Assume that the local newspaper just ran the following headline and article: "Audit Results: Airport executives from Kentucky racked up $500K in lavish expenses, concert tickets, and even gentlemen’s club tabs" LEXINGTON, Ky. (AP)—A small commercial airport in Kentucky—and the taxpayers who support it—picked up top executives’ tabs in recent years for Hannah Montana concert tickets, Nintendo Wii video game bundles and even a $4,400 gentlemen club check, according to a state auditor’s report. The report released Wednesday outlines indulgences ranging from pricey electronics and exercise equipment to lavish meals and champagne. In three years, officials tallied more than $500,000 in questionable personal expenses. [Author’s note: General fund expenses were approximately $10,000,000 annually.] Kentucky Auditor Crit Luallen said the former executive director at Lexington’s Blue Grass Airport created a culture of wasteful spending so vast, employees sometimes were paid twice for the same expense and used airport credit cards as if they were personal checkbooks. “I don’t think we have ever seen an audit where so many different individuals involved in the management of a public agency abused the trust with such arrogance and lack of ethical standards,” she said. Luallen says she has forwarded the case to the Kentucky attorney general, the U.S. attorney’s office, and the FBI. Although the audit only covered the past three years, it does refer to one of the more glaring examples reported by the Herald-Leader: a $4,400 charge Michael Gobb and two other directors incurred at a Dallas strip club in 2004. The charge, which appeared on the credit card statement of the airport’s director of planning, was listed as going to Millennium Restaurant. The word “marketing” was handwritten next to the amount. The Associated Press obtained that receipt and others through an open records request. The audit found that airport employees also used the coffers for tuxedos and other expensive clothing; more than 400 DVDs—many of them currently missing—for the internal airport library; $14,000 in holiday hams given out as gifts; and $7,400 for a NASCAR driving experience excursion for staff described as “team building.” More than 92 percent of the things Gobb charged to his airport card lacked proper documentation, Luallen said. While Luallen acknowledged that Gobb was responsible for the free-spending culture, she said the board and its public accounting firm should have supervised the airport more closely Required: a. Discuss the role of the board of directors in monitoring the behavior of a chief executive officer. b. If the chief executive officer has subordinates incur expenses that he or she approves, how can the board prevent abuse? c. Should external auditors be expected to detect abuses such as these? d. How should the use of credit cards be controlled?
> An audit engagement letter should normally include which of the following matters of agreement between the auditor and the client? a. Schedules and analyses to be prepared by the client’s employees. b. Methods of statistical sampling the auditor will use
> A primary advantage of using CAATs in the audit of an advanced computerized system is that it enables the auditor to a. Substantiate the accuracy of data through self-checking digits and hash totals. b. Utilize the speed and accuracy of the computer. c.
> Firms auditing public entities are required to have periodic inspections conducted by the PCAOB. Required: a. What are the major characteristics of PCAOB inspections? b. What types of firms typically have PCAOB inspections? How frequently are these eval
> Which of the following is an advantage of computer-assisted audit techniques (CAATs)? a. All the CAATs programs are written in one computer language. b. The software can be used for audits of clients that use differing computer equipment and file formats
> Define professional skepticism and professional judgment. During what stages of the audit are auditors required to demonstrate these characteristics?
> Indicate whether each of the following audit procedures is a test of controls, a substantive test, or a dual-purpose test. Next, indicate the financial statement assertion most closely related to each audit procedure. Required: a. Vouch recorded sales
> Distinguish between independence in fact and independence in appearance. Can auditors be independent in fact yet not be perceived to be independent in appearance?
> What reports (other than auditors’ report) on internal control do audit teams give to an entity’s management, board of directors, or audit committee?
> Identify the three fundamental principles underlying GAAS.
> Identify the role of the following bodies in the auditing standards-setting process: (1) the AICPA; (2) the PCAOB; (3) the SEC.
> Define generally accepted auditing standards (GAAS). What is the purpose of GAAS?
> How frequently are firms required to have PCAOB inspections?
> Provide examples of procedures that firms have used to monitor their quality control policies and procedures.
> What factors should auditors consider in deciding whether to accept or continue the engagement with a particular client? What should firms do if they decide to withdraw from an engagement?
> Comment upon each of the following statements you heard in a conversation between two newly hired staff auditors. a. “Of course, I’m qualified to be assigned to this engagement. I have an accounting degree from a top university and was an honors graduate
> What is a system of quality control? Identify the six elements of a system of quality control.
> Your small business client, Phillip’s Computer Repair Shop, is experiencing financial difficulties and has to lay off one of its four employees in the accounting area. Phillip has asked you to determine what duties should be assigned to the three remaini
> What are the four types of audit opinions? What is the conclusion of each one?
> What is a financial reporting framework? How is it related to the auditors’ reporting responsibilities?
> How are the sufficiency and appropriateness of evidence related to detection risk?
> What options are available to the auditor for presenting reports on the entity’s financial statements and internal control over financial reporting?
> Distinguish between relevance and reliability as these concepts relate to audit evidence. How are relevance and reliability associated with the appropriateness of audit evidence?
> Define external, external-internal, and internal documentary evidence.
> What is the basic relationship between the effectiveness of the client’s internal control and the necessary effectiveness of substantive procedures?
> What is materiality? During what stages of the audit do auditors consider materiality?
> Define reasonable assurance. How does the audit team provide reasonable assurance in the engagement?
> Identify which of the major fundamental principles (responsibilities, performance, or reporting) is most closely related to each of the following: a. The need for auditors to consider their financial relationships with prospective clients. b. An auditor
> Auditors are required to obtain a sufficient understanding of each component of a client’s internal control. This understanding is used to assess control risk and plan the audit of the client’s financial statements. Required: a. For what purposes should
> The primary purpose for obtaining an understanding of the entity’s environment (including its internal control) in a financial statement audit is a. To determine the nature, timing, and extent of substantive procedures to be performed. b. To make consult
> Which of the following best demonstrates the concept of professional skepticism? a. Relying more extensively on external evidence rather than internal evidence. b. Focusing on items that have a more significant quantitative effect on the entity’s financi
> One of an accounting firm’s basic objectives is to provide professional services that conform to professional standards. Reasonable assurance of achieving this objective can be obtained by following a. Generally accepted auditing standards. b. Standards
> Which of the following categories of principles is most closely related to gathering audit evidence? a. Performance. b. Reasonable assurance. c. Reporting. d. Responsibilities.
> Which of the following principles is most closely associated with the auditors’ conclusion as to the fair presentation of the entity’s financial statements? a. Communication principle. b. Performance principle. c. Reporting principle. d. Responsibilities
> What are (a) an internal control deficiency, (b) a significant deficiency, and (c) a material weakness?
> Which of the following opinions would be issued if auditors believed that the entity’s financial statements were not presented in conformity with GAAP? a. Adverse opinion. b. Disclaimer of opinion. c. Qualified opinion. d. Unmodified opinion.
> Which of the following best describes the general contents of the introductory paragraph of the auditors’ report? a. A description of an audit examination, including the fact that the audit was conducted under standards established by the PCAOB. b. The a
> Which of the following combinations of standards and types of audits are most closely related to the activities of the Public Company Accounting Oversight Board? a. Develop Auditing Standards for the audits of nonpublic entities. b. Develop Auditing Stan
> The particular and specialized actions that auditors take to obtain evidence during a specific engagement are known as a. Audit procedures. b. Audit standards. c. Interpretive publications. d. Statements on Auditing Standards.
> Sorrell, CPA, is auditing the financial statements of Van Dyke as of December 31, 2017. Sorrell’s substantive procedures and other tests indicated that Van Dyke’s financial statements were prepared in accordance with g
> In each of the following, identify which of the elements of the fundamental principles is most applicable. In addition, discuss what action(s) (if any) you believe auditors should take with respect to these issues. a. An entity has contacted you about pe
> Which of the following is true with respect to PCAOB inspections of accounting firms? a. All firms performing audits of public companies are required to have annual inspections conducted by the PCAOB. b. PCAOB inspections review a sample of audits conduc
> The reporting principle requires auditors to express their opinion through the issuance of a written report. Required: a. What is the purpose of the auditors’ opinion and report? b. What are the major paragraph(s) in the auditors’ report on the examinat
> Respond to each of the following comments that you heard related to the audit of Swan Company, a public entity. a. “We don’t need to consider the risk of material misstatement in our work because we really can’t do anything to reduce that risk.” b. “Beca
> Identify how each of the following statements relates to the performance principle by considering which element(s) of the principle are related to that statement. (A statement may be related to more than one element.) Use the following elements in provid
> You have accepted the engagement of auditing the financial statements of the C. Reis Company, a small manufacturing firm that has been your client for several years. Because you were busy writing the report for another engagement, you sent a staff accoun
> Generally accepted auditing standards (the performance principle) require auditors to gather sufficient appropriate evidence on which to base an opinion. Required: a. Briefly define the characteristics “sufficient” and “appropriate” as they relate to au
> Your public accounting practice is located in a city of 15,000 people. The majority of your work, conducted by you and two assistants, consists of compiling clients’ monthly statements and preparing income tax returns for individuals from cash data and p
> Which of the following is not related to ethical requirements of auditors? a. Due care. b. Independence in appearance. c. Independence in fact. d. Professional judgment.
> Which of the following statements is not true with respect to the performance principle? a. Auditors are required to prepare a written audit plan during the planning stages of initial audits but are not required to do so in continuing audits. b. Audit te
> Which of the following concepts is least related to the standard of due care? a. Independence in fact. b. Professional skepticism. c. Prudent auditor. d. Reasonable assurance.
> Which of the following is most closely related to the relevance of audit evidence? a. Auditors decide to physically inspect investment securities held by a custodian instead of obtaining confirmations from the custodian. b. In addition to confirmations o
> AMI International is a large office products company. Headquarters management imposed pressure on operating division managers to meet profit forecasts. The division managers met these profit goals using several accounting manipulations involving the reco
> What is the difference between document examination and reperformance when conducting tests of controls?
> North, CPA, is planning an independent audit of the financial statements of General Company. In determining the nature, timing, and extent of the audit procedures, North is considering General’s internal audit function, which is staffed by Tyler. Requir
> You are a CPA in a regional public accounting firm that has 10 offices in three states. Mr. Shine has approached you with a request for an audit. He is president of Hitech Software and Games Inc., a five-year-old company that has recently grown to $500 m
> The president of Allpurpose Loan Company had a genuine dislike for external auditors. Almost any conflict generated a towering rage. Consequently, the company changed auditors often. The firm of Wells & Ratley (W&R), CPAs, was recently hired to audit the
> Assume that Smith & Smith, CPAs, audited Apollo Shoes Inc., last year. Now CEO Larry Lancaster wishes to engage Anderson, Olds, and Watershed, CPAs (AOW) to audit its annual financial statements. Lancaster is generally pleased with the services provided
> The preparation of audit documentation is an integral part of an auditor’s examination of financial statements. On a recurring engagement, auditors review the audit plans and audit documentation from the prior audit while planning the current audit to de
> What are some of the limitations to practicing public accounting across state and national boundaries?
> For each of the following situations, describe how the auditors’ report on internal control over financial reporting would be modified from the standard, unqualified report. Do not write the actual reports. a. The auditors have identified a material weak
> A CPA accumulates various types of evidence on which to base the opinion on financial statements. Among this evidence are confirmations from third parties. Required: a. What is an audit confirmation? b. What characteristics of the confirmation process a
> Auditors use different types of audit procedures to gather the evidence necessary to conclude that the risk of material misstatement for each relevant assertion has been reduced to an acceptably low level. List eight different types of procedures auditor
> Which of the following combinations would provide the auditor the most reliable evidence? Source of Evidence Effectiveness of Internal Control a. Internal More effective b. Internal Less effective c. External More effective d. External Less effectiv
> The eight general audit procedures produce evidence about the principal management assertions in financial statements. However, some procedures are useful for producing evidence about certain assertions, and other procedures are useful for producing evid
> Name some other types of auditors in addition to external, internal, and governmental auditors.
> What are the advantages and disadvantages of documenting internal control by using (1) an internal control questionnaire, (2) a narrative memorandum, and (3) a flowchart?
> Define what is meant by compliance auditing.
> What is operational auditing? How does the AICPA view operational auditing?
> What are some examples of assurance services performed on nonfinancial information?
> Why should auditors act as though there is always a potential conflict of interest between the auditor and the management of the enterprise under audit?
> Refer to the internal control questionnaire on a payroll system (Exhibit 5.15). a. Assume that the answer to each question is no. Prepare a table matching the questions to errors or frauds that could occur because of the absence of the control. Your colu
> What are the defining characteristics of (a) white-collar crime, (b) employee fraud, (c) embezzlement, (d) larceny, (e) defalcation, (f) management fraud, and (g) errors?
> What is the auditor’s responsibility regarding fraud risk?
> What is the primary difference between a material misstatement due to fraud or error?
> What is meant by the terms nature, timing, and extent of further audit procedures?
> How is the audit risk model used to plan the audit?
> Which of the following procedures would provide the most reliable audit evidence? a. Inquiries of the client’s internal audit staff. b. Inspection of prenumbered client purchase orders filed in the vouchers payable department. c. Inspection of vendor sal
> What are the components of the risk of material misstatement (RMM)? What are the components of the audit risk model?
> Define audit risk.
> What is the control environment?
> What is the purpose of an audit strategy memorandum? What information should it contain?
> How do the professional audit standards differ for (a) errors, (b) frauds, (c) direct-effect noncompliance, and (d) indirect-effect noncompliance?
> When are analytical procedures required, and when are they optional?
> What are some of the ratios that can be used in preliminary analytical procedures?
> What are the five steps involved with the use of preliminary analytical procedures?
> What is the purpose of performing preliminary analytical procedures in audit planning?
> What are some types of knowledge and understanding about a client’s business and industry that an auditor is expected to obtain? What are some of the methods and sources of information for understanding a client’s business and industry?
> The most reliable evidence regarding the existence of newly acquired computer equipment is a. Inquiry of management. b. Documentation prepared externally. c. Evaluation of the client’s procedures. d. Physical observation.
> What is the major concern for auditors related to evidence obtained from related parties?
> Why should auditors understand their clients’ performance measures when assessing inherent risk?
> If tests of controls induce the audit team to change the assessed level of control risk for fixed assets from 0.4 to 1.0 and audit risk (0.05) and inherent risk remain constant, the acceptable level of detection risk is most likely to a. Change from 0.1
> How does control risk affect the nature, timing, and extent of further audit procedures?
> The auditors assessed risk of material misstatement at 0.50 and said they wanted to achieve a 0.05 risk of failing to express a correct opinion on financial statements that were materially misstated. What detection risk do the auditors plan to use for pl
> The risk of material misstatement is composed of which audit risk components? a. Inherent risk and control risk. b. Control risk and detection risk. c. Inherent risk and detection risk. d. Inherent risk, control risk, and detection risk.
> The likelihood that material misstatements may have entered the accounting system and not been detected and corrected by the client’s internal control is referred to as a. Inherent risk. b. Control risk. c. Detection risk. d. Risk of material misstatemen
> Which of the following circumstances would most likely cause an audit team to perform extended procedures? a. Supporting documents are produced when requested. b. The client made several large adjustments at or near year-end. c. The company has recently
> One of the typical characteristics of management fraud is a. Falsification of documents in order to misappropriate funds from an employer. b. Victimization of investors through the use of materially misleading financial statements. c. Illegal acts commit
> Auditing standards do not require auditors of financial statements to a. Understand the nature of errors and frauds. b. Assess the risk of occurrence of errors and frauds. c. Design audits to provide reasonable assurance of detecting errors and frauds. d
> Ordinarily, what source of evidence should least affect audit conclusions? a. External documentary evidence. b. Inquiry of management. c. Documentation prepared by the audit team. d. Inquiry of entity legal counsel.
> What is the primary objective of the fraud brainstorming session? a. Determine audit risk and materiality. b. Identify whether analytical procedures should be applied to the revenue accounts. c. Assess the potential for material misstatement due to fraud
