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9-22

The following questions deal with materiality. Choose the best response.
a. Which one of the following statements is correct concerning the concept of
materiality?
(1) Materiality is determined by reference to guidelines established by the AICPA.
(2) Materiality depends only on the dollar amount of an item relative to other
items in the financial statements.
(3) Materiality depends on the nature of an item rather than the dollar amount.
(4) Materiality is a matter of professional judgment.
Answer: (4) Materiality is a matter of professional judgment.
b. Which of the following is not correct about materiality?
(1) The concept of materiality recognizes that some matters are important for fair
presentation of financial statements in conformity with accounting standards,
whereas other matters are not important.
(2) An auditor considers materiality for planning purposes in terms of the largest
aggregate level of misstatements that could be considered material to any one of
the financial statements.
(3) Materiality judgments are made in light of surrounding circumstances and
necessarily involve both quantitative and qualitative judgments.
(4) An auditors consideration of materiality is influenced by the auditors
perception of the needs of a reasonable person who will rely on the financial
statements.
Answer: (2) An auditor considers materiality for planning purposes in
terms of the largest aggregate level of misstatements that could be
considered material to any one of the financial statements.
c. In considering materiality for planning purposes, an auditor believes that
misstatements aggregating $10,000 will have a material effect on an entitys income
statement, but that misstatements will have to aggregate $20,000 to materially affect
the balance sheet. Ordinarily, it is appropriate to design audit procedures that are
expected to detect misstatements that aggregate
(1) $10,000
(2) $15,000
(3) $20,000
(4) $30,000
Answer: (1) $10,000
9-23
The following questions concern audit risk. Choose the best response.
a. Some account balances, such as those for pensions and leases, are the result of
complex calculations. The susceptibility to material misstatements in these types of
accounts is defined as
(1) Audit risk.

(2) Detection risk.


(3) Sampling risk.
(4) Inherent risk.
Answer: (4) inherent risk.
b. Inherent risk and control risk differ from planned detection risk in that they
(1) Arise from the misapplication of auditing procedures.
(2) May be assessed in either quantitative or non quantitative terms.
(3) Exist independently of the financial statement audit.
(4) Can be changed at the auditors discretion.
Answer: (3) exist independently of the financial statement audit.
c. Which of the following best describes the element of inherent risk that underlies the
application of auditing standards?
(1) Cash audit work may have to be carried out in a more conclusive manner than
inventory audit work.
(2) Intercompany transactions are usually subject to less detailed scrutiny than
arms-length transactions with outside parties.
(3) Inventories may require more attention by the auditor on an engagement for
a merchandising enterprise than on an engagement for a public utility.
(4) The scope of the audit need not be expanded if misstatements that arouse
suspicion of fraud are of relatively insignificant amounts.
Answer: (1) Cash audit work may have to be carried out in a more
conclusive manner than inventory audit work.
9-24
The following questions deal with audit risk and evidence. Choose the best response.
a. As the acceptable level of detection risk decreases, an auditor may
(1) Reduce substantive testing by relying on the assessments of inherent risk and
control risk.
(2) Postpone the planned timing of substantive tests from interim dates to the
year-end.
(3) Eliminate the assessed level of inherent risk from consideration as a planning
factor.
(4) Lower the assessed level of control risk from the maximum level to below the
maximum.
Answer: (2) postpone the planned timing of substantive tests from interim
dates to the year-end.
b. As lower acceptable levels of both audit risk and materiality are established, the
auditor should plan more work on individual accounts to
(1) Find smaller misstatements.
(2) Find larger misstatements.
(3) Increase the tolerable misstatement in the accounts.
(4) Increase materiality in the accounts.
Answer: (1) find smaller misstatements.

c. Based on evidence gathered and evaluated, an auditor decides to increase the


assessed level of control risk from that originally planned. To achieve an overall audit
risk level that is substantially the same as the planned audit risk level, the auditor could
(1) Decrease detection risk.
(2) Increase materiality levels.
(3) Decrease substantive testing.
(4) Increase inherent risk.
Answer: (1) decrease detection risk.
10-30
The following are general questions about internal control. Choose the best response.
a. When considering internal control, an auditor must be aware of the concept of
reasonable assurance, which recognizes that the
(1) Employment of competent personnel provides assurance that managements
control objectives will be achieved.
(2) Establishment and maintenance of internal control is an important
responsibility of management and not of the auditor.
(3) Cost of internal control should not exceed the benefits expected to be derived
therefrom.
(4) Separation of incompatible functions is necessary to ascertain that the
internal control is effective.
Answer: (3) cost of internal control should not exceed the benefits expected
to be derived therefrom.
b. Actions, policies, and procedures that reflect the overall attitude of management,
directors and owners of the entity about internal control relate to which of the following
internal control components?
(1) Control environment
(2) Information and communication
(3) Risk assessment
(4) Monitoring
Answer: (1) Control environment
c. Vendor account reconciliations are performed by three clerks in the accounts payable
department on Friday of each week. The accounts payable supervisor reviews the
completed reconciliations the following Monday to ensure they have been completed.
The work performed by the supervisor is an example of which COSO component?
(1) Control activities
(2) Information and communication
(3) Risk assessment
(4) Monitoring
Answer: (4) Monitoring
d. What is the independent auditors principal purpose for obtaining an understanding
of internal control and assessing control risk in a financial statement audit?

(1) To comply with generally accepted accounting principles.


(2) To obtain a measure of assurance of managements efficiency.
(3) To maintain a state of independence in mental attitude during the audit.
(4) To determine the nature, timing, and extent of subsequent audit work.
Answer: (4) To determine the nature, timing, and extent of subsequent
audit work.
10-33
Following are descriptions of ten internal controls.
Required: Indicate which of the five COSO internal control components is
best represented by each internal control.
a. Control environment
b. Risk assessment
c. Control activities
d. Information and communication
e. Monitoring
1. The companys computer systems track individual transactions and automatically
accumulate transactions to create a trial balance.
Answer: Information and Communication.
2. The company must receive university transcripts documenting all college degrees
earned before an individual can begin their first day of employment with the company.
Answer: Control Environment.
3. Senior management obtains data about external events that might affect the entity
and evaluates the impact of that information on its existing accounting processes.
Answer: Risk Assessment.
4. Each quarter, department managers are required to perform a self-assessment of the
departments compliance with company policies. Reports summarizing the results are to
be submitted to the senior executive overseeing that department.
Answer: Monitoring.
5. Before a cash disbursement can be processed, all payee information must be verified
by matching the payee to the companys approved vendor listing.
Answer : Control Activities.
6. The system automatically reconciles the detailed accounts receivable subsidiary
ledger to the accounts receivable general ledger account on daily basis.
Answer: Information and Communication.
7. The company has developed a detailed series of accounting policy and procedures
manuals to help provide detailed instructions to employees about how controls are to be
performed.
Answer: Control Activities.

8. The company has an organizational chart that establishes the formal lines of
reporting and authorization protocols.
Answer: Control Environment.
9. The compensation committee reviews compensation plans for senior executives to
determine if those plans create unintended pressures that might lead to distorted
financial statements.
Answer: Risk Assessment.
10. On a monthly basis, department heads review a budget to actual performance report
and investigate unusual differences.
Answer: Control Activities.