Identify three of the documents required by the Securities Exchange Act of 1934 that are commonly encountered by auditors. Briefly describe the purpose of each of these documents.
> In a situation that uses inspection of records and documents as a type of evidence, distinguish between vouching and tracing in terms of the direction of testing and the assertions being tested.
> List and define the audit procedures for obtaining audit evidence.
> Explain why in most instances audit evidence is persuasive rather than convincing.
> Define audit evidence. Provide an example of evidence from accounting records and other information.
> List and define the assertions about account balances, and related disclosures, at the period end.
> List and define the assertions about classes of transactions and events, and related disclosures, for the period under audit.
> How do management assertions relate to the financial statements?
> List and discuss the four categories of financial ratios that are presented in the chapter.
> Significant differences between the auditor’s expectation and the entity’s book value require explanation through quantification, corroboration, and evaluation. Explain each of these terms.
> Auditing standards require auditors to make certain inquiries of management regarding fraud. Which of the following inquiries is required? a. Whether management has ever intentionally violated the securities laws. b. Whether management has any knowledge
> When discussing the use of analytical procedures, what is meant by the “precision of the expectation”? In applying this notion to an analytical procedure, how might an auditor calculate a tolerable difference?
> Why are indexing and cross-referencing important to the documentation of audit working papers?
> Consider the “assurance bucket” analogy. Why are some of the buckets larger than others for particular assertions or accounts?
> Discuss the relative reliability of the different types of audit procedures.
> Explain why the auditor divides the financial statements into components or segments in order to test management’s assertions.
> Distinguish between errors and fraud. Give three examples of each.
> Distinguish between factual, judgmental, and projected misstatements.
> Many entities are subject to regulations by state and federal regulatory bodies. For example, the Environmental Protection Agency has a mission of protecting human health and the environment. What business risks would an entity face if it operated in the
> Give three examples of conditions and events that may indicate the existence of business risks.
> What are some limitations of the audit risk model?
> Which of the following is a misappropriation of assets? a. Classifying inventory held for resale as supplies. b. Investing cash and earning at a 3 percent rate of return as opposed to paying off a loan with an interest rate of 7 percent. c. An employee o
> Distinguish between sampling risk (i.e., possibility that the sample drawn is not representative of the population) and professional judgment errors (non sampling) risk.
> How do inherent risk and control risk differ from detection risk?
> Marv Jackal, CPA, determines that a number of risks of material misstatement are pervasive to the overall financial statements. How should Jackal respond to such pervasive risks?
> Why would a company institute a control policy that required mandatory vacations?
> What steps should an auditor perform to identify the risk of material misstatement due to fraud?
> Distinguish between audit risk and engagement risk.
> What actions should the engagement team members be informed of by the engagement partner and other engagement team members as part of their supervisory role?
> What are some of the sources of information that may be used to identify transactions with related parties?
> Distinguish between illegal acts that are “direct and material” and those that are “material but indirect.” List five circumstances that may indicate that an illegal act has occurred.
> List the matters an auditor should consider when developing an audit plan.
> Which of the following characteristics most likely would heighten an auditor’s concern about the risk of intentional manipulation of financial statements? a. Turnover of senior accounting personnel is low. b. Insiders recently purchased additional shares
> What is an audit committee and what are its responsibilities?
> What factors should an external auditor use to assess the objectivity and competence of internal auditors?
> What is the purpose of an engagement letter? List the important information that the engagement letter should contain.
> Who is responsible for initiating the communication between the predecessor and successor auditors? What type of information should be requested from the predecessor auditor?
> List four factors that would cause the auditor to use a lower percentage for establishing tolerable misstatement.
> Give three examples of qualitative factors that might affect the auditor’s choice of the percentage to apply to the benchmark used to establish overall materiality.
> List and describe the three major steps in applying materiality to an audit.
> Why is it important for CPA firms to develop policies and procedures for establishing materiality?
> What are the three general types of audit tests? Define each type of audit test and give two examples.
> What types of inquiries about a prospective client should an auditor make to third parties?
> As lower acceptable levels of both audit risk and materiality are established, the auditor should plan more work on individual accounts to a. Find smaller errors. b. Find larger errors. c. Increase the tolerable misstatements in the accounts. d. Decrease
> What roles do information systems and systems of internal control play in the high level model of business discussed in the chapter, and why might it be important for an auditor to understand these roles?
> Compare and contrast management’s responsibility for the entity’s financial statements with the auditor’s responsibilities for detecting errors and fraud in the financial statements.
> Discuss how the events that have so dramatically affected auditors and the public accounting profession since the Enron scandal may in some sense be “healthy” for the profession.
> Briefly discuss the key events that led up to the Sarbanes-Oxley Act of 2002 and the creation of the PCAOB.
> Give one example each of compliance, operational, and forensic audits.
> List and briefly describe the four categories of Principles Underlying an Audit Conducted in Accordance with GAAS.
> Why is independence such an important standard for auditors? How does auditor independence relate to the agency relationship between owners and managers discussed in Chapter 1?
> Discuss why auditing standards are important for evaluating whether an auditor has done an adequate audit, especially when the auditor fails to detect a material misstatement in the financial statements.
> The firm of Le and Lysius was conducting the audit of Coomes Molding Corporation for the fiscal year ended October 31. Michelle Le, the partner in charge of the audit, decides that MUS is the appropriate sampling technique to use in order to audit Coomes
> Risk of material misstatement refers to a combination of which two components of the audit risk model? a. Audit risk and inherent risk. b. Audit risk and control risk. c. Inherent risk and control risk. d. Control risk and detection risk.
> Audit sampling involves applying an audit procedure to less than 100 percent of the population for the purpose of evaluating some characteristic of the population. The fact that an audit involves sampling is noted in the scope paragraph of the auditor’s
> Following are examples of control deficiencies that may represent significant deficiencies or material weaknesses. For each of the following scenarios, indicate whether the deficiency is a significant deficiency or material weakness. Justify your decisio
> Following are examples of control deficiencies that may represent significant deficiencies or material weaknesses. For each control deficiency, indicate whether it is a significant deficiency or material weakness. Justify your decision. a. The entity use
> Following are three examples of controls for accounts that you have determined are significant for the audit of ICFR. For each control, determine the nature, timing, and extent of testing of the control’s design and operating effectiven
> Ken Smith, the partner in charge of the audit of Houghton Enterprises, identified the following significant deficiencies during the audit of the December 31, 2018, financial statements: 1. Controls for granting credit to new customers were not adequate.
> Cook, CPA, has been engaged to audit the financial statements of General Department Stores, Inc., a continuing audit entity, which is a chain of medium-sized retail stores. General’s fiscal year will end on June 30, 2018, and General’s management has ask
> The Audit Committee of a small manufacturing company that sells its products globally has directed internal audit to perform specific annual reviews to monitor manual journal entries, with a particular focus on potential management override activities. I
> Auditors use various tools to document their understanding of an entity’s internal control system, including narrative descriptions, internal control questionnaires, and flowcharts. Required: a. Identify the relative strengths of each tool. b. Briefly d
> Assume that you are an audit senior in charge of planning the audit of an entity that your firm has audited for the previous four years. During the audit planning meeting with the manager and partner in charge of the engagement, the partner noted that th
> Johnson, CPA, has been engaged to audit the financial statements of Rose, Inc., a publicly held retailing company. Before assessing control risk, Johnson is required to obtain an understanding of Rose’s control environment. Required: a. Identify additio
> The existence of audit risk is recognized by the statement in the auditor’s standard report that the auditor a. Obtains reasonable assurance about whether the financial statements are free of material misstatement. b. Assesses the accounting principles u
> An auditor is required to obtain sufficient understanding of each component of an entity’s internal control system to plan the audit of the entity’s financial statements and to assess control risk for the assertions embodied in the account balance, trans
> Arthur, CPA, is auditing The Home Improvement Store as of December 31, 2018. As with all audit engagements, Arthur’s initial procedures are to analyze the entity’s financial data by reviewing trends in significant rati
> At December 31, 2018, Earth Wear has $5,890,000 in a liability account labeled “Reserve for returns.” The footnotes to the financial statements contain the following policy: “At the time of sale, the
> Audit documentation is the auditor’s record of work performed and conclusions reached on an audit engagement. Required: a. What are the functions of audit documentation? b. List and describe the various types of audit documents. c. What factors affect t
> The confirmation process is defined as the process of obtaining and evaluating a direct communication from a third party in response to a request for information about a particular item affecting financial statement assertions. Required: a. List the fac
> Inspection of records and documents relates to the auditor’s examination of entity accounting records and other information. One issue that affects the reliability of documentary evidence is whether the documents are internal or external. Following are e
> Evidence comes in various types and has different degrees of reliability. Following are some statements that compare various types of evidence. a. A bank confirmation versus observation of the segregation of duties between cash receipts and recording pay
> For each of the audit procedures listed in Problem 5-32, identify the category (assertions about classes of transactions and events or assertions about account balances) and the primary assertion being tested. Data from Problem 5-32: For each of the fo
> For each of the following specific audit procedures, indicate the type of audit procedure it represents: (1) inspection of records or documents, (2) inspection of tangible assets, (3) observation, (4) inquiry, (5) confirmation, (6) recalculation, (7) rep
> Management assertions about classes of transactions are a. Occurrence. b. Completeness. c. Authorization. d. Accuracy. e. Cutoff. f. Classification. g. Presentation. For each management assertion, indicate an example of a misstatement that could occur fo
> Which of the following concepts are pervasive in the application of auditing standards? a. Internal control. b. Expected misstatement. c. Control risk. d. Materiality and audit risk.
> Assume that your firm is considering accepting New Skin Pharma as a new audit client. New Skin is a start-up biotech firm that has publicly traded stock on NASDAQ. Your audit partner has asked you to perform some preliminary work for the firm’s client ac
> Management fraud (e.g., fraudulent financial reporting) is a relatively rare event. However, when it does occur, the frauds (e.g., Enron and WorldCom) can have a significant effect on shareholders, employees, and other parties. AU-C 240, Consideration of
> Industry conditions can be a source of business risks for an entity. Describe how each of the following industry conditions can result in business risks. a. The entity’s market characteristics (e.g., demand, capacity, etc.) and competition. b. The cyclic
> In developing an understanding of the entity and its environment, the auditor can obtain information from numerous sources, such as knowledge from prior audits and discussions with management. List five additional potential sources (internal or external)
> For each of the following situations, explain how risk of material misstatement should be assessed and what effect that assessment will have on detection risk. a. Johnson, Inc., is a fast-growing trucking company operating in the southeastern part of the
> When planning a financial statement audit, a CPA must understand audit risk and its components. The firm of Pack & Peck evaluates the risk of material misstatement (RMM) by disaggregating RMM into its two components: inherent risk and control risk.
> You are considering acceptable audit risk at the financial statement level. For each of the following independent scenarios, based only on the information provided, indicate the effect on acceptable audit risk compared to a typical private company audit.
> The CPA firm of Quigley & Associates uses a qualitative approach to implementing the audit risk model. Audit risk is categorized using two terms: very low and low. The risk of material misstatement and detection risk are categorized using three terms
> The CPA firm of Lumley & Lu uses a quantitative approach to implementing the audit risk model. Calculate detection risk for each of the following hypothetical clients. Client No. Audit Risk Risk of Material Misstatement Detection Risk 5% 20% 2 5
> Suppose that you are the auditor of a major retail client who has reported the following income before taxes (IBT) for the first two quarters of the year: 1st quarter = $1,200,000 and 2nd quarter = $1,500,000. You are in the process of establishing overa
> Briefly discuss why auditors must often exercise creativity and innovation in auditing financial statements. Give an example different from the one offered in the chapter’s conclusion.
> Section 301 of the Sarbanes-Oxley Act requires that public companies have an audit committee. Independent auditors are increasingly involved with audit committees. Required: a. Describe what an audit committee is. b. Identify the reasons why audit commi
> A CPA has been asked to audit the financial statements of a publicly held company for the first time. All preliminary verbal discussions and inquiries among the CPA, the company, the predecessor auditor, and all other necessary parties have been complete
> Parker is the in-charge auditor for the upcoming annual audit of FGH Company, a continuing audit client. Parker will supervise two assistants on the engagement and will visit the entity before the fieldwork begins. Parker has completed the engagement let
> The audit committee of the board of directors of Rebel Corporation asked Tish & Field, CPAs, to audit Rebel’s financial statements for the year ended December 31, 2018. Tish & Field explained the need to make an inquiry of the predecessor auditor and re
> You are the audit manager for Ken-Ron Enterprises. Your firm has been the entity’s auditor for 15 years. Your firm normally uses a range of 3% to 5% of income before taxes to calculate overall materiality and 50–75% of
> For each of the following scenarios, perform the three steps in the materiality process: (1) determine overall materiality, (2) determine tolerable misstatement, and (3) evaluate the audit findings. Scenario 1: Murphy & Johnson is a privately owned manuf
> Dale Boucher, the owner of a small electronics firm, asked Sally Jones, CPA, to conduct an audit of the company’s records. Boucher told Jones that the audit was to be completed in time to submit audited financial statements to a bank as part of a loan ap
> Audits can be categorized into five types: (1) financial statement audits, (2) audits of internal control, (3) compliance audits, (4) operational audits, and (5) forensic audits. Required: For each of the following descriptions, indicate which type of a
> Using the audit report included in Chapter 1, identify and briefly explain the phrases or words that indicate to the users that the financial statements are not necessarily an “exact” representation of the results of operations and financial position of
> Many companies post their financial statements and auditor’s report on their home pages, generally under a heading labeled “investor relations.” Use one of the Internet search engines to do the following: a. Visit Intel’s (www.intel.com) and Microsoft’s
> Discuss why the emergence of advanced audit technologies, such as audit data analytics, is placing an even greater premium on auditors’ knowledge of fundamental business, accounting, and auditing concepts, and on their ability to exercise professional ju
> John Josephs, an audit manager for Tip, Acanoe & Tylerto, was asked to speak at a dinner meeting of the local Small Business Administration Association. The president of the association has suggested that he talk about the various phases of the audit pro
> You were recently hired by the CPA firm of Honson & Hansen. Within two weeks, you were sent to the first-year staff training course. The instructor asks you to prepare answers for the following questions: a. How is audit evidence defined? b. How does aud
> Green bloom Garden Centers is a small, privately held corporation that has two stores in Orlando, Florida. The Green bloom family owns 100 percent of the company’s stock, and family members manage the operations. Sales at the company’s stores have been g
