AP 01: OVERVIEW OF AUDIT PROCESS

1. Given that an audit in accordance with generally accepted auditing standards is influenced by the possibility of
material errors and fraud, the auditor should conduct the audit with an attitude of
A. Professional skepticism
B. Professional responsiveness
C. Conservative advocacy
D. Objective judgment

2. Which of the following is not a distinguishing feature of risk-based auditing?

A. Identifying areas posing the highest risk of financial statement errors
B. Analysis of internal control
C. Collecting and evaluating evidence
D. Concentrating audit resources in those areas presenting the highest risk of financial statement errors

3. Inherent risk is defined as the susceptibility of an account balance or class of transactions to error that could be
material assuming that there were no related internal controls. Of the following conditions, which one does not
increase inherent risk?
A. The client has entered into numerous related party transactions during the year under audit.
B. Internal control over shipping, billing, and recording of sales revenue is weak.
C. The board of directors approved a substantial bonus for the president and chief executive officer, and also approved
an attractive stock option plan for themselves.
D. The client has lost a major customer accounting for approximately 30% of annual revenue.

4. 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. Procedures to be undertaken to discover litigation, claims, and assessments.
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 inventory observation procedures to be performed.

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

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

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

7. The ultimate purpose of assessing control risk is to contribute to the auditor’s evaluation of the risk that
A. Tests of controls may fail to identify procedures relevant to assertions.
B. Material misstatements may exist in the financial statements.
C. Entity policies may be overridden by senior management.
D. Specified controls requiring segregation of duties may be circumvented by collusion.
8. During consideration of the internal control structure in a financial statement audit, an auditor is not obligated to
A. Perform procedures to understand the design of the internal control structure policies.
B. Search for significant deficiencies in the operation of the internal control structure.
C. Determine whether the control procedures relevant to audit planning have been placed in operations.
D. Understand the internal control environment and the accounting system.

9. An auditor may compensate for a high assessed level of control risk by increasing the
A. Level of detection risk.
B. Extent of test of details.
C. Preliminary judgment about audit risk.
D. Extent of tests of controls.

10. An auditor evaluates the existing internal control in order to

A. Ascertain whether irregularities are probable
B. Ascertain whether any employees have incompatible functions
C. Determine the extent of control tests which must be performed
D. Determine the extent of substantive tests which must be performed.

11. After obtaining an understanding of the internal control structure and assessing control risk, an auditor decided not
to perform additional tests of controls. The auditor most likely concluded that the
A. Internal control structure was properly designed and justifiably may be relied on.
B. Evidence obtainable through tests of controls would not support an increased level of control risk.
C. Assessed level of inherent risk exceeded the assessed level of control risk.
D. Additional evidence to support a further reduction in control risk was not cost-beneficial to obtain.

12. An auditor may decide to assess control risk at the maximum level for certain assertions because the auditor believes
A. Sufficient evidential matter to support the assertions is likely to be available.
B. The entity’s control environment, accounting system, and control procedures are interrelated.
C. More emphasis on tests of controls than substantive tests is warranted.
D. Control policies and procedures are unlikely to pertain to the assertions.

13. When obtaining an understanding of an entity's control environment, an auditor should concentrate on the substance
of management's policies and procedures rather than their form because
A. The policies and procedures may be so weak that no reliance is contemplated by the auditor
B. The board of directors may not be aware of management's attitude toward the control environment
C. Management may establish appropriate policies and procedures but not act on them
D. The auditor may believe that the policies and procedures are inappropriate for that particular entity

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

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

A. Aggregate materiality thresholds are a function of the auditor's preliminary judgments concerning audit risk
B. The smallest aggregate level of errors or fraud that could be considered material to any one of the financial
statements is referred to as a "materiality threshold."
C. Materiality thresholds may change between the planning and review stages of the audit. These changes may be due
to quantitative and/or qualitative factors.
D. In general, the more misstatements the auditor expects, the higher should be the aggregate materiality threshold
16. Which of the following statements is true with regard to the relationship among audit risk, audit evidence, and
materiality?
A. Where inherent risk is high and control risk is low, the auditor may safely ignore inherent risk.
B. Aggregate materiality thresholds should not change under conditions of changing risk levels.
C. Under conditions of high inherent and control risk, the auditor should place more emphasis on obtaining external
evidence and should reduce reliance on internal evidence.
D. The lower the inherent risk and control risk, the lower the aggregate materiality threshold.

17. The probability of an auditor's procedures leading to the conclusion that a material error does not exist in an account
balance when, in fact, such error does exist is referred to as
A. Inherent risk
B. Control risk
C. Detection risk
D. Prevention risk

18. Having evaluated inherent risk and control risk, the auditor determines detection risk
A. As the complement of overall audit risk.
B. At a level that equates the joint probability of inherent risk, control risk, and detection risk with overall audit risk.
C. As a product of further study of the business and industry and application of analytical procedures.
D. By performing substantive audit tests.

19. Which of the following conditions supports an increase in detection risk?

A. Internal control over cash receipts is excellent
B. Internal control over shipping, billing, and recording of sales revenue is weak
C. Application of analytical procedures reveals a significant increase in sales revenue in December, the last month of the
fiscal year
D. Study of the business reveals that the client recently acquired a new company in an unrelated industry

20. Regardless of the assessed level of control risk, an auditor would perform some
A. Substantive tests to restrict detection risk for significant transaction classes.
B. Dual-purpose tests to evaluate both the risk of monetary misstatement and preliminary control risk.
C. Tests of controls to determine the effectiveness of internal control policies.
D. Analytical procedures to verify the design of internal control procedures.

21. Analytical procedures used in the overall review stage of the audit generally include
A. Gathering evidence concerning account balances that have not changed from the prior year.
B. Performing tests of transactions to corroborate management’s financial statement assertions.
C. Considering unusual or unexpected account balances that were not previously identified.
D. Retesting controls that appeared to be ineffective during the assessment of control risk.

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

23. Significant unexpected fluctuations identified by analytical procedures will usually necessitate a(an)
A. Auditor investigation
B. Explanation in the representation letter
C. Consistency qualification
D. Review of internal control
24. 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 regularly assuming subordinates' duties
B. Managers subject to formal performance reviews on a regular basis
C. Managers not complying with corporate directives and procedures.
D. Managers dealing in matters outside their profit center's scope

25. 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. A new federal regulation making customer licenses more difficult to obtain may adversely affect the client's
operations
B. The president and chief executive officer of the client corporation has held numerous meetings with the controller for
the purpose of discussing accounting practices that will maximize reported profits
C. The client has been named as a defendant in a product liability suit
D. The client has experienced a decrease in revenue from increased import competition

26. Which of the following statements best describes the auditor's responsibility regarding the detection of fraud?
A. The auditor should design audit procedures that will provide reasonable assurance that the financial statements are
free from material misstatement due to errors and/or fraud
B. The auditor is responsible for the failure to detect fraud only when such failure clearly results from nonperformance
of audit procedures specifically described in the engagement letter
C. The auditor is responsible for the failure to detect fraud only when an unqualified opinion is issued
D. The auditor must extend auditing procedures to actively search for evidence of fraud where the examination indicates
that fraud may exist

27. The risk of fraudulent financial reporting increases in the presence of

A. Substantial increases in sales.
B. Frequent changes in suppliers
C. Incentive systems based on operating income.
D. Improved control systems.

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

29. To maximize independence, the external auditors should report to the

A. Chief financial officer
B. Audit committee
C. Director of information systems
D. Controller

30. Which of the following statements best describes the “date of the financial statements?”
A. The date on which the audit has obtained sufficient appropriate audit evidence on which to base the opinion on the
financial statements.
B. The date on which those with the recognized authority assert that they have prepared the entity’s complete set of
financial statements, including the related notes, and that they have taken responsibility for them.
C. The date of the end of the latest period covered by the financial statements, which is normally the date of the most
recent balance sheet in the financial statements subject to audit.
D. The date that the auditor’s report and audited financial statements are made available to third parties.
31. Which of the following statements best describes the auditor’s responsibility concerning the appropriateness of the
going concern assumption in the preparation of the financial statements?
A. The auditor’s responsibility is to make a specific assessment of the entity’s ability to continue as a going concern.
B. The auditor’s responsibility is to consider the appropriateness of management’s use of the going concern assumption
and consider whether there are material uncertainties about the entity’s ability to continue as a going concern that
need to be disclosed in the financial statements.
C. The auditor’s responsibility is to predict future events or conditions that may cause the entity to cease to continue as
a going concern.
D. The auditor’s responsibility is to give a guarantee in the audit report that the entity has the ability to continue as a
going concern.

32. The responsibility for the identification and disclosure of related parties and transactions with such parties rests with
the
A. Securities and Exchange Commission (SEC).
B. Entity’s management.
C. Financial Reporting Standards Council (FRSC).
D. Auditor.

33. The best description of the scope of internal auditing is that it encompasses
A. Primarily financial auditing
B. Both financial and operational auditing
C. Primarily the safeguarding of assets and verifying the existence of such assets
D. Primarily operational auditing

34. A typical objective of an operational audit is to determine whether an entity's

A. Financial statements fairly present financial position, results of operations, and cash flows
B. Financial statements fairly present financial position and cash flows
C. Specific operating units are functioning efficiently and effectively
D. Financial statements present fairly the results of operations

35. Which of the following statements is not a distinction between independent auditing and internal auditing?
A. The internal auditor's span of coverage goes beyond financial auditing to encompass operational and performance
auditing.
B. Independent auditors represent third party users external to the auditee entity, whereas internal auditors report
directly to management.
C. Internal auditors are employees of the auditee, whereas independent auditors are independent contractors.
D. Although independent auditors strive for both validity and relevance of evidence, internal auditors are concerned
almost exclusively with validity.