3.4 Flashcards
Regarding a nonissuer’s compliance with laws and regulations, an auditor performing an audit of the entity’s financial statements is responsible for
Obtaining a general understanding of the legal and regulatory framework applicable to the entity and how the entity is complying with that framework.
The auditor should obtain a general understanding of (1) the legal and regulatory framework applicable to the entity and the industry or sector in which it operates and (2) how it is complying with the framework. Thus, the auditor’s primary responsibility for noncompliance is to obtain sufficient appropriate audit evidence regarding material amounts and disclosures that are determined by laws and regulations generally recognized to have a direct effect on their determination.
Which of the following is the most reliable analytical approach to verification of the year-end financial statement balances of a wholesale business?
Verify commission expense by multiplying sales revenue by the company’s standard commission rate.
If the wholesaler uses a standard commission rate, commission expense should be related to sales revenue. The auditor should also compare actual with budgeted and prior year amounts.
Analytical procedures used to form an overall conclusion of an audit generally would include
Considering the adequacy of the evidence gathered in response to unexpected balances identified in planning.
Analytical procedures used to form an overall conclusion ordinarily should include reading the financial statements and considering (1) the adequacy of evidence gathered in response to unusual or unexpected balances identified in planning or conducting the audit and (2) unusual or unexpected balances or relationships not previously detected.
Detection risk differs from both control risk and inherent risk in that detection risk
Can be changed at the auditor’s discretion.
Detection risk is the risk that the procedures performed to reduce audit risk to an acceptably low level will not detect a misstatement that exists and could be material individually or combined with other misstatements (AU-C 200 and AS 1101). Detection risk is set by the auditor and is a function of the effectiveness of the procedures the auditor performs for testing an assertion.
Which of the following factors most likely would heighten an auditor’s concern about the risk of fraudulent financial reporting?
An overly complex organizational structure involving unusual lines of authority.
Certain risk factors are related to misstatements arising from fraudulent reporting. One of the risk factors relating to the opportunity to commit fraud is an overly complex organizational structure involving numerous or unusual legal entities or managerial lines of authority.
Before performing substantive analytical procedures at an interim date prior to the balance sheet date, an auditor should
Consider whether the amounts of the year-end balances selected for interim testing are reasonably predictable.
Among the auditor’s considerations is whether the year-end balances of accounts on which substantive analytical procedures are performed at an interim date are reasonably predictable as to amount, relative significance, and composition.
Which of the following would a successor auditor ask the predecessor auditor to provide after accepting an audit engagement?
Matters that may facilitate the evaluation of financial reporting consistency between the current and prior years.
An objective of an initial audit is to obtain sufficient appropriate evidence regarding opening balances. The auditor should determine whether they (1) contain misstatements materially affecting the current statements and (2) reflect appropriate accounting policies consistently applied in the current statements. Relevant audit evidence about these matters may include (1) the most recent audited statements, (2) the predecessor’s report on them, (3) the results of inquiry of the predecessor, and (4) a review of the predecessor’s audit documentation (AU-C 510).
An auditor who discovers that a client’s employees paid small bribes to municipal officials most likely would withdraw from the engagement if
Management fails to take the appropriate remedial action.
When the auditor concludes that an illegal act has or is likely to have occurred, (s)he should discuss the matter with the appropriate level of management and request that any necessary remedial actions be taken. If the alleged noncompliance has a material effect on the financial statements or the client does not take the remedial action that the auditor considers necessary, the auditor should express a qualified or adverse opinion, depending on the level of materiality, or withdraw from the engagement.
An auditor’s engagement letter most likely would include a statement that
Limits the auditor’s responsibility to detect fraud and error.
The terms of the engagement should be documented in an engagement letter that states the (1) objective and scope of the audit, (2) responsibilities of the auditor and management, (3) inherent limitations of the audit and internal control, (4) applicable financial reporting framework, and (5) expected form and content of audit reports. An engagement letter should be sent by the CPA to the prospective client on each engagement, audit or otherwise. Because of the inherent limitations of the audit and of internal control, the risk of not detecting some material misstatements, whether due to fraud or error, is unavoidable. This risk exists even if the audit is in accordance with GAAS.
Audit planning for an initial audit most likely includes
Performing procedures involving opening balances.
First-year audits involve additional planning considerations. Examples are (1) communication with the predecessor auditor, (2) audit procedures regarding opening balances, (3) assignment of firm personnel with appropriate qualifications, and (4) procedures required by the firm’s system of quality control for initial engagements.
Which of the following would be considered an analytical procedure?
Developing the current year’s expected net sales based on the entity’s sales trend of prior years.
Analytical procedures are evaluations of financial information made by a study of plausible relationships among financial and nonfinancial data using models that range from simple to complex. Plausible relationships among data are reasonably expected to exist and continue in the absence of known conditions to the contrary. Thus, the auditor develops expectations or predictions of recorded balances or ratios using certain sources of information. For example, the auditor may use financial information from comparable prior periods to estimate sales based on prior-year amounts and their trend.
An auditor who is engaged in obtaining information to identify the risks of material misstatement due to fraud should perform which procedures?
I. Make inquiries directly to the audit committee or its chair
II. Apply analytical procedures to revenue accounts
III. Obtain personal financial statements from senior management
I & II only.
Obtaining information for identifying fraud risks includes inquiring of management, those charged with governance, the internal auditors, and others. It also involves considering the analytical procedures performed as risk assessment procedures and the existence of fraud risk factors. Furthermore, the auditor should apply analytical procedures to revenue accounts, for example, by comparing recorded sales and production capacity to detect fictitious sales or analyzing sales and returns before and after the balance sheet date to detect undisclosed side agreements or returns. However, the auditor does not solicit personal financial statements from management.
Each of the following is a type of known misstatement, except
Differences between management and the auditor’s judgment regarding estimates.
Known misstatements are specifically identified during the audit. In contrast with known misstatements, the amount of likely misstatements cannot be specifically identified. A likely misstatement may derive from differences between the auditor’s and management’s judgments about accounting estimates or extrapolations from audit evidence.
Prior to beginning the field work on a new audit engagement in which a CPA does not possess expertise in the industry in which the client operates, the CPA should
Perform risk assessment procedures.
The auditor should obtain an understanding of the entity and its environment, including its internal control. For this purpose, the auditor performs the following risk assessment procedures: (1) inquiries of management and others within the entity, (2) analytical procedures, and (3) observation and inspection.
Which of the following information that comes to an auditor’s attention most likely would raise a question about noncompliance with laws and regulations?
The discovery of unexplained payments made to government employees.
According to AU-C 250, the discovery of unexplained payments made to government officials or employees is specific information that may raise a question about possible noncompliance with laws and regulations.
