Auditing A Business Risk Approach with Cases 8th Edition By Rittenberg – Test Bank

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Auditing A Business Risk Approach with Cases 8th Edition By Rittenberg – Test Bank

Chapter 2: Corporate Governance and Audits

Student: ___________________________________________________________________________

  1. The objective of financial reporting is to provide useful information to interested users.
    True    False

 

  1. Financial transparency relates to how well resources are protected and managed by the company and its management.
    True    False

 

  1. Corporate governance is a process by which the owners, but not the creditors, exert control over the resources of the enterprise.
    True    False

 

  1. Management can influence who sits on the board and the audit committee as well as other governance controls that might be put into place.
    True    False

 

  1. A commission sponsored by the New York Stock Exchange issued a report in 2010 indicating that successful governance depends heavily upon honest, competent, and industrious managers.
    True    False

 

  1. The board’s fundamental objective should be to build a system of internal controls that will ensure the financial statements are free from all error.
    True    False

 

  1. An important aspect of governance is the independentjudgment of boards about what is in the best interests of the company and its shareholders.
    True    False

 

  1. The external auditor has the primary responsibility for creating a culture of performance with integrity and ethical behavior within the client’s organization.
    True    False

 

  1. Since the board is responsible to protect the interest of the shareholders, independence is not a necessary attribute for board members.
    True    False

 

  1. Companies must strike the right balance in the appointment of independent and non-independent directors to ensure an appropriate range and mix of expertise, diversity, and knowledge on the board.
    True    False

 

  1. It is effective for a board to take a “check the box” mentality when implementing and complying with governance mandates and best practices.
    True    False

 

  1. The first decade of the twenty-first century has seen more changes in corporate governance than at any time since the Great Depression.
    True    False

 

  1. Governance failures over the past decade were primarily limited to the United States.
    True    False

 

  1. Board of directors that did not spend sufficient time or have sufficient expertise to perform duties led to corporate governance failures.
    True    False

 

  1. The audit committee is a subcommittee of the board of directors comprised of independent outside directors.
    True    False

 

  1. The auditor must communicate significant audit adjustments to the audit committee.
    True    False

 

  1. Any major disagreement the auditor has with management should be discussed with the audit committee.
    True    False

 

  1. Managers of organizations are hired by Boards of Directors to perform responsibilities such as the implementation of internal control.
    True    False

 

  1. The Sarbanes-Oxley Act prohibits auditors from performing consulting services for their audit clients.
    True    False

 

  1. The Public Company Accounting Oversight Board (PCAOB) set standards for audits of private and public companies.
    True    False

 

  1. An auditor is required to communicate new accounting principles adopted by the organization to the audit committee.
    True    False

 

  1. Audit committees are motivated to make sure the auditors do their job, because poor performance on the part of the auditors will directly reflect on the performance of the audit committee members.
    True    False

 

  1. The Sarbanes-Oxley Act makes the audit committee the client of the external audit firm.
    True    False

 

  1. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 replaces the requirements of the Sarbanes-Oxley Act of 2002 for financial sector companies.
    True    False

 

  1. The Public Company Accounting Oversight Board has five members, all of which must be CPAs.
    True    False

 

  1. The Public Company Accounting Oversight Board has the power of performing inspection of public accounting firms to determine their performance and check for improvements if any.
    True    False

 

  1. In order to safeguard independence of the firm, partners and managers of public accounting firms must go through a cooling off period prior to taking a high level position of employment with a public client company.
    True    False

 

  1. The Sarbanes-Oxley Act includes provisions requiring the auditor and the management to certify the financial statements and its disclosures and quality of internal controls.
    True    False

 

  1. The Sarbanes-Oxley Act requires that public companies report on internal financial controls.
    True    False

 

  1. The Sarbanes-Oxley Act requires partners or managers significantly participating in audits to rotate off the engagement every five years.
    True    False

 

  1. The audit committee must be composed of outsiders such as the organization’s attorney and audit partner.
    True    False

 

  1. The nominating committee is a standing committee of the board of directors whose purpose is to oversee the accounting and financial reporting processes of the company and the financial statement audits.
    True    False

 

  1. When operating effectively the audit committee may replace the processes performed by the external auditors.
    True    False

 

  1. The audit committee will receive feedback from both the internal and external auditors on a number of issues including the quality of internal controls over financial reporting.
    True    False

 

  1. For public companies, the audit committee must be composed of outside directors who are also all financial experts.
    True    False

 

  1. The audit committee relies on the internal and external auditors to develop and communicate objective information needed by the audit committee to effectively perform its oversight functions.
    True    False

 

  1. The audit committee typically would not review the Management Discussion and Analysis section of the annual report filed with the SEC since that section of the report is the responsibility of management and includes forward looking statements.
    True    False

 

  1. A survey of audit committee members conducted by KPMG in 2010 indicated that, on average, companies hold 12 audit committee meetings annually.
    True    False

 

  1. Management of companies should have the ability to hire and fire the external auditor.
    True    False

 

  1. The audit committee should have the authority to hire and fire the external auditors.
    True    False

 

  1. The purpose of the audit committee is to oversee all aspects of the financial reporting process, including preparation and filing of financial statements, internal control over financial reporting, and related risks.
    True    False

 

  1. At least half of the members of an audit committee should be composed of independent directors.
    True    False

 

  1. The audit committee is responsible for ensuring that management designs and implements sound internal control, which is essential for reliable financial reporting for any organization.
    True    False

 

  1. The chief (internal) audit executive should have direct reporting access to the audit committee, and the committee should oversee the activities and budget of the internal audit function.
    True    False

 

  1. The audit committee should meet in separate executive sessions with management, the external auditor, the internal auditor, legal counsel, and other advisors.
    True    False

 

  1. The board should not consider limiting the number of years an individual can serve on the audit committee since the more an audit committee member understands the company the more effective that member will be able to perform the required duties.
    True    False

 

  1. Recent academic research shows that companies with good corporate governance have higher return on equity than other companies.
    True    False

 

  1. According to SAS 61, auditors are required to inform the audit committee of any significant audit adjustments discovered during the engagement.
    True    False

 

  1. The audit committee must be assured that the auditor is free of any restrictions and has not been influenced by management during the course of the audit.
    True    False

 

  1. The Public Company Accounting Oversight Board obtains its authority to set audit standards for public companies from the U.S. Congress.
    True    False

 

  1. The American Institute of Certified Public Accountants no longer retains the right to set audit standards for public companies as the Securities Exchange Commission has relinquished such power.
    True    False

 

  1. Corporate governance is a process by which the owners and creditors of an organization
    A. exert control.
    B. require accountability.
    C. exert control and require accountability.
    D. neither exert control nor require accountability.

 

  1. Stockholders require accountability from management for:
    A. financial performance
    B. financial transparency
    C. quality of internal controls
    D. all of the above

 

  1. The responsibility for operating an enterprise is delegated to the:
    A. auditor.
    B. audit committee.
    C. management.
    D. board of directors.

 

  1. Section 304 of the Sarbanes-Oxley Act requires executives to forfeit any bonus or incentive-based pay or profits (including stock options) from the sale of stock received in the twelve months prior to an earnings restatement. This is often referred to as:
    A. claw back provision
    B. give back provision
    C. restatement provision
    D. fraud provision

 

  1. Governance demands accountability back through the system to the:
    A.  shareholders
    B. audit committee
    C. management
    D. all of the above

 

  1. The audit client of the CPA firm is:
    A. management.
    B. the SEC.
    C. the audit committee.
    D. the stockholders.

 

  1. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 was enacted in response to the financial crisis of 2008 and 2009 and included the following corporate governance requirement(s):
    A. Mandates enhanced stock exchange listing standards on compensation committee independence
    B. Requires the external auditors report to the audit committee
    C. Mandates that at least one member of the audit committee be a financial expert
    D. All of the above

 

  1. The audit committee has oversight responsibilities for:
    A. outside reporting.
    B. internal auditing.
    C. external auditing.
    D. all of the above.

 

  1. Which of the following should be communicated by the auditor to the audit committee?
    A. auditor’s responsibilities under GAAP.
    B. all significant audit adjustments.
    C. significant accounting policies.
    D. all are required communications.

 

  1. Which one of the following will provide auditing standards of public companies?
    A. GAO
    B. AICPA
    C. GAAP
    D. PCAOB

 

  1. The PCAOB has the authority to do all of the following except:
    A. perform peer reviews on public accounting firms
    B. establish quality control standards for auditors of public companies
    C. take responsibility for an organization’s financial statements
    D. set audit standards

 

  1. Management of an organization has the responsibility for all of the following except:
    A. accounting principles used in financial reporting
    B. engagement of a qualified auditor
    C. internal control over financial reporting
    D. financial statements and disclosures

 

  1. A commission sponsored by the New York Stock Exchange issued a report in 2010 indicating that successful governance depends heavily upon:
    A. honest managers
    B. competent managers
    C. industrious managers
    D. all of the above

 

  1. The board’s fundamental objective should be to:
    A. ensure the financial statements are free from all error
    B. ensure management’s interests are properly reflected in the strategy of the company
    C. build long-term sustainable growth in shareholder value for the corporation
    D. none of the above

 

  1. The corporate governance responsibilities of management include:
    A. establishing risk management processes
    B. establishing proper internal controls
    C. requiring high ethical standards
    D. all of the above

 

  1. The Sarbanes-Oxley Act of 2002 requires management of public companies to:
    A. certify the accuracy of financial statements.
    B. establish a corporate code of conduct.
    C. take accountability for restated earnings.
    D. all of the above

 

  1. All of the following groups have responsibility for ensuring proper corporate governance except:
    A. stockholders
    B. board of directors
    C. regulatory agencies
    D. all of the above have responsibility

 

  1. Governance failures over the past decade related to the stockholders included all of the following except:
    A. focus on short-term prices
    B. failure to perform long-term growth analysis
    C. abdication of  most responsibilities to management and analysts as long as stock price increased
    D. all of the above are failures

 

  1. Governance failures over the past decade related to the external auditor included all of the following except:
    A. failure of the external audio to implement proper internal controls in the financial systems of their clients
    B. promotion of personnel based on ability to sell non-audit products
    C. replacement of  direct tests of accounting balances with inquiries, risk analysis, and analytics
    D. all of the above are failures

 

  1. Which group is responsible for ensuring that the organization is run according to the organization’s charter and that there is proper accountability?
    A. regulatory agencies such as the SEC
    B. external auditors
    C. board of directors
    D. internal auditors

 

  1. Specific activities performed by regulatory agencies such as the SEC include the following except:
    A. reviewing of filings
    B. interacting with the FASB in setting accounting standards
    C. auditing the financial statements to express an opinion
    D. all of the above are performed

 

  1. Specific activities performed by external auditors include(s):
    A. preparation of client financial statements in conformity with GAAP
    B. services such as audit, tax or consulting
    C. creating and specifying independence standards
    D. all of the above are performed

 

  1. Specific activities performed by management include the following except:
    A. formulating strategy and risk management
    B. implementing effective internal controls
    C. hiring of the external auditors
    D. all of the above are performed

 

  1. The Public Oversight Board issued a report citing concerns with the audit process. These concerns included all of the following except:
    A. analytical procedures were being used inappropriately to replace direct tests of account balances
    B. audit documentation, especially related to the planning of the audit, was not in compliance with professional standards
    C. auditors were ignoring warning signals of fraud and other problems
    D. all of the above were cited

 

  1. An audit committee must be comprised of outside directors and at least one outside financial expert.  Which of the following is considered an outside director?
    A. A director who is not a member of management and has no other relationship to the organization.
    B. A consultant to the organization who works as an honorary member of the board.
    C. A director who is also a member of management and has no other relationship to the company.
    D. A director who is a CPA and CIO of an affiliated organization.

 

  1. Which of the following members of the board of directors of McKeever Corporation is most qualified serve on McKeever’s audit committee?
    A. Jon Adams, internal auditor of McKeever Corporation
    B. Megan Wiley, attorney to McKeever Corporation
    C. Karen Jones, consultant to McKeever Corporation
    D. None of the above should serve on the audit committee of McKeever Corporation

 

  1. The audit committee’s primary responsibilities related to the financial reporting process include:
    A. providing oversight of the accounting and financial reporting processes
    B. appointing, compensating, and overseeing the external auditor
    C. ensuring that the board establishes a whistleblower program
    D. all of the above

 

  1. It is expected that the external auditor report the following to the audit committee except:
    A. critical accounting policies and practices used by management
    B. materiality methodology and thresholds used by the auditor
    C. material alternative GAAP treatments that have been discussed with management
    D. material written communications between the auditor and management

 

  1. Which of the following board of directors of Robbins Corporation should not serve on the audit committee?
    A. John Williams, professor at the University of Kalamazoo
    B. Tyrone Marks, treasurer of Robbins Corporation
    C. Stacy Bobbitt, member of the board of directors of the First National Bank and Trust
    D. Jill Cemoss, chairman of the board of Big Brothers and Sisters, a non-profit organization

 

  1. The audit committee’s major areas of responsibility include all of the following except:
    A. oversight of the internal control system
    B. oversight of the internal audit function and external auditor
    C. preparation of financial statements
    D. establishment and oversight of a whistleblower process

 

  1. The audit committee should have:
    A. at least one financial expert
    B. members with very similar backgrounds and perspectives to avoid conflict
    C. at least one independent director
    D. all of the above

 

  1. External auditors should expect the audit committees at their clients to ask them relevant and probing questions. Some of the relevant questions that audit committee members should ask the external auditor include all of the following except:
    A. What are the most significant risks to financial reporting at this company?
    B. What level of assurance do your procedures provide with respect to the annual financial statements?
    C. How do you calculate materiality and what is your materiality threshold for the engagement?
    D. How do you assess the competence of company personnel engaged in financial reporting and related processes?

 

  1. The audit committee should perform the following in relation to the management of the external auditor except:
    A. hiring
    B. firing (if appropriate)
    C. determining the audit fee
    D. all of the above should be performed

 

  1. The audit committee should disclose the processes it uses in discharging its responsibilities, including all of the following except:
    A. the number of meetings each year
    B. how the committee oversees the internal audit function
    C. committee activities performed to assess the risk of fraudulent financial reporting
    D. the committee’s role in its direct implementation of  internal controls

 

  1. The Sarbanes-Oxley Act of 2002 requires which of the following?
    A. Only the largest four accounting firms may audit public companies.
    B. Smaller public companies that cannot afford to become compliant with the act must delist and become pink sheet companies.
    C. All publicly held companies will provide a report on internal control over financial reporting.
    D. Chief financial officers of public companies must be CPAs.

 

  1. The PCAOB has broad powers affecting the audit profession, including:
    A. Requiring all public accounting firms that audit any U.S. company to register with the PCAOB
    B. Setting auditing standards for auditors of  public companies
    C. Performing inspections of all public accounting firms in the AICPA to determine their performance
    D. all of the above

 

  1. The Public Company Accounting Oversight Board was established by:
    A. an act of Congress.
    B. the Securities and Exchange Commission.
    C. the Public Oversight Board.
    D. the self-governing association of certified public accountants.

 

  1. Brooklyn Mercantile, Inc., a public company, receives audit services from Gregory and Elder, LLC.  Brooklyn may engage Gregory and Elder to perform corporate tax returns only if:
    A. Gregory and Elder is registered with the PCAOB.
    B. Gregory and Elder is independent of Brooklyn for tax purposes.
    C. tax services by Gregory and Elder are approved by Brooklyn’s audit committee.
    D. the PCAOB approves such “non-audit” services in writing.

 

  1. Audit committees are required to have what person in its composition?
    A. A CPA
    B. A public regulator
    C. A financial expert
    D. An attorney-at-law

 

  1. According to the Sarbanes-Oxley Act of 2002, how often must audit managers and partners rotate off an engagement of a public company?
    A. Each busy season
    B. When independence is in question
    C. Every five years
    D. Managers and partners are not required to rotate off of public client engagements

 

  1. Which of the following are the CEO and CFO of a public company prohibited from performing under the Sarbanes-Oxley Act of 2002?
    A. Certification of financial statements
    B. Disclosure of off-balance sheet transactions
    C. Reporting on internal control over financial reporting
    D. Selecting the external auditors

 

  1. The organization that will continue to set auditing standards for firms auditing private companies is the
    A. FASB
    B. GAO
    C. SEC
    D. AICPA

 

  1. The AICPA is an organization that is
    A. historically self-regulated.
    B. regulated by the federal government.
    C. regulated the state governments.
    D. a new organization established by an act of congress in 2002.

 

  1. A proper system of corporate governance is one that demands
    A. decision making by auditors in place of management.
    B. accountability back through the system to the shareholders.
    C. internal audit representation on the board of directors.
    D. audit planning to obtain competent and sufficient audit evidence.

 

  1. The auditor may properly address the risk associated with an organization that does not demonstrate a commitment to good governance in the all of the following ways except:
    A. not accepting the client
    B. performing more audit work to better manage the financial risk to the auditor
    C. charging a higher audit fee without performing increased audit work to compensate the auditor for the risk
    D. all of the above are proper are proper

 

  1. Companies with good governance generally have the following characteristic(s):
    A. are less likely to engage in “financial engineering”
    B. take the requirements of good internal control over financial reporting seriously
    C. make a commitment to financial competencies needed
    D. all of the above

 

  1. The role of the auditor and the audit committee

    Describe the relationship between the external auditor and the audit committee of the company receiving audit services.

 

 

 

 

 

  1. Characteristics of an effective audit committee

    List and discuss at least four attributes of an effective audit committee that provides important oversight functions.

 

 

 

 

 

  1. Discuss what corporate governance is and briefly describe an overview of the corporate governance process.

 

 

 

 

 

  1. Discuss some of the more significant provisions of the Sarbanes-Oxley Act of 2002.

 

 

 

 

 

 

 

Chapter 2: Corporate Governance and Audits Key

  1. The objective of financial reporting is to provide useful information to interested users.
    TRUE

 

  1. Financial transparency relates to how well resources are protected and managed by the company and its management.
    FALSE

 

  1. Corporate governance is a process by which the owners, but not the creditors, exert control over the resources of the enterprise.
    FALSE

 

  1. Management can influence who sits on the board and the audit committee as well as other governance controls that might be put into place.
    TRUE

 

  1. A commission sponsored by the New York Stock Exchange issued a report in 2010 indicating that successful governance depends heavily upon honest, competent, and industrious managers.
    TRUE

 

  1. The board’s fundamental objective should be to build a system of internal controls that will ensure the financial statements are free from all error.
    FALSE

 

  1. An important aspect of governance is the independentjudgment of boards about what is in the best interests of the company and its shareholders.
    TRUE

 

  1. The external auditor has the primary responsibility for creating a culture of performance with integrity and ethical behavior within the client’s organization.
    FALSE

 

  1. Since the board is responsible to protect the interest of the shareholders, independence is not a necessary attribute for board members.
    FALSE

 

  1. Companies must strike the right balance in the appointment of independent and non-independent directors to ensure an appropriate range and mix of expertise, diversity, and knowledge on the board.
    TRUE

 

  1. It is effective for a board to take a “check the box” mentality when implementing and complying with governance mandates and best practices.
    FALSE

 

  1. The first decade of the twenty-first century has seen more changes in corporate governance than at any time since the Great Depression.
    TRUE

 

  1. Governance failures over the past decade were primarily limited to the United States.
    FALSE

 

  1. Board of directors that did not spend sufficient time or have sufficient expertise to perform duties led to corporate governance failures.
    TRUE

 

  1. The audit committee is a subcommittee of the board of directors comprised of independent outside directors.
    TRUE

 

  1. The auditor must communicate significant audit adjustments to the audit committee.
    TRUE

 

  1. Any major disagreement the auditor has with management should be discussed with the audit committee.
    TRUE

 

  1. Managers of organizations are hired by Boards of Directors to perform responsibilities such as the implementation of internal control.
    TRUE

 

  1. The Sarbanes-Oxley Act prohibits auditors from performing consulting services for their audit clients.
    TRUE

 

  1. The Public Company Accounting Oversight Board (PCAOB) set standards for audits of private and public companies.
    FALSE

 

  1. An auditor is required to communicate new accounting principles adopted by the organization to the audit committee.
    TRUE

 

  1. Audit committees are motivated to make sure the auditors do their job, because poor performance on the part of the auditors will directly reflect on the performance of the audit committee members.
    TRUE

 

  1. The Sarbanes-Oxley Act makes the audit committee the client of the external audit firm.
    TRUE

 

  1. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 replaces the requirements of the Sarbanes-Oxley Act of 2002 for financial sector companies.
    FALSE

 

  1. The Public Company Accounting Oversight Board has five members, all of which must be CPAs.
    FALSE

 

  1. The Public Company Accounting Oversight Board has the power of performing inspection of public accounting firms to determine their performance and check for improvements if any.
    TRUE

 

  1. In order to safeguard independence of the firm, partners and managers of public accounting firms must go through a cooling off period prior to taking a high level position of employment with a public client company.
    TRUE

 

  1. The Sarbanes-Oxley Act includes provisions requiring the auditor and the management to certify the financial statements and its disclosures and quality of internal controls.
    TRUE

 

  1. The Sarbanes-Oxley Act requires that public companies report on internal financial controls.
    TRUE

 

  1. The Sarbanes-Oxley Act requires partners or managers significantly participating in audits to rotate off the engagement every five years.
    TRUE

 

  1. The audit committee must be composed of outsiders such as the organization’s attorney and audit partner.
    FALSE

 

  1. The nominating committee is a standing committee of the board of directors whose purpose is to oversee the accounting and financial reporting processes of the company and the financial statement audits.
    FALSE

 

  1. When operating effectively the audit committee may replace the processes performed by the external auditors.
    FALSE

 

  1. The audit committee will receive feedback from both the internal and external auditors on a number of issues including the quality of internal controls over financial reporting.
    TRUE

 

  1. For public companies, the audit committee must be composed of outside directors who are also all financial experts.
    FALSE

 

  1. The audit committee relies on the internal and external auditors to develop and communicate objective information needed by the audit committee to effectively perform its oversight functions.
    TRUE

 

  1. The audit committee typically would not review the Management Discussion and Analysis section of the annual report filed with the SEC since that section of the report is the responsibility of management and includes forward looking statements.
    FALSE

 

  1. A survey of audit committee members conducted by KPMG in 2010 indicated that, on average, companies hold 12 audit committee meetings annually.
    FALSE

 

  1. Management of companies should have the ability to hire and fire the external auditor.
    FALSE

 

  1. The audit committee should have the authority to hire and fire the external auditors.
    TRUE

 

  1. The purpose of the audit committee is to oversee all aspects of the financial reporting process, including preparation and filing of financial statements, internal control over financial reporting, and related risks.
    TRUE

 

  1. At least half of the members of an audit committee should be composed of independent directors.
    FALSE

 

  1. The audit committee is responsible for ensuring that management designs and implements sound internal control, which is essential for reliable financial reporting for any organization.
    TRUE

 

  1. The chief (internal) audit executive should have direct reporting access to the audit committee, and the committee should oversee the activities and budget of the internal audit function.
    TRUE

 

  1. The audit committee should meet in separate executive sessions with management, the external auditor, the internal auditor, legal counsel, and other advisors.
    TRUE

 

  1. The board should not consider limiting the number of years an individual can serve on the audit committee since the more an audit committee member understands the company the more effective that member will be able to perform the required duties.
    FALSE

 

  1. Recent academic research shows that companies with good corporate governance have higher return on equity than other companies.
    TRUE

 

  1. According to SAS 61, auditors are required to inform the audit committee of any significant audit adjustments discovered during the engagement.
    TRUE

 

  1. The audit committee must be assured that the auditor is free of any restrictions and has not been influenced by management during the course of the audit.
    TRUE

 

  1. The Public Company Accounting Oversight Board obtains its authority to set audit standards for public companies from the U.S. Congress.
    TRUE

 

  1. The American Institute of Certified Public Accountants no longer retains the right to set audit standards for public companies as the Securities Exchange Commission has relinquished such power.
    FALSE

 

  1. Corporate governance is a process by which the owners and creditors of an organization
    A.exert control.
    B. require accountability.
    C. exert control and require accountability.
    D. neither exert control nor require accountability.

 

  1. Stockholders require accountability from management for:
    A.financial performance
    B. financial transparency
    C. quality of internal controls
    D. all of the above

 

  1. The responsibility for operating an enterprise is delegated to the:
    A.auditor.
    B. audit committee.
    C. management.
    D. board of directors.

 

  1. Section 304 of the Sarbanes-Oxley Act requires executives to forfeit any bonus or incentive-based pay or profits (including stock options) from the sale of stock received in the twelve months prior to an earnings restatement. This is often referred to as:
    A.claw back provision
    B. give back provision
    C. restatement provision
    D. fraud provision

 

  1. Governance demands accountability back through the system to the:
    A. shareholders
    B. audit committee
    C. management
    D. all of the above

 

  1. The audit client of the CPA firm is:
    A.management.
    B. the SEC.
    C. the audit committee.
    D. the stockholders.

 

  1. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 was enacted in response to the financial crisis of 2008 and 2009 and included the following corporate governance requirement(s):
    A.Mandates enhanced stock exchange listing standards on compensation committee independence
    B. Requires the external auditors report to the audit committee
    C. Mandates that at least one member of the audit committee be a financial expert
    D. All of the above

 

  1. The audit committee has oversight responsibilities for:
    A.outside reporting.
    B. internal auditing.
    C. external auditing.
    D. all of the above.

 

  1. Which of the following should be communicated by the auditor to the audit committee?
    A.auditor’s responsibilities under GAAP.
    B. all significant audit adjustments.
    C. significant accounting policies.
    D. all are required communications.

 

  1. Which one of the following will provide auditing standards of public companies?
    A.GAO
    B. AICPA
    C. GAAP
    D. PCAOB

 

  1. The PCAOB has the authority to do all of the following except:
    A.perform peer reviews on public accounting firms
    B. establish quality control standards for auditors of public companies
    C. take responsibility for an organization’s financial statements
    D. set audit standards

 

  1. Management of an organization has the responsibility for all of the following except:
    A.accounting principles used in financial reporting
    B. engagement of a qualified auditor
    C. internal control over financial reporting
    D. financial statements and disclosures

 

  1. A commission sponsored by the New York Stock Exchange issued a report in 2010 indicating that successful governance depends heavily upon:
    A.honest managers
    B. competent managers
    C. industrious managers
    D. all of the above

 

  1. The board’s fundamental objective should be to:
    A.ensure the financial statements are free from all error
    B. ensure management’s interests are properly reflected in the strategy of the company
    C. build long-term sustainable growth in shareholder value for the corporation
    D. none of the above

 

  1. The corporate governance responsibilities of management include:
    A.establishing risk management processes
    B. establishing proper internal controls
    C. requiring high ethical standards
    D. all of the above

 

  1. The Sarbanes-Oxley Act of 2002 requires management of public companies to:
    A.certify the accuracy of financial statements.
    B. establish a corporate code of conduct.
    C. take accountability for restated earnings.
    D. all of the above

 

  1. All of the following groups have responsibility for ensuring proper corporate governance except:
    A.stockholders
    B. board of directors
    C. regulatory agencies
    D. all of the above have responsibility

 

  1. Governance failures over the past decade related to the stockholders included all of the following except:
    A.focus on short-term prices
    B. failure to perform long-term growth analysis
    C. abdication of  most responsibilities to management and analysts as long as stock price increased
    D. all of the above are failures

 

  1. Governance failures over the past decade related to the external auditor included all of the following except:
    A.failure of the external audio to implement proper internal controls in the financial systems of their clients
    B. promotion of personnel based on ability to sell non-audit products
    C. replacement of  direct tests of accounting balances with inquiries, risk analysis, and analytics
    D. all of the above are failures

 

  1. Which group is responsible for ensuring that the organization is run according to the organization’s charter and that there is proper accountability?
    A.regulatory agencies such as the SEC
    B. external auditors
    C. board of directors
    D. internal auditors

 

  1. Specific activities performed by regulatory agencies such as the SEC include the following except:
    A.reviewing of filings
    B. interacting with the FASB in setting accounting standards
    C. auditing the financial statements to express an opinion
    D. all of the above are performed

 

  1. Specific activities performed by external auditors include(s):
    A.preparation of client financial statements in conformity with GAAP
    B. services such as audit, tax or consulting
    C. creating and specifying independence standards
    D. all of the above are performed

 

  1. Specific activities performed by management include the following except:
    A.formulating strategy and risk management
    B. implementing effective internal controls
    C. hiring of the external auditors
    D. all of the above are performed

 

  1. The Public Oversight Board issued a report citing concerns with the audit process. These concerns included all of the following except:
    A.analytical procedures were being used inappropriately to replace direct tests of account balances
    B. audit documentation, especially related to the planning of the audit, was not in compliance with professional standards
    C. auditors were ignoring warning signals of fraud and other problems
    D. all of the above were cited

 

  1. An audit committee must be comprised of outside directors and at least one outside financial expert.  Which of the following is considered an outside director?
    A.A director who is not a member of management and has no other relationship to the organization.
    B. A consultant to the organization who works as an honorary member of the board.
    C. A director who is also a member of management and has no other relationship to the company.
    D. A director who is a CPA and CIO of an affiliated organization.

 

  1. Which of the following members of the board of directors of McKeever Corporation is most qualified serve on McKeever’s audit committee?
    A.Jon Adams, internal auditor of McKeever Corporation
    B. Megan Wiley, attorney to McKeever Corporation
    C. Karen Jones, consultant to McKeever Corporation
    D. None of the above should serve on the audit committee of McKeever Corporation

 

  1. The audit committee’s primary responsibilities related to the financial reporting process include:
    A.providing oversight of the accounting and financial reporting processes
    B. appointing, compensating, and overseeing the external auditor
    C. ensuring that the board establishes a whistleblower program
    D. all of the above

 

  1. It is expected that the external auditor report the following to the audit committee except:
    A.critical accounting policies and practices used by management
    B. materiality methodology and thresholds used by the auditor
    C. material alternative GAAP treatments that have been discussed with management
    D. material written communications between the auditor and management

 

  1. Which of the following board of directors of Robbins Corporation should not serve on the audit committee?
    A.John Williams, professor at the University of Kalamazoo
    B. Tyrone Marks, treasurer of Robbins Corporation
    C. Stacy Bobbitt, member of the board of directors of the First National Bank and Trust
    D. Jill Cemoss, chairman of the board of Big Brothers and Sisters, a non-profit organization

 

  1. The audit committee’s major areas of responsibility include all of the following except:
    A.oversight of the internal control system
    B. oversight of the internal audit function and external auditor
    C. preparation of financial statements
    D. establishment and oversight of a whistleblower process

 

  1. The audit committee should have:
    A.at least one financial expert
    B. members with very similar backgrounds and perspectives to avoid conflict
    C. at least one independent director
    D. all of the above

 

  1. External auditors should expect the audit committees at their clients to ask them relevant and probing questions. Some of the relevant questions that audit committee members should ask the external auditor include all of the following except:
    A.What are the most significant risks to financial reporting at this company?
    B. What level of assurance do your procedures provide with respect to the annual financial statements?
    C. How do you calculate materiality and what is your materiality threshold for the engagement?
    D. How do you assess the competence of company personnel engaged in financial reporting and related processes?

 

  1. The audit committee should perform the following in relation to the management of the external auditor except:
    A.hiring
    B. firing (if appropriate)
    C. determining the audit fee
    D. all of the above should be performed

 

  1. The audit committee should disclose the processes it uses in discharging its responsibilities, including all of the following except:
    A.the number of meetings each year
    B. how the committee oversees the internal audit function
    C. committee activities performed to assess the risk of fraudulent financial reporting
    D. the committee’s role in its direct implementation of  internal controls

 

  1. The Sarbanes-Oxley Act of 2002 requires which of the following?
    A.Only the largest four accounting firms may audit public companies.
    B. Smaller public companies that cannot afford to become compliant with the act must delist and become pink sheet companies.
    C. All publicly held companies will provide a report on internal control over financial reporting.
    D. Chief financial officers of public companies must be CPAs.

 

  1. The PCAOB has broad powers affecting the audit profession, including:
    A.Requiring all public accounting firms that audit any U.S. company to register with the PCAOB
    B. Setting auditing standards for auditors of  public companies
    C. Performing inspections of all public accounting firms in the AICPA to determine their performance
    D. all of the above

 

  1. The Public Company Accounting Oversight Board was established by:
    A.an act of Congress.
    B. the Securities and Exchange Commission.
    C. the Public Oversight Board.
    D. the self-governing association of certified public accountants.

 

  1. Brooklyn Mercantile, Inc., a public company, receives audit services from Gregory and Elder, LLC.  Brooklyn may engage Gregory and Elder to perform corporate tax returns only if:
    A.Gregory and Elder is registered with the PCAOB.
    B. Gregory and Elder is independent of Brooklyn for tax purposes.
    C. tax services by Gregory and Elder are approved by Brooklyn’s audit committee.
    D. the PCAOB approves such “non-audit” services in writing.

 

  1. Audit committees are required to have what person in its composition?
    A.A CPA
    B. A public regulator
    C. A financial expert
    D. An attorney-at-law

 

  1. According to the Sarbanes-Oxley Act of 2002, how often must audit managers and partners rotate off an engagement of a public company?
    A.Each busy season
    B. When independence is in question
    C. Every five years
    D. Managers and partners are not required to rotate off of public client engagements

 

  1. Which of the following are the CEO and CFO of a public company prohibited from performing under the Sarbanes-Oxley Act of 2002?
    A.Certification of financial statements
    B. Disclosure of off-balance sheet transactions
    C. Reporting on internal control over financial reporting
    D. Selecting the external auditors

 

  1. The organization that will continue to set auditing standards for firms auditing private companies is the
    A.FASB
    B. GAO
    C. SEC
    D. AICPA

 

  1. The AICPA is an organization that is
    A.historically self-regulated.
    B. regulated by the federal government.
    C. regulated the state governments.
    D. a new organization established by an act of congress in 2002.

 

  1. A proper system of corporate governance is one that demands
    A.decision making by auditors in place of management.
    B. accountability back through the system to the shareholders.
    C. internal audit representation on the board of directors.
    D. audit planning to obtain competent and sufficient audit evidence.

 

  1. The auditor may properly address the risk associated with an organization that does not demonstrate a commitment to good governance in the all of the following ways except:
    A.not accepting the client
    B. performing more audit work to better manage the financial risk to the auditor
    C. charging a higher audit fee without performing increased audit work to compensate the auditor for the risk
    D. all of the above are proper are proper

 

  1. Companies with good governance generally have the following characteristic(s):
    A.are less likely to engage in “financial engineering”
    B. take the requirements of good internal control over financial reporting seriously
    C. make a commitment to financial competencies needed
    D. all of the above

 

  1. The role of the auditor and the audit committee

    Describe the relationship between the external auditor and the audit committee of the company receiving audit services.

The audit committee hires the auditor to perform audits of financial statements that are the representations and responsibilities of management. The audit committee is the literal client of the auditor.  The audit committee has the responsibility to assess the quality of audit services received, including the independence of the external audit firm.  The audit committee has the ultimate ability to fire the audit firm.

According to SAS 61 of the auditing standards, the auditors must communicate specific issues to the audit committee.  These items of communication include:

The firm’s responsibility to audit in accordance with Generally Accepted Auditing Standards and its responsibility to review other information contained in annual reports and public documents.
The client company’s adoption of significant accounting policies and principles.
The client company management’s judgments and estimates of certain accounting balances.
Significant audit adjustments proposed by the auditors.
All major accounting disagreements with management whether or not resolved.
   

 

  1. Characteristics of an effective audit committee

    List and discuss at least four attributes of an effective audit committee that provides important oversight functions.

Attributes of an effective audit committee includes:

1. The audit committee members should be comprised of outside directors.  Outside directors are not members of management and they do not have other relationships with the company.
2. The audit committee members should be financially literate and at least one member should have financial expertise.
3. The committee should be responsible for assessing the independence of the auditor.
4. The committee should have a discussion with the auditor about the auditor’s judgments about the company’s accounting principles.
5. The committee should be apprised of significant changes in accounting information systems and the related controls.
6. The committee should receive all regulatory reports and meet periodically with regulatory auditors to discuss findings and concerns.
7. The committee should have direct oversight over the internal audit function.  It should review the budget, should review the audit plan and discuss internal audit findings.
8. The committee should meet regularly to discuss all matters of corporate governance.
9. The committee may consider separation of the Chairman of the Board and CEO positions.
   

 

  1. Discuss what corporate governance is and briefly describe an overview of the corporate governance process.

Corporate governance is defined as “a process by which the owners and creditors of an organization exert control and require accountability for the resources entrusted to the organization. The owners (stockholders) elect a board of directors to provide oversight of the organization’s activities.”

Responsibility runs down the organization. Governance starts with the stockholders/owners delegating responsibilities through an elected board of directors to management and, in turn, to operating units with oversight and assistance from internal auditors. Accountability runs upward in the organization. Operations personnel are held responsible for their actions and decisions by management, Management has to account for their decisions and actions to the board of directors, and both the board and management are held accountable by the stockholders.

 

  1. Discuss some of the more significant provisions of the Sarbanes-Oxley Act of 2002.

Some of the more significant provisions of the Act include:

Establishing the PCAOB with broad powers including the power to set auditing standards for audits of public companies.

Requiring that the CEO and CFO certify quarterly and annual reports.

Requiring management of public companies to provide a comprehensive report on internal controls over financial reporting.

Requiring management forfeiture of certain compensation in instances where there is a restatements as a result of misconduct.

Empowering audit committees to be the formal audit client of the external auditor with the responsibility to hire and fire and pre-approve any non-audit services

Requiring that the audit committee have at least one person what is a financial expert and that other members be knowledgeable in financial accounting as well as internal control

Requiring partners in charge of audit engagements, as well as all other partners with a significant role in the audit, to be rotated off public company engagements every five years.

Increasing the disclosure of all off-balance sheet transactions that have a material effect.

Establishment of an effective whistle-blowing program.

Requiring a cooling-off period before audit team members can take a high-level position with an audit client.

Limiting the non-audit services that audit firms can provide to their audit clients.

Mandating analysis of audit firm competition and the potential need for audit firm rotation.

 

Chapter 10: Auditing Revenue and Related Accounts

Student: ___________________________________________________________________________

  1. The revenue cycle considered by auditors includes the sales process but not cash collections.
    True    False

 

  1. The revenue cycle involves the procedures in generating a sales order, shipping the products, recording the transaction and collecting the receivable.
    True    False

 

  1. The shipping department confirms the shipment of goods by completing the packing slip and returning it to the purchasing department.
    True    False

 

  1. Monthly statements provide a detailed list of the customer’s activity for the previous month and a listing of all open items.
    True    False

 

  1. Invoices are processed, including their mailing to customers, only subsequent to proof of valid delivery to customers.
    True    False

 

  1. The use of prenumbered sales invoices is the primary control procedure to satisfy the assertion of completeness.
    True    False

 

  1. A comprehensive chart of accounts and a review of complex or unusual transactions by supervisory personnel are control procedures necessary for proper classification of accounts.
    True    False

 

  1. Formal procedures for approving acceptance of returns that are beyond the warranty period are an appropriate control procedure for identifying and recording returned goods.
    True    False

 

  1. One of the benefits of establishing a formal credit policy for granting credit is that management does not need to perform monitoring of accounts receivable.
    True    False

 

  1. Monitoring of the revenue cycle may be accomplished partially through the use of exception reporting
    True    False

 

  1. Monitoring is one of the five components of the COSO internal control framework.
    True    False

 

  1. The audit team is required by auditing standards to make an ordinary presumption of the risk of fraud due to revenue misstatements on every engagement.
    True    False

 

  1. A company that ships a large quantity of its products from its manufacturing plant to a warehouse that it leases until the customer is ready for the product should record the delivery as revenue.
    True    False

 

  1. The intentional loading of sales at the end of a period to customers that do not need the goods at that time should not be recorded as revenues.
    True    False

 

  1. All companies attempting to comply with GAAP should refer to the Securities and Exchange Commission for guidance as it supersedes all AICPA, PCAOB, FASB and EITF literature.
    True    False

 

  1. A tendency for fraud exists when stock options are close to becoming exercised by executives and financial personnel.
    True    False

 

  1. A red flag that may alert the auditor to fraud in the revenue cycle is a trend of revenue growth that is consistent with industry results.
    True    False

 

  1. Financial accounting personnel who do not have the proper education, experience and backgrounds may signal the auditor to the risk of financial statement fraud.
    True    False

 

  1. The auditor of James Corporation should be alert to the risk of material misstatements when James Corporation’s cash flows from operations are negative and net income (rather than loss) is reported.
    True    False

 

  1. Ratio analysis performed by the audit team may include the comparison of gross sales to industry averages and previous periods.
    True    False

 

  1. The auditor’s determination that day’s sales in accounts receivable increased from 44 days to 100 days would usually be found through the use of ratio analysis.
    True    False

 

  1. Edge and Gregg, LLP would most likely discover channel stuffing in the financial statements of a client through the use of trend analysis.
    True    False

 

  1. Use of reasonableness tests by Bono Mullins, PC will include relationships between financial but not non-financial data.
    True    False

 

  1. The auditor has determined that the control risk for the existence assertion is low; therefore the auditor may reduce the number of items tested on a substantive basis.
    True    False

 

  1. Confirmations of bank accounts may help the auditor to determine if material amounts of accounts receivable have been pledged or discounted.
    True    False

 

  1. When the auditor seeks evidence concerning the allowance for doubtful accounts he or she would most likely use an aged trial balance to help identify past due balances.
    True    False

 

  1. Current auditing standards do not require the confirmation of receivables if accounts receivable are not material.
    True    False

 

  1. Accounts receivable confirmations should be prepared on the auditing firm’s letterhead.
    True    False

 

  1. Alternative procedures to the confirmation of receivables include review of subsequent collections and examination of supporting documents.
    True    False

 

  1. Lapping of accounts receivable is least likely to occur when there is an inadequate segregation of duties.
    True    False

 

  1. Positive accounts receivable confirmations should be used on all accounts which represent small immaterial balances.
    True    False

 

  1. When the client has a large number of relatively small accounts receivable and the assessed level of control risk for receivables and related revenue transactions is high, the auditor is more likely to use negative confirmations.
    True    False

 

  1. The auditor would examine a sample of sales transactions throughout the entire period to determine if sales were recorded in the proper period when performing a sales cutoff test.
    True    False

 

  1. An example of a control over the sales cycle is the authorization of price lists by the appropriate sales and marketing manager.
    True    False

 

  1. An auditor would test controls related to the occurrence/existence of sales transactions by sampling recorded revenues and tracing them back to invoices and shipping documents
    True    False

 

  1. If control risk is assessed high, the auditor may send significantly fewer confirmations for a sample of accounts receivable than if the control risk is assessed low.
    True    False

 

  1. In planning an audit for the revenue cycle, the auditor must realize the integrated relationship of evidence found between the accounts receivable and the notes payable accounts.
    True    False

 

  1. A method of testing for the completeness of sales is to test the sequence of sales invoices used during the period under audit.
    True    False

 

  1. A review of the terms of client debt agreements assists the audit of the presentation and disclosure assertion for accounts receivable.
    True    False

 

  1. The use of audit software makes the audit of the revenue cycle more effective, but not more efficient.
    True    False

 

  1. Testing cutoff involves procedures applied to sales transactions selected from those recorded several days prior to period end and several days following period end.
    True    False

 

  1. Valid evidence obtained in an audit for testing the cutoff of gross sales includes receiving reports for returned merchandise.
    True    False

 

  1. An example of a test for completeness in the revenue cycle includes the sampling of shipping documents and tracing them to the sales journal and general ledger.
    True    False

 

  1. Negative confirmations are used to confirm material balances.
    True    False

 

  1. Exceptions found in the confirmations of accounts receivable balances need not be projected as errors to the population as they are typically isolated errors.
    True    False

 

  1. A timing difference type of exception in the confirmation process may include a misunderstanding by the reader as to the date being confirmed.
    True    False

 

  1. Negative confirmations are considered to be more persuasive than positive confirmations.
    True    False

 

  1. The purpose of summarizing confirmation results is to list the extent of sales tested in relation to the response rate.
    True    False

 

  1. An auditor’s primary concern with identifying related party sales and receivables rests with the presentation and disclosure assertion.
    True    False

 

  1. Customer complaints noted in returned accounts receivable confirmations may be an indicator of fraud.
    True    False

 

  1. The audit team typically reviews journal entries in the receivables ledger for unusual entries that may be indicators of fraudulent activity.
    True    False

 

  1. Estimation of the allowance for doubtful accounts is a simple management decision as it is determined as a percentage of sales.
    True    False

 

  1. The auditor will come up with an independent estimation of the allowance for doubtful accounts based on a thorough understanding of the client and the client’s business that is compared to the recorded allowance.
    True    False

 

  1. It is beneficial in the testing of notes receivable to confirm not only the balance of the notes, but also their terms.
    True    False

 

  1. The most important control to ensure completeness of sales and shipping is pre-numbered shipping and billing documents.
    True    False

 

  1. An aging of accounts receivable is useful in estimating the reasonableness of the allowance for doubtful accounts.
    True    False

 

  1. Which of the following processes are included in the revenue cycle?
    A. Shipping products to customers.
    B. Payments to suppliers.
    C. Issuance of capital stock.
    D. Preparation of a time card.

 

  1. Which of the following is the best example of the control objective in the revenue cycle that all transactions are recorded accurately?
    A. Sales are recorded at the invoice price expected to be collected from customers.
    B. Sales orders have sequential numbering.
    C. Recorded sales transactions are evidenced by valid invoices and shipping documents.
    D. Credits to customer accounts are classified as liabilities.

 

  1. The relationship between the sales cycle and an inventory system can best be noted in which of the following examples?
    A. Credit is established prior to completion of a sales order.
    B. Invoices are sent to customers only after shipment is evidenced.
    C. Availability of products ordered are verified prior to processing a sale.
    D. Billing information is added to the database for new customers.

 

  1. Credit approval policies are implemented by organizations primarily to
    A. determine revenue recognition policies.
    B. ensure customer satisfaction.
    C. prevent lapping by the accounts receivable department.
    D. ensure the realization of receivables.

 

  1. Sales transactions should be documented at initiation in order to do which of the following?
    A. provide the customer a copy of the transaction.
    B. provide evidence of authorization and recording.
    C. offer credit to customers.
    D. generate back orders.

 

  1. The significance of the bill of lading is to provide which of the following?
    A. the warehouse personnel with the product that must be shipped to customers.
    B. invoices to customers for proper collection.
    C. a credit application for customer approval.
    D. evidence of title transfer of goods to customers.

 

  1. The risk of material misstatement due to fraud relating to revenue recognition should be
    A. approached in a manner that is identical to control risk assessment.
    B. given lower priority to the risk of embezzlement.
    C. ordinarily presumed by the auditor.
    D. assumed to have been considered by the audit committee.

 

  1. Which of the following is a method used by companies to fraudulently inflate revenues?
    A. use of hidden “side letters” giving the customer an irrevocable right to return the product.
    B. recording of fictitious sales.
    C. shipment of product not ordered by customers.
    D. all of the above.

 

  1. Which of the following provides evidence that the delivery of a product by a company to one of its customers is sufficient for the company to record revenue?
    A. A check received from the customer.
    B. An agreement to purchase product signed by the customer.
    C. A pick ticket in the warehouse.
    D. A bill of lading and tracking number with the shipper.

 

  1. Which of the following must exist prior to the recognition of revenue by a company from the sale of a product?
    A. The cash is realized on the sale of the product.
    B. A price is discussed based upon the customer’s resale of the product.
    C. The customer is given the option to return the product at any time.
    D. The product is adequately delivered to the customer.

 

  1. Fraud related to revenue recognition will most likely be identified by the auditor through which of the following independent situations?
    A. Sales have increased 5% in the current period over the previous period and is consistent with the results of competitors.
    B. Gross margin is equivalent in the current period to previous periods and is below that of the industry.
    C. Sales are higher in the month preceding each quarter end.
    D. The sales of a revolutionary new product are increasing beyond that of the competition in the periods immediately following its introduction.

 

  1. Calculating the turnover of receivables is often used in testing the sales cycle by auditors when performing
    A. trend analysis.
    B. ratio analysis.
    C. reasonableness testing.
    D. non-statistical sampling.

 

  1. Hardman and Jennings, LLP, an audit firm, compares bad debt expense of a client in the current period to bad debt recorded for the past three periods. Hardman and Jennings is performing which type of analysis?
    A. trend
    B. ratio
    C. critical
    D. reasonableness

 

  1. Lithgow and Harris, CPAs are performing the audit of WildFlower Grocery Stores. Lithgow and Harris relates annual revenue by sales per square feet and sales per customer. What type of analysis is Lithgow and Harris most likely performing?
    A. Ratio analysis.
    B. Trend analysis
    C. Reasonableness tests.
    D. Non-statistical analysis.

 

  1. In an audit of financial statements, the risk of the high rate of return of products sold includes that of
    A. sales that are recorded improperly.
    B. an estimate of accrued returns that reduces net income.
    C. a reduction of net sales for an increase to the sales returns and allowance account.
    D. consignment goods that are returned and forwarded to third parties.

 

  1. Which of the following is the major risk associated with receivables?
    A. they may be sold to a bank with recourse.
    B. they may be recorded as long-term when in fact they will be realized in the current period.
    C. they will not be realized for the entire amount due.
    D. they are pledged as collateral as disclosed in the footnotes to financial statements.

 

  1. Which of the following is a proper control for the detection of unusual sales transactions recorded in the general ledger?
    A. Electronic authorization prior to posting.
    B. Use of sequentially numbered sales documents.
    C. Random statements to customers.
    D. Review of transactions by upper management or the board.

 

  1. Which of the following is a control that may be implemented to ensure all sales that occur are recorded in the general ledger?
    A. use of prenumbered shipping, invoice and sales documents.
    B. use of prenumbered statements, inventory lists and credit memos.
    C. reconciliation of invoices with customer statements.
    D. use of pre-authorized price lists.

 

  1. The internal audit department at Monument Company receives electronic exceptions reports for all sales transactions entered over $10,000 in total. This process is performed for the purpose of
    A. drafting financial statements.
    B. monitoring revenue transactions.
    C. providing management reports to the controller.
    D. providing suggestions for operational improvement.

 

  1. Auditors will examine significant sales returns immediately subsequent to the period under audit in order to do which of the following?
    A. substantiate cutoff and the occurrence of net sales transactions.
    B. test the sufficiency of cash balances to cover refunds.
    C. monitor customer satisfaction for disclosure.
    D. assess the nature of procedures that will be performed for the next period’s audit.

 

  1. The auditor of the revenue cycle of ABC Company computes an estimate of ABC’s allowance for doubtful accounts and compares it to the estimate provided by ABC’s management. The purpose for this procedure is to substantiate which of the following assertions?
    A. existence of receivables
    B. completeness of receivables
    C. valuation of receivables
    D. rights to receivables

 

  1. What evidence is utilized by the auditor for analytical purposes in substantiating the  allowance for bad debt estimate?
    A. Accounts receivable aging schedule
    B. Copies of checks received from customers.
    C. Confirmations returned without exception.
    D. Stock prices of customer companies.

 

  1. Much of the understanding of revenue transactions for compliance with GAAP can be performed by which of the following procedures?
    A. examining sales contracts and inquiry of management.
    B. confirming sales with customers.
    C. discussing the transactions with qualified members of the Financial Accounting Standards Board.
    D. comparing shipping documents with invoices.

 

  1. The auditor traces recorded sales to invoices, sales orders and shipping documents in order to substantiate which of the following assertions?
    A. cutoff.
    B. completeness.
    C. legality.
    D. occurrence/existence.

 

  1. In the audit of the revenue of Hiram Manufacturing Company, the auditors obtain a number of shipping documents shortly before year-end and immediately following the year under audit. The auditors compare the documents to the sales journal in order to test which of the following?
    A. existence of sales.
    B. presentation and disclosure of receivables.
    C. cutoff of sales transactions.
    D. completeness of receivables.

 

  1. Completeness of revenues may be tested by the auditor through the selection of a sample of which of the following?
    A. shipping documents and tracing them to the sales journal.
    B. accounts receivable and tracing them to cash receipts.
    C. recorded sales transactions and tracing them to the general ledger.
    D. inventory records and tracing them to the shipping documents.

 

  1. Homer and Moe, PC are auditing the financial statements of Lyoncraft, Inc. and decide to confirm a sample of accounts receivable. This test is performed by Homer and Moe primarily to substantiate which of the following?
    A. existence of related party transactions.
    B. existence of accounts receivable.
    C. obligation of debt.
    D. cutoff of the allowance for bad debt.

 

  1. The aged accounts receivable report is utilized by the auditor to
    A. encourage the client to collect on receivables that are long past due.
    B. select the type of confirmations that will be sent to banks.
    C. assess the adequacy of the allowance for doubtful accounts.
    D. identify debits in the receivables balance that should be reclassified to payables.

 

  1. According to auditing standards, accounts receivable confirmations are required to be used
    A. on every audit engagement.
    B. if the client agrees in writing to the procedure.
    C. if the balance is material.
    D. if environmental risk is low.

 

  1. The primary difference between positive and negative confirmations used in the audit of accounts receivable is
    A. the mode of response.
    B. the amount of information included.
    C. the control of the confirmation process by the auditor.
    D. the valuation of the receivable.

 

  1. For which of the following accounts receivable customer populations would the use of negative confirmations be most appropriate?
    A. A retail truck and trailer sales company with high inherent risk and moderate control risk over the revenue cycle.
    B. A utility company with control risk over the revenue cycle assessed high.
    C. A mortgage banking company with control risk over the purchasing cycle assessed low.
    D. A cable company with control risk over the revenue cycle assessed low

 

  1. Accounts receivable confirmations usually provide strong evidence about which of the following?
    A. the existence of receivables.
    B. the completeness of receivables.
    C. the presentation and disclosure of receivables.
    D. the obligations of receivables.

 

  1. Confirmations that are sent to customers asking them to review the current balance due the client and return the letters directly to the auditor indicating whether they agree with the indicated balance, are known as
    A. direct confirmations.
    B. indirect confirmations.
    C. positive confirmations.
    D. negative confirmations.

 

  1. Which one of the following procedures would be considered improper for an auditor in the process of confirming receivables?
    A. The auditor allows the client’s staff to prepare the confirmation letters after the auditor has chosen the items to be confirmed.
    B. The auditor allows the client to sign the confirmations after they are prepared.
    C. The auditor allows the client’s staff to mail the confirmation letters after he or she has proofed the typing of the letters.
    D. The auditor asks the addressee to return the confirmation to the audit firm’s office.

 

  1. An auditor’s examination of the sales account using a cut-off test would most likely detect which of the following?
    A. kiting.
    B. sales that should be deferred.
    C. lapping of accounts receivable.
    D. sales recorded in the wrong period.

 

  1. Alternative procedures that would provide evidence of the existence of receivables would include which of the following?
    A. physical observation of customer facilities.
    B. review of subsequent collections.
    C. analysis of the aged trial balance.
    D. a confirmation to the client management for customer accounts.

 

  1. Auditors are concerned with the addresses provided for customers in the confirmation of accounts receivable because
    A. confirmations are selected based upon zip codes.
    B. a P.O. Box is more reliable than a street address.
    C. confirmations should be sent only to business addresses and not residential.
    D. the address may be routed to the client for retrieval and fraudulent signing.

 

  1. Unreturned positive confirmations for accounts receivable warrant which of the following by the auditor?
    A. replacing the sample selection with a new customer.
    B. sending second requests and possibly performing alternative procedures.
    C. the projection of larger misstatements to the population.
    D. requesting that the client send additional audit correspondence to customers.

 

  1. An example of alternative procedures for the confirmation of accounts receivable includes which of the following?
    A. inquiry of management.
    B. tracing source documents to recorded amounts.
    C. review of subsequent collections on account by the client.
    D. providing an estimate of the allowance for doubtful accounts to be recorded by the client.

 

  1. A key indicator of fraud in the revenue cycle is the auditor’s detection of which of the following?
    A. customer collections that are over 90 days past due.
    B. credit entries in customer accounts receivable for authorized write-offs.
    C. recurring entries in the sales journal.
    D. altered shipping documents and invoices.

 

  1. In the audit of accounting estimates, such as the allowance for doubtful accounts, the auditor strives to provide reasonable assurance that
    A. all material accounting estimates have been developed properly.
    B. the estimates are reasonable.
    C. the estimates are presented in accordance with GAAP.
    D. all of the above are true.

 

  1. The allowance for doubtful accounts will not be precise by either the client or the auditor because of which of the following?
    A. it is an accounting estimate based upon judgment.
    B. GAAP is not clear on the calculation of the allowance.
    C. it is merely a reserve that is reversed by the client as income is needed for profitable results.
    D. the precision is determined by the results of confirmation responses.

 

  1. To determine whether any accounts receivable are pledged or assigned to others, the auditor would most likely perform which of the following?
    A. examine subsequent collections.
    B. test a sample of transactions to the general ledger.
    C. review loan agreements and board of directors’ minutes.
    D. derive an independent estimate of the allowance and compare it to pledged assets.

 

  1. Which of the following criteria must be met in order to recognize revenue in the current accounting period?
    A. delivery has occurred or the services have been rendered.
    B. price is fixed or determinable.
    C. collectibility if reasonably assured.
    D. all of the above.

 

  1. Management has been found involved in many fraudulent schemes; a common one is “channel stuffing.” What does “channel stuffing” involve?
    A. overly complex transactions.
    B. growth through stock acquisitions.
    C. shipment of goods not ordered.
    D. management compensation schemes.

 

  1. Which of the following is not a form of ratio analysis?
    A. turnover of receivables.
    B. monthly sales analysis compared with past years.
    C. gross margin analysis.
    D. sales in last month to total sales.

 

  1. Sources of information used for determining substantive procedures include which of the following?
    A. knowledge of client’s business and industry.
    B. assessment of risk of material misstatement.
    C. results of analytical procedures.
    D. all of the above.

 

  1. Which of the following audit procedures does not address existence/occurrence for accounts receivables and sales?
    A. trace bill of lading to sales invoice and sales journal.
    B. confirm balances of unpaid invoices with customers.
    C. examine subsequent collection.
    D. scan sales journal for duplicate entries.

 

  1. Which of the following audit procedures does not address the rights, presentation and disclosure assertion for pledged, discounted, assigned, and related-party accounts receivable?
    A. review work performed in other audit areas.
    B. inquire of management.
    C. review adequacy of allowance for doubtful accounts.
    D. review loan agreements.

 

  1. A sample of positive confirmations is mailed for material accounts receivable balances. The auditor does not receive a response for many of the confirmations. Which of the following is not an acceptable alternative procedure?
    A. subsequent collection.
    B. inquiry of management.
    C. mailing second and third confirmations.
    D. examination of supporting documents.

 

  1. Internal control over the revenue cycle

    White Floyd, Inc., a retail store, is concerned about the lack of control procedures over the recording of sales transactions. The company is concerned that the transactions might not be recorded accurately and valued properly in accordance with GAAP. Recommend control procedures to help ensure that transactions are recorded accurately and valued properly.

 

 

 

 

 

  1. Control over completeness for the revenue cycle

    What control procedures should be implemented to ensure the completeness objective is met with respect to sales?

 

 

 

 

 

  1. Accounts receivable Controls

    In the financial statements, there are many risks associated with an audit that must be considered. Identify and discuss five separate risks that may exist related to accounts receivable.

 

 

 

 

 

  1. Substantive procedures for sales and receivables assertions

    The auditor for Knowles, Inc. is attempting to determine whether the recorded sales and accounts receivable are supported by valid transactions. Identify the assertions being tested and develop the substantive procedures to be used to satisfy the auditor’s objectives.

 

 

 

 

 

  1. Accounts receivable presentation and disclosure

    Develop a list of substantive tests to test whether pledged, discounted, assigned, and related-party accounts receivable are properly disclosed.

 

 

 

 

 

  1. Improper revenue recognition

    Historically the accounting profession has come under fire for fraudulent financial reporting due to questionable improper revenue recognition. Identify at least six examples of questionable revenue recognition practices that an auditor must consider in performing an audit engagement.

 

 

 

 

 

  1. Analytical Procedures

    Explain ratio analysis as an analytical procedure used by auditor. Give examples of the ratios that auditor might want to compute.

 

 

 

 

 

  1. Requirements for confirming accounts receivable

    Confirmation of accounts receivable is required under GAAS unless certain conditions exist. Identify the conditions that will be present in an audit that does not confirm accounts receivable.

 

 

 

 

 

  1. Confirmations of receivables

    You are the auditor of Maple Bank for the year 2012. Maple has a large number of customers with consumer loan accounts. The loan accounts have balances averaging $800 in a homogeneous population and the customers usually pay close attention to their balances.

    Your preliminary assessment of internal control over the loan area is that control risk is low and results of tests of controls support that assessment. Inherent risk is deemed to be lower as well.

    Discuss the confirmation process and the types of confirmations that may be used for the audit of Maple Bank. Which confirmation type would you select for Maple and why?

 

 

 

 

 

  1. Confirmations of receivables at an interim date

    When internal controls are strong, the auditor may decide to confirm receivables before year end. Roll-forward procedures are then used to obtain adequate evidence for the roll-forward period. Discuss why the auditor would want to confirm receivables before balance sheet date, the risks involved, and at least three of the roll-forward procedures that the auditor performs to gain assurance on the roll-forward period.

 

 

 

 

 

 

 

Chapter 10: Auditing Revenue and Related Accounts Key

  1. The revenue cycle considered by auditors includes the sales process but not cash collections.
    FALSE

 

  1. The revenue cycle involves the procedures in generating a sales order, shipping the products, recording the transaction and collecting the receivable.
    TRUE

 

  1. The shipping department confirms the shipment of goods by completing the packing slip and returning it to the purchasing department.
    FALSE

 

  1. Monthly statements provide a detailed list of the customer’s activity for the previous month and a listing of all open items.
    TRUE

 

  1. Invoices are processed, including their mailing to customers, only subsequent to proof of valid delivery to customers.
    TRUE

 

  1. The use of prenumbered sales invoices is the primary control procedure to satisfy the assertion of completeness.
    FALSE

 

  1. A comprehensive chart of accounts and a review of complex or unusual transactions by supervisory personnel are control procedures necessary for proper classification of accounts.
    TRUE

 

  1. Formal procedures for approving acceptance of returns that are beyond the warranty period are an appropriate control procedure for identifying and recording returned goods.
    TRUE

 

  1. One of the benefits of establishing a formal credit policy for granting credit is that management does not need to perform monitoring of accounts receivable.
    FALSE

 

  1. Monitoring of the revenue cycle may be accomplished partially through the use of exception reporting
    TRUE

 

  1. Monitoring is one of the five components of the COSO internal control framework.
    TRUE

 

  1. The audit team is required by auditing standards to make an ordinary presumption of the risk of fraud due to revenue misstatements on every engagement.
    TRUE

 

  1. A company that ships a large quantity of its products from its manufacturing plant to a warehouse that it leases until the customer is ready for the product should record the delivery as revenue.
    FALSE

 

  1. The intentional loading of sales at the end of a period to customers that do not need the goods at that time should not be recorded as revenues.
    TRUE

 

  1. All companies attempting to comply with GAAP should refer to the Securities and Exchange Commission for guidance as it supersedes all AICPA, PCAOB, FASB and EITF literature.
    FALSE

 

  1. A tendency for fraud exists when stock options are close to becoming exercised by executives and financial personnel.
    TRUE

 

  1. A red flag that may alert the auditor to fraud in the revenue cycle is a trend of revenue growth that is consistent with industry results.
    FALSE

 

  1. Financial accounting personnel who do not have the proper education, experience and backgrounds may signal the auditor to the risk of financial statement fraud.
    TRUE

 

  1. The auditor of James Corporation should be alert to the risk of material misstatements when James Corporation’s cash flows from operations are negative and net income (rather than loss) is reported.
    TRUE

 

  1. Ratio analysis performed by the audit team may include the comparison of gross sales to industry averages and previous periods.
    FALSE

 

  1. The auditor’s determination that day’s sales in accounts receivable increased from 44 days to 100 days would usually be found through the use of ratio analysis.
    TRUE

 

  1. Edge and Gregg, LLP would most likely discover channel stuffing in the financial statements of a client through the use of trend analysis.
    TRUE

 

  1. Use of reasonableness tests by Bono Mullins, PC will include relationships between financial but not non-financial data.
    FALSE

 

  1. The auditor has determined that the control risk for the existence assertion is low; therefore the auditor may reduce the number of items tested on a substantive basis.
    TRUE

 

  1. Confirmations of bank accounts may help the auditor to determine if material amounts of accounts receivable have been pledged or discounted.
    TRUE

 

  1. When the auditor seeks evidence concerning the allowance for doubtful accounts he or she would most likely use an aged trial balance to help identify past due balances.
    TRUE

 

  1. Current auditing standards do not require the confirmation of receivables if accounts receivable are not material.
    TRUE

 

  1. Accounts receivable confirmations should be prepared on the auditing firm’s letterhead.
    FALSE

 

  1. Alternative procedures to the confirmation of receivables include review of subsequent collections and examination of supporting documents.
    TRUE

 

  1. Lapping of accounts receivable is least likely to occur when there is an inadequate segregation of duties.
    FALSE

 

  1. Positive accounts receivable confirmations should be used on all accounts which represent small immaterial balances.
    FALSE

 

  1. When the client has a large number of relatively small accounts receivable and the assessed level of control risk for receivables and related revenue transactions is high, the auditor is more likely to use negative confirmations.
    FALSE

 

  1. The auditor would examine a sample of sales transactions throughout the entire period to determine if sales were recorded in the proper period when performing a sales cutoff test.
    FALSE

 

  1. An example of a control over the sales cycle is the authorization of price lists by the appropriate sales and marketing manager.
    TRUE

 

  1. An auditor would test controls related to the occurrence/existence of sales transactions by sampling recorded revenues and tracing them back to invoices and shipping documents
    TRUE

 

  1. If control risk is assessed high, the auditor may send significantly fewer confirmations for a sample of accounts receivable than if the control risk is assessed low.
    FALSE

 

  1. In planning an audit for the revenue cycle, the auditor must realize the integrated relationship of evidence found between the accounts receivable and the notes payable accounts.
    FALSE

 

  1. A method of testing for the completeness of sales is to test the sequence of sales invoices used during the period under audit.
    TRUE

 

  1. A review of the terms of client debt agreements assists the audit of the presentation and disclosure assertion for accounts receivable.
    TRUE

 

  1. The use of audit software makes the audit of the revenue cycle more effective, but not more efficient.
    FALSE

 

  1. Testing cutoff involves procedures applied to sales transactions selected from those recorded several days prior to period end and several days following period end.
    TRUE

 

  1. Valid evidence obtained in an audit for testing the cutoff of gross sales includes receiving reports for returned merchandise.
    FALSE

 

  1. An example of a test for completeness in the revenue cycle includes the sampling of shipping documents and tracing them to the sales journal and general ledger.
    TRUE

 

  1. Negative confirmations are used to confirm material balances.
    FALSE

 

  1. Exceptions found in the confirmations of accounts receivable balances need not be projected as errors to the population as they are typically isolated errors.
    FALSE

 

  1. A timing difference type of exception in the confirmation process may include a misunderstanding by the reader as to the date being confirmed.
    TRUE

 

  1. Negative confirmations are considered to be more persuasive than positive confirmations.
    FALSE

 

  1. The purpose of summarizing confirmation results is to list the extent of sales tested in relation to the response rate.
    FALSE

 

  1. An auditor’s primary concern with identifying related party sales and receivables rests with the presentation and disclosure assertion.
    TRUE

 

  1. Customer complaints noted in returned accounts receivable confirmations may be an indicator of fraud.
    TRUE

 

  1. The audit team typically reviews journal entries in the receivables ledger for unusual entries that may be indicators of fraudulent activity.
    TRUE

 

  1. Estimation of the allowance for doubtful accounts is a simple management decision as it is determined as a percentage of sales.
    FALSE

 

  1. The auditor will come up with an independent estimation of the allowance for doubtful accounts based on a thorough understanding of the client and the client’s business that is compared to the recorded allowance.
    TRUE

 

  1. It is beneficial in the testing of notes receivable to confirm not only the balance of the notes, but also their terms.
    TRUE

 

  1. The most important control to ensure completeness of sales and shipping is pre-numbered shipping and billing documents.
    TRUE

 

  1. An aging of accounts receivable is useful in estimating the reasonableness of the allowance for doubtful accounts.
    TRUE

 

  1. Which of the following processes are included in the revenue cycle?
    A.Shipping products to customers.
    B. Payments to suppliers.
    C. Issuance of capital stock.
    D. Preparation of a time card.

 

  1. Which of the following is the best example of the control objective in the revenue cycle that all transactions are recorded accurately?
    A.Sales are recorded at the invoice price expected to be collected from customers.
    B. Sales orders have sequential numbering.
    C. Recorded sales transactions are evidenced by valid invoices and shipping documents.
    D. Credits to customer accounts are classified as liabilities.

 

  1. The relationship between the sales cycle and an inventory system can best be noted in which of the following examples?
    A.Credit is established prior to completion of a sales order.
    B. Invoices are sent to customers only after shipment is evidenced.
    C. Availability of products ordered are verified prior to processing a sale.
    D. Billing information is added to the database for new customers.

 

  1. Credit approval policies are implemented by organizations primarily to
    A.determine revenue recognition policies.
    B. ensure customer satisfaction.
    C. prevent lapping by the accounts receivable department.
    D. ensure the realization of receivables.

 

  1. Sales transactions should be documented at initiation in order to do which of the following?
    A.provide the customer a copy of the transaction.
    B. provide evidence of authorization and recording.
    C. offer credit to customers.
    D. generate back orders.

 

  1. The significance of the bill of lading is to provide which of the following?
    A.the warehouse personnel with the product that must be shipped to customers.
    B. invoices to customers for proper collection.
    C. a credit application for customer approval.
    D. evidence of title transfer of goods to customers.

 

  1. The risk of material misstatement due to fraud relating to revenue recognition should be
    A.approached in a manner that is identical to control risk assessment.
    B. given lower priority to the risk of embezzlement.
    C. ordinarily presumed by the auditor.
    D. assumed to have been considered by the audit committee.

 

  1. Which of the following is a method used by companies to fraudulently inflate revenues?
    A.use of hidden “side letters” giving the customer an irrevocable right to return the product.
    B. recording of fictitious sales.
    C. shipment of product not ordered by customers.
    D. all of the above.

 

  1. Which of the following provides evidence that the delivery of a product by a company to one of its customers is sufficient for the company to record revenue?
    A.A check received from the customer.
    B. An agreement to purchase product signed by the customer.
    C. A pick ticket in the warehouse.
    D. A bill of lading and tracking number with the shipper.

 

  1. Which of the following must exist prior to the recognition of revenue by a company from the sale of a product?
    A.The cash is realized on the sale of the product.
    B. A price is discussed based upon the customer’s resale of the product.
    C. The customer is given the option to return the product at any time.
    D. The product is adequately delivered to the customer.

 

  1. Fraud related to revenue recognition will most likely be identified by the auditor through which of the following independent situations?
    A.Sales have increased 5% in the current period over the previous period and is consistent with the results of competitors.
    B. Gross margin is equivalent in the current period to previous periods and is below that of the industry.
    C. Sales are higher in the month preceding each quarter end.
    D. The sales of a revolutionary new product are increasing beyond that of the competition in the periods immediately following its introduction.

 

  1. Calculating the turnover of receivables is often used in testing the sales cycle by auditors when performing
    A.trend analysis.
    B. ratio analysis.
    C. reasonableness testing.
    D. non-statistical sampling.

 

  1. Hardman and Jennings, LLP, an audit firm, compares bad debt expense of a client in the current period to bad debt recorded for the past three periods. Hardman and Jennings is performing which type of analysis?
    A.trend
    B. ratio
    C. critical
    D. reasonableness

 

  1. Lithgow and Harris, CPAs are performing the audit of WildFlower Grocery Stores. Lithgow and Harris relates annual revenue by sales per square feet and sales per customer. What type of analysis is Lithgow and Harris most likely performing?
    A.Ratio analysis.
    B. Trend analysis
    C. Reasonableness tests.
    D. Non-statistical analysis.

 

  1. In an audit of financial statements, the risk of the high rate of return of products sold includes that of
    A.sales that are recorded improperly.
    B. an estimate of accrued returns that reduces net income.
    C. a reduction of net sales for an increase to the sales returns and allowance account.
    D. consignment goods that are returned and forwarded to third parties.

 

  1. Which of the following is the major risk associated with receivables?
    A.they may be sold to a bank with recourse.
    B. they may be recorded as long-term when in fact they will be realized in the current period.
    C. they will not be realized for the entire amount due.
    D. they are pledged as collateral as disclosed in the footnotes to financial statements.

 

  1. Which of the following is a proper control for the detection of unusual sales transactions recorded in the general ledger?
    A.Electronic authorization prior to posting.
    B. Use of sequentially numbered sales documents.
    C. Random statements to customers.
    D. Review of transactions by upper management or the board.

 

  1. Which of the following is a control that may be implemented to ensure all sales that occur are recorded in the general ledger?
    A.use of prenumbered shipping, invoice and sales documents.
    B. use of prenumbered statements, inventory lists and credit memos.
    C. reconciliation of invoices with customer statements.
    D. use of pre-authorized price lists.

 

  1. The internal audit department at Monument Company receives electronic exceptions reports for all sales transactions entered over $10,000 in total. This process is performed for the purpose of
    A.drafting financial statements.
    B. monitoring revenue transactions.
    C. providing management reports to the controller.
    D. providing suggestions for operational improvement.

 

  1. Auditors will examine significant sales returns immediately subsequent to the period under audit in order to do which of the following?
    A.substantiate cutoff and the occurrence of net sales transactions.
    B. test the sufficiency of cash balances to cover refunds.
    C. monitor customer satisfaction for disclosure.
    D. assess the nature of procedures that will be performed for the next period’s audit.

 

  1. The auditor of the revenue cycle of ABC Company computes an estimate of ABC’s allowance for doubtful accounts and compares it to the estimate provided by ABC’s management. The purpose for this procedure is to substantiate which of the following assertions?
    A.existence of receivables
    B. completeness of receivables
    C. valuation of receivables
    D. rights to receivables

 

  1. What evidence is utilized by the auditor for analytical purposes in substantiating the  allowance for bad debt estimate?
    A.Accounts receivable aging schedule
    B. Copies of checks received from customers.
    C. Confirmations returned without exception.
    D. Stock prices of customer companies.

 

  1. Much of the understanding of revenue transactions for compliance with GAAP can be performed by which of the following procedures?
    A.examining sales contracts and inquiry of management.
    B. confirming sales with customers.
    C. discussing the transactions with qualified members of the Financial Accounting Standards Board.
    D. comparing shipping documents with invoices.

 

  1. The auditor traces recorded sales to invoices, sales orders and shipping documents in order to substantiate which of the following assertions?
    A.cutoff.
    B. completeness.
    C. legality.
    D. occurrence/existence.

 

  1. In the audit of the revenue of Hiram Manufacturing Company, the auditors obtain a number of shipping documents shortly before year-end and immediately following the year under audit. The auditors compare the documents to the sales journal in order to test which of the following?
    A.existence of sales.
    B. presentation and disclosure of receivables.
    C. cutoff of sales transactions.
    D. completeness of receivables.

 

  1. Completeness of revenues may be tested by the auditor through the selection of a sample of which of the following?
    A.shipping documents and tracing them to the sales journal.
    B. accounts receivable and tracing them to cash receipts.
    C. recorded sales transactions and tracing them to the general ledger.
    D. inventory records and tracing them to the shipping documents.

 

  1. Homer and Moe, PC are auditing the financial statements of Lyoncraft, Inc. and decide to confirm a sample of accounts receivable. This test is performed by Homer and Moe primarily to substantiate which of the following?
    A.existence of related party transactions.
    B. existence of accounts receivable.
    C. obligation of debt.
    D. cutoff of the allowance for bad debt.

 

  1. The aged accounts receivable report is utilized by the auditor to
    A.encourage the client to collect on receivables that are long past due.
    B. select the type of confirmations that will be sent to banks.
    C. assess the adequacy of the allowance for doubtful accounts.
    D. identify debits in the receivables balance that should be reclassified to payables.

 

  1. According to auditing standards, accounts receivable confirmations are required to be used
    A.on every audit engagement.
    B. if the client agrees in writing to the procedure.
    C. if the balance is material.
    D. if environmental risk is low.

 

  1. The primary difference between positive and negative confirmations used in the audit of accounts receivable is
    A.the mode of response.
    B. the amount of information included.
    C. the control of the confirmation process by the auditor.
    D. the valuation of the receivable.

 

  1. For which of the following accounts receivable customer populations would the use of negative confirmations be most appropriate?
    A.A retail truck and trailer sales company with high inherent risk and moderate control risk over the revenue cycle.
    B. A utility company with control risk over the revenue cycle assessed high.
    C. A mortgage banking company with control risk over the purchasing cycle assessed low.
    D. A cable company with control risk over the revenue cycle assessed low

 

  1. Accounts receivable confirmations usually provide strong evidence about which of the following?
    A.the existence of receivables.
    B. the completeness of receivables.
    C. the presentation and disclosure of receivables.
    D. the obligations of receivables.

 

  1. Confirmations that are sent to customers asking them to review the current balance due the client and return the letters directly to the auditor indicating whether they agree with the indicated balance, are known as
    A.direct confirmations.
    B. indirect confirmations.
    C. positive confirmations.
    D. negative confirmations.

 

  1. Which one of the following procedures would be considered improper for an auditor in the process of confirming receivables?
    A.The auditor allows the client’s staff to prepare the confirmation letters after the auditor has chosen the items to be confirmed.
    B. The auditor allows the client to sign the confirmations after they are prepared.
    C. The auditor allows the client’s staff to mail the confirmation letters after he or she has proofed the typing of the letters.
    D. The auditor asks the addressee to return the confirmation to the audit firm’s office.

 

  1. An auditor’s examination of the sales account using a cut-off test would most likely detect which of the following?
    A.kiting.
    B. sales that should be deferred.
    C. lapping of accounts receivable.
    D. sales recorded in the wrong period.

 

  1. Alternative procedures that would provide evidence of the existence of receivables would include which of the following?
    A.physical observation of customer facilities.
    B. review of subsequent collections.
    C. analysis of the aged trial balance.
    D. a confirmation to the client management for customer accounts.

 

  1. Auditors are concerned with the addresses provided for customers in the confirmation of accounts receivable because
    A.confirmations are selected based upon zip codes.
    B. a P.O. Box is more reliable than a street address.
    C. confirmations should be sent only to business addresses and not residential.
    D. the address may be routed to the client for retrieval and fraudulent signing.

 

  1. Unreturned positive confirmations for accounts receivable warrant which of the following by the auditor?
    A.replacing the sample selection with a new customer.
    B. sending second requests and possibly performing alternative procedures.
    C. the projection of larger misstatements to the population.
    D. requesting that the client send additional audit correspondence to customers.

 

  1. An example of alternative procedures for the confirmation of accounts receivable includes which of the following?
    A.inquiry of management.
    B. tracing source documents to recorded amounts.
    C. review of subsequent collections on account by the client.
    D. providing an estimate of the allowance for doubtful accounts to be recorded by the client.

 

  1. A key indicator of fraud in the revenue cycle is the auditor’s detection of which of the following?
    A.customer collections that are over 90 days past due.
    B. credit entries in customer accounts receivable for authorized write-offs.
    C. recurring entries in the sales journal.
    D. altered shipping documents and invoices.

 

  1. In the audit of accounting estimates, such as the allowance for doubtful accounts, the auditor strives to provide reasonable assurance that
    A.all material accounting estimates have been developed properly.
    B. the estimates are reasonable.
    C. the estimates are presented in accordance with GAAP.
    D. all of the above are true.

 

  1. The allowance for doubtful accounts will not be precise by either the client or the auditor because of which of the following?
    A.it is an accounting estimate based upon judgment.
    B. GAAP is not clear on the calculation of the allowance.
    C. it is merely a reserve that is reversed by the client as income is needed for profitable results.
    D. the precision is determined by the results of confirmation responses.

 

  1. To determine whether any accounts receivable are pledged or assigned to others, the auditor would most likely perform which of the following?
    A.examine subsequent collections.
    B. test a sample of transactions to the general ledger.
    C. review loan agreements and board of directors’ minutes.
    D. derive an independent estimate of the allowance and compare it to pledged assets.

 

  1. Which of the following criteria must be met in order to recognize revenue in the current accounting period?
    A.delivery has occurred or the services have been rendered.
    B. price is fixed or determinable.
    C. collectibility if reasonably assured.
    D. all of the above.

 

  1. Management has been found involved in many fraudulent schemes; a common one is “channel stuffing.” What does “channel stuffing” involve?
    A.overly complex transactions.
    B. growth through stock acquisitions.
    C. shipment of goods not ordered.
    D. management compensation schemes.

 

  1. Which of the following is not a form of ratio analysis?
    A.turnover of receivables.
    B. monthly sales analysis compared with past years.
    C. gross margin analysis.
    D. sales in last month to total sales.

 

  1. Sources of information used for determining substantive procedures include which of the following?
    A.knowledge of client’s business and industry.
    B. assessment of risk of material misstatement.
    C. results of analytical procedures.
    D. all of the above.

 

  1. Which of the following audit procedures does not address existence/occurrence for accounts receivables and sales?
    A.trace bill of lading to sales invoice and sales journal.
    B. confirm balances of unpaid invoices with customers.
    C. examine subsequent collection.
    D. scan sales journal for duplicate entries.

 

  1. Which of the following audit procedures does not address the rights, presentation and disclosure assertion for pledged, discounted, assigned, and related-party accounts receivable?
    A.review work performed in other audit areas.
    B. inquire of management.
    C. review adequacy of allowance for doubtful accounts.
    D. review loan agreements.

 

  1. A sample of positive confirmations is mailed for material accounts receivable balances. The auditor does not receive a response for many of the confirmations. Which of the following is not an acceptable alternative procedure?
    A.subsequent collection.
    B. inquiry of management.
    C. mailing second and third confirmations.
    D. examination of supporting documents.

 

  1. Internal control over the revenue cycle

    White Floyd, Inc., a retail store, is concerned about the lack of control procedures over the recording of sales transactions. The company is concerned that the transactions might not be recorded accurately and valued properly in accordance with GAAP. Recommend control procedures to help ensure that transactions are recorded accurately and valued properly.

Control procedures that should be implemented to ensure that sales transactions are properly recorded are:

· Sales orders are filled by authorized personnel following an authorized price catalog.
· Sales prices are to be maintained on the computer and access to the computer file is restricted to those authorized to change it.
· Internal audit department periodically should perform tests of sales invoices to see if the terms agree with authorized price lists.
· Executive approval should be required of all large, unusual, or complex sales transactions.
· Oral or written verification of prices with customers should be required for all nonstandard sales.
· Products shipped and billed must be checked against an existing product list.
   

 

  1. Control over completeness for the revenue cycle

    What control procedures should be implemented to ensure the completeness objective is met with respect to sales?

Control procedures to ensure that the objective of completeness is met for the revenue accounts are:

· Prenumbered shipping and invoice documents should be used and accounted for periodically.
· Online computer input of all transactions and independent logging of the transactions should be created for subsequent use in performing reconciliations.
· Recorded transactions should be reviewed periodically, compared with budgets, and variances investigated.
· Monthly statements should be mailed regularly to customers.
· Subsidiary ledgers should be reconciled periodically to the general ledger and any differences investigated.
· A separate department should investigate all customer accounts receivable inquiries.
   

 

  1. Accounts receivable Controls

    In the financial statements, there are many risks associated with an audit that must be considered. Identify and discuss five separate risks that may exist related to accounts receivable.

Potential risks associated with accounts receivable include:

· Sales of receivables made with recourse and recorded as sales transactions rather than financing transactions.
· Receivables pledged as collateral against specific loans with restricted use. Disclosures of such restrictions are required.
· Receivables incorrectly classified as current when the likelihood of collection during the next year is low.
· Collection of a receivable contingent on specific events that cannot currently be estimated.
· Payment is not required until the purchaser sells the product to its end customers.
   

 

  1. Substantive procedures for sales and receivables assertions

    The auditor for Knowles, Inc. is attempting to determine whether the recorded sales and accounts receivable are supported by valid transactions. Identify the assertions being tested and develop the substantive procedures to be used to satisfy the auditor’s objectives.

The auditor is testing the existence and occurrence assertion as the concern is from recorded amounts in the direction of source documents and transactions. The auditor would most likely perform the following substantive procedures:

· confirm balances or invoices with customers based on a sample that is representative of the receivables (and possibly sales) population.
· send second and possibly third confirmation requests.
· examine subsequent collections on account for receivables.
· scan sales journal for duplicate entries.
· trace recorded amounts of sales and receivables to customer sales invoices, orders and bills of lading
   

 

  1. Accounts receivable presentation and disclosure

    Develop a list of substantive tests to test whether pledged, discounted, assigned, and related-party accounts receivable are properly disclosed.

The substantive procedures that would be used to determine whether all appropriate disclosures are made concerning accounts receivable and sales would include the following:

· obtain confirmations from banks and financial institutions.
· inquire of management.
· review work performed in other audit areas.
· review trial balance of accounts receivable for related parties.
   
   

 

  1. Improper revenue recognition

    Historically the accounting profession has come under fire for fraudulent financial reporting due to questionable improper revenue recognition. Identify at least six examples of questionable revenue recognition practices that an auditor must consider in performing an audit engagement.

Questionable and improper revenue recognition practices would include:

· recording of sales in earlier periods, including channel stuffing.
· recording sales under “bill and hold” agreements, that is, recording a sale but not shipping the goods or shipping at a later date, pending customer approval.
· recording shipments to the company’s own warehouse as sales to a customer.
· undisclosed side agreements with customers giving them an unconditional right to return the product.
· shipment of unfinished product or shipment before agreed to by customer(s).
· over-shipment of products
· recording consignment sales as final sales.
· recording sales with rights of return when the likelihood of return is high without a proper corresponding estimate for returns.
· recording the entire amount of transactions involving operating leases up-front as sales transactions.
· recording fictitious sales that never occurred.
· shipping used goods that were previously returned as new.
· applying revenue recognition principles improperly and aggressively.
   

 

  1. Analytical Procedures

    Explain ratio analysis as an analytical procedure used by auditor. Give examples of the ratios that auditor might want to compute.

Ratio analysis is useful in highlighting account balances that are out of line or different from reasonable expectations. Ratios can be compared across time for a client, as well as compared with the industry ratios. The approach to ratio analysis is similar to what a financial analyst would perform in examining a financial statement. Auditors might want to compute ratios like:
*Gross margin analysis, including a comparison with industry averages and previous year’s averages for the client
*Turnover of receivables (ratio of credit sales to average net receivables) or the number of days’ sales in accounts receivable
*Average balance per customer
*Receivables as a percentage of current assets
*Aging of receivables
*Allowance for uncollectible accounts as a percentage of accounts receivable
*Bad debt expense as a percentage of net credit sales
*Sales in the last month to total sales
*Sales discounts to credit sales
*Returns and allowances as a percentage of sales

 

  1. Requirements for confirming accounts receivable

    Confirmation of accounts receivable is required under GAAS unless certain conditions exist. Identify the conditions that will be present in an audit that does not confirm accounts receivable.

The auditor is required to confirm accounts receivable unless one of the following conditions exist:

· Accounts receivable are not material (or there are no receivables).
· The use of confirmations would be ineffective (recipients would not give full consideration).
· The auditor’s combined assessment of inherent risk and control risk is low, and that assessment, in conjunction with the evidence provided by other substantive tests, is sufficient to reduce audit risk to an acceptably low level.
   

 

  1. Confirmations of receivables

    You are the auditor of Maple Bank for the year 2012. Maple has a large number of customers with consumer loan accounts. The loan accounts have balances averaging $800 in a homogeneous population and the customers usually pay close attention to their balances.

    Your preliminary assessment of internal control over the loan area is that control risk is low and results of tests of controls support that assessment. Inherent risk is deemed to be lower as well.

    Discuss the confirmation process and the types of confirmations that may be used for the audit of Maple Bank. Which confirmation type would you select for Maple and why?

Auditors may select positive or negative confirmations depending on the circumstances. Positive confirmations are used in most situations where the client customer is asked to respond to the request in writing whether they agree or disagree with its contents.Negative confirms, on the other hand are only returned by the client customer if they disagree with the information listed. Negative confirmations may also only be used in certain situations. In the case of Maple Bank, an argument could be made for either form of confirmation to substantiate certain assertions relating to the loan receivable balances. Positive confirmations could be used with statistical sampling methods; however the auditor may forgo efficiency because of the tedious nature of positive form confirmation. Negative confirmations may be used if it is concluded that the balances represent a large number of bank customers and are small, environmental risk is assessed low and the customer is expected to give full consideration to the request. It may be a good idea for the auditor to use negative form confirmations in the case of Maple as consumer loans are usually smaller in balance ($800 average), the balances represent a large base of customers, and control risk and inherent risk are lower. The banking customers may be also be expected to read the confirmation and to check it against their balances. This form, however, may not be used with statistical methods of selecting the sample and projecting errors.

{Note: A student may also conclude that the balances are not small enough to use negative confirmations. This assessment is judgmental in nature and more information and experience would be needed to make this determination. The objective of this essay is to assess the student’s understanding of positive versus negative confirmations and the confirmation process.}

The auditor must also keep control of the confirmations as the sample is selected; confirmations are prepared, mailed and then returned to the audit firm location. Though the confirmation may be on client letterhead and signed by the appropriate officer, the auditor will mail the confirmations and offer a return envelope addressed to the audit firm offices.

The auditor will also prepare a confirmation summary if positive confirmations are selected. This summary will assist the auditor in monitoring the extent of exceptions, including errors, and following up on such matters and non-returned confirmation letters. It will also be used in determining the extent of misstatements found in the sample for projection back to the population.

 

  1. Confirmations of receivables at an interim date

    When internal controls are strong, the auditor may decide to confirm receivables before year end. Roll-forward procedures are then used to obtain adequate evidence for the roll-forward period. Discuss why the auditor would want to confirm receivables before balance sheet date, the risks involved, and at least three of the roll-forward procedures that the auditor performs to gain assurance on the roll-forward period.

The auditor usually prefers to perform as many audit procedures as possible before balance sheet date in order to better spread out the work since many clients have a December 31 year-end. However, collecting evidence before year-end increases the risk that the account may be materially misstated since the evidence is collected before the completion of the entire year. As a result the auditor has to perform a cost/benefit analysis as to whether it is beneficial to gather evidence at the interim. If there are good controls and a high degree of reliability can be achieved using roll-forward procedures for the roll-forward period then performing confirmations at the interim makes sense, e.g., with property, plant and equipment accounts. Depending upon their materiality and risk of misstatement, confirming receivables at the interim may or may not be a useful procedure since there may be no reduction of work after the balance sheet date. The auditor is responsible to gather sufficient, competent evidence for the entire fiscal year, not just up to the roll forward period.

If the auditor decides that it is useful to confirm receivables at the interim, the evidence must be collect to extent that conclusion to the year-end. Common roll forward procedures to do this are:

* Compare individual balances at the interim with the year-end and confirm any that have  substantially increased.

* Compare monthly sales, collection, sales discounts, and sales returns and allowances during the roll forward period with those for prior months and prior years to see if they appear out of line, in which case corroborative evidence of management’s explanation has to be collected.

* Reconcile receivable subsidiary records to the general ledger at both the interim and the year-end dates.

* Test the cut-off of sales, cash collections, and credit memos for returns and allowances at year-end.

* Scan journals to identify receivables postings from unusual sources and investigate unusual items.

* Compute the number of days’ sales in receivables at both the confirmation date and year-end, and compare these data with each other and with data from prior periods.

* Compute the gross profit percentage during the roll-forward period, and compare that to the percentage for the year and for prior periods.

 

Chapter 18: Advanced Topics Concerning Complex Audit Judgments

Student: ___________________________________________________________________________

  1. The SEC has the authority to issue guidance on sustainability disclosures and in 2010 issued interpretive guidance regarding public companies’ disclosure requirements for climate change matters.
    True    False

 

  1. The importance of sustainability reporting has become a topic of decreasing focus to organizations and societies around the globe in recent years.
    True    False

 

  1. Ford Motor Company defines sustainability as — a business model that creates value consistent with the long-term preservation and enhancement of environmental, social and financial capital.
    True    False

 

  1. According to KPMG’s 2008 International Survey of Corporate Responsibility Reporting, about 25 percent of the largest 250 companies in the world now issue reports detailing their sustainability efforts and associated outcomes.
    True    False

 

  1. Sustainability reporting is required to be filed with the SEC as part of a public company’s annual 10-K.
    True    False

 

  1. Sustainability reporting is defined as mandatory corporate disclosures about sustainability initiatives, plans, and associated outcomes.
    True    False

 

  1. Auditors are not responsible for making judgments regarding the fair value of securities for a future time period because they are only concerned about historical cost based values.
    True    False

 

  1. Auditors are constantly challenged to evaluate the quality of a client’s estimates, including areas such as obsolescence of inventory, allowance for doubtful accounts, and tax provisions among others.
    True    False

 

  1. Auditor needs to assess disclosures about what lines of business the company may discontinue.
    True    False

 

  1. Statement on Auditing Standards No. 107 provides the AICPA’s basic guidance on materiality judgments.
    True    False

 

  1. An auditor’s consideration of materiality is a matter of professional judgment and is influenced by the auditor’s perception of the needs of users of financial statements.
    True    False

 

  1. The significant judgments of “Loaned securities” by an auditor are subject to fair value estimates and also must consider the likelihood of securities that will be returned.
    True    False

 

  1. Materiality judgments are made in light of the surrounding circumstances but need not necessarily involve both quantitative and qualitative considerations.
    True    False

 

  1. The significant judgments of net finance receivables are subject to allowance for noncollectibility.
    True    False

 

  1. The significant judgments of “Deferred income taxes” are subject to estimates of future profitable operations against which the deferred asset might be utilized.
    True    False

 

  1. The purpose of making materiality judgments is to make sure that financial statements are free of any material misstatement.
    True    False

 

  1. The auditor considers materiality only at the overall financial statement level.
    True    False

 

  1. The significant judgments of “Discontinued assets” are subject to impairment testing that are most likely based on sale or disposal price.
    True    False

 

  1. If the auditor believes that misstatements aggregating approximately $50,000 would be material to the income statement, but misstatements aggregating approximately $100,000 would be material to the balance sheet, the auditor typically assesses overall materiality at $100,000 or less.
    True    False

 

  1. Planning materiality helps the auditor determine the extent of audit evidence needed.
    True    False

 

  1. In performing substantive analytical procedures, the threshold for determining whether differences between the client’s account balance and the auditor’s expectation should be based on planning materiality.
    True    False

 

  1. If a company’s net income varies significantly from year to year, the auditor might consider using an average of the net income from the prior three to five years as the materiality benchmark.
    True    False

 

  1. The accumulation of all potential misstatements in a place where the audit team can assess the materiality of misstatements is often based on posting materiality.
    True    False

 

  1. A materiality level where the auditor believes that the errors below that level would not, even when aggregated with all other misstatements, be material to the financial statements is called as posting materiality.
    True    False

 

  1. Auditors should consider only quantitative effects and not qualitative effects in making materiality judgments.
    True    False

 

  1. Misstatements detected during the audit that were initially deemed to be immaterial need not be summarized to determine their aggregate effects.
    True    False

 

  1. The auditor need not inform the audit committee about adjustments arising from the audit that were considered to be material.
    True    False

 

  1. Auditors request the client to book all known misstatements even if the recording cost is very high so that there are no carryovers from year to year.
    True    False

 

  1. Although the SEC guidance is developed for public companies, the concepts regarding materiality are sound and could be followed by private companies and other organizations.
    True    False

 

  1. The discovery of an intentional misstatement, even if immaterial, could impact the auditor’s opinion on the effectiveness of the client’s internal controls.
    True    False

 

  1. Auditors need to consider the risk and take appropriate actions relating to material misstatements of fact contained in the client’s MD&A section of the 10-K filed with the SEC.
    True    False

 

  1. The auditor should have performed sufficient work to have confidence in the most likely estimate of misstatements in an account balance and that estimate should be used for making materiality judgments.
    True    False

 

  1. Volume of transactions affected is one of the critical criteria in assessing materiality of internal control deficiencies.
    True    False

 

  1. It is a mandate for all companies listed with the NASDAQ stock exchange to maintain an internal audit function.
    True    False

 

  1. In order to achieve efficiency, a CPA firm can provide both internal and external audit services for the same client.
    True    False

 

  1. Goodwill has to be evaluated for impairment once a year and not necessarily at the balance sheet date. However, the date for evaluation has to be consistently applied.
    True    False

 

  1. If the market value of a company is below book value and a significant amount of goodwill exists, the presumption is that there has been an impairment of goodwill.
    True    False

 

  1. Audit Standard No. 5 by the PCAOB encourages the external auditor to utilize the work of internal auditors and other objective parties within the organization when performing the assessment of internal control over financial reporting.
    True    False

 

  1. According to the ASC 350 guidance, intangible assets that are not amortized will be tested for impairment at least annually by comparing the fair values of those assets with their recorded amounts.
    True    False

 

  1. Goodwill arising from many acquisitions can be netted into one test at the company level.
    True    False

 

  1. At a fair value level 1, while addressing the challenge of determining identical assets, analysis of the volume of trading activity could be one of the sources of audit evidence.
    True    False

 

  1. Relevant economic and industry factors could be used as a source of audit evidence while addressing the audit challenge of determining active or inactive markets.
    True    False

 

  1. In audit considerations, fair value level 1 is broad and applies to financial instruments, property, or lower of cost or market considerations for inventory, loans, or receivables.
    True    False

 

  1. Audits of Level 3 balances are the easiest as they involve an observable, active market.
    True    False

 

  1. Assuming that other assets have been properly valued, if the market value of the reporting unit is equal to the carrying value of the assets of the reporting unit the presumption is that goodwill has been impaired.
    True    False

 

  1. Current FMV of assets and liabilities of non-goodwill assets is one of the factors affecting goodwill impairment valuations.
    True    False

 

  1. A sensitivity analysis of changes in value based on industry and cash-flow assumptions is one of the aspects of the audit program for goodwill impairment testing.
    True    False

 

  1. While conducting an audit program for goodwill impairment testing, if the original reporting unit no longer exists because operations have been fully integrated into operations of the parent company, the approach would be to determine whether all other assets have been adjusted to fair value, where applicable.
    True    False

 

  1. Considering SAB 59 and SAS No. 92, the cash position of the investee is one of the factors that indicate that an other-than-temporary impairment of a security’s value has occurred.
    True    False

 

  1. The assessment as to whether a misstatement in cash-flow classification is material should remain within the income statement perspective.
    True    False

 

  1. According to a report issued by Ernst & Young Australia, common sustainability-related terms include which of the following:
    A. non-financial reporting.
    B. corporate social responsibility reporting.
    C. Triple bottom line reporting .
    D. all of the above.

 

  1. The groups that have demanded that companies provide sustainability disclosures include which of the following.
    A. external auditors.
    B. socially responsible investment funds.
    C. the PCAOB.
    D. all of the above.

 

  1. Which of the following indexes track the financial performance of sustainability-driven companies?
    A. S&P Sustainability Indexes.
    B. Dow Jones Sustainability Indexes.
    C. NASDAQ Sustainability Indexes.
    D. all of the above.

 

  1. When implementing sustainability reporting, companies determine what to report and how to report it by using various available guidelines, the most prominent of which includes:
    A. The Global Reporting Initiative Reporting Framework.
    B. The World Initiative Reporting Framework.
    C. The Best Practice Sustainability Reporting Standards.
    D. The Sustainability Generally Accepted Standards.

 

  1. External assurance over sustainability reports must be provided by which of the following:
    A. Certified Public Accountants in conjunction with the annual financial audit.
    B. those with competence in the subject matter and assurance practices.
    C. Certified Sustainability Experts.
    D. individuals that are not independent with the company issuing the sustainability report.

 

  1. The two general types of assurance that can be provided to sustainability reports include which of the following:
    A. Reasonable assurance and Limited assurance.
    B. Material assurance and Reasonable assurance.
    C. Limited assurance and material assurance.
    D. Reasonable assurance and Compliance assurance

 

  1. Which of the following is needed by a client while estimating fair value?
    A. A systematic process to identify each asset that is subject to realizable value or at cost.
    B. A process to identify relevant historical values.
    C. An analysis of whether the organization has the ability to hold the asset to maturity and whether the decline in value is permanent.
    D. A realistic process to estimate future cash flows to discount back to a present value.

 

  1. Level 1 in the fair value audit consideration indicates which of the following?
    A. observable information on similar items.
    B. nonexistence of active markets.
    C. quoted prices on identical items.
    D. relevant economic and industry factors.

 

  1. The audit approach for Level 2 requires the auditor to determine which of the following?
    A. the correspondence of the client’s assets to similar assets in an active market.
    B. contingent liabilities.
    C. sensitivity of model.
    D. the performance of tests of controls.

 

  1. Almost every asset and liability account requires significant judgments. Which of the following accounts is subject to allowance for noncollectibility?
    A. Inventories
    B. Marketable securities
    C. Other receivables
    D. Deferred revenue

 

  1. Which one of the following potential audit problems is not true in affecting goodwill impairment valuations?
    A. Goodwill arising from acquisitions can be netted into one test at the operating segment level, but not netted at the company level.
    B. Market valuation may be volatile. A material temporary decline in market value may not be a good indicator of FMV.
    C. FMV might not exist, might require independent appraisals by investment bankers or estimates using cash flow and discounted present value factors.
    D. No assumptions are required about competition, economic development, product placement, and so forth.

 

  1. If the acquired company remains intact after the acquisition, it is defined as the:
    A. financing segment.
    B. investing segment.
    C. operating segment.
    D. non-operating segment.

 

  1. Impairment is measured by the difference between market value of the operating segment and which of the following?
    A. carrying value of net assets.
    B. fair market value of net assets.
    C. book value of total assets.
    D. book value of current assets.

 

  1. In a standard audit program for goodwill impairment testing, if the original reporting unit no longer exists because operations have been fully integrated into operations of the parent company the auditor should do which of the following?
    A. compare market value with carrying value. A market value less than carrying value is presumptive evidence that goodwill has been impaired.
    B. compare fair value with realizable value. A fair value less than realizable value is presumptive evidence that goodwill has been impaired.
    C. compare book value with realizable value. A book value less than realizable value is presumptive evidence that goodwill has been impaired.
    D. compare book value with market value. A market value less than book value is presumptive evidence that goodwill has been impaired.

 

  1. The FASB has set a hierarchy of inputs to consider in assessing fair value. Which of the following relates to Level 1?
    A. Quoted prices for identical items in active, liquid, and visible markets.
    B. Unobservable inputs to be used in illiquid situations.
    C. Observable information for similar items in active or inactive markets.
    D. Unobservable inputs to be used in situations where markets don’t exist.

 

  1. The primary scope of services performed in external auditing (CPA) is:
    A. risk analysis.
    B. control analysis.
    C. operations analysis.
    D. audit of financial statements.

 

  1. The scope of services performed in internal auditing (CIA) includes all of the following except
    A. providing assurance on financial statement related items.
    B. evaluating the effectiveness of operations and related controls .
    C. investigating concerns of fraud.
    D. all of the above are included.

 

  1. Which of the following is true of external auditing?
    A. Major focus areas are processes, including risks, controls, and effectiveness and efficiency of processes.
    B. Consulting is performed when agreed to by management.
    C. Primary scope of services performed includes audits of financial statements.
    D. Parties receiving assurance include the audit committee and upper management.

 

  1. Which of the following is true of internal auditing?
    A. Only serves the audit committee of the board of directors
    B. Primary nature of services include assurance and consulting
    C. Is required to report activities and department findings to external stakeholders annually
    D. Independence and objectivity are not relevant because they are employees of the company

 

  1. For the same client, SEC prohibits a CPA firm from providing which of the following services?
    A. tax and external audit services
    B. internal and external audit services.
    C. management letter and audit services.
    D. internal control and financial statement audits.

 

  1. Which of the following has represented the fastest growth area in public accounting practice
    over the past few years?
    A. M&A advisory outsourcing
    B. Internal audit outsourcing
    C. Portfolio management
    D. Wealth management

 

  1. Which one of the following factors is not considered when assessing the quality of internal audit?
    A. Quality of working-paper documentation, reports, and recommendations.
    B. Review of quality of audit policies, programs, and procedures.
    C. Attestation services as demanded by market place.
    D. Educational level and professional experience.

 

  1. The partial or complete outsourcing of internal audit activities is made to public accounting firms or to other specialized firms that perform which of the following types of services?
    A. primarily risk, control, and audit activities.
    B. attestation services as demanded by market place.
    C. operations analysis and risk analysis.
    D. analytical and substantial procedures.

 

  1. A best practice is to have an oversight of the internal audit function as a responsibility of which of the following parties?
    A. management.
    B. internal auditors.
    C. audit committee.
    D. external auditors.

 

  1. Which is the international body that sets standards for the practice of internal auditing across the world?
    A. The Internal Audit Reporting Standards Board
    B. The Institute of Internal Auditors
    C. The International Accounting Standards Board
    D. The Charter of Certified Internal Auditors

 

  1. Audit Standard No. 5 by the PCAOB encourages the external auditor to utilize the work of which of the following?
    A. experts.
    B. internal auditors.
    C. independent valuation professionals.
    D. internal officers of the company.

 

  1. In making judgments about the effect of the internal auditors’ work on the external auditor’s procedures in specific audit areas, which of the following is not among three issues related to the audit areas that should be considered by the external auditor?
    A. Materiality of the financial statement amounts.
    B. Risk of material misstatement of the assertions related to these financial statement amounts.
    C. Review of quality of audit policies, programs, and procedures.
    D. Degree of subjectivity involved in the evaluation of the audit evidence gathered in support of the assertions.

 

  1. SAB 108 mandates what is termed a(n) ___ to uncorrected misstatements.
    A. matrix approach
    B. dual approach.
    C. percentage approach
    D. judgmental approach

 

  1. Misstatements detected during the audit that were initially deemed to be immaterial must be summarized to determine their:
    A. control.
    B. quantitative effect.
    C. aggregate effects.
    D. nature of misstatement.

 

  1. The adjustments arising from the audit that were considered to be material should be informed by the auditor to the:
    A. audit staff.
    B. management.
    C. audit committee.
    D. internal auditors.

 

  1. Which method focuses on the materiality of current year misstatements and the reversing effect of prior-year misstatements on the income statement?
    A. Rollover method
    B. Iron curtain method
    C. Percentage approach
    D. Judgmental method

 

  1. Which method focuses on assuring that the year-end balance sheet is correct and does not consider the impact of prior-year uncorrected misstatements reversing in later years?
    A. Rollover
    B. Iron curtain
    C. Dual
    D. Percentage

 

  1. The discovery of an intentional misstatement, even if immaterial, could impact the auditor’s opinion on the effectiveness of the client’s:
    A. external controls.
    B. interim financial statements.
    C. internal controls.
    D. segment reports.

 

  1. The dual approach requires which of the following?
    A. the application of the rollover method.
    B. the application of the iron curtain method.
    C. simultaneous application of both the rollover and iron curtain methods.
    D. sequential application of both the rollover and iron curtain methods.

 

  1. Which of the following Statements on Auditing Standards (SAS) provides the AICPA’s basic guidance on materiality judgments?
    A. 107
    B. 61
    C. 89
    D. 92

 

  1. Planning materiality is typically less than overall materiality and helps the auditor to determine the extent of:
    A. audit evidence needed.
    B. analytical procedure performed.
    C. substantive procedure performed.
    D. work performed.

 

  1. Which of the following best describes the nature of discontinued assets?
    A. Impairment testing based on most likely sale or disposal price.
    B. Impairment testing only if plants are closed or equipment is not used.
    C. Lower of cost or market impairments, including an allowance for obsolescence.
    D. Estimates and assumptions made in preparation of the estimate of income tax expense for the year.

 

  1. Which of the following is not true about materiality judgment?
    A. The auditor’s consideration of materiality is influenced by the auditor’s perception of the needs of users of financial statements.
    B. The auditor considers materiality only in relation to classes of transactions, account balances, and disclosures.
    C. Materiality judgments make sure that the auditor gathers sufficient evidential matter to obtain reasonable assurance about whether the financial statements are free of material misstatement.
    D. Materiality decisions differ from one audit client to another.

 

  1. Which of the following is an approach to setting posting materiality?
    A. Dual approach
    B. Percentage approach
    C. Qualitative approach
    D. Planning approach

 

  1. The FASB has set a hierarchy of inputs to consider in assessing fair value. Which of the following valuations are generally viewed as highly subjective?
    A. Level 1
    B. Level 2
    C. Level 3
    D. Level 4

 

  1. A material misstatement in the financial statements, including those requiring restatements strongly implies a material weakness in which of the following?
    A. income statement.
    B. balance sheet.
    C. internal control.
    D. cash flow statements.

 

  1. The FASB has set a hierarchy of inputs to consider in assessing fair value.  Price taken from a recent trade on the NIKKEI of an index stock would fall under which level?
    A. Level 0
    B. Level 1
    C. Level 2
    D. Level 3

 

  1. Which one of the following general factors should not be considered critical in assessing severity of internal control deficiencies?
    A. Control environment
    B. Evidence from a poorly controlled system
    C. Repeatability of a process
    D. Complexity and subjectivity of the account balance

 

  1. Which of the following factors in assessing severity of internal control deficiencies indicates that a deficiency that may have been considered a material weakness at an interim date would not be considered a material weakness at the year end?
    A. Remediation of a control deficiency.
    B. Existence of compensating controls.
    C. Complexity and subjectivity of the account balance.
    D. Effectiveness of oversight and governance.

 

  1. Although different audit firms take different approaches, planning materiality could be the same as overall materiality, or could be a percentage of overall materiality, generally ranging from:
    A. 25% to 75% of overall materiality.
    B. 50% to 75% of overall materiality.
    C. 25% to 50% of overall materiality.
    D. 40% to 75% of overall materiality.

 

  1. Which of the following is associated with Level 3 in the FASB hierarchy for ascertaining fair value?
    A. Mark to market model
    B. Replacement model
    C. Mark to model
    D. Historical cost model

 

  1. For nonprofit entities, appropriate benchmarks for materiality judgments would include which of the following?
    A. total assets and total liabilities.
    B. total revenues and  total assets.
    C. total liabilities, total income, or total assets.
    D. total expenses, total revenues, or total assets.

 

  1. Under which approach is the client expected to estimate fair value based on a model of the future cash flows associated with the instrument or the asset?
    A. Mark to market model
    B. Replacement model
    C. Mark to model
    D. Historical cost model

 

  1. Critical Criteria in Assessing Severity of Internal Control Deficiencies


    What general factors should be considered by an auditor in evaluating whether or not a control deficiency is a material weakness, or a significant deficiency, or a control issue?

 

 

 

 

 

  1. Considering Qualitative Factors

    What are the considerations that may cause a quantitatively small misstatement to be considered material?

 

 

 

 

 

  1. Evaluating the Quality of Client’s Internal Audit Function

    An external auditor has to assess the quality of the internal audit function and determine whether the internal auditors’ work is relevant to the external audit and of sufficient quantity and quality regardless of how the client staffs the internal audit function. Explain?

 

 

 

 

 

  1. Effect of Internal Audit’s Work on the External Audit

    Which are the audit judgments made by the external auditor that should not be delegated to the internal auditor?

 

 

 

 

 

  1. Audit Program for Goodwill Impairment Testing

    Outline the major elements of an audit program to determine whether there is a goodwill impairment, and if there is, the extent of the goodwill impairment?

 

 

 

 

 

  1. Purpose of Materiality Judgments and Common Benchmarks and Thresholds

    What are the key aspects in materiality judgments? Explain the purpose of materiality judgments, common benchmarks, and thresholds.

 

 

 

 

 

  1. Assessing Whether Misstatements Are Material

    What additional information might the auditor choose to analyze to determine whether or not the financial statements are misstated by a material amount?

 

 

 

 

 

 

 

Chapter 18: Advanced Topics Concerning Complex Audit Judgments Key

  1. The SEC has the authority to issue guidance on sustainability disclosures and in 2010 issued interpretive guidance regarding public companies’ disclosure requirements for climate change matters.
    TRUE

 

  1. The importance of sustainability reporting has become a topic of decreasing focus to organizations and societies around the globe in recent years.
    FALSE

 

  1. Ford Motor Company defines sustainability as — a business model that creates value consistent with the long-term preservation and enhancement of environmental, social and financial capital.
    TRUE

 

  1. According to KPMG’s 2008 International Survey of Corporate Responsibility Reporting, about 25 percent of the largest 250 companies in the world now issue reports detailing their sustainability efforts and associated outcomes.
    FALSE

 

  1. Sustainability reporting is required to be filed with the SEC as part of a public company’s annual 10-K.
    FALSE

 

  1. Sustainability reporting is defined as mandatory corporate disclosures about sustainability initiatives, plans, and associated outcomes.
    FALSE

 

  1. Auditors are not responsible for making judgments regarding the fair value of securities for a future time period because they are only concerned about historical cost based values.
    FALSE

 

  1. Auditors are constantly challenged to evaluate the quality of a client’s estimates, including areas such as obsolescence of inventory, allowance for doubtful accounts, and tax provisions among others.
    TRUE

 

  1. Auditor needs to assess disclosures about what lines of business the company may discontinue.
    TRUE

 

  1. Statement on Auditing Standards No. 107 provides the AICPA’s basic guidance on materiality judgments.
    TRUE

 

  1. An auditor’s consideration of materiality is a matter of professional judgment and is influenced by the auditor’s perception of the needs of users of financial statements.
    TRUE

 

  1. The significant judgments of “Loaned securities” by an auditor are subject to fair value estimates and also must consider the likelihood of securities that will be returned.
    TRUE

 

  1. Materiality judgments are made in light of the surrounding circumstances but need not necessarily involve both quantitative and qualitative considerations.
    FALSE

 

  1. The significant judgments of net finance receivables are subject to allowance for noncollectibility.
    TRUE

 

  1. The significant judgments of “Deferred income taxes” are subject to estimates of future profitable operations against which the deferred asset might be utilized.
    TRUE

 

  1. The purpose of making materiality judgments is to make sure that financial statements are free of any material misstatement.
    TRUE

 

  1. The auditor considers materiality only at the overall financial statement level.
    FALSE

 

  1. The significant judgments of “Discontinued assets” are subject to impairment testing that are most likely based on sale or disposal price.
    TRUE

 

  1. If the auditor believes that misstatements aggregating approximately $50,000 would be material to the income statement, but misstatements aggregating approximately $100,000 would be material to the balance sheet, the auditor typically assesses overall materiality at $100,000 or less.
    FALSE

 

  1. Planning materiality helps the auditor determine the extent of audit evidence needed.
    TRUE

 

  1. In performing substantive analytical procedures, the threshold for determining whether differences between the client’s account balance and the auditor’s expectation should be based on planning materiality.
    TRUE

 

  1. If a company’s net income varies significantly from year to year, the auditor might consider using an average of the net income from the prior three to five years as the materiality benchmark.
    FALSE

 

  1. The accumulation of all potential misstatements in a place where the audit team can assess the materiality of misstatements is often based on posting materiality.
    TRUE

 

  1. A materiality level where the auditor believes that the errors below that level would not, even when aggregated with all other misstatements, be material to the financial statements is called as posting materiality.
    TRUE

 

  1. Auditors should consider only quantitative effects and not qualitative effects in making materiality judgments.
    FALSE

 

  1. Misstatements detected during the audit that were initially deemed to be immaterial need not be summarized to determine their aggregate effects.
    FALSE

 

  1. The auditor need not inform the audit committee about adjustments arising from the audit that were considered to be material.
    FALSE

 

  1. Auditors request the client to book all known misstatements even if the recording cost is very high so that there are no carryovers from year to year.
    FALSE

 

  1. Although the SEC guidance is developed for public companies, the concepts regarding materiality are sound and could be followed by private companies and other organizations.
    TRUE

 

  1. The discovery of an intentional misstatement, even if immaterial, could impact the auditor’s opinion on the effectiveness of the client’s internal controls.
    TRUE

 

  1. Auditors need to consider the risk and take appropriate actions relating to material misstatements of fact contained in the client’s MD&A section of the 10-K filed with the SEC.
    TRUE

 

  1. The auditor should have performed sufficient work to have confidence in the most likely estimate of misstatements in an account balance and that estimate should be used for making materiality judgments.
    TRUE

 

  1. Volume of transactions affected is one of the critical criteria in assessing materiality of internal control deficiencies.
    TRUE

 

  1. It is a mandate for all companies listed with the NASDAQ stock exchange to maintain an internal audit function.
    FALSE

 

  1. In order to achieve efficiency, a CPA firm can provide both internal and external audit services for the same client.
    FALSE

 

  1. Goodwill has to be evaluated for impairment once a year and not necessarily at the balance sheet date. However, the date for evaluation has to be consistently applied.
    TRUE

 

  1. If the market value of a company is below book value and a significant amount of goodwill exists, the presumption is that there has been an impairment of goodwill.
    TRUE

 

  1. Audit Standard No. 5 by the PCAOB encourages the external auditor to utilize the work of internal auditors and other objective parties within the organization when performing the assessment of internal control over financial reporting.
    TRUE

 

  1. According to the ASC 350 guidance, intangible assets that are not amortized will be tested for impairment at least annually by comparing the fair values of those assets with their recorded amounts.
    TRUE

 

  1. Goodwill arising from many acquisitions can be netted into one test at the company level.
    FALSE

 

  1. At a fair value level 1, while addressing the challenge of determining identical assets, analysis of the volume of trading activity could be one of the sources of audit evidence.
    TRUE

 

  1. Relevant economic and industry factors could be used as a source of audit evidence while addressing the audit challenge of determining active or inactive markets.
    FALSE

 

  1. In audit considerations, fair value level 1 is broad and applies to financial instruments, property, or lower of cost or market considerations for inventory, loans, or receivables.
    FALSE

 

  1. Audits of Level 3 balances are the easiest as they involve an observable, active market.
    FALSE

 

  1. Assuming that other assets have been properly valued, if the market value of the reporting unit is equal to the carrying value of the assets of the reporting unit the presumption is that goodwill has been impaired.
    FALSE

 

  1. Current FMV of assets and liabilities of non-goodwill assets is one of the factors affecting goodwill impairment valuations.
    FALSE

 

  1. A sensitivity analysis of changes in value based on industry and cash-flow assumptions is one of the aspects of the audit program for goodwill impairment testing.
    TRUE

 

  1. While conducting an audit program for goodwill impairment testing, if the original reporting unit no longer exists because operations have been fully integrated into operations of the parent company, the approach would be to determine whether all other assets have been adjusted to fair value, where applicable.
    TRUE

 

  1. Considering SAB 59 and SAS No. 92, the cash position of the investee is one of the factors that indicate that an other-than-temporary impairment of a security’s value has occurred.
    TRUE

 

  1. The assessment as to whether a misstatement in cash-flow classification is material should remain within the income statement perspective.
    FALSE

 

  1. According to a report issued by Ernst & Young Australia, common sustainability-related terms include which of the following:
    A.non-financial reporting.
    B. corporate social responsibility reporting.
    C. Triple bottom line reporting .
    D. all of the above.

 

  1. The groups that have demanded that companies provide sustainability disclosures include which of the following.
    A.external auditors.
    B. socially responsible investment funds.
    C. the PCAOB.
    D. all of the above.

 

  1. Which of the following indexes track the financial performance of sustainability-driven companies?
    A.S&P Sustainability Indexes.
    B. Dow Jones Sustainability Indexes.
    C. NASDAQ Sustainability Indexes.
    D. all of the above.

 

  1. When implementing sustainability reporting, companies determine what to report and how to report it by using various available guidelines, the most prominent of which includes:
    A.The Global Reporting Initiative Reporting Framework.
    B. The World Initiative Reporting Framework.
    C. The Best Practice Sustainability Reporting Standards.
    D. The Sustainability Generally Accepted Standards.

 

  1. External assurance over sustainability reports must be provided by which of the following:
    A.Certified Public Accountants in conjunction with the annual financial audit.
    B. those with competence in the subject matter and assurance practices.
    C. Certified Sustainability Experts.
    D. individuals that are not independent with the company issuing the sustainability report.

 

  1. The two general types of assurance that can be provided to sustainability reports include which of the following:
    A.Reasonable assurance and Limited assurance.
    B. Material assurance and Reasonable assurance.
    C. Limited assurance and material assurance.
    D. Reasonable assurance and Compliance assurance

 

  1. Which of the following is needed by a client while estimating fair value?
    A.A systematic process to identify each asset that is subject to realizable value or at cost.
    B. A process to identify relevant historical values.
    C. An analysis of whether the organization has the ability to hold the asset to maturity and whether the decline in value is permanent.
    D. A realistic process to estimate future cash flows to discount back to a present value.

 

  1. Level 1 in the fair value audit consideration indicates which of the following?
    A.observable information on similar items.
    B. nonexistence of active markets.
    C. quoted prices on identical items.
    D. relevant economic and industry factors.

 

  1. The audit approach for Level 2 requires the auditor to determine which of the following?
    A.the correspondence of the client’s assets to similar assets in an active market.
    B. contingent liabilities.
    C. sensitivity of model.
    D. the performance of tests of controls.

 

  1. Almost every asset and liability account requires significant judgments. Which of the following accounts is subject to allowance for noncollectibility?
    A.Inventories
    B. Marketable securities
    C. Other receivables
    D. Deferred revenue

 

  1. Which one of the following potential audit problems is not true in affecting goodwill impairment valuations?
    A.Goodwill arising from acquisitions can be netted into one test at the operating segment level, but not netted at the company level.
    B. Market valuation may be volatile. A material temporary decline in market value may not be a good indicator of FMV.
    C. FMV might not exist, might require independent appraisals by investment bankers or estimates using cash flow and discounted present value factors.
    D. No assumptions are required about competition, economic development, product placement, and so forth.

 

  1. If the acquired company remains intact after the acquisition, it is defined as the:
    A.financing segment.
    B. investing segment.
    C. operating segment.
    D. non-operating segment.

 

  1. Impairment is measured by the difference between market value of the operating segment and which of the following?
    A.carrying value of net assets.
    B. fair market value of net assets.
    C. book value of total assets.
    D. book value of current assets.

 

  1. In a standard audit program for goodwill impairment testing, if the original reporting unit no longer exists because operations have been fully integrated into operations of the parent company the auditor should do which of the following?
    A.compare market value with carrying value. A market value less than carrying value is presumptive evidence that goodwill has been impaired.
    B. compare fair value with realizable value. A fair value less than realizable value is presumptive evidence that goodwill has been impaired.
    C. compare book value with realizable value. A book value less than realizable value is presumptive evidence that goodwill has been impaired.
    D. compare book value with market value. A market value less than book value is presumptive evidence that goodwill has been impaired.

 

  1. The FASB has set a hierarchy of inputs to consider in assessing fair value. Which of the following relates to Level 1?
    A.Quoted prices for identical items in active, liquid, and visible markets.
    B. Unobservable inputs to be used in illiquid situations.
    C. Observable information for similar items in active or inactive markets.
    D. Unobservable inputs to be used in situations where markets don’t exist.

 

  1. The primary scope of services performed in external auditing (CPA) is:
    A.risk analysis.
    B. control analysis.
    C. operations analysis.
    D. audit of financial statements.

 

  1. The scope of services performed in internal auditing (CIA) includes all of the following except
    A. providing assurance on financial statement related items.
    B. evaluating the effectiveness of operations and related controls .
    C. investigating concerns of fraud.
    D. all of the above are included.

 

  1. Which of the following is true of external auditing?
    A.Major focus areas are processes, including risks, controls, and effectiveness and efficiency of processes.
    B. Consulting is performed when agreed to by management.
    C. Primary scope of services performed includes audits of financial statements.
    D. Parties receiving assurance include the audit committee and upper management.

 

  1. Which of the following is true of internal auditing?
    A.Only serves the audit committee of the board of directors
    B. Primary nature of services include assurance and consulting
    C. Is required to report activities and department findings to external stakeholders annually
    D. Independence and objectivity are not relevant because they are employees of the company

 

  1. For the same client, SEC prohibits a CPA firm from providing which of the following services?
    A.tax and external audit services
    B. internal and external audit services.
    C. management letter and audit services.
    D. internal control and financial statement audits.

 

  1. Which of the following has represented the fastest growth area in public accounting practice
    over the past few years?
    A.M&A advisory outsourcing
    B. Internal audit outsourcing
    C. Portfolio management
    D. Wealth management

 

  1. Which one of the following factors is not considered when assessing the quality of internal audit?
    A.Quality of working-paper documentation, reports, and recommendations.
    B. Review of quality of audit policies, programs, and procedures.
    C. Attestation services as demanded by market place.
    D. Educational level and professional experience.

 

  1. The partial or complete outsourcing of internal audit activities is made to public accounting firms or to other specialized firms that perform which of the following types of services?
    A.primarily risk, control, and audit activities.
    B. attestation services as demanded by market place.
    C. operations analysis and risk analysis.
    D. analytical and substantial procedures.

 

  1. A best practice is to have an oversight of the internal audit function as a responsibility of which of the following parties?
    A.management.
    B. internal auditors.
    C. audit committee.
    D. external auditors.

 

  1. Which is the international body that sets standards for the practice of internal auditing across the world?
    A.The Internal Audit Reporting Standards Board
    B. The Institute of Internal Auditors
    C. The International Accounting Standards Board
    D. The Charter of Certified Internal Auditors

 

  1. Audit Standard No. 5 by the PCAOB encourages the external auditor to utilize the work of which of the following?
    A.experts.
    B. internal auditors.
    C. independent valuation professionals.
    D. internal officers of the company.

 

  1. In making judgments about the effect of the internal auditors’ work on the external auditor’s procedures in specific audit areas, which of the following is not among three issues related to the audit areas that should be considered by the external auditor?
    A.Materiality of the financial statement amounts.
    B. Risk of material misstatement of the assertions related to these financial statement amounts.
    C. Review of quality of audit policies, programs, and procedures.
    D. Degree of subjectivity involved in the evaluation of the audit evidence gathered in support of the assertions.

 

  1. SAB 108 mandates what is termed a(n) ___ to uncorrected misstatements.
    A.matrix approach
    B. dual approach.
    C. percentage approach
    D. judgmental approach

 

  1. Misstatements detected during the audit that were initially deemed to be immaterial must be summarized to determine their:
    A.control.
    B. quantitative effect.
    C. aggregate effects.
    D. nature of misstatement.

 

  1. The adjustments arising from the audit that were considered to be material should be informed by the auditor to the:
    A.audit staff.
    B. management.
    C. audit committee.
    D. internal auditors.

 

  1. Which method focuses on the materiality of current year misstatements and the reversing effect of prior-year misstatements on the income statement?
    A.Rollover method
    B. Iron curtain method
    C. Percentage approach
    D. Judgmental method

 

  1. Which method focuses on assuring that the year-end balance sheet is correct and does not consider the impact of prior-year uncorrected misstatements reversing in later years?
    A.Rollover
    B. Iron curtain
    C. Dual
    D. Percentage

 

  1. The discovery of an intentional misstatement, even if immaterial, could impact the auditor’s opinion on the effectiveness of the client’s:
    A.external controls.
    B. interim financial statements.
    C. internal controls.
    D. segment reports.

 

  1. The dual approach requires which of the following?
    A.the application of the rollover method.
    B. the application of the iron curtain method.
    C. simultaneous application of both the rollover and iron curtain methods.
    D. sequential application of both the rollover and iron curtain methods.

 

  1. Which of the following Statements on Auditing Standards (SAS) provides the AICPA’s basic guidance on materiality judgments?
    A.107
    B. 61
    C. 89
    D. 92

 

  1. Planning materiality is typically less than overall materiality and helps the auditor to determine the extent of:
    A.audit evidence needed.
    B. analytical procedure performed.
    C. substantive procedure performed.
    D. work performed.

 

  1. Which of the following best describes the nature of discontinued assets?
    A.Impairment testing based on most likely sale or disposal price.
    B. Impairment testing only if plants are closed or equipment is not used.
    C. Lower of cost or market impairments, including an allowance for obsolescence.
    D. Estimates and assumptions made in preparation of the estimate of income tax expense for the year.

 

  1. Which of the following is not true about materiality judgment?
    A.The auditor’s consideration of materiality is influenced by the auditor’s perception of the needs of users of financial statements.
    B. The auditor considers materiality only in relation to classes of transactions, account balances, and disclosures.
    C. Materiality judgments make sure that the auditor gathers sufficient evidential matter to obtain reasonable assurance about whether the financial statements are free of material misstatement.
    D. Materiality decisions differ from one audit client to another.

 

  1. Which of the following is an approach to setting posting materiality?
    A.Dual approach
    B. Percentage approach
    C. Qualitative approach
    D. Planning approach

 

  1. The FASB has set a hierarchy of inputs to consider in assessing fair value. Which of the following valuations are generally viewed as highly subjective?
    A.Level 1
    B. Level 2
    C. Level 3
    D. Level 4

 

  1. A material misstatement in the financial statements, including those requiring restatements strongly implies a material weakness in which of the following?
    A.income statement.
    B. balance sheet.
    C. internal control.
    D. cash flow statements.

 

  1. The FASB has set a hierarchy of inputs to consider in assessing fair value.  Price taken from a recent trade on the NIKKEI of an index stock would fall under which level?
    A.Level 0
    B. Level 1
    C. Level 2
    D. Level 3

 

  1. Which one of the following general factors should not be considered critical in assessing severity of internal control deficiencies?
    A.Control environment
    B. Evidence from a poorly controlled system
    C. Repeatability of a process
    D. Complexity and subjectivity of the account balance

 

  1. Which of the following factors in assessing severity of internal control deficiencies indicates that a deficiency that may have been considered a material weakness at an interim date would not be considered a material weakness at the year end?
    A.Remediation of a control deficiency.
    B. Existence of compensating controls.
    C. Complexity and subjectivity of the account balance.
    D. Effectiveness of oversight and governance.

 

  1. Although different audit firms take different approaches, planning materiality could be the same as overall materiality, or could be a percentage of overall materiality, generally ranging from:
    A.25% to 75% of overall materiality.
    B. 50% to 75% of overall materiality.
    C. 25% to 50% of overall materiality.
    D. 40% to 75% of overall materiality.

 

  1. Which of the following is associated with Level 3 in the FASB hierarchy for ascertaining fair value?
    A.Mark to market model
    B. Replacement model
    C. Mark to model
    D. Historical cost model

 

  1. For nonprofit entities, appropriate benchmarks for materiality judgments would include which of the following?
    A.total assets and total liabilities.
    B. total revenues and  total assets.
    C. total liabilities, total income, or total assets.
    D. total expenses, total revenues, or total assets.

 

  1. Under which approach is the client expected to estimate fair value based on a model of the future cash flows associated with the instrument or the asset?
    A.Mark to market model
    B. Replacement model
    C. Mark to model
    D. Historical cost model

 

  1. Critical Criteria in Assessing Severity of Internal Control Deficiencies


    What general factors should be considered by an auditor in evaluating whether or not a control deficiency is a material weakness, or a significant deficiency, or a control issue?

The following general factors should be considered as the auditor evaluates whether or not a control deficiency is a material weakness, a significant deficiency, or simply a control issue that should be remediated by the client:

1. Control Environment. Weaknesses in specific components of the control environment have pervasive effects on the financial reporting process. More particularly, deficiencies in the competence of accounting personnel who deal with material account balances are normally considered a material weakness.

2. Repeatability of a Process. If a deficiency is repeatable, such as in a computerized process, the more likely it is to be material.

3. Volume of Transactions Affected. The auditor needs to assess the percentage of control failures multiplied by the average size of a transaction to determine if the amounts that could be misstated are material.

4. Complexity and Subjectivity of the Account Balance. The more complex and subjective a material account balance is, the more likely that a deficiency will be material.

5. Effectiveness of Oversight and Governance. One of the key elements of good internal control is that there should be strong oversight coming from the board of directors, and especially the audit committee. A lack of sufficient oversight would be considered a material weakness regardless of whether misstatements are actually detected in the financial statements.

6. Existence of Compensating Controls. Often there are other controls in place that might compensate for a deficiency in a particular control and that make the original weakness less likely to be judged material.

7. Remediation of a Control Deficiency. The auditor’s report addresses whether there are material weaknesses in the internal control as of the company’s year end. It is possible that a control deficiency may have been identified and remediated by the company prior to the company’s year end. Thus, a deficiency that may have been considered a material weakness at an interim date would no longer be considered a material weakness at year end.

 

  1. Considering Qualitative Factors

    What are the considerations that may cause a quantitatively small misstatement to be considered material?

Some of the considerations that may cause a quantitatively small misstatement to be considered material include whether the potential misstatement:

1. Arises from an item capable of precise measurement or whether it arises from an estimate and if so, the degree of imprecision inherent in the estimate.
2. Masks a change in earnings or other trends.
3. Hides a failure to meet analysts’ consensus expectations for the enterprise.
4. Changes a loss into income or vice versa.
5. Is in a segment that has been identified as having a significant effect on the company’s stock valuation.
6. Affects compliance with regulatory requirements.
7. Affects loan covenants or other contractual requirements.
8. Has the effect of increasing management’s compensation—for example, by satisfying requirements for the award of bonuses or other forms of incentive compensation.
9. Involves concealment of an unlawful transaction.

 

  1. Evaluating the Quality of Client’s Internal Audit Function

    An external auditor has to assess the quality of the internal audit function and determine whether the internal auditors’ work is relevant to the external audit and of sufficient quantity and quality regardless of how the client staffs the internal audit function. Explain?

The external auditor considers three primary characteristics in assessing the quality of the internal audit function:
1. Competence,
2. Objectivity, and
3. Quality of work performance.

Competence:
· Educational level and professional experience.
· Professional certification and continuing education.
· Review of quality of audit policies, programs, and procedures.
· Demonstrated supervision and review of internal auditors’ activities.
· Quality of working-paper documentation, reports, and recommendations.
· Periodic evaluation of internal auditors’ performance—both self-assessment and feedback
from auditees and audit committee.
· Periodic quality-control assessments performed in accordance with the International Standards for the Professional Practice of Internal Auditing.

Assessment of objectivity:
· An organizational reporting status is sufficient to assure audit coverage of major organizational risks as well as consideration of, and action on, the findings and recommendations of the internal auditors.
· Internal auditor has direct access and reports regularly to the board of directors, the audit
committee, or the owner-manager.
· Board of directors, the audit committee, or the owner-manager oversees employment
decisions related to the director of the internal audit function.
· Policies that prohibit internal auditors from auditing areas where relatives are employed in
important or audit-sensitive positions.
· Policies that minimize other potential conflicts of interest, such as auditing an area where they were employed before entering internal audit, or where they will be placed after spending time in internal audit.

Assessing the quality of internal audit work:
· Scope of work is appropriate to meet the objectives.
· Audit programs are adequate.
· Working papers adequately document work performed, including evidence of supervision and review.
· Conclusions are appropriate in the circumstances.
· Reports are consistent with the results of the work performed.

 

  1. Effect of Internal Audit’s Work on the External Audit

    Which are the audit judgments made by the external auditor that should not be delegated to the internal auditor?

Because the auditor has the ultimate responsibility to express an opinion on the financial statements, many of the audit judgments must be made by the external auditor and should not be delegated to the internal auditors.

Some of these judgments include assessments of::

· Inherent and control risks,
· The materiality of misstatements,
· The sufficiency of tests performed, and
· The evaluation of significant accounting estimates.

 

  1. Audit Program for Goodwill Impairment Testing

    Outline the major elements of an audit program to determine whether there is a goodwill impairment, and if there is, the extent of the goodwill impairment?

An overview of the audit program for goodwill impairment testing:

1. Review the methodology that the client initially used in determining the amount it used to purchase the reporting unit. Examine the initial client documents to determine:
a. Assumptions about economic growth and synergies expected with the acquisition.
b. Expected cash flow, discounted to present terms.
c. Cost savings expected from integrated operations.
d. Assumptions about the general economy, industry growth, and new-product innovation.

2. Compare actual results with those expected since the time of the acquisition.
a. Determine significant changes in assumptions and projected results.
b. Estimate the company’s acquisition model with new assumptions that reflect current market conditions, actual results, and current information about cost of capital to get an estimate of reporting unit fair value.
c. Compare fair value with carrying value and determine amount of goodwill impairment.

3. If the client does not have the original data, perform an independent analysis of the industry and develop:
a. A set of assumptions about future performance based on industry expectations and company products.
b. An estimated of future discounted cash flows.
c. A sensitivity analysis of changes in value based on industry and cash-flow assumptions.
d. A range of estimates and compare to carrying value of the reporting unit and goodwill carrying cost.

4. If the original reporting unit no longer exists because operations have been fully integrated into operations of the parent company:
a. Compare book value with market value. A market value less than book value is presumptive evidence that goodwill has been impaired.
b. Determine whether all other assets have been adjusted to fair value, where applicable.
c. Compute difference between market value and book value to determine the amount of goodwill impairment.
d. Review assumptions about future operations, industry position, expected future cash flows, and strategic plans for the business to determine if the write-off in part (c) is sufficient.

 

  1. Purpose of Materiality Judgments and Common Benchmarks and Thresholds

    What are the key aspects in materiality judgments? Explain the purpose of materiality judgments, common benchmarks, and thresholds.

The key aspects in materiality judgments are:

Auditors should pay attention to investor comment letters sent to the FASB, SEC, PCAOB, or other regulators to better understand materiality issues from an investor viewpoint. Investors are interested in long-term developing issues, not just short-term trends.

Audit firms realize that materiality judgments are difficult to make. As such, they spend a great deal of time training staff on how to make these judgments appropriately. Further, they have policies and computer decision aids that assist auditors in making the judgments correctly.

The purpose of materiality judgments, common benchmarks, and thresholds:

Auditors may over-rely on quantitative measures of materiality because such measures do not require much thinking. The SEC has been very critical of auditors’ exclusive use of quantitative measures and encourages auditors to document their thought process regarding materiality choices.

If a client has significant and nonrecurring charges to nonoperating expenses, then income from continuing operations may be a more appropriate materiality benchmark than net income.

For companies with a net loss, auditors sometimes use net loss as the benchmark. If a company’s net income varies significantly from year to year, the auditor might consider using an average of net income from the prior three to five years as the materiality benchmark.

For nonprofit entities, appropriate benchmarks would include total expenses, total revenues, or total assets.

If planning materiality is set too high, the auditor may not perform sufficient procedures to detect material misstatements in the financial statements. If planning materiality is set too low, more substantive procedures may be performed than necessary.

Posting materiality is a data accumulation and judgment aid that assists the auditor in aggregating information about the potential materiality of misstatements.

 

  1. Assessing Whether Misstatements Are Material

    What additional information might the auditor choose to analyze to determine whether or not the financial statements are misstated by a material amount?

During the course of the audit, most of the time there will be multiple misstatements detected. Once misstatements are detected, the auditor should evaluate each misstatement individually, and the auditor should consider the aggregate effect of all misstatements.

Further, if an individual misstatement causes the financial statement as a whole to be materially misstated, that effect cannot be eliminated by other misstatements that have a different directional effect on the financial statements.

For example, if a company’s revenues are materially overstated, the auditor is not allowed to conclude that the effect is immaterial if there is an equal and off setting overstatement of expenses. Rather, the auditor would conclude in this case that the financial statements taken as a whole are materially misstated. The rationale is that the trend in revenue growth may be just as important to a user as the effect on net income.

The auditor should inform the audit committee about adjustments arising from the audit that were considered to be material. In addition, the auditor should also provide a list of uncorrected misstatements that were deemed not to be material.

Most auditors request the client to book all known misstatements (unless recording cost is very high) so there are not carryovers from year to year. If the client does not want to book the misstatement, the auditor should assume that the client considers the amount to be material.

 

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