Audit Planning I Moroney Ch.3 Exam Questions

CHAPTER 3

AUDIT PLANNING l

CHAPTER LEARNING OBJECTIVES

1. Identify the different phases of an audit.

The phases of an audit include risk assessment, risk response, and reporting. During the risk assessment phase, an auditor will gain an understanding of their client in order to make an informed risk assessment, develop an audit strategy, and set their planning materiality. During the risk response phase, an auditor will execute their detailed testing of account balances and transactions. The final phase of every audit involves reviewing all of the evidence gathered throughout the audit and arriving at a conclusion regarding the fair presentation of the client’s financial statements. The auditor will then write an audit report that reflects their opinion based upon their findings.

2. Explain the process used in gaining an understanding of the client.

An auditor will gain an understanding of their client to aid in the risk identification process. This process involves consideration of issues at the entity level, the industry level, and the broader economic level. At the entity level, an auditor will identify the client’s major customers, suppliers, and stakeholders (that is, banks, shareholders, and employees). The auditor will also determine whether their client is an importer or exporter, who the client’s competitors are, what the client’s capacity is to adapt to changes in technology, and what the nature of any warranties provided to customers is. At the industry level, an auditor is interested in their client’s position within its industry. At the economic level, an auditor will assess how well positioned the client is to cope with current and changing government policy and economic conditions.

3. Explain how related parties can impact risk.

Related parties include parent companies, subsidiaries, joint ventures, associates, company management, and close family members of key management. Since related parties are not independent of each other, these transactions may not be in the normal course of business. This increases the risk of material misstatement and may impact the overall financial results. Therefore, related party transactions require some specific consideration throughout the audit and specific procedures should be performed and documented.

4. Evaluate fraud risk.

Fraud is an intentional act through the use of deception to obtain an unjust or illegal advantage. The two kinds of fraud are financial reporting fraud and misappropriation of assets. There are a number of techniques the auditor uses to assess the risk of fraud. The audit file must document the fraud risk assessment and procedures performed to support that assessment.

5. Explain the going concern assumption.

The going concern assumption is made when it is believed that a company will remain in business for the foreseeable future. An auditor will consider the appropriateness of this assumption during the risk assessment phase and then throughout the audit.

6. Explain how estimates can impact risk.

Accounting estimates impact the financial statements. Estimates involve estimation uncertainty, which increases with the complexity, subjectivity, and uncertainty of an estimate. The greater the estimation uncertainty, the greater the risk of material misstatement and the more audit effort required. There are a number of risk assessment procedures the auditor must perform with respect to estimates.

7. Appraise corporate governance.

Corporate governance is the rules, systems, and processes used to guide and control within companies. Among other things, governance structures are used to assess the level of risk faced and to design controls to reduce identified risks.

8. Evaluate how a client’s information technology (IT) can affect risk.

There are a number of risks associated with IT. During the risk assessment phase of the audit, the auditor will assess the likelihood that their client’s financial statements are misstated due to limitations in its IT system.

9. Explain how a client’s financial reporting practices and closing procedures can affect reported results.

There are a number of risks associated with a client’s closing procedures. Closing procedures are the processes used by a client at year end to ensure that transactions are recorded in the appropriate accounting period. From an audit perspective, there is a risk that the client’s closing procedures are inadequate.

TRUE-FALSE STATEMENTS

1. The risk assessment phase of an audit involves the performance of detailed tests of controls and substantive testing of transactions and accounts.

Difficulty: Easy

Learning Objective: Identify the different stages of an audit.

Section Reference: 3.1 Phases of an audit

CPA Competency: Audit and Assurance

AACSB: Analytic

2. The concept of materiality refers to the magnitude of a misstatement or omission that may influence the economic decision of a user.

Difficulty: Easy

Learning Objective: Identify the different phases of an audit.

Section Reference: 3.1 Phases of an audit

CPA Competency: Audit and Assurance

AACSB: Analytic

3. Auditors must gain an understanding of their client at the outset of every audit.

Difficulty: Easy

Learning Objective: Explain the process used in gaining an understanding of the client.

Section Reference: 3.2 Gaining an understanding of the client

CPA Competency: Audit and Assurance

AACSB: Analytic

4. The more competitive an audit client's industry, the less pressure is placed on the client's

profits.

Difficulty: Easy

Learning Objective: Evaluate fraud risk.

Section Reference: 3.4 Fraud risk

CPA Competency: Audit and Assurance

AACSB: Analytic

5. Fraud is an intentional act to obtain an unjust or illegal advantage through the use of

deception.

Difficulty: Easy

Learning Objective: Evaluate fraud risk.

Section Reference: 3.4 Fraud risk

CPA Competency: Audit and Assurance

AACSB: Analytic

6. Misappropriation of assets fraud involves intentionally misstating items or omitting important

facts from the financial statements.

Difficulty: Easy

Learning Objective: Evaluate fraud risk.

Section Reference: 3.4 Fraud risk

CPA Competency: Audit and Assurance

AACSB: Analytic

7. An example of an attitude or rationalization used to justify a fraud is high volume of

transactions close to year-end.

Difficulty: Easy

Learning Objective: Evaluate fraud risk.

Section Reference: 3.4 Fraud risk

CPA Competency: Audit and Assurance

AACSB: Analytic

8. Under the going concern assumption, assets are valued on the basis that they will continue to

be used for the purpose of conducting a business.

Difficulty: Easy

Learning Objective: Explain the going concern assumption.

Section Reference: 3.5 Going concern

CPA Competency: Audit and Assurance

AACSB: Analytic

9. Mitigating factors that reduce going concern risk include the ability to raise additional funds

through the sale of shares.

Difficulty: Easy

Learning Objective: Explain the going concern assumption.

Section Reference: 3.5 Going concern

CPA Competency: Audit and Assurance

AACSB: Analytic

10. When an estimate is developed using a simple model and objective data, it is higher in estimation uncertainty than when an estimate is developed using a complex valuation model incorporating subjective, future-looking assumptions.

Difficulty: Easy

Learning Objective: Explain how estimates can impact risk.

Section Reference: 3.6 Accounting estimates and related disclosures

CPA Competency: Audit and Assurance

AACSB: Analytic

11. A client's corporate governance structure is assessed when planning an audit.

Difficulty: Easy

Learning Objective: Appraise corporate governance.

Section Reference: 3.7 Corporate governance

CPA Competency: Audit and Assurance

AACSB: Analytic

12. Application controls are policies and procedures that relate to many applications.

Difficulty: Easy

Learning Objective: Explain how a client’s information technology (IT) can affect risk.

Section Reference: 3.8 Information technology

CPA Competency: Audit and Assurance

AACSB: Analytic

13. An auditor is not concerned with transactions and events being recorded in the correct accounting period.

Difficulty: Easy

Learning Objective: Explain how a client’s financial reporting practices and closing procedures can affect reported results.

Section Reference: 3.9 Closing procedures

CPA Competency: Audit and Assurance

AACSB: Analytic

MULTIPLE CHOICE QUESTIONS

14. Mathias Mousseau was at a client’s offices and was preparing his work for the following

day. He was considering the risk that a material misstatement due to significant error or fraud could occur in the client's financial statements. Which stage of the audit was he performing?

a) risk assessment phase

b) risk response phase

c) reporting phase

d) management response phase

Difficulty: Easy

Learning Objective: Identify the different phases of an audit.

Section Reference: 3.1 Phases of an audit

CPA Competency: Audit and Assurance

AACSB: Analytic

15. Wilfred Dominic was meeting with his manager to plan audit strategy in order to determine

the amount of time to spend testing the client's internal controls and conducting detailed testing

of transactions and account balances. Determining the audit strategy occurs during which phase

of the audit?

a) client acceptance stage

b) risk assessment phase

c) risk response phase

d) reporting phase

Difficulty: Easy

Learning Objective: Identify the different phases of an audit.

Section Reference: 3.1 Phases of an audit

CPA Competency: Audit and Assurance

AACSB: Analytic

16. When Parvinder Kaur started the preliminary risk identification process at a local dairy during the risk assessment phase of the audit he endeavoured to gather sufficient appropriate evidence. Which of the following elements were not involved in the preliminary risk identification?

a) going concern risk

b) client’s corporate governance

c) understanding the IT environment

d) control testing

Difficulty: Easy

Learning Objective: Identify the different phases of an audit.

Section Reference: 3.1 Phases of an audit

CPA Competency: Audit and Assurance

AACSB: Analytic

17. During the risk assessment phase of a grocery chain, Seren Dagdeviren tried to determine which procedures would be appropriate. Which of these procedures, if any, would you use in the planning phase of the audit?

a) observation and inspection

b) analytical procedures

c) both a and b

d) none of the above

Difficulty: Easy

Learning Objective: Identify the different phases of an audit.

Section Reference: 3.1 Phases of an audit

CPA Competency: Audit and Assurance

AACSB: Analytic

18. The risk response phase of an audit involves

a) evaluating the results of the detailed testing and forming an opinion on the fair presentation of the client's financial statements.

b) the assessment of the audit firm's quality control procedures.

c) the performance of detailed tests of controls and substantive testing of transactions and accounts.

d) gaining an understanding of the client.

Difficulty: Easy

Learning Objective: Identify the different phases of an audit.

Section Reference: 3.1 Phases of an audit

CPA Competency: Audit and Assurance

AACSB: Analytic

19. Preliminary risk identification can be affected by

a) fraud risk.

b) corporate governance.

c) both a and b

d) none of the above

Difficulty: Easy

Learning Objective: Identify the different phases of an audit.

Section Reference: 3.1 Phases of an audit

CPA Competency: Audit and Assurance

AACSB: Analytic

20. The purpose of planning an audit is to

a) conduct the audit in an efficient and effective manner.

b) reduce audit risk to an acceptably low level.

c) ensure that sufficient appropriate audit evidence is obtained to reach an appropriate audit opinion.

d) all of the answers are correct

Difficulty: Easy

Learning Objective: Identify the different phases of an audit.

Section Reference: 3.1 Phases of an audit

CPA Competency: Audit and Assurance

AACSB: Analytic

21. The reporting phase of an audit involves

a) evaluating the results of the detailed testing and forming an opinion on the fair presentation of the client's financial statements.

b) the assessment of the audit firm's quality control procedures.

c) the performance of detailed tests of controls and substantive testing of transactions and accounts.

d) gaining an understanding of the client.

Difficulty: Easy

Learning Objective: Identify the different phases of an audit.

Section Reference: 3.1 Phases of an audit

CPA Competency: Audit and Assurance

AACSB: Analytic

22. The risk assessment phase includes

a) testing controls.

b) substantive testing.

c) concluding on the effectiveness of internal controls.

d) identifying accounting estimates

Difficulty: Easy

Learning Objective: Identify the different phases of an audit.

Section Reference: 3.1 Phases of an audit

CPA Competency: Audit and Assurance

AACSB: Analytic

23. Which of the following terms refers to the quantity and quality of evidence that has been gathered?

a) risk assessment.

b) audit procedures.

c) materiality.

d) sufficient appropriate evidence.

Difficulty: Easy

Learning Objective: Identify the different phases of an audit.

Section Reference: 3.1 Phases of an audit

CPA Competency: Audit and Assurance

AACSB: Analytic

24. Which of the following terms refers to the magnitude of a misstatement or omission that may influence the economic decision of a user?

a) risk assessment

b) corporate governance

c) materiality

d) going concern

Difficulty: Easy

Learning Objective: Identify the different phases of an audit.

Section Reference: 3.1 Phases of an audit

CPA Competency: Audit and Assurance

AACSB: Analytic

25. Yasser performed several procedures, including observation and inspection of the

company’s plans and business strategies. He also made inquiries of those individuals that were

involved in the governance of the company, the internal auditors, and operating personnel.

These procedures will help Yasser to

a) determine fraud possibilities.

b) prepare year-end closing procedures.

c) gain an understanding of the client.

d) determine control risk.

Difficulty: Easy

Learning Objective: Explain the process used in gaining an understanding of the client.

Section Reference: 3.2 Gaining an understanding of the client

CPA Competency: Audit and Assurance

AACSB: Analytic

26. When Sheila Copes, CPA audited a new client she asked questions about what the client

does, how the client functions, the ownership structure of the client, and its sources of financing. She was getting an understanding of the client at the

a) entity level.

b) industry level.

c) economy level.

d) all of the answers are correct

Difficulty: Easy

Learning Objective: Explain the process used in gaining an understanding of the client.

Section Reference: 3.2 Gaining an understanding of the client

CPA Competency: Audit and Assurance

AACSB: Analytic

27. Claudia Martel knows that financial reporting fraud transactions require disclosure. However, she is not sure whether related party transactions require disclosure. You advise her

that related party transactions require

a) disclosure.

b) no disclosure.

c) disclosure only if there is risk of fraud.

d) auditor judgement.

Difficulty: Easy

Learning Objective: Explain the process used in gaining an understanding of the client.

Section Reference: 3.2 Gaining an understanding of the client

CPA Competency: Audit and Assurance

AACSB: Analytic

28. When gaining an understanding of their client, at which level do auditors not usually

consider the relevant issues?

a) audit committee level

b) economy level

c) entity level

d) industry level

Difficulty: Easy

Learning Objective: Explain the process used in gaining an understanding of the client.

Section Reference: 3.2 Gaining an understanding of the client

CPA Competency: Audit and Assurance

AACSB: Analytic

29. Which of the following is an example of information used by auditors in gaining an

understanding of a client at the entity level?

a) the level of competition in the client's industry

b) whether the client is an importer or exporter of goods

c) the client's ability to withstand currency fluctuations

d) the level of government support in the client's industry

Difficulty: Easy

Learning Objective: Explain the process used in gaining an understanding of the client.

Section Reference: 3.2 Gaining an understanding of the client

CPA Competency: Audit and Assurance

AACSB: Analytic

30. In assessing the client's relationship with its employees, the auditor will not consider

a) the level of unionization among the workforce.

b) the attitude of staff to their employer.

c) how well a client pays its employees.

d) the dividend policy.

Difficulty: Easy

Learning Objective: Explain the process used in gaining an understanding of the client.

Section Reference: 3.2 Gaining an understanding of the client

CPA Competency: Audit and Assurance

AACSB: Analytic

31. Which of the following statements regarding the level of demand for the goods sold or

services provided by companies is correct?

a) If a client's products or services are seasonal, this will affect revenue flow.

b) If a client operates in an industry subject to changing trends, the client does not risk inventory obsolescence.

c) If a client's products or services are seasonal, this will not affect revenue flow.

d) When a product or process is subject to technological change, there is never a risk that the client will be left behind by its competitors.

Difficulty: Easy

Learning Objective: Explain the process used in gaining an understanding of the client.

Section Reference: 3.2 Gaining an understanding of the client

CPA Competency: Audit and Assurance

AACSB: Analytic

32. Related parties include

a) any investment in another company’s shares.

b) all suppliers.

c) any employees.

d) subsidiaries.

Difficulty: Easy

Learning Objective: Explain how related parties can impact risk.

Section Reference: 3.3 Related parties

CPA Competency: Audit and Assurance

AACSB: Analytic

33. Georgia Marcelloni’s team has been asked to tackle three ongoing frauds and her partner

has asked her to follow up only on the financial reporting fraud. Which of the following items

will she be pursuing?

a) theft of stock by employees or customers

b) employees remaining on the payroll after ceasing employment

c) recording fictitious sales

d) unauthorized refunds to customers

Difficulty: Easy

Learning Objective: Evaluate fraud risk.

Section Reference: 3.4 Fraud risk

CPA Competency: Audit and Assurance

AACSB: Analytic

34. Saad Zuberov is a rookie auditor who has asked you about financial reporting frauds and

how they differ from misappropriation of assets frauds. Identify for Saad Zuberov which one of

the following frauds consists of misappropriation of assets.

a) improper asset valuation

b) unrecorded liabilities

c) theft of inventory

d) recording fictitious sales

Difficulty: Easy

Learning Objective: Evaluate fraud risk.

Section Reference: 3.4 Fraud risk

CPA Competency: Audit and Assurance

AACSB: Analytic

35. Red flags that auditors can use to alert them to the possibility that a fraud may have

occurred include

a) strong internal controls.

b) routine transactions.

c) a high turnover of key employees.

d) effective internal auditing staff.

Difficulty: Easy

Learning Objective: Evaluate fraud risk.

Section Reference: 3.4 Fraud risk

CPA Competency: Audit and Assurance

AACSB: Analytic

36. When assessing fraud risk, an auditor will adopt an attitude of

a) confidentiality.

b) professional scepticism.

c) belief in management.

d) knowledge.

Difficulty: Easy

Learning Objective: Evaluate fraud risk.

Section Reference: 3.4 Fraud risk

CPA Competency: Audit and Assurance

AACSB: Analytic

37. Which of the following is an example of a misappropriation of assets fraud?

a) unauthorized discounts or refunds to customers

b) inappropriate application of accounting principles

c) unrecorded liabilities

d) improper asset valuations

Difficulty: Easy

Learning Objective: Evaluate fraud risk.

Section Reference: 3.4 Fraud risk

CPA Competency: Audit and Assurance

AACSB: Analytic

38. When assessing the risk of fraud, an auditor can consider

a) attitudes and rationalization to justify a fraud.

b) incentives and pressures to commit fraud.

c) opportunities to perpetuate a fraud.

d) all of the answers are correct

Difficulty: Easy

Learning Objective: Evaluate fraud risk.

Section Reference: 3.4 Fraud risk

CPA Competency: Audit and Assurance

AACSB: Analytic

39. Attitudes and rationalization to justify a fraud include

a) significant related party transactions.

b) an excessive focus on profit maximization.

c) a significant decline in demand for the client's products or services.

d) a high volume of transactions close to year-end.

Difficulty: Easy

Learning Objective: Evaluate fraud risk.

Section Reference: 3.4 Fraud risk

CPA Competency: Audit and Assurance

AACSB: Analytic

40. Eva Islam, CPA is auditing a company where it is experiencing strikes regularly, has been

under investigation with non-compliance with legislation, and is falling behind competitors.

What kind of risk is being assessed?

a) fraud risk

b) going concern risk

c) both a and b

d) none of the above

Difficulty: Easy

Learning Objective: Explain the going concern assumption.

Section Reference: 3.5 Going concern

CPA Competency: Audit and Assurance

AACSB: Analytic

41. William Jones has been asked to review manual or automated procedures that typically

operate at a business process level and apply to the processing of transactions by individual

applications. What kind of controls is William going to be assessing?

a) output controls

b) general controls

c) both output and general controls

d) application controls

Difficulty: Easy

Learning Objective: Explain the going concern assumption.

Section Reference: 3.5 Going concern

CPA Competency: Audit and Assurance

AACSB: Analytic

42. The going concern assumption is made when it is believed that

a) a company will become insolvent within the next accounting period.

b) the board of directors does not believe the company's financial statements are fairly presented.

c) a company will remain in business for the foreseeable future.

d) a company is a separate legal entity.

Difficulty: Easy

Learning Objective: Explain the going concern assumption.

Section Reference: 3.5 Going concern

CPA Competency: Audit and Assurance

AACSB: Analytic

43. If auditors identify risk factors that indicate that the going concern assumption is in doubt,

they will

a) undertake procedures to gather evidence regarding each risk factor.

b) refuse to continue as the auditor of their client.

c) report the client to the Canada Revenue Agency.

d) reduce the extent of further audit testing that they undertake.

Difficulty: Easy

Learning Objective: Explain the going concern assumption.

Section Reference: 3.5 Going concern

CPA Competency: Audit and Assurance

AACSB: Analytic

44. Which of the following is not an example of a mitigating factor that reduces the risk that the

going concern assumption may be in doubt?

a) the ability to raise additional funds via borrowings

b) a letter of guarantee from a parent company

c) the ability to sell an unprofitable segment of the business

d) significant rapid increase in competition

Difficulty: Easy

Learning Objective: Explain the going concern assumption.

Section Reference: 3.5 Going concern

CPA Competency: Audit and Assurance

AACSB: Analytic

45. Risks associated with information technology include

a) loss of data.

b) errors in programs.

c) unauthorized access to computers.

d) all of the answers are correct

Difficulty: Easy

Learning Objective: Explain the going concern assumption.

Section Reference: 3.5 Going concern

CPA Competency: Audit and Assurance

AACSB: Technology

46. Which statement about the going concern assumption is correct?

a) The company will not be able to continue operating in the next accounting period.

b) The auditor is responsible for the company to be able to continue operating in the foreseeable future.

c) The company will be able to continue operating in the foreseeable future.

d) The company cannot make the upcoming debt payments.

Difficulty: Easy

Learning Objective: Explain the going concern assumption.

Section Reference: 3.5 Going concern

CPA Competency: Audit and Assurance

AACSB: Analytic

47. The task of assessing the company’s ability to continue as a going concern is the responsibility of

a) the external auditor.

b) the internal auditor.

c) management.

d) the audit committee.

Difficulty: Easy

Learning Objective: Explain the going concern assumption.

Section Reference: 3.5 Going concern

CPA Competency: Audit and Assurance

AACSB: Analytic

48. Which of the following is an indicator that the company may not be able to continue as a going concern?

a) issuing bonus shares to shareholders instead of cash dividends

b) ability to increase borrowing

c) negative cash flows from operating activities

d) introduction of a new product into the market

Difficulty: Easy

Learning Objective: Explain the going concern assumption.

Section Reference: 3.5 Going concern

CPA Competency: Audit and Assurance

AACSB: Analytic

49. Which of the following is considered an accounting estimate?

a) accounts receivable

b) cash

c) allowance for doubtful accounts

d) inventory

Difficulty: Easy

Learning Objective: Explain how estimates can impact risk.

Section Reference: 3.6 Accounting estimates and related disclosures

CPA Competency: Audit and Assurance

AACSB: Analytic

50. Which of the following is not a factor that will impact estimation uncertainty?

a) materiality

b) subjectivity

c) uncertainty

d) complexity

Difficulty: Easy

Learning Objective: Explain how estimates can impact risk.

Section Reference: 3.6 Accounting estimates and related disclosures

CPA Competency: Audit and Assurance

AACSB: Analytic

51. The level of estimation uncertainty for the fair value measurement of a publicly traded equity security would be

a) low.

b) medium.

c) high.

d) cannot be determined

Difficulty: Medium

Learning Objective: Explain how estimates can impact risk.

Section Reference: 3.6 Accounting estimates and related disclosures

CPA Competency: Audit and Assurance

AACSB: Analytic

52. The level of estimation uncertainty for the fair value measurement of a derivative instrument that is not publicly traded would be

a) low

b) medium

c) high

d) cannot be determined

Difficulty: Medium

Learning Objective: Explain how estimates can impact risk.

Section Reference: 3.6 Accounting estimates and related disclosures

CPA Competency: Audit and Assurance

AACSB: Analytic

53. Corporate governance means

a) the viability of a company to remain in business for the foreseeable future.

b) the rules, systems, and processes within companies used to guide and control them.

c) an intentional act through the use of deception to obtain an unjust or illegal advantage.

d) the processes used by a client when finalizing the accounts for an accounting period.

Difficulty: Easy

Learning Objective: Appraise corporate governance.

Section Reference: 3.7 Corporate governance

CPA Competency: Audit and Assurance

AACSB: Analytic

54. The corporate governance principle of most concern to the auditor is

a) safeguarding the integrity in financial reporting.

b) making timely and balanced disclosures.

c) promoting ethical and responsible decision making.

d) respecting the rights of shareholders.

Difficulty: Easy

Learning Objective: Appraise corporate governance.

Section Reference: 3.7 Corporate governance

CPA Competency: Audit and Assurance

AACSB: Analytic

55. When gaining an understanding of a client, the auditor will consider the risks associated with information technology. Risks associated with information technology include

a) unauthorized access to computers, software, or data.

b) errors in programs.

c) lack of back-up procedures.

d) all of the answers are correct

Difficulty: Easy

Learning Objective: Evaluate how a client’s information technology (IT) can affect risk.

Section Reference: 3.8 Information technology

CPA Competency: Audit and Assurance

AACSB: Analytic

56. Which of the following is not a risk associated with the installation of a new IT system?

a) loss of data in transfer to the new system

b) inadequately trained staff

c) data not processed correctly

d) selection of an inappropriate system for reporting needs

Difficulty: Easy

Learning Objective: Evaluate how a client’s information technology (IT) can affect risk.

Section Reference: 3.8 Information technology

CPA Competency: Audit and Assurance

AACSB: Analytic

57. Unauthorized access to a company's data can occur when

a) inadequate backups of data are maintained.

b) there are poor password protection procedures.

c) computer programs are tested thoroughly.

d) there are sufficient security procedures.

Difficulty: Easy

Learning Objective: Evaluate how a client’s information technology (IT) can affect risk.

Section Reference: 3.8 Information technology

CPA Competency: Audit and Assurance

AACSB: Technology

58. Which of the following is not an example of a risk when a client installs a new IT system?

a) Client staff are not adequately trained to use the new system effectively.

b) The system may not be appropriate for the client.

c) The client has appropriate procedures for selecting new IT systems.

d) Data may be lost or corrupted.

Difficulty: Easy

Learning Objective: Evaluate how a client’s information technology (IT) can affect risk.

Section Reference: 3.8 Information technology

CPA Competency: Audit and Assurance

AACSB: Analytic

59. Which of the following statements relating to application controls is correct?

a) They impact on the procedures used for data entry, data processing, and output.

b) They include procedures for purchasing new computers.

c) They are not designed to prevent or detect a material misstatement in the financial statements.

d) They include the use of passwords and other security measures to minimize the risk of unauthorized access.

Difficulty: Easy

Learning Objective: Evaluate how a client’s information technology (IT) can affect risk.

Section Reference: 3.8 Information technology

CPA Competency: Audit and Assurance

AACSB: Analytic

60. Auditors can assess the adequacy of their client's closing procedures by

a) checking the accuracy of accrual calculations around year end.

b) looking at earnings trends to assess whether reported income is in line with similar periods in prior years.

c) both a and b

d) none of the above

Difficulty: Easy

Learning Objective: Explain how a client’s financial reporting practices and closing procedures can affect reported results.

Section Reference: 3.9 Closing procedures

CPA Competency: Audit and Assurance

AACSB: Analytic

61. If auditors believe there is a risk that expenses incurred before year end will be excluded from the current year's expenses, they will

a) send out confirmation requests to a sample of the client's debtors.

b) trace transactions recorded close to year end to source documentation.

c) perform analytical review analysis on the client's statement of financial position.

d) none of the above

Difficulty: Easy

Learning Objective: Explain how a client’s financial reporting practices and closing procedures can affect reported results.

Section Reference: 3.9 Closing procedures

CPA Competency: Audit and Assurance

AACSB: Analytic

62. The auditor is concerned about the audit client's closing procedures to ensure

a) transactions and events have been recorded in the correct accounting period.

b) closing procedures have been correctly applied.

c) the financial statements accurately reflect the results of the audit client’s closing procedures.

d) all of the answers are correct

Difficulty: Easy

Learning Objective: Explain how a client’s financial reporting practices and closing procedures can affect reported results.

Section Reference: 3.9 Closing procedures

CPA Competency: Audit and Assurance

AACSB: Analytic

63. In order to report strong results, an audit client may

a) include revenue earned in the next income year in the current year’s income.

b) bring forward expenses to the current income year.

c) defer revenue earned in the current year to the next income year.

d) omit closing procedures.

Difficulty: Easy

Learning Objective: Explain how a client’s financial reporting practices and closing procedures can affect reported results.

Section Reference: 3.9 Closing procedures

CPA Competency: Audit and Assurance

AACSB: Analytic

SHORT ANSWER QUESTIONS

64. Explain the three main phases of an audit of financial statements.

Difficulty: Easy

Learning Objective: Identify the different phases of an audit.

Section Reference: 3.1 Phases of an audit

CPA Competency: Audit and Assurance

AACSB: Analytic

65. Why must auditors gain an understanding of their client at the start of every audit?

Difficulty: Easy

Learning Objective: Explain the process used in gaining an understanding of the client.

Section Reference: 3.2 Gaining an understanding of the client

CPA Competency: Audit and Assurance

AACSB: Analytic

66. Indicate whether you agree or disagree with the following statements and explain your reasoning.

a) Related party transactions require proper identification and consideration when considering risk. However, there is no requirement to disclose related party transactions unless they have an impact on material misstatements.

b) When assessing fraud risk, auditors should adopt an attitude of professional scepticism to ensure that any indicator of a potential fraud is properly investigated.

c) The responsibility for preventing and detecting fraud rests with those charged with governance at the client as well as the auditors.

d) The auditor should not ask management and those charged with governance if they are aware of a known fraud or suspect there has been fraud.

e) Elvie Lee explained to her friend how application controls work: “Application controls are designed to prevent and detect a material misstatement in the financial statements.”

Difficulty: Medium

Learning Objective: Explain how related parties can impact risk.

Learning Objective: Evaluate fraud risk.

Learning Objective: Appraise corporate governance.

Learning Objective: Evaluate how a client’s information technology (IT) can affect risk.

Section Reference: 3.3 Related parties

Section Reference: 3.4 Fraud risk

Section Reference: 3.7 Corporate governance

Section Reference: 3.8 Information technology

CPA Competency: Audit and Assurance

AACSB: Analytic

67. What is fraud and what are some of the red flags that can alert auditors to the possibility that a fraud may have occurred?

Difficulty: Easy

Learning Objective: Evaluate fraud risk.

Section Reference: 3.4 Fraud risk

CPA Competency: Audit and Assurance

AACSB: Analytic

68. Bill Dodds was the accounts payable manager of Big Build Property Management Ltd. Bill started with the company as a bookkeeper and worked up to his current management position. He was promoted due to his dedication to the company and his reliability – he often worked evenings and weekends, rarely called in sick, and he never took holidays. Despite making a good wage, Bill enjoyed living large, and the majority of his paycheque went to pay for his luxury car and designer clothes. As Bill was living paycheque to paycheque he was disappointed he did not have a “nest egg” set aside for retirement or emergency purposes.

Big Build Property Management had a history of profitability. To reward its employees, the company had established a bonus scheme for meeting profit targets. It was a shock to all employees when at the end of 2022, the company announced it had had the worst year in the company’s history. The losses were significant and the company planned significant lay-offs in an attempt to turn this situation around. As a result, the accounting department was reduced by 35%, and the remaining staff was asked to do more. Bill found not only was he managing an unhappy accounts payable group, he was also now signing cheques, processing payables, and reconciling the bank account. This meant Bill was required to work even more without any pay increase or bonus in sight. For the first time in his career at Big Build, Bill was unhappy. While he was fearful further lay-offs may be coming, he also felt unappreciated and after all of his hard work, he was unhappy he was being asked to do more.

Required:

Discuss the incentives, opportunities, and rationalizations to commit fraud in this case.

Answers:

Incentives and Pressures — While few employees would take the opportunity to commit fraud, adding an element of pressure could sway an honest worker. Pressure may come from the individual’s personal life. In this case, the following incentives/pressures exist:

• Management has a focus on the need to reach target profits.

• There are falling profits at the company.

• Bill also lives paycheque to paycheque and likes to live large. With the fear of losing his job, he may feel pressure to commit fraud to maintain his standard of living.

Opportunity — This is where there is an opportunity to perpetrate a fraud due to weak or non-existent internal controls.

• Bill rarely called in sick, and never took holidays. This makes it easier to cover up any fraud that could be taking place.

• Lack of segregation of duties. Bill now processes accounts payable, signs cheques, and performs the bank reconciliation. As a result he can make fraudulent payments to himself and cover them up.

• With fewer staff now in place to perform the work required, there is likely less focus on internal controls and more focus on getting the job done. Again there is evidence of this with the lack of segregation of duties in the accounting department. This would make it easier to commit fraud and cover it up.

Rationalization — This is when fraudsters justify their actions to themselves. In this case as Bill is being asked to do more for the same remuneration, he may have an attitude of ”I deserve more money” and “they owe it to me.”

Bloomcode: Comprehension

Difficulty: Easy

Learning Objective: Evaluate fraud risk.

Section Reference: 3.4 Fraud risk

CPA Competency: Audit and Assurance

AACSB: Analytic

69. What should auditors do if there are risk factors that indicate that the going concern assumption is at risk?

Difficulty: Medium

Learning Objective: Explain the going concern assumption.

Section Reference: 3.5 Going concern

CPA Competency: Audit and Assurance

AACSB: Analytic

70. CAS 540 indicates that the higher the estimation uncertainty, the higher the risk of material misstatement and the greater the audit effort. What causes the increase in estimation uncertainty? Provide an example of an accounting estimate with high estimation uncertainty and explain why the level of uncertainty in your example is considered to be high.

Difficulty: Medium

Learning Objective: Explain how estimates can impact risk.

Section Reference: 3.6 Accounting estimates and related disclosures

CPA Competency: Audit and Assurance

AACSB: Analytic

ESSAY QUESTIONS

71. CAS 300 Planning an Audit of Financial Statements requires that auditors plan their audits. Why is planning such an important stage of every audit? Explain the various aspects of the preliminary risk identification process.

Difficulty: Easy

Learning Objective: Identify the different phases of an audit.

Section Reference: 3.1 Phases of an audit

CPA Competency: Audit and Assurance

AACSB: Analytic

72. When gaining an understanding of their clients, auditors consider the particular information technology risks faced by their clients. Explain the particular risks associated with information technology and discuss the main controls that companies can have in place to mitigate these risks.

Difficulty: Easy

Learning Objective: Explain the process used in gaining an understanding of the client.

Learning Objective: Evaluate how a client’s information technology (IT) can affect risk.

Section Reference: 3.2 Gaining an understanding of the client

Section Reference: 3.8 Information technology

CPA Competency: Audit and Assurance

AACSB: Analytic

73. Corporate governance is the rules, systems, and processes within companies used to guide and control them. Why are auditors concerned with the corporate governance structures of their clients and what is the current status of corporate governance regulation in Canada?

Difficulty: Easy

Learning Objective: Appraise corporate governance.

Section Reference: 3.7 Corporate governance

CPA Competency: Audit and Assurance

AACSB: Analytic

CASE QUESTION

74. Last year the review of Lethbridge Broadcasting did not go well for Bossy & Bossier CPAs. In an attempt to meet budget, Mike Bossy, the auditor-in-charge, left out the review of closing procedures. His Group Partner’s review notes were professional but his annual review commentary was not as complimentary. Mike was not convinced that he was at fault and felt that according to his firm’s mandate, as spelled out in the engagement letter, it was the client’s responsibility to ensure the adequacy of closing procedures.

This year the firm will be starting the audit of a new broadcasting client and the partner is planning the risk assessment procedures. His partner’s review note reads: “Ensure that Mike Bossy gains a detailed knowledge of the Quebecor Media broadcasting operations at the entity level.”

Required:

a) Comment on the partner’s Lethbridge Broadcasting concerns and explain how the closing process is supposed to work.

b) Discuss the entity-level audit procedures Mike will have to follow in order to gain an understanding of Quebecor Media operations and why these entity-level procedures are important.

Difficulty: Medium

Learning Objective: Explain the process used in gaining an understanding of the client.

Learning Objective: Explain how a client’s financial reporting practices and closing procedures can affect reported results.

Section Reference: 3.2 Gaining an understanding of the client

Section Reference 3.9 Closing procedures

CPA Competency: Audit and Assurance

AACSB: Analytic

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