Principles of Auditing and Other Assurance Services 20th Edition Whittington Test Bank 1

Solution Manual for Principles of Auditing and Other
Assurance Services 20th Edition Whittington Pany

0077729145 9780077729141
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Chapter 06
Audit Planning, Understanding the Client, Assessing Risks, and

Responding
True / False Questions
1. Audit committees should be made up of the most qualified directors regardless of whether they
are part of management of the company.
True False
2. Analytical procedures are seldom used during the risk assessment stage of an audit engagement
because they are substantive procedures.
True False
3. Preliminary arrangements with clients should be set forth in the management letter.
True False
4. An audit plan includes a detailed listing of the audit procedures to be performed in the verification
of items in the financial statements.
True False
5. The auditors' tests of controls are designed to substantiate the fairness of specific financial
statement accounts.
True False
6-1
Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw-Hill Education.
6. At least a portion of the auditors' consideration of internal control usually is performed at an
interim date rather than at the balance sheet date.
True False
7. The substantive approach to an audit is appropriate for many small businesses.
True False
8. Confirming a bank account establishes existence but not rights to the cash balance.
True False
9. The completeness of recording of assets is generally verified by tracing from the source
documents to the recorded entry.
True False
10. Vouching the acquisition of assets is an audit procedure that is often performed to establish the
valuation of the assets.
True False
Multiple Choice Questions
11. Which of the following factors most likely would cause a CPA to not accept a new audit
engagement?
A. The prospective client has fired its prior auditor.

B. The CPA lacks a thorough understanding of the prospective client's operations and industry.
C. The CPA is unable to review the predecessor auditor's working papers due to a major fire that
destroyed both hard and soft copy documentation.
D. The prospective client is unwilling to make financial records available to the CPA.
12. Which of the following factors most likely would heighten an auditor's concern about the risk of
fraudulent financial reporting?
A. Large amounts of liquid assets that are easily convertible into cash.
B. Low growth and profitability as compared to other entity's in the same industry.
C. Financial management's participation in the initial selection of accounting principles.
D. An overly complex organizational structure involving unusual lines of authority.
6-2
13. Which of the following factors would most likely cause a CPA to decide not to accept a new audit
engagement?
A. Lack of understanding of the potential client's internal auditors' computer-assisted audit

techniques.
B. Management's disregard for internal control.
C. The existence of related party transactions.
D. Management's attempt to meet earnings per share growth rate goals.
14. Which of the following matters is generally included in an auditor's engagement letter?
A. Limitations of the engagement.

B. Factors to be considered in establishing preliminary judgments about materiality.
C. Management's liability for all illegal acts committed by its employees.
D. The auditor's responsibility to obtain negative assurance relating to non-compliance with laws
and regulations.
15. Which of the following would heighten an auditor's concern about the risk of fraudulent financial
reporting?
A. Inability to generate positive cash flows from operations, while reporting large increases in
earnings.
B. Management's lack of interest in increasing the dividend paid on common stock.
C. Large amounts of liquid assets that are easily convertible into cash.
D. Inability to borrow necessary capital without obtaining waivers on debt covenants.
16. To best test existence, an auditor would sample from the:
A. General ledger to source documents.

B. General ledger to the financial statements.
C. Source documents to the general ledger.
D. Source documents to journals.
17. The auditors' understanding established with a client should be established through a(an):
A. Oral communication with the client.

B. Written communication with the client.
C. Written or oral communication with the client.
D. Completely detailed audit plan.
18. Which of the following would be least likely to be considered an audit planning procedure?
A. Use an engagement letter.

B. Develop the overall audit strategy.
C. Perform the risk assessment.
D. Develop the audit plan.
6-3
19. While assessing the risks of material misstatement, auditors identify risks, relate risk to what
could go wrong, consider the magnitude of risks, and:
A. Assess the risk of misstatements due to illegal acts.

B. Consider the complexity of the transactions involved.
C. Consider the likelihood that the risks could result in material misstatements.
D. Determine materiality levels.
20. Which of the following is correct concerning requirements about auditor communications about
fraud?
A. Fraud that involves senior management should be reported directly to the audit committee
regardless of the amount involved.
B. All fraud with a material effect on the financial statements should be reported directly by the
auditor to the Securities and Exchange Commission.
C. Fraud with a material effect on the financial statements should ordinarily be disclosed by the
auditor through use of an "emphasis of a matter" paragraph added to the audit report.
D. The auditor has no responsibility to disclose fraud outside the entity under any circumstances.
21.
A predecessor auditor will ordinarily initiate communication with the successor auditor:
Prior to the Successor’s Subsequent to

Acceptance of the Engagement the
Successor’s
Acceptance of
the
Engagement
A. Yes Yes
B. Yes No
C. No Yes
D. No No
A. Option A
B. Option B
C. Option C
D. Option D
6-4
22.
Which measure of materiality (or both) considers quantitative considerations?
Planning Evaluation
A. Yes Yes
B. Yes No
C. No Yes
D. No No
A. Option A
B. Option B
C. Option C
D. Option D
23. Which of the following factors most likely would lead a CPA to conclude that a potential audit
engagement should not be accepted?
A. There are significant related party transactions that management claims occurred in the
ordinary course of business.
B. Internal control activities requiring the segregation of duties are subject to management
override.
C. Management continues to employ an inefficient system of information technology to record
financial transactions.
D. It is unlikely that sufficient evidence is available to support an opinion on the financial
statements.
24. In using the information on the statement of cash flows while obtaining an understanding of a
profitable, growing company, which of the following would ordinarily be least surprising to an
auditor?
A. Decreases in accounts payable.

B. Decreases in accounts receivable.
C. Negative cash flows from investing.
D. Negative operating cash flows.
6-5
25.
Audits of financial statements are designed to obtain reasonable assurance of detecting material
misstatements due to:
Errors Misappropriation of Assets

A. Yes Yes
B. Yes No
C. No Yes
D. No No
A. Option A
B. Option B
C. Option C
D. Option D
26. Which of the following is not one of the assertions made by management about an account
balance?
A. Relevance.
B. Existence.
C. Valuation.
D. Rights and obligations.
27. When a company has changed auditors, according to the Professional Standards:
A. The successor auditor has the responsibility to initiate contact with the predecessor auditor to
ask about the client before the engagement is accepted; the predecessor has no responsibility
to initiate this contact, even when aware of matters bearing on the integrity of management.
B. The predecessor must always respond fully to all inquiries made by the successor auditor.
C. The successor must discuss with the predecessor matters bearing on the engagement prior to
accepting the engagement.
D. The successor may choose not to attempt any communication with the predecessor auditor.
28. Which of the following procedures is not performed as a part of planning an audit engagement?
A. Reviewing the working papers of the prior year.

B. Developing an overall audit strategy.
C. Confirmation of all major accounts.
D. Designing an audit plan.
6-6
29. The risk of a material misstatement occurring in an account, assuming an absence of internal
control, is referred to as:
A. Account risk.
B. Control risk.
C. Detection risk.
D. Inherent risk.
30. Which of the following is least likely to be considered a financial statement audit risk factor?
A. Management operating and financing decisions are dominated by top management.

B. A new client with no prior audit history.
C. Rate of change in the entity's industry is rapid.
D. Profitability of the entity relative to its industry is inconsistent.
31. Which of the following is an example of fraudulent financial reporting?
A. Company management falsifies inventory count tags thereby overstating ending inventory and
understating cost of goods sold.
B. An employee diverts customer payments to his personal use, concealing his actions by
debiting an expense account, thus overstating expenses.
C. An employee steals inventory and the "shrinkage" is recorded in cost of goods sold.
D. An employee "borrows" tools from the company and neglects to return them; the cost is
reported as a miscellaneous operating expense.
32. Which of the following is most likely to be considered a risk factor relating to fraudulent financial
reporting?
A. Low turnover of senior management.

B. Extreme degree of competition within the industry.
C. Capital structure including various operating subsidiaries.
D. Sales goals in excess of any of the preceding three years.
33. Which of the following conditions identified during the audit increases the risk of employee fraud?
A. Large amounts of cash in the bank.

B. Existence of a mandatory vacation policy for employees performing key functions.
C. Inventory items of small size, but high value.
D. Presence of reconciling items on a client prepared year-end proof of cash.
6-7
34. Which of the following statements is accurate about "fraud risk factors" considered when
conducting an audit?
A. Factors whose presence indicates that fraud exists.

B. Factors whose presence often have been observed in circumstances where frauds have
occurred.
C. Factors whose presence will require modification to planned audit procedures.
D. Factors obtained during the audit which lead to required communications with the audit
committee.
35. Which of the following is not an example of a likely adjustment in the auditors' overall audit
approach when significant risk is found to exist?
A. Apply increased professional skepticism about material transactions.

B. Increase the assessed level of detection risk.
C. Assign personnel with particular skill to areas of high risk.
D. Obtain increased evidence about the appropriateness of management's selection of
accounting principles.
36. Which of the following is least likely to be required on an audit?
A. Evaluate the business rationale for significant, unusual transactions.

B. Make a legal determination of whether fraud has occurred.
C. Review accounting estimates for biases.
D. Test appropriateness of journal entries and adjustments.
37. Which of the following is (are) considered a further audit procedure(s) that may be designed after
assessing the risks of material misstatement?
Substantive Tests of Details Substantive Analytical Procedures

A. Yes Yes
B. Yes No
C. No Yes
D. No No
A. Option A
B. Option B
C. Option C
D. Option D
6-8
38. Which of the following circumstances would an auditor most likely consider a risk factor relating to
misstatements arising from fraudulent financial reporting?
A. Several members of management have recently purchased additional shares of the entity's
stock.
B. Several members of the board of directors have recently sold shares of the entity's stock.
C. The entity distributes financial forecasts to financial analysts that predict conservative
operating results.
D. Management is interested in maintaining the entity's earnings trend by using aggressive
accounting practices.
39. A successor auditor is required to attempt communication with the predecessor auditor prior to:
A. Performing test of controls.

B. Testing beginning balances for the current year.
C. Making a proposal for the audit engagement.
D. Accepting the engagement.
40. If the business environment is experiencing a recession, the auditor most likely would focus
increased attention on which of the following accounts?
A. Purchase returns and allowances.

B. Allowance for doubtful accounts.
C. Common stock.
D. Noncontrolling interest of a subsidiary purchased during the year.
41. The risk that the auditors' procedures will lead them to conclude that a material misstatement
does not exist in an account balance when in fact such a misstatement does exist is referred to
as:
A. Account risk.
B. Control risk.
C. Detection risk.
D. Inherent risk.
42. Which of the following statements is correct regarding the auditor's determination of materiality?
A. The planning level of materiality should normally be the larger of the amount considered for the
balance sheet versus the income statement.
B. The auditors' planning level of materiality may be disaggregated into smaller "tolerable
misstatements" for the various accounts.
C. Auditors may use various rules of thumb to arrive at an evaluation level of materiality, but not
for determining the planning level of materiality.
D. The amount used for the planning should equal that used for evaluation.
6-9
43. The auditors must consider materiality in planning an audit engagement. Materiality for planning
purposes is:
A. The auditors' preliminary estimate of the largest amount of misstatement that would be
material to any one of the client's financial statements.
B. The auditors' preliminary estimate of the smallest amount of misstatement that would be
C. The auditors' preliminary estimate of the amount of misstatement that would be material to the
client's balance sheet.
D. An amount that cannot be quantitatively stated since it depends on the nature of the item.
44. Which of the following topics is not normally included in an engagement letter?
A. The auditors' preliminary assessment of internal control.

B. The auditors' estimate of the fee for the engagement.
C. Limitations on the scope of the engagement.
D. A description of responsibility for the detection of fraud.
45. Which of the following is most likely to be an overall response to fraud risks identified in an audit?
A. Only use certified public accountants on the engagement.

B. Place increased emphasis on the audit of objective transactions rather than subjective
transactions.
C. Supervise members of the audit team less closely and rely more upon judgment.
D. Use less predictable audit procedures.
46. Which of the following is not an assertion that is made in the financial statements by
management concerning each major account balance?
A. Completeness.
B. Rights and obligations.
C. Legality.
D. Valuation.
47. Tests for unrecorded assets typically involve tracing from:
A. Source documents to recorded journal entries.

B. Source documents to observations.
C. Recorded journal entries to documents.
D. Recorded journal entries to observations.
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48. Tracing from source documents forward to ledgers is most likely to address which assertion
related to posted entries?
A. Completeness.
B. Existence.
C. Rights.
D. Valuation.
49. Determining that receivables are presented at net realizable value is most directly related to
which management assertion?
A. Existence.
B. Rights.
C. Valuation.
D. Presentation and disclosure.
50. Which of the following is not a general objective for the audit of asset accounts?
A. Establishing existence of assets.

B. Establishing proper valuation of assets.
C. Establishing proper liabilities relating to assets.
D. Establishing the completeness of assets.
51. Which of the following is not used by auditors to establish the completeness of recorded
assets?
A. Assessing control risk.

B. Tracing from source documents to entries in the accounting records.
C. Performing analytical procedures.
D. Vouching transactions.
52. To test for unsupported entries in the journals, the direction of audit testing should be to the:
A. Ledger entries.
B. Journal entries.
C. Original source documents.
D. Financial statements.
53. A form filed with the SEC when a company changes auditors is a:
A. Form 8-K.
B. Form 10-K.
C. Form S-1.
D. Form B-1.
6-11
54. Which of the following is least likely to render a quantitatively small misstatement material?
A. Affects the registrant's compliance with regulatory requirements.

B. Masks a change in earnings or other trends.
C. Arises from an item not capable of precise measurement.
D. The transaction involves a related party.
55. Which of the following is not a required source of information for the auditors' assessment of
fraud risk?
A. Discussion among audit team members.

B. Fraud risk factors.
C. Results of tests of controls.
D. Inquiry of management and others.
56. Auditors must assess fraud risk on every audit and respond to the risks that are identified. Which
of the following is not a procedure required to further address the fraud risk of management
override of internal control?
A. Reviewing accounting estimates for biases.

B. Examining physical controls over assets.
C. Evaluating the business rationale for significant unusual transactions.
D. Examining journal entries and other adjustments for evidence of fraud.
57. Preliminary arrangements agreed to by the auditors and the client should be reduced to writing by
the auditors. The best place to set forth these arrangements is in:
A. A memorandum to be placed in the permanent section of the auditing working papers.

B. An engagement letter.
C. A client representation letter.
D. A confirmation letter attached to the constructive services letter.
58. The auditors are planning an audit engagement for a new client in a business that is unfamiliar to
the auditors. Which of the following would be the most useful source of information for the
auditors during the preliminary planning stage when they are trying to obtain a general
understanding of audit problems that might be encountered?
A. Client manuals of accounts and charts of accounts.

B. AICPA Industry Audit Guides.
C. Prior-year working papers of the predecessor auditors.
D. Latest annual and interim financial statements issued by the client.
6-12
59. The auditors will not ordinarily initiate discussion with the audit committee concerning the:
A. Extent to which the work of internal auditors will influence the scope of the examination.
B. Extent to which change in the company's organization will influence the scope of the
examination.
C. Details of potential problems which the auditors believe might cause a qualified opinion.
D. Details of the procedures which the auditors intend to apply.
60. Which statement is correct relating to a potential successor auditor's responsibility for
communicating with the predecessor auditors in connection with a prospective new audit client?
A. The successor auditors have no responsibility to contact the predecessor auditors.

B. The successor auditors should obtain permission from the prospective client to contact the
predecessor auditors.
C. The successor auditors should contact the predecessors regardless of whether the
prospective client authorizes contact.
D. The successor auditors need not contact the predecessors if the successors are aware of all
available relevant facts.
61. Which of the following situations would most likely require special audit planning by the auditors?
A. Some items of factory and office equipment do not bear identification numbers.
B. Depreciation methods used on the client's tax return differ from those used on the books.
C. Assets costing less than $500 are expensed even though the expected life exceeds one year.
D. Inventory is comprised of precious stones.
62. When planning an audit, an auditor should:
A. Consider whether the extent of substantive procedures may be reduced based on the results
of the internal control questionnaire.
B. Make preliminary judgments about materiality levels for audit purposes.
C. Conclude whether changes in compliance with prescribed control procedures justifies reliance
on them.
D. Prepare a preliminary draft of the management representation letter.
63. An auditor who accepts an audit engagement and does not possess the industry expertise of the
business entity, should:
A. Engage financial experts familiar with the nature of the business entity.
B. Obtain a knowledge of matters that relate to the nature of the entity's business.
C. Refer a substantial portion of the audit to another CPA who will act as the principal auditor.
D. First inform management that an unqualified opinion cannot be issued.
6-13
64. With respect to the auditor's planning of a year-end audit, which of the following statements is
always true?
A. An engagement should not be accepted after the fiscal year-end.

B. An inventory count must be observed at the balance sheet date.
C. The client's audit committee should not be told of any specific audit procedures which will be
performed.
D. It is an acceptable practice to carry out parts of the examination at interim dates.
65. Hawkins requested permission to communicate with the predecessor auditor and review certain
portions of the predecessor auditor's working papers. The prospective client's refusal to permit
this will bear directly on Hawkins' decision concerning the:
A. Adequacy of the preplanned audit plan.

B. Ability to establish consistency in application of accounting principles between years.
C. Apparent scope limitation.
D. Integrity of management.
66. The auditor faces a risk that the audit will not detect material misstatements in the financial
statements. In regard to minimizing this risk, the auditor primarily relies on:
A. Substantive procedures.
B. Tests of controls.
C. Internal control.
D. Statistical analysis.
67. An abnormal fluctuation in gross profit that might suggest the need for extended audit procedures
for sales and inventories would most likely be identified in the risk assessment phase of the audit
by the use of:
A. Tests of transactions and balances.

B. An assessment of internal control.
C. An audit time budget.
D. Analytical procedures.
68. Before accepting an audit engagement, a successor auditor should make specific inquiries of the
predecessor auditor regarding the predecessor's:
A. Awareness of the consistency in the application of generally accepted accounting principles

between accounting periods.
B. Evaluation of all matters of continuing accounting significance.
C. Opinion of any subsequent events occurring since the predecessor's audit report was issued.
D. Understanding as to the reasons for the change of auditors.
6-14
69. Which of the following is least likely to be included in an auditor's inquiry of management while
obtaining information to identify the risks of material misstatement due to fraud?
A. Are all financial reporting operations at one location?

B. Does it have knowledge of fraud or suspect fraud?
C. Does it have programs to mitigate fraud risks?
D. Has it reported to the audit committee the nature of the company's internal control?
70. An auditor selects a sample from the file of shipping documents to determine whether invoices
were prepared. This test is performed to satisfy the audit objective of:
A. Accuracy.
B. Completeness.
C. Control.
D. Existence.
71.
Individuals who commit fraud are ordinarily able to rationalize the act and also have an:
Incentive Opportunity
A. Yes Yes
B. Yes No
C. No Yes
D. No No
A. Option A
B. Option B
C. Option C
D. Option D
72. PCAOB standards suggest which of the following when interpreting the federal securities laws
relating to materiality?
A. A material amount would significantly alter the "total mix" of information made available to an
investor.
B. Materiality cannot be used as a basis for interpreting federal securities laws.
C. A material amount is that at which an individual's decision would be changed.
D. Materiality is composed of quantitative and not qualitative aspects.
6-15
73. Which of the following is correct concerning the PCAOB's concept of a significant account?
A. It is the same as a relevant assertion.

B. The auditor need only consider significant accounts when controls do not operate effectively.
C. In deciding whether an account is a significant account one does not consider the effect of
internal control.
D. It is an account for which qualitative materiality considerations are particularly important.
Essay Questions
6-16
74. On September 3, 20X1, Larkin, CPA, was engaged to audit the financial statements of Precious
Metals Co. (PM), for the year ended October 31, 20X1. PM purchases precious metals at
wholesale prices and resells them to craft clubs at retail. PM is a new client whose common stock
was first offered to the public five years ago. PM received an unqualified opinion on its financial
statements in each of the prior three years, but changes auditors after each engagement. In
accepting the engagement, Larkin completed all of the appropriate client acceptance procedures.
Larkin instructed Johnson, an assistant on the engagement, to draft a planning checklist that
would assist Larkin in preparing the audit staff for the fieldwork that is scheduled to begin on
October 17, 20X1. On October 5, 20X1, Johnson prepared the planning checklist below
(engagement letter points have been omitted). Indicate the inappropriate points that are included
on Johnson's planning checklist.
I. Understanding the engagement

In planning the audit, have the engagement personnel considered:
1. PM’s accounting policies and procedures?
2. Financial statement items likely to require adjustment?
3. The nature of the reports expected to be rendered?
4. The effects of accounting and auditing pronouncements, particularly new ones?
5. Methods of audit sampling to be used?
6. Whether the method of sampling is likely to be approved by PM?
7. The extent of involvement of other independent auditors or internal auditors?
8. Procedures to evaluate competence and objectivity of PM’s internal auditors?
In planning the audit, have engaged personnel discussed:
The general scope and timing of the audit work with PM’s management, board of directors, or audit
9.
committee?
The risk of misstatement due to fraud for each assertion for each account with PM’s management,
10.
board of directors, and the audit committee?
II. Assigning personnel to the engagement

Has a time budget for the engagement been prepared to determine the staffing requirements and to
schedule the fieldwork, and has it been approved by:
11. The engagement partner?
12. PM’s controller and audit committee?
13. Has the engagement staffing schedule been approved by the engagement partner?
Have the following factors been considered:
14. Engagement size and complexity?
15. Personnel available?
16. Timing of the work to be performed?
17. Continuity and periodic rotation of personnel?
18. Need to restrict engagement to CPAs?
III. Knowledge of the entity’s business

Has an overall understanding of PM’s operations been obtained by reviewing:
19. Successor auditor’s working papers?
20. Financial statements and interim financial statements?
21. Minutes of stockholders’ and board of directors’ meetings?
22. Filings with regulatory agencies?
6-17
23. Recent management letters?
24. The Codification of Statements on Auditing Standards?
25. Economic conditions, government regulations, and specialist accounting practices?
26. Have engagement personnel obtained knowledge of PM’s organization and operating characteristics?
Have engagement personnel considered:
27. Factors affecting the risk of misstatements due to error or fraud?
28. Materiality?
29. Degree of understanding of internal control to plan the audit?
30. Methods that PM uses to process accounting information?
31. Whether their investments in PM stock are material?
IV. Assessing auditability

Has the adequacy of the accounting records been assessed for proper:
32. Descriptions of transactions to permit the appropriate financial statement classification?
33. Information about transactions to permit the recording of appropriate monetary amounts?
34. Recording of transactions in the appropriate accounting period?
Have the following factors regarding the integrity of management been considered in planning the audit:
Responses to previous inquiries of local attorneys, bankers, and other business leaders regarding PM’s
35.
standing in the community?
36. PM’s credit rating?
37. Have inquiries of a sample of PM’s customers regarding PM’s credit-granting policies been made?
V. Assessing risk
38. Has detection risk been appropriately restricted to determine how much inherent risk can be accepted?
Has consideration been given to permitting PM’s internal auditors to make the assessment of inherent
39.
risk and evaluations of significant accounting estimates?
If control risk is assessed at below the maximum level:
40. Is the audit fee high enough to handle any likely litigation?
Have specific internal control activities that are likely to prevent or detect material misstatements in
41.
those assertions been identified?
If control risk is assessed at the maximum level for some or all assertions:
42. Is the scope of substantive testing appropriately decreased?
43. Have tests of controls to evaluate the design and operation of such activities been performed?
VI. Illegal acts

Have the following matters been considered in assessing the risk that PM has not complied with laws and
regulations that have a direct and material effect on the financial statements:
44. PM’s policy relative to the prevention of illegal acts?
45. PM’s understanding of the requirements of laws and regulations pertinent to its business?
Obtaining management’s written assurance that no employees have committed any illegal acts of any
46.
type?
VII. Analytical procedures

In planning the audit, have analytical procedures been used that focus on:
Enhancing an understanding of PM’s business and the transactions and events of the year under
47.
audit?
6-18
48. Identifying areas that may represent specific risks relevant to the audit?
49. Evaluating the overall financial statement presentation?
VIII. Audit strategies and the audit plan

50. Has the program been developed for the engagement and approved by the engagement partner?
75. Engagement letters are used by most auditors in performing professional services.
a. Describe the purpose of an engagement letter.

b. List four items that are normally included in an engagement letter.
76. As a part of the planning process, auditors develop an audit strategy, an audit plan, and a time
budget.
a. Describe an audit strategy and explain its purpose.

b. Describe an audit plan and explain its purpose.
c. Describe a time budget and explain its purpose.
6-19
77. Auditors perform various tasks in planning an audit engagement. Provide an overall description of
how each task is performed and its purpose.
a. Obtain an understanding of the client's business.

b. Assess audit risk and materiality for the engagement.
c. Assess fraud risk.
d. Assess the risk of material misstatement of assertions about financial statement accounts and
classes of transactions.
78. Many auditors take an approach to assessing the risk of material misstatement by beginning with
an assessment of business risks.
a. Define business risks.

b. Why have auditors found it effective to take the approach of assessing business risks?
c. Identify a business risk and explain how it might affect the auditor's audit procedures.
6-20
Chapter 06 Audit Planning, Understanding the Client, Assessing Risks,
and Responding Answer Key
True / False Questions
1. Audit committees should be made up of the most qualified directors regardless of whether
they are part of management of the company.
FALSE
AACSB: Analytical Thinking

AICPA: BB Industry
AICPA: FN Measurement
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 06-02 Identify the factors that auditors consider in accepting new clients.
Topic: Obtaining Clients
2. Analytical procedures are seldom used during the risk assessment stage of an audit
engagement because they are substantive procedures.
FALSE

AICPA: BB Industry
AICPA: FN Risk Analysis
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 06-04 Describe the nature of the risk assessment procedures that auditors use to obtain an understanding
of the client and its environment.
Topic: Understanding Client and Environment
3. Preliminary arrangements with clients should be set forth in the management letter.
FALSE

AICPA: BB Industry
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 06-03 Explain the auditors' responsibilities when planning an audit.
Topic: Planning the Audit
6-21
4. An audit plan includes a detailed listing of the audit procedures to be performed in the
verification of items in the financial statements.
TRUE

AICPA: BB Industry
Blooms: Understand
5. The auditors' tests of controls are designed to substantiate the fairness of specific financial
statement accounts.
FALSE

AICPA: BB Industry
Blooms: Understand
Learning Objective: 06-01 Describe the major steps in the audit process.
Topic: Audit Process
6. At least a portion of the auditors' consideration of internal control usually is performed at an

interim date rather than at the balance sheet date.
TRUE

AICPA: BB Industry
Blooms: Understand
Learning Objective: 06-07 Discuss how the auditors design further audit procedures in response to the assessed risks of
material misstatement.
Topic: Assessing Risks and Designing Audit Procedures
7. The substantive approach to an audit is appropriate for many small businesses.
TRUE

AICPA: BB Industry
Blooms: Understand
Learning Objective: 06-08 Distinguish between the systems and the substantive procedures portions of the audit plan.
Topic: Audit Plan
6-22
8. Confirming a bank account establishes existence but not rights to the cash balance.
FALSE

AICPA: BB Industry
Blooms: Apply
Difficulty: 3 Hard
Topic: Audit Plan
9. The completeness of recording of assets is generally verified by tracing from the source
documents to the recorded entry.
TRUE

AICPA: BB Industry
Blooms: Apply
Difficulty: 3 Hard
Topic: Audit Plan
10. Vouching the acquisition of assets is an audit procedure that is often performed to establish
the valuation of the assets.
TRUE

AICPA: BB Industry
Blooms: Apply
Difficulty: 3 Hard
Multiple Choice Questions
6-23
11. Which of the following factors most likely would cause a CPA to not accept a new audit
engagement?
A. The prospective client has fired its prior auditor.

B. The CPA lacks a thorough understanding of the prospective client's operations and
industry.
C. The CPA is unable to review the predecessor auditor's working papers due to a major fire
that destroyed both hard and soft copy documentation.
D. The prospective client is unwilling to make financial records available to the CPA.

AICPA: BB Industry
Blooms: Understand
Source: AICPA
12. Which of the following factors most likely would heighten an auditor's concern about the risk of
fraudulent financial reporting?
A. Large amounts of liquid assets that are easily convertible into cash.
B. Low growth and profitability as compared to other entity's in the same industry.
C. Financial management's participation in the initial selection of accounting principles.
D. An overly complex organizational structure involving unusual lines of authority.

AICPA: BB Industry
Blooms: Apply
Difficulty: 3 Hard
Learning Objective: 06-06 Describe how the auditors address fraud risk.
Source: AICPA
13. Which of the following factors would most likely cause a CPA to decide not to accept a new
audit engagement?
A. Lack of understanding of the potential client's internal auditors' computer-assisted audit

techniques.
B. Management's disregard for internal control.
C. The existence of related party transactions.
D. Management's attempt to meet earnings per share growth rate goals.

AICPA: BB Industry
Blooms: Apply
Difficulty: 3 Hard
6-24
14. Which of the following matters is generally included in an auditor's engagement letter?
A. Limitations of the engagement.

B. Factors to be considered in establishing preliminary judgments about materiality.
C. Management's liability for all illegal acts committed by its employees.
D. The auditor's responsibility to obtain negative assurance relating to non-compliance with
laws and regulations.

AICPA: BB Industry
Blooms: Apply
Difficulty: 3 Hard
15. Which of the following would heighten an auditor's concern about the risk of fraudulent
financial reporting?
A. Inability to generate positive cash flows from operations, while reporting large increases in
earnings.
B. Management's lack of interest in increasing the dividend paid on common stock.
C. Large amounts of liquid assets that are easily convertible into cash.
D. Inability to borrow necessary capital without obtaining waivers on debt covenants.

AICPA: BB Industry
Blooms: Apply
Difficulty: 3 Hard
Source: AICPA
16. To best test existence, an auditor would sample from the:
A. General ledger to source documents.

B. General ledger to the financial statements.
C. Source documents to the general ledger.
D. Source documents to journals.

AICPA: BB Industry
Blooms: Understand
6-25
17. The auditors' understanding established with a client should be established through a(an):
A. Oral communication with the client.

B. Written communication with the client.
C. Written or oral communication with the client.
D. Completely detailed audit plan.
AICPA: BB Industry
Blooms: Remember
Difficulty: 1 Easy
18. Which of the following would be least likely to be considered an audit planning procedure?
A. Use an engagement letter.

B. Develop the overall audit strategy.
C. Perform the risk assessment.
D. Develop the audit plan.

AICPA: BB Industry
Blooms: Understand
19. While assessing the risks of material misstatement, auditors identify risks, relate risk to what
could go wrong, consider the magnitude of risks, and:
A. Assess the risk of misstatements due to illegal acts.

B. Consider the complexity of the transactions involved.
C. Consider the likelihood that the risks could result in material misstatements.
D. Determine materiality levels.

AICPA: BB Industry
Blooms: Understand
Learning Objective: 06-05 Describe the manner in which an audit is affected by the auditors' assessment of audit risk and
materiality.
6-26
20. Which of the following is correct concerning requirements about auditor communications about
fraud?
A. Fraud that involves senior management should be reported directly to the audit committee
regardless of the amount involved.
B. All fraud with a material effect on the financial statements should be reported directly by
the auditor to the Securities and Exchange Commission.
C. Fraud with a material effect on the financial statements should ordinarily be disclosed by
the auditor through use of an "emphasis of a matter" paragraph added to the audit report.
D. The auditor has no responsibility to disclose fraud outside the entity under any
circumstances.
AICPA: BB Industry
Blooms: Apply
Difficulty: 3 Hard
21.
A predecessor auditor will ordinarily initiate communication with the successor auditor:
A.
B.
C.
D.
A. Option A
B. Option B
C. Option C
D. Option D

AICPA: BB Industry
Blooms: Apply
Difficulty: 3 Hard
6-27
22.
Which measure of materiality (or both) considers quantitative considerations?
Planning Evaluation
A. Yes Yes
B. Yes No
C. No Yes
D. No No
A. Option A
B. Option B
C. Option C
D. Option D
AICPA: BB Industry
Blooms: Understand
23. Which of the following factors most likely would lead a CPA to conclude that a potential audit
engagement should not be accepted?
A. There are significant related party transactions that management claims occurred in the
ordinary course of business.
B. Internal control activities requiring the segregation of duties are subject to management
override.
C. Management continues to employ an inefficient system of information technology to record
financial transactions.
D. It is unlikely that sufficient evidence is available to support an opinion on the financial
statements.

AICPA: BB Industry
Blooms: Understand
Source: AICPA
6-28
24. In using the information on the statement of cash flows while obtaining an understanding of a
profitable, growing company, which of the following would ordinarily be least surprising to an
auditor?
A. Decreases in accounts payable.

B. Decreases in accounts receivable.
C. Negative cash flows from investing.
D. Negative operating cash flows.

AICPA: BB Industry
Blooms: Apply
Difficulty: 3 Hard
25.
Audits of financial statements are designed to obtain reasonable assurance of detecting
material misstatements due to:
Errors Misappropriation of Assets

A. Yes Yes
B. Yes No
C. No Yes
D. No No
A. Option A
B. Option B
C. Option C
D. Option D
AICPA: BB Industry
Blooms: Understand
materiality.
6-29
26. Which of the following is not one of the assertions made by management about an account
balance?
A. Relevance.
B. Existence.
C. Valuation.
D. Rights and obligations.

AICPA: BB Industry
Blooms: Remember
Difficulty: 1 Easy
materiality.
27. When a company has changed auditors, according to the Professional Standards:
A. The successor auditor has the responsibility to initiate contact with the predecessor auditor
to ask about the client before the engagement is accepted; the predecessor has no
responsibility to initiate this contact, even when aware of matters bearing on the integrity of
management.
B. The predecessor must always respond fully to all inquiries made by the successor auditor.
C. The successor must discuss with the predecessor matters bearing on the engagement
prior to accepting the engagement.
D. The successor may choose not to attempt any communication with the predecessor
auditor.

AICPA: BB Industry
Blooms: Apply
Difficulty: 3 Hard
28. Which of the following procedures is not performed as a part of planning an audit
engagement?
A. Reviewing the working papers of the prior year.

B. Developing an overall audit strategy.
C. Confirmation of all major accounts.
D. Designing an audit plan.

AICPA: BB Industry
Blooms: Understand
6-30
29. The risk of a material misstatement occurring in an account, assuming an absence of internal
control, is referred to as:
A. Account risk.
B. Control risk.
C. Detection risk.
D. Inherent risk.

AICPA: BB Industry
Blooms: Understand
30. Which of the following is least likely to be considered a financial statement audit risk factor?
A. Management operating and financing decisions are dominated by top management.

B. A new client with no prior audit history.
C. Rate of change in the entity's industry is rapid.
D. Profitability of the entity relative to its industry is inconsistent.
AICPA: BB Industry
Blooms: Apply
Difficulty: 3 Hard
materiality.
31. Which of the following is an example of fraudulent financial reporting?
A. Company management falsifies inventory count tags thereby overstating ending inventory
and understating cost of goods sold.
B. An employee diverts customer payments to his personal use, concealing his actions by
debiting an expense account, thus overstating expenses.
C. An employee steals inventory and the "shrinkage" is recorded in cost of goods sold.
D. An employee "borrows" tools from the company and neglects to return them; the cost is
reported as a miscellaneous operating expense.

AICPA: BB Industry
Blooms: Understand
6-31
32. Which of the following is most likely to be considered a risk factor relating to fraudulent
financial reporting?
A. Low turnover of senior management.

B. Extreme degree of competition within the industry.
C. Capital structure including various operating subsidiaries.
D. Sales goals in excess of any of the preceding three years.

AICPA: BB Industry
Blooms: Apply
Difficulty: 3 Hard
33. Which of the following conditions identified during the audit increases the risk of employee
fraud?
A. Large amounts of cash in the bank.

B. Existence of a mandatory vacation policy for employees performing key functions.
C. Inventory items of small size, but high value.
D. Presence of reconciling items on a client prepared year-end proof of cash.
AICPA: BB Industry
Blooms: Understand
34. Which of the following statements is accurate about "fraud risk factors" considered when
conducting an audit?
A. Factors whose presence indicates that fraud exists.

B. Factors whose presence often have been observed in circumstances where frauds have
occurred.
C. Factors whose presence will require modification to planned audit procedures.
D. Factors obtained during the audit which lead to required communications with the audit
committee.

AICPA: BB Industry
Blooms: Apply
Difficulty: 3 Hard
6-32
35. Which of the following is not an example of a likely adjustment in the auditors' overall audit
approach when significant risk is found to exist?
A. Apply increased professional skepticism about material transactions.

B. Increase the assessed level of detection risk.
C. Assign personnel with particular skill to areas of high risk.
D. Obtain increased evidence about the appropriateness of management's selection of
accounting principles.

AICPA: BB Industry
Blooms: Understand
36. Which of the following is least likely to be required on an audit?
A. Evaluate the business rationale for significant, unusual transactions.

B. Make a legal determination of whether fraud has occurred.
C. Review accounting estimates for biases.
D. Test appropriateness of journal entries and adjustments.
AICPA: BB Industry
Blooms: Understand
6-33
37. Which of the following is (are) considered a further audit procedure(s) that may be designed
after assessing the risks of material misstatement?
Substantive Tests of Details Substantive Analytical Procedures

A. Yes Yes
B. Yes No
C. No Yes
D. No No
A. Option A
B. Option B
C. Option C
D. Option D

AICPA: BB Industry
Blooms: Remember
Difficulty: 1 Easy
Topic: Audit Plan
38. Which of the following circumstances would an auditor most likely consider a risk factor
relating to misstatements arising from fraudulent financial reporting?
A. Several members of management have recently purchased additional shares of the entity's
stock.
B. Several members of the board of directors have recently sold shares of the entity's stock.
C. The entity distributes financial forecasts to financial analysts that predict conservative
operating results.
D. Management is interested in maintaining the entity's earnings trend by using aggressive
accounting practices.

AICPA: BB Industry
Blooms: Understand
Source: AICPA
6-34
39. A successor auditor is required to attempt communication with the predecessor auditor prior
to:
A. Performing test of controls.

B. Testing beginning balances for the current year.
C. Making a proposal for the audit engagement.
D. Accepting the engagement.

AICPA: BB Industry
Blooms: Understand
Source: AICPA
40. If the business environment is experiencing a recession, the auditor most likely would focus
increased attention on which of the following accounts?
A. Purchase returns and allowances.

B. Allowance for doubtful accounts.
C. Common stock.
D. Noncontrolling interest of a subsidiary purchased during the year.
AICPA: BB Industry
Blooms: Apply
Difficulty: 3 Hard
Source: AICPA
Topic: Audit Plan
41. The risk that the auditors' procedures will lead them to conclude that a material misstatement
does not exist in an account balance when in fact such a misstatement does exist is referred
to as:
A. Account risk.
B. Control risk.
C. Detection risk.
D. Inherent risk.
AICPA: BB Industry
Blooms: Understand
6-35
42. Which of the following statements is correct regarding the auditor's determination of
materiality?
A. The planning level of materiality should normally be the larger of the amount considered for
the balance sheet versus the income statement.
B. The auditors' planning level of materiality may be disaggregated into smaller "tolerable
misstatements" for the various accounts.
C. Auditors may use various rules of thumb to arrive at an evaluation level of materiality, but
not for determining the planning level of materiality.
D. The amount used for the planning should equal that used for evaluation.
AICPA: BB Industry
Blooms: Apply
Difficulty: 3 Hard
43. The auditors must consider materiality in planning an audit engagement. Materiality for
planning purposes is:
A. The auditors' preliminary estimate of the largest amount of misstatement that would be
B. The auditors' preliminary estimate of the smallest amount of misstatement that would be
C. The auditors' preliminary estimate of the amount of misstatement that would be material to
the client's balance sheet.
D. An amount that cannot be quantitatively stated since it depends on the nature of the item.

AICPA: BB Industry
Blooms: Understand
6-36
44. Which of the following topics is not normally included in an engagement letter?
A. The auditors' preliminary assessment of internal control.

B. The auditors' estimate of the fee for the engagement.
C. Limitations on the scope of the engagement.
D. A description of responsibility for the detection of fraud.
AICPA: BB Industry
Blooms: Apply
Difficulty: 3 Hard
45. Which of the following is most likely to be an overall response to fraud risks identified in an
audit?
A. Only use certified public accountants on the engagement.

B. Place increased emphasis on the audit of objective transactions rather than subjective
transactions.
C. Supervise members of the audit team less closely and rely more upon judgment.
D. Use less predictable audit procedures.

AICPA: BB Industry
Blooms: Apply
Difficulty: 3 Hard
materiality.
46. Which of the following is not an assertion that is made in the financial statements by
management concerning each major account balance?
A. Completeness.
B. Rights and obligations.
C. Legality.
D. Valuation.

AICPA: BB Industry
Blooms: Remember
Difficulty: 1 Easy
materiality.
6-37
47. Tests for unrecorded assets typically involve tracing from:
A. Source documents to recorded journal entries.

B. Source documents to observations.
C. Recorded journal entries to documents.
D. Recorded journal entries to observations.
AICPA: BB Industry
Blooms: Apply
Difficulty: 3 Hard
48. Tracing from source documents forward to ledgers is most likely to address which assertion
related to posted entries?
A. Completeness.
B. Existence.
C. Rights.
D. Valuation.

AICPA: BB Industry
Blooms: Apply
Difficulty: 3 Hard
49. Determining that receivables are presented at net realizable value is most directly related to
which management assertion?
A. Existence.
B. Rights.
C. Valuation.
D. Presentation and disclosure.
AICPA: BB Industry
Blooms: Understand
materiality.
6-38
50. Which of the following is not a general objective for the audit of asset accounts?
A. Establishing existence of assets.

B. Establishing proper valuation of assets.
C. Establishing proper liabilities relating to assets.
D. Establishing the completeness of assets.
AICPA: BB Industry
Blooms: Understand
Topic: Audit Plan
51. Which of the following is not used by auditors to establish the completeness of recorded
assets?
A. Assessing control risk.

B. Tracing from source documents to entries in the accounting records.
C. Performing analytical procedures.
D. Vouching transactions.
AICPA: BB Industry
Blooms: Apply
Difficulty: 3 Hard
52. To test for unsupported entries in the journals, the direction of audit testing should be to the:
A. Ledger entries.
B. Journal entries.
C. Original source documents.
D. Financial statements.
AICPA: BB Industry
Blooms: Apply
Difficulty: 3 Hard
6-39
53. A form filed with the SEC when a company changes auditors is a:
A. Form 8-K.
B. Form 10-K.
C. Form S-1.
D. Form B-1.
AICPA: BB Industry
Blooms: Understand
54. Which of the following is least likely to render a quantitatively small misstatement material?
A. Affects the registrant's compliance with regulatory requirements.

B. Masks a change in earnings or other trends.
C. Arises from an item not capable of precise measurement.
D. The transaction involves a related party.

AICPA: BB Industry
Blooms: Apply
Difficulty: 3 Hard
materiality.
55. Which of the following is not a required source of information for the auditors' assessment of
fraud risk?
A. Discussion among audit team members.

B. Fraud risk factors.
C. Results of tests of controls.
D. Inquiry of management and others.
AICPA: BB Industry
Blooms: Understand
materiality.
6-40
56. Auditors must assess fraud risk on every audit and respond to the risks that are identified.
Which of the following is not a procedure required to further address the fraud risk of
management override of internal control?
A. Reviewing accounting estimates for biases.

B. Examining physical controls over assets.
C. Evaluating the business rationale for significant unusual transactions.
D. Examining journal entries and other adjustments for evidence of fraud.

AICPA: BB Industry
Blooms: Understand
materiality.
57. Preliminary arrangements agreed to by the auditors and the client should be reduced to writing
by the auditors. The best place to set forth these arrangements is in:
A. A memorandum to be placed in the permanent section of the auditing working papers.

B. An engagement letter.
C. A client representation letter.
D. A confirmation letter attached to the constructive services letter.

AICPA: BB Industry
Blooms: Remember
Difficulty: 1 Easy
Source: AICPA
58. The auditors are planning an audit engagement for a new client in a business that is unfamiliar
to the auditors. Which of the following would be the most useful source of information for the
auditors during the preliminary planning stage when they are trying to obtain a general
understanding of audit problems that might be encountered?
A. Client manuals of accounts and charts of accounts.

B. AICPA Industry Audit Guides.
C. Prior-year working papers of the predecessor auditors.
D. Latest annual and interim financial statements issued by the client.
AICPA: BB Industry
Blooms: Apply
Difficulty: 3 Hard
Source: AICPA
6-41
59. The auditors will not ordinarily initiate discussion with the audit committee concerning the:
A. Extent to which the work of internal auditors will influence the scope of the examination.
B. Extent to which change in the company's organization will influence the scope of the
examination.
C. Details of potential problems which the auditors believe might cause a qualified opinion.
D. Details of the procedures which the auditors intend to apply.

AICPA: BB Industry
Blooms: Apply
Difficulty: 3 Hard
Source: AICPA
60. Which statement is correct relating to a potential successor auditor's responsibility for
communicating with the predecessor auditors in connection with a prospective new audit
client?
A. The successor auditors have no responsibility to contact the predecessor auditors.

B. The successor auditors should obtain permission from the prospective client to contact the
predecessor auditors.
C. The successor auditors should contact the predecessors regardless of whether the
prospective client authorizes contact.
D. The successor auditors need not contact the predecessors if the successors are aware of
all available relevant facts.

AICPA: BB Industry
Blooms: Understand
Source: AICPA
6-42
61. Which of the following situations would most likely require special audit planning by the
auditors?
A. Some items of factory and office equipment do not bear identification numbers.
B. Depreciation methods used on the client's tax return differ from those used on the books.
C. Assets costing less than $500 are expensed even though the expected life exceeds one
year.
D. Inventory is comprised of precious stones.

AICPA: BB Industry
Blooms: Understand
Source: AICPA
62. When planning an audit, an auditor should:
A. Consider whether the extent of substantive procedures may be reduced based on the
results of the internal control questionnaire.
B. Make preliminary judgments about materiality levels for audit purposes.
C. Conclude whether changes in compliance with prescribed control procedures justifies
reliance on them.
D. Prepare a preliminary draft of the management representation letter.

AICPA: BB Industry
Blooms: Understand
Source: AICPA
63. An auditor who accepts an audit engagement and does not possess the industry expertise of
the business entity, should:
A. Engage financial experts familiar with the nature of the business entity.
B. Obtain a knowledge of matters that relate to the nature of the entity's business.
C. Refer a substantial portion of the audit to another CPA who will act as the principal auditor.
D. First inform management that an unqualified opinion cannot be issued.
AICPA: BB Industry
Blooms: Understand
Source: AICPA
6-43
64. With respect to the auditor's planning of a year-end audit, which of the following statements is
always true?
A. An engagement should not be accepted after the fiscal year-end.

B. An inventory count must be observed at the balance sheet date.
C. The client's audit committee should not be told of any specific audit procedures which will
be performed.
D. It is an acceptable practice to carry out parts of the examination at interim dates.

AICPA: BB Industry
Blooms: Understand
Source: AICPA
65. Hawkins requested permission to communicate with the predecessor auditor and review
certain portions of the predecessor auditor's working papers. The prospective client's refusal to
permit this will bear directly on Hawkins' decision concerning the:
A. Adequacy of the preplanned audit plan.

B. Ability to establish consistency in application of accounting principles between years.
C. Apparent scope limitation.
D. Integrity of management.

AICPA: BB Industry
Blooms: Understand
Source: AICPA
66. The auditor faces a risk that the audit will not detect material misstatements in the financial
statements. In regard to minimizing this risk, the auditor primarily relies on:
A. Substantive procedures.
B. Tests of controls.
C. Internal control.
D. Statistical analysis.
AICPA: BB Industry
Blooms: Remember
Difficulty: 1 Easy
Source: AICPA
Topic: Audit Plan
6-44
67. An abnormal fluctuation in gross profit that might suggest the need for extended audit
procedures for sales and inventories would most likely be identified in the risk assessment
phase of the audit by the use of:
A. Tests of transactions and balances.

B. An assessment of internal control.
C. An audit time budget.
D. Analytical procedures.

AICPA: BB Industry
Blooms: Understand
Source: AICPA
68. Before accepting an audit engagement, a successor auditor should make specific inquiries of
the predecessor auditor regarding the predecessor's:
A. Awareness of the consistency in the application of generally accepted accounting

principles between accounting periods.
B. Evaluation of all matters of continuing accounting significance.
C. Opinion of any subsequent events occurring since the predecessor's audit report was
issued.
D. Understanding as to the reasons for the change of auditors.

AICPA: BB Industry
Blooms: Understand
Source: AICPA
69. Which of the following is least likely to be included in an auditor's inquiry of management while
obtaining information to identify the risks of material misstatement due to fraud?
A. Are all financial reporting operations at one location?

B. Does it have knowledge of fraud or suspect fraud?
C. Does it have programs to mitigate fraud risks?
D. Has it reported to the audit committee the nature of the company's internal control?
AICPA: BB Industry
Blooms: Apply
Difficulty: 3 Hard
6-45
70. An auditor selects a sample from the file of shipping documents to determine whether invoices
were prepared. This test is performed to satisfy the audit objective of:
A. Accuracy.
B. Completeness.
C. Control.
D. Existence.

AICPA: BB Industry
Blooms: Apply
Difficulty: 3 Hard
Source: AICPA
71.
Individuals who commit fraud are ordinarily able to rationalize the act and also have an:
Incentive Opportunity
A. Yes Yes
B. Yes No
C. No Yes
D. No No
A. Option A
B. Option B
C. Option C
D. Option D
AICPA: BB Industry
Blooms: Remember
Difficulty: 1 Easy
6-46
72. PCAOB standards suggest which of the following when interpreting the federal securities laws
relating to materiality?
A. A material amount would significantly alter the "total mix" of information made available to
an investor.
B. Materiality cannot be used as a basis for interpreting federal securities laws.
C. A material amount is that at which an individual's decision would be changed.
D. Materiality is composed of quantitative and not qualitative aspects.

AICPA: BB Industry
Blooms: Understand
73. Which of the following is correct concerning the PCAOB's concept of a significant account?
A. It is the same as a relevant assertion.

B. The auditor need only consider significant accounts when controls do not operate
effectively.
C. In deciding whether an account is a significant account one does not consider the effect of
internal control.
D. It is an account for which qualitative materiality considerations are particularly important.

AICPA: BB Industry
Blooms: Apply
Difficulty: 3 Hard
materiality.
Essay Questions
6-47
74. On September 3, 20X1, Larkin, CPA, was engaged to audit the financial statements of
Precious Metals Co. (PM), for the year ended October 31, 20X1. PM purchases precious
metals at wholesale prices and resells them to craft clubs at retail. PM is a new client whose
common stock was first offered to the public five years ago. PM received an unqualified
opinion on its financial statements in each of the prior three years, but changes auditors after
each engagement. In accepting the engagement, Larkin completed all of the appropriate client
acceptance procedures.
Larkin instructed Johnson, an assistant on the engagement, to draft a planning checklist that
would assist Larkin in preparing the audit staff for the fieldwork that is scheduled to begin on
October 17, 20X1. On October 5, 20X1, Johnson prepared the planning checklist below
(engagement letter points have been omitted). Indicate the inappropriate points that are
included on Johnson's planning checklist.
I. Understanding the engagement

In planning the audit, have the engagement personnel considered:
1. PM’s accounting policies and procedures?
2. Financial statement items likely to require adjustment?
3. The nature of the reports expected to be rendered?
4. The effects of accounting and auditing pronouncements, particularly new ones?
5. Methods of audit sampling to be used?
6. Whether the method of sampling is likely to be approved by PM?
7. The extent of involvement of other independent auditors or internal auditors?
8. Procedures to evaluate competence and objectivity of PM’s internal auditors?
In planning the audit, have engaged personnel discussed:
The general scope and timing of the audit work with PM’s management, board of directors, or audit
9.
committee?
The risk of misstatement due to fraud for each assertion for each account with PM’s management,
10.
board of directors, and the audit committee?
II. Assigning personnel to the engagement

Has a time budget for the engagement been prepared to determine the staffing requirements and to
schedule the fieldwork, and has it been approved by:
11. The engagement partner?
12. PM’s controller and audit committee?
13. Has the engagement staffing schedule been approved by the engagement partner?
Have the following factors been considered:
14. Engagement size and complexity?
15. Personnel available?
16. Timing of the work to be performed?
17. Continuity and periodic rotation of personnel?
18. Need to restrict engagement to CPAs?
III. Knowledge of the entity’s business

Has an overall understanding of PM’s operations been obtained by reviewing:
19. Successor auditor’s working papers?
20. Financial statements and interim financial statements?
21. Minutes of stockholders’ and board of directors’ meetings?
6-48
22. Filings with regulatory agencies?
23. Recent management letters?
24. The Codification of Statements on Auditing Standards?
25. Economic conditions, government regulations, and specialist accounting practices?
Have engagement personnel obtained knowledge of PM’s organization and operating
26.
characteristics?
Have engagement personnel considered:
27. Factors affecting the risk of misstatements due to error or fraud?
28. Materiality?
29. Degree of understanding of internal control to plan the audit?
30. Methods that PM uses to process accounting information?
31. Whether their investments in PM stock are material?
IV. Assessing auditability

Has the adequacy of the accounting records been assessed for proper:
32. Descriptions of transactions to permit the appropriate financial statement classification?
33. Information about transactions to permit the recording of appropriate monetary amounts?
34. Recording of transactions in the appropriate accounting period?
Have the following factors regarding the integrity of management been considered in planning the audit:
Responses to previous inquiries of local attorneys, bankers, and other business leaders regarding
35.
PM’s standing in the community?
36. PM’s credit rating?
37. Have inquiries of a sample of PM’s customers regarding PM’s credit-granting policies been made?
V. Assessing risk
Has detection risk been appropriately restricted to determine how much inherent risk can be
38.
accepted?
Has consideration been given to permitting PM’s internal auditors to make the assessment of
39.
inherent risk and evaluations of significant accounting estimates?
If control risk is assessed at below the maximum level:
40. Is the audit fee high enough to handle any likely litigation?
Have specific internal control activities that are likely to prevent or detect material misstatements in
41.
those assertions been identified?
If control risk is assessed at the maximum level for some or all assertions:
42. Is the scope of substantive testing appropriately decreased?
43. Have tests of controls to evaluate the design and operation of such activities been performed?
VI. Illegal acts

Have the following matters been considered in assessing the risk that PM has not complied with laws
and regulations that have a direct and material effect on the financial statements:
44. PM’s policy relative to the prevention of illegal acts?
45. PM’s understanding of the requirements of laws and regulations pertinent to its business?
Obtaining management’s written assurance that no employees have committed any illegal acts of
46.
any type?
VII. Analytical procedures
6-49
In planning the audit, have analytical procedures been used that focus on:
Enhancing an understanding of PM’s business and the transactions and events of the year under
47.
audit?
48. Identifying areas that may represent specific risks relevant to the audit?
49. Evaluating the overall financial statement presentation?
VIII. Audit strategies and the audit plan

50. Has the program been developed for the engagement and approved by the engagement partner?
The following are inappropriate points:
6. The client should not be asked to approve the sampling method.

10. Although discussions with management, the board of directors, and the audit committee
will be held on fraud, the details at the assertion level for each account will not ordinarily be
discussed. The professional standards do require that members of the audit team discuss the
potential for material misstatement due to fraud either during planning or in conjunction with
the information-gathering procedures related to fraud subsequent to planning.
12. The controller and audit committee should not approve the time budget.
18. There is ordinarily no reason to restrict an engagement to CPAs.
19. A review of the predecessor auditor's working papers might be appropriate—not the
successor (Larkin CPA).
24. SAS do not provide guidance on PM's operations. Larkin will use PCAOB Auditing
Standards to conduct the engagement.
31. Engagement personnel should have no investments in PM stock.
37. Customers are not ordinarily consulted concerning credit-granting policies.
38. Inherent and control risk are more conventionally assessed so as to determine the
appropriate level of detection risk.
39. Internal auditors do not make judgment about the assessment of inherent risk and
evaluation of estimates.
40. Such a litigation concern is not appropriate in this document.
42. One does not expect a decrease in the scope of substantive testing when control risk is
assessed at the maximum level.
43. Tests of controls are not ordinarily performed when a plan exists to assess control risk at
the maximum level. Tests of controls are not performed when a substantive approach is
employed to conduct the engagement.
46. Management need not attempt to determine whether employees have committed illegal
acts of any type.
49. Evaluating overall financial statement presentation is not ordinarily an objective of
analytical procedures.

AICPA: BB Industry
Blooms: Apply
Difficulty: 3 Hard
Source: AICPA
6-50
75. Engagement letters are used by most auditors in performing professional services.
a. Describe the purpose of an engagement letter.

b. List four items that are normally included in an engagement letter.
a. The purpose of an engagement letter is to establish a written contract between the auditors
and the client. Thus, the letter tends to prevent misunderstandings between those two parties.
b. Items that are normally included in an engagement letter include (only four required):
• Name of the entity and statements to be examined.

• Scope of services.
• Description of responsibility for detecting fraud.
• Obligations of the client's staff to prepare schedules.
• Fee or method of determining fee.
• Provision for client's acceptance signature.
• Management's obligation to conclude about the materiality of misstatements not recorded.

AICPA: BB Industry
Blooms: Understand
6-51
76. As a part of the planning process, auditors develop an audit strategy, an audit plan, and a time
budget.
a. Describe an audit strategy and explain its purpose.

b. Describe an audit plan and explain its purpose.
c. Describe a time budget and explain its purpose.
a. The overall audit strategy involves determining the characteristics of the engagement that
define its scope, determining the engagement's reporting objectives to plan the timing of
procedures, and considering important factors that will determine the focus of the audit team's
efforts.
b. The audit plan is a written or electronic document that includes the nature, timing, and
extent of audit procedures to be performed by the audit team members in order to obtain
sufficient audit evidence. It includes planned risk assessment procedures, planned further
audit procedures, and other necessary audit procedures. It is also used as a tool for
scheduling and controlling the work.
c. The time budget includes an estimate of the time required for each audit task. It serves as a
basis for the fee estimate, controls the audit work, and may be used to evaluate performance
by the audit staff.

AICPA: BB Industry
Blooms: Understand
6-52
77. Auditors perform various tasks in planning an audit engagement. Provide an overall
description of how each task is performed and its purpose.
a. Obtain an understanding of the client's business.

b. Assess audit risk and materiality for the engagement.
c. Assess fraud risk.
d. Assess the risk of material misstatement of assertions about financial statement accounts
and classes of transactions.
a. The auditors obtain an understanding of the client's business through procedures such as
inquiry of client personnel, observing client operations, studying AICPA Audit and Accounting
Guides and Industry Risk Alerts and other industry publications, and reviewing prior annual
reports, SEC filings, tax returns, and interim financial statements. An understanding of the
client's business is necessary to the evaluation of the appropriateness of the client's
transactions, accounting principles used, and the estimates and assumptions embodied in the
financial statements. In addition, it provides part of the information to assess the risks of
b. Audit risk is the possibility that the auditors will fail to modify the opinion on financial
statements that are materially misstated. The auditors assess this risk by considering
characteristics of management, operations, and the engagement. Materiality for planning
purposes is the auditors' preliminary estimate of the smallest amount of misstatement that
would affect the decisions of reasonable users of the financial statements. The auditors use
judgment to determine the amount of planning materiality, usually based on some rule of
thumb.
Audit risk and materiality determine the overall scope of the engagement. The lower the
amount of planning materiality, the more extensive the scope of the audit. The higher the risk
of misstatement of the financial statements, the more extensive the scope of the audit.
c. The auditors are required to assess fraud risk on every audit. This assessment is based on
information derived from: (1) the discussion among the audit staff about the risk of fraud; (2)
inquiries of management, the audit committee, internal auditors, and others; (3) the results of
risk assessment analytical procedures, and consideration of fraud risk factors. If the auditors
identify fraud risks they may respond with: (1) an overall response to the way the audit is
conducted or (2) a response specifically to address the identified risk. In all audits, they must
include responses to further address the risk of management override of internal control.
d. The auditors assess the risk of material misstatement (composed of inherent risk and
control risk) for each significant assertion about financial statement accounts and classes of
assertions by considering the information about the client and its environment including
internal control, and the nature of the account. These risk assessments are used to determine
the nature, timing, and extent of the substantive procedures that will reduce the detection risk
to the appropriate level.
6-53
AICPA: BB Industry
Blooms: Apply
Difficulty: 3 Hard
materiality.
78. Many auditors take an approach to assessing the risk of material misstatement by beginning
with an assessment of business risks.
a. Define business risks.

b. Why have auditors found it effective to take the approach of assessing business risks?
c. Identify a business risk and explain how it might affect the auditor's audit procedures.
a. Business risks are those that threaten management's ability to achieve the organization's
objectives.
b. Auditors have found this approach effective because significant business risks often create
related risks of material misstatement (inherent risks) that the auditors should address in
designing their audit procedures.
c. Students may provide a number of examples. The textbook provides the following:
Assume that the auditors have identified as a significant business risk and audit risk that sales
personnel, informally or through written side agreements, may be modifying the terms of
contracts with customers which may affect the amount of revenue that should be recognized.
The auditors must design tests that are focused on determining whether such modifications of
terms have been made, perhaps by obtaining tailored confirmations from customers about the
existence of such side agreements.

AICPA: BB Industry
Blooms: Understand
6-54

Principles of Auditing and Other Assurance Services 20th Edition Whittington Test Bank 1

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Principles of Auditing and Other Assurance Services 20th Edition Whittington Test Bank 1

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Solution Manual for Principles of Auditing and Other

Assurance Services 20th Edition Whittington Pany

Audit Planning, Understanding the Client, Assessing Risks, and

True / False Questions

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

Multiple Choice Questions

A. The prospective client has fired its prior auditor.

A. Lack of understanding of the potential client's internal auditors' computer-assisted audit

A. Limitations of the engagement.

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

A. General ledger to source documents.

A. Oral communication with the client.

A. Use an engagement letter.

A. Assess the risk of misstatements due to illegal acts.

Prior to the Successor’s Subsequent to

A. Decreases in accounts payable.

Errors Misappropriation of Assets

A. Reviewing the working papers of the prior year.

A. Management operating and financing decisions are dominated by top management.

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

A. Low turnover of senior management.

A. Large amounts of cash in the bank.

A. Factors whose presence indicates that fraud exists.

A. Apply increased professional skepticism about material transactions.

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

A. Evaluate the business rationale for significant, unusual transactions.

Substantive Tests of Details Substantive Analytical Procedures

A. Performing test of controls.

A. Purchase returns and allowances.

A. The auditors' preliminary assessment of internal control.

A. Only use certified public accountants on the engagement.

47. Tests for unrecorded assets typically involve tracing from:

A. Source documents to recorded journal entries.

A. Establishing existence of assets.

A. Assessing control risk.

A. Affects the registrant's compliance with regulatory requirements.

A. Discussion among audit team members.

A. Reviewing accounting estimates for biases.

A. A memorandum to be placed in the permanent section of the auditing working papers.

A. Client manuals of accounts and charts of accounts.

A. The successor auditors have no responsibility to contact the predecessor auditors.

62. When planning an audit, an auditor should:

A. An engagement should not be accepted after the fiscal year-end.

A. Adequacy of the preplanned audit plan.

A. Tests of transactions and balances.

A. Awareness of the consistency in the application of generally accepted accounting principles

A. Are all financial reporting operations at one location?

A. It is the same as a relevant assertion.

I. Understanding the engagement

II. Assigning personnel to the engagement

III. Knowledge of the entity’s business

IV. Assessing auditability

VI. Illegal acts

VII. Analytical procedures

VIII. Audit strategies and the audit plan

a. Describe the purpose of an engagement letter.

a. Describe an audit strategy and explain its purpose.

a. Obtain an understanding of the client's business.

a. Define business risks.

True / False Questions

AACSB: Analytical Thinking

AACSB: Analytical Thinking

AACSB: Analytical Thinking

AACSB: Analytical Thinking