Chapter 6 - Test Bank

Chapter 06 - Audit Planning, Understanding the Client, Assessing Risks, and Responding
Chapter 06
Audit Planning, Understanding the Client, Assessing Risks, and Responding
True / False Questions
1. Audit committees should be made up of the most qualified directors regardless of whether
they are part of management of the company.
True False
2. Analytical procedures are seldom used during the risk assessment stage of an audit
engagement because they are substantive procedures.
True False
3. Preliminary arrangements with clients should be set forth in the management letter.
True False
4. An audit plan includes a detailed listing of the audit procedures to be performed in the
verification of items in the financial statements.
True False
5. The auditors' tests of controls are designed to substantiate the fairness of specific financial
statement accounts.
True False
6. At least a portion of the auditors' consideration of internal control usually is performed at

an interim date rather than at the balance sheet date.
True False
6-1
7. The substantive approach to an audit is appropriate for many small businesses.

True False
8. Confirming a bank account establishes existence but not rights to the cash balance.
True False
9. The completeness of recording of assets is generally verified by tracing from the source
documents to the recorded entry.
True False
10. Vouching the acquisition of assets is an audit procedure that is often performed to
establish the valuation of the assets.
True False
Multiple Choice Questions
11. Which of the following factors most likely would cause a CPA to not accept a new audit
engagement?
A. The prospective client has fired its prior auditor.
B. The CPA lacks a thorough understanding of the prospective client's operations and
industry.
C. The CPA is unable to review the predecessor auditor's working papers due to a major fire
that destroyed both hard and soft copy documentation.
D. The prospective client is unwilling to make financial records available to the CPA.
12. Which of the following factors most likely would heighten an auditor's concern about the
risk of fraudulent financial reporting?
A. Large amounts of liquid assets that are easily convertible into cash.
B. Low growth and profitability as compared to other entity's in the same industry.
C. Financial management's participation in the initial selection of accounting principles.
D. An overly complex organizational structure involving unusual lines of authority.
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13. Which of the following factors would most likely cause a CPA to decide not to accept a
new audit engagement?
A. Lack of understanding of the potential client's internal auditors' computer-assisted audit
techniques.
B. Management's disregard for internal control.
C. The existence of related party transactions.
D. Management's attempt to meet earnings per share growth rate goals.
14. Which of the following matters is generally included in an auditor's engagement letter?
A. Limitations of the engagement.
B. Factors to be considered in establishing preliminary judgments about materiality.
C. Management's liability for all illegal acts committed by its employees.
D. The auditor's responsibility to obtain negative assurance relating to non-compliance with
laws and regulations.
15. Which of the following would heighten an auditor's concern about the risk of fraudulent
financial reporting?
A. Inability to generate positive cash flows from operations, while reporting large increases in
earnings.
B. Management's lack of interest in increasing the dividend paid on common stock.
C. Large amounts of liquid assets that are easily convertible into cash.
D. Inability to borrow necessary capital without obtaining waivers on debt covenants.
16. To best test existence, an auditor would sample from the:

A. General ledger to source documents.
B. General ledger to the financial statements.
C. Source documents to the general ledger.
D. Source documents to journals.
17. The auditors' understanding established with a client should be established through a(an):
A. Oral communication with the client.
B. Written communication with the client.
C. Written or oral communication with the client.
D. Completely detailed audit plan.
6-3
18. Which of the following would be least likely to be considered an audit planning
procedure?
A. Use an engagement letter.
B. Develop the overall audit strategy.
C. Perform the risk assessment.
D. Develop the audit plan.
19. While assessing the risks of material misstatement auditors identify risks, relate risk to
what could go wrong, consider the magnitude of risks and:
A. Assess the risk of misstatements due to illegal acts.
B. Consider the complexity of the transactions involved.
C. Consider the likelihood that the risks could result in material misstatements.
D. Determine materiality levels.
20. Which of the following is correct concerning requirements about auditor communications
about fraud?
A. Fraud that involves senior management should be reported directly to the audit committee
regardless of the amount involved.
B. All fraud with a material effect on the financial statements should be reported directly by
the auditor to the Securities and Exchange Commission.
C. Fraud with a material effect on the financial statements should ordinarily be disclosed by
the auditor through use of an "emphasis of a matter" paragraph added to the audit report.
D. The auditor has no responsibility to disclose fraud outside the entity under any
circumstances.
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21. A predecessor auditor will ordinarily initiate communication with the successor auditor:
A. Option A
B. Option B
C. Option C
D. Option D
22. Which measure of materiality (or both) considers quantitative considerations?
A. Option A
B. Option B
C. Option C
D. Option D
23. Which of the following factors most likely would lead a CPA to conclude that a potential
audit engagement should not be accepted?
A. There are significant related party transactions that management claims occurred in the
ordinary course of business.
B. Internal control activities requiring the segregation of duties are subject to management
override.
C. Management continues to employ an inefficient system of information technology to
record financial transactions.
D. It is unlikely that sufficient evidence is available to support an opinion on the financial
statements.
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24. In using the information on the statement of cash flows while obtaining an understanding
of a profitable, growing company, which of the following would ordinarily be least surprising
to an auditor?
A. Decreases in accounts payable.
B. Decreases in accounts receivable.
C. Negative cash flows from investing.
D. Negative operating cash flows.
25. Audits of financial statements are designed to obtain reasonable assurance of detecting
material misstatements due to:
A. Option A
B. Option B
C. Option C
D. Option D
26. Which of the following is not one of the assertions made by management about an
account balance?
A. Relevance.
B. Existence.
C. Valuation.
D. Rights and obligations.
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27. When a company has changed auditors, according to the Professional Standards:
A. The successor auditor has the responsibility to initiate contact with the predecessor auditor
to ask about the client before the engagement is accepted; the predecessor has no
responsibility to initiate this contact, even when aware of matters bearing on the integrity of
management.
B. The predecessor must always respond fully to all inquiries made by the successor auditor.
C. The successor must discuss with the predecessor matters bearing on the engagement prior
to accepting the engagement.
D. The successor may choose not to attempt any communication with the predecessor auditor.
28. Which of the following procedures is not performed as a part of planning an audit
engagement?
A. Reviewing the working papers of the prior year.
B. Developing an overall audit strategy.
C. Confirmation of all major accounts.
D. Designing an audit program.
29. The risk of a material misstatement occurring in an account, assuming an absence of

internal control, is referred to as:
A. Account risk.
B. Control risk.
C. Detection risk.
D. Inherent risk.
30. Which of the following is least likely to be considered a financial statement audit risk
factor?
A. Management operating and financing decisions are dominated by top management.
B. A new client with no prior audit history.
C. Rate of change in the entity's industry is rapid.
D. Profitability of the entity relative to its industry is inconsistent.
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31. Which of the following is an example of fraudulent financial reporting?

A. Company management falsifies inventory count tags thereby overstating ending inventory
and understating cost of goods sold.
B. An employee diverts customer payments to his personal use, concealing his actions by
debiting an expense account, thus overstating expenses.
C. An employee steals inventor and the "shrinkage" is recorded in cost of goods sold.
D. An employee "borrows" tools from the company and neglects to return them; the cost is
reported as a miscellaneous operating expense.
32. Which of the following is most likely to be considered a risk factor relating to fraudulent
A. Low turnover of senior management.
B. Extreme degree of competition within the industry.
C. Capital structure including various operating subsidiaries.
D. Sales goals in excess of any of the preceding three years.
33. Which of the following conditions identified during the audit increases the risk of
employee fraud?
A. Large amounts of cash in the bank.
B. Existence of a mandatory vacation policy for employees performing key functions.
C. Inventory items of small size, but high value.
D. Presence of reconciling items on a client prepared year-end proof of cash.
34. Which of the following statements is accurate about "fraud risk factors" considered when
conducting an audit?
A. Factors whose presence indicates that fraud exists.
B. Factors whose presence often have been observed in circumstances where frauds have
occurred.
C. Factors whose presence will require modification to planned audit procedures.
D. Factors obtained during the audit which lead to required communications with the audit
committee.
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35. Which of the following is not an example of a likely adjustment in the auditors' overall
audit approach when significant risk is found to exist?
A. Apply increased professional skepticism about material transactions.
B. Increase the assessed level of detection risk.
C. Assign personnel with particular skill to areas of high risk.
D. Obtain increased evidence about the appropriateness of management's selection of
accounting principles.
36. Which of the following is least likely to be required on an audit?

A. Evaluate the business rationale for significant, unusual transactions.
B. Make a legal determination of whether fraud has occurred.
C. Review accounting estimates for biases.
D. Test appropriateness of journal entries and adjustments.
37. Which of the following is (are) considered a further audit procedure(s) that may be
designed after assessing the risks of material misstatement?
A. Option A
B. Option B
C. Option C
D. Option D
38. Which of the following circumstances would an auditor most likely consider a risk factor
relating to misstatements arising from fraudulent financial reporting?
A. Several members of management have recently purchased additional shares of the entity's
stock.
B. Several members of the board of directors have recently sold shares of the entity's stock.
C. The entity distributes financial forecasts to financial analysts that predict conservative
operating results.
D. Management is interested in maintaining the entity's earnings trend by using aggressive
accounting practices.
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39. A successor auditor is required to attempt communication with the predecessor auditor
prior to:
A. Performing test of controls.
B. Testing beginning balances for the current year.
C. Making a proposal for the audit engagement.
D. Accepting the engagement.
40. If the business environment is experiencing a recession, the auditor most likely would
focus increased attention on which of the following accounts?
A. Purchase returns and allowances.
B. Allowance for doubtful accounts.
C. Common stock.
D. Noncontrolling interest of a subsidiary purchased during the year.
41. The risk that the auditors' procedures will lead them to conclude that a material
misstatement does not exist in an account balance when in fact such a misstatement does exist
is referred to as:
A. Account risk.
B. Control risk.
C. Detection risk.
D. Inherent risk.
42. Which of the following statements is correct regarding the auditor's determination of
materiality?
A. The planning level of materiality should normally be the larger of the amount considered
for the balance sheet versus the income statement.
B. The auditors' planning level of materiality may be disaggregated into smaller "tolerable
misstatements" for the various accounts.
C. Auditors may use various rules of thumb to arrive at an evaluation level of materiality, but
not for determining the planning level of materiality.
D. The amount used for the planning should equal that used for evaluation.
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43. The auditors must consider materiality in planning an audit engagement. Materiality for
planning purposes is:
A. The auditors' preliminary estimate of the largest amount of misstatement that would be
material to any one of the client's financial statements.
B. The auditors' preliminary estimate of the smallest amount of misstatement that would be
C. The auditors' preliminary estimate of the amount of misstatement that would be material to
the client's balance sheet.
D. An amount that cannot be quantitatively stated since it depends on the nature of the item.
44. Which of the following topics is not normally included in an engagement letter?
A. The auditors' preliminary assessment of internal control.
B. The auditors' estimate of the fee for the engagement.
C. Limitations on the scope of the engagement.
D. A description of responsibility for the detection of fraud.
45. Which of the following is most likely to be an overall response to fraud risks identified in
an audit?
A. Only use certified public accountants on the engagement.
B. Place increased emphasis on the audit of objective transactions rather than subjective
transactions.
C. Supervise members of the audit team less closely and rely more upon judgment.
D. Use less predictable audit procedures.
46. Which of the following is not an assertion that is made in the financial statements by
management concerning each major account balance?
A. Completeness.
B. Rights and obligations.
C. Legality.
D. Valuation.
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47. Tests for unrecorded assets typically involve tracing from:

A. Source documents to recorded journal entries.
B. Source documents to observations.
C. Recorded journal entries to documents.
D. Recorded journal entries to observations.
48. Tracing from source documents forward to ledgers is most likely to address which
assertion related to posted entries:
A. Completeness.
B. Existence.
C. Rights.
D. Valuation.
49. Determining that receivables are presented at net-realizable value is most directly related
to which management assertion?
A. Existence.
B. Rights.
C. Valuation.
D. Presentation and disclosure.
50. Which of the following is not a general objective for the audit of asset accounts?
A. Establishing existence of assets.
B. Establishing proper valuation of assets.
C. Establishing proper liabilities relating to assets.
D. Establishing the completeness of assets.
51. Which of the following is not used by auditors to establish the completeness of recorded
assets?
A. Assessing control risk.
B. Tracing from source documents to entries in the accounting records.
C. Performing analytical procedures.
D. Vouching transactions.
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52. To test for unsupported entries in the journals, the direction of audit testing should be to
the:
A. Ledger entries.
B. Journal entries.
C. Original source documents.
D. Financial statements.
53. A form filed with the SEC when a company changes auditors is a:
A. Form 8-K.
B. Form 10-K.
C. Form S-1.
D. Form B-1.
54. Which of the following is least likely to render material a quantitatively small
misstatement material?
A. Affects the registrant's compliance with regulatory requirements.
B. Masks a change in earnings or other trends.
C. Arises from an item not capable of precise measurement.
D. The transaction involves a related party.
55. Which of the following is not a required source of information for the auditors' assessment
of fraud risk?
A. Discussion among audit team members.
B. Fraud risk factors.
C. Results of tests of controls.
D. Inquiry of management and others.
56. Auditors must assess fraud risk on every audit and respond to the risks that are identified.
Which of the following is not a procedure required to further address the fraud risk of
management override of internal control?
A. Reviewing accounting estimates for biases.
B. Examining physical controls over assets.
C. Evaluating the business rationale for significant unusual transactions.
D. Examining journal entries and other adjustments for evidence of fraud.
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57. Preliminary arrangements agreed to by the auditors and the client should be reduced to
writing by the auditors. The best place to set forth these arrangements is in:
A. A memorandum to be placed in the permanent section of the auditing working papers.
B. An engagement letter.
C. A client representation letter.
D. A confirmation letter attached to the constructive services letter.
58. The auditors are planning an audit engagement for a new client in a business that is
unfamiliar to the auditors. Which of the following would be the most useful source of
information for the auditors during the preliminary planning stage when they are trying to
obtain a general understanding of audit problems that might be encountered?
A. Client manuals of accounts and charts of accounts.
B. AICPA Industry Audit Guides.
C. Prior-year working papers of the predecessor auditors.
D. Latest annual and interim financial statements issued by the client.
59. The auditors will not ordinarily initiate discussion with the audit committee concerning
the:
A. Extent to which the work of internal auditors will influence the scope of the examination.
B. Extent to which change in the company's organization will influence the scope of the
examination.
C. Details of potential problems which the auditors believe might cause a qualified opinion.
D. Details of the procedures which the auditors intend to apply.
60. Which statement is correct relating to a potential successor auditor's responsibility for
communicating with the predecessor auditors in connection with a prospective new audit
client?
A. The successor auditors have no responsibility to contact the predecessor auditors.
B. The successor auditors should obtain permission from the prospective client to contact the
predecessor auditors.
C. The successor auditors should contact the predecessors regardless of whether the
prospective client authorizes contact.
D. The successor auditors need not contact the predecessors if the successors are aware of all
available relevant facts.
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61. Which of the following situations would most likely require special audit planning by the
auditors?
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 stones.
62. When planning an audit, an auditor should:

A. Consider whether the extent of substantive procedures may be reduced based on the results
of the internal control questionnaire.
B. Make preliminary judgments about materiality levels for audit purposes.
C. Conclude whether changes in compliance with prescribed control procedures justifies
reliance on them.
D. Prepare a preliminary draft of the management representation letter.
63. 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 a knowledge of matters that relate to the nature of the entity's business.
C. Refer a substantial portion of the audit to another CPA who will act as the principal auditor.
D. First inform management that an unqualified opinion cannot be issued.
64. With respect to the auditor's planning of a year-end audit, which of the following
statements is always true?
A. An engagement should not be accepted after the fiscal year-end.
B. An inventory count must be observed at the balance sheet date.
C. The client's audit committee should not be told of any specific audit procedures which will
be performed.
D. It is an acceptable practice to carry out parts of the examination at interim dates.
6-15
65. Hawkins requested permission to communicate with the predecessor auditor and review
certain portions of the predecessor auditor's working papers. The prospective client's refusal
to permit this will bear directly on Hawkins' decision concerning the:
A. Adequacy of the preplanned audit program.
B. Ability to establish consistency in application of accounting principles between years.
C. Apparent scope limitation.
D. Integrity of management.
66. The auditor faces a risk that the audit will not detect material misstatements in the
financial statements. In regard to minimizing this risk, the auditor primarily relies on:
A. Substantive procedures.
B. Tests of controls.
C. Internal control.
D. Statistical analysis.
67. 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 risk assessment
phase of the audit by the use of:
A. Tests of transactions and balances.
B. An assessment of internal control.
C. Specialized audit programs.
D. Analytical procedures.
68. Before accepting an audit engagement, a successor auditor should make specific inquiries
of the predecessor auditor regarding the predecessor's:
A. Awareness of the consistency in the application of generally accepted accounting
principles between accounting periods.
B. Evaluation of all matters of continuing accounting significance.
C. Opinion of any subsequent events occurring since the predecessor's audit report was
issued.
D. Understanding as to the reasons for the change of auditors.
6-16
69. Which of the following is least likely to be included in an auditor's inquiry of

management while obtaining information to identify the risks of material misstatement due to
fraud?
A. Are all financial reporting operations at one location?
B. Does it have knowledge of fraud or suspect fraud?
C. Does it have programs to mitigate fraud risks?
D. Has it reported to the audit committee the nature of the company's internal control?
70. An auditor selects a sample from the file of shipping documents to determine whether
invoices were prepared. This test is performed to satisfy the audit objective of:
A. Accuracy.
B. Completeness.
C. Control.
D. Existence.
71. Individuals who commit fraud are ordinarily able to rationalize the act and also have an:
A. Option A
B. Option B
C. Option C
D. Option D
72. PCAOB standards suggest which of the following when interpreting the federal securities
laws relating to materiality?
A. A material amount would significantly alter the "total mix" of information made available
to an investor.
B. Materiality cannot be used as a basis for interpreting federal securities laws.
C. A material amount is that at which an individual's decision would be changed.
D. Materiality is composed of quantitative and not qualitative aspects.
6-17
73. Which of the following is correct concerning the PCAOB's concept of a significant
account?
A. It is the same as a relevant assertion.
B. The auditor need only consider significant accounts when controls do not operate
effectively.
C. In deciding whether an account is a significant account one does not consider the effect of
internal control.
D. It is an account for which qualitative materiality considerations are particularly important.
Essay Questions
Note: Although not entirely necessary, the following question is best used if the examination
also includes Chapter 7. Also, an instructor might consider using only portions of this
question.
6-18
74. On September 3, 20X1, Larkin, CPA, was engaged to audit the financial statements of
Precious Metals Co. (PM), for the year ended October 31, 20X1. PM purchases precious
metals at wholesale prices and resells them to craft clubs at retail. PM is a new client whose
common stock was first offered to the public five years ago. PM received an unqualified
opinion on its financial statements in each of the prior three years, but changes auditors after
each engagement. In accepting the engagement, Larkin completed all of the appropriate client
acceptance procedures.
Larkin instructed Johnson, an assistant on the engagement, to draft a planning checklist that
would assist Larkin in preparing the audit staff for the fieldwork that is scheduled to begin on
October 17, 20X1. On October 5, 20X1, Johnson prepared the planning checklist below
(engagement letter points have been omitted). Indicate the inappropriate points that are
included on Johnson's planning checklist.
I. Understanding the assignment
In planning the audit, have the engagement personnel considered:
1. PM's accounting policies and procedures?
2. Financial statement items likely to require adjustment?
3. The nature of the reports expected to be rendered?
4. The effects of accounting and auditing pronouncements, particularly new ones?
5. Methods of audit sampling to be used?
6. Whether the method of sampling is likely to be approved by PM?
7. The extent of involvement of other independent auditors or internal auditors?
8. Procedures to evaluate competence and objectivity of PM's internal auditors?
In planning the audit, have engaged personnel discussed:
9. The general scope and timing of the audit work with PM's management, board of directors,
or audit committee?
10. The risk of misstatement due to fraud for each assertion for each account with PM's
management, board of directors, and the audit committee?
II. Assigning personnel to the engagement
Has a time budget for the engagement been prepared to determine the staffing requirements
and to schedule the fieldwork, and has it been approved by:
11. The engagement partner?
12. PM's controller and audit committee?
13. Has the engagement staffing schedule been approved by the engagement partner?
Have the following factors been considered:
14. Engagement size and complexity?
15. Personnel available?
16. Timing of the work to be performed?
17. Continuity and periodic rotation of personnel?
18. Need to restrict engagement to CPAs?
6-19
III. Knowledge of the entity's business

Has an overall understanding of PM's operations been obtained by reviewing:
19. Successor auditor's working papers?
20. Financial statements and interim financial statements?
21. Minutes of stockholders' and board of directors' meetings?
22. Filings with regulatory agencies?
23. Recent management letters?
24. The Codification of Statements on Auditing Standards?
25. Economic conditions, government regulations, and specialist accounting practices?
26. Have engagement personnel obtained knowledge of PM's organization and operating
characteristics?
Have engagement personnel considered
27. Factors affecting the risk of misstatements due to error or fraud?
28. Materiality?
29. Degree of understanding of internal control to plan the audit?
30. Methods that PM uses to process accounting information?
31. Whether their investments in PM stock are material?
IV. Assessing auditability
Has the adequacy of the accounting records been assessed for proper:
32. Descriptions of transactions to permit the appropriate financial statement classification?
33. Information about transactions to permit the recording of appropriate monetary amounts?
34. Recording of transactions in the appropriate accounting period?
Have the following factors regarding the integrity of management been considered in
planning the audit:
35. Responses to previous inquiries of local attorneys, bankers, and other business leaders
regarding PM's standing in the community?
36. PM's credit rating?
37. Have inquiries of a sample of PM's customers regarding PM's credit-granting policies
been made?
6-20
V. Assessing risk
38. Has detection risk been appropriately restricted to determine how much inherent risk can
be accepted?
39. Has consideration been given to permitting PM's internal auditors to make the assessment
of inherent risk and evaluations of significant accounting estimates?
If control risk is assessed at below the maximum level
40. Is the audit fee high enough to handle any likely litigation?
41. Have specific internal control activities that are likely to prevent or detect material
misstatements in those assertions been identified?
If control risk is assessed at the maximum level for some or all assertions
42. Is the scope of substantive testing appropriately decreased?
43. Have tests of controls to evaluate the design and operation of such activities been
performed?
VI. Illegal acts
Have the following matters been considered in assessing the risk that PM has not complied
with laws and regulations that have a direct and material effect on the financial statements:
44. PM's policy relative to the prevention of illegal acts?
45. PM's understanding of the requirements of law and regulations pertinent to its business?
46. Obtaining management's written assurance that no employees have committed any illegal
acts of any type?
VII. Analytical procedures
In planning the audit, have analytical procedures been used that focus on:
47. Enhancing an understanding of PM's business and the transactions and events of the year
under audit?
48. Identifying areas that may represent specific risks relevant to the audit?
49. Evaluating the overall financial statement presentation?
VIII. Audit strategies and the audit program
50. Has the program been developed for the engagement and approved by the engagement
partner?
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75. Engagement letters are used by most auditors in performing professional services.
a. Describe the purpose of an engagement letter.
b. List four items that are normally included in an engagement letter.
76. As a part of the planning process, the auditors often prepare an audit plan, an audit
program, and a time budget.
a. Describe an audit plan and explain its purpose.
b. Describe an audit program and explain its purpose.
c. Describe a time budget and explain its purpose.
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77. Auditors perform various tasks in planning an audit engagement. Provide an overall
description of how each task is performed and its purpose.
a. Obtain an understanding of the client's business.
b. Assess audit risk and materiality for the engagement.
c. Assess fraud risk.
d. Assess the risk of material misstatement of assertions about financial statement accounts
and classes of transactions.
78. Many auditors take an approach to assessing the risk of material misstatement by
beginning with an assessment of business risks.
a. Define business risks.
b. Why have auditors found it effective to take the approach of assessing business risks?
c. Identify a business risk and explain how it might affect the auditor's audit procedures.
6-23
Chapter 06 Audit Planning, Understanding the Client, Assessing Risks, and

Responding Answer Key
True / False Questions
1. Audit committees should be made up of the most qualified directors regardless of whether
they are part of management of the company.
FALSE
AACSB: Analytic
AICPA BB: Industry
AICPA FN: Measurement
Bloom's: Understand
Difficulty: Medium
Learning Objective: 06-02 Identify the factors that auditors consider in accepting new clients.
Topic: Obtaining Clients
2. Analytical procedures are seldom used during the risk assessment stage of an audit
engagement because they are substantive procedures.
FALSE
AACSB: Analytic
AICPA BB: Industry
AICPA FN: Risk Analysis
Bloom's: Remember
Difficulty: Easy
Learning Objective: 06-04 Describe the nature of the risk assessment procedures that auditors use to obtain an understanding of the client
and its environment.
Topic: Understanding Client and Environment
6-24
3. Preliminary arrangements with clients should be set forth in the management letter.
FALSE
AACSB: Analytic
AICPA BB: Industry
Bloom's: Remember
Difficulty: Easy
Learning Objective: 06-03 Explain the auditors' responsibilities when planning an audit.
Topic: Planning the Audit
4. An audit plan includes a detailed listing of the audit procedures to be performed in the
verification of items in the financial statements.
FALSE
AACSB: Analytic
AICPA BB: Industry
Bloom's: Understand
Difficulty: Medium
5. The auditors' tests of controls are designed to substantiate the fairness of specific financial
statement accounts.
FALSE
AACSB: Analytic
AICPA BB: Industry
Bloom's: Understand
Difficulty: Medium
Learning Objective: 06-01 Describe the major steps in the audit process.
Topic: Audit Process
6-25
6. At least a portion of the auditors' consideration of internal control usually is performed at

an interim date rather than at the balance sheet date.
TRUE
AACSB: Analytic
AICPA BB: Industry
Bloom's: Understand
Difficulty: Medium
Learning Objective: 06-07 Discuss how the auditors design further audit procedures in response to the assessed risks of material
misstatement.
Topic: Assessing Risks and Designing Audit Procedures
7. The substantive approach to an audit is appropriate for many small businesses.

TRUE
AACSB: Analytic
AICPA BB: Industry
Bloom's: Understand
Difficulty: Medium
Learning Objective: 06-08 Distinguish between the systems and the substantive procedures portions of the audit program.
Topic: Audit Program
8. Confirming a bank account establishes existence but not rights to the cash balance.
FALSE
AACSB: Analytic
AICPA BB: Industry
Bloom's: Apply
Difficulty: Hard
6-26
9. The completeness of recording of assets is generally verified by tracing from the source
documents to the recorded entry.
TRUE
AACSB: Analytic
AICPA BB: Industry
Bloom's: Apply
Difficulty: Hard
10. Vouching the acquisition of assets is an audit procedure that is often performed to
establish the valuation of the assets.
TRUE
AACSB: Analytic
AICPA BB: Industry
Bloom's: Apply
Difficulty: Hard
misstatement.
Multiple Choice Questions
11. Which of the following factors most likely would cause a CPA to not accept a new audit
engagement?
A. The prospective client has fired its prior auditor.
B. The CPA lacks a thorough understanding of the prospective client's operations and
industry.
C. The CPA is unable to review the predecessor auditor's working papers due to a major fire
that destroyed both hard and soft copy documentation.
D. The prospective client is unwilling to make financial records available to the CPA.
AACSB: Analytic
AICPA BB: Industry
Bloom's: Understand
Difficulty: Medium
Source: AICPA
6-27
12. Which of the following factors most likely would heighten an auditor's concern about the
risk of fraudulent financial reporting?
A. Large amounts of liquid assets that are easily convertible into cash.
B. Low growth and profitability as compared to other entity's in the same industry.
C. Financial management's participation in the initial selection of accounting principles.
D. An overly complex organizational structure involving unusual lines of authority.
AACSB: Analytic
AICPA BB: Industry
Bloom's: Apply
Difficulty: Hard
Learning Objective: 06-06 Describe how the auditors address fraud risk.
Source: AICPA
13. Which of the following factors would most likely cause a CPA to decide not to accept a
new audit engagement?
A. Lack of understanding of the potential client's internal auditors' computer-assisted audit
techniques.
B. Management's disregard for internal control.
C. The existence of related party transactions.
D. Management's attempt to meet earnings per share growth rate goals.
AACSB: Analytic
AICPA BB: Industry
Bloom's: Apply
Difficulty: Hard
6-28
14. Which of the following matters is generally included in an auditor's engagement letter?
A. Limitations of the engagement.
B. Factors to be considered in establishing preliminary judgments about materiality.
C. Management's liability for all illegal acts committed by its employees.
D. The auditor's responsibility to obtain negative assurance relating to non-compliance with
laws and regulations.
AACSB: Analytic
AICPA BB: Industry
Bloom's: Apply
Difficulty: Hard
15. Which of the following would heighten an auditor's concern about the risk of fraudulent
A. Inability to generate positive cash flows from operations, while reporting large increases in
earnings.
B. Management's lack of interest in increasing the dividend paid on common stock.
C. Large amounts of liquid assets that are easily convertible into cash.
D. Inability to borrow necessary capital without obtaining waivers on debt covenants.
AACSB: Analytic
AICPA BB: Industry
Bloom's: Apply
Difficulty: Hard
Source: AICPA
6-29
16. To best test existence, an auditor would sample from the:

A. General ledger to source documents.
B. General ledger to the financial statements.
C. Source documents to the general ledger.
D. Source documents to journals.
AACSB: Analytic
AICPA BB: Industry
Bloom's: Understand
Difficulty: Medium
misstatement.
17. The auditors' understanding established with a client should be established through a(an):
A. Oral communication with the client.
B. Written communication with the client.
C. Written or oral communication with the client.
D. Completely detailed audit plan.
AACSB: Analytic
AICPA BB: Industry
Bloom's: Remember
Difficulty: Easy
18. Which of the following would be least likely to be considered an audit planning
procedure?
A. Use an engagement letter.
B. Develop the overall audit strategy.
C. Perform the risk assessment.
D. Develop the audit plan.
AACSB: Analytic
AICPA BB: Industry
Bloom's: Understand
Difficulty: Medium
6-30
19. While assessing the risks of material misstatement auditors identify risks, relate risk to
what could go wrong, consider the magnitude of risks and:
A. Assess the risk of misstatements due to illegal acts.
B. Consider the complexity of the transactions involved.
C. Consider the likelihood that the risks could result in material misstatements.
D. Determine materiality levels.
AACSB: Analytic
AICPA BB: Industry
Bloom's: Understand
Difficulty: Medium
Learning Objective: 06-05 Describe the manner in which an audit is affected by the auditors' assessment of audit risk and materiality.
20. Which of the following is correct concerning requirements about auditor communications
about fraud?
A. Fraud that involves senior management should be reported directly to the audit committee
regardless of the amount involved.
B. All fraud with a material effect on the financial statements should be reported directly by
the auditor to the Securities and Exchange Commission.
C. Fraud with a material effect on the financial statements should ordinarily be disclosed by
the auditor through use of an "emphasis of a matter" paragraph added to the audit report.
D. The auditor has no responsibility to disclose fraud outside the entity under any
circumstances.
AACSB: Analytic
AICPA BB: Industry
Bloom's: Apply
Difficulty: Hard
6-31
21. A predecessor auditor will ordinarily initiate communication with the successor auditor:
A. Option A
B. Option B
C. Option C
D. Option D
AACSB: Analytic
AICPA BB: Industry
Bloom's: Apply
Difficulty: Hard
22. Which measure of materiality (or both) considers quantitative considerations?
A. Option A
B. Option B
C. Option C
D. Option D
AACSB: Analytic
AICPA BB: Industry
Bloom's: Understand
Difficulty: Medium
6-32
23. Which of the following factors most likely would lead a CPA to conclude that a potential
audit engagement should not be accepted?
A. There are significant related party transactions that management claims occurred in the
ordinary course of business.
B. Internal control activities requiring the segregation of duties are subject to management
override.
C. Management continues to employ an inefficient system of information technology to
record financial transactions.
D. It is unlikely that sufficient evidence is available to support an opinion on the financial
statements.
AACSB: Analytic
AICPA BB: Industry
Bloom's: Understand
Difficulty: Medium
Source: AICPA
24. In using the information on the statement of cash flows while obtaining an understanding
of a profitable, growing company, which of the following would ordinarily be least surprising
to an auditor?
A. Decreases in accounts payable.
B. Decreases in accounts receivable.
C. Negative cash flows from investing.
D. Negative operating cash flows.
AACSB: Analytic
AICPA BB: Industry
Bloom's: Apply
Difficulty: Hard
6-33
25. Audits of financial statements are designed to obtain reasonable assurance of detecting
material misstatements due to:
A. Option A
B. Option B
C. Option C
D. Option D
AACSB: Analytic
AICPA BB: Industry
Bloom's: Understand
Difficulty: Medium
26. Which of the following is not one of the assertions made by management about an
account balance?
A. Relevance.
B. Existence.
C. Valuation.
D. Rights and obligations.
AACSB: Analytic
AICPA BB: Industry
Bloom's: Remember
Difficulty: Easy
6-34
27. When a company has changed auditors, according to the Professional Standards:
A. The successor auditor has the responsibility to initiate contact with the predecessor auditor
to ask about the client before the engagement is accepted; the predecessor has no
responsibility to initiate this contact, even when aware of matters bearing on the integrity of
management.
B. The predecessor must always respond fully to all inquiries made by the successor auditor.
C. The successor must discuss with the predecessor matters bearing on the engagement prior
to accepting the engagement.
D. The successor may choose not to attempt any communication with the predecessor auditor.
AACSB: Analytic
AICPA BB: Industry
Bloom's: Apply
Difficulty: Hard
28. Which of the following procedures is not performed as a part of planning an audit
engagement?
A. Reviewing the working papers of the prior year.
B. Developing an overall audit strategy.
C. Confirmation of all major accounts.
D. Designing an audit program.
AACSB: Analytic
AICPA BB: Industry
Bloom's: Understand
Difficulty: Medium
6-35
29. The risk of a material misstatement occurring in an account, assuming an absence of

internal control, is referred to as:
A. Account risk.
B. Control risk.
C. Detection risk.
D. Inherent risk.
AACSB: Analytic
AICPA BB: Industry
Bloom's: Understand
Difficulty: Medium
30. Which of the following is least likely to be considered a financial statement audit risk
factor?
A. Management operating and financing decisions are dominated by top management.
B. A new client with no prior audit history.
C. Rate of change in the entity's industry is rapid.
D. Profitability of the entity relative to its industry is inconsistent.
AACSB: Analytic
AICPA BB: Industry
Bloom's: Apply
Difficulty: Hard
6-36
31. Which of the following is an example of fraudulent financial reporting?

A. Company management falsifies inventory count tags thereby overstating ending inventory
and understating cost of goods sold.
B. An employee diverts customer payments to his personal use, concealing his actions by
debiting an expense account, thus overstating expenses.
C. An employee steals inventor and the "shrinkage" is recorded in cost of goods sold.
D. An employee "borrows" tools from the company and neglects to return them; the cost is
reported as a miscellaneous operating expense.
AACSB: Analytic
AICPA BB: Industry
Bloom's: Understand
Difficulty: Medium
32. Which of the following is most likely to be considered a risk factor relating to fraudulent
A. Low turnover of senior management.
B. Extreme degree of competition within the industry.
C. Capital structure including various operating subsidiaries.
D. Sales goals in excess of any of the preceding three years.
AACSB: Analytic
AICPA BB: Industry
Bloom's: Apply
Difficulty: Hard
6-37
33. Which of the following conditions identified during the audit increases the risk of
employee fraud?
A. Large amounts of cash in the bank.
B. Existence of a mandatory vacation policy for employees performing key functions.
C. Inventory items of small size, but high value.
D. Presence of reconciling items on a client prepared year-end proof of cash.
AACSB: Analytic
AICPA BB: Industry
Bloom's: Understand
Difficulty: Medium
34. Which of the following statements is accurate about "fraud risk factors" considered when
conducting an audit?
A. Factors whose presence indicates that fraud exists.
B. Factors whose presence often have been observed in circumstances where frauds have
occurred.
C. Factors whose presence will require modification to planned audit procedures.
D. Factors obtained during the audit which lead to required communications with the audit
committee.
AACSB: Analytic
AICPA BB: Industry
Bloom's: Apply
Difficulty: Hard
6-38
35. Which of the following is not an example of a likely adjustment in the auditors' overall
audit approach when significant risk is found to exist?
A. Apply increased professional skepticism about material transactions.
B. Increase the assessed level of detection risk.
C. Assign personnel with particular skill to areas of high risk.
D. Obtain increased evidence about the appropriateness of management's selection of
accounting principles.
AACSB: Analytic
AICPA BB: Industry
Bloom's: Understand
Difficulty: Medium
36. Which of the following is least likely to be required on an audit?

A. Evaluate the business rationale for significant, unusual transactions.
B. Make a legal determination of whether fraud has occurred.
C. Review accounting estimates for biases.
D. Test appropriateness of journal entries and adjustments.
AACSB: Analytic
AICPA BB: Industry
Bloom's: Understand
Difficulty: Medium
6-39
37. Which of the following is (are) considered a further audit procedure(s) that may be
designed after assessing the risks of material misstatement?
A. Option A
B. Option B
C. Option C
D. Option D
AACSB: Analytic
AICPA BB: Industry
Bloom's: Remember
Difficulty: Easy
38. Which of the following circumstances would an auditor most likely consider a risk factor
relating to misstatements arising from fraudulent financial reporting?
A. Several members of management have recently purchased additional shares of the entity's
stock.
B. Several members of the board of directors have recently sold shares of the entity's stock.
C. The entity distributes financial forecasts to financial analysts that predict conservative
operating results.
D. Management is interested in maintaining the entity's earnings trend by using aggressive
accounting practices.
AACSB: Analytic
AICPA BB: Industry
Bloom's: Understand
Difficulty: Medium
Source: AICPA
6-40
39. A successor auditor is required to attempt communication with the predecessor auditor
prior to:
A. Performing test of controls.
B. Testing beginning balances for the current year.
C. Making a proposal for the audit engagement.
D. Accepting the engagement.
AACSB: Analytic
AICPA BB: Industry
Bloom's: Understand
Difficulty: Medium
Source: AICPA
40. If the business environment is experiencing a recession, the auditor most likely would
focus increased attention on which of the following accounts?
A. Purchase returns and allowances.
B. Allowance for doubtful accounts.
C. Common stock.
D. Noncontrolling interest of a subsidiary purchased during the year.
AACSB: Analytic
AICPA BB: Industry
Bloom's: Apply
Difficulty: Hard
Source: AICPA
6-41
41. The risk that the auditors' procedures will lead them to conclude that a material
misstatement does not exist in an account balance when in fact such a misstatement does exist
is referred to as:
A. Account risk.
B. Control risk.
C. Detection risk.
D. Inherent risk.
AACSB: Analytic
AICPA BB: Industry
Bloom's: Understand
Difficulty: Medium
42. Which of the following statements is correct regarding the auditor's determination of
materiality?
A. The planning level of materiality should normally be the larger of the amount considered
for the balance sheet versus the income statement.
B. The auditors' planning level of materiality may be disaggregated into smaller "tolerable
misstatements" for the various accounts.
C. Auditors may use various rules of thumb to arrive at an evaluation level of materiality, but
not for determining the planning level of materiality.
D. The amount used for the planning should equal that used for evaluation.
AACSB: Analytic
AICPA BB: Industry
Bloom's: Apply
Difficulty: Hard
6-42
43. The auditors must consider materiality in planning an audit engagement. Materiality for
planning purposes is:
A. The auditors' preliminary estimate of the largest amount of misstatement that would be
B. The auditors' preliminary estimate of the smallest amount of misstatement that would be
C. The auditors' preliminary estimate of the amount of misstatement that would be material to
the client's balance sheet.
D. An amount that cannot be quantitatively stated since it depends on the nature of the item.
AACSB: Analytic
AICPA BB: Industry
Bloom's: Understand
Difficulty: Medium
44. Which of the following topics is not normally included in an engagement letter?
A. The auditors' preliminary assessment of internal control.
B. The auditors' estimate of the fee for the engagement.
C. Limitations on the scope of the engagement.
D. A description of responsibility for the detection of fraud.
AACSB: Analytic
AICPA BB: Industry
Bloom's: Apply
Difficulty: Hard
6-43
45. Which of the following is most likely to be an overall response to fraud risks identified in
an audit?
A. Only use certified public accountants on the engagement.
B. Place increased emphasis on the audit of objective transactions rather than subjective
transactions.
C. Supervise members of the audit team less closely and rely more upon judgment.
D. Use less predictable audit procedures.
AACSB: Analytic
AICPA BB: Industry
Bloom's: Apply
Difficulty: Hard
46. Which of the following is not an assertion that is made in the financial statements by
management concerning each major account balance?
A. Completeness.
B. Rights and obligations.
C. Legality.
D. Valuation.
AACSB: Analytic
AICPA BB: Industry
Bloom's: Remember
Difficulty: Easy
6-44
47. Tests for unrecorded assets typically involve tracing from:

A. Source documents to recorded journal entries.
B. Source documents to observations.
C. Recorded journal entries to documents.
D. Recorded journal entries to observations.
AACSB: Analytic
AICPA BB: Industry
Bloom's: Apply
Difficulty: Hard
misstatement.
48. Tracing from source documents forward to ledgers is most likely to address which
assertion related to posted entries:
A. Completeness.
B. Existence.
C. Rights.
D. Valuation.
AACSB: Analytic
AICPA BB: Industry
Bloom's: Apply
Difficulty: Hard
misstatement.
49. Determining that receivables are presented at net-realizable value is most directly related
to which management assertion?
A. Existence.
B. Rights.
C. Valuation.
D. Presentation and disclosure.
AACSB: Analytic
AICPA BB: Industry
Bloom's: Understand
Difficulty: Medium
6-45
50. Which of the following is not a general objective for the audit of asset accounts?
A. Establishing existence of assets.
B. Establishing proper valuation of assets.
C. Establishing proper liabilities relating to assets.
D. Establishing the completeness of assets.
AACSB: Analytic
AICPA BB: Industry
Bloom's: Understand
Difficulty: Medium
51. Which of the following is not used by auditors to establish the completeness of recorded
assets?
A. Assessing control risk.
B. Tracing from source documents to entries in the accounting records.
C. Performing analytical procedures.
D. Vouching transactions.
AACSB: Analytic
AICPA BB: Industry
Bloom's: Apply
Difficulty: Hard
misstatement.
52. To test for unsupported entries in the journals, the direction of audit testing should be to
the:
A. Ledger entries.
B. Journal entries.
C. Original source documents.
D. Financial statements.
AACSB: Analytic
AICPA BB: Industry
Bloom's: Apply
Difficulty: Hard
misstatement.
6-46
53. A form filed with the SEC when a company changes auditors is a:
A. Form 8-K.
B. Form 10-K.
C. Form S-1.
D. Form B-1.
AACSB: Analytic
AICPA BB: Industry
Bloom's: Understand
Difficulty: Medium
54. Which of the following is least likely to render material a quantitatively small
misstatement material?
A. Affects the registrant's compliance with regulatory requirements.
B. Masks a change in earnings or other trends.
C. Arises from an item not capable of precise measurement.
D. The transaction involves a related party.
AACSB: Analytic
AICPA BB: Industry
Bloom's: Apply
Difficulty: Hard
55. Which of the following is not a required source of information for the auditors' assessment
of fraud risk?
A. Discussion among audit team members.
B. Fraud risk factors.
C. Results of tests of controls.
D. Inquiry of management and others.
AACSB: Analytic
AICPA BB: Industry
Bloom's: Understand
Difficulty: Medium
6-47
56. Auditors must assess fraud risk on every audit and respond to the risks that are identified.
Which of the following is not a procedure required to further address the fraud risk of
management override of internal control?
A. Reviewing accounting estimates for biases.
B. Examining physical controls over assets.
C. Evaluating the business rationale for significant unusual transactions.
D. Examining journal entries and other adjustments for evidence of fraud.
AACSB: Analytic
AICPA BB: Industry
Bloom's: Understand
Difficulty: Medium
57. Preliminary arrangements agreed to by the auditors and the client should be reduced to
writing by the auditors. The best place to set forth these arrangements is in:
A. A memorandum to be placed in the permanent section of the auditing working papers.
B. An engagement letter.
C. A client representation letter.
D. A confirmation letter attached to the constructive services letter.
AACSB: Analytic
AICPA BB: Industry
Bloom's: Remember
Difficulty: Easy
Source: AICPA
6-48
58. The auditors are planning an audit engagement for a new client in a business that is
unfamiliar to the auditors. Which of the following would be the most useful source of
information for the auditors during the preliminary planning stage when they are trying to
obtain a general understanding of audit problems that might be encountered?
A. Client manuals of accounts and charts of accounts.
B. AICPA Industry Audit Guides.
C. Prior-year working papers of the predecessor auditors.
D. Latest annual and interim financial statements issued by the client.
AACSB: Analytic
AICPA BB: Industry
Bloom's: Apply
Difficulty: Hard
Source: AICPA
59. The auditors will not ordinarily initiate discussion with the audit committee concerning
the:
A. Extent to which the work of internal auditors will influence the scope of the examination.
B. Extent to which change in the company's organization will influence the scope of the
examination.
C. Details of potential problems which the auditors believe might cause a qualified opinion.
D. Details of the procedures which the auditors intend to apply.
AACSB: Analytic
AICPA BB: Industry
Bloom's: Apply
Difficulty: Hard
Source: AICPA
6-49
60. Which statement is correct relating to a potential successor auditor's responsibility for
communicating with the predecessor auditors in connection with a prospective new audit
client?
A. The successor auditors have no responsibility to contact the predecessor auditors.
B. The successor auditors should obtain permission from the prospective client to contact the
predecessor auditors.
C. The successor auditors should contact the predecessors regardless of whether the
prospective client authorizes contact.
D. The successor auditors need not contact the predecessors if the successors are aware of all
available relevant facts.
AACSB: Analytic
AICPA BB: Industry
Bloom's: Understand
Difficulty: Medium
Source: AICPA
61. Which of the following situations would most likely require special audit planning by the
auditors?
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 stones.
AACSB: Analytic
AICPA BB: Industry
Bloom's: Understand
Difficulty: Medium
Source: AICPA
6-50
62. When planning an audit, an auditor should:

A. Consider whether the extent of substantive procedures may be reduced based on the results
of the internal control questionnaire.
B. Make preliminary judgments about materiality levels for audit purposes.
C. Conclude whether changes in compliance with prescribed control procedures justifies
reliance on them.
D. Prepare a preliminary draft of the management representation letter.
AACSB: Analytic
AICPA BB: Industry
Bloom's: Understand
Difficulty: Medium
Source: AICPA
63. 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 a knowledge of matters that relate to the nature of the entity's business.
C. Refer a substantial portion of the audit to another CPA who will act as the principal auditor.
D. First inform management that an unqualified opinion cannot be issued.
AACSB: Analytic
AICPA BB: Industry
Bloom's: Understand
Difficulty: Medium
Source: AICPA
6-51
64. With respect to the auditor's planning of a year-end audit, which of the following
statements is always true?
A. An engagement should not be accepted after the fiscal year-end.
B. An inventory count must be observed at the balance sheet date.
C. The client's audit committee should not be told of any specific audit procedures which will
be performed.
D. It is an acceptable practice to carry out parts of the examination at interim dates.
AACSB: Analytic
AICPA BB: Industry
Bloom's: Understand
Difficulty: Medium
Source: AICPA
65. Hawkins requested permission to communicate with the predecessor auditor and review
certain portions of the predecessor auditor's working papers. The prospective client's refusal
to permit this will bear directly on Hawkins' decision concerning the:
A. Adequacy of the preplanned audit program.
B. Ability to establish consistency in application of accounting principles between years.
C. Apparent scope limitation.
D. Integrity of management.
AACSB: Analytic
AICPA BB: Industry
Bloom's: Understand
Difficulty: Medium
Source: AICPA
6-52
66. The auditor faces a risk that the audit will not detect material misstatements in the
financial statements. In regard to minimizing this risk, the auditor primarily relies on:
A. Substantive procedures.
B. Tests of controls.
C. Internal control.
D. Statistical analysis.
AACSB: Analytic
AICPA BB: Industry
Bloom's: Remember
Difficulty: Easy
Source: AICPA
67. 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 risk assessment
phase of the audit by the use of:
A. Tests of transactions and balances.
B. An assessment of internal control.
C. Specialized audit programs.
D. Analytical procedures.
AACSB: Analytic
AICPA BB: Industry
Bloom's: Understand
Difficulty: Medium
Source: AICPA
6-53
68. Before accepting an audit engagement, a successor auditor should make specific inquiries
of the predecessor auditor regarding the predecessor's:
A. Awareness of the consistency in the application of generally accepted accounting
principles between accounting periods.
B. Evaluation of all matters of continuing accounting significance.
C. Opinion of any subsequent events occurring since the predecessor's audit report was
issued.
D. Understanding as to the reasons for the change of auditors.
AACSB: Analytic
AICPA BB: Industry
Bloom's: Understand
Difficulty: Medium
Source: AICPA
69. Which of the following is least likely to be included in an auditor's inquiry of

management while obtaining information to identify the risks of material misstatement due to
fraud?
A. Are all financial reporting operations at one location?
B. Does it have knowledge of fraud or suspect fraud?
C. Does it have programs to mitigate fraud risks?
D. Has it reported to the audit committee the nature of the company's internal control?
AACSB: Analytic
AICPA BB: Industry
Bloom's: Apply
Difficulty: Hard
6-54
70. An auditor selects a sample from the file of shipping documents to determine whether
invoices were prepared. This test is performed to satisfy the audit objective of:
A. Accuracy.
B. Completeness.
C. Control.
D. Existence.
AACSB: Analytic
AICPA BB: Industry
Bloom's: Apply
Difficulty: Hard
misstatement.
Source: AICPA
71. Individuals who commit fraud are ordinarily able to rationalize the act and also have an:
A. Option A
B. Option B
C. Option C
D. Option D
AACSB: Analytic
AICPA BB: Industry
Bloom's: Remember
Difficulty: Easy
6-55
72. PCAOB standards suggest which of the following when interpreting the federal securities
laws relating to materiality?
A. A material amount would significantly alter the "total mix" of information made available
to an investor.
B. Materiality cannot be used as a basis for interpreting federal securities laws.
C. A material amount is that at which an individual's decision would be changed.
D. Materiality is composed of quantitative and not qualitative aspects.
AACSB: Analytic
AICPA BB: Industry
Bloom's: Understand
Difficulty: Medium
73. Which of the following is correct concerning the PCAOB's concept of a significant
account?
A. It is the same as a relevant assertion.
B. The auditor need only consider significant accounts when controls do not operate
effectively.
C. In deciding whether an account is a significant account one does not consider the effect of
internal control.
D. It is an account for which qualitative materiality considerations are particularly important.
AACSB: Analytic
AICPA BB: Industry
Bloom's: Apply
Difficulty: Hard
Essay Questions
Note: Although not entirely necessary, the following question is best used if the examination
also includes Chapter 7. Also, an instructor might consider using only portions of this
question.
6-56
74. On September 3, 20X1, Larkin, CPA, was engaged to audit the financial statements of
Precious Metals Co. (PM), for the year ended October 31, 20X1. PM purchases precious
metals at wholesale prices and resells them to craft clubs at retail. PM is a new client whose
common stock was first offered to the public five years ago. PM received an unqualified
opinion on its financial statements in each of the prior three years, but changes auditors after
each engagement. In accepting the engagement, Larkin completed all of the appropriate client
acceptance procedures.
Larkin instructed Johnson, an assistant on the engagement, to draft a planning checklist that
would assist Larkin in preparing the audit staff for the fieldwork that is scheduled to begin on
October 17, 20X1. On October 5, 20X1, Johnson prepared the planning checklist below
(engagement letter points have been omitted). Indicate the inappropriate points that are
included on Johnson's planning checklist.
I. Understanding the assignment
In planning the audit, have the engagement personnel considered:
1. PM's accounting policies and procedures?
2. Financial statement items likely to require adjustment?
3. The nature of the reports expected to be rendered?
4. The effects of accounting and auditing pronouncements, particularly new ones?
5. Methods of audit sampling to be used?
6. Whether the method of sampling is likely to be approved by PM?
7. The extent of involvement of other independent auditors or internal auditors?
8. Procedures to evaluate competence and objectivity of PM's internal auditors?
In planning the audit, have engaged personnel discussed:
9. The general scope and timing of the audit work with PM's management, board of directors,
or audit committee?
10. The risk of misstatement due to fraud for each assertion for each account with PM's
management, board of directors, and the audit committee?
II. Assigning personnel to the engagement
Has a time budget for the engagement been prepared to determine the staffing requirements
and to schedule the fieldwork, and has it been approved by:
11. The engagement partner?
12. PM's controller and audit committee?
13. Has the engagement staffing schedule been approved by the engagement partner?
Have the following factors been considered:
14. Engagement size and complexity?
15. Personnel available?
16. Timing of the work to be performed?
17. Continuity and periodic rotation of personnel?
18. Need to restrict engagement to CPAs?
6-57
III. Knowledge of the entity's business

Has an overall understanding of PM's operations been obtained by reviewing:
19. Successor auditor's working papers?
20. Financial statements and interim financial statements?
21. Minutes of stockholders' and board of directors' meetings?
22. Filings with regulatory agencies?
23. Recent management letters?
24. The Codification of Statements on Auditing Standards?
25. Economic conditions, government regulations, and specialist accounting practices?
26. Have engagement personnel obtained knowledge of PM's organization and operating
characteristics?
Have engagement personnel considered
27. Factors affecting the risk of misstatements due to error or fraud?
28. Materiality?
29. Degree of understanding of internal control to plan the audit?
30. Methods that PM uses to process accounting information?
31. Whether their investments in PM stock are material?
IV. Assessing auditability
Has the adequacy of the accounting records been assessed for proper:
32. Descriptions of transactions to permit the appropriate financial statement classification?
33. Information about transactions to permit the recording of appropriate monetary amounts?
34. Recording of transactions in the appropriate accounting period?
Have the following factors regarding the integrity of management been considered in
planning the audit:
35. Responses to previous inquiries of local attorneys, bankers, and other business leaders
regarding PM's standing in the community?
36. PM's credit rating?
37. Have inquiries of a sample of PM's customers regarding PM's credit-granting policies
been made?
6-58
V. Assessing risk
38. Has detection risk been appropriately restricted to determine how much inherent risk can
be accepted?
39. Has consideration been given to permitting PM's internal auditors to make the assessment
of inherent risk and evaluations of significant accounting estimates?
If control risk is assessed at below the maximum level
40. Is the audit fee high enough to handle any likely litigation?
41. Have specific internal control activities that are likely to prevent or detect material
misstatements in those assertions been identified?
If control risk is assessed at the maximum level for some or all assertions
42. Is the scope of substantive testing appropriately decreased?
43. Have tests of controls to evaluate the design and operation of such activities been
performed?
VI. Illegal acts
Have the following matters been considered in assessing the risk that PM has not complied
with laws and regulations that have a direct and material effect on the financial statements:
44. PM's policy relative to the prevention of illegal acts?
45. PM's understanding of the requirements of law and regulations pertinent to its business?
46. Obtaining management's written assurance that no employees have committed any illegal
acts of any type?
VII. Analytical procedures
In planning the audit, have analytical procedures been used that focus on:
47. Enhancing an understanding of PM's business and the transactions and events of the year
under audit?
48. Identifying areas that may represent specific risks relevant to the audit?
49. Evaluating the overall financial statement presentation?
VIII. Audit strategies and the audit program
50. Has the program been developed for the engagement and approved by the engagement
partner?
6-59
The following are inappropriate points:

6. The client should not be asked to approve the sampling method.
10. Although discussions with management, the board of directors, and the audit committee
will be held on fraud, the details at the assertion level for each account will not ordinarily be
discussed. The professional standards do require that members of the audit team discuss the
potential for material misstatement due to fraud either during planning or in conjunction with
the information-gathering procedures related to fraud subsequent to planning.
12. The controller and audit committee should not approve the time budget.
18. There is ordinarily no reason to restrict an engagement to CPAs.
19. A review of the predecessor auditor's working papers might be appropriatenot the
successor (Larkin CPA).
24. SAS do not provide guidance on PM's operations.
31. Engagement personnel should have no investments in PM stock.
37. Customers are not ordinarily consulted concerning credit-granting policies.
38. Inherent and control risk are more conventionally assessed so as to determine the
appropriate level of detection risk.
39. Internal auditors do not make judgment about the assessment of inherent risk and
evaluation of estimates.
40. Such a litigation concern is not appropriate in this document.
42. One does not expect a decrease in the scope of substantive testing when control risk is
assessed at the maximum level.
43. Tests of controls are not ordinarily performed when a plan exists to assess control risk at
the maximum level.
46. Management need not attempt to determine whether employees have committed illegal
acts of any type.
49. Evaluating overall financial statement presentation is not ordinarily an objective of
analytical procedures.
AACSB: Analytic
AICPA BB: Industry
Bloom's: Apply
Difficulty: Hard
Source: AICPA
6-60
75. Engagement letters are used by most auditors in performing professional services.
a. Describe the purpose of an engagement letter.
b. List four items that are normally included in an engagement letter.
a. The purpose of an engagement letter is to establish a written contract between the auditors
and the client. Thus, the letter tends to prevent misunderstandings between those two parties.
b. Items that are normally included in an engagement letter include (only four required):
Name of the entity and statements to be examined.
Scope of services.
Description of responsibility for detecting fraud.
Obligations of the client's staff to prepare schedules.
Fee or method of determining fee.
Provision for client's acceptance signature.
Management's obligation to conclude about the materiality of misstatements not recorded.
AACSB: Analytic
AICPA BB: Industry
Bloom's: Understand
Difficulty: Medium
6-61
76. As a part of the planning process, the auditors often prepare an audit plan, an audit
program, and a time budget.
a. Describe an audit plan and explain its purpose.
b. Describe an audit program and explain its purpose.
c. Describe a time budget and explain its purpose.
a. The audit plan is an overview of the engagement, outlining the nature and characteristics of
the client and its environment and the overall audit strategy. The audit plan documents the
major considerations in planning the engagement.
b. The audit program is a detailed listing of audit procedures to be performed in the
engagement. It is a tool for scheduling and controlling the work.
c. The time budget includes an estimate of the time required for each audit task. It serves as a
basis for the fee estimate, controls the audit work, and may be used to evaluate performance
by the audit staff.
AACSB: Analytic
AICPA BB: Industry
Bloom's: Understand
Difficulty: Medium
6-62
77. Auditors perform various tasks in planning an audit engagement. Provide an overall
description of how each task is performed and its purpose.
a. Obtain an understanding of the client's business.
b. Assess audit risk and materiality for the engagement.
c. Assess fraud risk.
d. Assess the risk of material misstatement of assertions about financial statement accounts
and classes of transactions.
a. The auditors obtain an understanding of the client's business through procedures such as
inquiry of client personnel, observing client operations, studying AICPA Audit and
Accounting Guides and Industry Risk Alerts and other industry publications, and reviewing
prior annual reports, SEC filings, tax returns, and interim financial statements. An
understanding of the client's business is necessary to the evaluation of the appropriateness of
the client's transactions, accounting principles used, and the estimates and assumptions
embodied in the financial statements. In addition, it provides part of the information to assess
the risks of material misstatement.
b. Materiality for planning purposes is the auditors' preliminary estimate of the smallest
amount of misstatement that would affect the decisions of reasonable users of the financial
statements. The auditors use judgment to determine the amount of planning materiality,
usually based on some rule of thumb. Audit risk is the possibility that the auditors will fail to
modify the opinion on financial statements that are materially misstated. The auditors assess
this risk by considering characteristics of management, operations, and the engagement.
Audit risk and materiality determine the overall scope of the engagement. The lower the
amount of planning materiality, the more extensive the scope of the audit. The higher the risk
of misstatement of the financial statements, the more extensive the scope of the audit.
c. The auditors are required to assess fraud risk on every audit. This assessment is based on
information derived from (1) the discussion among the audit staff about the risk of fraud, (2)
inquiries of management, the audit committee, internal auditors and others, (3) the results of
risk assessment analytical procedures, and consideration of fraud risk factors. If the auditors
identify fraud risks they may respond with (1) an overall response to the way the audit is
conducted, or (2) a response specifically to address the identified risk. In all audits they must
include responses to further address the risk of management override of internal control.
d. The auditors assess the risk of material misstatement (composed of inherent risk and
control risk) for each significant assertion about financial statement accounts and classes of
assertions by considering the information about the client and its environment including
internal control, and the nature of the account. These risk assessments are used to determine
the nature, timing, and extent of the substantive procedures that will reduce the detection risk
to the appropriate level.
6-63
AACSB: Analytic
AICPA BB: Industry
Bloom's: Apply
Difficulty: Hard
misstatement.
78. Many auditors take an approach to assessing the risk of material misstatement by
beginning with an assessment of business risks.
a. Define business risks.
b. Why have auditors found it effective to take the approach of assessing business risks?
c. Identify a business risk and explain how it might affect the auditor's audit procedures.
a. Business risks are those that threaten management's ability to achieve the organization's
objectives.
b. Auditors have found this approach effective because significant business risks often create
related risks of material misstatement (inherent risks) that the auditors should address in
designing their audit procedures.
c. Students may provide a number of examples. The textbook provides the following:
Assume that the auditors have identified as a significant business risk and audit risk that sales
personnel, informally or through written side agreements, may be modifying the terms of
contracts with customers which may affect the amount of revenue that should be recognized.
The auditors must design tests that are focused on determining whether such modifications of
terms have been made, perhaps by obtaining tailored confirmations from customers about the
existence of such side agreements.
AACSB: Analytic
AICPA BB: Industry
Bloom's: Understand
Difficulty: Medium
6-64

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Chapter 6 - Test Bank

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Chapter 06 - Audit Planning, Understanding the Client, Assessing Risks, and Responding

True / False Questions

6. At least a portion of the auditors' consideration of internal control usually is performed at

7. The substantive approach to an audit is appropriate for many small businesses.

Multiple Choice Questions

16. To best test existence, an auditor would sample from the:

22. Which measure of materiality (or both) considers quantitative considerations?

29. The risk of a material misstatement occurring in an account, assuming an absence of

31. Which of the following is an example of fraudulent financial reporting?

36. Which of the following is least likely to be required on an audit?

47. Tests for unrecorded assets typically involve tracing from:

62. When planning an audit, an auditor should:

69. Which of the following is least likely to be included in an auditor's inquiry of

III. Knowledge of the entity's business

Chapter 06 Audit Planning, Understanding the Client, Assessing Risks, and

True / False Questions

6. At least a portion of the auditors' consideration of internal control usually is performed at

7. The substantive approach to an audit is appropriate for many small businesses.

Multiple Choice Questions

16. To best test existence, an auditor would sample from the:

22. Which measure of materiality (or both) considers quantitative considerations?

29. The risk of a material misstatement occurring in an account, assuming an absence of

31. Which of the following is an example of fraudulent financial reporting?

36. Which of the following is least likely to be required on an audit?

47. Tests for unrecorded assets typically involve tracing from:

62. When planning an audit, an auditor should:

69. Which of the following is least likely to be included in an auditor's inquiry of

III. Knowledge of the entity's business

The following are inappropriate points:

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