17. If the auditor determines that internal controls are not functioning as designed, and a compensating control does not exist, the auditor will assess control risk and the risk of material misstatement (RMM) as
    1. low and set detection risk as low.
    2. low and set detection risk as high.
    3. high and set detection risk as high.
    4. high and set detection risk as low.

18. Which of the following best illustrates the concept of sampling risk?
    1. An auditor may fail to recognize errors in the documents examined for the chosen sample.
    2. An auditor may select audit procedures that are not appropriate to achieve the specific objective.
    3. The documents related to the chosen sample may not be available for inspection.
    4. A randomly chosen sample may not be representative of the population as a whole on the characteristic of interest.

19. An auditor wants to determine that all sales adjustments are recorded. This relates to which of the following transaction-class assertions;

1. Occurrence
2. Completeness
3. Accuracy
4. Classification

24. Phillips CPA Firm is auditing the accounts of Tojo Enterprises, Inc., a national distributor of kitchen appliances. After reviewing the minutes of board of directors meetings as well as recent SEC filings, Phillips CPA firm have noted that key executives are extremely close to achieving a substantial bonus if the firms stock price achieves a certain level in the market. Based on this finding, what might Phillips CPA Firm decide to do?

a. Phillips CPA Firm are likely to audit competing companies within the same industry as a basis for comparison.

b. Phillips CPA Firm are likely to assess control risk as low on the premise that managements desire to achieve stock price forecasts will increase fraud risk.

c. Phillips CPA Firm are likely to assume fraud risk is high, due to senior managements proximity to achieving certain desired stock prices.

d. None of these answer choices are correct.

25. The sales cutoff test is designed to obtain reasonable assurance that ________.

1. sales have been recorded for the correct amounts
2. sales were actually made
3. sales and accounts receivable are recorded in the accounting period in which the transactions occurred
4. sales have been recorded in the correct accounts

26. Dawn and Guy are working on the audit of the revenue-receivables cycle for Nexus Enterprises, LLC, a provider of gym equipment throughout the United States and Canada. Dawn has heard one of the audit partners discussing this cycle, and asks Guy to explain what exactly this cycle is. Which of the following most accurately describe the revenue-receivables cycle?

1. The revenue-receivables cycle involves multiple steps. Typically, the first step is a customer placing an order for goods and inventory being shipped out. If the sale is made on credit, then a receivable is created for the customer, who will subsequently remit payment at a future date.
2. The revenue-receivables cycle typically is initiated by a customer ordering products from the client. Once the product is ordered, a payable will be created and the customer allowed a certain number of days to pay. Once the customer remits payment, the cycle starts over again.
3. The revenue-receivables cycle is one of the most common cycles in any business, regardless of the industry. The client records a receivable in the amount of the sale, and remits payment to the customer within a prespecified number of days.
4. None of these answer choices are correct.

27. John, the audit partner in charge of Hasbro CPA Firm has called a meeting of his audit teams to discuss the upcoming audit of Tyson Enterprises LLC, a large multinational retailer of clothes and other fashionable apparel throughout the United States and Latin America. John wants to brainstorm and discuss the possible risks of material misstatement that may be present with this client. Which of the following represents the most likely risk of material misstatement for this client?

a. The client sells its goods in other countries, not just the United States. This exposes the client to additional risks pertaining to foreign currency exchange rates, and also the risk of non-collection of receivables from foreign customers.

b. The client is a large firm, so it is possible that the clients reporting hierarchy and decentralized system of governance and operation might increase the risk of material misstatement due to local managers circumventing rules and procedures.

c. The client operates its production facilities in the United States, which could expose the client to overseas labor union disputes as well as having to contend with foreign strikes and collective bargaining issues.

d. The client operates in the fashion industry, which changes rapidly. In addition, this industry is often fickle with consumer demands and tastes shifting rapidly

28. Steve, the owner of a small CPA firm has been hired on a consulting basis by GlowBright, Inc. to evaluate their process for accepting new clients. Steve has analyzed the previous system and noted that many clients were accepted by the firm who were often either late settling receivables, or didnt settle their receivables at all. As a result of this, Steve has formulated some new considerations for the firm when considering accepting new clients. Which of the following would best represent these considerations?

a. Before accepting a new customer, the client firm should request references from previous vendors of that firm so that payment history and terms can be documented. This will help the client firm determine the suitability of the prospective customer.

b. Before accepting a new customer, the client firm should consider credit checking the prospective new client to gauge creditworthiness. Such a check will also help determine what, if any initial credit terms should be offered.

c. When considering a new customer, the safest option for the client firm is to request that for the first year, all sales will be made on a cash basis only. This will allow the client firm to build a history with the customer and reevaluate the credit decision in the future.

d. None of these answer choices are correct.

29. & 30. Brad Scarlett is reviewing the results of the subsequent events audit procedures. Brad is writing a report for the audit partner based on these results and will be attending a meeting tomorrow with the partner and representatives of the company to discuss them. The issue will be whether the financial statements should be amended or additional notes included for these subsequent events.

Many of the items are not material, and Brad will recommend that no action be taken with respect to these. However, there are several items that Brad believes are material and should be discussed at the meeting. These are:

1. The board is planning to issue shares in a private offering on February 15.
2. The share issue is to fund the purchase of a 60% stake in another company. The negotiations are in the final stages, and although the contract is not yet signed, it will be signed by February 15.

c. A lawsuit was filed in court in the week after year-end claiming damages for illness allegedly caused by chemicals used at a subsidiary companys manufacturing plant in the early 2000s. This is the tenth such lawsuit filed, and the client has denied responsibility in all cases because it was unreasonable to believe at that time that these chemicals had adverse health effects. The claimant has new scientific evidence that counters this defense.

d. The review of subsequent cash receipts has revealed that several of the receivables that were considered doubtful have now been paid.

The year-end for the company is December 31, and the audit report is due to be signed on February 20.

For each item, discuss what type of subsequent event it is and the appropriate treatment in the financial statements.

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