AUDIT PLANNING

1. Preplanning the audit involves several key activities. Which of the following would not be included in preplanning
an audit?
A. Investigating the client’s background
B. Determining the likelihood of issuing an unqualified audit opinion on the client’s financial statements
C. Communicating with the prospective client’s prior auditor to inquire about any disagreements with the client.
D. Understanding the client’s reasons for obtaining an audit

2. During audit planning, which of the following is not a factor that affects the auditor's judgment as to the quantity,
type, and content of working papers?
A. The auditor's preliminary assessment of control risk
B. The auditor's preliminary evaluation of inherent risk based on discussions with the client
C. The nature of the client’s business
D. The type of report to be issued by the auditor

3. Which one of the following is not considered a valid source of information about the client's processes?
A. Confirmation from third-parties
B. Review of the client's budget
C. A tour of the client's plant facility
D. Management inquiry

4. The element of the audit planning process most likely to be agreed upon with the client before the implementation
of 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. schedules and analyses to be prepared by the client's staff.

5. Which of the following is not a component of audit planning?

A. Observing the client's annual physical inventory taking and making test counts of selected items
B. Making arrangements with the client concerning the timing of audit fieldwork and use of the client's staff in
completing certain phases of the examination
C. Obtaining an understanding of the business
D. Developing audit programs

6. R & O, CPAs, have been retained as the auditors of City Corporation. What are R & O's responsibilities with
regards to contacting City Corporation’s predecessor auditors?
A. If City Corporation had a disagreement with the predecessor auditors, R & O should not contact the predecessor
auditors.
B. R & O is not required to attempt communication with the predecessor auditors under any circumstances.
C. R & O should attempt communications with the predecessor auditors and ask if they had any accounting policy
disagreements with City Corporation.
D. It would be unethical for R & O to ask the predecessor auditors about the integrity of City Corporation's
management.

7. An initial audit requires more audit time to complete than a recurring audit. One of the reasons for this is that
A. the new auditors are usually assigned to an initial audit.
B. the predecessor auditors need to be consulted.
C. the client's business, industry, and internal control are unfamiliar to the auditor and he needs to carefully study
them.
D. a larger proportion of customer accounts receivable need to be confirmed on an initial audit.

8. Prior to beginning the fieldwork on a new audit engagement in which he does not possess industry expertise, the
CPA should
A. reduce audit risk by lowering the preliminary levels of materiality.
B. design special substantive tests to compensate for the lack of industry expertise.
C. engage financial experts who are familiar with the nature of the industry.
D. obtain a knowledge of matters that relates to the nature of the entity's business and industry.

9. Which of the following will an auditor least likely discuss with the former auditors of a potential client prior to
acceptance of an audit engagement?
A. Integrity of the management
B. Fees charged for the services
C. Disagreements between the predecessor auditor and the management regarding accounting principles
D. Reasons for changing audit firms

10. What is the most likely course of action to be taken by an auditor in assessing management integrity?
 A. Tour the plant
B. Review the minutes of the board of directors
C. Research the background and histories of officers
D. Review the bank reconciliation statements

11. An engagement letter should be written before the start of an audit because
A. it may limit the auditor’s legal liability by specifying the auditor’s responsibilities.
B. it specifies the client’s responsibility for preparing schedules and making the records available to the auditor.
C. it specifies the basis for billing the audit for the upcoming year.
D. All of the choices given are correct

12. 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 whether:
A. the predecessor's work should be utilized.
B. the company follows the policy of rotating its auditors.
C. in the predecessor's opinion, internal control of the company is satisfactory.
D. the engagement should be accepted.

13. A written understanding between the auditor and the client concerning the auditor's responsibility for the discovery
of noncompliance to laws is usually set forth in a(an)
A. client representation letter.
B. letter of audit inquiry.
C. management letter.
D. engagement letter.

14. Prior to acceptance of an audit engagement with a client who has terminated the services of the predecessor auditor,
the CPA should
A. contact the predecessor auditor without advising the prospective client and request a complete report of the
circumstances leading to the termination of the engagement with an understanding that all information
disclosed will be kept confidential.
B. accept the engagement without contacting the predecessor auditor since the CPA can include audit procedures
to verify the reason given by the client for the termination of the engagement.
C. not communicate with the predecessor auditor because this would in effect be asking the auditor to violate the
confidential relationship between an auditor and the client.
D. advise the client of the intention to contact the predecessor auditor and request a permission for the contact.

15. Before accepting an audit engagement, a successor auditor should make specific inquiries of the predecessor auditor
regarding the predecessor’s

A. opinion of any subsequent events occurring since the predecessor’s audit report was issued.
B. understanding as to the reasons for the change of auditors.
C. awareness of the consistency in the application of PFRS between periods.
D. evaluation of all matters of continuing accounting significance.

16. A successor auditor would most likely make specific inquiries of the predecessor auditor regarding
A. specialized accounting principles being used by the client’s industry.
B. the competency of the client’s internal audit staff.
C. the uncertainty inherent in applying sampling procedures.
D. disagreements with management as to auditing procedures.

17. Which of the following statements concerning materiality thresholds is incorrect?

A. Aggregate materiality thresholds are a function of the auditor's preliminary judgment concerning audit risk.
B. In general, the more misstatements the auditor expects, the higher should be the aggregate materiality threshold.
C. The smallest aggregate level of errors or fraud that could be considered material to any of the financial
statements is referred to as a "materiality threshold."
D. Materiality thresholds may change between the planning and review stages of the audit. These changes may be
due to quantitative and/or qualitative factors.

18. Which of the following concepts about materiality is incorrect?

A. Materiality is directly related to the acceptable level of detection risk.
B. Materiality does not apply if internal control is highly effective.
C. Materiality is a matter of professional audit judgment.
D. Materiality is more closely related to fieldwork and reporting standards than to general standards.

19. Which of the following would not be a source of information about the risk of a potential new audit client?
A. The predecessor auditor
B. Management
 C. The internet
D. The new auditor’s permanent file

20. In comparing management fraud with employee fraud, the auditor’s risk of failing to discover the fraud is greater
for:
A. employee fraud because of the larger number of employees in the organization.
B. employee fraud because of the higher crime rate among blue collar workers.
C. management fraud because of management’s ability to override existing internal controls.
D. management fraud because managers are inherently smarter than employees.

21. Management’s integrity affects all of the following risks except:

A. enterprise risk
B. financial reporting risk
C. engagement risk
D. all of the above risks are affected

22. The auditor is most likely to presume that a high risk of irregularities exists if
A. the client is a multinational company that does business in numerous foreign countries.
B. the client does business with several related parties.
C. inadequate segregation of duties places an employee in a position to perpetrate and conceal thefts.
D. inadequate employee training results in lengthy EDP exception reports each month.

23. Which of the following audit risk components may be assessed in non-quantitative terms?
Inherent Risk Control Risk Detection Risk
A. Yes Yes No
B. Yes No Yes
C. No Yes Yes
D. Yes Yes Yes
24. Which of the following combinations of engagement risk, audit risk, and materiality would lead the auditor to most
audit work?
Engagement Risk Audit Risk Materiality
A. Low High High
B. Moderate Low Low
C. Low Moderate Low
D. High High High

25. Which of the following conditions justifies an auditor’s decision of raising the materiality level?
A. Internal control over revenue and receipts cycle is excellent.
B. Application of analytical procedures reveals a significant increase in sales revenue in December, the last month
of the fiscal year.
C. Internal control over shipping, billing, and recording of sales revenue is weak.
D. Study of the business reveals that the client recently acquired a new company in an unrelated industry.

26. Which of the following does an auditor least likely perform in assessing audit risk?
A. Gather audit evidence in support of recorded transactions.
B. Obtain an understanding of the client's system of internal control.
C. Understand the economic substance of significant transactions completed by the client.
D. Understand the entity and the industry in which it operates.

27. Which type of risk does the management of a company have the most control over in the short term?
A. Inherent risk
B. Control risk
C. Detection risk
D. Sufficiency risk

28. In which of the following order would the auditors perform the following steps?
A. Determine audit risk; assess control risk; determine detection risk; set materiality.
B. Set materiality; determine audit risk; assess control risk; determine detection risk.
C. Set materiality; assess control risk; determine detection risk; determine audit risk.
D. Determine audit risk; set materiality; assess control risk; determine detection risk.

29. If the results of the auditor's tests of controls induce the auditor to change the assessed level of control risk for
inventory from 0.2 to 0.4 and audit risk and inherent risk remain constant, what is the effect on the acceptable level
of detection risk?
A. A change in detection risk cannot be calculated because audit risk and inherent risk values are not given.
B. Detection risk would increase from 0.3 to 0.6.
C. Detection risk would decrease from 0.4 to 0.2.
D. Detection risk would not change since audit risk and inherent risk do not change.
30. Which of the following may cause the management to intentionally understate profits?
A. Management wants to create "cookie jar" reserves for a rainy day.
B. The company is under scrutiny by tax authorities.
C. The company is suffering a large loss and wants to take a "big bath."
D. All of the given choices

31. Which of the following is true?

A. Auditors are responsible for detecting all fraudulent financial reporting.
B. Auditors must specifically consider fraud risk from overstating liabilities.
C. Auditors must specifically consider fraud risk from management override of controls.
D. All of them are true

32. Why should the auditor plan more work on individual accounts as lower acceptable levels of both audit risk and
materiality are established?
A. To find smaller errors
B. To find larger errors
C. To increase the tolerable error in the accounts
D. To decrease the risk of overreliance

33. With respect to errors and fraud, the auditor should plan to
A. search for errors or fraud that would have a material effect on the financial statements.
B. discover errors or fraud that would have a material effect on the financial statements.
C. search for errors that would have a material effect and for fraud that would have either material or immaterial
effects on the financial statements.
D. search for fraud that would have a material effect and for errors that would have either material or immaterial
effects on the financial statements.

34. The auditor’s responsibility for identifying "direct-effect" non-compliance to laws and regulations differs from their
responsibility for detecting
A. errors.
B. indirect-effect non-compliance to laws and regulations.
C. fraud.
D. management fraud.

35. Which of the following might be considered a "red flag” that may indicate possible fraud in a large manufacturing
company with several subsidiaries?
A. The existence of a financial subsidiary
B. A consistent record of above average return on investment for all subsidiaries
C. Complex sales transactions and transfers of funds between affiliated companies
D. Use of separate bank accounts for payrolls by each subsidiary

36. Experience has shown that certain conditions in an organization are symptoms of possible management fraud.
Which of the following conditions would not be considered an indicator of possible fraud?

A. Managers are regularly assuming subordinates' duties

B. Managers are dealing in matters outside their profit center's scope
C. Managers are not complying with corporate directives and procedures
D. Managers are subject to formal performance reviews on a regular basis.

37. Warning signs that cause the auditor to question management integrity must be taken seriously and pursued
vigorously. Which of the following may lead the auditor to suspect management dishonesty?
A. The president/CEO of the client corporation has held numerous meetings with the controller for the purpose of
discussing accounting practices that will maximize reported profits.
B. The client has been named as a defendant in a product liability suit.
C. The client has experienced a decrease in revenue from increased import competition.
D. A new statutory regulation making customer licenses more difficult to obtain may adversely affect the client's
operations.

38. Which of the following methods may be used to commit fraudulent financial reporting?
A. Overstate revenues
B. Understate liabilities
C. Fail to provide adequate disclosure
D. Each of the given choices can be used to commit fraudulent financial reporting

39. Which of the following internal control polices, when absent, would increase the opportunity for fraud?
A. Appropriate segregation of duties or independent checks
B. Job applicant screening for employees with access to assets
 C. Mandatory vacations for employees with access to assets
D. The absence of any of the given choices increases the opportunity for fraud

40. Whom should the auditors contact when they suspect a fraud?
A. Senior management
B. Expected perpetrators of the fraud
C. Audit committee of the board of directors
D. Either the senior management or the audit committee

41. Analytical procedures performed in the planning stage of an audit suggest that several accounts have unexpected
relationships. The results of these procedures most likely would indicate that:
A. Irregularities exist among the relevant account balances.
B. Additional tests of details are required.
C. Internal control activities are not operating effectively.
D. The communication with the audit committee should be revised.

42. Which of the following statements identifies a potential weakness when comparing client data with the industry’?
A. Industry data may not be representative of the client’s business.
B. Other companies in the industry could use accounting principles different from what the client is using.
C. Data bases are comprised of data from thousands of companies of various sizes, which may limit the
effectiveness of the comparisons.
D. All the given choices are weaknesses.

43. Which of the following statements is correct with respect to the auditor’s use of analytical procedures?
A. Analytical procedures are time saving procedures that auditors may employ at their discretion.
B. Analytical procedures are powerful tools that are required to be used during the planning and testing phases of
the audit.
C. Analytical procedures may be used to identify misstatements in a client’s accounts.
D. Analytical procedures are required to be used during the planning and completion phases of the audit.

44. Which of the following is not an information source for developing analytical procedures used in the audit?
A. Relationships among financial statement elements
B. Relationships between financial and relevant nonfinancial data
C. Comparison of financial data with anticipated results (e.g., budgets and forecasts)
D. Comparison of current year financial data with projections for next year's financial results

45. Which of the following results from analytical procedures might indicate obsolete inventory?
A. A decline in inventory turnover
B. A decline in days' sales in inventory
C. A decline in the gross margin ratio
D. An increase in operating margin

46. Auditors try to identify predictable relationships when using analytical procedures. Which of the following accounts
would most likely yield the highest level of evidence regarding relationships that involve transactions?
A. Accounts payable
B. Accounts receivable
C. Payroll expense
D. Advertising expense

47. Analytical procedures are performed in the following order:

A. Calculate predictions and compare them to the recorded amount; define a significant difference; develop an
expectation; investigate significant differences.
B. Calculate predictions and compare them to the recorded amount; investigate significant differences; define a
significant difference; develop an expectation.
C. Develop an expectation; define a significant difference; calculate predictions and compare them to the recorded
amount; investigate significant differences.
D. Develop an expectation; calculate predictions and compare them to the recorded amount; define a significant
difference; investigate significant differences.

48. An auditor compares expenses as a percent of sales to expectations. This is an example of:
A. Ratio analysis
B. Trend analysis
C. Internal control analysis
D. Vertical analysis

49. How is the audit program best described at the beginning of the audit process?
A. Temporary
B. Conclusive
 C. Confirmed
D. Optional

50. After discovering that a related-party transaction exists, the auditor should be aware that the
A. substance of the transaction could be significantly different from its form.
B. adequacy of disclosure of the transaction is secondary to its legal form.
C. transaction is assumed to be outside the ordinary course of business.
D. financial statements should recognize the legal form of the transaction rather than its substance.

51. In which of the following would the auditor most likely find information about compensation of corporate officers?
A. Corporate charter
B. Corporate by-laws
C. Corporate minutes
D. Audit engagement letter

52. 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 the expenses of the corporation.
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.

53. An auditor judges an item to be immaterial when planning an audit. However, the auditor may still include the item
if it is subsequently determined that
A. sufficient number of staff is available.
B. adverse effects related to the item are likely to occur.
C. related evidence is reliable.
D. miscellaneous income is affected.

54. Which of the following is least likely required in an audit?

A. Test appropriateness of journal entries and adjustment
B. Review accounting estimates for biases
C. Evaluate the business rationale for significantly unusual transactions
D. Make a legal determination of whether fraud has occurred

55. Of the following procedures, which one is not considered a part of “obtaining an understanding of the client’s
environment?”
A. Reading trade publications to gain a better understanding of the client's industry
B. Confirming customer accounts receivable for existence and valuation
C. Touring the client's manufacturing and warehousing facilities to gain a clearer understanding of the entity’s
operations
D. Studying the internal controls over cash receipts and disbursements

56. The element of the audit planning process most likely to be agreed upon with the client before the implementation
of the audit strategy is the determination of the
A. timing of inventory observation procedures to be performed.
B. evidence to be gathered to provide a sufficient basis for the auditor's opinion.
C. procedures to be undertaken to discover litigation, claims, and assessments.
D. pending legal matters to be included in the inquiry of the client's attorney.

57. Which of the following concepts is most useful in assessing the scope of an auditor's program relating to various
accounts?
A. Attribute sampling
B. Materiality
C. The reliability of information
D. Management fraud

58. With respect to the auditor's planning of a year-end examination, which of the following statements is always true?
A. An engagement proposed after the fiscal year ends should not be accepted.
B. An inventory count must be observed at the balance sheet date.
C. The client's audit committee should not be told of the specific audit procedures that will be performed.
D. It is an acceptable practice to carry out substantial parts of the examination at interim dates.