Which of the following statements is true regarding communications between predecessor and successor auditors?

A measure of how willing the auditor is to accept that the financial statements may be materially misstated after the audit is completed and an unqualified opinion has been issued is the

A) inherent risk.

B) acceptable audit risk.

C) statistical risk.

D) financial risk.

The first phase in planning an audit and designing an audit approach is to

A) accept the client and perform initial audit planning.

B) set the preliminary judgment of materiality.

C) understand the client's business and industry.

D) perform preliminary audit procedures.

_______ is the risk that the financial statements contain a material misstatement due to fraud or error prior to the audit.

A) Inherent risk

B) Client business risk

C) Acceptable audit risk

D) Risk of material misstatement

In what order should the following steps occur?

A.  Set preliminary judgment of materiality and performance materiality.

B.  Understand the clients business and industry.

C.  Perform preliminary analytical procedures.

D.  Accept the client and perform initial audit planning.

A) D, B, C, A

B) B, A, C, D

C) B, D, A, C

D) D, C, B, A

The auditor uses knowledge gained from the understanding of the client's business and industry to assess

A) client business risk.

B) control risk.

C) inherent risk.

D) audit risk.

When an auditor sets a low acceptable audit risk, it means that he wants to be more certain that the financial statements are notmaterially misstated.

TRUE OR FALSE

As acceptable audit risk is decreased, the likely cost of conducting an audit increases.

TRUE OR FALSE

Assessing acceptable audit risk, client business risk, and risk of material misstatement helps determine the audit procedures that will be needed.

TRUE OR FALSE

A 100 % audit risk is complete certainty.

TRUE OR FALSE

Initial audit planning involves four matters. Which of the following is notone of these?

A) Develop an overall audit strategy.

B) Request that bank balances be confirmed.

C) Schedule engagement staff and audit specialists.

D) Identify the client's reason for the audit.

Smith, CPA, has requested permission to communicate with the predecessor auditor in order to review certain workpapers for high risk accounts for a new audit client. The new audit client's refusal to allow this communication to occur would impact Smith's decision concerning

A) the auditor's ability to design audit tests.

B) possible scope exception due to lack of access.

C) the desirability of accepting the prospective engagement.

D) violation of the GAAP rules concerning consistency and comparability of financial information.

When dealing with audit risk,

A) audit risk should not be a factor when determining if a new client should be accepted.

B) audits with a low acceptable audit risk generally result in lower audit fees.

C) if management of a company has a reputation of integrity, but is also known to take aggressive financial risks, the auditor should not accept the company as a new client.

D) if the auditor concludes that acceptable audit risk is low, but the client is still acceptable, the auditor may still accept the engagement but increase the fee proposed to the client.

A written understanding detailing what the auditor expects from the client in performing an audit will normally be expressed in the

A) management letter requested by the auditor.

B) engagement letter.

C) audit Plan.

D) audit Strategy for the client.

For public companies, the ________ is responsible for hiring the auditor as required by the Sarbanes-Oxley Act.

A) client's management

B) client's chief executive officer

C) client's chief financial officer

D) client's audit committee

Which of the following statements is true regarding communications between predecessor and successor auditors? 

A) The burden of initiating the communication rests with the predecessor.

B) The predecessor's response can be limited to stating that no information will be provided.

C) The predecessor should communicate with the successor only if the client is public.

D) The predecessor auditor of a public company does not need permission from the client before communicating with the successor auditor.

The purpose of an engagement letter is to

A) document the CPA firm's responsibility to external users of the audited financial statements.

B) document the terms of the engagement.

C) notify the audit staff of an upcoming engagement so that personnel scheduling can be facilitated.

D) emphasize management's responsibility for approving the audit program.

The written communication stating the auditor cannotguarantee that all acts of fraud will be discovered is found in the

A) engagement letter.

B) representation letter.

C) responsibility letter.

D) client letter.

Which of the following normally signs the engagement letter for an audit of a private company?

A) management

B) board of directors representative

C) audit committee representative

D) corporate treasurer

The two major factors affecting acceptable audit risk are

A) inherent risk and the intended uses of the financial statements.

B) control risk and the intended uses of the financial statements.

C) the likely statement users and their intended uses of the statements.

D) the audit firm and the intended uses of the statements

An engagement letter sent to a publicly held audit client usually would notinclude a(n)

A) reference to the auditor's responsibility for the detection of errors or irregularities.

B) estimation of the time to be spent on the audit work by audit staff and management.

C) statement that management advisory services would be made available upon request.

D) reference to management's responsibility for the financial statements.

The preliminary audit strategy

A) is set before the auditor understands the client's reasons for the audit.

B) guides the development of the audit plan.

C) is determined after the engagement staffing is set.

D) is the detailed steps to be followed for the substantive audit tests.

The purpose of the requirement in having communication between the predecessor and successor auditors is to

A) allow the predecessor to disclose information which would otherwise be confidential.

B) help the successor auditor to evaluate whether to accept the engagement.

C) help the client by facilitating the change of auditors.

D) ensure the predecessor collects all unpaid fees prior to a change in auditor.

The predecessor auditor is required to respond to the request of the successor auditor for information, but the response can be limited to stating that no information will be provided when

A) the predecessor auditor has poor relations with the successor auditor.

B) the client is dissatisfied with the predecessor's work.

C) there are actual or potential legal problems between the client and the predecessor.

D) the predecessor believes that the client lacks integrity.

Which of the following best expresses the understanding of the terms of the engagement that exist between the client and the CPA firm?

A) Management asserts there are no errors, material or immaterial, in the general ledger.

B) Auditors assert that the primary audit goal is audit efficiency.

C) Auditors assert that their primary responsibility is to plan and perform the audit in order to provide reasonable assurance as to the detection of material misstatement due to error or fraud.

D) Management asserts that they will provide the auditor with a risk assessment as to material misstatements due to errors or fraud in the company's financial statements.

When selecting staff for the audit engagement

A) only staff members who are CPAs should be assigned to the audit.

B) only managers and above need to have appropriate competence and capabilities to perform the audit.

C) continuity of staff members from year to year should not be a factor.

D) staff assigned to the audit must be knowledgeable about the client's industry.

When developing the overall strategy for the audit, the auditor will

A) decide whether to accept a new client.

B) determine if any audit specialists will be required.

C) identify why the auditor needs an audit.

D) obtain an engagement letter.

Before accepting a new client, most CPA firms investigate the company to determine its acceptability. However, AICPA confidentiality requirements prohibit CPA firms from contacting certain parties–namely the company's attorneys and bankers–during this investigation.

TRUE OR FALSE

For prospective clients that have previously been audited by another CPA firm, the predecessor auditor must initiate the communication with the successor auditor.

TRUE OR FALSE

When a successor auditor contacts a company's previous auditor, the predecessor auditor is required to respond fully and without limit to the request for information.

TRUE OR FALSE

A predecessor auditor who has been contacted by a successor auditor for information about the client does nothave to obtain permission from the former client before providing any confidential information to the successor auditor because the confidentiality requirement does notextend to former clients.

TRUE OR FALSE

An auditor must evaluate a specialist's professional qualifications and understand the objectives of the specialist's work.

TRUE OR FALSE

Because of audit risk, some CPA firms now refuse any new clients in certain high-risk industries.

TRUE OR FALSE

An engagement letter establishes a clear understanding of the terms of the engagement between the client and the auditor.

TRUE OR FALSE

Because auditors are responsible for having appropriate competence and capabilities to perform an audit, auditors are notnormally permitted to consult with outside specialists during an audit engagement.

TRUE OR FALSE

If a prospective client has been audited in the past, the successor auditor will typically rely solely on the representations about the client by the predecessor auditor.

TRUE OR FALSE

A major consideration in audit staffing is the need for continuity from year to year.

TRUE OR FALSE

When a successor auditor requests information from a company's previous auditor, and there are legal problems or disputes between the client and the predecessor auditor, the predecessor auditor's response to the new auditor may be limited to stating that no information will be provided.

TRUE OR FALSE

Staff assigned to an audit engagement must be knowledgeable about the client's industry.

TRUE OR FALSE

In order to obtain an understanding of the client's business, the audit firm will consider

A) inherent and control risk of the client.

B) audit risk to the CPA firm.

C) the client's business risk and the risk of material misstatements in the financial statements.

D) the CPA firm's potential ongoing revenue from the audit client.

Most auditors assess the risk of material misstatement as high for related parties and related-party transactions because

A) of the unique classification of related-party transactions required on the balance sheet.

B) of the lack of independence between the parties.

C) of the unique classification of related-party transactions required on the income statement.

D) it is required by generally accepted accounting principles.

A tour of the client's facilities provides the auditor an opportunity to 

A) meet key personnel.

B) observe operations.

C) assess physical safeguards over assets.

D) all of the above

The auditor determines that Matthews Company occupies the 3rd floor of an office tower for which it pays no rent. The most likely explanation is

A) they got lucky the landlord hasn't noticed the lack of payments.

B) the landlord has weak internal controls over billings.

C) a related party transaction in which a major shareholder owns the office tower.

D) Matthews Company is engaging in fraudulent activities.

An official record of meetings of the board of directors and stockholders is included in the corporate

A) bylaws.

B) charter.

C) minutes.

D) license.

A related party transaction may be indicated when another company

A) subsidizes certain operating expenses of the company.

B) purchases its securities at their fair value.

C) loans to company at market rates.

D) has had a distributor relationship with the company for 10 years.

Which of the following is an accurate statement regarding a public company's code of ethics?

A) A code of ethics is required under The Foreign Corrupt Practices Act.

B) A code of ethics is required only for mid-level managers and below.

C) The SEC requires companies to disclose amendments and waivers to the code of ethics for the CEO, CFO and principal accounting officer.

D) The PCAOB requires companies to review their code of ethics every five years.

An auditor should examine minutes of the board of directors' meetings

A) through the date of the financial statements.

B) through the date of the audit report.

C) only at the beginning of the audit.

D) on a test basis.

Which of the following would most likely notbe classified as a related-party transaction?

A) an advance of one week's salary to an employee

B) sales of merchandise between affiliated companies

C) loans or credit sales to the principal owner of the client company

D) exchanges of equipment between two companies owned by the same person

Which of the following best describes the corporate minutes of an entity?

A) official record of the meetings of the board of directors and the stockholders

B) unofficial record of the meeting of the board of directors

C) official record of management meeting with investors and creditors of the company

D) unofficial record of the board of directors meetings 

Related party

A) transactions must be disclosed in the footnotes even if the amounts are immaterial.

B) disclosures include the nature of the related party relationship and a description of the transaction.

C) transactions are considered arm's-length transactions.

D) disclosures are required only for public companies.

Auditors should understand client objectives related to

A) reliability of financial reporting.

B) effectiveness and efficiency of operations.

C) compliance with laws and regulations.

D) all of the above.

When analyzing a client's performance measurement system,

A) ratio analysis and benchmarking against key competitors are utilized.

B) only income statement numbers are used.

C) inherent risk of financial statement misstatements may be decreased if the performance measurement system encourages aggressive accounting.

D) the auditor is likely to decrease the extent of testing if the client has set unreasonable objectives.

Auditors should obtain copies of the client's code of ethics and minutes of the meetings of the board of directors to aid in their understanding of the company's management and governance structure.

TRUE OR FALSE

Many risks are common to all clients in certain industries.

TRUE OR FALSE

Transactions with related parties must be disclosed in the financial statements if they are deemed to be material.

TRUE OR FALSE

All known related parties must be identified and included in the auditor's permanent files related to the client.

TRUE OR FALSE

Because of the lack of independence between related parties, the Sarbanes-Oxley Act prohibits all related party transactions.

TRUE OR FALSE

Management's philosophy and operating style influence the risk of material misstatements in the financial statements.

TRUE OR FALSE

The auditor should read the corporate minutes to obtain authorizations and other information that is relevant to performing the audit.

TRUE OR FALSE

Material transactions between the client and the client's related parties must be disclosed in the auditor's report.

TRUE OR FALSE

A tour of the client's facilities can help the auditor assess physical safeguards over assets and interpret accounting data related to assets such as factory equipment.

TRUE OR FALSE

Operations are approaches followed by the entity to achieve organizational objectives.

TRUE OR FALSE

Which of the following is a correct statement regarding analytical procedures?

A) A major strength in using industry ratios for auditing is the difference between the nature of the client's financial information and that of the firms making up the industry totals.

B) Common-size financial statements display all items as a percentage change from a base year.

C) In identifying areas of specific risk, the auditor is likely to focus on the liquidity activity ratios.

D) In order to look for a misstatement in the allowance for bad debts, the auditor should divide gross sales by sales returns and allowances.

Which of the following would notbe classified as an analytical procedure?

A) benchmarking the company's profitability ratios against others in the industry

B) preparing common size financial statements

C) calculating income statement account balances as a percent of sales when the level of sales has changed from the prior year

D) reconciling fixed asset dispositions with the fixed asset ledger

When performing planning analytical procedures for a client the auditor detected that the gross profit percentage had declined by 50% from the previous year to the year currently under audit. The auditor should

A) investigate the possibility the client may have made an error in their cost of goods sold computation.

B) assist management in developing greater cost efficiencies in their product line.

C) prepare a going concern opinion for the client.

D) advise the client to have extensive disclosure to alleviate investor concerns.

Which is a liquidity activity ratio?

A) profit margin

B) inventory turnover

C) return on assets

D) times interest earned 

When using financial ratios, the most important comparisons are to those of previous years for the company and to industry averages or similar companies for the same year.

TRUE OR FALSE

Auditors perform preliminary analytical procedures to better understand the client's business and to assess client business risk.

TRUE OR FALSE

In order to be meaningful, a company's ratios should be compared to their prior year's ratios, not industry benchmarks.

TRUE OR FALSE

Preliminary analytical procedures can help the auditor assess client business risk.

TRUE OR FALSE

Auditing standards define ________ as the magnitude of misstatements that individually, or when aggregated with other misstatements, could reasonably be expected to influence the economic decisions of users made on the basis of the financial statements.

A) fraud

B) inherent risk

C) materiality

D) significant

Which of the following is part of planning?

A) Set materiality for the financial statements as a whole.

B) Estimate total misstatement in the segment.

C) Estimate the combined misstatement.

D) Compare the combined estimated with preliminary judgment.

When dealing with materiality,

A) if the client refuses to correct a material misstatement, the auditor is required to adjust the financial statements.

B) management is responsible for determining whether financial statements are materially misstated.

C) materiality must be determined as as percentage of sales.

D) the auditor must bring any material misstatements to the client's attention.

________ materiality is materiality for segments of the audit.

A) Segment

B) Individual

C) Financial statement

D) Performance

Materiality does notdepend on the decisions of users who rely on the statements to make the decisions.

TRUE OR FALSE

The first step in applying materiality is to determine performance materiality.

TRUE OR FALSE

Audit standards require the auditor to consider materiality early in the audit. Which statement(s) regarding preliminary materiality are true?

I.   Preliminary materiality may change during the engagement.

II.  Preliminary materiality is the maximum amount by which the auditor believes the financials could be misstated and still not affect the decisions of reasonable users.

A) I only

B) II only

C) both I and II

D) neither I nor II

Why do auditors establish a preliminary judgment about materiality?

A) to determine the appropriate level of staff to assign to the audit

B) so the client can know what records to make available to the auditor

C) to help plan the appropriate evidence to accumulate

D) to finalize the control risk assessment

If an auditor establishes a relatively high level for materiality, then the auditor will

A) accumulate more evidence than if a lower level had been set.

B) accumulate less evidence than if a lower level had been set.

C) accumulate approximately the same evidence as would be the case were materiality lower.

D) accumulate an undetermined amount of evidence.

Which of the following is a reason that the auditors may change the preliminary judgment about materiality?

A) The auditors decide that the preliminary judgment was too large.

B) The auditors decide that the preliminary judgment was too small.

C) Client circumstance may have changed due to qualitative events.

D) all of the above

Which of the following is the primary basis used to decide materiality for a profit-oriented entity?

A) net sales

B) net assets

C) net income before tax

D) all of the above

Auditing standards ________ that the basis used to determine the preliminary judgment about materiality be documented in the audit files.

A) permit

B) do not allow

C) require

D) strongly encourage

Amounts involving fraud are usually considered ________ important than unintentional errors of equal dollar amounts.

A) less

B) no less

C) no more

D) more

Qualitative factors can affect an auditor's assessment of materiality. Which of the following statements is true?

I.   Misstatements that are otherwise immaterial may be material if they affect earnings trends.

II.  Misstatements that are otherwise minor may be material if there are possible consequences arising from contractual obligations. 

A) I only

B) II only

C) I and II

D) neither I nor II

The five steps in applying materiality are listed below in random order.

1.   Estimate the combined misstatement.

2.   Estimate the total misstatement in the segment.

3.   Set materiality for the financial statements as a whole.

4.   Determine performance materiality.

5.   Compare combined estimate with preliminary judgment about materiality.

The first three steps in correct sequence would be

A) 1, 2, 5 

B) 3, 4, 2 

C) 2, 1, 5 

D) 3, 2, 4

Which of the following statements is notcorrect?

A) Materiality is a relative rather than an absolute concept.

B) The most important base used as the criterion for deciding materiality is total assets.

C) Qualitative factors as well as quantitative factors affect materiality.

D) Given equal dollar amounts, frauds are usually considered more important than errors.

When setting a preliminary judgment about materiality,

A) more evidence is required for a low dollar amount than for a high dollar amount.

B) less evidence is required for a low dollar amount than for a high dollar amount.

C) the same amount of evidence is required for either low or high dollar amounts.

D) there is no relationship between materiality and the dollar amount of evidence needed.

Lewis Corporation has a few large accounts receivable that total one million dollars, whereas Clark Corporation has many small accounts receivable that total one million dollars. Misstatement in any one account is more significant for Lewis corporation because of the concept of

A) materiality.

B) audit risk.

C) reasonable assurance.

D) comparative analysis.

When determining materiality,

A) the preliminary judgment about materiality can be increased, but not decreased during the audit.

B) auditing standards provide specific materiality guidelines to practitioners.

C) only one benchmark can be used.

D) the application of guidelines requires considerable professional judgment.

Determining materiality requires professional judgment.

TRUE OR FALSE

The auditor's preliminary judgment about materiality is the maximum amount by which the auditor believes the financial statements could be misstated and still notaffect the decisions of reasonable users.

TRUE OR FALSE

Preliminary judgments about materiality are often changed during the course of the engagement.

TRUE OR FALSE

Net assets are the most often used base for deciding materiality.

TRUE OR FALSE

The lower the dollar amount of the preliminary judgment, the more audit evidence is required.

TRUE OR FALSE

Amounts involving fraud are notusually considered qualitative factors affecting the preliminary materiality judgment.

TRUE OR FALSE

CPA firms can establish policy guidelines to help their auditors determine materiality.

TRUE OR FALSE

Statements on Auditing Standards provide detailed, objective guidance on how auditors are to establish a preliminary materiality level, thus eliminating the need for subjective auditor judgment in this task.

TRUE OR FALSE

If the preliminary judgment of materiality increases, the amount of audit evidence required will decrease.

TRUE OR FALSE

Net income before taxes is the normal base used to determine materiality for a not-for-profit organization.

TRUE OR FALSE

The amount(s) set by the auditor at less than the materiality for the financial statements as a whole to reduce to an appropriately low level the probability that the aggregate of uncorrected and undetected misstatements exceeds materiality for the financial statements as a whole is referred to as

A) the materiality range.

B) the error range.

C) tolerable materiality.

D) performance materiality.

Auditors generally allocate the preliminary judgment about materiality to the:

A) balance sheet only.

B) income statement only.

C) income statement and balance sheet.

D) statement of cash flows.

Which of the following is an incorrect statement regarding the allocation of the preliminary judgment about materiality to balance sheet accounts?

A) Auditors expect certain accounts to have more misstatements than others.

B) The allocation has virtually no effect on audit costs because the auditor must collect sufficient appropriate audit evidence.

C) Auditors expect to identify overstatements as well as understatements in the accounts.

D) Relative audit costs affect the allocation.

Which of the following statements is true concerning the allocation of preliminary materiality?

A) It is necessary to allocate preliminary materiality to financial statements as a whole rather than by segments.

B) Preliminary materiality should be allocated to income statement accounts only.

C) Preliminary materiality is required by the SEC.

D) The PCAOB term used when preliminary materiality is allocated to segments is tolerable misstatement.

Which of the following statements is false?

A) Either an overstatement of an asset account or an understatement of a liability account would have the same effect on the income statement.

B) A misclassification in the balance sheet will have no effect on operating income.

C) Either an overstatement of an asset account or an overstatement of a liability account would have the same effect on the income statement.

D) Either an understatement of an asset account or an overstatement of a liability account would have the same effect on the income statement.

When allocating performance materiality,

A) it is easy to predict in advance which accounts are most likely to be misstated.

B) only overstatements need to be considered.

C) professional judgment is critical.

D) the sum of all the performance materiality levels cannot exceed the preliminary judgment about materiality.

When allocating materiality, most practitioners choose to allocate to

A) the income statement accounts because they are more important.

B) the balance sheet accounts because most audits focus on the balance sheet.

C) both balance sheet and income statement accounts because there could be errors on either.

D) all of the financial statements because it is required by GAAS.

Which of the following is a correct statement regarding performance materiality?

A) Determining performance materiality is necessary because auditors accumulate evidence by segments.

B) The level of performance materiality does not affect the amount of evidence needed.

C) Performance materiality cannot vary for different classes of transactions.

D) Performance materiality is required for public companies, but not for private companies.

Most practitioners allocate the preliminary judgment about materiality to both the balance sheet and income statement accounts.

TRUE OR FALSE

The primary purpose of allocating the preliminary judgment about materiality to financial statement accounts is to help the auditor decide the appropriate evidence to accumulate.

TRUE OR FALSE

Both overstatements and understatements must be considered when allocating materiality to balance sheet accounts.

TRUE OR FALSE

If an auditor assigns a tolerable misstatement of $1,000 to accounts payable, he or she would need to obtain more audit evidence for that account than if $100,000 had been assigned.

TRUE OR FALSE

To maximize audit efficiency, the auditor should allocate less tolerable misstatement to accounts that can be verified by using low-cost audit procedures, such as analytical procedures, than to accounts that are more costly to audit.

TRUE OR FALSE

Auditors are ________ to document the known and likely misstatements in the financial statements under audit.

A) permitted

B) required

C) not allowed

D) strongly encouraged

________ misstatements are those where the auditor can determine the amount of the misstatement in the account.

A) Potential

B) Likely

C) Known

D) Projected

When evaluating the audit findings, the auditor should be satisfied that the

A) amount of known misstatement is documented in the management representation letter.

B) estimate of the total known and likely misstatements is less than a material amount.

C) estimate of the total likely misstatement includes sample error.

D) amount of known misstatement is acknowledged and recorded by the client.

List the five steps in applying materiality in an audit.

The preliminary judgment on materiality is compared to the total estimated misstatement amount to determine if an account balance is materially misstated.

TRUE OR FALSE

Total estimated misstatements include known misstatements and projected misstatements plus a sampling error.

TRUE OR FALSE

If the total misstatement of an account is known, a sampling error still needs to be determined.

TRUE OR FALSE

Sampling risk results if the sample accurately represents the population.

TRUE OR FALSE

If the auditor approaches the audit of the accounts in s sequential manner, the findings of the audit of accounts audited earlier can be used to revise the performance materiality established for accounts audited later.

TRUE OR FALSE