Chapter 03 - Audit Planning, Types of Audit Tests, and Materiality

Chapter 03 Audit Planning, Types of Audit Tests, and Materiality

True / False Questions

1. The first phase of audit planning is risk assessment. True False

. !hen the prospe"ti#e "lient has pre#iously $een audited, auditing standards re%uire that the su""essor auditor make "ertain in%uiries of the prede"essor auditor $efore a""epting the engagement. True False

3. The Code of Professional Condu"t does not allo& an auditor to dis"lose "onfidential "lient information &ithout the "lient's "onsent. True False

(. )f the prospe"ti#e "lient refuses to allo& the prede"essor auditor to "ommuni"ate &ith the su""essor auditor, the su""essor auditor should ha#e reser#ations a$out a""epting the "lient. True False

*. )n order to properly preplan the audit, the auditor must determine the engagement team re%uirements and ensure the independen"e of the audit team and audit firm. True False

+. )f the internal auditor is "ompetent and o$,e"ti#e, the auditor may generally rely on the &ork of an internal auditor in "ertain areas to redu"e the amount of e-ternal audit &ork in these areas. True False

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Chapter 03 - Audit Planning, Types of Audit Tests, and Materiality

.. All "ompanies must ha#e an audit "ommittee. True False

/. The audit "ommittee is dire"tly responsi$le for the appointment, "ompensation, and o#ersight of the &ork of any a""ounting firm employed $y a pu$li" "ompany. True False

0. The e-ternal auditor is re%uired to make a num$er of important "ommuni"ations to the audit "ommittee during or at the end of the audit engagement. True False

10. The engagement partner is typi"ally responsi$le for doing the detailed audit testing. True False

11. There are fi#e general types of audit tests. True False

1 . Materiality signifi"antly impa"ts the auditor's de"isions a$out ho& mu"h and &hat kind of e#iden"e to gather. True False

13. Materiality is $ased only on a %uantitati#e analysis of the finan"ial statements. True False

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Chapter 03 - Audit Planning, Types of Audit Tests, and Materiality

Multiple Choice Questions

1(. 1a&kins re%uested permission to "ommuni"ate &ith the prede"essor auditor and re#ie& "ertain portions of the prede"essor auditor's &orking papers. The prospe"ti#e "lient's refusal to permit this &ill $ear dire"tly on 1a&kins' de"ision "on"erning the A. Ade%ua"y of the preplanned audit program. 2. A$ility to esta$lish "onsisten"y in appli"ation of a""ounting prin"iples $et&een years. C. Apparent s"ope limitation. 3. )ntegrity of management.

1*. )n assessing &hether to a""ept a "lient for an audit engagement, a CPA should "onsider A. The "urrent finan"ial health of the prospe"ti#e "lient. 2. The integrity of management. C. The CPA's o#erall engagement risk. 3. All of the a$o#e should $e "onsidered.

1+. 4#aluating a prospe"ti#e "lient re%uires the follo&ing step5s67 A. Communi"ate &ith the prede"essor auditor. 2. Preplan the audit. C. 4sta$lish the terms of the engagement. 3. 8one of the a$o#e.

1.. An auditor has &ithdra&n from an audit engagement of a pu$li"ly held "ompany after finding fraud that may materially affe"t the finan"ial statements. The auditor should set forth the reasons and findings in "orresponden"e &ith the A. 9e"urities and 4-"hange Commission. 2. Client's legal "ounsel. C. 9to"k e-"hanges &here the "ompany's sto"k is traded. 3. Audit "ommittee of the $oard of dire"tors.

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Chapter 03 - Audit Planning, Types of Audit Tests, and Materiality

1/. !hen a CPA is approa"hed to perform an audit for the first time, the CPA should make in%uiries of the prede"essor auditor. This is a ne"essary pro"edure $e"ause the prede"essor may $e a$le to pro#ide the su""essor &ith information that &ill assist the su""essor in determining A. !hether the prede"essor's &ork should $e utili:ed. 2. !hether, in the prede"essor's opinion, the finan"ial statements are materially "orre"t. C. !hether, in the prede"essor's opinion, the "ompany's internal "ontrols ha#e $een satisfa"tory. 3. !hether the engagement should $e a""epted.

10. !hi"h of the follo&ing should an auditor o$tain from the prede"essor auditor prior to a""epting an audit engagement; A. Analysis of $alan"e sheet a""ounts. 2. Analysis of in"ome statement a""ounts. C. All matters of "ontinuing a""ounting signifi"an"e. 3. Fa"ts that might $ear on management integrity.

0. !hi"h of the follo&ing fa"tors most likely &ould "ause a CPA not to a""ept a ne& audit engagement; A. The prospe"ti#e "lient's un&illingness to permit in%uiry of its legal "ounsel. 2. The ina$ility to re#ie& the prede"essor auditor's do"umentation. C. The CPA's la"k of understanding of the prospe"ti#e "lient's operations and industry. 3. )ndi"ations that management has not in#estigated employees in key positions $efore hiring them.

1. An auditor &ho dis"o#ers that a "lient's employees paid small $ri$es to muni"ipal offi"ials most likely &ould &ithdra& from the engagement if A. The payments #iolated the "lient's poli"ies regarding the pre#ention of illegal a"ts. 2. The "lient re"ei#es finan"ial assistan"e from a federal go#ernment agen"y. C. 3o"umentation that is ne"essary to pro#e that the $ri$es &ere paid does not e-ist. 3. Management fails to take the appropriate remedial a"tion.

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Chapter 03 - Audit Planning, Types of Audit Tests, and Materiality

. A su""essor auditor should re%uest the ne& "lient to authori:e the prede"essor auditor to allo& a re#ie& of the prede"essor's A. 4ngagement letter. 2. Audit &orking papers. C. 4ngagement letter and audit &orking papers. 3. )t &ould not $e typi"al to allo& a re#ie& of either the engagement letter or the audit &orking papers.

3. 4#aluating a prospe"ti#e "lient re%uires the follo&ing step5s67 A. Communi"ate &ith the 94C. 2. Preplan the audit. C. 3etermine if the firm is independent of the "lient. 3. Communi"ate &ith the A)CPA.

(. !hi"h of the follo&ing fa"tors most likely &ould lead a CPA to "on"lude that a potential audit engagement should $e re,e"ted; A. The details of most re"orded transa"tions are not a#aila$le after a spe"ified period of time. 2. )nternal "ontrol a"ti#ities re%uiring segregation of duties are su$,e"t to management o#erride. C. )t is unlikely that suffi"ient appropriate e#iden"e is a#aila$le to support an opinion on the finan"ial statements. 3. Management has a reputation for "onsulting &ith se#eral a""ounting firms a$out signifi"ant a""ounting issues.

*. !hi"h of the follo&ing fa"tors most likely &ould "ause a CPA to de"ide not to a""ept a ne& audit engagement; A. The CPA's la"k of understanding of the prospe"ti#e "lient's internal auditor's "omputerassisted audit te"hni%ues. 2. Management's disregard of its responsi$ility to maintain an ade%uate "ontrol en#ironment. C. The CPA's ina$ility to determine &hether related party transa"tions &ere "onsummated on terms e%ui#alent to arm's-length transa"tions. 3. Management's refusal to permit the CPA to perform su$stanti#e pro"edures $efore the year-end.

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Chapter 03 - Audit Planning, Types of Audit Tests, and Materiality

+. 2efore a""epting an engagement to audit a ne& "lient, a CPA is re%uired to o$tain A. An understanding of the prospe"ti#e "lient's industry and $usiness. 2. The prospe"ti#e "lient's signature on the engagement letter. C. A preliminary understanding of the prospe"ti#e "lient's "ontrol en#ironment. 3. The prospe"ti#e "lient's "onsent to make in%uiries of the prede"essor auditor, if any.

.. !hi"h of the follo&ing situations &ould most likely re%uire spe"ial audit planning; A. 9ome items of fa"tory and offi"e e%uipment do not $ear identifi"ation num$ers. 2. 3epre"iation methods used on the "lient's ta- return differ from those used on the $ooks. C. Assets "osting less than <*00 are e-pensed e#en though the e-pe"ted life e-"eeds one year. 3. )n#entory is "omprised of pre"ious stones.

/. 3uring the initial planning phase of an audit, a CPA most likely &ould A. )dentify spe"ifi" internal "ontrol a"ti#ities that are likely to pre#ent fraud. 2. 4#aluate the reasona$leness of the "lient's a""ounting estimates. C. 3is"uss the timing of the audit pro"edures &ith the "lient's management. 3. )n%uire of the "lient's attorney as to any unre"orded "laims.

0. An auditor is re%uired to esta$lish an understanding &ith a "lient regarding the responsi$ilities for ea"h engagement. This understanding generally in"ludes A. Management's responsi$ility to guarantee that there are no material misstatements due to fraud. 2. The auditor's responsi$ility to plan and perform the audit to pro#ide reasona$le, $ut not a$solute, assuran"e of dete"ting material errors or fraud. C. Management's responsi$ility for pro#iding the auditor &ith an assessment of the risk of material misstatement due to fraud. 3. The auditor's responsi$ility for the fairness of the finan"ial statements.

30. A &ritten understanding $et&een the auditor and the "lient "on"erning the auditor's responsi$ility for the dis"o#ery of illegal a"ts is usually set forth in a5n6 A. Client representation letter. 2. =etter of audit in%uiry. C. Management letter. 3. 4ngagement letter.

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Chapter 03 - Audit Planning, Types of Audit Tests, and Materiality

31. 4ngagement letters in"lude all of the follo&ing e-"ept7 A. A list of additional ser#i"es that &ill $e pro#ided. 2. A list of ad,usting ,ournal entries. C. )nformation a$out the audit fee. 3. Arrangements in#ol#ing the use of spe"ialists.

3 . !hi"h of the follo&ing matters generally is in"luded in an auditor's engagement letter; A. Management's responsi$ility for the entity's "omplian"e &ith la&s and regulations. 2. The fa"tors to $e "onsidered in setting preliminary ,udgments a$out materiality. C. Management's lia$ility for illegal a"ts "ommitted $y its employees. 3. The auditor's responsi$ility to guarantee a""ura"y of the finan"ial statements.

33. To pro#ide for the greatest degree of independen"e in performing internal audit fun"tions, an internal auditor most likely should report to the A. >i"e-President - Finan"e 2. Corporate "ontroller. C. Audit "ommittee of the $oard of dire"tors. 3. Corporate sto"kholders.

3(. All of the follo&ing refer to an internal auditor's "ompeten"e e-"ept7 A. The party in the entity to &hi"h the internal auditor reports. 2. The %uality of internal audit do"uments and reports. C. Professional "ertifi"ation. 3. 9uper#ision and re#ie& of internal audit a"ti#ities.

3*. An independent auditor might "onsider the pro"edures performed $y the internal auditors $e"ause A. They are employees &hose &ork must $e re#ie&ed during su$stanti#e testing. 2. They are employees &hose &ork might $e relied upon. C. Their &ork impa"ts the "ost?$enefit tradeoff in e#aluating inherent limitations. 3. Their degree of independen"e may $e inferred $y the nature of their &ork.

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Chapter 03 - Audit Planning, Types of Audit Tests, and Materiality

3+. As generally "on"ei#ed, the audit "ommittee of a pu$li"ly held "ompany should $e made up of A. @epresentati#es of the ma,or e%uity interests 5preferred sto"k, "ommon sto"k6. 2. The audit partner, the "hief finan"ial offi"er, the legal "ounsel, and at least one outsider. C. @epresentati#es from the "lient's management, in#estors, suppliers, and "ustomers. 3. Mem$ers of the $oard of dire"tors &ho are not offi"ers or employees.

3.. To emphasi:e auditor independen"e from management, pu$li"ly traded "orporations are re%uired to A. Appoint a partner of the CPA firm "ondu"ting the e-amination to the "orporation's audit "ommittee. 2. 4sta$lish a poli"y of dis"ouraging so"ial "onta"t $et&een employees of the "orporation and the independent auditors. C. @e%uest that a representati#e of the independent auditor $e on hand at the annual sto"kholders' meeting. 3. 1a#e the independent auditor report to an audit "ommittee of independent mem$ers of the $oard of dire"tors.

3/. An auditor o$tains kno&ledge a$out a ne& "lient's $usiness and its industry in order to A. Make "onstru"ti#e suggestions "on"erning impro#ements to the "lient's internal "ontrol. 2. 3e#elop an attitude of professional skepti"ism "on"erning management's finan"ial statement assertions. C. 4#aluate &hether the aggregation of kno&n misstatements "auses the finan"ial statements taken as a &hole to $e materially misstated. 3. Anderstand the e#ents and transa"tions that may ha#e an effe"t on the "lient's finan"ial statements.

30. !hi"h of the follo&ing is an e-ample of a related party transa"tion; A. An a"tion is taken $y the dire"tors of Company A to pro#ide additional "ompensation for #i"e presidents in "harge of the prin"ipal $usiness fun"tions of Company A. 2. A long-term agreement is made $y Company A to pro#ide mer"handise or ser#i"es to Company 2, a long-time, friendly "ompetitor. C. A short-term loan is granted to Company A $y a $ank that has a depositor &ho is a mem$er of the $oard of dire"tors of Company A. 3. A nonmonetary e-"hange o""urs &here$y Company A e-"hanges property for similar property o&ned $y Company 2, an un"onsolidated su$sidiary of Company A.

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Chapter 03 - Audit Planning, Types of Audit Tests, and Materiality

(0. An independent auditor finds that 1olda&ay Corporation o""upies offi"e spa"e, at no "harge, in an offi"e $uilding o&ned $y a shareholder. This finding likely indi"ates the e-isten"e of A. Management fraud. 2. @elated party transa"tions. C. !indo& dressing. 3. !eak internal "ontrol.

(1. !hi"h of the follo&ing &ould not ne"essarily $e a related party transa"tion; A. 9ales to another "orporation &ith a similar name. 2. Pur"hases from another "orporation that is "ontrolled $y the "orporation's "hief sto"kholder. C. =oan from the "orporation to a ma,or sto"kholder. 3. 9ale of land to the "orporation $y the spouse of a dire"tor.

( . The e-isten"e of a related party transa"tion may $e indi"ated &hen another entity A. 9ells real estate to the "orporation at a pri"e that is "ompara$le to its appraised #alue. 2. A$sor$s e-penses of the "orporation under audit. C. 2orro&s from the "orporation at a rate of interest &hi"h e%uals the "urrent market rate. 3. =ends to the "orporation at a rate of interest &hi"h e%uals the "urrent market rate.

(3. )n the "onte-t of an audit of finan"ial statements, su$stanti#e pro"edures are audit pro"edures that A. May $e eliminated under "ertain "onditions. 2. Are primarily designed to dis"o#er signifi"ant su$se%uent e#ents. C. May $e either tests of details of transa"tions, tests of details of a""ount $alan"es, or analyti"al pro"edures. 3. !ill in"rease proportionately &ith an in"rease in the auditor's relian"e on internal "ontrol.

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Chapter 03 - Audit Planning, Types of Audit Tests, and Materiality

((. !hi"h of the follo&ing is not an audit pro"edure that is "ommonly used in performing tests of "ontrols; A. )n%uiring. 2. B$ser#ing. C. Confirming. 3. )nspe"ting.

(*. Tolera$le misstatement is A. Materiality allo"ated to an assertion. 2. Materiality for the $alan"e sheet as a &hole. C. Materiality for the in"ome statement as a &hole. 3. Materiality allo"ated to a spe"ifi" a""ount.

(+. !hi"h of the follo&ing &ould an auditor most likely use in determining the auditor's planning materiality; A. The anti"ipated sample si:e for planned su$stanti#e pro"edures. 2. The entity's annuali:ed interim 5i.e. %uarterly6 finan"ial statements. C. The results of the internal "ontrol %uestionnaire. 3. The "ontents of the management representation letter.

(.. !hi"h of the follo&ing is not a %ualitati#e fa"tor that may affe"t an auditor's esta$lishment of materiality; A. Potential for fraud. 2. The "ompany is "lose to #iolating loan "o#enants. C. Firm poli"y sets materiality at (C of preta- in"ome. 3. A small misstatement &ould interrupt an earnings trend.

(/. !hi"h of the follo&ing is not a "on"ern as to &hether a misstatement is %ualitati#ely material; A. The misstatement hides a failure to meet analysts' e-pe"tations. 2. The misstatement is less than *C of preta- in"ome. C. The misstatement in"reases management's "ompensation. 3. The misstatement "hanges a small amount of profit to a small reported loss.

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Chapter 03 - Audit Planning, Types of Audit Tests, and Materiality

(0. )n assessing the "ompeten"e of an internal auditor, an independent CPA most likely &ould o$tain information a$out the A. Duality of the internal auditor's &ork. 2. Brgani:ation's "ommitment to integrity and ethi"al #alues. C. )nfluen"e of management on the s"ope of the internal auditor's duties. 3. Brgani:ational le#els to &hi"h the internal auditor reports.

*0. !hi"h of the follo&ing pro"edures &ould an auditor most likely in"lude in the initial planning of a finan"ial statement audit; A. Perform detailed testing of the indi#idual $alan"e sheet a""ounts. 2. 4-amining do"uments to dete"t illegal a"ts ha#ing a material effe"t on the finan"ial statements. C. Considering &hether the "lient's a""ounting estimates are reasona$le in the "ir"umstan"es. 3. 3etermining the e-tent of in#ol#ement of the "lient's internal auditors.

*1. The in-"harge auditor most likely &ould ha#e a super#isory responsi$ility to e-plain to the staff assistants A. That immaterial fraud is not to $e reported to the "lient's audit "ommittee. 2. 1o& the results of #arious auditing pro"edures performed $y the assistants should $e e#aluated. C. 1o& the o#erall audit strategy &ill allo& the firm to rea"h a suffi"iently lo& le#el of audit risk. 3. 1o& o#erall materiality &as sele"ted.

* . !hi"h of the follo&ing audit pro"edures &ould $e least likely to dis"lose the e-isten"e of related party transa"tions of a "lient during the period under audit; A. @eading E"onfli"t-of-interestE statements o$tained $y the "lient from its management. 2. 9"anning a""ounting re"ords for large transa"tions at or ,ust prior to the end of the period under audit. C. @eading minutes of the 2oard of 3ire"tors meetings for authori:ation or dis"ussion of material transa"tions. 3. Confirming pur"hases and sales transa"tions &ith the #endors and?or "ustomers in#ol#ed.

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Chapter 03 - Audit Planning, Types of Audit Tests, and Materiality

*3. A dual-purpose test A. 9imultaneously tests de$its and "redits. 2. )s a pro"edure "ompleted $y $oth the internal and e-ternal auditors. C. )s useful to $oth the entity and the auditor. 3. )s $oth a su$stanti#e test of transa"tions and a test of "ontrols.

*(. The element of the audit planning pro"ess most likely to $e agreed upon &ith the "lient $efore implementation of the audit strategy is the determination of the A. Methods of statisti"al sampling to $e used in "onfirming a""ounts re"ei#a$le. 2. Pending legal matters to $e in"luded in the in%uiry of the "lient's attorney. C. 4#iden"e to $e gathered to pro#ide a suffi"ient $asis for the auditor's opinion. 3. Timing of the audit.

**. The audit "lient's $oard of dire"tors and audit "ommittee refused to take any a"tion &ith respe"t to an immaterial illegal a"t &hi"h &as $rought to their attention $y the auditor. 2e"ause of their failure to a"t, the auditor &ithdre& from the engagement. The auditor's de"ision to &ithdra& &as primarily due to dou$ts "on"erning A. Ade%uate finan"ial statement dis"losures. 2. Complian"e &ith the statutory la&s and regulations. C. 9"ope limitations resulting from their ina"tion. 3. The integrity of management.

*+. !hi"h of the follo&ing pro"edures &ould an auditor most likely in"lude in the initial planning of an e-amination of finan"ial statements; A. Assess the need for the use of spe"ialists in the audit. 2. )n%uiring of the "lient's attorney as to any "laims that are likely to $e asserted. C. Perform detailed testing of the indi#idual finan"ial statement a""ounts. 3. 3etermining &hether ne"essary internal "ontrols pro"edures are $eing applied as pres"ri$ed.

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Chapter 03 - Audit Planning, Types of Audit Tests, and Materiality

*.. An entity's finan"ial statements &ere misstated o#er a period of years due to large amounts of re#enue $eing re"orded in ,ournal entries that in#ol#ed de$its and "redits to an illogi"al "om$ination of a""ounts. The auditor "ould most likely ha#e $een alerted to this fraud $y A. 9"anning the general ,ournal for unusual entries. 2. Performing a re#enue "utoff test at year-end. C. Tra"ing a sample of ,ournal entries to the general ledger. 3. 4-amining do"umentary e#iden"e of sales returns and allo&an"es re"orded after year-end.

*/. Ander the 9ar$anes-B-ley A"t, the audit "ommittee of a pu$li" "ompany has the follo&ing re%uirement5s67 A. 4a"h mem$er of the "ommittee must $e a $oard mem$er and shall $e independent. 2. The audit "ommittee must preappro#e all audit and nonaudit ser#i"es. C. The audit "ommittee must esta$lish and maintain pro"edures to handle all issues that relate to a""ounting, internal "ontrol, and auditing. 3. All of the a$o#e.

*0. !hi"h of the follo&ing is a general audit test; A. Fee assessment pro"edures. 2. Tests of "ontrols. C. Preparation of "orporate ta- returns. 3. A"ti#e testing pro"edures.

+0. !hi"h of the follo&ing arranges the general types of audit tests in the order they are normally performed in an audit; A. 9u$stanti#e pro"edures, tests of "ontrols, and risk assessment pro"edures. 2. 9u$stanti#e pro"edures, risk assessment pro"edures, and tests of "ontrols. C. @isk assessment pro"edures, tests of "ontrols, and su$stanti#e pro"edures. 3. @isk assessment pro"edures, su$stanti#e pro"edures, and tests of "ontrols.

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Chapter 03 - Audit Planning, Types of Audit Tests, and Materiality

+1. !hi"h of the follo&ing relati#ely small misstatements most likely &ould ha#e a material effe"t on an entity's finan"ial statements; A. An illegal payment to a foreign offi"ial that &as not re"orded. 2. A pie"e of o$solete offi"e e%uipment that &as not retired. C. A petty "ash fund dis$ursement that &as not properly authori:ed. 3. An un"olle"ti$le a""ount re"ei#a$le that &as not &ritten-off.

+ . !hi"h of the follo&ing is the most important %ualitati#e fa"tor that auditors should "onsider &hen making materiality ,udgments; A. A misstatement e-"eeded fi#e per"ent of net in"ome. 2. The auditor also pro#ides "onsulting ser#i"es to the audit "lient. C. The misstatement &ill "ause the "lient to fail to meet an earnings fore"ast. 3. The audit "ommittee is not &ell-edu"ated a$out the a""ounting prin"iple in %uestion.

+3. !hi"h element5s6 is?are per#asi#e to the appli"ation of generally a""epted auditing standards, parti"ularly the standards of field&ork and reporting; A. The elements of materiality and audit risk. 2. The element of internal "ontrol. C. The element of "orro$orating e#iden"e. 3. The element of reasona$le assuran"e.

+(. !hi"h of the follo&ing statements is not "orre"t a$out materiality; A. The "on"ept of materiality re"ogni:es that some matters are important for fair presentation of finan"ial statements in "onformity &ith FAAP, &hile other matters are not important. 2. An auditor "onsiders materiality for the aggregate le#el of misstatements that "ould $e material to any one of the finan"ial statements indi#idually. C. Materiality ,udgments are made in light of surrounding "ir"umstan"es and ne"essarily in#ol#e $oth %uantitati#e and %ualitati#e ,udgments. 3. An auditor's "onsideration of materiality is influen"ed $y the auditor's per"eption of the needs of a reasona$le person &ho &ill rely on the finan"ial statements.

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Chapter 03 - Audit Planning, Types of Audit Tests, and Materiality

Short Answer Questions

+*. Cart and 2lan"he, a regional a""ounting firm is determining &hether it &ants to a""ept a ne& "lient, )#y Photos. )#y Photos is "urrently a pri#ately held photography studio operating ( studios in se#eral states, $ut the "ompany's management is planning an )nitial Pu$li" Bffering in the near future. This is the "ompany's first audit. !hat steps should Cart and 2lan"he take in e#aluating this ne& "lient;

++. 3efine the engagement letter and dis"uss its importan"e.

+.. 23G A""ounting is auditing a ne& "lient, A =a Carte Catering. 23G "ould sa#e audit time $y using &ork from A =a Carte's internal audit staff. The staff "onsists of three a""ountants &ith pu$li" a""ounting e-perien"e and "ertifi"ation. A =a Carte re%uires e#ery mem$er of its a""ounting department to spend t&o out of e#ery fi#e years on the internal audit staff. Then, the employee is rotated $a"k into the a""ounting department for a "ouple of years. !hat fa"tors should 23G "onsider &hen determining &hether or not it "an use &ork of the internal audit staff; )n this "ase, &hat should 23G de"ide;

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Chapter 03 - Audit Planning, Types of Audit Tests, and Materiality

+/. 8ame three 9ar$anes-B-ley A"t re%uirements of the mem$ers and duties of the audit "ommittee of a pu$li" "ompany.

+0. 1o& &ould an auditor identify related parties and &hat is the importan"e of doing so;

.0. )n the planning stages of an audit, &hat information does an auditor gain through analyti"al pro"edures;

.1. 3is"uss the purposes for planning the audit and identify the steps that are performed during this phase of the engagement.

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Chapter 03 - Audit Planning, Types of Audit Tests, and Materiality

. . 8ame and des"ri$e three super#isory a"ti#ities that should $e performed $y the engagement partner and other engagement team mem$ers performing super#isory a"ti#ities.

.3. 8ame the three types of analyti"al pro"edures and pro#ide a definition and e-ample for ea"h.

.(. Bften in an audit, total "om$ined tolera$le misstatement is greater than o#erall materiality. !hy is this the "ase;

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Chapter 03 - Audit Planning, Types of Audit Tests, and Materiality

Chapter 03 Audit Planning, Types of Audit Tests, and Materiality Ans&er Gey

True / False Questions

1. The first phase of audit planning is risk assessment. FA S!

AACSB: Analytic AICPA BB: Industry AICPA FN: Risk Analysis Blooms: Remember Difficulty: 1 Easy earnin! "b#ecti$e: %&'%1 (nderstand t)e auditor*s re+uirements for client acce,tance and continuance.o,ic: Client Acce,tance and Continuance

. !hen the prospe"ti#e "lient has pre#iously $een audited, auditing standards re%uire that the su""essor auditor make "ertain in%uiries of the prede"essor auditor $efore a""epting the engagement. T"#!

AACSB: Communication AICPA BB: Industry AICPA FN: Risk Analysis Blooms: Remember Difficulty: 1 Easy earnin! "b#ecti$e: %&'%1 (nderstand t)e auditor*s re+uirements for client acce,tance and continuance.o,ic: Client Acce,tance and Continuance

3. The Code of Professional Condu"t does not allo& an auditor to dis"lose "onfidential "lient information &ithout the "lient's "onsent. T"#!

AACSB: Et)ics AICPA BB: Industry AICPA FN: Re,ortin! Blooms: Remember Difficulty: 1 Easy earnin! "b#ecti$e: %&'%1 (nderstand t)e auditor*s re+uirements for client acce,tance and continuance.o,ic: Client Acce,tance and Continuance

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Chapter 03 - Audit Planning, Types of Audit Tests, and Materiality

(. )f the prospe"ti#e "lient refuses to allo& the prede"essor auditor to "ommuni"ate &ith the su""essor auditor, the su""essor auditor should ha#e reser#ations a$out a""epting the "lient. T"#!

AACSB: Et)ics AICPA BB: Industry AICPA FN: Decision /akin! Blooms: Remember Difficulty: 1 Easy earnin! "b#ecti$e: %&'%1 (nderstand t)e auditor*s re+uirements for client acce,tance and continuance.o,ic: Client Acce,tance and Continuance

*. )n order to properly preplan the audit, the auditor must determine the engagement team re%uirements and ensure the independen"e of the audit team and audit firm. T"#!

AACSB: Analytic AICPA BB: Resource /ana!ement AICPA FN: Decision /akin! Blooms: Remember Difficulty: 1 Easy earnin! "b#ecti$e: %&'%0 (nderstand t)e ste,s t)at are in$ol$ed in t)e ,reliminary en!a!ement acti$ities.o,ic: Preliminary En!a!ement Acti$ities

+. )f the internal auditor is "ompetent and o$,e"ti#e, the auditor may generally rely on the &ork of an internal auditor in "ertain areas to redu"e the amount of e-ternal audit &ork in these areas. T"#!

AACSB: Et)ics AICPA BB: Resource /ana!ement AICPA FN: Risk Analysis Blooms: Remember Difficulty: 1 Easy earnin! "b#ecti$e: %&'%1 (nderstand )o2 t)e 2ork of t)e internal auditors can assist in t)e ,erformance of t)e audit.o,ic: (sin! t)e 3ork of t)e Internal Auditors

3-10

Chapter 03 - Audit Planning, Types of Audit Tests, and Materiality

.. All "ompanies must ha#e an audit "ommittee. FA S!

AACSB: Analytic AICPA BB: e!al AICPA FN: Risk Analysis Blooms: Remember Difficulty: 1 Easy earnin! "b#ecti$e: %&'%4 5no2 t)e res,onsibilities of t)e audit committee and )o2 it relates to t)e e6ternal auditors.o,ic: .)e Role of t)e Audit Committee

/. The audit "ommittee is dire"tly responsi$le for the appointment, "ompensation, and o#ersight of the &ork of any a""ounting firm employed $y a pu$li" "ompany. T"#!

AACSB: Analytic AICPA BB: Industry AICPA FN: Re,ortin! Blooms: Remember Difficulty: 1 Easy earnin! "b#ecti$e: %&'%4 5no2 t)e res,onsibilities of t)e audit committee and )o2 it relates to t)e e6ternal auditors.o,ic: .)e Role of t)e Audit Committee

0. The e-ternal auditor is re%uired to make a num$er of important "ommuni"ations to the audit "ommittee during or at the end of the audit engagement. T"#!

AACSB: Communication AICPA BB: Industry AICPA FN: Re,ortin! Blooms: Remember Difficulty: 1 Easy earnin! "b#ecti$e: %&'%4 5no2 t)e res,onsibilities of t)e audit committee and )o2 it relates to t)e e6ternal auditors.o,ic: .)e Role of t)e Audit Committee

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Chapter 03 - Audit Planning, Types of Audit Tests, and Materiality

10. The engagement partner is typi"ally responsi$le for doing the detailed audit testing. FA S!

AACSB: Analytic AICPA BB: Resource /ana!ement AICPA FN: Decision /akin! Blooms: Remember Difficulty: 1 Easy earnin! "b#ecti$e: %&'%7 (nderstand t)e im,ortance of su,er$ision to t)e ,lannin! and conduct of t)e audit.o,ic: Su,er$ision of t)e Audit

11. There are fi#e general types of audit tests. FA S!

AACSB: Analytic AICPA BB: Industry AICPA FN: Risk Analysis Blooms: Remember Difficulty: 1 Easy earnin! "b#ecti$e: %&'%8 5no2 t)e ty,es of audit tests.o,ic: .y,es of Audit .ests

1 . Materiality signifi"antly impa"ts the auditor's de"isions a$out ho& mu"h and &hat kind of e#iden"e to gather. T"#!

AACSB: Communication AICPA BB: e!al AICPA FN: Risk Analysis Blooms: (nderstand Difficulty: 1 Easy earnin! "b#ecti$e: %&'1% (nderstand t)e conce,t of materiality.o,ic: /ateriality

13. Materiality is $ased only on a %uantitati#e analysis of the finan"ial statements. FA S!

AACSB: Communication AICPA BB: e!al AICPA FN: Risk Analysis Blooms: (nderstand Difficulty: 1 Easy earnin! "b#ecti$e: %&'1% (nderstand t)e conce,t of materiality.o,ic: /ateriality

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Chapter 03 - Audit Planning, Types of Audit Tests, and Materiality

Multiple Choice Questions

1(. 1a&kins re%uested permission to "ommuni"ate &ith the prede"essor auditor and re#ie& "ertain portions of the prede"essor auditor's &orking papers. The prospe"ti#e "lient's refusal to permit this &ill $ear dire"tly on 1a&kins' de"ision "on"erning the A. Ade%ua"y of the preplanned audit program. 2. A$ility to esta$lish "onsisten"y in appli"ation of a""ounting prin"iples $et&een years. C. Apparent s"ope limitation. $% )ntegrity of management.

AACSB: Communication AICPA BB: e!al AICPA FN: Decision /akin! Blooms: A,,ly Difficulty: 1 Easy earnin! "b#ecti$e: %&'%1 (nderstand t)e auditor*s re+uirements for client acce,tance and continuance.o,ic: Client Acce,tance and Continuance

1*. )n assessing &hether to a""ept a "lient for an audit engagement, a CPA should "onsider A. The "urrent finan"ial health of the prospe"ti#e "lient. 2. The integrity of management. C. The CPA's o#erall engagement risk. $% All of the a$o#e should $e "onsidered.

AACSB: Analytic AICPA BB: Industry AICPA FN: Risk Analysis Blooms: Remember Difficulty: 1 Easy earnin! "b#ecti$e: %&'%1 (nderstand t)e auditor*s re+uirements for client acce,tance and continuance.o,ic: Client Acce,tance and Continuance

3-

Chapter 03 - Audit Planning, Types of Audit Tests, and Materiality

1+. 4#aluating a prospe"ti#e "lient re%uires the follo&ing step5s67 A% Communi"ate &ith the prede"essor auditor. 2. Preplan the audit. C. 4sta$lish the terms of the engagement. 3. 8one of the a$o#e.

AACSB: Communication AICPA BB: Industry AICPA FN: Decision /akin! Blooms: Remember Difficulty: 1 Easy earnin! "b#ecti$e: %&'%1 (nderstand t)e auditor*s re+uirements for client acce,tance and continuance.o,ic: Client Acce,tance and Continuance

1.. An auditor has &ithdra&n from an audit engagement of a pu$li"ly held "ompany after finding fraud that may materially affe"t the finan"ial statements. The auditor should set forth the reasons and findings in "orresponden"e &ith the A. 9e"urities and 4-"hange Commission. 2. Client's legal "ounsel. C. 9to"k e-"hanges &here the "ompany's sto"k is traded. $% Audit "ommittee of the $oard of dire"tors.

AACSB: Communication AICPA BB: e!al AICPA FN: Re,ortin! Blooms: Remember Difficulty: 0 /oderate earnin! "b#ecti$e: %&'%1 (nderstand t)e auditor*s re+uirements for client acce,tance and continuance.o,ic: Client Acce,tance and Continuance

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Chapter 03 - Audit Planning, Types of Audit Tests, and Materiality

1/. !hen a CPA is approa"hed to perform an audit for the first time, the CPA should make in%uiries of the prede"essor auditor. This is a ne"essary pro"edure $e"ause the prede"essor may $e a$le to pro#ide the su""essor &ith information that &ill assist the su""essor in determining A. !hether the prede"essor's &ork should $e utili:ed. 2. !hether, in the prede"essor's opinion, the finan"ial statements are materially "orre"t. C. !hether, in the prede"essor's opinion, the "ompany's internal "ontrols ha#e $een satisfa"tory. $% !hether the engagement should $e a""epted.

AACSB: Communication AICPA BB: e!al AICPA FN: Decision /akin! Blooms: Remember Difficulty: 0 /oderate earnin! "b#ecti$e: %&'%1 (nderstand t)e auditor*s re+uirements for client acce,tance and continuance.o,ic: Client Acce,tance and Continuance

10. !hi"h of the follo&ing should an auditor o$tain from the prede"essor auditor prior to a""epting an audit engagement; A. Analysis of $alan"e sheet a""ounts. 2. Analysis of in"ome statement a""ounts. C. All matters of "ontinuing a""ounting signifi"an"e. $% Fa"ts that might $ear on management integrity.

AACSB: Communication AICPA BB: e!al AICPA FN: Decision /akin! Blooms: A,,ly Difficulty: 0 /oderate earnin! "b#ecti$e: %&'%1 (nderstand t)e auditor*s re+uirements for client acce,tance and continuance.o,ic: Client Acce,tance and Continuance

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Chapter 03 - Audit Planning, Types of Audit Tests, and Materiality

0. !hi"h of the follo&ing fa"tors most likely &ould "ause a CPA not to a""ept a ne& audit engagement; A% The prospe"ti#e "lient's un&illingness to permit in%uiry of its legal "ounsel. 2. The ina$ility to re#ie& the prede"essor auditor's do"umentation. C. The CPA's la"k of understanding of the prospe"ti#e "lient's operations and industry. 3. )ndi"ations that management has not in#estigated employees in key positions $efore hiring them.

AACSB: Communication AICPA BB: e!al AICPA FN: Decision /akin! Blooms: (nderstand Difficulty: & 9ard earnin! "b#ecti$e: %&'%1 (nderstand t)e auditor*s re+uirements for client acce,tance and continuance.o,ic: Client Acce,tance and Continuance

1. An auditor &ho dis"o#ers that a "lient's employees paid small $ri$es to muni"ipal offi"ials most likely &ould &ithdra& from the engagement if A. The payments #iolated the "lient's poli"ies regarding the pre#ention of illegal a"ts. 2. The "lient re"ei#es finan"ial assistan"e from a federal go#ernment agen"y. C. 3o"umentation that is ne"essary to pro#e that the $ri$es &ere paid does not e-ist. $% Management fails to take the appropriate remedial a"tion.

AACSB: Communication AICPA BB: e!al AICPA FN: Re,ortin! Blooms: E$aluate Difficulty: & 9ard earnin! "b#ecti$e: %&'%1 (nderstand t)e auditor*s re+uirements for client acce,tance and continuance.o,ic: Client Acce,tance and Continuance

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Chapter 03 - Audit Planning, Types of Audit Tests, and Materiality

. A su""essor auditor should re%uest the ne& "lient to authori:e the prede"essor auditor to allo& a re#ie& of the prede"essor's A. 4ngagement letter. &% Audit &orking papers. C. 4ngagement letter and audit &orking papers. 3. )t &ould not $e typi"al to allo& a re#ie& of either the engagement letter or the audit &orking papers.

AACSB: Communication AICPA BB: e!al AICPA FN: Decision /akin! Blooms: Analy:e Difficulty: 0 /oderate earnin! "b#ecti$e: %&'%1 (nderstand t)e auditor*s re+uirements for client acce,tance and continuance.o,ic: Client Acce,tance and Continuance

3. 4#aluating a prospe"ti#e "lient re%uires the follo&ing step5s67 A. Communi"ate &ith the 94C. 2. Preplan the audit. C% 3etermine if the firm is independent of the "lient. 3. Communi"ate &ith the A)CPA.

AACSB: Communication AICPA BB: Industry AICPA FN: Risk Analysis Blooms: A,,ly Difficulty: 1 Easy earnin! "b#ecti$e: %&'%1 (nderstand t)e auditor*s re+uirements for client acce,tance and continuance.o,ic: Client Acce,tance and Continuance

3- +

Chapter 03 - Audit Planning, Types of Audit Tests, and Materiality

(. !hi"h of the follo&ing fa"tors most likely &ould lead a CPA to "on"lude that a potential audit engagement should $e re,e"ted; A. The details of most re"orded transa"tions are not a#aila$le after a spe"ified period of time. 2. )nternal "ontrol a"ti#ities re%uiring segregation of duties are su$,e"t to management o#erride. C% )t is unlikely that suffi"ient appropriate e#iden"e is a#aila$le to support an opinion on the finan"ial statements. 3. Management has a reputation for "onsulting &ith se#eral a""ounting firms a$out signifi"ant a""ounting issues.

AACSB: Communication AICPA BB: Critical .)inkin! AICPA FN: Risk Analysis Blooms: A,,ly Difficulty: & 9ard earnin! "b#ecti$e: %&'%1 (nderstand t)e auditor*s re+uirements for client acce,tance and continuance.o,ic: Client Acce,tance and Continuance

*. !hi"h of the follo&ing fa"tors most likely &ould "ause a CPA to de"ide not to a""ept a ne& audit engagement; A. The CPA's la"k of understanding of the prospe"ti#e "lient's internal auditor's "omputerassisted audit te"hni%ues. &% Management's disregard of its responsi$ility to maintain an ade%uate "ontrol en#ironment. C. The CPA's ina$ility to determine &hether related party transa"tions &ere "onsummated on terms e%ui#alent to arm's-length transa"tions. 3. Management's refusal to permit the CPA to perform su$stanti#e pro"edures $efore the year-end.

AACSB: Communication AICPA BB: Critical .)inkin! AICPA FN: Risk Analysis Blooms: A,,ly Difficulty: & 9ard earnin! "b#ecti$e: %&'%1 (nderstand t)e auditor*s re+uirements for client acce,tance and continuance.o,ic: Client Acce,tance and Continuance

3- .

Chapter 03 - Audit Planning, Types of Audit Tests, and Materiality

+. 2efore a""epting an engagement to audit a ne& "lient, a CPA is re%uired to o$tain A. An understanding of the prospe"ti#e "lient's industry and $usiness. 2. The prospe"ti#e "lient's signature on the engagement letter. C. A preliminary understanding of the prospe"ti#e "lient's "ontrol en#ironment. $% The prospe"ti#e "lient's "onsent to make in%uiries of the prede"essor auditor, if any.

AACSB: Communication AICPA BB: e!al AICPA FN: Decision /akin! Blooms: E$aluate Difficulty: & 9ard earnin! "b#ecti$e: %&'%1 (nderstand t)e auditor*s re+uirements for client acce,tance and continuance.o,ic: Client Acce,tance and Continuance

.. !hi"h of the follo&ing situations &ould most likely re%uire spe"ial audit planning; A. 9ome items of fa"tory and offi"e e%uipment do not $ear identifi"ation num$ers. 2. 3epre"iation methods used on the "lient's ta- return differ from those used on the $ooks. C. Assets "osting less than <*00 are e-pensed e#en though the e-pe"ted life e-"eeds one year. $% )n#entory is "omprised of pre"ious stones.

AACSB: Analytic AICPA BB: Industry AICPA FN: Decision /akin! Blooms: A,,ly Difficulty: 1 Easy earnin! "b#ecti$e: %&'%0 (nderstand t)e ste,s t)at are in$ol$ed in t)e ,reliminary en!a!ement acti$ities.o,ic: Preliminary En!a!ement Acti$ities

/. 3uring the initial planning phase of an audit, a CPA most likely &ould A. )dentify spe"ifi" internal "ontrol a"ti#ities that are likely to pre#ent fraud. 2. 4#aluate the reasona$leness of the "lient's a""ounting estimates. C% 3is"uss the timing of the audit pro"edures &ith the "lient's management. 3. )n%uire of the "lient's attorney as to any unre"orded "laims.

AACSB: Communication AICPA BB: Industry AICPA FN: Decision /akin! Blooms: E$aluate Difficulty: & 9ard earnin! "b#ecti$e: %&'%0 (nderstand t)e ste,s t)at are in$ol$ed in t)e ,reliminary en!a!ement acti$ities.o,ic: Preliminary En!a!ement Acti$ities

3- /

Chapter 03 - Audit Planning, Types of Audit Tests, and Materiality

0. An auditor is re%uired to esta$lish an understanding &ith a "lient regarding the responsi$ilities for ea"h engagement. This understanding generally in"ludes A. Management's responsi$ility to guarantee that there are no material misstatements due to fraud. &% The auditor's responsi$ility to plan and perform the audit to pro#ide reasona$le, $ut not a$solute, assuran"e of dete"ting material errors or fraud. C. Management's responsi$ility for pro#iding the auditor &ith an assessment of the risk of material misstatement due to fraud. 3. The auditor's responsi$ility for the fairness of the finan"ial statements.

AACSB: Communication AICPA BB: Industry AICPA FN: Decision /akin! Blooms: E$aluate Difficulty: 0 /oderate earnin! "b#ecti$e: %&'%& 5no2 2)at is re+uired to establis) an understandin! 2it) t)e client.o,ic: Establis) an (nderstandin! 2it) t)e Client

30. A &ritten understanding $et&een the auditor and the "lient "on"erning the auditor's responsi$ility for the dis"o#ery of illegal a"ts is usually set forth in a5n6 A. Client representation letter. 2. =etter of audit in%uiry. C. Management letter. $% 4ngagement letter.

AACSB: Communication AICPA BB: Industry AICPA FN: Decision /akin! Blooms: Remember Difficulty: 1 Easy earnin! "b#ecti$e: %&'%; 5no2 t)e ty,es of information t)at are included in an en!a!ement letter.o,ic: .)e En!a!ement etter

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Chapter 03 - Audit Planning, Types of Audit Tests, and Materiality

31. 4ngagement letters in"lude all of the follo&ing e-"ept7 A. A list of additional ser#i"es that &ill $e pro#ided. &% A list of ad,usting ,ournal entries. C. )nformation a$out the audit fee. 3. Arrangements in#ol#ing the use of spe"ialists.

AACSB: Communication AICPA BB: Industry AICPA FN: Decision /akin! Blooms: Remember Difficulty: 1 Easy earnin! "b#ecti$e: %&'%; 5no2 t)e ty,es of information t)at are included in an en!a!ement letter.o,ic: .)e En!a!ement etter

3 . !hi"h of the follo&ing matters generally is in"luded in an auditor's engagement letter; A% Management's responsi$ility for the entity's "omplian"e &ith la&s and regulations. 2. The fa"tors to $e "onsidered in setting preliminary ,udgments a$out materiality. C. Management's lia$ility for illegal a"ts "ommitted $y its employees. 3. The auditor's responsi$ility to guarantee a""ura"y of the finan"ial statements.

AACSB: Communication AICPA BB: Industry AICPA FN: Decision /akin! Blooms: Remember Difficulty: & 9ard earnin! "b#ecti$e: %&'%; 5no2 t)e ty,es of information t)at are included in an en!a!ement letter.o,ic: .)e En!a!ement etter

33. To pro#ide for the greatest degree of independen"e in performing internal audit fun"tions, an internal auditor most likely should report to the A. >i"e-President - Finan"e 2. Corporate "ontroller. C% Audit "ommittee of the $oard of dire"tors. 3. Corporate sto"kholders.

AACSB: Et)ics AICPA BB: e!al AICPA FN: Decision /akin! Blooms: Remember Difficulty: 1 Easy earnin! "b#ecti$e: %&'%4 5no2 t)e res,onsibilities of t)e audit committee and )o2 it relates to t)e e6ternal auditors.o,ic: .)e Role of t)e Audit Committee

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Chapter 03 - Audit Planning, Types of Audit Tests, and Materiality

3(. All of the follo&ing refer to an internal auditor's "ompeten"e e-"ept7 A% The party in the entity to &hi"h the internal auditor reports. 2. The %uality of internal audit do"uments and reports. C. Professional "ertifi"ation. 3. 9uper#ision and re#ie& of internal audit a"ti#ities.

AACSB: Communication AICPA BB: Industry AICPA FN: Decision /akin! Blooms: (nderstand Difficulty: 1 Easy earnin! "b#ecti$e: %&'%1 (nderstand )o2 t)e 2ork of t)e internal auditors can assist in t)e ,erformance of t)e audit.o,ic: (sin! t)e 3ork of t)e Internal Auditors

3*. An independent auditor might "onsider the pro"edures performed $y the internal auditors $e"ause A. They are employees &hose &ork must $e re#ie&ed during su$stanti#e testing. &% They are employees &hose &ork might $e relied upon. C. Their &ork impa"ts the "ost?$enefit tradeoff in e#aluating inherent limitations. 3. Their degree of independen"e may $e inferred $y the nature of their &ork.

AACSB: Communication AICPA BB: Industry AICPA FN: Decision /akin! Blooms: (nderstand Difficulty: 1 Easy earnin! "b#ecti$e: %&'%1 (nderstand )o2 t)e 2ork of t)e internal auditors can assist in t)e ,erformance of t)e auditearnin! "b#ecti$e: %&'%8 5no2 t)e ty,es of audit tests.o,ic: .y,es of Audit .ests .o,ic: (sin! t)e 3ork of t)e Internal Auditors

3+. As generally "on"ei#ed, the audit "ommittee of a pu$li"ly held "ompany should $e made up of A. @epresentati#es of the ma,or e%uity interests 5preferred sto"k, "ommon sto"k6. 2. The audit partner, the "hief finan"ial offi"er, the legal "ounsel, and at least one outsider. C. @epresentati#es from the "lient's management, in#estors, suppliers, and "ustomers. $% Mem$ers of the $oard of dire"tors &ho are not offi"ers or employees.

AACSB: Communication AICPA BB: e!al AICPA FN: Re,ortin! Blooms: Remember Difficulty: 1 Easy earnin! "b#ecti$e: %&'%4 5no2 t)e res,onsibilities of t)e audit committee and )o2 it relates to t)e e6ternal auditors.o,ic: .)e Role of t)e Audit Committee

3-31

Chapter 03 - Audit Planning, Types of Audit Tests, and Materiality

3.. To emphasi:e auditor independen"e from management, pu$li"ly traded "orporations are re%uired to A. Appoint a partner of the CPA firm "ondu"ting the e-amination to the "orporation's audit "ommittee. 2. 4sta$lish a poli"y of dis"ouraging so"ial "onta"t $et&een employees of the "orporation and the independent auditors. C. @e%uest that a representati#e of the independent auditor $e on hand at the annual sto"kholders' meeting. $% 1a#e the independent auditor report to an audit "ommittee of independent mem$ers of the $oard of dire"tors.

AACSB: Communication AICPA BB: e!al AICPA FN: Re,ortin! Blooms: Remember Difficulty: 1 Easy earnin! "b#ecti$e: %&'%0 (nderstand t)e ste,s t)at are in$ol$ed in t)e ,reliminary en!a!ement acti$itiesearnin! "b#ecti$e: %&'%4 5no2 t)e res,onsibilities of t)e audit committee and )o2 it relates to t)e e6ternal auditors.o,ic: Preliminary En!a!ement Acti$ities .o,ic: .)e Role of t)e Audit Committee

3/. An auditor o$tains kno&ledge a$out a ne& "lient's $usiness and its industry in order to A. Make "onstru"ti#e suggestions "on"erning impro#ements to the "lient's internal "ontrol. 2. 3e#elop an attitude of professional skepti"ism "on"erning management's finan"ial statement assertions. C. 4#aluate &hether the aggregation of kno&n misstatements "auses the finan"ial statements taken as a &hole to $e materially misstated. $% Anderstand the e#ents and transa"tions that may ha#e an effe"t on the "lient's finan"ial statements.

AACSB: Communication AICPA BB: Industry AICPA FN: Risk Analysis Blooms: A,,ly Difficulty: 1 Easy earnin! "b#ecti$e: %&'%< 5no2 t)e ste,s t)at are ,erformed in ,lannin! an audit en!a!ement.o,ic: Plannin! t)e Audit

3-3

Chapter 03 - Audit Planning, Types of Audit Tests, and Materiality

30. !hi"h of the follo&ing is an e-ample of a related party transa"tion; A. An a"tion is taken $y the dire"tors of Company A to pro#ide additional "ompensation for #i"e presidents in "harge of the prin"ipal $usiness fun"tions of Company A. 2. A long-term agreement is made $y Company A to pro#ide mer"handise or ser#i"es to Company 2, a long-time, friendly "ompetitor. C. A short-term loan is granted to Company A $y a $ank that has a depositor &ho is a mem$er of the $oard of dire"tors of Company A. $% A nonmonetary e-"hange o""urs &here$y Company A e-"hanges property for similar property o&ned $y Company 2, an un"onsolidated su$sidiary of Company A.

AACSB: Communication AICPA BB: Industry AICPA FN: Re,ortin! Blooms: A,,ly Difficulty: 1 Easy earnin! "b#ecti$e: %&'%< 5no2 t)e ste,s t)at are ,erformed in ,lannin! an audit en!a!ement.o,ic: Plannin! t)e Audit

(0. An independent auditor finds that 1olda&ay Corporation o""upies offi"e spa"e, at no "harge, in an offi"e $uilding o&ned $y a shareholder. This finding likely indi"ates the e-isten"e of A. Management fraud. &% @elated party transa"tions. C. !indo& dressing. 3. !eak internal "ontrol.

AACSB: Communication AICPA BB: Industry AICPA FN: Re,ortin! Blooms: (nderstand Difficulty: 1 Easy earnin! "b#ecti$e: %&'%< 5no2 t)e ste,s t)at are ,erformed in ,lannin! an audit en!a!ement.o,ic: Plannin! t)e Audit

3-33

Chapter 03 - Audit Planning, Types of Audit Tests, and Materiality

(1. !hi"h of the follo&ing &ould not ne"essarily $e a related party transa"tion; A% 9ales to another "orporation &ith a similar name. 2. Pur"hases from another "orporation that is "ontrolled $y the "orporation's "hief sto"kholder. C. =oan from the "orporation to a ma,or sto"kholder. 3. 9ale of land to the "orporation $y the spouse of a dire"tor.

AACSB: Communication AICPA BB: Industry AICPA FN: Re,ortin! Blooms: Remember Difficulty: 1 Easy earnin! "b#ecti$e: %&'%< 5no2 t)e ste,s t)at are ,erformed in ,lannin! an audit en!a!ement.o,ic: Plannin! t)e Audit

( . The e-isten"e of a related party transa"tion may $e indi"ated &hen another entity A. 9ells real estate to the "orporation at a pri"e that is "ompara$le to its appraised #alue. &% A$sor$s e-penses of the "orporation under audit. C. 2orro&s from the "orporation at a rate of interest &hi"h e%uals the "urrent market rate. 3. =ends to the "orporation at a rate of interest &hi"h e%uals the "urrent market rate.

AACSB: Communication AICPA BB: Industry AICPA FN: Re,ortin! Blooms: (nderstand Difficulty: 1 Easy earnin! "b#ecti$e: %&'%< 5no2 t)e ste,s t)at are ,erformed in ,lannin! an audit en!a!ement.o,ic: Plannin! t)e Audit

(3. )n the "onte-t of an audit of finan"ial statements, su$stanti#e pro"edures are audit pro"edures that A. May $e eliminated under "ertain "onditions. 2. Are primarily designed to dis"o#er signifi"ant su$se%uent e#ents. C% May $e either tests of details of transa"tions, tests of details of a""ount $alan"es, or analyti"al pro"edures. 3. !ill in"rease proportionately &ith an in"rease in the auditor's relian"e on internal "ontrol.

AACSB: Analytic AICPA BB: Industry AICPA FN: Decision /akin! Blooms: Remember Difficulty: 1 Easy earnin! "b#ecti$e: %&'%8 5no2 t)e ty,es of audit tests.o,ic: .y,es of Audit .ests

3-3(

Chapter 03 - Audit Planning, Types of Audit Tests, and Materiality

((. !hi"h of the follo&ing is not an audit pro"edure that is "ommonly used in performing tests of "ontrols; A. )n%uiring. 2. B$ser#ing. C% Confirming. 3. )nspe"ting.

AACSB: Analytic AICPA BB: Industry AICPA FN: Risk Analysis Blooms: Remember Difficulty: 1 Easy earnin! "b#ecti$e: %&'%8 5no2 t)e ty,es of audit tests.o,ic: .y,es of Audit .ests

(*. Tolera$le misstatement is A. Materiality allo"ated to an assertion. 2. Materiality for the $alan"e sheet as a &hole. C. Materiality for the in"ome statement as a &hole. $% Materiality allo"ated to a spe"ifi" a""ount.

AACSB: Analytic AICPA BB: Critical .)inkin! AICPA FN: /easurement Blooms: (nderstand Difficulty: 1 Easy earnin! "b#ecti$e: %&'1% (nderstand t)e conce,t of materiality.o,ic: /ateriality

(+. !hi"h of the follo&ing &ould an auditor most likely use in determining the auditor's planning materiality; A. The anti"ipated sample si:e for planned su$stanti#e pro"edures. &% The entity's annuali:ed interim 5i.e. %uarterly6 finan"ial statements. C. The results of the internal "ontrol %uestionnaire. 3. The "ontents of the management representation letter.

AACSB: Analytic AICPA BB: Industry AICPA FN: Risk Analysis Blooms: (nderstand Difficulty: 1 Easy earnin! "b#ecti$e: %&'1% (nderstand t)e conce,t of materialityearnin! "b#ecti$e: %&'11 5no2 t)e ste,s to a,,lyin! materiality in an audit.o,ic: A,,lyin! /ateriality .o,ic: /ateriality

3-3*

Chapter 03 - Audit Planning, Types of Audit Tests, and Materiality

(.. !hi"h of the follo&ing is not a %ualitati#e fa"tor that may affe"t an auditor's esta$lishment of materiality; A. Potential for fraud. 2. The "ompany is "lose to #iolating loan "o#enants. C% Firm poli"y sets materiality at (C of preta- in"ome. 3. A small misstatement &ould interrupt an earnings trend.

AACSB: Analytic AICPA BB: Critical .)inkin! AICPA FN: Risk Analysis Blooms: Remember Difficulty: 1 Easy earnin! "b#ecti$e: %&'1% (nderstand t)e conce,t of materiality.o,ic: /ateriality

(/. !hi"h of the follo&ing is not a "on"ern as to &hether a misstatement is %ualitati#ely material; A. The misstatement hides a failure to meet analysts' e-pe"tations. &% The misstatement is less than *C of preta- in"ome. C. The misstatement in"reases management's "ompensation. 3. The misstatement "hanges a small amount of profit to a small reported loss.

AACSB: Analytic AICPA BB: Critical .)inkin! AICPA FN: Risk Analysis Blooms: (nderstand Difficulty: 0 /oderate earnin! "b#ecti$e: %&'1% (nderstand t)e conce,t of materiality.o,ic: /ateriality

(0. )n assessing the "ompeten"e of an internal auditor, an independent CPA most likely &ould o$tain information a$out the A% Duality of the internal auditor's &ork. 2. Brgani:ation's "ommitment to integrity and ethi"al #alues. C. )nfluen"e of management on the s"ope of the internal auditor's duties. 3. Brgani:ational le#els to &hi"h the internal auditor reports.

AACSB: Communication AICPA BB: Industry AICPA FN: Decision /akin! Blooms: Remember Difficulty: 0 /oderate earnin! "b#ecti$e: %&'%1 (nderstand )o2 t)e 2ork of t)e internal auditors can assist in t)e ,erformance of t)e audit.o,ic: (sin! t)e 3ork of t)e Internal Auditors

3-3+

Chapter 03 - Audit Planning, Types of Audit Tests, and Materiality

*0. !hi"h of the follo&ing pro"edures &ould an auditor most likely in"lude in the initial planning of a finan"ial statement audit; A. Perform detailed testing of the indi#idual $alan"e sheet a""ounts. 2. 4-amining do"uments to dete"t illegal a"ts ha#ing a material effe"t on the finan"ial statements. C. Considering &hether the "lient's a""ounting estimates are reasona$le in the "ir"umstan"es. $% 3etermining the e-tent of in#ol#ement of the "lient's internal auditors.

AACSB: Communication AICPA BB: Industry AICPA FN: Decision /akin! Blooms: A,,ly Difficulty: 0 /oderate earnin! "b#ecti$e: %&'%1 (nderstand )o2 t)e 2ork of t)e internal auditors can assist in t)e ,erformance of t)e auditearnin! "b#ecti$e: %&'%< 5no2 t)e ste,s t)at are ,erformed in ,lannin! an audit en!a!ement.o,ic: Plannin! t)e Audit .o,ic: (sin! t)e 3ork of t)e Internal Auditors

*1. The in-"harge auditor most likely &ould ha#e a super#isory responsi$ility to e-plain to the staff assistants A. That immaterial fraud is not to $e reported to the "lient's audit "ommittee. &% 1o& the results of #arious auditing pro"edures performed $y the assistants should $e e#aluated. C. 1o& the o#erall audit strategy &ill allo& the firm to rea"h a suffi"iently lo& le#el of audit risk. 3. 1o& o#erall materiality &as sele"ted.

AACSB: Communication AICPA BB: Resource /ana!ement AICPA FN: Decision /akin! Blooms: A,,ly Difficulty: 0 /oderate earnin! "b#ecti$e: %&'%< 5no2 t)e ste,s t)at are ,erformed in ,lannin! an audit en!a!ement.o,ic: Plannin! t)e Audit

3-3.

Chapter 03 - Audit Planning, Types of Audit Tests, and Materiality

* . !hi"h of the follo&ing audit pro"edures &ould $e least likely to dis"lose the e-isten"e of related party transa"tions of a "lient during the period under audit; A. @eading E"onfli"t-of-interestE statements o$tained $y the "lient from its management. 2. 9"anning a""ounting re"ords for large transa"tions at or ,ust prior to the end of the period under audit. C. @eading minutes of the 2oard of 3ire"tors meetings for authori:ation or dis"ussion of material transa"tions. $% Confirming pur"hases and sales transa"tions &ith the #endors and?or "ustomers in#ol#ed.

AACSB: Communication AICPA BB: Critical .)inkin! AICPA FN: Decision /akin! Blooms: (nderstand Difficulty: 0 /oderate earnin! "b#ecti$e: %&'%< 5no2 t)e ste,s t)at are ,erformed in ,lannin! an audit en!a!ement.o,ic: Plannin! t)e Audit

*3. A dual-purpose test A. 9imultaneously tests de$its and "redits. 2. )s a pro"edure "ompleted $y $oth the internal and e-ternal auditors. C. )s useful to $oth the entity and the auditor. $% )s $oth a su$stanti#e test of transa"tions and a test of "ontrols.

AACSB: Analytic AICPA BB: Critical .)inkin! AICPA FN: Decision /akin! Blooms: Remember Difficulty: 1 Easy earnin! "b#ecti$e: %&'%8 5no2 t)e ty,es of audit tests.o,ic: .y,es of Audit .ests

3-3/

Chapter 03 - Audit Planning, Types of Audit Tests, and Materiality

*(. The element of the audit planning pro"ess most likely to $e agreed upon &ith the "lient $efore implementation of the audit strategy is the determination of the A. Methods of statisti"al sampling to $e used in "onfirming a""ounts re"ei#a$le. 2. Pending legal matters to $e in"luded in the in%uiry of the "lient's attorney. C. 4#iden"e to $e gathered to pro#ide a suffi"ient $asis for the auditor's opinion. $% Timing of the audit.

AACSB: Communication AICPA BB: Industry AICPA FN: Decision /akin! Blooms: E$aluate Difficulty: & 9ard earnin! "b#ecti$e: %&'%& 5no2 2)at is re+uired to establis) an understandin! 2it) t)e clientearnin! "b#ecti$e: %&'%; 5no2 t)e ty,es of information t)at are included in an en!a!ement letterearnin! "b#ecti$e: %&'%< 5no2 t)e ste,s t)at are ,erformed in ,lannin! an audit en!a!ement.o,ic: Establis) an (nderstandin! 2it) t)e Client .o,ic: Plannin! t)e Audit .o,ic: .)e En!a!ement etter

**. The audit "lient's $oard of dire"tors and audit "ommittee refused to take any a"tion &ith respe"t to an immaterial illegal a"t &hi"h &as $rought to their attention $y the auditor. 2e"ause of their failure to a"t, the auditor &ithdre& from the engagement. The auditor's de"ision to &ithdra& &as primarily due to dou$ts "on"erning A. Ade%uate finan"ial statement dis"losures. 2. Complian"e &ith the statutory la&s and regulations. C. 9"ope limitations resulting from their ina"tion. $% The integrity of management.

AACSB: Et)ics AICPA BB: e!al AICPA FN: Risk Analysis Blooms: (nderstand Difficulty: & 9ard earnin! "b#ecti$e: %&'%4 5no2 t)e res,onsibilities of t)e audit committee and )o2 it relates to t)e e6ternal auditors.o,ic: .)e Role of t)e Audit Committee

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Chapter 03 - Audit Planning, Types of Audit Tests, and Materiality

*+. !hi"h of the follo&ing pro"edures &ould an auditor most likely in"lude in the initial planning of an e-amination of finan"ial statements; A% Assess the need for the use of spe"ialists in the audit. 2. )n%uiring of the "lient's attorney as to any "laims that are likely to $e asserted. C. Perform detailed testing of the indi#idual finan"ial statement a""ounts. 3. 3etermining &hether ne"essary internal "ontrols pro"edures are $eing applied as pres"ri$ed.

AACSB: Communication AICPA BB: Industry AICPA FN: Decision /akin! Blooms: E$aluate Difficulty: & 9ard earnin! "b#ecti$e: %&'%< 5no2 t)e ste,s t)at are ,erformed in ,lannin! an audit en!a!ement.o,ic: Plannin! t)e Audit

*.. An entity's finan"ial statements &ere misstated o#er a period of years due to large amounts of re#enue $eing re"orded in ,ournal entries that in#ol#ed de$its and "redits to an illogi"al "om$ination of a""ounts. The auditor "ould most likely ha#e $een alerted to this fraud $y A% 9"anning the general ,ournal for unusual entries. 2. Performing a re#enue "utoff test at year-end. C. Tra"ing a sample of ,ournal entries to the general ledger. 3. 4-amining do"umentary e#iden"e of sales returns and allo&an"es re"orded after year-end.

AACSB: Analytic AICPA BB: Critical .)inkin! AICPA FN: Decision /akin! Blooms: A,,ly Difficulty: & 9ard earnin! "b#ecti$e: %&'%8 5no2 t)e ty,es of audit tests.o,ic: .y,es of Audit .ests

3-(0

Chapter 03 - Audit Planning, Types of Audit Tests, and Materiality

*/. Ander the 9ar$anes-B-ley A"t, the audit "ommittee of a pu$li" "ompany has the follo&ing re%uirement5s67 A. 4a"h mem$er of the "ommittee must $e a $oard mem$er and shall $e independent. 2. The audit "ommittee must preappro#e all audit and nonaudit ser#i"es. C. The audit "ommittee must esta$lish and maintain pro"edures to handle all issues that relate to a""ounting, internal "ontrol, and auditing. $% All of the a$o#e.

AACSB: Et)ics AICPA BB: e!al AICPA FN: Decision /akin! Blooms: Remember Difficulty: 0 /oderate earnin! "b#ecti$e: %&'%4 5no2 t)e res,onsibilities of t)e audit committee and )o2 it relates to t)e e6ternal auditors.o,ic: .)e Role of t)e Audit Committee

*0. !hi"h of the follo&ing is a general audit test; A. Fee assessment pro"edures. &% Tests of "ontrols. C. Preparation of "orporate ta- returns. 3. A"ti#e testing pro"edures.

AACSB: Communication AICPA BB: Industry AICPA FN: Decision /akin! Blooms: Remember Difficulty: 1 Easy earnin! "b#ecti$e: %&'%8 5no2 t)e ty,es of audit tests.o,ic: .y,es of Audit .ests

+0. !hi"h of the follo&ing arranges the general types of audit tests in the order they are normally performed in an audit; A. 9u$stanti#e pro"edures, tests of "ontrols, and risk assessment pro"edures. 2. 9u$stanti#e pro"edures, risk assessment pro"edures, and tests of "ontrols. C% @isk assessment pro"edures, tests of "ontrols, and su$stanti#e pro"edures. 3. @isk assessment pro"edures, su$stanti#e pro"edures, and tests of "ontrols.

AACSB: Communication AICPA BB: Industry AICPA FN: Decision /akin! Blooms: Remember Difficulty: 1 Easy earnin! "b#ecti$e: %&'%8 5no2 t)e ty,es of audit tests.o,ic: .y,es of Audit .ests

3-(1

Chapter 03 - Audit Planning, Types of Audit Tests, and Materiality

+1. !hi"h of the follo&ing relati#ely small misstatements most likely &ould ha#e a material effe"t on an entity's finan"ial statements; A% An illegal payment to a foreign offi"ial that &as not re"orded. 2. A pie"e of o$solete offi"e e%uipment that &as not retired. C. A petty "ash fund dis$ursement that &as not properly authori:ed. 3. An un"olle"ti$le a""ount re"ei#a$le that &as not &ritten-off.

AACSB: Analytic AICPA BB: e!al AICPA FN: Risk Analysis Blooms: A,,ly Difficulty: 0 /oderate earnin! "b#ecti$e: %&'1% (nderstand t)e conce,t of materiality.o,ic: /ateriality

+ . !hi"h of the follo&ing is the most important %ualitati#e fa"tor that auditors should "onsider &hen making materiality ,udgments; A. A misstatement e-"eeded fi#e per"ent of net in"ome. 2. The auditor also pro#ides "onsulting ser#i"es to the audit "lient. C% The misstatement &ill "ause the "lient to fail to meet an earnings fore"ast. 3. The audit "ommittee is not &ell-edu"ated a$out the a""ounting prin"iple in %uestion.

AACSB: Analytic AICPA BB: Critical .)inkin! AICPA FN: Risk Analysis Blooms: Analy:e Difficulty: 0 /oderate earnin! "b#ecti$e: %&'1% (nderstand t)e conce,t of materiality.o,ic: /ateriality

+3. !hi"h element5s6 is?are per#asi#e to the appli"ation of generally a""epted auditing standards, parti"ularly the standards of field&ork and reporting; A% The elements of materiality and audit risk. 2. The element of internal "ontrol. C. The element of "orro$orating e#iden"e. 3. The element of reasona$le assuran"e.

AACSB: Analytic AICPA BB: Critical .)inkin! AICPA FN: Decision /akin! Blooms: (nderstand Difficulty: & 9ard earnin! "b#ecti$e: %&'1% (nderstand t)e conce,t of materiality.o,ic: /ateriality

3-(

Chapter 03 - Audit Planning, Types of Audit Tests, and Materiality

+(. !hi"h of the follo&ing statements is not "orre"t a$out materiality; A. The "on"ept of materiality re"ogni:es that some matters are important for fair presentation of finan"ial statements in "onformity &ith FAAP, &hile other matters are not important. &% An auditor "onsiders materiality for the aggregate le#el of misstatements that "ould $e material to any one of the finan"ial statements indi#idually. C. Materiality ,udgments are made in light of surrounding "ir"umstan"es and ne"essarily in#ol#e $oth %uantitati#e and %ualitati#e ,udgments. 3. An auditor's "onsideration of materiality is influen"ed $y the auditor's per"eption of the needs of a reasona$le person &ho &ill rely on the finan"ial statements.

AACSB: Analytic AICPA BB: Critical .)inkin! AICPA FN: Risk Analysis Blooms: Analy:e Difficulty: & 9ard earnin! "b#ecti$e: %&'1% (nderstand t)e conce,t of materialityearnin! "b#ecti$e: %&'11 5no2 t)e ste,s to a,,lyin! materiality in an audit.o,ic: A,,lyin! /ateriality .o,ic: /ateriality

3-(3

Chapter 03 - Audit Planning, Types of Audit Tests, and Materiality

Short Answer Questions

+*. Cart and 2lan"he, a regional a""ounting firm is determining &hether it &ants to a""ept a ne& "lient, )#y Photos. )#y Photos is "urrently a pri#ately held photography studio operating ( studios in se#eral states, $ut the "ompany's management is planning an )nitial Pu$li" Bffering in the near future. This is the "ompany's first audit. !hat steps should Cart and 2lan"he take in e#aluating this ne& "lient; To e#aluate the "lient, the auditors should o$tain and re#ie& a#aila$le finan"ial information and should in%uire of third parties a$out any information "on"erning the integrity of the prospe"ti#e "lient and its management. These in%uiries should $e dire"ted to the prospe"ti#e "lient's $ankers and attorneys, "redit agen"ies, and other mem$ers of the $usiness "ommunity &ho may ha#e su"h kno&ledge. The auditor should also "onsider &hether the prospe"ti#e "lient has any "ir"umstan"es that &ill re%uire spe"ial attention or that may represent unusual $usiness or audit risks, su"h as litigation or going "on"ern pro$lems. The auditor should also determine if Cart and 2lan"he is independent of )#y Photos and has the ne"essary te"hni"al skills and kno&ledge of the industry to "omplete the engagement. Finally, Cart and 2lan"he needs to determine if a""eptan"e of the "lient &ould #iolate any appli"a$le regulatory agen"y re%uirements or the Code of Professional Condu"t.

AACSB: Communication AICPA BB: Industry AICPA FN: Decision /akin! Blooms: A,,ly Difficulty: & 9ard earnin! "b#ecti$e: %&'%1 (nderstand t)e auditor*s re+uirements for client acce,tance and continuance.o,ic: Client Acce,tance and Continuance

++. 3efine the engagement letter and dis"uss its importan"e. An engagement letter formali:es the arrangement rea"hed $et&een the auditor and the "lient. This letter ser#es as a "ontra"t, outlining the responsi$ilities of $oth parties and pre#enting misunderstandings $et&een the t&o parties.

AACSB: Communication AICPA BB: Industry AICPA FN: Decision /akin! Blooms: Remember Difficulty: 1 Easy earnin! "b#ecti$e: %&'%; 5no2 t)e ty,es of information t)at are included in an en!a!ement letter.o,ic: .)e En!a!ement etter

3-((

Chapter 03 - Audit Planning, Types of Audit Tests, and Materiality

+.. 23G A""ounting is auditing a ne& "lient, A =a Carte Catering. 23G "ould sa#e audit time $y using &ork from A =a Carte's internal audit staff. The staff "onsists of three a""ountants &ith pu$li" a""ounting e-perien"e and "ertifi"ation. A =a Carte re%uires e#ery mem$er of its a""ounting department to spend t&o out of e#ery fi#e years on the internal audit staff. Then, the employee is rotated $a"k into the a""ounting department for a "ouple of years. !hat fa"tors should 23G "onsider &hen determining &hether or not it "an use &ork of the internal audit staff; )n this "ase, &hat should 23G de"ide; The ma,or issue for 23G is the "ompeten"e and o$,e"ti#ity of the internal auditors and the effe"t of their &ork on the audit. A =a Carte's internal audit staff seems "ompetent, as all of its auditors are "ertified. 1o&e#er, 23G should seriously %uestion ho& o$,e"ti#e the audit staff is. All of the internal auditors are also asso"iated &ith other positions &ithin the "ompany. Further, all of the auditors are from the a""ounting department, so none of them "ould o$,e"ti#ely audit the a""ounting area they &orked in. To maintain independen"e, 23G &ould not $e a$le to use the &ork of the internal audit staff in pla"e of 23G's &ork.

AACSB: Communication AICPA BB: Industry AICPA FN: Decision /akin! Blooms: Analy:e Difficulty: 0 /oderate earnin! "b#ecti$e: %&'%1 (nderstand )o2 t)e 2ork of t)e internal auditors can assist in t)e ,erformance of t)e audit.o,ic: (sin! t)e 3ork of t)e Internal Auditors

3-(*

Chapter 03 - Audit Planning, Types of Audit Tests, and Materiality

+/. 8ame three 9ar$anes-B-ley A"t re%uirements of the mem$ers and duties of the audit "ommittee of a pu$li" "ompany. Students 'ust pro(ide three of the following) 1. 4a"h mem$er of the audit "ommittee must $e a mem$er of the $oard of dire"tors and must $e independent. . The audit "ommittee is dire"tly responsi$le for the appointment, "ompensation, and o#ersight of the &ork of any registered pu$li" a""ounting firm employed $y the "ompany. 3. The audit "ommittee must preappro#e all audit and nonaudit ser#i"es pro#ided $y its auditor. (. The audit "ommittee must esta$lish pro"edures for the re"eipt, retention, and treatment of "omplaints re"ei#ed $y the "ompany regarding a""ounting, internal "ontrol, and auditing. *. 4a"h audit "ommittee mem$er must ha#e the authority to engage independent "ounsel or other ad#isors as he or she deems ne"essary to "arry out his or her duties.

AACSB: Communication AICPA BB: e!al AICPA FN: Decision /akin! Blooms: Remember Difficulty: 0 /oderate earnin! "b#ecti$e: %&'%4 5no2 t)e res,onsibilities of t)e audit committee and )o2 it relates to t)e e6ternal auditors.o,ic: .)e Role of t)e Audit Committee

+0. 1o& &ould an auditor identify related parties and &hat is the importan"e of doing so; Transa"tions $et&een an entity and any related parties may not $e made at Earms length.E A""ordingly, the auditor must s"rutini:e su"h transa"tions and ensure proper dis"losures regarding related parties are made in a""ordan"e &ith FAAP. The auditor "an identify related parties $y e#aluating the "lient's pro"edures for identifying related parties, re%uesting a list of related parties from management and for pu$li"ly traded "lients, re#ie&ing filings &ith the 9e"urities and 4-"hange Commission and other regulatory agen"ies. )t is important that the auditor attempts to identify all related parties during the planning phase of the audit so that the auditor "an properly plan for e#aluating transa"tions that may ha#e o""urred $et&een the entity and any related parties.

AACSB: Communication AICPA BB: Industry AICPA FN: Decision /akin! Blooms: (nderstand Difficulty: 0 /oderate earnin! "b#ecti$e: %&'%< 5no2 t)e ste,s t)at are ,erformed in ,lannin! an audit en!a!ement.o,ic: Plannin! t)e Audit

3-(+

Chapter 03 - Audit Planning, Types of Audit Tests, and Materiality

.0. )n the planning stages of an audit, &hat information does an auditor gain through analyti"al pro"edures; An auditor is re%uired to apply analyti"al pro"edures at the planning phase for all audits. )n the planning phase, analyti"al pro"edures help the auditor to understand the "lient's $usiness and transa"tions. Analyti"al pro"edures also guide the auditor to&ards finan"ial statement a""ounts that are likely to "ontain errors. !ith this information, the auditor is a$le to plan the nature, timing, and e-tent of audit pro"edures.

AACSB: Analytic AICPA BB: Critical .)inkin! AICPA FN: Decision /akin! Blooms: Remember Difficulty: 1 Easy earnin! "b#ecti$e: %&'%< 5no2 t)e ste,s t)at are ,erformed in ,lannin! an audit en!a!ement.o,ic: Plannin! t)e Audit

.1. 3is"uss the purposes for planning the audit and identify the steps that are performed during this phase of the engagement. 4ngagement planning in#ol#es all the issues the auditor should "onsider in de#eloping an o#erall strategy for "ondu"ting the audit. The o$,e"ti#e of the audit plan is to "ondu"t an effe"ti#e and effi"ient audit. This means that the audit is to $e "ondu"ted in a""ordan"e &ith auditing standards and that the risk of material misstatements is redu"ed to an a""epta$ly lo& le#el. The audit plan should also "onsider ho& to "ondu"t the engagement in a "ost-effe"ti#e manner. !hen preparing the audit plan, the auditor should $e guided $y the results of the risk assessment and pro"edures performed to gain and support the understanding of the entity. Additional steps that should $e performed in"lude7 1. Assess a preliminary le#el for "ontrol risk $y a""ount and assertion. . Assess the possi$ility of illegal a"ts. 3. )dentify related parties. (. Condu"t preliminary analyti"al pro"edures. *. 3e#elop an o#erall audit strategy and prepare audit programs. +. Consider additional #alue-added ser#i"es.

AACSB: Analytic AICPA BB: Critical .)inkin! AICPA FN: Decision /akin! Blooms: Remember Difficulty: 1 Easy earnin! "b#ecti$e: %&'%< 5no2 t)e ste,s t)at are ,erformed in ,lannin! an audit en!a!ement.o,ic: Plannin! t)e Audit

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Chapter 03 - Audit Planning, Types of Audit Tests, and Materiality

. . 8ame and des"ri$e three super#isory a"ti#ities that should $e performed $y the engagement partner and other engagement team mem$ers performing super#isory a"ti#ities. Student*s e+a'ples 'ay (ary) )nform engagement team mem$ers of their responsi$ilities in"luding 16 the o$,e"ti#es of the planned pro"edures, 6 the nature, timing, and e-tent of planned pro"edures, and 36 matters that "ould affe"t the pro"edures to $e performed or the e#aluation of the results of pro"edures. 3ire"t engagement team mem$ers to $ring signifi"ant a""ounting and auditing issues they identify to the attention of super#isory engagement team mem$ers. @e#ie& the &ork of engagement team mem$ers to e#aluate 16 the &ork performed and do"umented, 6 the o$,e"ti#es of the pro"edures &ere a"hie#ed, and 36 the results of the &ork support the "on"lusions rea"hed.

AACSB: Analytic AICPA BB: Resource /ana!ement AICPA FN: Decision /akin! Blooms: Remember Difficulty: 1 Easy earnin! "b#ecti$e: %&'%7 (nderstand t)e im,ortance of su,er$ision to t)e ,lannin! and conduct of t)e audit.o,ic: Su,er$ision of t)e Audit

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Chapter 03 - Audit Planning, Types of Audit Tests, and Materiality

.3. 8ame the three types of analyti"al pro"edures and pro#ide a definition and e-ample for ea"h. The three types of analyti"al pro"edures are trend analysis, ratio analysis, and reasona$leness analysis. Student*s e+a'ples 'ay (ary) Trend analysis in#ol#es the e-amination of "hanges in an a""ount o#er time. For instan"e, an auditor might e-amine the "lient's re#enue o#er a period of ten years to see if the trend is "onsistent &ith the auditor's e-pe"tation. @atio analysis is the "omparison, a"ross time or to a $en"hmark, of relationships $et&een finan"ial statement a""ounts or $et&een an a""ount and nonfinan"ial data. As an e-ample, an auditor "ould "ompare the "lient's in#entory turno#er for the "urrent and prior year to industry results to test for o$soles"en"e. @easona$leness analysis is the de#elopment of a model to form an e-pe"tation using finan"ial data, nonfinan"ial data, or $oth, to test a""ount $alan"es or "hanges in a""ount $alan"es $et&een a""ounting periods. For e-ample, an auditor might test re#enue against an e-pe"tation formed using standard pri"es and the num$er of re"orded sales.

AACSB: Analytic AICPA BB: Critical .)inkin! AICPA FN: Decision /akin! Blooms: A,,ly Difficulty: 0 /oderate earnin! "b#ecti$e: %&'%8 5no2 t)e ty,es of audit tests.o,ic: .y,es of Audit .ests

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Chapter 03 - Audit Planning, Types of Audit Tests, and Materiality

.(. Bften in an audit, total "om$ined tolera$le misstatement is greater than o#erall materiality. !hy is this the "ase; Answers 'ay (ary, ,ut could include) 1. 8ot all a""ounts &ill $e misstated $y the full amount of their tolera$le misstatement allo"ation. . Audits of the indi#idual a""ounts are "ondu"ted simultaneously. )f a""ounts &ere audited se%uentially, unad,usted misstatements o$ser#ed during testing &ould "ount against materiality and, theoreti"ally, the auditor "ould "arry the unused portion of materiality to the ne-t a""ount, and so forth. 3. !hen "ontrol &eaknesses or misstatements are identified in an a""ount, the auditors typi"ally perform additional pro"edures in that and related a""ounts. Thus, the a"tual testing &ill often a"hie#e a mu"h smaller margin for misstatement than planned tolera$le misstatement. (. B#erall finan"ial statement materiality ser#es as a Esafety net.E )f indi#idual misstatements in a""ounts are $elo& their tolera$le misstatement, $ut the aggregate of the misstatements is greater than materiality, an ad,ustment &ill need to $e made.

AACSB: Analytic AICPA BB: Critical .)inkin! AICPA FN: /easurement Blooms: (nderstand Difficulty: & 9ard earnin! "b#ecti$e: %&'1% (nderstand t)e conce,t of materialityearnin! "b#ecti$e: %&'11 5no2 t)e ste,s to a,,lyin! materiality in an audit.o,ic: A,,lyin! /ateriality .o,ic: /ateriality

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