Auditing An International Approach 7th Edition – Test Bank

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Sample Questions Posted Below

 

 

 

 

c5

Student: ___________________________________________________________________________

1. An “accountable party” can be all of the following at the same time except ________.

A. an auditor

 

B. an entity

 

C. a client

 

D. an auditee

 

2. Audit risk can be offset by ________.

A. general management

 

B. engagement management

 

C. audit management

 

D. quality management

 

3. What is the best description of the engagement letter?

A. The letter soliciting a potential client.

 

B. A letter from a successor auditor to a predecessor auditor asking to review the working papers for the previous year.

 

C. The audit contract, which may include special requests.

 

D. The letter at the end of the audit engagement reviewing any concerns the auditors wish management to be aware of.

 

4. An auditor should assess a client’s business risks ________.

A. early in the engagement, based on discussion with management

 

B. at the end of the engagement after all evidence has been assembled

 

C. as part of the year-end evidence gathering

 

D. only if the client requests the auditor to do so in the engagement letter

 

5. Generally accepted auditing standards require that analytical procedures should be applied ________.

A. in the planning and final review stages of the audit and as a substantive test during the audit

 

B. in the planning and final review stages of the audit, and can be used as a substantive test during the audit

 

C. in the planning stage, and can be applied as a substantive test and in the final review stage

 

D. in the final review stage, and can be applied as a substantive test in the planning stage

 

6. For audits of financial statements made in accordance with generally accepted auditing standards, the use of analytical procedures is required to some extent ________.

A. as a substantive test and in the final review stage

 

B. as a substantive test but not in the final review stage

 

C. in the final review stage but not as a substantive test

 

D. neither in the final review stage nor as a substantive test

 

7. Which of the following is likely to be found in the minutes of the board of directors?

A. Approval of customer credit limits.

 

B. Approval of a new computer for the controller.

 

C. Authorization of employee salaries.

 

D. Authorization of executive salaries.

 

8. In the planning stage, analytical procedures are used to ________.

A. assess overall reasonableness of the financial statements

 

B. identify potential problem areas

 

C. determine the mathematical correctness of the financial statements

 

D. provide direct evidence about the balances in accounts

 

9. Assume that application of analytical procedures revealed significant unexplained differences between recorded amounts and the auditor’s expectations. If management is unable to provide an acceptable explanation, the auditor should ________.

A. consider the matter a scope limitation

 

B. perform additional audit procedures to investigate the matter further

 

C. intensify the audit with the expectation of detecting management fraud

 

D. withdraw from the engagement

 

10. If fictitious sales were recorded and the fictitious accounts receivable were written off as bad debt expense, ________.

A. income would be overstated

 

B. income would be understated

 

C. income would not be misstated

 

D. accounts receivable would be understated

 

11. The concept of materiality refers to ________.

A. any misstatement in the financial statements

 

B. the overall degree of risk in an organization

 

C. an amount of misstatement that could lead someone to make a poor decision and suffer a loss

 

D. an amount of risk in an organization sufficient to offset the expected returns of any investment in the company

 

12. A bank with a large loan would most likely be interested in materiality based on ________.

A. operating cash flows

 

B. normalized net income

 

C. sales revenue

 

D. net assets

 

13. If an auditor were to use 5% of income before taxes as a basis for materiality, it would be an example of judgment based on ________.

A. absolute size

 

B. relative size

 

C. nature of the item

 

D. cumulative effects

 

14. How should auditors use the concept of materiality?

A. As a guide to assessing inherent risk

 

B. As a guide in assessing control risk.

 

C. As a guide in deciding to report a deficiency to the audit committee.

 

D. As a guide in planning the audit program.

 

15. The overall audit strategy typically includes ________.

A. the detailed audit plan

 

B. specific procedures for determining inherent and control risk

 

C. decisions about unusual client accounting principles

 

D. audit evidence gathering procedures

 

16. The CASs provide the overall objective of a financial statement auditor and set out the requirements that must be met to meet that objective.

True    False

 

17. Since auditing is a public profession, auditors are obligated to continue auditing a client once they start.

True    False

 

18. When there is a change in auditors, the Rules of Professional Conduct do not permit the predecessor auditor to give information to the successor auditor without explicit approval by the client.

True    False

 

19. The auditor’s objective in obtaining an understanding of the client’s business and risks is to design audit procedures that will serve as a basis for their report.

True    False

 

20. Analytical procedures are required at both the beginning and the end of an audit.

True    False

 

21. During the preliminary analytical review, the auditor discovered that the auditee forecast sales of 10,000 units but only 5,000 were sold. The auditors should consider performing a careful lower-of-cost-or-market valuation of the year-end inventory.

True    False

 

22. Auditors’ analytical procedures can include review of prior year adjusting entries, conversations with client personnel, and study of the minutes of board of directors’ meetings.

True    False

 

23. The enquiries of the client that result from preliminary analytical review provide direct evidence about the amounts in the financial statements.

True    False

 

24. Relationships on the financial statements that do not make sense may indicate problem areas in the accounts.

True    False

 

25. Materiality is primarily a quantitative calculation.

True    False

 

26. Materiality levels determined at the planning stage are used to decide how much work to do on each financial statement account.

True    False

 

27. Audit planning is an ongoing process where information gained as the audit is performed may result in changes to the plan.

True    False

 

28. The detailed audit plan guides development of the overall audit strategy.

True    False

 

29. Analytical procedures consist of evaluating financial information by studying financial and nonfinancial data and looking for plausible or implausible relationships. The procedures can range from making simple comparisons to using complex models involving many relationships and elements of data. They can involve time-series comparisons of recorded amounts and ratios developed from recorded amounts, and they always include comparison to expectations developed by the auditors.

Required:

A) Describe the broad purposes of analytical procedures.
B) Identify the sources of information from which an auditor develops expectations.

 

 

 

 

30. Analytical procedures are one type of evidence-gathering procedure. According to auditing standards, there are five general forms of analytical procedures. Auditing standards also provide examples of five sources of information for analytical procedures.

Required:

Describe three of the five general forms of analytical procedures. For each form, describe a typical source of the information for the form. For each source, include any questions or concerns an auditor would have about the reliability or relevancy of the source.

 

 

 

 

31. Contrast horizontal and vertical analysis. Give an example of each.

 

 

 

 

32. This question tests your ability to perceive the place(s) where potential problems may exist and the type of problem (overstatement or understatement) that may exist.

Required:

For each of the items below, identify the account(s) that need(s) to be audited carefully and the reason; for example, “potential overstatement or understatement of _______.”

A) Current year accounts receivable is larger than last year but the allowance for doubtful accounts is the same.
B) Current year inventory is larger than last year but the current year gross margin (profit) is larger.
C) Current year long-term liabilities are larger than last year but the interest expense is the same.
D) Current-year fixed assets total is larger than last year but current amortization expense is the same as last year.

 

 

 

 

33. What is meant by materiality?

 

 

 

 

34. This question is about the auditor’s concept of materiality considered in the planning stage of the audit.

Required:

A) Define or describe the independent auditor’s concept of “planning materiality.”
B) Name (but do not describe or explain) three common relationships or considerations used by the auditor quantifying materiality.

 

 

 

 

35. What are auditors referring to when they talk about the nature, timing, and extent of audit procedures?

 

 

 

 

 

 

c5 Key

1. An “accountable party” can be all of the following at the same time except ________.

A. an auditor

 

B. an entity

 

C. a client

 

D. an auditee

 

Accessibility: Keyboard Navigation
Blooms: Comprehension
Difficulty: Moderate
Learning Objective: 05-02 Explain the main characteristics of an independent audit engagement.
Smieliauskas – Chapter 05 #1
Topic: 05-03 Independent Audit Engagement Characteristics
 

 

2. Audit risk can be offset by ________.

A. general management

 

B. engagement management

 

C. audit management

 

D. quality management

 

Accessibility: Keyboard Navigation
Blooms: Application
Difficulty: Easy
Learning Objective: 05-03 Describe the activities auditors undertake to decide whether to accept a financial statement audit engagement; and the first tasks performed once an audit engagement is accepted.
Smieliauskas – Chapter 05 #2
Topic: 05-05 Pre-engagement Activities
 

 

3. What is the best description of the engagement letter?

A. The letter soliciting a potential client.

 

B. A letter from a successor auditor to a predecessor auditor asking to review the working papers for the previous year.

 

C. The audit contract, which may include special requests.

 

D. The letter at the end of the audit engagement reviewing any concerns the auditors wish management to be aware of.

 

Accessibility: Keyboard Navigation
Blooms: Knowledge
Difficulty: Easy
Learning Objective: 05-03 Describe the activities auditors undertake to decide whether to accept a financial statement audit engagement; and the first tasks performed once an audit engagement is accepted.
Smieliauskas – Chapter 05 #3
Topic: 05-10 Engagement Letters
 

 

4. An auditor should assess a client’s business risks ________.

A. early in the engagement, based on discussion with management

 

B. at the end of the engagement after all evidence has been assembled

 

C. as part of the year-end evidence gathering

 

D. only if the client requests the auditor to do so in the engagement letter

 

Accessibility: Keyboard Navigation
Blooms: Comprehension
Difficulty: Moderate
Learning Objective: 05-04 Explain why auditors need to understand the auditee organization’s business and environment and its risks and controls at the start of a financial statement audit.
Smieliauskas – Chapter 05 #4
Topic: 05-13 Understanding the Business and Its Environment and Risks
 

 

5. Generally accepted auditing standards require that analytical procedures should be applied ________.

A. in the planning and final review stages of the audit and as a substantive test during the audit

 

B. in the planning and final review stages of the audit, and can be used as a substantive test during the audit

 

C. in the planning stage, and can be applied as a substantive test and in the final review stage

 

D. in the final review stage, and can be applied as a substantive test in the planning stage

 

Accessibility: Keyboard Navigation
Blooms: Comprehension
Difficulty: Moderate
Learning Objective: 05-05 Use preliminary analytical procedures on management’s draft financial statements to identify areas where misstatements are most likely.
Smieliauskas – Chapter 05 #5
Topic: 05-15 Preliminary Analytical Procedures
Topic: 05-16 Applying Analytical Procedures to Management’s Draft Financial Statements
Topic: 05-17 Analysis Procedures for Attention Directing
 

 

6. For audits of financial statements made in accordance with generally accepted auditing standards, the use of analytical procedures is required to some extent ________.

A. as a substantive test and in the final review stage

 

B. as a substantive test but not in the final review stage

 

C. in the final review stage but not as a substantive test

 

D. neither in the final review stage nor as a substantive test

 

Accessibility: Keyboard Navigation
Blooms: Comprehension
Difficulty: Easy
Learning Objective: 05-05 Use preliminary analytical procedures on management’s draft financial statements to identify areas where misstatements are most likely.
Smieliauskas – Chapter 05 #6
Topic: 05-15 Preliminary Analytical Procedures
Topic: 05-16 Applying Analytical Procedures to Management’s Draft Financial Statements
Topic: 05-17 Analysis Procedures for Attention Directing
 

 

7. Which of the following is likely to be found in the minutes of the board of directors?

A. Approval of customer credit limits.

 

B. Approval of a new computer for the controller.

 

C. Authorization of employee salaries.

 

D. Authorization of executive salaries.

 

Accessibility: Keyboard Navigation
Blooms: Knowledge
Difficulty: Easy
Learning Objective: 05-05 Use preliminary analytical procedures on management’s draft financial statements to identify areas where misstatements are most likely.
Smieliauskas – Chapter 05 #7
Topic: 05-15 Preliminary Analytical Procedures
Topic: 05-16 Applying Analytical Procedures to Management’s Draft Financial Statements
Topic: 05-17 Analysis Procedures for Attention Directing
 

 

8. In the planning stage, analytical procedures are used to ________.

A. assess overall reasonableness of the financial statements

 

B. identify potential problem areas

 

C. determine the mathematical correctness of the financial statements

 

D. provide direct evidence about the balances in accounts

 

Accessibility: Keyboard Navigation
Blooms: Knowledge
Difficulty: Easy
Learning Objective: 05-05 Use preliminary analytical procedures on management’s draft financial statements to identify areas where misstatements are most likely.
Smieliauskas – Chapter 05 #8
Topic: 05-15 Preliminary Analytical Procedures
Topic: 05-16 Applying Analytical Procedures to Management’s Draft Financial Statements
Topic: 05-17 Analysis Procedures for Attention Directing
 

 

9. Assume that application of analytical procedures revealed significant unexplained differences between recorded amounts and the auditor’s expectations. If management is unable to provide an acceptable explanation, the auditor should ________.

A. consider the matter a scope limitation

 

B. perform additional audit procedures to investigate the matter further

 

C. intensify the audit with the expectation of detecting management fraud

 

D. withdraw from the engagement

 

Accessibility: Keyboard Navigation
Blooms: Application
Difficulty: Moderate
Learning Objective: 05-05 Use preliminary analytical procedures on management’s draft financial statements to identify areas where misstatements are most likely.
Smieliauskas – Chapter 05 #9
Topic: 05-15 Preliminary Analytical Procedures
Topic: 05-16 Applying Analytical Procedures to Management’s Draft Financial Statements
Topic: 05-17 Analysis Procedures for Attention Directing
 

 

10. If fictitious sales were recorded and the fictitious accounts receivable were written off as bad debt expense, ________.

A. income would be overstated

 

B. income would be understated

 

C. income would not be misstated

 

D. accounts receivable would be understated

 

Accessibility: Keyboard Navigation
Blooms: Analysis
Difficulty: Moderate
Learning Objective: 05-05 Use preliminary analytical procedures on management’s draft financial statements to identify areas where misstatements are most likely.
Smieliauskas – Chapter 05 #10
Topic: 05-15 Preliminary Analytical Procedures
Topic: 05-16 Applying Analytical Procedures to Management’s Draft Financial Statements
Topic: 05-17 Analysis Procedures for Attention Directing
 

 

11. The concept of materiality refers to ________.

A. any misstatement in the financial statements

 

B. the overall degree of risk in an organization

 

C. an amount of misstatement that could lead someone to make a poor decision and suffer a loss

 

D. an amount of risk in an organization sufficient to offset the expected returns of any investment in the company

 

Accessibility: Keyboard Navigation
Blooms: Comprehension
Difficulty: Easy
Learning Objective: 05-06 Explain the materiality levels used for planning the audit and how these amounts are determined.
Smieliauskas – Chapter 05 #11
Topic: 05-20 Materiality Decisions in the Context of the Whole Audit Process
 

 

12. A bank with a large loan would most likely be interested in materiality based on ________.

A. operating cash flows

 

B. normalized net income

 

C. sales revenue

 

D. net assets

 

Accessibility: Keyboard Navigation
Blooms: Application
Difficulty: Moderate
Learning Objective: 05-06 Explain the materiality levels used for planning the audit and how these amounts are determined.
Smieliauskas – Chapter 05 #12
Topic: 05-21 Financial Statement Materiality
Topic: 05-22 Materiality Judgment Criteria
Topic: 05-23 Summary of Materiality Levels in the Auditing Standards
 

 

13. If an auditor were to use 5% of income before taxes as a basis for materiality, it would be an example of judgment based on ________.

A. absolute size

 

B. relative size

 

C. nature of the item

 

D. cumulative effects

 

Accessibility: Keyboard Navigation
Blooms: Comprehension
Difficulty: Moderate
Learning Objective: 05-06 Explain the materiality levels used for planning the audit and how these amounts are determined.
Smieliauskas – Chapter 05 #13
Topic: 05-22 Materiality Judgment Criteria
 

 

14. How should auditors use the concept of materiality?

A. As a guide to assessing inherent risk

 

B. As a guide in assessing control risk.

 

C. As a guide in deciding to report a deficiency to the audit committee.

 

D. As a guide in planning the audit program.

 

Accessibility: Keyboard Navigation
Blooms: Comprehension
Difficulty: Moderate
Learning Objective: 05-06 Explain the materiality levels used for planning the audit and how these amounts are determined.
Smieliauskas – Chapter 05 #14
Topic: 05-20 Materiality Decisions in the Context of the Whole Audit Process
Topic: 05-21 Financial Statement Materiality
 

 

15. The overall audit strategy typically includes ________.

A. the detailed audit plan

 

B. specific procedures for determining inherent and control risk

 

C. decisions about unusual client accounting principles

 

D. audit evidence gathering procedures

 

Accessibility: Keyboard Navigation
Blooms: Knowledge
Difficulty: Moderate
Learning Objective: 05-07 List the preliminary planning decisions set out in the overall audit strategy.
Smieliauskas – Chapter 05 #15
Topic: 05-25 Overall Audit Strategy
 

 

16. The CASs provide the overall objective of a financial statement auditor and set out the requirements that must be met to meet that objective.

TRUE

 

Accessibility: Keyboard Navigation
Blooms: Knowledge
Difficulty: Easy
Learning Objective: 05-01 Summarize the financial statement audit process.
Smieliauskas – Chapter 05 #16
Topic: 05-02 Overview of the Financial Statement Audit Process
 

 

17. Since auditing is a public profession, auditors are obligated to continue auditing a client once they start.

FALSE

 

Accessibility: Keyboard Navigation
Blooms: Knowledge
Difficulty: Easy
Learning Objective: 05-03 Describe the activities auditors undertake to decide whether to accept a financial statement audit engagement; and the first tasks performed once an audit engagement is accepted.
Smieliauskas – Chapter 05 #17
Topic: 05-06 Audit Engagement Acceptance and Continuance
 

 

18. When there is a change in auditors, the Rules of Professional Conduct do not permit the predecessor auditor to give information to the successor auditor without explicit approval by the client.

TRUE

 

Accessibility: Keyboard Navigation
Blooms: Comprehension
Difficulty: Moderate
Learning Objective: 05-03 Describe the activities auditors undertake to decide whether to accept a financial statement audit engagement; and the first tasks performed once an audit engagement is accepted.
Smieliauskas – Chapter 05 #18
Topic: 05-08 Communication between Predecessor and Successor Auditors
 

 

19. The auditor’s objective in obtaining an understanding of the client’s business and risks is to design audit procedures that will serve as a basis for their report.

TRUE

 

Accessibility: Keyboard Navigation
Blooms: Knowledge
Difficulty: Easy
Learning Objective: 05-04 Explain why auditors need to understand the auditee organization’s business and environment and its risks and controls at the start of a financial statement audit.
Smieliauskas – Chapter 05 #19
Topic: 05-13 Understanding the Business and Its Environment and Risks
 

 

20. Analytical procedures are required at both the beginning and the end of an audit.

TRUE

 

Accessibility: Keyboard Navigation
Blooms: Knowledge
Difficulty: Easy
Learning Objective: 05-05 Use preliminary analytical procedures on management’s draft financial statements to identify areas where misstatements are most likely.
Smieliauskas – Chapter 05 #20
Topic: 05-15 Preliminary Analytical Procedures
Topic: 05-16 Applying Analytical Procedures to Management’s Draft Financial Statements
Topic: 05-17 Analysis Procedures for Attention Directing
 

 

21. During the preliminary analytical review, the auditor discovered that the auditee forecast sales of 10,000 units but only 5,000 were sold. The auditors should consider performing a careful lower-of-cost-or-market valuation of the year-end inventory.

TRUE

 

Accessibility: Keyboard Navigation
Blooms: Application
Difficulty: Difficult
Learning Objective: 05-05 Use preliminary analytical procedures on management’s draft financial statements to identify areas where misstatements are most likely.
Smieliauskas – Chapter 05 #21
Topic: 05-15 Preliminary Analytical Procedures
Topic: 05-16 Applying Analytical Procedures to Management’s Draft Financial Statements
Topic: 05-17 Analysis Procedures for Attention Directing
 

 

22. Auditors’ analytical procedures can include review of prior year adjusting entries, conversations with client personnel, and study of the minutes of board of directors’ meetings.

TRUE

 

Accessibility: Keyboard Navigation
Blooms: Knowledge
Difficulty: Easy
Learning Objective: 05-05 Use preliminary analytical procedures on management’s draft financial statements to identify areas where misstatements are most likely.
Smieliauskas – Chapter 05 #22
Topic: 05-15 Preliminary Analytical Procedures
Topic: 05-16 Applying Analytical Procedures to Management’s Draft Financial Statements
Topic: 05-17 Analysis Procedures for Attention Directing
 

 

23. The enquiries of the client that result from preliminary analytical review provide direct evidence about the amounts in the financial statements.

FALSE

 

Accessibility: Keyboard Navigation
Blooms: Knowledge
Difficulty: Easy
Learning Objective: 05-05 Use preliminary analytical procedures on management’s draft financial statements to identify areas where misstatements are most likely.
Smieliauskas – Chapter 05 #23
Topic: 05-15 Preliminary Analytical Procedures
Topic: 05-16 Applying Analytical Procedures to Management’s Draft Financial Statements
Topic: 05-17 Analysis Procedures for Attention Directing
 

 

24. Relationships on the financial statements that do not make sense may indicate problem areas in the accounts.

TRUE

 

Accessibility: Keyboard Navigation
Blooms: Knowledge
Difficulty: Easy
Learning Objective: 05-05 Use preliminary analytical procedures on management’s draft financial statements to identify areas where misstatements are most likely.
Smieliauskas – Chapter 05 #24
Topic: 05-15 Preliminary Analytical Procedures
Topic: 05-16 Applying Analytical Procedures to Management’s Draft Financial Statements
Topic: 05-17 Analysis Procedures for Attention Directing
 

 

25. Materiality is primarily a quantitative calculation.

FALSE

 

Accessibility: Keyboard Navigation
Blooms: Comprehension
Difficulty: Easy
Learning Objective: 05-06 Explain the materiality levels used for planning the audit and how these amounts are determined.
Smieliauskas – Chapter 05 #25
Topic: 05-22 Materiality Judgment Criteria
 

 

26. Materiality levels determined at the planning stage are used to decide how much work to do on each financial statement account.

TRUE

 

Accessibility: Keyboard Navigation
Blooms: Knowledge
Difficulty: Easy
Learning Objective: 05-06 Explain the materiality levels used for planning the audit and how these amounts are determined.
Smieliauskas – Chapter 05 #26
Topic: 05-20 Materiality Decisions in the Context of the Whole Audit Process
Topic: 05-21 Financial Statement Materiality
 

 

27. Audit planning is an ongoing process where information gained as the audit is performed may result in changes to the plan.

TRUE

 

Accessibility: Keyboard Navigation
Blooms: Knowledge
Difficulty: Moderate
Learning Objective: 05-07 List the preliminary planning decisions set out in the overall audit strategy.
Smieliauskas – Chapter 05 #27
Topic: 05-25 Overall Audit Strategy
 

 

28. The detailed audit plan guides development of the overall audit strategy.

FALSE

 

Accessibility: Keyboard Navigation
Blooms: Knowledge
Difficulty: Moderate
Learning Objective: 05-07 List the preliminary planning decisions set out in the overall audit strategy.
Smieliauskas – Chapter 05 #28
Topic: 05-25 Overall Audit Strategy
 

 

29. Analytical procedures consist of evaluating financial information by studying financial and nonfinancial data and looking for plausible or implausible relationships. The procedures can range from making simple comparisons to using complex models involving many relationships and elements of data. They can involve time-series comparisons of recorded amounts and ratios developed from recorded amounts, and they always include comparison to expectations developed by the auditors.

Required:

A) Describe the broad purposes of analytical procedures.
B) Identify the sources of information from which an auditor develops expectations.

A) Analytical procedures are used for these broad purposes:

i. To assist the auditor in planning the nature, timing, and extent of other auditing procedures.
ii. As a substantive test to obtain evidence about particular assertions related to account balances or classes of transactions.
iii. As an overall review of the financial information in the final review stage of the audit.

B) An auditor’s expectations are developed from the following sources of information:

i. Financial information for comparable prior periods giving consideration to known changes.
ii. Anticipated results-for example, budgets, forecasts, and extrapolations.
iii. Relationships among elements of financial information within the period.
iv. Information regarding the industry in which the client operates.
v. Relationships of financial information with relevant nonfinancial information.

 

Blooms: Comprehension
Difficulty: Moderate
Learning Objective: 05-05 Use preliminary analytical procedures on management’s draft financial statements to identify areas where misstatements are most likely.
Smieliauskas – Chapter 05 #29
Topic: 05-15 Preliminary Analytical Procedures
Topic: 05-16 Applying Analytical Procedures to Management’s Draft Financial Statements
Topic: 05-17 Analysis Procedures for Attention Directing
 

 

30. Analytical procedures are one type of evidence-gathering procedure. According to auditing standards, there are five general forms of analytical procedures. Auditing standards also provide examples of five sources of information for analytical procedures.

Required:

Describe three of the five general forms of analytical procedures. For each form, describe a typical source of the information for the form. For each source, include any questions or concerns an auditor would have about the reliability or relevancy of the source.

A) The five general forms of analytical procedures are:

i. Comparison of current-year account balances to one or more prior periods.
ii. Comparison of the current-year account balances to budgets and forecasts prepared by the company.
iii. Evaluation of the relationships of current-year account balances to other current-year balances to determine if they conform to expectations based on the company’s historical experience.
iv. Comparison of current-year account balances and financial ratios with similar information for the industry in which the company operates.
v. Study of the relationships of current-year account balances with relevant non-financial information (e.g., physical production statistics).

B) The five sources of information for analytical procedures are:

i. Financial account information for prior period(s). Company budgets and forecasts.
ii. Financial relationships among accounts in the current period.
iii. Industry statistics.
iv. Nonfinancial information, such as physical production statistics.

C) Concerns about relevance and reliability of the sources of information are:

i. Has the financial information from prior period(s) been audited?
ii. Are company budgets or forecasts generally accurate? What processes does the client go through to develop these?
iii. Are the industry statistics from a reliable source? Are the industry statistics specific enough to the client or the particular segment or division of the client being examined?
iv. Has the nonfinancial information been audited? Have the controls over the production of the nonfinancial information been tested?

 

Blooms: Comprehension
Difficulty: Moderate
Learning Objective: 05-05 Use preliminary analytical procedures on management’s draft financial statements to identify areas where misstatements are most likely.
Smieliauskas – Chapter 05 #30
Topic: 05-15 Preliminary Analytical Procedures
Topic: 05-16 Applying Analytical Procedures to Management’s Draft Financial Statements
Topic: 05-17 Analysis Procedures for Attention Directing
 

 

31. Contrast horizontal and vertical analysis. Give an example of each.

Horizontal analysis refers to changes in financial statement amounts and ratios across two or more years. An example would be the increase in revenues from one year to the next. Vertical analysis refers to the relationship among financial statement amounts in the same year. An example would be the ratio of cost of goods sold to product sales revenue.

 

Blooms: Knowledge
Difficulty: Easy
Learning Objective: 05-05 Use preliminary analytical procedures on management’s draft financial statements to identify areas where misstatements are most likely.
Smieliauskas – Chapter 05 #31
Topic: 05-15 Preliminary Analytical Procedures
Topic: 05-16 Applying Analytical Procedures to Management’s Draft Financial Statements
Topic: 05-17 Analysis Procedures for Attention Directing
 

 

32. This question tests your ability to perceive the place(s) where potential problems may exist and the type of problem (overstatement or understatement) that may exist.

Required:

For each of the items below, identify the account(s) that need(s) to be audited carefully and the reason; for example, “potential overstatement or understatement of _______.”

A) Current year accounts receivable is larger than last year but the allowance for doubtful accounts is the same.
B) Current year inventory is larger than last year but the current year gross margin (profit) is larger.
C) Current year long-term liabilities are larger than last year but the interest expense is the same.
D) Current-year fixed assets total is larger than last year but current amortization expense is the same as last year.

A) The collectability of accounts receivable is of concern. The allowance for doubtful accounts may be understated. The bad debt expense may be understated. Accounts receivable may be overstated.
B) The existence assertion related to the inventory account is of concern. Inventory may be overstated. Cost of goods sold may be understated.
C) The amount of accrued interest and interest expense is of concern. Interest expense may be understated. It is less likely, but long-term liabilities could be overstated.
D) Amortization expense and accumulated amortization may be understated. It is also possible that fixed assets are overstated.

 

Blooms: Application
Difficulty: Moderate
Learning Objective: 05-05 Use preliminary analytical procedures on management’s draft financial statements to identify areas where misstatements are most likely.
Smieliauskas – Chapter 05 #32
Topic: 05-15 Preliminary Analytical Procedures
Topic: 05-16 Applying Analytical Procedures to Management’s Draft Financial Statements
Topic: 05-17 Analysis Procedures for Attention Directing
 

 

33. What is meant by materiality?

Materiality is the aggregate amount of errors that may occur in the financial statements before the decision making of users of the financial statement is affected by these errors. In order to assess materiality, the auditor must understand who the users of the financial statements are and for what purpose the financial statements will be used.

 

Blooms: Knowledge
Difficulty: Moderate
Learning Objective: 05-06 Explain the materiality levels used for planning the audit and how these amounts are determined.
Smieliauskas – Chapter 05 #33
Topic: 05-20 Materiality Decisions in the Context of the Whole Audit Process
Topic: 05-21 Financial Statement Materiality
 

 

34. This question is about the auditor’s concept of materiality considered in the planning stage of the audit.

Required:

A) Define or describe the independent auditor’s concept of “planning materiality.”
B) Name (but do not describe or explain) three common relationships or considerations used by the auditor quantifying materiality.

A) Planning materiality is the largest amount of uncorrected dollar misstatements the auditor believes could exist in audited financial statements without causing them to be considered misleading.
B) Absolute size, relative size, nature of the item or issue, circumstances, uncertainty, cumulative effects.

 

Blooms: Application
Difficulty: Moderate
Learning Objective: 05-06 Explain the materiality levels used for planning the audit and how these amounts are determined.
Smieliauskas – Chapter 05 #34
Topic: 05-20 Materiality Decisions in the Context of the Whole Audit Process
Topic: 05-21 Financial Statement Materiality
 

 

35. What are auditors referring to when they talk about the nature, timing, and extent of audit procedures?

The nature of audit procedures refers to evidence techniques they will use, such as examination or recalculation. Timing refers to when the these procedures will be performed, whether before (interim date), at, or after the auditee’s year end. Timing may have other aspects such as surprise procedures (unannounced to auditee personnel) or the need observe periodic auditee procedures, such as rotating inventory counts during the year. The extent usually refers to the sample sizes of data examined, such as the number of customer accounts receivable to confirm, or the number of inventory categories, products, or locations to count.
The nature, timing, and extent of the audit procedures for each component of the audit are documented in the detailed audit plan.

 

Blooms: Comprehension
Difficulty: Difficult
Learning Objective: 05-07 List the preliminary planning decisions set out in the overall audit strategy.
Smieliauskas – Chapter 05 #35
Topic: 05-25 Overall Audit Strategy
 

 

 

c5 Summary

Category # of Questions
Accessibility: Keyboard Navigation 28
Blooms: Analysis 1
Blooms: Application 6
Blooms: Comprehension 12
Blooms: Knowledge 16
Difficulty: Difficult 2
Difficulty: Easy 16
Difficulty: Moderate 17
Learning Objective: 05-01 Summarize the financial statement audit process. 1
Learning Objective: 05-02 Explain the main characteristics of an independent audit engagement. 1
Learning Objective: 05-03 Describe the activities auditors undertake to decide whether to accept a financial statement audit engagement; and the first tasks performed once an audit engagement is accepted. 4
Learning Objective: 05-04 Explain why auditors need to understand the auditee organization’s business and environment and its risks and controls at the start of a financial statement audit. 2
Learning Objective: 05-05 Use preliminary analytical procedures on management’s draft financial statements to identify areas where misstatements are most likely. 15
Learning Objective: 05-06 Explain the materiality levels used for planning the audit and how these amounts are determined. 8
Learning Objective: 05-07 List the preliminary planning decisions set out in the overall audit strategy. 4
Smieliauskas – Chapter 05 35
Topic: 05-02 Overview of the Financial Statement Audit Process 1
Topic: 05-03 Independent Audit Engagement Characteristics 1
Topic: 05-05 Pre-engagement Activities 1
Topic: 05-06 Audit Engagement Acceptance and Continuance 1
Topic: 05-08 Communication between Predecessor and Successor Auditors 1
Topic: 05-10 Engagement Letters 1
Topic: 05-13 Understanding the Business and Its Environment and Risks 2
Topic: 05-15 Preliminary Analytical Procedures 15
Topic: 05-16 Applying Analytical Procedures to Management’s Draft Financial Statements 15
Topic: 05-17 Analysis Procedures for Attention Directing 15
Topic: 05-20 Materiality Decisions in the Context of the Whole Audit Process 5
Topic: 05-21 Financial Statement Materiality 5
Topic: 05-22 Materiality Judgment Criteria 3
Topic: 05-23 Summary of Materiality Levels in the Auditing Standards 1
Topic: 05-25 Overall Audit Strategy 4

 

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