Auditing (D215)
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Free Auditing (D215) Questions
A CPA firm is testing the existence assertion for inventory. The inventory balance represents 5% of total assets on the balance sheet. The firm's client uses a perpetual inventory system to account for inventory and performs cycle counts throughout the year. The client's internal audit staff observe and test these cycle counts. For the current year, the adjustments made to the inventory balance based on these counts have been immaterial. The client does plan to perform a physical inventory count at year-end. Should the CPA firm rely on the cycle counts instead of performing a physical inventory count at year-end
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Yes, because the assessed risk of material misstatement appears to be low.
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Yes, because additional procedures are unable to be performed after the interim period.
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No, because the inventory existence assertion is required to be performed at year-end.
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No, because internal controls appear to be ineffective.
Explanation
Correct Answer:
A. Yes, because the assessed risk of material misstatement appears to be low.
Explanation:
The CPA firm can rely on the client's cycle counts if the assessed risk of material misstatement is low, the perpetual inventory system is reliable, and past adjustments have been immaterial. The CPA must also consider whether the internal audit team’s oversight of cycle counts provides sufficient assurance about inventory existence.
Why other options are wrong
B. Yes, because additional procedures are unable to be performed after the interim period: This is incorrect because auditors can perform procedures after an interim period if needed, such as roll-forward procedures.
C. No, because the inventory existence assertion is required to be performed at year-end: While inventory existence is important, it does not have to be tested exclusively at year-end if sufficient alternative procedures, such as cycle counts, provide reasonable assurance.
D. No, because internal controls appear to be ineffective: The scenario does not indicate ineffective controls; rather, it states that adjustments have been immaterial, suggesting the perpetual inventory system and cycle counts are functioning effectively.
What is the impact of this situation on sample selection
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The sample should be clustered.
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The sample should be stratified.
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The sample size should be increased.
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The sample size should be decreased.
Explanation
Correct Answer:
C. The sample size should be increased.
Explanation
In situations where there is an increased risk of material misstatement—such as concerns about a company's ability to continue operations—the auditor needs to perform more extensive substantive testing to mitigate the higher risk. This typically results in a larger sample size to ensure sufficient coverage of the transactions and to gather enough evidence to draw accurate conclusions about the financial statements.
Why other options are wrong
A. Clustering is typically used when there are naturally occurring groups or clusters of transactions, not in response to an increased risk of misstatement.
B. Stratification is useful when there is a significant variation in the size or risk of transactions, but the issue here is more about the general risk of misstatement than the nature of the transactions themselves.
D. Decreasing the sample size would be inappropriate in the face of higher risk as it could result in insufficient evidence.
After performing risk assessment procedures and tests of controls, an auditor has determined that the risk of a material misstatement (RMM) is high. How should the auditor proceed
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Withdraw from the audit engagement
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Select a substantive approach for the audit strategy
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Issue a qualified opinion in the auditor's report
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Select a reliance on a controls approach for the audit strategy
Explanation
Correct Answer:
B. Select a substantive approach for the audit strategy
Explanation
When the risk of material misstatement (RMM) is high, the auditor should select a substantive approach, which involves performing detailed testing to gather sufficient evidence to support the financial statements, as reliance on controls may not be sufficient in this case.
Why other options are wrong
A. Withdraw from the audit engagement: Withdrawing from the audit engagement is not a standard response unless there are other issues such as an inability to obtain sufficient evidence.
C. Issue a qualified opinion in the auditor's report: A qualified opinion is issued when there are material misstatements or scope limitations, not necessarily when the RMM is high.
D. Select a reliance on a controls approach for the audit strategy: If the RMM is high, the auditor may not be able to rely on controls and will instead focus on substantive procedures.
Which group performs an audit and review of financial statements to ensure financial statement users' needs are met
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Internal auditors
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The Internal Revenue Service (IRS)
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Independent third-party auditors
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The Financial Accounting Standards Board (FASB)
Explanation
Correct Answer:
C. Independent third-party auditors
Explanation
Independent third-party auditors perform audits and reviews of financial statements to provide an objective evaluation and ensure that the financial statements meet the needs of users, such as investors, creditors, and regulatory authorities.
Why other options are wrong
A. Internal auditors: Internal auditors assess and improve an organization's internal controls and processes but do not typically perform external audits or reviews for financial statement users.
B. The Internal Revenue Service (IRS): The IRS is responsible for enforcing tax laws and regulations, not for auditing financial statements for external users.
D. The Financial Accounting Standards Board (FASB): FASB sets accounting standards but does not perform audits or reviews of financial statements.
An auditor uses financial statement assertions to guide the identification of possible errors or misstatements in the financial statement. Which procedure should the auditor perform next
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Perform tests of controls
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Review the entity-level controls
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Identify the relevant controls to test
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Determine the preliminary audit strategy
Explanation
Correct Answer:
C. Identify the relevant controls to test
Explanation
After identifying financial statement assertions and possible misstatements, the auditor should identify the relevant controls to test. This helps to assess whether the client's internal controls can prevent or detect misstatements, enabling the auditor to determine the reliance on those controls and the scope of further audit procedures.
Why other options are wrong
A. Perform tests of controls: Testing controls comes after identifying the relevant controls that need to be assessed, so it is not the next immediate step.
B. Review the entity-level controls: While this is part of understanding the internal control system, the auditor should first identify the relevant controls to test at the assertion level.
D. Determine the preliminary audit strategy: The audit strategy is refined after assessing the control environment, so identifying the relevant controls to test is a precursor to determining the strategy.
During fieldwork, an auditor noted several significant subsequent events that arose after the balance sheet date. The auditor has reviewed the client's footnote disclosure for the subsequent events and believes the disclosure is appropriate. However, the auditor is concerned that a financial statement user may reach improper conclusions about the client's financial condition if the disclosure about subsequent events is not noted by the user. How should the auditor respond to this situation
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Refuse to issue an audit report for the client
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Avoid referencing the subsequent events in the audit report
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Issue an audit report that includes a qualified opinion
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Include an emphasis-of-matter paragraph after the opinion in the audit report
Explanation
Correct Answer:
D. Include an emphasis-of-matter paragraph after the opinion in the audit report
Explanation:
An emphasis-of-matter paragraph is used when the auditor wants to draw attention to an issue that is appropriately disclosed in the financial statements but is significant enough that financial statement users should be aware of it. Since the subsequent events are properly disclosed but could still be misinterpreted, the emphasis-of-matter paragraph helps highlight their importance without modifying the opinion.
Why other options are wrong
A. Refuse to issue an audit report for the client: This action is extreme and only considered in cases of severe scope limitation or fraudulent activity, neither of which applies here.
B. Avoid referencing the subsequent events in the audit report: Since the auditor believes there is a risk of misinterpretation, ignoring the issue would not be a responsible course of action.
C. Issue an audit report that includes a qualified opinion: A qualified opinion is used when the financial statements are materially misstated or there is a scope limitation. Here, the disclosure is adequate, so a qualification is unnecessary.
Which classification should be used for a deficiency in internal control that would affect the decisions of the users of financial statements
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Control outlier
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Material weakness
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Significant deficiency
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Acceptable irregularity
Explanation
Correct Answer:
B. Material weakness
Explanation
A material weakness in internal control refers to a deficiency or combination of deficiencies that could lead to a material misstatement of the financial statements, which, in turn, would influence the decisions of users of those statements. It is the most severe classification for internal control deficiencies.
Why other options are wrong
A. Control outlier: This is not a recognized term within the classification of internal control deficiencies.
C. Significant deficiency: A significant deficiency is a less severe issue than a material weakness, but it still requires attention. However, it does not have the same potential to significantly affect financial statement users' decisions as a material weakness.
D. Acceptable irregularity: This is not a standard classification for internal control deficiencies and would not be used to describe significant issues.
Which type of control is applied to each transaction during normal processing in order to stop fraud or errors from occurring
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Detective
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Corrective
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Preventative
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Environment
Explanation
Correct Answer:
C. Preventative
Explanation
Preventative controls are designed to stop fraud or errors from occurring in the first place. These controls are applied during the normal processing of transactions to ensure that mistakes or fraudulent activities are avoided before they happen. Examples include segregation of duties and approval processes.
Why other options are wrong
A. Detective: Detective controls are designed to identify errors or fraud after they have occurred, not to prevent them.
B. Corrective: Corrective controls are designed to correct errors or fraud after detection, but they do not prevent them from occurring initially.
D. Environment: Environment controls relate to the overall control environment of the organization and are not transaction-specific controls to prevent errors or fraud.
During a yearly audit, the audit team becomes aware of the company's pressure to increase next year's profit. Which factor should the audit team be on the lookout for in the near future
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Accruals for subsequent year sales in the current year
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Disposals of inventory during the week before the current year-end
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Payroll expenses incurred the month after the year-end and recorded in the last month of the year
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Sales commissions paid to staff incurred during the last week of the year and not recorded in the current year
Explanation
Correct Answer:
A. Accruals for subsequent year sales in the current year
Explanation
The audit team should be on the lookout for improper revenue recognition, such as accruals for sales in the current year that belong to the subsequent year. This practice would inflate the current year’s revenue and profit, driven by the company's pressure to increase next year's profit.
Why other options are wrong
B. Disposals of inventory during the week before the current year-end: While inventory disposals may be relevant, they are not as directly related to pressure for increasing next year's profit as improper revenue recognition.
C. Payroll expenses incurred the month after the year-end and recorded in the last month of the year: This involves the improper timing of expenses, but the main concern in this case is revenue recognition, not expense misclassification.
D. Sales commissions paid to staff incurred during the last week of the year and not recorded in the current year: This situation could be an issue of timing, but it is not directly related to increasing next year's profit through the premature recognition of revenue.
Paradigm Toys has been in business for 50 years and makes primarily dolls and puppets. Demand for toys has become increasingly more technology-based. There are concerns about Paradigm's ability to maintain sufficient capital to continue operations in the future, resulting in an increased risk of material misstatement. Auditors need to make decisions about the sample size and techniques needed to substantively test sales revenues
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The sample size should be increased.
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The sample should be stratified.
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The sample size should be decreased.
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The sample should be clustered.
Explanation
Correct Answer:
A. The sample size should be increased.
Explanation:
When the risk of material misstatement is high, auditors increase the sample size to obtain more reliable audit evidence and reduce detection risk. Given the declining sales and concerns about the company’s ability to maintain capital, the likelihood of misstatements in revenue recognition increases. A larger sample size helps ensure that any potential misstatements are identified.
Why other options are wrong
B. The sample should be stratified: Stratification is useful when dividing the population into subgroups for targeted testing, but in this case, the primary concern is the overall risk of material misstatement, which requires a general increase in sample size.
C. The sample size should be decreased: A decrease in sample size would increase detection risk, which is inappropriate given the heightened risk of misstatement.
D. The sample should be clustered: Clustering groups similar transactions together, which may reduce variability in results but does not necessarily improve the detection of misstatements. Increasing the overall sample size is a more effective approach in this scenario.
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