Part 5 section 2 management assertions matching questions 1-8

I ' I Name p(\\V)v\\ C:V\\ L SO LLrrt:o10 5:30 Class FORM A Part 1 Multiple Choice (152 Points) AF 470 Financial Auditing Midterm Exam Prof Hogan Fall 2015 332 Points three hours Choose the best answer for each of the following questions and enter the answer in the space provided. You may omit one question. Write "OMIT" in the answer space for the question omitted. 1. By reducing information risk, an audit facilitates which "economic factor of production" a. Labor c. Management ability b. Land d. Financial capital allocation Answer 2. "A systematic process of objectively obtaining and evaluating evidence regarding assertions about economic actions and events to ascertain the degree of correspondence between those assertions and established criteria and communicating the results to interested users" refers to: a. Financial Statement audit c. Attest service b. Compliance audit service d. Assurance service Answer 3. D A Internal Revenue Service agent is doing an audit of an individual's income tax return. Name the type of engagement performed and the most likely criteria. a. Financial; Generally Accepted Accounting Principles. b. Financial; Generally Accepted Auditing Standards. c. Financial; Internal Revenue Code. d. Compliance; Internal Revenue Code. e. Compliance; Generally Accepted Accounting Principles. f. Compliance; Generally Accepted Auditing Standards. Answer 4. Examples of frauds are presented in our textbook. Which company "billed group psychiatric sessions as individual sessions"? a. Enron. c. Parmalat. b. Health South. d. Worldcom. Answer 5. Which is one of the three conditions "generally present when material misstatements due to fraud occur" (i.e. Fraud Triangle)? a. Ratings c. Reality b. Rationalization d. Realizable Answer 6. Consider the following statements: I. Conceptually, to DECREASE the level of DETECTION RISK, the auditor would do MORE substantive testing (i.e. more audit work) II. When considering a preliminary judgment of materiality, if the auditor sets a HIGHER dollar amount for materiality, rather than a LOWER dollar amount, MORE evidence (i.e. substantive testing) is required. a. I is true; II is true. b. I is true; II is false. c. I is false; II is true. d. I is false; II is false. Answer 7. --- In class in discussing the audit risk model we considered several cases as follows: Case Audit Risk .05 .05 I II Inherent Risk Control Risk Detection Risk (rounded) .50 .50 .20 1. 00 1. 00 ??? What would be the required level of detection risk for case II. Compared with Case I would the auditor expect to do more or less audit work (substantive testing) for case II? a. b. e. .05; less audit work. .05; more audit work. none of the above. c. d. 1.00; less audit work. 1.00; more audit work. Answer 8. To be appropriate, evidence should be relevant and reliable. Under which of the situations would evidence be presumed to be LESS rather than MORE reliable: a. b. c. d. Evidence is obtained from accounting records developed under a properly designed system of internal controls. Evidence is derived from objective rather than subjective (i.e. judgmental) sources. Evidence is obtained from within the audit client's organization rather than independent outside sources. Auditor directly obtains the evidence. Answer 3 9. Company management capitalized expenses in order to increase income. This is called: a. depredation. b. error. c. financial reporting fraud, or fraudulent financial reporting. d. misappropriation of assets, or theft. e. none of the above. Answer 10. Management states that the company owns the items listed as assets, relates to which assertion? a. b. c. d. Completeness Existence Rights and obligations Valuation and Allocation Answer 11. D As a test of sales for completeness (i.e. understatement), an auditor selects 50 sales recorded in the sales journal and vouches them to sales invoices and then to the respective shipping document. This evidence is not appropriate because of the violation of: a. Auditor's direct knowledge. b. Objectivity c. Reliability d. Relevance Answer 12. The a. b. c. d. assertion "completeness" involves: Following accounting standards Ownership Overstatement Understatement Answer 13. Generally, the difference between "error" and "fraud" is a. b. Incentive Initiative c. d. Intent Incitement Answer 14. Professional skepticism is best described as: a. an intent to deceive. b. a trustful manner. c. a questioning mind. d. the ability to follow professional standards. Answer 15. In class, we discussed the notion of an audit philosophy of tests of accounts for overstatement and understatement to gain audit efficiencies. Consider the following statements: I. When sales are tested [directly] for UNDERstatement; then conceptually, accounts receivable are also tested for UNDERstatement. II. Generally, liabilities would be tested for UNDERstatement. a. b. I is true; I is true; II is true. II is false. c. d. I is false; II is true. I is false; II is false. Answer 16. A Consider the following statements: I. For balance sheet accounts, evidence is considered to be more timely if it involves selecting amounts as of the balance sheet date. II. For income statement accounts, evidence is considered to be more timely if it involves selecting transactions throughout the period. a. I is true; II is true. b. I is true; II is false . c. I is false; II is true. d. I is false; II is false. Answer 17. Consider the following statements: I. Tolerable misstatement is the amount the financial statements could be misstated and the auditor could still properly give an unqualified (i.e. "good") auditor's opinion. II. Conceptually, the auditor will do enough audit work in an account to discover misstatements which individually, or in total exceed the amount of tolerable misstatement involving the account. a. I is true; II is true. b. I is true; II is false. c. I is false; II is true. d. I is false; II is false. Answer 18. D Which of the following terms is associated with the auditing standard stating: In rare circumstances, the auditor may judge it necessary to depart from a relevant presumptively mandatory requirement. In such circumstances, the auditor should perform alternative procedures to achieve the intent of the requirement. AU-C200.26 a. Can c. Must b. May d. Should Answer I 19. Consider the following statements: I. Analytical procedures can be used in the preliminary phase of an audit to suggest areas, or accounts which should receive more attention during the audit. II. If one is looking for "unusual fluctuations to investigate further", then one would tend to believe that the current year's results are expected to look similar to the past year's results. a. I is true; II is true. b. I is true; II is false. c. I is false; II is true. d. I is false; II is false. Answer 20. In class we discussed the following example: Year 2015 Unaudited 2014 2013 5 3 3 Current ratio In the beginning stage of an auditor, the above ratio might suggest to the auditor which of the following: a. b. c. d. The company's financial picture has improved. Some current assets might be understated. Some current liabilities might be understated. Some current liabilities might be overstated. Answer --- ~ \\ What is the scope.of applicapility of the auditing standards of the AICPA? a. Nonpublic companies,traded iii non-U.S. markets. b. Nonpublic companies fu the U.S. c. Public companies traded in-non-U.S. markets. d. Pu~lic comp~es traded in the lJ:i,S. p.v~~ - ?. '2- Consider ~he following statements: ~e amount of evidence gathered is not important to an auditor since the quality of the evidence is of primary importance~ . j). . Internal documentation is more reliable t~ ~~ audito.r if the internal control surrounding the documentation is considered strong than if it is considered weak. \\ . a. I is true; II. II is true b. I is true; II. II is false A-~~- I c. I is false; II. II is true d. I is false; II. II is false If the auditor's assessment of audit risk is low (e.g., 1% rather than 5%), what is the effect on the amount of direct testing performed by the auditor? a. Increase in direct testing. b. Decrease in direct testing c. No change in direct testing. d. Direct testing is not needed. :;i Lt, The Publia Company Accounting Ovenigbt Bbard's thlld.,. general standard states thatdue cans is to be-exercised: in the,. . performance of an imdin Thia. standard is ordinarily. interpreted. to requiRI:, . IL . Thorough review of the existing aafeguard!I OV~ . . access to assets and rec:ords. . . . b. Limited revievi ~f the in~~o~ bf ~~h>:Y~~ fraud . and illegal acts~ . c. Objective review of the adequacy of the technical: . training and proficiency of fum personnel; IL. Critical teview of the jndgmcnt~ec! at every ;l'6 When tho auditor believes a misstitement i8 ot may btS'. . ' tluii:CSUU: of fraud but that the effect of the i:nisstatement is not . material to tho financial statements1 wbiCh of the foUowbig'::.. a........ ....: . ; , '. ;: , .. -~ ."t'"' isrem1i~d'l:~" .,,,.._,.'.' '':: . t ' .'~: "::a.;. conaidatm hnplicati~ fi>t ~thci asp~cts ~f thlsr :. audit "' ; ' \\>.-. Resign fro~ th~~~t:;: : : . 0 lcv~l ofsupervision::-;::, . 0;.; Cbmtu:~ ~mWi 'e-xsuirinatima.- ~. c~-~~ anthmitieS'.~ ~ (\\~...."-. . _ t-:.1vhfU&iiJ . ti.,'~:-;;: ;;j,11tt#.;;..'.-c.r. ;~Qriii.ni.rli~ ai>~ta. . ~ . " !fP .. ~ . ~AU ;;r-- .. . .. ~ rati01!Jllize-actand'al$1i ba'V1i a'ir!.:1~~:~:.; ''.'1.' ; i: . . ' : 1.' :.~' ? , . ~. ':;~ ?~ : .. '. J/ Y::.~~ 1 1~ ' ''\\\\ ~ ~ ..,~ jfll14.. - , t ?. S"" A&tU aceeptable'ICVel of de~tfonrisk ~ases, 0-.lSSUIBDCC diiectly pmided froDll'" '. '., . . ' I L : ' . : .' ' .' ' ' ii:." .sb1lsbuid.vetesta: sh~d~e:.;> ,... ~ : u;iD v .bi. SUbsbmtive tests. should decxCaset,.! . .;i: c:.Teiita ofcOnirois shoidd.mcreaso;;,: ... '. (\\- d .. : Test!l:ofcQJltro~ !lbouhtdecrease-.:; , ~-: . ' ..' 1 : . : ; r ,' 1 ldcimih'1'~ ". '. ' :. . '. . 11 1 ,' ; ... '. ; . .. . . I 0 1 .. .. ., 1 , : Opp~tJc' " : , ..~;;:}-:;~,r::'.:;~J._.:;J : !t::~,. ?;CJ Wbicli.of the follo~g relatiVely miBn iniiistatements most likelf. coulll Q a material eff~ mi e~ty'S. financial . sn~-tsi~ : . '.; . . . ... ~ an .. , . . . ~ An illegal payment to afQreigia~fficial that w~ not. UIUiiiiAiU recorded..." :. . ' b. A piece of obsolete' office equipiiient that was not. I retired.: . . . c, A petty cash fund disbursement that was n.Qt iJioperlY. authorized; . '. d. An uncollectible accountreceivilble that was.not.. written off. (\\.~a.. l'\\iV~~~ ~-, 3 I Ai.~~-tiettet .sh~fildo~f,inclwll,:: z,, l ~ 1. A ~? In testing the existence 1:18Sertion.foran~se~ ~audit01r. ordinarily.workil fromtheL " . ' ' ,.' : _! ~ P-1t1anciat'st:itements to th.,. p~tentlally. ~coid~~.. itCms._~ .", I ' 'It ; II ,, r, ' ' ' ':' ,' ; .. b.; P(>te;tialli. ~c-oltled item. tctlic ~~lai s'tat~..:; " , :~ >..: :..:-::~ ~: :. :;~r~::. t_ ~.: -d,:, AccotintiDi'~!!~i~ to the sup'p9ng_ e.:vi~ece.:;.. .~,; ~. . .,. t ' ~ s11pjiottWij:~Videnc;i;tq"Ul1:1iicc;o~Pii!ier;:o~1,:.. /~!: . ' . : ~, -~~ r , .l:.;,~~fltr !'i I ~ .' .1,_;. . ~ . .= . 'I q~.-1;rro~s ~.;-L '=>G-,:; 1 A.'-A') 3~ k/R~~~E ~ /.-J~Sr/\\Q..'r HAPP'{ Dl~~~~~i}4::J: ~~~e~1;:_.: 1 ; , .' 1 :: : :.: \\ : 1 , \\.,; . P t- ' (' lL / 1, ' _. ..' , 1 Part 2 Sarbanes - Oxley and PCAOB (25 points) 1. The PCAOB has been authorized to establish auditing standards to be followed on audits of companies whose stock is publically traded. Only two of the five standard setters are allowed to be CPAs. (I) Write a sentence, or two, IN FAVOR of the policy of allowing only two members of the Board to be CPAs; (II) Write a sentence, or two, AGAINST the policy of allowing only two members of the Board to be CPAs; 2. Answer the "true" - 1. "false" questions shown below. Two CPAs allowed on the Board: I. In favor II. 2. Against True A. B. C. D. E. The name of the PCAOB is the Public Company Accounting Oversight Board. The Chair of the PCAOB must be a partner in a CPA firm. Section 404 of the Sarbanes - Oxley law requires the partner of the CPA firm auditing a company to take responsibility for the company's internal controls. The Sarbanes-Oxley Act strengthened auditor independence by requiring audit committees to appoint the auditors. Section 404 of the Sarbanes-Oxley law requires that both the company management and the CPA firm auditing the company issue a report on the company's internal controls. Answers: A. - False Statements "TRUE" B. or "FALSE" c. D. E. Part 3 Audit Risk Model (35 points) I. Define the following risk components Audit Risk, and Control Risk. Audit Risk Control Risk II. Classify each of the following items as related to: a. audit risk; b. control risk; c. inherent risk; or d. detection Risk. 1. 2. 3. 4. 5. 1. An inexperienced staff auditor misses a material misstatement of an account. The partner feels that the audit is very important. The account balance represents an asset which is easily stolen. The company has an inadequate system to safeguard assets. The account balance is made up of subjective estimates. 2. 3. Section III is on the next page 4. 5. Section III Explanation of part of model. Assume that an auditor uses different engagements as follows: Engagement I Audit Risk . 05 .05 II Inherent Risk .25 .50 the audit Control Risk .25 .25 risk model on two Detection Risk (as calculated) .80 to be determined A. Calculate "detection risk". Compared to engagement I, will the auditor do more or less "audit work" on engagement II. NO Discussion is necessary. B. "Tell a story" to explain "part A" in a manner that someone Not familiar with the audit risk model would likely understand. DO NOT refer to the audit risk model directly in your discussion. A. Detection risk The auditor will do on engagement II compared to I. Do NOT Discuss. B. Story [Do NOT refer directly to the audit risk model] l\\ Part 4 Materiality Considerations (25 points) The concept of Materiality is considered when audit. It is also referred to in the auditors' report. doing an 1. Define the term "Materiality". 2. The concept of Materiality is considered to have a "Qualitative" dimension. Explain what is meant by this term, give an example. 3. There is a relationship between "materiality" and the amount of audit work (i.e. Substantive testing or evidence) done on an audit. Complete the following sentence: As materiality GOES UP, the amount of audit work (substantive testing) 4. Discuss the Tolerable Misstatement situation shown below. The auditor determines materiality for the company being audited to be One Hundred Thousand Dollars [$100,000]. Tolerable misstatement of Thirty Thousand dollars [$30,000] is assigned to each of the following four accounts. Unknown errors in each of the accounts are indicated below. Audit work is performed on each account as discussed in class. The client makes any corrections to accounts as suggested by the auditor. After the completion of audit work, the auditor issues an unqualified (i.e. GOOD) auditors' opinion. Was this the correct opinion? Discuss and show any applicable calculations. Account Unknown error in account before any audit work is done (all accounts are overstated) Cash $ 25,000 Accounts receivable 40,000 Prepaid Assets 20,000 Property, Plant and Equipment 80,000 Part 5 Management Assertions (25 points) I. Conceptually, management makes assertions about the financial statements. (1) Define what is meant by management assertions. (2) How does the concept of management assertions help the auditor in auditing an entity's financial statements? II. Indicate the most applicable of each of the following assertions. Use only ONE letter for each item. Assertions about Classes of Transactions and Events: A. Occurrence D. Classification B. Completeness E. Cutoff C. Accuracy Assertions about Account Balances F. Existence H. Valuation and Allocation G. Completeness I. Rights and Obligations Assertions about Presentation and Disclosure J. Occurrence and Rights and Obligations K. Completeness L. Accuracy and Valuation M. Classification and Understandability Items 1. 2. 3. 4. 5. 6. 7. 8. Company management says that the company owns assets included in the accounting records. All inventory purchases that took place have been recorded. Sales shipped FOB destination, still in transit at the end of year 1, are excluded from revenue for year 1. Management states that probable losses from all lawsuits and claims against the company have been recognized in the financial statements. Management complies with accounting principles in determining depreciation expense. All sales that have been recorded, took place. The financial statement footnotes include the significant accounting principles used. No footnotes are included with the financial statements. Answers (USE ONLY ONE LETTER) 1. 3. 5. 7. 2. 4. 6. 8. l? Part 6 Types of Audit Evidence (20 points) I. Evidence has been defined as relating to auditors' conclusions. State what the conclusions are about. II. Classify each of the following according to type of audit evidence: A. B. Analytical procedures Confirmation E. F. c. Examination of documents Inquiry G. H. D. I. Observation Inspection of Assets Physical Examination] Recalculation Reperf ormance Scanning i.e. Procedures: 1. Review vendor balances (Accounts payable subsidiary ledger) looking for balances with debit amounts. 2. Discuss with company personnel how warranty expense was determined. 3. Examine a check from a customer before it is deposited in the company's bank account. 4. An auditor extends [i.e. multiplies] inventory quantities by unit prices to check the mathematical accuracy. 5. Trace shipping documents to related sales invoices to determine that sales have been billed. 6. Send letters to customers asking them how much they owe the company. 7. The auditor performs an internal control procedure (i.e. a walkthrough) to gain an understanding of the client's internal control system. 8. Compare company expense numbers with similar data from previous years. Select only ONE letter for each of the procedures Answers 1. 3. 5. 7. 2. 4. 6. 8. Part 7 Audit Philosophy and Direction of Tests (30 points) We considered broad "accounting systems" involving the Sales Cycle AND Inventory Observation to illustrate the direction of testing involving the test for overstatement or understatement. Requirements: 1. Consider THREE ADJACENT pieces of the sales cycle [do NOT use "Sales Order"] and discuss the proper direction of testing for Sales for OVERstatement. 2. In a physical inventory observation, discuss the proper direction when taking test counts to test for OVERstatement of inventory. 3. The double-entry accounting system conceptually can be used to gain audit efficiencies. Use "journal entries" and explain how (A) Accounts receivable is tested for understatement by gathering evidence about another account; and (B) how a liability is tested for overstatement by gathering evidence about another account. 4. What type of evidence is used to test sales for overstatement? 1. Sales for OVERstatement 2. Physical Inventory testing for OVERstatement 3A. Journal entries & Discussion. Accounts receivable for UNDERstatement. 3B. Journal entries & Discussion. A liability for OVERstatement. 4. Type of evidence: Sales for OVERstatement Part 8 I. Appropriateness of Audit Evidence (20 points) Define the term "reliability". II. For each situation presented below, indicate which means of gathering evidence would be considered more reliable AND indicate a reason from the following list: A. Independent source of the information (Independence of provider) ; B. Auditor's direct knowledge; C. Effectiveness of the client's Internal Controls. D. Knowledgeable source (qualifications of individuals providing the information) ; and E. Degree of Objectivity or Subjectivity of the account. DO NOT DISCUSS your answer. Answers Item CHOOSE ONLY ONE LETTER. Number more reliable Letter for reason a. b. c. d. a. 1. b. The auditor relies on an analysis prepared by the controller of gross margin to sales for the current and prior periods; or (2) The auditor calculates gross margin to sales and compares to similar data for prior periods. Test the existence of accounts receivable, 1. By tracing amounts from copies of sales invoices to amounts in the accounts receivable subsidiary ledger; or, 2. By sending accounts receivable confirmation letters to selected customers. c. In considering the valuation of inventory 1. The auditor reviews and makes test counts of computer components; or 2. The auditor reviews and makes test counts of the inventory consisting of lumber of different lengths. d. Auditor tests two segments of the company. 1. In the first segment, the auditor notices that people are assigned to check the work of other employees; or 2. In the second segment, no one bothers to check others' work