Accounting 408 Name ________________________

Exam 2
Chapters 4-6, E Row _______

I. Multiple Choice. (2 points each, 92 points total) Read the following questions carefully
and indicate the one best answer to each question by placing a mark on the appropriate
space on the answer sheet.

1. Incompatible duties are those that allow a fraud to be perpetrated

a. and concealed through collusive actions.
b. by a single employee.
c. and concealed by a single employee.
d. by accounting personnel.
e. and concealed by a group of two or more employees.

2. Tests of controls are auditing procedures performed to determine:

a. whether required policies and procedures have been put in place.
b. the efficiency of the pertinent policies and procedures.
c. the fairness of specific financial statement assertions.
d. whether required policies and procedures are being executed.
e. the effectiveness of control structure policies and procedures.

3. Consider the following steps, taken in the process of assessing control risk:

A: Identify the necessary controls that would likely prevent or detect misstatements
B: Evaluate the evidence and make the assessment
C: Perform tests of controls on the necessary controls to determine the effectiveness of
their design and operation.
D: Identify potential misstatements that could occur in the entity's assertion.

What is the correct order in which these steps would be taken?

a. D C A B
b. C D A B
c. A D C B
d. D A C B

4. Direct communication of certain internal control structure conditions identified by the

auditor is required to be made to
a. management.
b. the SEC.
c. internal auditors.
d. the audit committee.
e. the CFO.
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5. In general, as an account balance decreases, the amount of evidence required to

support it will
a. increase.
b. decrease.
c. remain the same.
d. change in an unpredictable fashion.

6. An auditor may decide to assess control risk at the maximum level for certain assertions
because the auditor believes
a. control policies and procedures are unlikely to pertain to the assertions.
b. the entity's control environment, accounting system, and control procedures are
interrelated.
c. sufficient evidential matter to support the assertions is likely to be available.
d. more emphasis on tests of control than substantive tests is warranted.

7. In the investigation of a potential new client, if the client refuses to give permission to
inquire of the predecessor auditor, or if the predecessor does not respond fully, the
successor auditor should
a. consider the implications in making the accept/reject decision.
b. inform the AICPA.
c. request an AICPA-sanctioned peer review of the predecessor.
d. request assistance from the SEC.

8. Materiality at the account balance level is considered when planning an audit because
a. some users make decisions based upon individual account balances.
b. the auditor's opinion applies to the financial statements taken as a whole.
c. official pronouncements have specified different levels of materiality for various
financial statement items.
d. the auditor verifies account balances in reaching an overall conclusion on the
fairness of the financial statements.

9. All else being equal, as the materiality threshold decreases, the amount of evidence
required will
a. increase.
b. decrease.
c. remain the same.
d. change in an unpredictable fashion.

10. Inherent risk is defined in terms of

a. a total absence of controls.
b. an ideal set of controls.
c. the existing controls.
d. the standard controls for the client's industry.
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11. Assume an auditor has chosen the preliminary strategy of primarily substantive testing.
Which of the following is not a validly specified component of this strategy?
a. set control risk below maximum.
b. plan to obtain an understanding of the internal control structure.
c. plan few, if any, tests of controls.
d. plan extensive substantive tests.

12. In a small organization, the best means of compensating for the inability to achieve a
proper segregation of duties is through
a. bonding of all employees.
b. use of an independent auditor.
c. active owner participation in the business.
d. use of temporary personnel.

13. The least likely procedure to obtain an understanding of the internal control structure
would be
a. previous experience with the client.
b. inspection of documents and records.
c. inquiry of management.
d. confirming transactions.

14. Documenting the understanding of the internal control structure is required

a. in all audits.
b. on initial engagements only.
c. whenever the lower assessed level of control risk approach is planned.
d. whenever the primarily substantive approach is planned.

15. Which of the following statements is not true concerning the documentation of the
understanding of the internal control structure?
a. documentation and obtaining the understanding may be done concurrently.
b. documentation should show all policies and procedures in the control structure.
c. in repeat engagements, documentation may be limited to updating prior
documentation for changes made in the current year.
d. the documentation may take on various forms, including questionnaires, flowcharts,
decision tables and narrative memoranda.

16. To support a below maximum control risk assessment, tests of controls should be
performed on
a. all controls.
b. no controls.
c. only those controls that are considered strengths.
d. only those controls that appear weak.
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17. Which of the following is associated with tests of controls but not procedures to obtain an
understanding?
a. inquiring.
b. observing.
c. inspecting.
d. reperforming.

18. Dual purpose tests are audit tests designed to

a. test more than one control with a single procedure.
b. test controls that are relevant to multiple assertions.
c. test for monetary errors while testing for compliance with controls.
d. provide evidence for more than a single accounting period.

19. A final assessment of control risk that is too high may lead the auditor to perform
a. more tests of controls than necessary.
b. more substantive tests than necessary.
c. fewer tests of controls than necessary.
d. fewer substantive tests than necessary.

20. Of the following items, the most competent audit evidence is a

a. validated bank deposit slip.
b. confirmation obtained directly from a customer of the audit client.
c. bill of lading for merchandise received from a common carrier.
d. vendor's invoice obtained from the audit client.

21. In testing documentary evidence to establish the existence assertion for an asset, an
auditor ordinarily works from the
a. vendor's records to the client's records.
b. potentially unrecorded items to the financial statements.
c. accounting records to the supporting evidence.
d. supporting evidence to the accounting records.

22. If reported sales for 19X2 erroneously include sales that occurred in 19X1, the assertion
violated on the 19X2 statements would be
a. existence or occurrence.
b. completeness.
c. valuation or allocation.
d. presentation and disclosure.

23. The performance of audit work before the financial statement date is
a. not possible if the due care standard is to be met.
b. usually avoided if at all possible.
c. acceptable only for new clients.
d. desirable for workload distribution throughout the year.
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24. Professional standards require the use of analytical procedures in the

a. planning and testing phases.
b. planning phase and at the conclusion of the audit.
c. testing phase and at the conclusion of the audit.
d. planning and testing phases and at the conclusion of the audit.

25. The auditor will allocate more materiality to accounts with a

a. high chance of error but that are easy to audit.
b. high chance of error and that are difficult to audit.
c. low chance of error and that are easy to audit.
d. low chance of error but that are difficult to audit.

26. Inherent risk may be greater for some assertions than for others. For the account "Cash
on Hand," the highest level of inherent risk would most likely be set for which of the
following assertions?
a. existence or occurrence.
b. valuation.
c. completeness.
d. presentation and disclosure.

27. Auditor error in the selection or application of auditing procedures, is a factor included in
a. audit risk.
b. control risk.
c. detection risk.
d. inherent risk.

28. On the basis of audit evidence gathered and evaluated, an auditor decides to increase
the assessed level of control risk from that originally planned. To achieve an overall
audit risk level that is substantially the same as the planned audit risk level, the auditor
would
a. increase inherent risk.
b. increase materiality levels.
c. decrease substantive testing.
d. decrease detection risk.

29. Inherent risk and control risk differ from detection risk in that inherent risk and control risk
are
a. elements of audit risk while detection risk is not.
b. changed at the auditor's discretion while detection risk is not.
c. considered at the individual account-balance level while detection risk is not.
d. functions of the client and its environment while detection risk is not.

30. The relationship between materiality and audit risk

a. is direct.
b. is inverse.
c. varies depending on the characteristics of the client.
d. cannot be determined.
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31. When performing the substantive audit of details of an account balance, auditors are
concerned with two aspects of sampling risk: 1) the risk of incorrect rejection (RIR), 2)
the risk of incorrect acceptance (RIA). Which of the following is true about RIR and RIA?
a. The RIR is of greater concern to the auditor than the RIA.
b. The RIA is of greater concern to the auditor than the RIR.
c. The RIA and the RIR are of equal importance to the auditor.
d. Neither the RIR nor the RIA need be considered by the auditor.

32. The auditor tested a sample of recorded sales invoices for evidence of credit approval.
Based on the results of the sample, the auditor concluded that there was a satisfactory
rate of approvals. Unknown to the auditor, credit approvals in the population were not
satisfactory. This would be an example of what?
a. Risk of assessing control risk too low.
b. Risk of assessing control risk too high.
c. Risk of incorrect acceptance.
d. Risk of incorrect rejection.

33. For which of the following audit tests would an auditor most likely use attribute sampling?
a. Making an independent estimate of the amount of a LIFO inventory.
b. Examining invoices in support of the valuation of fixed asset additions.
c. Selecting accounts receivable for confirmation of account balances.
d. Inspecting employee time cards for proper approval by supervisors.

34. Which of the following may be used to reduce the risk of nonsampling errors?
a. Increasing the size of the audit samples.
b. Stratifying audit samples.
c. Adequately planning the audit.
d. Using statistical sampling techniques.

35. Select the description that illustrates sampling risk.

a. Completing audit procedures inappropriate for the audit objectives.
b. Failing to recognize misstatements or deviations in the documents examined.
c. Arriving at incorrect statistical conclusions because of computational errors.
d. Choosing a sample with proportionately more misstatements or deviations that the
population.

36. Which of the following matters is an auditor required to communicate to an entity's audit
committee?
a. The basis for assessing control risk below the maximum.
b. The process used by management in formulating sensitive accounting estimates.
c. The auditor's preliminary judgments about materiality levels.
d. The justification for performing substantive procedures at interim dates.
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37. Which of the following would not be a factor in determining the competency of evidential
matter?
a. source of the evidence
b. cost of gathering the evidence
c. the degree of objectivity of the evidence
d. the relevance of the evidence

38. Which of the following would generally be considered the least competent form of
evidence?
a. the auditor's computation of earnings per share
b. prenumbered sales invoices prepared by the accounts receivable clerk
c. confirmation from an out-of-state bank
d. the auditor's inspection of new machinery acquisitions for the current year where the
client is a computer manufacturer

39. Which of the following auditing procedures is most likely to disclose an unrecorded
transaction?
a. vouching
b. tracing
c. observing
d. counting
e. confirming

40. Working papers provide all of the following except

a. a means for coordinating the examination.
b. evidence that the examination was made in accordance with GAAS.
c. the principal support for the auditor's report.
d. the principal support for the financial statements.
e. a means for supervising the audit.

41. Which of the following models expresses the general relationship of the auditor's
assessments of control risk (CR), inherent risk (IR), the detection risk associated with
analytical procedures and other relevant substantive tests (AP), and overall allowable
audit risk (AR) that would lead the auditor to conclude that a substantive test of details of
an account balance is not necessary?

AP CR AR IR
a. 20% 40% 10% 100%
b. 20% 60% 5% 100%
c. 10% 70% 4.5% 100%
d. 30% 40% 5.5% 100%

42. If your firm policy is to hold audit risk at 5% on all audits, and you assess inherent risk at
its maximum and control risk at 30%, at what level should you hold detection risk?
a. 13%
b. 17%
c. 55%
d. 60%
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43. If your firm policy is to hold audit risk at 4% on all audits, and you assess inherent risk at
80%, control risk at 30%, and the risk that analytical procedures will not detect material
misstatements at 80%, what should be the level of test of details risk (RIA) that you use
to plan the substantive tests?
a. 6%
b. 17%
c. 21%
d. 33%

44. A CPA firm requires that all working papers contain the signatures of the preparer and
the reviewer. This procedure provides evidence of adherence to the generally accepted
auditing standard related to
a. supervision.
b. adequate technical training and proficiency.
c. independence.
d. understanding the internal control structure.

45. Substantive auditing tests are performed by the auditor to substantiate that
a. an understanding of the internal control structure has been obtained.
b. management has effectively designed internal control structure policies and
procedures and that they are operating effectively.
c. the rate of errors and irregularities found in tests of controls did not exceed the
auditor’s tolerable rate.
d. account balances are not materially misstated.

46. In performing an audit, which one of the following procedures is most likely to be used as
a substantive test?
a. Comparing last year’s interest expense with this year’s interest expense.
b. comparing signatures on checks with the authorized check signatures.
c. Reviewing initials on receiving documents.
d. Reviewing procedures followed in receiving, depositing, and disbursing cash.
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II. Problems

1. (10 points) Use the provided tables for this question. Determine the sample size, upper
deviation limit, and identify the controls that support the auditor's planned control risk for
each of the following attributes. When determining sample size, report the actual sample
size you find in the table, but when determining the upper deviation limit, round each
sample size to the nearest sample size in the table in the most appropriate way.

Risk of
Assessing Support
Control Expected Tolerable Number of Upper Planned
Attri- Risk Too Deviation Deviation Sample Sample Deviation CR?
bute Low Rate Rate Size Deviations Limit (Y/N)

a 10% 0.5% 7% 1

b 5% 2.5% 6% 4

c 5% 1.0% 9% 1

2. (6 points) Molly Markus, CPA, selected a sample of size 50 to audit the accounts
receivable account of a client. The client’s book value of the 50 accounts in the sample
was $19,250. While examining the sample items, Molly found five errors totaling $350 in
the sample, resulting in a corrected audit value for the sample of $18,900. Assume there
are a total of 950 accounts in the population of accounts receivable with a total book
value of $361,950. If nonstatistical difference estimation is used and the tolerable error
is $15,000, what is the amount of the allowance for sampling risk?
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2. (12 points) The professional auditing standards identify five assertions made by
management that are contained in the financial statements. If any of these assertions is
a misrepresentation, the statements could be materially misstated. The assertions
identified by the profession are:

A. Existence or occurrence
B. Completeness
C. Rights and obligations
D. Valuation or allocation
E. Presentation and disclosure

Following is a list of errors encountered during the conduct of an audit. Using the letters
given above, print your answer in the space provided to indicate the assertion that is
being misrepresented by each listed error in the following questions.

_____ 1. A short-term loan obtained from the bank was not recorded.

_____ 2. The current portion of long-term debt was excluded from the current liabilities
section of the balance sheet.

_____ 3. Reported sales include transactions from the subsequent period.

_____ 4. The allowance for doubtful accounts was understated because of the failure to
properly age the receivables at year end.

_____ 5. A related party transaction was not fully described in the notes to the financial
statements.

_____ 6. A count of the petty cash account found it contained $397, but the recorded
value of petty cash is $450.
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Answers
I. Multiple Choice

Question Answer
1. c
2. e
3. d
4. d
5. b
6. a
7. a
8. d
9. a
10. a
11. a
12. c
13. d
14. a
15. b
16. c
17. d
18. c
19. b
20. b
21. c
22. a
23. d
24. b
25. b
26. a
27. c
28. d
29. d
30. b
31. b
32. a
33. d
34. c
35. d
36. b
37. b
38. b
39. b
40. d
41. a
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42. b
43. c
44. a
45. d
46. a

II. Other Questions

1.

Upper Support
Sample
Deviation Planned
Size
Limit CR?
55 6.9 Y
150 6.0 Y
51 9.1 N

2.
_
d = 350 / 50 = 7

^
D = 950 x 7 = 6,650

Allowance for
Sampling Risk = 15,000 - 6,650 = 8,350

3.

Item Answer
1. B
2. E
3. A
4. D
5. E
6. A or D