San Jose State University

ACCOUNTING 129A

Chapter 9

1. If it is probable that the judgment of a reasonable person will be changed or influenced by the omission or misstatement of information, then that information is, by definition of FASB Statement No. 2:
   1. material.
   2. insignificant.
   3. significant.
   4. relevant.

2. The scope paragraph of the standard unqualified auditor's report states that "… the standards require that we plan and perform the audit to obtain                                                    assurance about whether the financial statements are free of material misstatement." What type of assurance is given?
   1. Immediate
   2. Limited
   3. Reasonable
   4. Absolute

3. Auditors are responsible for determining whether financial statements are materially misstated, so upon discovering a material misstatement they must bring it to the attention of:
   1. regulators.
   2. the audit firm's managing partner.
   3. the client shareholders.
   4. the client.

0. 1. 1. Audit standards require the auditor to consider materiality early in the audit. Which statement(s) regarding preliminary materiality are true?
1. Preliminary materiality may change during the engagement.

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

1. I only
2. II only
3. both I and II
4. neither are true

1. 1. 2. Why do auditors establish a preliminary judgment about materiality?
         1. To determine the appropriate level of staff to assign to the audit
         2. So that the client can know what records to make available to the auditor
         3. To help plan the appropriate evidence to accumulate
         4. To finalize the control risk assessment

1. 1. 3. If an auditor establishes a relatively high level for materiality, then the auditor will:
         1. accumulate more evidence than if a lower level had been set.
         2. accumulate less evidence than if a lower level had been set.
         3. accumulate approximately the same evidence as would be the case were materiality lower.
         4. accumulate an undetermined amount of evidence.

1. 1. 4. The preliminary judgment about materiality and the amount of audit evidence accumulated are

                      related.

1. 1. 1. 1. directly
         2. indirectly
         3. not
         4. inversely

1. 1. 5. Which of the following is the primary basis used to decide materiality for a for-profit entity?
         1. Net sales
         2. Net assets
         3. Net income before tax
         4. All of the above

1. 1. 6. Auditing standards                          that the basis used to determine the preliminary judgment about materiality be documented in the audit files.
         1. permit
         2. do not allow
         3. require
         4. strongly encourage

1. 1. 7. Amounts involving fraud are usually considered                               important than unintentional errors of equal dollar amounts.
         1. less
         2. no less
         3. no more
         4. more

0. 1. 8. Qualitative factors can affect an auditor's assessment of materiality. Which of the following statements is true?
1. Misstatements that are otherwise immaterial may be material if they affect earnings trends.
2. Misstatements that are otherwise minor may be material if there are possible consequences arising from contractual obligations.

1. I only
2. II only
3. I and II
4. neither I nor II

1. 1. 9. The five steps in applying materiality are listed below in random order.
1. Estimate the combined misstatement.
2. Estimate the total misstatement in the segment.
3. Set materiality for the financial statements as a whole.
4. Determine performance materiality.
5. Compare combined estimate with preliminary judgment about materiality. The first three steps in correct sequence would be:

A) 1, 2, 5

B) 3, 4, 2

C) 2, 1, 5

D) 3, 2, 4

1. 1. 10. Which of the following statements is not correct?
          1. Materiality is a relative rather than an absolute concept.
          2. The most important base used as the criterion for deciding materiality is total assets.
          3. Qualitative factors as well as quantitative factors affect materiality.
          4. Given equal dollar amounts, frauds are usually considered more important than errors.

1. 1. 11. Certain types of misstatements are likely to be more important than other types to users, even if the dollar amounts are the same. Which of the following demonstrates this?

A)

B)

C)

D)

1. 1. 12. When setting a preliminary judgment about materiality:
          1. more evidence is required for a low dollar amount than for a high dollar amount.
          2. less evidence is required for a low dollar amount than for a high dollar amount.
          3. the same amount of evidence is required for either low or high dollar amounts.
          4. there is no relationship between it and the dollar amount of evidence needed.

1. 1. 13. Lewis Corporation has a few large accounts receivable that total one million dollars whereas Clark Corporation has many small accounts receivable that total one million dollars. Misstatement in any one account is more significant for Lewis corporation because of the concept of:
          1. materiality.
          2. audit risk.
          3. reasonable assurance.
          4. comparative analysis.

1. 1. 1. 1. 1. When auditors allocate the preliminary judgment about materiality to account balances, the materiality allocated to any given account balance is referred to as:
               1. the materiality range.
               2. the error range.
               3. tolerable materiality.
               4. performance materiality.

1. 1. 1. 1. 2. Auditors generally allocate the preliminary judgment about materiality to the:
               1. balance sheet only.
               2. income statement only.
               3. income statement and balance sheet.
               4. statement of cash flows.

1. 1. 1. 1. 3. Which of the following is an incorrect statement regarding the allocation of the preliminary judgment about materiality to balance sheet accounts?
               1. Auditors expect certain accounts to have more misstatements than others.
               2. The allocation has virtually no effect on audit costs because the auditor must collect sufficient appropriate audit evidence.
               3. Auditors expect to identify overstatements as well as understatements in the accounts.
               4. Relative audit costs affect the allocation.

1. 1. 1. 1. 4. Which of the following statements is true concerning the allocation of preliminary materiality?
               1. It is necessary to allocate preliminary materiality to financial statements as a whole rather than by segments.
               2. Preliminary materiality should be allocated to income statement accounts only.
               3. Preliminary materiality is required by the SEC.

1. 1. 1. 1. 1. 4. The PCAOB term used when preliminary materiality is allocated to segments is tolerable misstatement.

1. 1. 1. 1. 5. Which of the following statements is false?
               1. Either an overstatement of an asset account or an understatement of a liability account would have the same effect on the income statement.
               2. A misclassification in the balance sheet will have no effect on operating income.
               3. Either an overstatement of an asset account or an overstatement of a liability account would have the same effect on the income statement.
               4. Either an understatement of an asset account or an overstatement of a liability account would have the same effect on the income statement.

1. 1. 1. 1. 6. Which of the following are major difficulties auditors face when allocating materiality to balance sheet accounts?

A)

B)

C)

D)

1. 1. 1. 1. 7. When allocating performance materiality:
               1. it is easy to predict in advance which accounts are mot likely to be misstated.
               2. only overstatements need to be considered.
               3. professional judgment is critical.
               4. the sum of all the performance materiality levels cannot exceed the preliminary judgment about materiality.

1. 1. 1. 1. 8. When allocating materiality, most practitioners choose to allocate to:
               1. the income statement accounts because they are more important.
               2. the balance sheet accounts because most audits focus on the balance sheet.
               3. both balance sheet and income statement accounts because there could be errors on either.

1. 1. 1. 1. 1. 4. all of the financial statements because it is required by GAAS.

1. 1. 1. 1. 9. Which of the following is a correct statement regarding performance materiality?
               1. Determining performance materiality is necessary because auditors accumulate evidence by segments.
               2. The level of performance materiality does not affect the amount of evidence needed.
               3. Performance materiality cannot vary for different classes of transactions.
               4. Performance materiality is required for public companies, but not for private companies.

1. 1. 1. 1. 1. 1. 1. Auditors are                         to document the known and likely misstatements in the financial statements under audit.
                     1. permitted
                     2. required
                     3. not allowed
                     4. strongly encouraged

1. 1. 1. 1. 1. 1. 2.                        misstatements are those where the auditor can determine the amount of the misstatement in the account.
                     1. Potential
                     2. Likely
                     3. Known
                     4. Projected

1. 1. 1. 1. 1. 1. 3. Likely misstatements can result from:

A)

B)

C)

D)

1. 1. 1. 1. 1. 1. 4. When evaluating the audit findings, the auditor should be satisfied that the:
                     1. amount of known misstatement is documented in the management representation letter.
                     2. estimate of the total known and likely misstatements is less than a material amount.
                     3. estimate of the total likely misstatement includes sample error.
                     4. amount of known misstatement is acknowledged and recorded by the client.

1. 1. 1. 1. 1. 1. 1. 1. 1. Which of the following audit risk components may be assessed in non-quantitative terms?

A)

B)

C)

D)

1. 1. 1. 1. 1. 1. 1. 1. 2. Based on audit 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 would:

A) increase materiality levels.

B) decrease detection risk.

C) decrease substantive testing.

D) increase inherent risk.

1. 1. 1. 1. 1. 1. 1. 1. 3. When dealing with audit risk:

A) auditors accept some level of risk in performing the audit function.

B) most risks that auditors encounter are relatively easy to measure.

C) the audit risk model is only used for classes of transactions.

D) most audit firms prefer to use a quantitative assessment for risk.

1) The measurement of the auditor's assessment of the likelihood that there are material misstatements due to error or fraud in a segment before considering the effectiveness of internal controls is defined as:

A) audit risk.

B) inherent risk.

C) sampling risk.

D) detection risk.

2) The risk that audit evidence for a segment will fail to detect misstatements exceeding performance materiality levels is:

A) audit risk.

B) control risk.

C) inherent risk.

D) planned detection risk.

3) As the risk of material misstatement increases, detection risk should:

A) medium increase.

B) decrease.

C) stay the same.

D) Is indeterminate.

4) Inherent risk is                           related to detection risk and                          related to the amount of audit evidence.

A) directly, inversely

B) directly, directly

C) inversely, inversely

D) inversely, directly

5) Auditors frequently refer to the terms audit assurance, overall assurance, and level of assurance to refer to                                                  .

A) detection risk

B) audit report risk

C) acceptable audit risk

D) inherent risk

6) If planned detection risk is reduced, the amount of evidence the auditor accumulates will:

A) increase.

B) decrease.

C) remain unchanged.

D) be indeterminate.

7) Planned detection risk

1. determines the amount of substantive evidence the auditor plans to accumulate.
2. is dependent on inherent risk and business risk.

1. I only
2. II only
3. I and II
4. None of the above

8) Inherent risk is often high for an account such as:

A) inventory.

B) land.

C) capital stock.

D) notes payable.

9) Inherent risk and control risk:

A) are inversely related to each other.

B) are inversely related to detection risk.

C) are directly related to detection risk.

D) are directly related to audit risk.

10) To what extent do auditors typically rely on internal controls of their public company clients?

A) Extensively

B) Only very little

C) Infrequently

D) Never

11) Auditors typically rely on internal controls of their private company clients:

A) only as needed to complete the audit and satisfy Sarbanes-Oxley requirements.

B) only if the controls are determined to be effective.

C) only if the client asks an auditor to test controls.

D) only if the controls are sufficient to increase Control Risk to an acceptable level.

12) Which is a true statement about audit risk?

A) Audit risk measures the risk that a material misstatement could occur and not be detected by internal control.

B) When auditors decide on a higher acceptable audit risk, they want to be more certain that the financial statements are not materially misstated.

C) Audit assurance is the complement of acceptable audit risk.

D) There is an inverse relationship between acceptable audit risk and planned detection risk.

13) The risk of material misstatement refers to:

A) control risk and acceptable audit risk.

B) inherent risk.

C) the combination of inherent risk and control risk.

D) inherent risk and audit risk

14) When assessing risk, it is important to remember that:

A) for acceptable audit risk, the SEC decides the risk the CPA firm should take for public clients.

B) inherent risk can be changed by the auditor.

C) detection risk can only be determined after audit risk, inherent risk, and control risk are determined.

D) control risk is determined by company management since they are responsible for internal control.

15) Auditors may assess inherent risk and control risk:

A)

B)

C)

D)

16) In a financial statement audit, inherent risk is evaluated to help an auditor assess which of the following?

A) The internal audit department's objectivity in reporting a material misstatement of a financial statement assertion it detects to the audit committee

B) The risk the internal control system will not detect a material misstatement of a financial statement assertion

C) The risk that the audit procedures implemented will not detect a material misstatement of a financial statement assertion

D) The susceptibility of a financial statement assertion to a material misstatement assuming there are no related controls

17) Which of the following statements is not true?

A) Inherent risk is inversely related to the amount of audit evidence whereas detection risk is directly related to the amount of audit evidence required.

B) Inherent risk is directly related to evidence whereas detection risk is inversely related to the amount of audit evidence required.

C) Inherent risk is the susceptibility of the financial statements to material error, assuming no internal controls.

D) Inherent risk and control risk are assessed by the auditor and function independently of the financial statement audit.

18) An auditor who audits a business cycle that has low inherent risk should:

A) increase the amount of audit evidence gathered.

B) assign more experienced staff to that area.

C) increase the performance materiality level for the area.

D) expand planning procedures.

1) If an auditor believes the chance of financial failure is high and there is a corresponding increase in business risk for the auditor, acceptable audit risk would likely:

A) be reduced.

B) be increased.

C) remain the same.

D) be calculated using a computerized statistical package.

2) When management has an adequate level of integrity for the auditor to accept the engagement but cannot be regarded as completely honest in all dealings, auditors normally:

A) reduce acceptable audit risk and increase inherent risk.

B) reduce inherent risk and control risk.

C) increase inherent risk and control risk.

D) increase acceptable audit risk and reduce inherent risk

3) When the auditor is attempting to determine the extent to which external users rely on a client's financial statements, they may consider several factors except for:

A) client size.

B) concentration of ownership.

C) nature and amounts of liabilities.

D) assessment of detection risk.

1) Which of the following statements regarding inherent risk is correct?

A) Inherent risk is unaffected by the auditor's experience with client's organization.

B) Most auditors set a low inherent risk in the first year of an audit and increase it if experience shows that it was incorrect.

C) Most auditors set a high inherent risk in the first year of an audit and reduce it in subsequent years as they gain more knowledge about the company.

D) Inherent risk is dependent upon the strengths in client's internal control system.

2) Auditors begin their assessments of inherent risk during audit planning. Which of the following would not help in assessing inherent risk during the planning phase?

A) Obtaining client's agreement on the engagement letter

B) Obtaining knowledge about the client's business and industry

C) Touring the client's plant and offices

D) Identifying related parties

3) Which of the following is not a primary consideration when assessing inherent risk?

A) Nature of client's business

B) Existence of related parties

C) Degree of separation of duties

D) Susceptibility to misappropriation of assets Chapter 10

1) The person responsible for reconciling sales invoices to customer orders does not access to the company's master price list in order to correctly compute sales. This is an example of a(n):

A) operating deficiency.

B) design deficiency.

C) training deficiency.

D) management deficiency.

2) You are performing the audit of internal control for Clifton Company. Which of the following would represent a material weakness in internal control?

A) The company's audit committee has experienced unusual turnover of members.

B) The company's CFO was indicted for embezzling from the company.

C) Bank reconciliations are done monthly.

D) The CEO retired after twenty years of service to the company

3) The employee in charge of authorizing credit to the company's customers does not fully understand the concept of credit risk. This lack of knowledge would constitute:

A) a deficiency in operation of internal controls.

B) a deficiency in design of internal controls.

C) a deficiency of management.

D) not constitute a deficiency.

4) When assessing whether the financial statements are auditable, the auditor must consider:

A) that the integrity of management and the adequacy of accounting records are the two primary factors determining auditability.

B) that the integrity of management and the adequacy of risk management are the two primary factors determining auditability.

C) that if all of the transaction information is available only in electronic form without a visible audit trail, the company cannot be audited.

D) the control risk before determining if the entity is auditable.

5) Once auditors determine that entity level controls are designed and placed in the operation they:

A) make a preliminary assessment for each transaction-related audit objective for each major type of transaction.

B) make a preliminary assessment of control risk.

C) obtain an understanding of the design and implementation of internal control.

D) prepare audit documentation in order to opine on the company's internal control system.

6) Which of the following is the correct definition of "control deficiency"?

A) A control deficiency exists if the design or operation of controls does not permit company personnel to prevent or detect misstatements on a timely basis.

B) A control deficiency exists if one or more deficiencies exist that adversely affect a company's ability to prepare external financial statements reliably.

C) A control deficiency exists if the design or operation of controls results in a more than remote likelihood that controls will not prevent or detect misstatements.

D) A control deficiency exists if the design or operation of controls results in a more than probable likelihood that controls will prevent or detect misstatements.

7) Which of the following deficiency exists if a necessary control is missing or not properly formulated?

A) Control

B) Significant

C) Design

D) Operating

8) To determine if significant internal control deficiencies are material weaknesses, they must be evaluated on their:

A)

B)

C)

D)

9) The auditor must communicate:

A) only material weaknesses in internal control to those charged with governance.

B) both significant deficiencies and material weaknesses in internal control to those charged with governance.

C) any significant deficiencies in internal control to those charged with governance using a management letter.

D) issues regarding internal control to those charged with governance in writing within 90 days following the audit report release.

10) Before making the final assessment of internal control at the end of an integrated audit, the auditor must:

A)

B)

C)

D)

11) Significant deficiencies and material weaknesses in internal control of a public company must be reported in writing to which of the following?

A) Public Company Accounting Oversight Board

B) Members of management who are responsible for the related area of the company

C) Audit committee of the company's board of directors and to management

D) AICPA

12) Significant deficiencies are matters that come to an auditor's attention and should be communicated to an entity's audit committee because they represent:

A) material frauds perpetrated by high-level management.

B) internal control deficiencies that could adversely affect a company's ability to initiate, record, process, or report external financial statements reliably.

C) flagrant violations of the entity's documented conflict-of-interest policies.

D) intentional attempts by client personnel to limit the scope of the auditor's field work.

13) How must significant deficiencies and material weaknesses be communicated to those charged with governance?

A) Either oral or written communication is acceptable.

B) Oral communication is required.

C) Written communication is required.

D) Written communication is required for material weaknesses, but oral communication is allowed for significant deficiencies.

14) A five-step approach can be used to identify deficiencies, significant deficiencies, and material weaknesses. The first step in this approach is:

A) identify the absence of key controls.

B) consider the possibility of compensating controls.

C) determine potential misstatements that could result.

D) identify existing controls.

15) When assessing control risk:

A) many auditors use actuarial tables to assist in the control risk assessment process.

B) each control can be used to satisfy only one audit objective.

C) many auditors use a control risk matrix to assist in the control risk assessment process.

D) all controls, including key controls, should be considered.

16) When a compensating control exists, the absence of a key control:

A) is no longer a concern because there is no longer a significant deficiency or material weakness.

B) is still a major concern to the auditor.

C) could cause a material loss, so it must be tested using substantive procedures.

D) is magnified and must be removed from the sampling process and examined in its entirety

1) If the results of tests of controls support the design and operations of controls as expected, the auditor uses                                                 control risk as the preliminary assessment.

A) a lower

B) the same

C) a higher

D) either a lower or higher

2) An auditor is likely to use four types of procedures to support the operating effectiveness of internal controls. Which of the following would generally not be used?

A) Make inquiries of appropriate client personnel

B) Examine documents, records, and reports

C) Reperform client procedures

D) Inspect design documents

3) Which of the following represents a correct statement regarding internal control testing?

A) When auditors plan to use evidence about the operating effectiveness of internal control contained in prior audits, auditing standards require tests of the controls' effectiveness at least every other year.

B) The greater the risk, the less audit evidence the auditor should obtain that controls are operating effectively.

C) The auditor uses control risk assessment and results of tests of controls to determine planned detection risk and the related substantive tests for the financial statement audit.

D) Testing of internal controls can only be performed by the auditor at the end of the fiscal year.

1) When determining what type of report to issue on internal control under Section 404:

A) an adverse opinion on internal control must be given if any weaknesses in a key internal control is discovered.

B) a scope limitation requires the auditor to disclaim an opinion on internal controls.

C) if the auditor gives a qualified opinion on the financial statements, they must give a qualified opinion on internal controls.

D) a scope limitation requires the auditor to express a qualified opinion or a disclaimer of opinion on internal controls.

1) A control available in a small company, which may be necessitated because of lack of competent personnel, is:

A) a wider segregation of duties.

B) a voucher system.

C) fewer transactions to process.

D) the owner-manager's direct involvement in the control process.

2) When auditing a private company, the auditor should obtain an understanding of internal control sufficient to:

A) provide reasonable protection against client fraud and defalcations by client employees.

B) assess control risk.

C) provide a basis for suggestions to the client for improving the accounting system.

D) provide a method for safeguarding assets, checking the accuracy and reliability of accounting data, promoting operational efficiency, and encouraging adherence to prescribed managerial policies.

3) In the audit of a private company, the auditor will test internal controls when control risk is initially assessed at:

A)

B)