Chapter 1

Multiple-Choice Questions

1. Recording, classifying, and summarizing economic events in a logical

easy manner for the purpose of providing financial information for decision
making is commonly called:
c a. finance.
b. auditing.
c. accounting.
d. economics.

2. In the audit of historical financial statements, which of the following

easy accounting bases is the most common?
c a. Regulatory accounting principles.
b. Cash basis of accounting.
c. Generally accepted accounting principles.
d. Liquidation basis of accounting.

3. Any service that requires a CPA firm to issue a report about the
easy reliability of an assertion that is made by another party is a(n):
b a. accounting and bookkeeping service.
b. attestation service.
c. assurance service.
d. tax service.

4. Three common types of attestation services are:

easy a. audits, reviews, and “other” attestation services.
a b. audits, verifications, and “other” attestation services.
c. reviews, verifications, and “other” attestation services.
d. audits, reviews, and verifications.

5. (SOX) The organization that is responsible for providing oversight for auditors
easy of public companies is called the ________.
d a. Auditing Standards Board.
b. American Institute of Certified Public Accountants.
c. Public Oversight Board.
d. Public Company Accounting Oversight Board.

6. (SOX) The Sarbanes-Oxley Act applies to which of the following companies?

easy a. All companies.
c b. Privately held companies.
c. Public companies.

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 d. All public companies and privately held companies with assets
greater than $500 million.

7. Providing quantitative information that management and others can use

medium to make decisions is the function of:
d a. management information systems.
b. auditing.
c. finance.
d. accounting.

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8. An audit of historical financial statements most commonly includes the:
medium a. balance sheet, the income statement, and the statement of cash
flows.
d b. income statement, the statement of cash flows, and the statement
of net working capital.
c. statement of cash flows, the balance sheet, and the retained
earnings statement.
d. balance sheet, the income statement, and the statement of cash
flows.

9. The ___________ rate may be defined as approximately the rate a bank

medium could earn by investing in U.S. treasury notes for the same length as the
length of a business loan.
c a. nominal
b. stated
c. risk-free
d. prevailing

10. The use of the Certified Public Accountant title is regulated by:
medium a. the federal government.
b b. state law through a licensing department or agency of each state.
c. the American Institute of Certified Public Accountants through the
licensing departments of the tax and auditing committees.
d. the Securities and Exchange Commission.

11. An operational audit has as one of its objectives to:

medium a. determine whether the financial statements fairly present the
entity’s operations.
c b. evaluate the feasibility of attaining the entity’s operational
objectives.
c. make recommendations for improving performance.
d. report on the entity’s relative success in attaining profit
maximization.

12. An audit of historical financial statements is most often performed to

determine whether the:
medium a. organization is operating efficiently and effectively.
d b. entity is following specific procedures or rules set down by some
higher authority.
c. management team is fulfilling its fiduciary responsibilities to
shareholders.
d. none of these choices.

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13. An examination of part of an organization’s procedures and methods for
medium the purpose of evaluating efficiency and effectiveness is what type of
audit?
a a. Operational audit.
b. Compliance audit.
c. Financial statement audit.
d. Production audit.

14. An audit to determine whether an entity is following specific procedures

medium or rules set down by some higher authority is classified as a(n):
b a. audit of financial statements.
b. compliance audit.
c. operational audit.
d. production audit.

15. Which of the following is a type of audit evidence?

medium a. Oral responses to the auditor from employees of the company under
audit.
d b. Written communications from company employees or outsiders.
c. Observations made by an auditor.
d. Evidence may take any of the above forms.

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16. Which of the following services provides the lowest level of assurance
on a financial statement?
medium a. A review.
a b. An audit.
c. Neither service provides assurance on financial statements.
d. Each service provides the same level of assurance on financial
statements.

17. The three requirements for becoming a CPA include all but which of the
following?
medium a. Uniform CPA examination requirement.
c b. Educational requirements.
c. Character requirements.
d. Experience requirement.

18. In “auditing” financial accounting data, the primary concern is with:

medium a. determining whether recorded information properly reflects the
a economic events that occurred during the accounting period.
b. determining if fraud has occurred.
c. determining if taxable income has been calculated correctly.
d. analyzing the financial information to be sure that it complies with
government requirements.

19. Financial statement users often receive unreliable financial information

medium from companies. Which of the following is not a common reason for
this?
d a. Complex business transactions.
b. Large amounts of data.
c. Lack of firsthand knowledge about the business.
d. Each of these choices is a common reason for unreliable financial
information.

20. Which of the following is not a Trust Services principle as defined by the
AICPA or CICA?
challenging a. Online privacy.
d b. Availability.
c. Processing integrity.
d. Operational integrity.

21. Which one of the following is more difficult to evaluate objectively?

challenging a. Presentation of financial statements in accordance with generally
c accepted accounting principles.
b. Compliance with government regulations.

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 c. Efficiency and effectiveness of operations.
d. All three of the above are equally difficult.

22. (SOX) The Sarbanes-Oxley Act prohibits a CPA firm that audits a public
challenging company from providing which of the following types of services to
that company?
c a. Reviews of quarterly financial statements.
b. Preparation of corporate tax returns.
c. Most consulting services.
d. Tax services.

23. Which of the following audits can be regarded as generally being a

compliance audit?
challenging a. IRS agents’ examinations of taxpayer returns.
a b. GAO auditor’s evaluation of the computer operations of
governmental units.
c. An internal auditor’s review of a company’s payroll authorization
procedures.
d. A CPA firm’s audit of the local school district.

24. Which of the following can be significantly affected by an audit?

challenging a. Business risk.
b b. Information risk.
c. The risk-free interest rate.
d. Inherent risk.

25. The trait that distinguishes auditors from accountants is the:

challenging a. auditor’s ability to interpret accounting principles generally accepted
in the United States.
d b. auditor’s education beyond the Bachelor’s degree.
c. auditor’s ability to interpret FASB Statements.
d. auditor’s accumulation and interpretation of evidence related to a
company’s financial statements.

26. Attestation services on information technology include WebTrust

challenging services and SysTrust services. Which of the following statements
most accurately describes SysTrust services?
b a. SysTrust services provide assurance on business processes,
transaction integrity and information processes.
b. SysTrust services provide assurance on system reliability in critical
areas such as security and data integrity.
c. ysTrust services provide assurance on internal control over financial
reporting.
d. SysTrust services provide assurance as to whether accounting

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 personnel are following procedures prescribed by the company
controller.

Essay Questions

27. Discuss the three primary requirements for becoming a CPA.

easy
Answer:
The three primary requirements for becoming a CPA are:
 Educational requirement. An undergraduate degree with a major
in accounting is required. Most states now require 150 semester
hours for licensure and some states require 150 semester hours
before taking the CPA exam.
 Uniform CPA examination requirement . This is a four-part exam
with components on auditing and attestation, financial
accounting and reporting, regulation, and business environment
and concepts.
 Experience requirement. The experience requirement varies from
state to state with some states requiring no experience, while
other states require up to two years of audit experience.

28. Two types of attestation services provided by CPA firms are audits and
easy reviews. Discuss the similarities and differences between these two
types of attestation services. Which type provides the least assurance?

Answer:
Two primary types of attestation services are: audits of historical
financial statements and reviews of historical financial statements.
While both services involve the accumulation and evaluation of
evidence regarding assertions made by management in the
company’s financial statements, a review involves a less extensive
examination and provides a lower level of assurance about the
client’s financial statements than an audit.

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29. Discuss the differences and similarities between the roles of accountants
medium and auditors. What additional expertise must an auditor possess beyond
that of an accountant?

Answer:
The role of accountants is to record, classify, and summarize
economic events in a logical manner for the purpose of providing
financial information for decision making. To do this, accountants
must have a sound understanding of the principles and rules that
provide the basis for preparing the financial information. In addition,
accountants are responsible for developing systems to ensure that
the entity’s economic events are properly recorded on a timely basis
and at a reasonable cost.
The role of auditors is to determine whether the financial
information prepared by accountants properly reflects the economic
events that occurred. To do this, the auditor must not only
understand the principles and rules that provide the basis for
preparing financial information, but must also possess expertise in
the accumulation and evaluation of audit evidence. It is this latter
expertise that distinguishes auditors from accountants.

30. Discuss the similarities and differences between financial statement

medium audits, operational audits, and compliance audits. Give an example of
each type.

Answer:
Financial statement audits, operational audits, and compliance
audits are similar in that each type of audit involves accumulating
and evaluating evidence about information to ascertain and report
on the degree of correspondence between the information and
established criteria. The differences between each type of audit are
the information being examined and the criteria used to evaluate
the information. An example of a financial statement audit would be
the annual audit of IBM Corporation, in which the external auditors
examine IBM’s financial statements to determine the degree of
correspondence between those financial statements and generally
accepted accounting principles. An example of an operational audit
would be an internal auditor’s evaluation of whether the company’s
computerized payroll-processing system is operating efficiently and
effectively. An example of a compliance audit would be an IRS
auditor’s examination of an entity’s federal tax return to determine
the degree of compliance with the Internal Revenue Code.

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31. Discuss the similarities and differences between the roles of
medium independent auditors, GAO auditors, internal revenue agents, and
internal auditors.

Answer:
The roles of all four types of auditors are similar in that they involve
the accumulation and evaluation of evidence about information to
ascertain and report on the degree of correspondence between the
information and established criteria. The differences in their roles
center around the information audited and the criteria used to
evaluate that information. Independent auditors primarily audit
companies’ financial statements. GAO auditors’ primary
responsibility is to perform the audit function for Congress. IRS
auditors are responsible for the enforcement of federal tax laws.
Internal auditors primarily perform operational and compliance
audits for their employing company.

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32. (SOX) What is an engagement to attest on internal control over financial
medium reporting?

Answer:
Section 404 of the Sarbanes-Oxley Act requires public companies to
report management’s assessment of the effectiveness of internal
control over financial reporting. The Act further requires auditors to
attest to the effectiveness of internal control over financial
reporting. This evaluation, which is integrated with the audit of
financial statements, provides forward-looking information, because
effective internal controls reduce the likelihood of future
misstatements in the financial statements.

33. To do an audit, it is necessary for information to be in a verifiable form

challenging and some criteria by which the auditor can evaluate the information. (A)
What information and criteria would an independent CPA firm use when
auditing a company’s historical financial statements? (B) What
information and criteria would an Internal Revenue Service auditor use
when auditing that same company’s tax return? (C) What information
and criteria would an internal auditor use when performing an
operational audit to evaluate whether the company’s computerized
payroll processing system is operating efficiently and effectively?

Answer:
(A) The information used by a CPA firm in a financial statement
audit is the financial information in the company’s financial
statements. The most commonly used criteria are accounting
principles generally accepted in the United States.

(B) The information used by an IRS auditor is the financial

information in the company’s federal tax return. The criteria are the
internal revenue code and interpretations.

(C) The information used by an internal auditor when performing an

operational audit of the payroll system could include various items
such as the number of errors made, costs incurred by the payroll
department, and number of payroll records processed each month.
The criteria would consist of company standards for departmental
efficiency and effectiveness.

34. Explain what is meant by information risk, and discuss the four causes
challenging of this risk.

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 Answer:
Information risk is the possibility that information upon which a
business decision is made is inaccurate. Four causes of information
risk are:
 remoteness of information,
 biases and motives of the provider,
 voluminous data, and
 complex exchange transactions.

35. Attestation services fall into five categories. What are these categories?
challenging Answer:
The five categories of attestation services include:
 audits of historical financial statements,
 attestation on internal control over financial reporting,
 reviews of historical financial statements,
 attestation services on information technology, and
 other attestation services that may be applied to a broad range
of subject matter.

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36. Discuss four factors that are likely to significantly reduce information risk
challenging in the next five to ten years.

Answer:
Four factors that are likely to significantly reduce information risk in
the next five to ten years are:
 technological advances,
 more companies will go on-line, reducing the risk of investors
obtaining outdated information,
 new accounting and auditing standards, and
 auditors will find more efficient and effective audit techniques.

Other Objective Answer Format Questions

37. The criteria by which an auditor evaluates the information under audit
easy may vary with the information being audited.
a a. True
b. False

38. The criteria used by an external auditor to evaluate published financial

easy statements are known as generally accepted auditing standards.
b a. True
b. False

39. (SOX) The Sarbanes-Oxley Act establishes standards related to the audits of
easy privately held companies.
b a. True
b. False

40. (SOX) The Sarbanes-Oxley Act is widely viewed as having ushered in sweeping
easy changes to auditing and financial reporting.
a a. True
b. False

41. Only companies that file annual statements with the Securities and
easy Exchange Commission are required to have an annual external audit.
b a. True
b. False

42. The financial statements most commonly audited by external auditors

easy are the balance sheet, the income statement, and the statement of
b changes in retained earnings.
a. True

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 b. False

43. The primary purpose of a compliance audit is to determine whether the

medium financial statements are prepared in compliance with generally accepted
b accounting principles.
a. True
b. False

44. Results of compliance audits are typically reported to someone within

medium the organizational unit being audited rather than to a broad spectrum of
a outside users.
a. True
b. False

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45. The primary role of the United States General Accounting Office is the
medium enforcement of the federal tax laws as defined by Congress and
b interpreted by the courts.
a. True
b. False

46. CPA firms are never allowed to provide bookkeeping services for audit
medium clients.
b a. True
b. False

47. (SOX) Section 404 of the Sarbanes-Oxley Act requires public companies to
medium have an external auditor attest to their internal control over financial
a reporting.
a. True
b. False

48. (SOX) The Sarbanes-Oxley Act requires a company’s chairman of the board of
challenging directors, CEO, and CFO to certify the company’s financial statements.
b a. True
b. False

49. (SOX) The criterion that is most likely to be used as a framework in evaluating
challenging a company’s internal control over financial reporting under Section 404
b of the Sarbanes-Oxley Act is the Enterprise Risk Management
framework.
a. True
b. False

50. Most public companies’ audited financial statements are available on the
challenging SEC’s EDGAR database.
a a. True
b. False

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