Deck 8: Audit Planning and Materiality

Question 1

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

Answer 1

True

Question 2

A 100% audit risk is complete certainty.

Answer 2

False

Question 3

When an auditor sets a low acceptable audit risk, it means that he or she wants to be more certain that the financial statements are not materially misstated.

Answer 3

True

Question 4

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

Question 5

Client business risk includes the auditor identifying declines in economic conditions that adversely affect both sales and the collectability of accounts receivable.

Question 6

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.

Question 7

Assume an audit client identified in the planning stage of the audit the risk of material misstatement for revenue recognition and accounts receivable due to complex valuation related issues; this situation warrants the auditor to accumulate additional audit evidence and to assign more experienced staff to perform the testing in this area.

Question 8

There are three main reasons why an auditor should properly plan audit engagements. Discuss each of these reasons.

Question 9

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.

Question 10

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.

Question 11

Zero risk is certainty, and a 100% audit risk is complete uncertainty.

Question 12

________ 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

Question 13

Client business risk is the risk that the entity fails to achieve its objectives or execute its strategies.

Question 14

The auditor is likely to accumulate more evidence when the audit is for a company

A)
B)
C)
D)

Question 15

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.

Question 16

The risk of material misstatement is a function of the susceptibility of the financial statements to misstatement; the effectiveness of the client's controls in preventing or detecting these misstatements has no impact on the risk of material misstatement.

Question 17

Initial audit planning involves four matters. Which of the following is not one 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.

Question 18

In what order should the following steps occur?
A) Set preliminary judgment of materiality and performance materiality.
B) Understand the client's 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

Question 19

One of the purposes of an engagement letter is to avoid misunderstandings with the client. This is important for

A)
B)
C)
D)

Question 20

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

Question 21

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

Question 22

The written communication stating the auditor cannot guarantee that all acts of fraud will be discovered is found in the

A) engagement letter.
B) representation letter.
C) responsibility letter.
D) client letter.

Question 23

When may the auditor refer to a specialist in the audit report?

A)
B)
C)
D)

Question 24

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.

Question 25

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.

Question 26

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.

Question 27

Which is usually included in an engagement letter?

A)
B)
C)
D)

Question 28

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

Question 29

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.

Question 30

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.

Question 31

An engagement letter sent to a publicly held audit client usually would not include 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.

Question 32

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.

Question 33

A successor auditor may perform which of the following for a new audit client?

A)
B)
C)
D)

Question 34

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.

Question 35

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.

Question 36

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.

Question 37

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.

Question 38

Which is usually included in an engagement letter?

A)
B)
C)
D)

Question 39

Which is usually included in an engagement letter?

A)
B)
C)
D)

Question 40

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.

Question 41

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.

Question 42

If the client will not permit the predecessor auditor to communicate with the successor auditor, or the predecessor does not provide a comprehensive response to the successor auditor, the successor auditor must not accept the audit engagement.

Question 43

A predecessor auditor who has been contacted by a successor auditor for information about the client does not have to obtain permission from the former client before providing any confidential information to the successor auditor because the confidentiality requirement does not extend to former clients.

Question 44

Which is usually included in the engagement letter?

A)
B)
C)
D)

Question 45

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

Question 46

The burden of initiating communication with the successor audit rests with the predecessor auditor, especially in the event of legal problems or disputes between the client and the predecessor auditor.

Question 47

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

Question 48

Auditing standards recommend, but do not require, that auditors obtain an understanding with the client in an engagement letter approved by the audit committee of public companies.

Question 49

AICPA auditing standards require the auditor to determine whether the financial statement framework to be used by management to prepare the financial statements is appropriate under the circumstances.

Question 50

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

Question 51

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.

Question 52

Because auditors are responsible for having appropriate competence and capabilities to perform an audit, auditors are not normally permitted to consult with outside specialists during an audit engagement.

Question 53

A successor auditor must seek the written permission of a prospective audit client before making other investigations regarding the prospective audit client, including gathering information from local attorneys, other CPAs, banks, and other businesses.

Question 54

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.

Question 55

Which is usually included in the engagement letter?

A)
B)
C)
D)

Question 56

A CPA firm may decide not to continue doing audits for an existing audit client simply due to what the CPA firm deems to be excessive risk, alone, even if the audit engagement is very profitable to the CPA firm.

Question 57

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

Question 58

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

Question 59

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.

Question 60

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

Question 61

Discuss the essential activities involved in the initial planning of an audit.

Question 62

Discuss the primary purpose of an audit engagement letter. Is an engagement letter required?

Question 63

The auditor's report should not refer to the specialist unless the specialist's report results in a modification of the audit opinion.

Question 64

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.

Question 65

Specialists may be employed by the client, employed by the audit firm, or affiliated with the client and the audit firm.

Question 66

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

Question 67

The engagement letter may include an agreement to provide other services to the audit client such as tax returns and management consulting services allowed under the Code of Professional Conduct and regulatory requirements.

Question 68

Discuss several reasons why an auditor may not wish to continue a relationship with an existing audit client.

Question 69

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.

Question 70

Discuss the factors an auditor should consider before accepting a company as an audit client.

Question 71

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.

Question 72

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

Question 73

Which of the following would most likely not be 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

Question 74

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.

Question 75

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.

Question 76

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.

Question 77

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.

Question 78

Discuss the required communications between predecessor and successor auditors.

Question 79

Discuss four of the matters that should be specified in an engagement letter.

Question 80

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.