TBCH02

CHAPTER 2: Standards, Materiality, and Risk MULTIPLE CHOICE a.

1. a. b. c. d.

Due professional care requires A critical review of the work done at every level of supervision. The examination of all corroborating evidence available. The exercise of error-free judgment. A consideration of internal control structure that includes tests of controls. (AICPA ADAPTED)

c

2. The first general standard requires that the audit of financial statements be performed by a person or persons having adequate technical training and a. Independence with respect to the financial statements and supplementary disclosures. b. Exercising professional care as judged by peer reviewers. c. Proficiency as an auditor, which likely has been acquired from previous experience. d. Objectivity as an auditor, as verified by proper supervision. (AICPA ADAPTED)

d 3. An auditor, while performing an audit, strives to achieve the appearance of independence in order to a. Reduce risk and liability. b. Comply with the generally accepted standards of fieldwork. c. Become independent in fact. d. Maintain public confidence in the profession. (AICPA ADAPTED) d

4. Adequate technical training and proficiency as an auditor encompasses an ability to understand a computer system sufficiently to identify and evaluate a. The processing and imparting of information. b. Essential accounting control features. c. All control procedures. d. The degree to which programming conforms to the application of generally accepted accounting principles. (AICPA ADAPTED)

c

5. a. b. c. d.

Competence as a certified public accountant includes all of the following except Having the technical qualifications to perform an engagement. Possessing the ability to supervise and evaluate the quality of staff work. Warranting the infallibility of the work performed. Consulting others if additional technical information is needed. (AICPA ADAPTED)

a

6. a. b. c. d.

Ultimately, the decision about whether or not an auditor is independent must be made by the Auditor. Client. Audit committee. Public. (AICPA ADAPTED)

7

c

7. Madison Corporation has a few large accounts receivable that total $1,000,000. Nassau Corporation has a great number of small accounts receivable that also total $1,000,000. The importance of an error in any one account is, therefore, greater for Madison than for Nassau. This is an example of the auditor's concept of a. Account bias. b. Audit risk. c. Materiality. d. Reasonable assurance. (AICPA ADAPTED)

b

8. a. b. c. d.

b

9. There is an inverse relationship between the effectiveness of an entity's internal control structure and the a. Reliability of financial statements. b. Extent of detailed audit tests required. c. Degree of staff supervision required in the performance of an audit. d. Fairness of management assertions in the financial statements.

a

10. Which of the following best describes the character of the three generally accepted auditing standards classified as general standards? a. Criteria for competence, independence, and professional care of individuals performing the audit. b. Criteria for the content of the financial statements and related footnote disclosures. c. Criteria for the content of the auditor's report. d. The requirements for planning and supervision. (AICPA ADAPTED)

c

11. a. b. c. d.

The generally accepted standards of fieldwork relate to The competence, independence, and professional care of persons performing the audit. Criteria for the content of the auditor's report on financial statements. Audit planning and evidence gathering. The need to maintain independence in mental attitude. (AICPA ADAPTED)

d

12. a. b. c. d.

Which of the following statements is correct concerning the concept of materiality? Materiality is determined by reference to AICPA guidelines. Materiality depends only on the dollar amount involved. Materiality depends on the nature of an item rather than on the dollar amount. Materiality is a matter of professional judgment. (AICPA ADAPTED)

a

13. a. b. c. d.

The generally accepted standards of reporting encompass all of the following except Consideration of an entity's internal control structure. Consistent application of accounting principles. Informative disclosures. Conformity of financial statements with GAAP.

Which of the following best describes what is meant by generally accepted auditing standards? Acts to be performed by the auditor. Measures of the quality of an auditor's performance. Procedures used to gather evidence to support financial statements. Audit objectives generally determined on audit engagements. (AICPA ADAPTED)

8

c

14. An objective of the fourth generally accepted standard of reporting, relating to the expression of an opinion, is to a. Prohibit the auditor from issuing a report that does not include an opinion on the financial statements taken as a whole. b. Inform users that the financial statements and related notes are the joint responsibility of the auditor and management. c. Prevent users of financial statements from misinterpreting the degree of responsibility assumed by the auditor. d. Ensure adequate informative disclosures in the financial statements.

d

15. The least important evidence of a public accounting firm's evaluation of its system of quality controls would concern the firm's policies and procedures with respect to a. Employment (hiring). b. Confidentiality of audit engagements. c. Assigning personnel to audit engagements. d. Determination of audit fees. (AICPA ADAPTED)

a

16. a. b. c. d.

Which of the following is not an element of quality control? Documentation. Inspection. Supervision. Consultation.

(AICPA ADAPTED)

d

17. Williams & Co., a large international public accounting firm, is due to have a peer review. The peer review will most likely be performed by a. Employees and partners of Williams & Co. who are not associated with the particular audit being reviewed. b. Audit review staff of the Securities and Exchange Commission. c. Audit review staff of the AICPA. d. Employees and partners of another firm. (AICPA ADAPTED)

b

18. a. b. c. d.

In a financial statement audit, audit risk represents the probability that Internal control fails and the failure is not detected by the auditor's procedures. The auditor unknowingly fails to modify an opinion on materially misstated financial statements. Inherent and control risk cause errors that could be material to the financial statements. The auditor is not retained to conduct a financial statement audit in the succeeding year.

a

19. a. b. c. d.

In a financial statement audit, inherent risk represents The susceptibility of an account balance to error that could be material. The risk that error could occur and not be prevented or detected by the internal control structure. The risk that error could occur and not be detected by the auditor's procedures. The risk that the auditor fails to modify materially misstated financial statements.

d

20. a. b. c. d.

What is the magnitude of audit risk if inherent risk is .50, control risk .40, and detection risk .10? .20. .10. .04. Not determinable from the facts given.

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c

21. a. b. c. d.

The "hallmark" of auditing is Available audit technology. Generally accepted auditing standards. Professional judgment. Materiality and audit risk.

d

22. An auditor is most likely to refer to one or more of the three general auditing standards in determining a. The nature of a report qualification. b. The scope of auditing procedures. c. Requirements for the consideration of internal control. d. Whether the auditor should undertake an audit engagement. (AICPA ADAPTED)

a

23. Which of the following is mandatory if the auditor is to comply with the general standards of the AICPA’s generally accepted auditing standards? a. Adequate technical training b. Use analytical procedures. c. Use statistical sampling when feasible on an audit engagement. d. Confirmation of material accounts receivable balances. (AICPA ADAPTED)

b

24. The first general standard requires that a person or persons have adequate technical training and proficiency as an auditor. This standard is met by a. Understanding business and finance. b. Education and experience in auditing. c. Continuing professional education. d. Knowledge of Statements of Auditing Standards. (AICPA ADAPTED)

a

25. What is the meaning of the generally accepted auditing standard that requires that the auditor be independent? a. The auditor must be without bias with respect to the client audited. b. The auditor must adopt a critical attitude during the audit. c. The auditor's sole obligation is to third parties. d. The auditor may have a direct ownership interest in the client's business if it is not material. (AICPA ADAPTED)

d

26. The third general standard states that due care is to be exercised in the performance of an audit, and should be interpreted to mean that an auditor who undertakes an engagement assumes a duty to perform a. With reasonable diligence and without fault or error. b. As a professional who will assume responsibility for losses consequent upon error of judgment. c. To the satisfaction of the client and third parties. d. As a professional possessing the degree of skill commonly possessed by others in the field. (AICPA ADAPTED)

10

a

27. The first standard of fieldwork, which states that the work is to be adequately planned, and assistants, if any, are to be properly supervised, recognizes that a. Early appointment of the auditor is advantageous both to the auditor and to the client. b. Acceptance of an audit engagement after the close of the client's fiscal year is generally not permissible. c. Appointment of the auditor subsequent to the physical count of inventories requires a disclaimer of opinion. d. Performance of substantial parts of the engagement is necessary at interim dates. (AICPA ADAPTED)

b

28. In connection with the third generally accepted auditing standard of fieldwork, an auditor examines corroborating evidential matter that includes all of the following except a. Client accounting manuals. b. Written client representations. c. Vendor invoices. d. Minutes of board meetings. (AICPA ADAPTED)

a

29. Which of the following underlies the application of generally accepted auditing standards, particularly the standards of fieldwork and reporting? a. The elements of materiality and risk. b. The element of internal control. c. The element of corroborating evidence. d. The element of reasonable assurance. (AICPA ADAPTED)

c

30. The fourth generally accepted auditing standard of reporting requires an auditor to render a report whenever an auditor's name is associated with financial statements. The overall purpose of the fourth standard of reporting is to require that reports a. Assure that the auditor is independent with respect to the financial statements audited. b. State that the audit has been conducted in accordance with generally accepted auditing standards. c. Indicate the character of the engagement and the degree of responsibility assumed by the auditor. d. Express whether the accounting principles used in preparing the financial statements have been applied consistently in the period audited. (AICPA ADAPTED)

d

31. The auditor's judgment concerning the overall fairness of the presentation of financial positions, results of operations, and cash flows is applied within the framework of a. Quality control. b. Generally accepted auditing standards that include the concept of materiality. c. The auditor's evaluation of the audited company's internal controls. d. Generally accepted accounting principles. (AICPA ADAPTED)

d

32. a. b. c. d.

The concept of materiality would be least important to an auditor in determining Transactions that should be reviewed. The need for disclosing a particular transaction or event. The extent of audit work planned for particular accounts. The effects of an auditor's direct financial interest in a client. (AICPA ADAPTED)

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b

33. The objective of quality control mandates that a public accounting firm should establish policies and procedures for professional development that provide reasonable assurance that all entry-level personnel a. Prepare working papers that are standardized in form and content. b. Have the knowledge required to enable them to fulfill responsibilities assigned. c. Will advance within the organization. d. Develop specialties in specific areas of public accounting. (AICPA ADAPTED)

b

34. In pursuing its quality control objectives with respect to assigning personnel to engagements, a public accounting firm may use policies and procedures such as a. Rotating employees from assignment to assignment on a random basis to aid in the staff training effort. b. Requiring timely identification of the staffing requirements of specific engagements so that enough qualified personnel can be made available. c. Allowing staff to select the assignments of their choice to promote better client relationships. d. Assigning a number of employees to each engagement in excess of the number required so as not to overburden the staff and interfere with the quality of the audit work performed. (AICPA ADAPTED)

d

35. A public accounting firm studies its personnel advancement experience to determine whether individuals meeting stated criteria are assigned increased degrees of responsibility. This is evidence of the firm's adherence to a. Generally accepted auditing standards. b. Attestation standards. c. Supervision and review. d. Quality control standards. (AICPA ADAPTED)

d

36. Which of the following statements best describes the primary purpose of Statements on Auditing Standards? a. Guides intended to set forth auditing procedures that are applicable to a variety of situations. b. Outlines intended to narrow the areas of inconsistency and divergence of auditor opinion. c. Authoritative statements, enforced through the code of professional conduct, and intended to limit the degree of auditor judgment. d. Interpretations intended to clarify the meaning of generally accepted auditing standards. (AICPA ADAPTED) SHORT ANSWER 1. Describe what is meant by planned detection risk and what effect planned detection risk would have on evidence. Answer: Detection risk is the likelihood that error could occur and not be detected by the auditor’s procedures. Detection risk is inversely related to the amount of audit evidence an auditor would plan to gather. As detection risk goes up, the amount of evidence gathered goes down.

12

2. Define inherent risk and name two examples of factors that may increase inherent risk. Answer: Inherent risk is the susceptibility of an account balance to error that could be material assuming there are no related internal controls. Examples will vary among students, including: the client's business or industry, management's predisposition to manage earnings, and insights obtained from prior engagements. 3. What is the importance of internal controls to an auditor in an audit engagement? Answer: The second standard of fieldwork within GAAS, requires that an auditor obtain an understanding of an entity's internal controls to help in planning the audit and designing audit tests. 4. What is the demand for due care within an audit or attestation engagement? Answer: Competent professional staff should plan attestation and audit engagements, and the work of all assistants assigned to the engagement should be supervised. 5. Differentiate between independence in fact and independence in appearance. Answer: Independence of fact is a state of mind, an attitude of impartiality, which underlies both an attestation standard and a GAAS. Independence in appearance is the ability to demonstrate independence by remaining free of any overt interest in a client that would damage the appearance of independence. PROBLEMS 1. List and describe the ten GAAS. Answer: General Standards 1. The audit is to be performed by a person or persons having adequate technical training and proficiency as an auditor. 2. In all matters relating to the assignment, independence in mental attitude is to be maintained by the auditor or auditors. 3. Due professional care is to be exercised in the performance of the audit and the preparation of the report. Standards of Field Work 4. The work is to be adequately planned and assistants, if any, are to be properly supervised. 5. A sufficient understanding of internal control is to be obtained to plan the audit and to determine the nature, timing, and extent of tests to be performed. 6. Sufficient competent evidential matter is to be obtained through inspection, observation, inquiries, and confirmation to afford a reasonable and basis for an opinion regarding the financial statements under audit. Standards of Reporting 7. The report shall state whether the financial statements are presented in accordance with generally accepted accounting principles.

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8. The report shall identify those circumstances in which such principles have not been consistently observed in the current period in relation to the preceding period. 9. Informative disclosures in the financial statements are to be regarded as reasonably adequate unless otherwise stated in the report. 10. The report shall either contain an expression of opinion regarding the financial statements taken as a whole, or an assertion to the effect that an overall opinion cannot be expressed. When an overall opinion cannot be expressed, the reasons, therefore, should be stated. In all cases where an auditor’s name is associated with financial statements, the report should contain a clear-cut indication of the character of the auditor’s work, if any, and the degree of responsibility the auditor is taking. 2. The following four situations involve the process of planning audit evidence requirements. Calculate the planned detection risk for each different situation.

Situations Risk Acceptable Audit Risk Inherent Risk Control Risk Planned Detection Risk

1

2

5% 100% 100% ?

5% 60% 40% ?

Answer:  Situation #1 Planned Detection Risk .05  Situation #2 Planned Detection Risk .2083  Situation #3 Planned Detection Risk .04  Situation #4 Planned Detection Risk .0417

14

3 1% 50% 50% ?

4 1% 40% 60% ?