) Assists in understanding a client's business and identifying areas of potential risk.
B) Enables the auditor to review the financial and non-financial information of a client.
C) May reduce the level of detailed audit testing if the control system surrounding the reliability of the information is strong.
D) Provides adjustments to error levels during tests of control.

Question 25

Which of the following is not an important consideration in an auditor's evaluation of an entity's business risk?

A) The specific business risks that an entity faces may result in financial report errors and fraud.
B) Business risk factors affect the ability of an entity to be profitable and survive.
C) Auditing standards include many entity business risk factors that identify circumstances that increase the likelihood of material misstatements.
D) Auditing standards require the auditor to evaluate the entity's business risk in order to provide suggestions to improve the entity's profitability.

Question 26

The auditor is most likely to rely on analytical procedures alone if a balance is:

A) material and internal controls are good.
B) immaterial and internal controls are poor.
C) immaterial and inherent risk is high.
D) immaterial and internal controls are good.

Question 27

Analytical procedures used in planning an audit should focus on identifying:

A) the predictability of financial data from individual transactions.
B) the various assertions that are embodied in the financial report.
C) areas that may represent specific risk relevant to the audit.
D) material weaknesses in internal control.

Question 28

Significant unexpected differences identified by analytical procedures will usually necessitate:

A) a review of internal control.
B) an explanation in the representation letter.
C) investigation by the auditor.
D) addition of an 'emphasis of matter' paragraph to the auditor's report.

Question 29

Analytical procedures may be classified as being primarily:

A) tests of control.
B) detailed tests of balances.
C) tests of ratios.
D) substantive tests.

Question 30

Which of the following is not a typical analytical procedure?

A) Study of relationships of the financial information with relevant non-financial information.
B) Comparison of the financial information with similar information regarding the industry in which the entity operates.
C) Comparison of recorded amounts of major disbursements with appropriate invoices.
D) Comparison of the financial information with budgeted amounts.

Question 31

Which of the following procedures would not be used to obtain an understanding of the entity and its environment?

A) Observe entity operations.
B) Re-perform entity processes.
C) Verify proper evaluation of inventory subject to technological obsolescence.
D) Review prior year's audit documentation.

Question 32

Which of the following is not a threat in a SWOT analysis?

A) Changing buyer tastes.
B) Additional regulatory requirements.
C) Rising sales of substitute products.
D) Diversifying into related products.

Question 33

Which of the following tends to be most predictable for purposes of analytical procedures applied as substantive tests?

A) Relationships involving statement of financial position accounts.
B) Transactions subject to management discretion.
C) Relationships involving income statement accounts.
D) Data subject to audit testing in the prior year.

Question 34

An auditor compares this year's revenues and expenses with those of the previous year and investigates all changes exceeding 10 per cent. By carrying out this procedure the auditor would be most likely to learn that:

A) an increase in property tax rates has not been recognised in the client's accrual.
B) the provision for uncollectible accounts is inadequate because of worsening economic conditions.
C) fourth-quarter payroll taxes were not paid.
D) the client changed its capitalisation policy for small tools.

Question 35

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

A) engage financial experts familiar with the nature of the business entity.
B) obtain knowledge of matters that relate to the nature of the entity's business.
C) refer a substantial portion of the audit to another auditor, who will act as the principal auditor.
D) first inform management that an unmodified auditor's opinion cannot be issued.

Question 36

An example of an analytical procedure is the comparison of:

A) recorded amounts of major disbursements with appropriate invoices.
B) results of a statistical sample with the expected characteristics of the actual population.
C) computer-generated data with similar data generated by a manual accounting system.
D) financial information with similar information regarding the industry in which the entity operates.

Question 37

One reason why the independent auditor performs analytical procedures of the client's operations is to identify:

A) deficiencies of a material nature in the internal control.
B) unusual transactions.
C) non-compliance with prescribed control procedures.
D) improper separation of accounting and other financial duties.

Question 38

Auditors sometimes use comparison of ratios as audit evidence. For example, an unexplained decrease in the ratio of gross profit to sales may suggest which of the following possibilities?

A) Unrecorded sales.
B) Merchandise purchases charged to selling and general expense.
C) Fictitious sales.
D) Unrecorded purchases.

Question 39

The auditor generally gives most emphasis to ratio and trend analysis in the examination of:

A) retained earnings.
B) income.
C) financial position.
D) cash flows.

Question 40

Analytical procedures that are required in all audits of financial reports are analytical procedures:

A) relevant to achieving important audit objectives related to particular assertions.
B) expected to be efficient and effective in the circumstances.
C) based on available and reliable financial data.
D) used in the planning and overall review stages.

Question 41

Which of the following is a nonfinancial performance measure?

A) Warranty rates.
B) Return on investment.
C) Net profit.
D) Sales.

Question 42

An auditor would place most reliance on the results of analytical procedures when there is:

A) material balance, low inherent risk, low control risk.
B) immaterial balance, high inherent risk, high control risk.
C) material balance, low inherent risk, high control risk.
D) immaterial balance, low inherent risk, low control risk.

Question 43

The auditor notices significant fluctuations in key elements of the company's financial report. If management is unable to provide an acceptable explanation, the auditor should:

A) consider the matter a scope limitation.
B) perform additional audit procedures to investigate the matter further.
C) intensify the examination with the expectation of detecting management fraud.
D) withdraw from the engagement.

Question 44

An abnormal fluctuation in gross profit that might suggest the need for extended audit procedures for sales and inventories would most likely be identified in the planning phase of the audit by the use of:

A) tests of transactions and balances.
B) a preliminary review of internal accounting control.
C) specialised audit programs.
D) analytical procedures.