Chapter 6 Audit Planning Understanding The Client and Asse

Chapter 06 - Audit Planning, Understanding the Client, Assessing Risks, and Responding
Chapter 06
Audit Planning, Understanding the Client, Assessing Risks, and
Responding

True / False Questions

1. Audit committees should be made up of the most ualified directors regardless of !hether
the" are part of management of the compan".
#rue $alse

%. Anal"tical procedures are seldom used for planning an audit engagement because the" are
substanti&e procedures.
#rue $alse

'. Preliminar" arrangements !ith clients should be set forth in the management letter.
#rue $alse

(. An audit plan includes a detailed listing of the audit procedures to be performed in the
&erification of items in the financial statements.
#rue $alse

). #he auditors* tests of controls are designed to substantiate the fairness of specific financial
statement accounts.
#rue $alse

6. At least a portion of the auditors* consideration of internal control usuall" is performed at
an interim date rather than at the balance sheet date.
#rue $alse

+. #he substanti&e approach to an audit is appropriate for man" small businesses.
#rue $alse

6-1
,. Confirming a bank account establishes e-istence but not rights to the cash balance.
#rue $alse

.. #he completeness of recording of assets is generall" &erified b" tracing from the source
documents to the recorded entr".
#rue $alse

10. /ouching the acuisition of assets is an audit procedure that is often performed to
establish the &aluation of the assets.
#rue $alse

Multiple Choice Questions

11. 0hich of the follo!ing factors most likel" !ould cause a CPA to not accept a ne! audit
engagement1
A. #he prospecti&e client has fired its prior auditor.
2. #he CPA lacks a thorough understanding of the prospecti&e client*s operations and
industr".
C. #he CPA is unable to re&ie! the predecessor auditor*s !orking papers.
3. #he prospecti&e client is un!illing to make financial records a&ailable to the CPA.

1%. 0hich of the follo!ing factors most likel" !ould heighten an auditor*s concern about the
risk of fraudulent financial reporting1
A. 4arge amounts of liuid assets that are easil" con&ertible into cash.
2. 4o! gro!th and profitabilit" as compared to other entit"*s in the same industr".
C. $inancial management*s participation in the initial selection of accounting principles.
3. An o&erl" comple- organi5ational structure in&ol&ing unusual lines of authorit".

6-%
1'. 0hich of the follo!ing factors !ould most likel" cause a CPA to decide not to accept a
ne! audit engagement1
A. 4ack of understanding of the potential client*s internal auditors* computer-assisted audit
techniues.
2. 6anagement*s disregard for internal control.
C. #he e-istence of related part" transactions.
3. 6anagement*s attempt to meet earnings per share gro!th rate goals.

1(. 0hich of the follo!ing matters is generall" included in an auditor*s engagement letter1
A. 4imitations of the engagement.
2. $actors to be considered in establishing preliminar" 7udgments about materialit".
C. 6anagement*s liabilit" for illegal acts committed b" its emplo"ees.
3. #he auditor*s responsibilit" to obtain negati&e assurance relating to the occurrence of
illegal acts.

1). 0hich of the follo!ing !ould heighten an auditor*s concern about the risk of fraudulent
financial reporting1
A. 8nabilit" to generate positi&e cash flo!s from operations, !hile reporting large increases in
earnings.
2. 6anagement*s lack of interest in increasing the di&idend paid on common stock.
C. 4arge amounts of liuid assets that are easil" con&ertible into cash.
3. 8nabilit" to borro! necessar" capital !ithout obtaining !ai&ers on debt co&enants.

16. #o best test e-istence, an auditor !ould sample from the9
A. :eneral 4edger to source documents.
2. :eneral 4edger to the financial statements.
C. ;ource documents to the general ledger.
3. ;ource documents to 7ournals.

1+. #he auditors* understanding established !ith a client should be established through a<an=
A. >ral communication !ith the client.
2. 0ritten communication !ith the client.
C. 0ritten or oral communication !ith the client.
3. Completel" detailed audit plan.

6-'
1,. 0hich of the follo!ing !ould be least likel" to be considered an audit planning
procedure1
A. Use an engagement letter.
2. 3e&elop the o&erall audit strateg"
C. Perform the risk assessment.
3. 3e&elop the audit plan.

1.. 0hile assessing the risks of material misstatement auditors identif" risks, relate risk to
!hat could go !rong, consider the magnitude of risks and
A. Assess the risk of misstatements due to illegal acts.
2. Consider the comple-it" of the transactions in&ol&ed.
C. Consider the likelihood that the risks could result in material misstatements.
3. 3etermine materialit" le&els.

%0. 0hich of the follo!ing is correct concerning reuirements about auditor communications
about fraud1
A. $raud that in&ol&es senior management should be reported directl" to the audit committee
regardless of the amount in&ol&ed.
2. All fraud !ith a material effect on the financial statements should be reported directl" b"
the auditor to the ;ecurities and ?-change Commission.
C. $raud !ith a material effect on the financial statements should ordinaril" be disclosed b"
the auditor through use of an @emphasis of a matter@ paragraph added to the audit report.
3. #he auditor has no responsibilit" to disclose fraud outside the entit" under an"
circumstances.

%1. A predecessor auditor is reuired to attempt to initiate communication !ith the successor
auditor9

A. >ption A
2. >ption 2
C. >ption C
3. >ption 3

6-(
%%. 0hich measure of materialit" <or both= considers uantitati&e considerations1

A. >ption A
2. >ption 2
C. >ption C
3. >ption 3

%'. 0hich of the follo!ing factors most likel" !ould lead a CPA to conclude that a potential
audit engagement should not be accepted1
A. #here are significant related part" transactions that management claims occurred in the
ordinar" course of business.
2. 8nternal control acti&ities reuiring the segregation of duties are sub7ect to management
o&erride.
C. 6anagement continues to emplo" an inefficient s"stem of information technolog" to
record financial transactions.
3. 8t is unlikel" that sufficient e&idence is a&ailable to support an opinion on the financial
statements.

%(. 8n using the information on the statement of cash flo!s !hile obtaining an understanding
of a profitable, gro!ing compan", !hich of the follo!ing !ould ordinaril" be least surprising
to an auditor1
A. 3ecreases in accounts pa"able.
2. 3ecreases in accounts recei&able.
C. Aegati&e cash flo!s from in&esting.
3. Aegati&e operating cash flo!s.

6-)
%). Audits of financial statements are designed to obtain reasonable assurance of detecting
material misstatements due to9

A. >ption A
2. >ption 2
C. >ption C
3. >ption 3

%6. 0hich of the follo!ing is not one of the assertions made b" management about an
account balance1
A. Rele&ance.
2. ?-istence.
C. /aluation.
3. Rights and obligations.

%+. 0hen a compan" has changed auditors, according to the Professional ;tandards9
A. #he successor auditor has the responsibilit" to initiate contact !ith the predecessor auditor
to ask about the client before the engagement is acceptedB the predecessor has no
responsibilit" to initiate this contact, e&en !hen a!are of matters bearing on the integrit" of
management.
2. #he predecessor must respond full" to all inuiries made b" the successor auditor.
C. #he successor must discuss !ith the predecessor matters bearing on the engagement prior
to accepting the engagement.
3. #he successor ma" choose not to attempt an" communication !ith the predecessor auditor.

%,. 0hich of the follo!ing procedures is not performed as a part of planning an audit
engagement1
A. Re&ie!ing the !orking papers of the prior "ear.
2. Performing anal"tical procedures.
C. Confirmation of all ma7or accounts.
3. 3esigning an audit program.

6-6
%.. #he risk of a material misstatement occurring in an account, assuming an absence of
internal control, is referred to as9
A. Account risk.
2. Control risk.
C. 3etection risk.
3. 8nherent risk.

'0. 0hich of the follo!ing is least likel" to be considered a financial statement audit risk
factor1
A. 6anagement operating and financing decisions are dominated b" top management.
2. A ne! client !ith no prior audit histor".
C. Rate of change in the entit"*s industr" is rapid.
3. Profitabilit" of the entit" relati&e to its industr" is inconsistent.

'1. 0hich of the follo!ing is an e-ample of fraudulent financial reporting1
A. Compan" management falsifies in&entor" count tags thereb" o&erstating ending in&entor"
and understating cost of goods sold.
2. An emplo"ee di&erts customer pa"ments to his personal use, concealing his actions b"
debiting an e-pense account, thus o&erstating e-penses.
C. An emplo"ee steals in&entor and the @shrinkage@ is recorded in cost of goods sold.
3. An emplo"ee @borro!s@ tools from the compan" and neglects to return themB the cost is
reported as a miscellaneous operating e-pense.

'%. 0hich of the follo!ing is most likel" to be considered a risk factor relating to fraudulent
A. 4o! turno&er of senior management.
2. ?-treme degree of competition !ithin the industr".
C. Capital structure including &arious operating subsidiaries.
3. ;ales goals in e-cess of an" of the preceding three "ears.

6-+
''. 0hich of the follo!ing conditions identified during the audit increases the risk of
emplo"ee fraud1
A. 4arge amounts of cash in the bank.
2. ?-istence of a mandator" &acation polic" for emplo"ees performing ke" functions.
C. 8n&entor" items of small si5e, but high &alue.
3. Presence of reconciling items on a client prepared "ear-end proof of cash.

'(. 0hich of the follo!ing statements is accurate about @fraud risk factors@ considered !hen
conducting an audit1
A. $actors !hose presence indicates that fraud e-ists.
2. $actors !hose presence often ha&e been obser&ed in circumstances !here frauds ha&e
occurred.
C. $actors !hose presence !ill reuire modification to planned audit procedures.
3. $actors obtained during the audit !hich lead to reuired communications !ith the audit
committee.

'). 0hich of the follo!ing is not an e-ample of a likel" ad7ustment in the auditors* o&erall
audit approach !hen significant risk is found to e-ist1
A. Appl" increased professional skepticism about material transactions.
2. 8ncrease the assessed le&el of detection risk.
C. Assign personnel !ith particular skill to areas of high risk.
3. >btain increased e&idence about the appropriateness of management*s selection of
accounting principles.

'6. 0hich of the follo!ing is least likel" to be reuired on an audit1
A. ?&aluate the business rationale for significant, unusual transactions.
2. 6ake a legal determination of !hether fraud has occurred.
C. Re&ie! accounting estimates for biases.
3. #est appropriateness of 7ournal entries and ad7ustments.

6-,
'+. 0hich of the follo!ing is <are= considered a further audit procedure<s= that ma" be
designed after assessing the risks of material misstatement1

A. >ption A
2. >ption 2
C. >ption C
3. >ption 3

',. 0hich of the follo!ing circumstances !ould an auditor most likel" consider a risk factor
relating to misstatements arising from fraudulent financial reporting1
A. ;e&eral members of management ha&e recentl" purchased additional shares of the entit"*s
stock.
2. ;e&eral members of the board of directors ha&e recentl" sold shares of the entit"*s stock.
C. #he entit" distributes financial forecasts to financial anal"sts that predict conser&ati&e
operating results.
3. 6anagement is interested in maintaining the entit"*s earnings trend b" using aggressi&e
accounting practices.

'.. A successor auditor is reuired to attempt communication !ith the predecessor auditor
prior to
A. Performing test of controls.
2. #esting beginning balances for the current "ear.
C. 6aking a proposal for the audit engagement.
3. Accepting the engagement.

(0. 8f the business en&ironment is e-periencing a recession, the auditor most likel" !ould
focus increased attention on !hich of the follo!ing accounts1
A. Purchase returns and allo!ances.
2. Allo!ance for doubtful accounts.
C. Common stock.
3. Aoncontrolling interest of a subsidiar" purchased during the "ear.

6-.
(1. #he risk that the auditors* procedures !ill lead them to conclude that a material
misstatement does not e-ist in an account balance !hen in fact such a misstatement does e-ist
is referred to as9
A. Account risk.
2. Control risk.
C. 3etection risk.
3. 8nherent risk.

(%. 0hich of the follo!ing statements is correct regarding the auditor*s determination of
materialit"1
A. #he planning le&el of materialit" should normall" be the larger of the amount considered
for the balance sheet &ersus the income statement.
2. #he auditors* planning le&el of materialit" ma" be disaggregated into smaller @tolerable
misstatements@ for the &arious accounts.
C. Auditors ma" use &arious rules of thumb to arri&e at an e&aluation le&el of materialit", but
not for determining the planning le&el of materialit".
3. #he amount used for the planning should eual that used for e&aluation.

('. #he auditors must consider materialit" in planning an audit engagement. 6aterialit" for
planning purposes is9
A. #he auditors* preliminar" estimate of the largest amount of misstatement that !ould be
material to an" one of the client*s financial statements.
2. #he auditors* preliminar" estimate of the smallest amount of misstatement that !ould be
C. #he auditors* preliminar" estimate of the amount of misstatement that !ould be material to
the client*s balance sheet.
3. An amount that cannot be uantitati&el" stated since it depends on the nature of the item.

((. 0hich of the follo!ing topics is not normall" included in an engagement letter1
A. #he auditors* preliminar" assessment of internal control.
2. #he auditors* estimate of the fee for the engagement.
C. 4imitations on the scope of the engagement.
3. A description of responsibilit" for the detection of fraud.

6-10
(). 0hich of the follo!ing is most likel" to be an o&erall response to fraud risks identified in
an audit1
A. >nl" use certified public accountants on the engagement.
2. Place increased emphasis on the audit of ob7ecti&e transactions rather than sub7ecti&e
transactions.
C. ;uper&ise members of the audit team less closel" and rel" more upon 7udgment.
3. Use less predictable audit procedures.

(6. 0hich of the follo!ing is not an assertion that is made in the financial statements b"
management concerning each ma7or account balance1
A. Completeness.
C. 4egalit".
3. /aluation.

(+. #ests for unrecorded assets t"picall" in&ol&e tracing from9
A. ;ource documents to recorded 7ournal entries.
2. ;ource documents to obser&ations.
C. Recorded 7ournal entries to documents.
3. Recorded 7ournal entries to obser&ations.

(,. #racing from source documents for!ard to ledgers is most likel" to address !hich
assertion related to posted entries9
A. Completeness.
2. ?-istence.
C. Rights.
3. /aluation.

(.. 3etermining that recei&ables are presented at net-reali5able &alue is most directl" related
to !hich management assertion1
A. ?-istence.
2. Rights.
C. /aluation.
3. Presentation and disclosure.

6-11
)0. 0hich of the follo!ing is not a general ob7ecti&e for the audit of asset accounts1
A. ?stablishing e-istence of assets.
2. ?stablishing proper &aluation of assets.
C. ?stablishing proper liabilities relating to assets.
3. ?stablishing the completeness of assets.

)1. 0hich of the follo!ing is not used b" auditors to establish the completeness of recorded
assets1
A. Assessing control risk.
2. #racing from source documents to entries in the accounting records.
C. Performing anal"tical procedures.
3. /ouching transactions.

)%. #o test for unsupported entries in the 7ournals, the direction of audit testing should be to
the9
A. 4edger entries.
2. Cournal entries.
C. >riginal source documents.
3. $inancial statements.

)'. A form filed !ith the ;?C !hen a compan" changes auditors is a9
A. $orm ,-D.
2. $orm 10-D.
C. $orm ;-1.
3. $orm 2-1.

)(. 0hich of the follo!ing is least likel" to render material a uantitati&el" small
misstatement material1
A. Affects the registrant*s compliance !ith regulator" reuirements.
2. 6asks a change in earnings or other trends.
C. Arises from an item not capable of precise measurement.
3. #he #ransaction in&ol&es a related part".
6-1%
)). A successor auditor has accepted an engagement that !as pre&iousl" performed b" a
predecessor auditor and, prior to accepting the engagement, has communicated !ith the
predecessor. 0hen the successor belie&es that the predecessor has performed satisfactor"
pre&ious audits, !hich of the follo!ing is correct1
A. A second communication is reuired and must include details of pre&ious audits.
2. >rdinaril" the successor auditors ma" be able to accept the opening balances of the current
"ear !ith a minimum of &erification !ork.
C. Absent ongoing litigation, a predecessor must pro&ide all !orking papers reuested b" the
predecessor.
3. #he client should be informed of the need to perform a detailed audit of all opening
balances.

)6. #he first standard of field !ork recogni5es that earl" appointment of the independent
auditors has man" ad&antages to the auditors and the client. 0hich of the follo!ing
ad&antages is least likel" to occur as a result of earl" appointment of the auditors1
A. #he auditors !ill be able to plan the audit !ork so that it ma" be done e-peditiousl".
2. #he auditors !ill be able to complete substanti&e procedures prior to "ear-end.
C. #he auditors !ill be able to better plan for the obser&ation of the ph"sical in&entories.
3. #he auditors !ill be able to perform the e-amination more efficientl" and !ill be finished
at an earl" date after the "ear-end.

)+. Preliminar" arrangements agreed to b" the auditors and the client should be reduced to
!riting b" the auditors. #he best place to set forth these arrangements is in9
A. A memorandum to be placed in the permanent section of the auditing !orking papers.
2. An engagement letter.
C. A client representation letter.
3. A confirmation letter attached to the constructi&e ser&ices letter.

),. #he auditors are planning an audit engagement for a ne! client in a business that is
unfamiliar to the auditors. 0hich of the follo!ing !ould be the most useful source of
information for the auditors during the preliminar" planning stage !hen the" are tr"ing to
obtain a general understanding of audit problems that might be encountered1
A. Client manuals of accounts and charts of accounts.
2. A8CPA 8ndustr" Audit :uides.
C. Prior-"ear !orking papers of the predecessor auditors.
3. 4atest annual and interim financial statements issued b" the client.

6-1'
).. #he auditors !ill not ordinaril" initiate discussion !ith the audit committee concerning
the9
A. ?-tent to !hich the !ork of internal auditors !ill influence the scope of the e-amination.
2. ?-tent to !hich change in the compan"*s organi5ation !ill influence the scope of the
e-amination.
C. 3etails of potential problems !hich the auditors belie&e might cause a ualified opinion.
3. 3etails of the procedures !hich the auditors intend to appl".

60. 0hich statement is correct relating to a potential successor auditor*s responsibilit" for
communicating !ith the predecessor auditors in connection !ith a prospecti&e ne! audit
client1
A. #he successor auditors ha&e no responsibilit" to contact the predecessor auditors.
2. #he successor auditors should obtain permission from the prospecti&e client to contact the
predecessor auditors.
C. #he successor auditors should contact the predecessors regardless of !hether the
prospecti&e client authori5es contact.
3. #he successor auditors need not contact the predecessors if the successors are a!are of all
a&ailable rele&ant facts.

61. 0hich of the follo!ing situations !ould most likel" reuire special audit planning b" the
auditors1
A. ;ome items of factor" and office euipment do not bear identification numbers.
2. 3epreciation methods used on the client*s ta- return differ from those used on the books.
C. Assets costing less than E)00 are e-pensed e&en though the e-pected life e-ceeds one "ear.
3. 8n&entor" is comprised of precious stones.

6%. 0hen planning an audit, an auditor should9
A. Consider !hether the e-tent of substanti&e procedures ma" be reduced based on the results
of the internal control uestionnaire.
2. 6ake preliminar" 7udgments about materialit" le&els for audit purposes.
C. Conclude !hether changes in compliance !ith prescribed control procedures 7ustifies
reliance on them.
3. Prepare a preliminar" draft of the management representation letter.

6-1(
6'. An auditor !ho accepts an audit engagement and does not possess the industr" e-pertise
of the business entit", should9
A. ?ngage financial e-perts familiar !ith the nature of the business entit".
2. >btain a kno!ledge of matters that relate to the nature of the entit"*s business.
C. Refer a substantial portion of the audit to another CPA !ho !ill act as the principal
auditor.
3. $irst inform management that an unualified opinion cannot be issued.

6(. 0ith respect to the auditor*s planning of a "ear-end audit, !hich of the follo!ing
statements is al!a"s true1
A. An engagement should not be accepted after the fiscal "ear-end.
2. An in&entor" count must be obser&ed at the balance sheet date.
C. #he client*s audit committee should not be told of an" specific audit procedures !hich !ill
be performed.
3. 8t is an acceptable practice to carr" out parts of the e-amination at interim dates.

6). Fa!kins reuested permission to communicate !ith the predecessor auditor and re&ie!
certain portions of the predecessor auditor*s !orking papers. #he prospecti&e client*s refusal
to permit this !ill bear directl" on Fa!kins* decision concerning the9
A. Adeuac" of the preplanned audit program.
2. Abilit" to establish consistenc" in application of accounting principles bet!een "ears.
C. Apparent scope limitation.
3. 8ntegrit" of management.

66. #he auditor faces a risk that the audit !ill not detect material misstatements in the
financial statements. 8n regard to minimi5ing this risk, the auditor primaril" relies on9
A. ;ubstanti&e procedures.
2. #ests of controls.
C. 8nternal control.
3. ;tatistical anal"sis.

6-1)
6+. An abnormal fluctuation in gross profit that might suggest the need for e-tended audit
procedures for sales and in&entories !ould most likel" be identified in the planning phase of
the audit b" the use of9
A. #ests of transactions and balances.
2. An assessment of internal control.
C. ;peciali5ed audit programs.
3. Anal"tical procedures.

6,. 2efore accepting an audit engagement, a successor auditor should make specific inuiries
of the predecessor auditor regarding the predecessor*s9
A. A!areness of the consistenc" in the application of generall" accepted accounting
principles bet!een accounting periods.
2. ?&aluation of all matters of continuing accounting significance.
C. >pinion of an" subseuent e&ents occurring since the predecessor*s audit report !as
issued.
3. Understanding as to the reasons for the change of auditors.

6.. 0hich of the follo!ing is least likel" to be included in an auditor*s inuir" of
management !hile obtaining information to identif" the risks of material misstatement due to
fraud1
A. Are all financial reporting operations at one location1
2. 3oes it ha&e kno!ledge of fraud or suspect fraud1
C. 3oes it ha&e programs to mitigate fraud risks1
3. Fas it reported to the audit committee the nature of the compan"*s internal control1

+0. An auditor selects a sample from the file of shipping documents to determine !hether
in&oices !ere prepared. #his test is performed to satisf" the audit ob7ecti&e of9
A. Accurac".
2. Completeness.
C. Control.
3. ?-istence.

6-16
+1. 8ndi&iduals !ho commit fraud are ordinaril" able to rationali5e the act and also ha&e an9

A. >ption A
2. >ption 2
C. >ption C
3. >ption 3

+%. 0hich of the follo!ing is not a reuired source of information for the auditors* assessment
of fraud risk1
A. 3iscussion among audit team members.
2. $raud risk factors.
C. Results of tests of controls.
3. 8nuir" of management and others.

+'. Auditors must assess fraud risk on e&er" audit and respond to the risks that are identified.
0hich of the follo!ing is not a procedure reuired to further address the fraud risk of
management o&erride of internal control1
A. Re&ie!ing accounting estimates for biases.
2. ?-amining ph"sical controls o&er assets.
C. ?&aluating the business rationale for significant unusual transactions.
3. ?-amining 7ournal entries and other ad7ustments for e&idence of fraud.

6-1+
Essa Questions

+(. ?ngagement letters are used b" most auditors in performing professional ser&ices.
a. 3escribe the purpose of an engagement letter.
b. 4ist four items that are normall" included in an engagement letter.

+). As a part of the planning process, the auditors often prepare an audit plan, an audit
program, and a time budget.
a. 3escribe an audit plan and e-plain its purpose.
b. 3escribe an audit program and e-plain its purpose.
c. 3escribe a time budget and e-plain its purpose.

+6. Auditors perform &arious tasks in planning an audit engagement. Pro&ide an o&erall
description of ho! each task is performed and its purpose.
a. >btain an understanding of the client*s business.
b. Assess audit risk and materialit" for the engagement.
c. Assess fraud risk.
d. Assess the risk of material misstatement of assertions about financial statement accounts
and classes of transactions.

6-1,
++. 6an" auditors take an approach to assessing the risk of material misstatement b"
beginning !ith an assessment of business risks.
a. 3efine business risks.
b. 0h" ha&e auditors found it effecti&e to take the approach of assessing business risks1
c. 8dentif" a business risk and e-plain ho! it might affect the auditor*s audit procedures.

6-1.
Chapter 06 Audit Planning, Understanding the Client, Assessing Risks, and
Responding Ans!er De"

True / False Questions

1. Audit committees should be made up of the most ualified directors regardless of !hether
the" are part of management of the compan".
FA!"E

Difficulty: Hard

%. Anal"tical procedures are seldom used for planning an audit engagement because the" are
substanti&e procedures.
FA!"E

Difficulty: Easy

'. Preliminar" arrangements !ith clients should be set forth in the management letter.
FA!"E

Difficulty: Easy

(. An audit plan includes a detailed listing of the audit procedures to be performed in the
&erification of items in the financial statements.
FA!"E

Difficulty: Medium

6-%0
). #he auditors* tests of controls are designed to substantiate the fairness of specific financial
statement accounts.
FA!"E

Difficulty: Medium

6. At least a portion of the auditors* consideration of internal control usuall" is performed at
an interim date rather than at the balance sheet date.
TRUE

Difficulty: Medium

+. #he substanti&e approach to an audit is appropriate for man" small businesses.
TRUE

Difficulty: Medium

,. Confirming a bank account establishes e-istence but not rights to the cash balance.
FA!"E

Difficulty: Hard

.. #he completeness of recording of assets is generall" &erified b" tracing from the source
documents to the recorded entr".
TRUE

Difficulty: Hard

10. /ouching the acuisition of assets is an audit procedure that is often performed to
establish the &aluation of the assets.
TRUE

Difficulty: Hard

6-%1

Multiple Choice Questions

11. 0hich of the follo!ing factors most likel" !ould cause a CPA to not accept a ne! audit
engagement1
A. #he prospecti&e client has fired its prior auditor.
2. #he CPA lacks a thorough understanding of the prospecti&e client*s operations and
industr".
C. #he CPA is unable to re&ie! the predecessor auditor*s !orking papers.
#$ #he prospecti&e client is un!illing to make financial records a&ailable to the CPA.

Difficulty: Medium
Source: AICPA

1%. 0hich of the follo!ing factors most likel" !ould heighten an auditor*s concern about the
risk of fraudulent financial reporting1
A. 4arge amounts of liuid assets that are easil" con&ertible into cash.
2. 4o! gro!th and profitabilit" as compared to other entit"*s in the same industr".
C. $inancial management*s participation in the initial selection of accounting principles.
#$ An o&erl" comple- organi5ational structure in&ol&ing unusual lines of authorit".

Difficulty: Hard
Source: AICPA

1'. 0hich of the follo!ing factors !ould most likel" cause a CPA to decide not to accept a
ne! audit engagement1
A. 4ack of understanding of the potential client*s internal auditors* computer-assisted audit
techniues.
%$ 6anagement*s disregard for internal control.
C. #he e-istence of related part" transactions.
3. 6anagement*s attempt to meet earnings per share gro!th rate goals.

Difficulty: Hard

6-%%
1(. 0hich of the follo!ing matters is generall" included in an auditor*s engagement letter1
A$ 4imitations of the engagement.
2. $actors to be considered in establishing preliminar" 7udgments about materialit".
C. 6anagement*s liabilit" for illegal acts committed b" its emplo"ees.
3. #he auditor*s responsibilit" to obtain negati&e assurance relating to the occurrence of
illegal acts.

Difficulty: Hard

1). 0hich of the follo!ing !ould heighten an auditor*s concern about the risk of fraudulent
A$ 8nabilit" to generate positi&e cash flo!s from operations, !hile reporting large increases in
earnings.
2. 6anagement*s lack of interest in increasing the di&idend paid on common stock.
C. 4arge amounts of liuid assets that are easil" con&ertible into cash.
3. 8nabilit" to borro! necessar" capital !ithout obtaining !ai&ers on debt co&enants.

Difficulty: Hard
Source: AICPA

16. #o best test e-istence, an auditor !ould sample from the9
A$ :eneral 4edger to source documents.
2. :eneral 4edger to the financial statements.
C. ;ource documents to the general ledger.
3. ;ource documents to 7ournals.

Difficulty: Medium

1+. #he auditors* understanding established !ith a client should be established through a<an=
A. >ral communication !ith the client.
%$ 0ritten communication !ith the client.
C. 0ritten or oral communication !ith the client.
3. Completel" detailed audit plan.

Difficulty: Easy

6-%'
1,. 0hich of the follo!ing !ould be least likel" to be considered an audit planning
procedure1
A. Use an engagement letter.
2. 3e&elop the o&erall audit strateg"
C$ Perform the risk assessment.
3. 3e&elop the audit plan.

Difficulty: Medium

1.. 0hile assessing the risks of material misstatement auditors identif" risks, relate risk to
!hat could go !rong, consider the magnitude of risks and
A. Assess the risk of misstatements due to illegal acts.
2. Consider the comple-it" of the transactions in&ol&ed.
C$ Consider the likelihood that the risks could result in material misstatements.
3. 3etermine materialit" le&els.

Difficulty: Medium

%0. 0hich of the follo!ing is correct concerning reuirements about auditor communications
about fraud1
A$ $raud that in&ol&es senior management should be reported directl" to the audit committee
regardless of the amount in&ol&ed.
2. All fraud !ith a material effect on the financial statements should be reported directl" b"
the auditor to the ;ecurities and ?-change Commission.
C. $raud !ith a material effect on the financial statements should ordinaril" be disclosed b"
the auditor through use of an @emphasis of a matter@ paragraph added to the audit report.
3. #he auditor has no responsibilit" to disclose fraud outside the entit" under an"
circumstances.

Difficulty: Hard

6-%(
%1. A predecessor auditor is reuired to attempt to initiate communication !ith the successor
auditor9

A. >ption A
2. >ption 2
C. >ption C
#$ >ption 3

Difficulty: Hard

%%. 0hich measure of materialit" <or both= considers uantitati&e considerations1

A$ >ption A
2. >ption 2
C. >ption C
3. >ption 3

Difficulty: Medium

6-%)
%'. 0hich of the follo!ing factors most likel" !ould lead a CPA to conclude that a potential
audit engagement should not be accepted1
A. #here are significant related part" transactions that management claims occurred in the
ordinar" course of business.
2. 8nternal control acti&ities reuiring the segregation of duties are sub7ect to management
o&erride.
C. 6anagement continues to emplo" an inefficient s"stem of information technolog" to
record financial transactions.
#$ 8t is unlikel" that sufficient e&idence is a&ailable to support an opinion on the financial
statements.

Difficulty: Medium
Source: AICPA

%(. 8n using the information on the statement of cash flo!s !hile obtaining an understanding
of a profitable, gro!ing compan", !hich of the follo!ing !ould ordinaril" be least surprising
to an auditor1
A. 3ecreases in accounts pa"able.
2. 3ecreases in accounts recei&able.
C$ Aegati&e cash flo!s from in&esting.
3. Aegati&e operating cash flo!s.

Difficulty: Hard

%). Audits of financial statements are designed to obtain reasonable assurance of detecting
material misstatements due to9

A$ >ption A
2. >ption 2
C. >ption C
3. >ption 3

Difficulty: Medium

6-%6
%6. 0hich of the follo!ing is not one of the assertions made b" management about an
account balance1
A$ Rele&ance.
2. ?-istence.
C. /aluation.

Difficulty: Easy

%+. 0hen a compan" has changed auditors, according to the Professional ;tandards9
A$ #he successor auditor has the responsibilit" to initiate contact !ith the predecessor auditor
to ask about the client before the engagement is acceptedB the predecessor has no
responsibilit" to initiate this contact, e&en !hen a!are of matters bearing on the integrit" of
management.
2. #he predecessor must respond full" to all inuiries made b" the successor auditor.
C. #he successor must discuss !ith the predecessor matters bearing on the engagement prior
to accepting the engagement.
3. #he successor ma" choose not to attempt an" communication !ith the predecessor auditor.

Difficulty: Hard

%,. 0hich of the follo!ing procedures is not performed as a part of planning an audit
engagement1
A. Re&ie!ing the !orking papers of the prior "ear.
2. Performing anal"tical procedures.
C$ Confirmation of all ma7or accounts.
3. 3esigning an audit program.

Difficulty: Hard

6-%+
%.. #he risk of a material misstatement occurring in an account, assuming an absence of
internal control, is referred to as9
A. Account risk.
2. Control risk.
C. 3etection risk.
#$ 8nherent risk.

Difficulty: Medium

'0. 0hich of the follo!ing is least likel" to be considered a financial statement audit risk
factor1
A$ 6anagement operating and financing decisions are dominated b" top management.
2. A ne! client !ith no prior audit histor".
C. Rate of change in the entit"*s industr" is rapid.
3. Profitabilit" of the entit" relati&e to its industr" is inconsistent.

Difficulty: Hard

'1. 0hich of the follo!ing is an e-ample of fraudulent financial reporting1
A$ Compan" management falsifies in&entor" count tags thereb" o&erstating ending in&entor"
and understating cost of goods sold.
2. An emplo"ee di&erts customer pa"ments to his personal use, concealing his actions b"
debiting an e-pense account, thus o&erstating e-penses.
C. An emplo"ee steals in&entor and the @shrinkage@ is recorded in cost of goods sold.
3. An emplo"ee @borro!s@ tools from the compan" and neglects to return themB the cost is
reported as a miscellaneous operating e-pense.

Difficulty: Medium

'%. 0hich of the follo!ing is most likel" to be considered a risk factor relating to fraudulent
A. 4o! turno&er of senior management.
%$ ?-treme degree of competition !ithin the industr".
C. Capital structure including &arious operating subsidiaries.
3. ;ales goals in e-cess of an" of the preceding three "ears.

Difficulty: Hard

6-%,
''. 0hich of the follo!ing conditions identified during the audit increases the risk of
emplo"ee fraud1
A. 4arge amounts of cash in the bank.
2. ?-istence of a mandator" &acation polic" for emplo"ees performing ke" functions.
C$ 8n&entor" items of small si5e, but high &alue.
3. Presence of reconciling items on a client prepared "ear-end proof of cash.

Difficulty: Medium

'(. 0hich of the follo!ing statements is accurate about @fraud risk factors@ considered !hen
conducting an audit1
A. $actors !hose presence indicates that fraud e-ists.
%$ $actors !hose presence often ha&e been obser&ed in circumstances !here frauds ha&e
occurred.
C. $actors !hose presence !ill reuire modification to planned audit procedures.
3. $actors obtained during the audit !hich lead to reuired communications !ith the audit
committee.

Difficulty: Hard

'). 0hich of the follo!ing is not an e-ample of a likel" ad7ustment in the auditors* o&erall
audit approach !hen significant risk is found to e-ist1
A. Appl" increased professional skepticism about material transactions.
%$ 8ncrease the assessed le&el of detection risk.
C. Assign personnel !ith particular skill to areas of high risk.
3. >btain increased e&idence about the appropriateness of management*s selection of
accounting principles.

Difficulty: Medium

'6. 0hich of the follo!ing is least likel" to be reuired on an audit1
A. ?&aluate the business rationale for significant, unusual transactions.
%$ 6ake a legal determination of !hether fraud has occurred.
C. Re&ie! accounting estimates for biases.
3. #est appropriateness of 7ournal entries and ad7ustments.

Difficulty: Medium

6-%.
'+. 0hich of the follo!ing is <are= considered a further audit procedure<s= that ma" be
designed after assessing the risks of material misstatement1

A$ >ption A
2. >ption 2
C. >ption C
3. >ption 3

Difficulty: Easy

',. 0hich of the follo!ing circumstances !ould an auditor most likel" consider a risk factor
relating to misstatements arising from fraudulent financial reporting1
A. ;e&eral members of management ha&e recentl" purchased additional shares of the entit"*s
stock.
2. ;e&eral members of the board of directors ha&e recentl" sold shares of the entit"*s stock.
C. #he entit" distributes financial forecasts to financial anal"sts that predict conser&ati&e
operating results.
#$ 6anagement is interested in maintaining the entit"*s earnings trend b" using aggressi&e
accounting practices.

Difficulty: Medium
Source: AICPA

'.. A successor auditor is reuired to attempt communication !ith the predecessor auditor
prior to
A. Performing test of controls.
2. #esting beginning balances for the current "ear.
C. 6aking a proposal for the audit engagement.
#$ Accepting the engagement.

Difficulty: Medium
Source: AICPA

6-'0
(0. 8f the business en&ironment is e-periencing a recession, the auditor most likel" !ould
focus increased attention on !hich of the follo!ing accounts1
A. Purchase returns and allo!ances.
%$ Allo!ance for doubtful accounts.
C. Common stock.
3. Aoncontrolling interest of a subsidiar" purchased during the "ear.

Difficulty: Hard
Source: AICPA

(1. #he risk that the auditors* procedures !ill lead them to conclude that a material
misstatement does not e-ist in an account balance !hen in fact such a misstatement does e-ist
is referred to as9
A. Account risk.
2. Control risk.
C$ 3etection risk.
3. 8nherent risk.

Difficulty: Medium

(%. 0hich of the follo!ing statements is correct regarding the auditor*s determination of
materialit"1
A. #he planning le&el of materialit" should normall" be the larger of the amount considered
for the balance sheet &ersus the income statement.
%$ #he auditors* planning le&el of materialit" ma" be disaggregated into smaller @tolerable
misstatements@ for the &arious accounts.
C. Auditors ma" use &arious rules of thumb to arri&e at an e&aluation le&el of materialit", but
not for determining the planning le&el of materialit".
3. #he amount used for the planning should eual that used for e&aluation.

Difficulty: Hard

6-'1
('. #he auditors must consider materialit" in planning an audit engagement. 6aterialit" for
planning purposes is9
A. #he auditors* preliminar" estimate of the largest amount of misstatement that !ould be
%$ #he auditors* preliminar" estimate of the smallest amount of misstatement that !ould be
C. #he auditors* preliminar" estimate of the amount of misstatement that !ould be material to
the client*s balance sheet.
3. An amount that cannot be uantitati&el" stated since it depends on the nature of the item.

Difficulty: Medium

((. 0hich of the follo!ing topics is not normall" included in an engagement letter1
A$ #he auditors* preliminar" assessment of internal control.
2. #he auditors* estimate of the fee for the engagement.
C. 4imitations on the scope of the engagement.
3. A description of responsibilit" for the detection of fraud.

Difficulty: Hard

(). 0hich of the follo!ing is most likel" to be an o&erall response to fraud risks identified in
an audit1
A. >nl" use certified public accountants on the engagement.
2. Place increased emphasis on the audit of ob7ecti&e transactions rather than sub7ecti&e
transactions.
C. ;uper&ise members of the audit team less closel" and rel" more upon 7udgment.
#$ Use less predictable audit procedures.

Difficulty: Hard

6-'%
(6. 0hich of the follo!ing is not an assertion that is made in the financial statements b"
management concerning each ma7or account balance1
A. Completeness.
C$ 4egalit".
3. /aluation.

Difficulty: Easy

(+. #ests for unrecorded assets t"picall" in&ol&e tracing from9
A$ ;ource documents to recorded 7ournal entries.
2. ;ource documents to obser&ations.
C. Recorded 7ournal entries to documents.
3. Recorded 7ournal entries to obser&ations.

Difficulty: Hard

(,. #racing from source documents for!ard to ledgers is most likel" to address !hich
assertion related to posted entries9
A$ Completeness.
2. ?-istence.
C. Rights.
3. /aluation.

Difficulty: Hard

(.. 3etermining that recei&ables are presented at net-reali5able &alue is most directl" related
to !hich management assertion1
A. ?-istence.
2. Rights.
C$ /aluation.
3. Presentation and disclosure.

Difficulty: Medium

6-''
)0. 0hich of the follo!ing is not a general ob7ecti&e for the audit of asset accounts1
A. ?stablishing e-istence of assets.
2. ?stablishing proper &aluation of assets.
C$ ?stablishing proper liabilities relating to assets.
3. ?stablishing the completeness of assets.

Difficulty: Medium

)1. 0hich of the follo!ing is not used b" auditors to establish the completeness of recorded
assets1
A. Assessing control risk.
2. #racing from source documents to entries in the accounting records.
C. Performing anal"tical procedures.
#$ /ouching transactions.

Difficulty: Hard

)%. #o test for unsupported entries in the 7ournals, the direction of audit testing should be to
the9
A. 4edger entries.
2. Cournal entries.
C$ >riginal source documents.
3. $inancial statements.

Difficulty: Hard

)'. A form filed !ith the ;?C !hen a compan" changes auditors is a9
A$ $orm ,-D.
2. $orm 10-D.
C. $orm ;-1.
3. $orm 2-1.

Difficulty: Medium

6-'(
)(. 0hich of the follo!ing is least likel" to render material a uantitati&el" small
misstatement material1
A. Affects the registrant*s compliance !ith regulator" reuirements.
2. 6asks a change in earnings or other trends.
C. Arises from an item not capable of precise measurement.
#$ #he #ransaction in&ol&es a related part".

Difficulty: Hard

)). A successor auditor has accepted an engagement that !as pre&iousl" performed b" a
predecessor auditor and, prior to accepting the engagement, has communicated !ith the
predecessor. 0hen the successor belie&es that the predecessor has performed satisfactor"
pre&ious audits, !hich of the follo!ing is correct1
A. A second communication is reuired and must include details of pre&ious audits.
%$ >rdinaril" the successor auditors ma" be able to accept the opening balances of the current
"ear !ith a minimum of &erification !ork.
C. Absent ongoing litigation, a predecessor must pro&ide all !orking papers reuested b" the
predecessor.
3. #he client should be informed of the need to perform a detailed audit of all opening
balances.

Difficulty: Hard

)6. #he first standard of field !ork recogni5es that earl" appointment of the independent
auditors has man" ad&antages to the auditors and the client. 0hich of the follo!ing
ad&antages is least likel" to occur as a result of earl" appointment of the auditors1
A. #he auditors !ill be able to plan the audit !ork so that it ma" be done e-peditiousl".
%$ #he auditors !ill be able to complete substanti&e procedures prior to "ear-end.
C. #he auditors !ill be able to better plan for the obser&ation of the ph"sical in&entories.
3. #he auditors !ill be able to perform the e-amination more efficientl" and !ill be finished
at an earl" date after the "ear-end.

Difficulty: Medium
Source: AICPA

6-')
)+. Preliminar" arrangements agreed to b" the auditors and the client should be reduced to
!riting b" the auditors. #he best place to set forth these arrangements is in9
A. A memorandum to be placed in the permanent section of the auditing !orking papers.
%$ An engagement letter.
C. A client representation letter.
3. A confirmation letter attached to the constructi&e ser&ices letter.

Difficulty: Easy
Source: AICPA

),. #he auditors are planning an audit engagement for a ne! client in a business that is
unfamiliar to the auditors. 0hich of the follo!ing !ould be the most useful source of
information for the auditors during the preliminar" planning stage !hen the" are tr"ing to
obtain a general understanding of audit problems that might be encountered1
A. Client manuals of accounts and charts of accounts.
2. A8CPA 8ndustr" Audit :uides.
C$ Prior-"ear !orking papers of the predecessor auditors.
3. 4atest annual and interim financial statements issued b" the client.

Difficulty: Hard
Source: AICPA

).. #he auditors !ill not ordinaril" initiate discussion !ith the audit committee concerning
the9
A. ?-tent to !hich the !ork of internal auditors !ill influence the scope of the e-amination.
2. ?-tent to !hich change in the compan"*s organi5ation !ill influence the scope of the
e-amination.
C. 3etails of potential problems !hich the auditors belie&e might cause a ualified opinion.
#$ 3etails of the procedures !hich the auditors intend to appl".

Difficulty: Hard
Source: AICPA

6-'6
60. 0hich statement is correct relating to a potential successor auditor*s responsibilit" for
communicating !ith the predecessor auditors in connection !ith a prospecti&e ne! audit
client1
A. #he successor auditors ha&e no responsibilit" to contact the predecessor auditors.
%$ #he successor auditors should obtain permission from the prospecti&e client to contact the
predecessor auditors.
C. #he successor auditors should contact the predecessors regardless of !hether the
prospecti&e client authori5es contact.
3. #he successor auditors need not contact the predecessors if the successors are a!are of all
a&ailable rele&ant facts.

Difficulty: Medium
Source: AICPA

61. 0hich of the follo!ing situations !ould most likel" reuire special audit planning b" the
auditors1
A. ;ome items of factor" and office euipment do not bear identification numbers.
2. 3epreciation methods used on the client*s ta- return differ from those used on the books.
C. Assets costing less than E)00 are e-pensed e&en though the e-pected life e-ceeds one "ear.
#$ 8n&entor" is comprised of precious stones.

Difficulty: Medium
Source: AICPA

6%. 0hen planning an audit, an auditor should9
A. Consider !hether the e-tent of substanti&e procedures ma" be reduced based on the results
of the internal control uestionnaire.
%$ 6ake preliminar" 7udgments about materialit" le&els for audit purposes.
C. Conclude !hether changes in compliance !ith prescribed control procedures 7ustifies
reliance on them.
3. Prepare a preliminar" draft of the management representation letter.

Difficulty: Medium
Source: AICPA

6-'+
6'. An auditor !ho accepts an audit engagement and does not possess the industr" e-pertise
of the business entit", should9
A. ?ngage financial e-perts familiar !ith the nature of the business entit".
%$ >btain a kno!ledge of matters that relate to the nature of the entit"*s business.
C. Refer a substantial portion of the audit to another CPA !ho !ill act as the principal
auditor.
3. $irst inform management that an unualified opinion cannot be issued.

Difficulty: Medium
Source: AICPA

6(. 0ith respect to the auditor*s planning of a "ear-end audit, !hich of the follo!ing
statements is al!a"s true1
A. An engagement should not be accepted after the fiscal "ear-end.
2. An in&entor" count must be obser&ed at the balance sheet date.
C. #he client*s audit committee should not be told of an" specific audit procedures !hich !ill
be performed.
#$ 8t is an acceptable practice to carr" out parts of the e-amination at interim dates.

Difficulty: Medium
Source: AICPA

6). Fa!kins reuested permission to communicate !ith the predecessor auditor and re&ie!
certain portions of the predecessor auditor*s !orking papers. #he prospecti&e client*s refusal
to permit this !ill bear directl" on Fa!kins* decision concerning the9
A. Adeuac" of the preplanned audit program.
2. Abilit" to establish consistenc" in application of accounting principles bet!een "ears.
C. Apparent scope limitation.
#$ 8ntegrit" of management.

Difficulty: Medium
Source: AICPA

6-',
66. #he auditor faces a risk that the audit !ill not detect material misstatements in the
financial statements. 8n regard to minimi5ing this risk, the auditor primaril" relies on9
A$ ;ubstanti&e procedures.
2. #ests of controls.
C. 8nternal control.
3. ;tatistical anal"sis.

Difficulty: Easy
Source: AICPA

6+. An abnormal fluctuation in gross profit that might suggest the need for e-tended audit
procedures for sales and in&entories !ould most likel" be identified in the planning phase of
the audit b" the use of9
A. #ests of transactions and balances.
2. An assessment of internal control.
C. ;peciali5ed audit programs.
#$ Anal"tical procedures.

Difficulty: Easy
Source: AICPA

6,. 2efore accepting an audit engagement, a successor auditor should make specific inuiries
of the predecessor auditor regarding the predecessor*s9
A. A!areness of the consistenc" in the application of generall" accepted accounting
principles bet!een accounting periods.
2. ?&aluation of all matters of continuing accounting significance.
C. >pinion of an" subseuent e&ents occurring since the predecessor*s audit report !as
issued.
#$ Understanding as to the reasons for the change of auditors.

Difficulty: Medium
Source: AICPA

6-'.
6.. 0hich of the follo!ing is least likel" to be included in an auditor*s inuir" of
management !hile obtaining information to identif" the risks of material misstatement due to
fraud1
A$ Are all financial reporting operations at one location1
2. 3oes it ha&e kno!ledge of fraud or suspect fraud1
C. 3oes it ha&e programs to mitigate fraud risks1
3. Fas it reported to the audit committee the nature of the compan"*s internal control1

Difficulty: Hard

+0. An auditor selects a sample from the file of shipping documents to determine !hether
in&oices !ere prepared. #his test is performed to satisf" the audit ob7ecti&e of9
A. Accurac".
%$ Completeness.
C. Control.
3. ?-istence.

Difficulty: Hard
Source: AICPA

+1. 8ndi&iduals !ho commit fraud are ordinaril" able to rationali5e the act and also ha&e an9

A$ >ption A
2. >ption 2
C. >ption C
3. >ption 3

Difficulty: Easy

6-(0
+%. 0hich of the follo!ing is not a reuired source of information for the auditors* assessment
of fraud risk1
A. 3iscussion among audit team members.
2. $raud risk factors.
C$ Results of tests of controls.
3. 8nuir" of management and others.

Difficulty: Medium

+'. Auditors must assess fraud risk on e&er" audit and respond to the risks that are identified.
0hich of the follo!ing is not a procedure reuired to further address the fraud risk of
management o&erride of internal control1
A. Re&ie!ing accounting estimates for biases.
%$ ?-amining ph"sical controls o&er assets.
C. ?&aluating the business rationale for significant unusual transactions.
3. ?-amining 7ournal entries and other ad7ustments for e&idence of fraud.

Difficulty: Medium

Essa Questions

+(. ?ngagement letters are used b" most auditors in performing professional ser&ices.
a. 3escribe the purpose of an engagement letter.
b. 4ist four items that are normall" included in an engagement letter.
a. #he purpose of an engagement letter is to establish a !ritten contract bet!een the auditors
and the client. #hus, the letter tends to pre&ent misunderstandings bet!een those t!o parties.
b. 8tems that are normall" included in an engagement letter include <onl" four reuired=9
Aame of the entit" and statements to be e-amined.
;cope of ser&ices.
3escription of responsibilit" for detecting fraud.
>bligations of the client*s staff to prepare schedules.
$ee or method of determining fee.
Pro&ision for client*s acceptance signature.
6anagement*s obligation to conclude about the materialit" of misstatements not recorded.

Difficulty: Medium

6-(1
+). As a part of the planning process, the auditors often prepare an audit plan, an audit
program, and a time budget.
a. 3escribe an audit plan and e-plain its purpose.
b. 3escribe an audit program and e-plain its purpose.
c. 3escribe a time budget and e-plain its purpose.
a. #he audit plan is an o&er&ie! of the engagement, outlining the nature and characteristics of
the client and its en&ironment and the o&erall audit strateg". #he audit plan documents the
ma7or considerations in planning the engagement.
b. #he audit program is a detailed listing of audit procedures to be performed in the
engagement. 8t is a tool for scheduling and controlling the !ork.
c. #he time budget includes an estimate of the time reuired for each audit task. 8t ser&es as a
basis for the fee estimate, controls the audit !ork, and ma" be used to e&aluate performance
b" the audit staff.

Difficulty: Medium

6-(%
+6. Auditors perform &arious tasks in planning an audit engagement. Pro&ide an o&erall
description of ho! each task is performed and its purpose.
a. >btain an understanding of the client*s business.
b. Assess audit risk and materialit" 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. #he auditors obtain an understanding of the client*s business through procedures such as
inuir" of client personnel, obser&ing client operations, stud"ing A8CPA Audit and
Accounting :uides and 8ndustr" Risk Alerts and other industr" publications, and re&ie!ing
prior annual reports, ;?C filings, ta- returns, and interim financial statements. An
understanding of the client*s business is necessar" to the e&aluation of the appropriateness of
the client*s transactions, accounting principles used, and the estimates and assumptions
embodied in the financial statements. 8n addition, it pro&ides part of the information to assess
the risks of material misstatement.
b. 6aterialit" for planning purposes is the auditors* preliminar" estimate of the smallest
amount of misstatement that !ould affect the decisions of reasonable users of the financial
statements. #he auditors use 7udgment to determine the amount of planning materialit",
usuall" based on some rule of thumb. Audit risk is the possibilit" that the auditors !ill fail to
modif" the opinion on financial statements that are materiall" misstated. #he auditors assess
this risk b" considering characteristics of management, operations, and the engagement.
Audit risk and materialit" determine the o&erall scope of the engagement. #he lo!er the
amount of planning materialit", the more e-tensi&e the scope of the audit. #he higher the risk
of misstatement of the financial statements, the more e-tensi&e the scope of the audit.
c. #he auditors are reuired to assess fraud risk on e&er" audit. #his assessment is based on
information deri&ed from <1= the discussion among the audit staff about the risk of fraud, <%=
inuiries of management, the audit committee, internal auditors and others, <'= the results of
planning anal"tical procedures, and consideration of fraud risk factors. 8f the auditors identif"
fraud risks the" ma" respond !ith <1= an o&erall response to the !a" the audit is conducted, or
<%= a response specificall" to address the identified risk. 8n all audits the" must include
responses to further address the risk of management o&erride of internal control.
d. #he 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 b" considering the information about the client and its en&ironment including
internal control, and the nature of the account. #hese risk assessments are used to determine
the nature, timing, and e-tent of the substanti&e procedures that !ill reduce the detection risk
to the appropriate le&el.

Difficulty: Hard

6-('
++. 6an" auditors take an approach to assessing the risk of material misstatement b"
beginning !ith an assessment of business risks.
a. 3efine business risks.
b. 0h" ha&e auditors found it effecti&e to take the approach of assessing business risks1
c. 8dentif" a business risk and e-plain ho! it might affect the auditor*s audit procedures.
a. 2usiness risks are those that threaten management*s abilit" to achie&e the organi5ation*s
ob7ecti&es.
b. Auditors ha&e found this approach effecti&e because significant business risks often create
related risks of material misstatement <inherent risks= that the auditors should address in
designing their audit procedures.
c. ;tudents ma" pro&ide a number of e-amples. #he te-tbook pro&ides the follo!ing9
Assume that the auditors ha&e identified as a significant business risk and audit risk that sales
personnel, informall" or through !ritten side agreements, ma" be modif"ing the terms of
contracts !ith customers !hich ma" affect the amount of re&enue that should be recogni5ed.
#he auditors must design tests that are focused on determining !hether such modifications of
terms ha&e been made, perhaps b" obtaining tailored confirmations from customers about the
e-istence of such side agreements.

Difficulty: Hard

6-((

Chapter 6 Audit Planning Understanding The Client and Asse

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Chapter 06 - Audit Planning, Understanding the Client, Assessing Risks, and Responding

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