3

14. Hawkins requested permission to communicate with the predecessor auditor and
review certain portions of the predecessor auditor's working papers. The prospective
client's refusal to permit this will bear directly on Hawkins' decision concerning the
A.

Adequacy of the preplanned audit program.

B. Ability to establish consistency in application of accounting principles between

years.
C.

Apparent scope limitation.

D.

Integrity of management.

D.

Integrity of management.

3
15. In assessing whether to accept a client for an audit engagement, a CPA should
consider
A. The current financial health of the prospective client.
B.

The integrity of management.

C.

The CPA's overall engagement risk.

D.

All of these should be considered.

D.

All of these should be considered.

16. Evaluating a prospective client requires which of the following steps?

A.
B.
C.
D.

Communicate with the predecessor auditor.

Preplan the audit.
Establish the terms of the engagement.
None of these.

3
A.

Communicate with the predecessor auditor.

17. An auditor has withdrawn from an audit engagement of a publicly held company after
finding fraud that may materially affect the financial statements. The auditor should
set forth the reasons and findings in correspondence with the
A.
B.

Securities and Exchange Commission.

Client's legal counsel.

C. Stock exchanges where the company's stock is traded.

D.

Audit committee of the board of directors.

3
D.

Audit committee of the board of directors.

18. When a CPA is approached to perform an audit for the first time, the CPA should
make inquiries of the predecessor auditor. This is a necessary procedure because the
predecessor may be able to provide the successor with information that will assist the
successor in determining
A. Whether the predecessor's work should be utilized.
B. Whether, in the predecessor's opinion, the financial statements are materially
correct.
C. Whether, in the predecessor's opinion, the company's internal controls have been
satisfactory.
D.

Whether the engagement should be accepted.

D. Whether the engagement should be accepted.

19. Which of the following should an auditor obtain from the predecessor auditor prior to
accepting an audit engagement?
A.

Analysis of balance sheet accounts.

B.

Analysis of income statement accounts.

C. All matters of continuing accounting significance.

D. Facts that might bear on management integrity.

3
D.

Facts that might bear on management integrity .

20. Which of the following factors most likely would cause a CPA not to accept a new
audit engagement?
A. The prospective client's unwillingness to permit inquiry of its legal counsel.
B. The inability to review the predecessor auditor's documentation.
C. The CPA's lack of understanding of the prospective client's operations and
industry.
D. Indications that management has not investigated employees in key positions
before hiring them.

3
A. The prospective client's unwillingness to permit inquiry of its legal

counsel.

21. An auditor who discovers that a client's employees paid small bribes to municipal
officials most likely would withdraw from the engagement if
A. The payments violated the client's policies regarding the prevention of illegal acts.
B. The client receives financial assistance from a federal government agency.
C. Documentation that is necessary to prove that the bribes were paid does not exist.
D. Management fails to take the appropriate remedial action.

3
D. Management fails to take the appropriate remedial action.

22. A successor auditor should request the new client to authorize the predecessor
auditor to allow a review of the predecessor's
A.

Engagement letter.

B.

Audit working papers.

C.

Engagement letter and audit working papers.

D. It would not be typical to allow a review of either the engagement letter or the audit
working papers.

B.

Audit working papers.

3
23. Evaluating a prospective client requires which of the following steps?
A.
B.

Communicate with the SEC.

Preplan the audit.

C. Determine if the firm is independent of the client.

D.

Communicate with the AICPA.

C.

Determine if the firm is independent of the client.

3
24. Which of the following factors most likely would lead a CPA to conclude that a
potential audit engagement should be rejected?
A. The details of most recorded transactions are not available after a specified period
of time.
B. Internal control activities requiring segregation of duties are subject to
management override.
C. It is unlikely that sufficient appropriate evidence is available to support an opinion
on the financial statements.
D. Management has a reputation for consulting with several accounting firms about
significant accounting issues.

C. It is unlikely that sufficient appropriate evidence is available to support

an opinion on the financial statements.

25. Which of the following factors most likely would cause a CPA to decide not to accept
a new audit engagement?
A. The CPA's lack of understanding of the prospective client's internal auditor's
computer-assisted audit techniques.
B. Management's disregard of its responsibility to maintain an adequate control
environment.
C. The CPA's inability to determine whether related party transactions were
consummated on terms equivalent to arm's-length transactions.
D. Management's refusal to permit the CPA to perform substantive procedures before
the year-end.

B.

Management's disregard of its responsibility to maintain an

3
26. Before accepting an engagement to audit a new client, a CPA is required to obtain
A. An understanding of the prospective client's industry and business.
B. The prospective client's signature on the engagement letter.
C. A preliminary understanding of the prospective client's control environment.
D. The prospective client's consent to make inquiries of the predecessor auditor.

D. The prospective client's consent to make inquiries of the predecessor

auditor.

3
27. Which of the following situations would most likely require special audit planning?
A. Some items of factory and office equipment do not bear identification numbers.
B. Depreciation methods used on the client's tax return differ from those used on the
books.
C. Assets costing less than $500 are expensed even though the expected life
exceeds one year.
D.

Inventory is comprised of precious stones.

D.

Inventory is comprised of precious stones.

28. During the initial planning phase of an audit, a CPA most likely would
A. Identify specific internal control activities that are likely to prevent fraud.
B. Evaluate the reasonableness of the client's accounting estimates.
C. Discuss the timing of the audit procedures with the client's management.
D. Inquire of the client's attorney as to any unrecorded claims.

3
C. Discuss the timing of the audit procedures with the client's

management.

29. An auditor is required to establish an understanding with a client regarding the

responsibilities for each engagement. This understanding generally includes
A. Management's responsibility to guarantee that there are no material misstatements
due to fraud.
B. The auditor's responsibility to plan and perform the audit to provide reasonable,
but not absolute, assurance of detecting material errors or fraud.
C. Management's responsibility for providing the auditor with an assessment of the
risk of material misstatement due to fraud.
D. The auditor's responsibility for the fairness of the financial statements.

3
B. The auditor's responsibility to plan and perform the audit to provide reasonable, but
not absolute, assurance of detecting material errors or fraud.

3
30. A written understanding between the auditor and the client concerning the auditor's
responsibility for the discovery of illegal acts is usually set forth in a(n)
A.

Client representation letter.

B.

Letter of audit inquiry.

C.

Management letter.

D.

Engagement letter.

D.

Engagement letter.

3
31. Engagement letters include all of the following except:
A. A list of additional services that will be provided.
B.

A list of adjusting journal entries.

C.

Information about the audit fee.

D.

Arrangements involving the use of specialists.

B.

A list of adjusting journal entries.

3
32. Which of the following matters generally is included in an auditor's engagement
letter?
A. Management's responsibility for the entity's compliance with laws and regulations.
B. The factors to be considered in setting preliminary judgments about materiality.
C. Management's liability for illegal acts committed by its employees.
D. The auditor's responsibility to guarantee accuracy of the financial statements.

A. Management's responsibility for the entity's compliance with laws and

regulations.

33. To provide for the greatest degree of independence in performing internal audit
activities, the internal audit function most likely should report to the
A.

Vice-President - Finance

B.

Corporate controller.

C.
D.

Audit committee of the board of directors.

Corporate stockholders.

3
C.

Audit committee of the board of directors .

34. All of the following refer to the competence of the internal audit function except:
A. The party in the entity to which the internal audit function reports.
B. The quality of internal audit documents and reports.
C.

Professional certification.

D. Supervision and review of internal audit activities.

3
A.

The party in the entity to which the internal audit function reports .

35. An independent auditor might consider the procedures performed by the internal audit
function because
A. They are employees whose work must be reviewed during substantive testing.
B. They are employees whose work might be relied upon.
C. Their work impacts the cost/benefit tradeoff in evaluating inherent limitations.
D. Their degree of independence may be inferred by the nature of their work.

B.

They are employees whose work might be relied upon.

36. As generally conceived, the audit committee of a publicly held company should be
made up of
A. Representatives of the major equity interests (preferred stock, common stock).
B. The audit partner, the chief financial officer, the legal counsel, and at least one
outsider.
C. Representatives from the client's management, investors, suppliers, and
customers.
D. Members of the board of directors who are not officers or employees.

D. Members of the board of directors who are not officers or employees .

3
37. To emphasize auditor independence from management, publicly traded corporations
are required to
A. Appoint a partner of the CPA firm conducting the examination to the corporation's
audit committee.
B. Establish a policy of discouraging social contact between employees of the
corporation and the independent auditors.
C. Request that a representative of the independent auditor be on hand at the annual
stockholders' meeting.
D. Have the independent auditor report to an audit committee of independent
members of the board of directors.

D. Have the independent auditor report to an audit committee of

independent members of the board of directors.

38. An auditor obtains knowledge about a new client's business and its industry in order
to

A. Make constructive suggestions concerning improvements to the client's internal

control.
B. Develop an attitude of professional skepticism concerning management's financial
statement assertions.
C. Evaluate whether the aggregation of known misstatements causes the financial
statements taken as a whole to be materially misstated.
D. Understand the events and transactions that may have an effect on the client's
financial statements.

D. Understand the events and transactions that may have an effect

3
39. Which of the following is an example of a related party transaction?
A. An action is taken by the directors of Company A to provide additional
compensation for vice presidents in charge of the principal business functions of
Company A.
B. A long-term agreement is made by Company A to provide merchandise or services
to Company B, a long-time, friendly competitor.
C. A short-term loan is granted to Company A by a bank that has a depositor who is a
member of the board of directors of Company A.
D. A nonmonetary exchange occurs whereby Company A exchanges property for
similar property owned by Company B, an unconsolidated subsidiary of Company

D. A nonmonetary exchange occurs whereby Company A exchanges

property for similar property owned by Company B, an unconsolidated

subsidiary of Company

40. An independent auditor finds that Holdaway Corporation occupies office space, at no
charge, in an office building owned by a shareholder. This finding likely indicates the
existence of
A.

Management fraud.

B.

Related party transactions.

C.

Window dressing.

D.

Weak internal control.

3
B.

Related party transactions.

41. Which of the following would not necessarily be a related party transaction?
A. Sales to another corporation with a similar name.
B. Purchases from another corporation that is controlled by the corporation's chief
stockholder.
C. Loan from the corporation to a major stockholder.
D. Sale of land to the corporation by the spouse of a director.

A.

Sales to another corporation with a similar name.

3
42. The existence of a related party transaction may be indicated when another entity
A. Sells real estate to the corporation at a price that is comparable to its appraised
value.
B. Absorbs expenses of the corporation under audit.
C. Borrows from the corporation at a rate of interest which equals the current market
rate.
D. Lends to the corporation at a rate of interest which equals the current market rate.

B.

Absorbs expenses of the corporation under audit .

43. In the context of an audit of financial statements, substantive procedures are audit
procedures that
A.

May be eliminated under certain conditions.

B. Are primarily designed to discover significant subsequent events.

C. May be either tests of details of transactions, tests of details of account balances,
or analytical procedures.
D. Will increase proportionately with an increase in the auditor's reliance on internal
control.

3
C. May be either tests of details of transactions, tests of details of account

balances, or analytical procedures.

44. Which of the following is not an audit procedure that is commonly used in performing
tests of controls?
A.

Inquiring.

B.

Observing.

C.

Confirming.

D.

Inspecting.

3
C.

Confirming.

45. Tolerable misstatement is

A.
B.

Materiality allocated to an assertion.

Materiality for the balance sheet as a whole.

C. Materiality for the income statement as a whole.

D.

Materiality allocated to a specific account.

D.

Materiality allocated to a specific account.

3
46. Which of the following would an auditor most likely use in determining the auditor's
overall materiality?
A. The anticipated sample size for planned substantive procedures.
B. The entity's annualized interim (i.e. quarterly) financial statements.
C. The results of the internal control questionnaire.
D. The contents of the management representation letter.

B.

The entity's annualized interim (i.e. quarterly) financial statements .

3
47. Which of the following is not a qualitative factor that may affect an auditor's
establishment of materiality?
A.

Potential for fraud.

B. The company is close to violating loan covenants.

C. Firm policy sets materiality at 4% of pretax income.
D. A small misstatement would interrupt an earnings trend.

C.

Firm policy sets materiality at 4% of pretax income.

3
48. Which of the following is not a concern as to whether a misstatement is qualitatively
material?
A. The misstatement hides a failure to meet analysts' expectations.
B. The misstatement is less than 5% of pretax income.
C. The misstatement increases management's compensation.
D. The misstatement changes a small amount of profit to a small reported loss.

B.

The misstatement is less than 5% of pretax income .

49. In assessing the competence of the internal audit function, an independent CPA most
likely would obtain information about the
A. Quality of the work of the internal audit function.
B. Organization's commitment to integrity and ethical values.
C. Influence of management on the scope of the internal audit function duties.
D. Organizational levels to which the internal audit function reports.

3
A.

Quality of the work of the internal audit function .

50. Which of the following procedures would an auditor most likely include in the initial
planning of a financial statement audit?
A. Perform detailed testing of the individual balance sheet accounts.
B. Examining documents to detect illegal acts having a material effect on the financial
statements.
C. Considering whether the client's accounting estimates are reasonable in the
circumstances.
D. Determining the extent of involvement of the client's internal audit function.

3
D. Determining the extent of involvement of the client's internal audit

function.

51. The in-charge auditor most likely would have a supervisory responsibility to explain to
the staff assistants
A. That immaterial fraud is not to be reported to the client's audit committee.
B. How the results of various auditing procedures performed by the assistants should
be evaluated.
C. How the overall audit strategy will allow the firm to reach a sufficiently low level of
audit risk.
D.

How overall materiality was selected.

3
B. How the results of various auditing procedures performed by the

assistants should be evaluated.

52 Which of the following audit procedures would be least likely to disclose the existence
. of related party transactions of a client during the period under audit?
A. Reading "conflict-of-interest" statements obtained by the client from its
management.
B. Scanning accounting records for large transactions at or just prior to the end of the
period under audit.
53. A dual-purpose test
C. Reading minutes of the Board of Directors meetings for authorization or discussion
of material transactions.
A.Confirming
Simultaneously
tests
debits
credits. with the vendors and/or customers
D.
purchases
and
salesand
transactions
involved.
B. Is a procedure completed by both the internal and external auditors.
C.

Is useful to both the entity and the auditor.

D. Is both a substantive test of transactions and a test of controls.

54. The element of the audit planning process most likely to be agreed upon with the
client before implementation of the audit strategy is the determination of the
A. Methods of statistical sampling to be used in confirming accounts receivable.
B. Pending legal matters to be included in the inquiry of the client's attorney.
C. Evidence to be gathered to provide a sufficient basis for the auditor's opinion.
D.

Timing of the audit.

3
D.

Timing of the audit.

3
55. The audit client's board of directors and audit committee refused to take any action
with respect to an immaterial illegal act which was brought to their attention by the
auditor. Because of their failure to act, the auditor withdrew from the engagement.
The auditor's decision to withdraw was primarily due to doubts concerning
A.

Adequate financial statement disclosures.

B. Compliance with the statutory laws and regulations.

C.
D.

Scope limitations resulting from their inaction.

The integrity of management.

D.

The integrity of management.

3
56. Which of the following procedures would an auditor most likely include in the initial
planning of an examination of financial statements?
A. Assess the need for the use of specialists in the audit.
B. Inquiring of the client's attorney as to any claims that are likely to be asserted.
C. Perform detailed testing of the individual financial statement accounts.
D. Determining whether necessary internal controls procedures are being applied as
prescribed.

A.

Assess the need for the use of specialists in the audit .

57. An entity's financial statements were misstated over a period of years due to large
amounts of revenue being recorded in journal entries that involved debits and credits
to an illogical combination of accounts. The auditor could most likely have been
alerted to this fraud by
A. Scanning the general journal for unusual entries.
B.

Performing a revenue cutoff test at year-end.

C. Tracing a sample of journal entries to the general ledger.

D. Examining documentary evidence of sales returns and allowances recorded after
year-end.

3
A.

Scanning the general journal for unusual entries .

3
58. Under the Sarbanes-Oxley Act, the audit committee of a public company has the
following requirement(s):
A. Each member of the committee must be a board member and shall be
independent.
B. The audit committee must preapprove all audit and nonaudit services.
C. The audit committee must establish and maintain procedures to handle all issues
that relate to accounting, internal control, and auditing.
D.

All of these.

D.

All of these.

59. Which of the following is a general audit test?

A.
B.
C.
D.

Fee assessment procedures.

Tests of controls.
Preparation of corporate tax returns.
Active testing procedures.

B.

Tests of controls.

60. Which of the following arranges the general types of audit tests in the order they are
normally performed in an audit?
A. Substantive procedures, tests of controls, and risk assessment procedures.
B. Substantive procedures, risk assessment procedures, and tests of controls.
C. Risk assessment procedures, tests of controls, and substantive procedures.
D. Risk assessment procedures, substantive procedures, and tests of controls.

3
C. Risk assessment procedures, tests of controls, and substantive

procedures.

61. Which of the following relatively small misstatements most likely would have a
material effect on an entity's financial statements?
A. An illegal payment to a foreign official that was not recorded.
B. A piece of obsolete office equipment that was not retired.
C. A petty cash fund disbursement that was not properly authorized.
D. An uncollectible account receivable that was not written-off.

3
A.

An illegal payment to a foreign official that was not recorded .

62. Which of the following is the most important qualitative factor that auditors should
consider when making materiality judgments?
A. A misstatement exceeded five percent of net income.
B. The auditor also provides consulting services to the audit client.
C. The misstatement will cause the client to fail to meet an earnings forecast.
D. The audit committee is not well-educated about the accounting principle in
question.

C. The misstatement will cause the client to fail to meet an earnings

forecast.

3
63. Which element(s) is/are pervasive to the application of generally accepted auditing
standards, particularly the standards of fieldwork and reporting?
A.
B.

The elements of materiality and audit risk.

The element of internal control.

C.

The element of corroborating evidence.

D.

The element of reasonable assurance.

A.

The elements of materiality and audit risk.

3
64. Which of the following statements is not correct about materiality?
A. The concept of materiality recognizes that some matters are important for fair
presentation of financial statements in conformity with GAAP, while other matters
are not important.
B. An auditor considers materiality for the aggregate level of misstatements that could
be material to any one of the financial statements individually.
C. Materiality judgments are made in light of surrounding circumstances and
necessarily involve both quantitative and qualitative judgments.
D. An auditor's consideration of materiality is influenced by the auditor's perception of
the needs of a reasonable person who will rely on the financial statements.

B. An auditor considers materiality for the aggregate level of

misstatements that could be material to any one of the financial

statements individually.