Midterm 8910111217

Chapter 8
Multiple-Choice Questions
1. Which of the following is not one of the three main reasons why the auditor
easy should properly plan engagements?
a a. To enable proper on-the-job training of employees.
b. To enable the auditor to obtain sufficient appropriate evidence.
c. To avoid misunderstandings with the client.
d. To help keep audit costs reasonable.
2. Avoiding misunderstandings with the client is important for:

easy
a Good client relations Facilitating high-quality work at a
reasonable cost
a. Yes Yes
b. No No
c. Yes No
d. No Yes
3. A measure of how willing the auditor is to accept that the financial statements
easy may be materially misstated after the audit is completed and an unqualified
opinion has been issued is the:
b a. inherent risk.
b. acceptable audit risk.
c. statistical risk.
d. financial risk.
4. A measure of the auditor’s assessment of the likelihood that there are material
easy misstatements in an account before considering the effectiveness of the client’s
internal control is called:
d a. control risk.
d. inherent risk.
5. When inherent risk is high, there will need to be:

Easy
d A lower assessment of audit More evidence accumulated by the
risk auditor
a. Yes Yes
b. No No
c. Yes No
d. No Yes
6. The auditor is likely to accumulate more evidence when the audit is for a
company:
easy
a Which has large amounts Which is to be sold in the near
of debt future
a. Yes Yes
b. No No
c. Yes No
d. No Yes
7. Which of the following is not typically included in initial audit planning?

easy a. Client acceptance/continuation decisions.
d b. Determination of the purpose of the audit.
c. Obtain an understanding with the client.
d. Perform analytical procedures as substantive tests.
8. Initial audit planning involves four matters. Which of the following is not one
of these?
easy a. Develop an overall audit strategy.
b b. Request that bank balances be confirmed.
c. Schedule engagement staff and audit specialists.
d. Identify the client’s reason for the audit.
9. Most auditors assess inherent risk as high for related parties and related-party
easy transactions because:
b a. of the unique classification of related-party transactions required on the
balance sheet.
b. of the lack of independence between the parties.
c. of the unique classification of related-party transactions required on the
income statement.
d. it is required by generally accepted accounting principles.
10. Which of the following is not correct regarding the communications between
easy successor and predecessor auditors?
a a. The burden of initiating the communication rests with the predecessor
auditor.
b. The burden of initiating the communication rests with the successor
auditor.
c. The predecessor auditor must receive their former client’s permission prior
to divulging information to the successor auditor
d. The predecessor auditor may choose to provide a limited response to a
successor auditor.
11. A successor auditor may perform which of the following for a new audit client?
easy
a Speak to local attorneys,
banks and other Speak to the predecessor auditors about
businesses regarding the disagreements they had with management
company’s reputation
a. Yes Yes
b. No No
c. Yes No
d. No Yes
12. Which of the following is not a potential effect of an auditor’s decision that a
medium lower acceptable audit risk is appropriate?
b a. More evidence is accumulated.
b. Less evidence is accumulated.
c. Special care is required in assigning experienced staff.
d. Review of audit documentation is performed by personnel not assigned to
the engagement.
13. It is easier and more common to implement increased evidence accumulation

medium for inherent risk than for acceptable audit risk because:
a a. inherent risk can usually be isolated to specific accounts.
b. inherent risk applies to the entire audit.
c. acceptable audit risk and sample sizes are set statistically.
d. acceptable audit risk does not impact on the amount of evidence which
must be accumulated.
14. (SOX) If an auditor is requested to perform nonaudit services for a public company
medium audit client, who is responsible for agreeing to those services with the audit
firm?
d a. The client’s management.
b. The client’s chief executive officer.
c. The client’s chief financial officer.
d. The client’s audit committee.
15. Which of the following statements is true regarding communications between

medium predecessor and successor auditors?
b a. The burden of initiating the communication rests with the predecessor.
b. The predecessor’s response can be limited to stating that no information
will be provided.
c. The predecessor should communicate with the successor only if the client
is public.
d. There must be communication between the predecessor and successor if the
successor is to accept the engagement.
16. Investigating new clients with a focus on assessing the auditor’s potential
medium relationship with that new client is a critical element in determining:
b a. inherent risk.
d. financial risk.
17. The purpose of an engagement letter is to:

medium a. document the CPA firm’s responsibility to external users of the audited
b financial statements.
b. document the terms of the engagement in writing to minimize
misunderstandings.
c. notify the audit staff of an upcoming engagement so that personnel
scheduling can be facilitated.
d. emphasize management’s responsibility for approving the audit program.
18. One means of informing the client that the auditor is not responsible for the
medium discovery of all acts of fraud is the:
a a. engagement letter.
b. representation letter.
c. responsibility letter.
d. client letter.
19. Which of the following normally signs the engagement letter for an audit of a
public company?
medium a. Corporate treasurer.
d b. Chief financial officer.
c. Chairman of the board of directors.
d. Audit committee.
20. Which of the following normally signs the engagement letter for an audit of a
private company?
medium a. Management.
a b. Board of directors representative.
c. Audit committee representative.
d. Corporate treasurer.
21. An understanding of a client’s business and industry and knowledge about

medium operations are essential for performing an adequate audit. For a new client, most
d of this information is obtained:
a. from the predecessor auditor.
b. from the Securities and Exchange Commission.
c. from the permanent file.
d. at the client’s premises.
22. The least effective method of identifying related parties for a public company
would be a(n):
medium a. inquiry of management.
c b. review of SEC filings.
c. distribution of the engagement letter to all stockholders.
d. examination of stockholders’ listings to identify principal stockholders.
23. An official record of meetings of the board of directors and stockholders is

medium included in the corporate:
c a. bylaws.
b. charter.
c. minutes.
d. license.
24. Which of the following is not likely to be a related party?

medium a. Affiliated companies.
c b. A major stockholder of the company.
c. A warehouse employee.
d. The chief executive officer.
25. Which of the following is most likely to occur at the beginning of an initial
audit engagement?
medium a. Prepare a rough draft of the financial statements and of the auditor’s report.
c b. Study and evaluate the system of internal administrative control.
c. Determine the client’s reason for an audit.
d. Consult with and review the work of the predecessor auditor prior to
discussing the engagement with the client management.
26. An auditor should examine minutes of the board of directors’ meetings:

medium a. through the date of the financial statements.
b b. through the date of the audit report.
c. only at the beginning of the audit.
d. on a test basis.
27. The first standard of field work, which states that the work is to be adequately
medium planned and that assistants, if any, are to be properly supervised, recognizes
that:
a a. early appointment of the auditor is advantageous to the auditor and the
client.
b. acceptance of an audit engagement after the close of the client’s fiscal year
is generally not permissible.
c. appointment of the auditor subsequent to the physical count of inventories
requires a disclaimer of opinion.
d. performance of substantial parts of the examination is necessary at interim
dates.
28. The corporate minutes are the official record of the meetings of the board of
medium directors and stockholders. The minutes typically include authorizations related
to:
d
The CPA’s use of outside Management compensation
specialists
a. Yes Yes
b. No No
c. Yes No
d. No Yes
29. An engagement letter sent to an audit client usually would not include a(n):
medium a. reference to the auditor’s responsibility for the detection of errors or
irregularities.
c b. estimation of the time to be spent on the audit work by audit staff and
management.
c. statement that management advisory services would be made available
upon request.
d. reference to management’s responsibility for the financial statements.
30. Which of the following is correct with respect to a company’s corporate

charter?
medium a. The corporate charter is granted by the federal government and is required
c to recognize the corporation as a separate entity.
b. The corporate charter includes the rules and procedures used to operate a
corporation.
c. The corporate charter includes the exact name of the corporation, the date
of incorporation, and the types of business the corporation is authorized to
conduct.
d. The corporate charter must be annually reviewed by the PCAOB.
31. Corporate bylaws include:

Medium
d The types and amounts of capital The rules and procedures used
stock the corporation is to operate the corporation
authorized to issue
a. Yes Yes
b. No No
c. Yes No
d. No Yes
32. In what order should the following steps occur?

medium A. Assess client business risk
b B. Understand the client’s business and industry
C. Perform preliminary analytical procedures
D. Assess acceptable audit risk
a. D, B, C, A.
b. B, A, D, C.
c. B, D, A, C.
d. D, C, B, A.
33. Which of the following statements is not correct with respect to analytical
procedures?
medium a. Auditing standards emphasize the need for auditors to develop and use
expectations.
b b. Analytical procedures must be performed throughout the audit.
c. Analytical procedures may be performed at any time during the audit.
d. Analytical procedures use comparisons and relationships to assess whether
account balances appear reasonable.
34. The most widely used profitability ratio is the:
medium a. quick ratio.
d b. profit margin.
c. return on assets.
d. earnings per share.
35. The purpose of the requirement in SAS No. 84 of having communication

challenging between the predecessor and successor auditor is to:
b a. allow the predecessor to disclose information which would otherwise be
confidential.
b. help the successor auditor to evaluate whether to accept the engagement.
c. help the client by facilitating the change of auditors.
d. ensure the predecessor collects all unpaid fees prior to a change in auditor.
36. The predecessor auditor is required to respond to the request of the successor
challenging auditor for information, but the response can be limited to stating that no
information will be provided when:
c a. the predecessor auditor has poor relations with the successor auditor.
b. the client is dissatisfied with the predecessor’s work.
c. there are actual or potential legal problems between the client and the
predecessor.
d. the predecessor believes that the client lacks integrity.
37. Which of the following is correct with respect to the use of analytical
procedures?
challenging a. Analytical procedures may be used in evaluating balances in the testing
d phase as long as the auditor also uses them in assessing the going concern
assumption.
b. Analytical procedures must be used throughout the audit.
c. Analytical procedures used in the testing phase of the audit are primarily
used to direct an auditor’s attention so that the auditor’s understanding of
the business is improved.
d. Analytical procedures are performed by studying plausible relationships
between financial and nonfinancial data.
38. Which of the following ratios is best used to assess a company’s ability to meet
challenging its long-term debt obligations?
c a. Quick ratio.
b. Return on common equity.
c. Debt to equity.
d. Current ratio.
39. Which of the following statements is not correct?

challenging a. Analytical procedures used in the planning phase of the audit are primarily
b directed at understanding the client’s business and directing the auditor’s
attention to areas that may contain possible misstatements.
b. Analytical procedures used in the completion phase are primarily aimed at
assessing going concern and secondarily aimed at directing the auditor’s
attention to areas that may contain possible misstatements.
c. Analytical procedures must be used in the planning and completion phases
of the audit, and are optional in the testing phase.
d. Analytical procedures used in the completion phase are primarily aimed at
directing the auditor’s attention to areas that may contain possible
misstatements and secondarily aimed at assessing going concern.
40. Which of the following would not likely be classified as a related-party

transaction?
medium a. An advance of one week’s salary to an employee.
a b. Sales of merchandise between affiliated companies.
c. Loans or credit sales to the principal owner of the client company.
d. Exchanges of equipment between two companies owned by the same
person.
41. Which of the following would not be found in the corporate charter?
challenging a. The kinds and amount of capital stock authorized.
d b. The date of incorporation.
c. The types of business activity that the corporation is allowed to conduct.
d. The rules and procedures adopted by the stockholders.
42. Which of the following would not usually be included in the minutes of the
board of directors?
challenging a. The duties and powers of the corporate officers.
a b. Declaration of dividends.
c. Authorization of long-term loans.
d. Approval of executive bonuses.
43. When are auditors likely to encounter judgment problems in the use of
analytical procedures?
challenging a. Whenever the auditor places reliance on management’s explanations for
d unusual fluctuations in account balances without first developing
independent expectations.
b. Whenever the auditor allows unaudited balances to unduly influence
his/her expectations of current balances.
c. Whenever the auditor fails to consider the pattern reflected by several
unusual fluctuations when trying to explain what caused them.
d. The auditor is likely to encounter judgment problems in each of the above
instances.
44. The major concern when using nonfinancial data in analytical procedures is the:
challenging a. accuracy of the nonfinancial data.
a b. source of the nonfinancial data.
c. type of nonfinancial data.
d. presence of multiple sources of nonfinancial data.
45. An auditor searching for related party transactions should obtain an

challenging understanding of each subsidiary’s relationship to the total entity because:
b a. the business structure may be deliberately designed to obscure related party
transactions.
b. this may reveal whether transactions would have taken place if the parties
had been unrelated.
c. transactions may have been consummated on terms equivalent to arm’s-
length transactions.
d. this may permit the audit of intercompany account balances to be
performed as of concurrent dates.
46. The first standard of fieldwork requires, in part, that audit work be properly
challenging planned. Proper planning as intended by the first standard of fieldwork would
occur when the auditor:
a a. physically observes the movement of securities already counted to guard
against the substitution of such securities for others that are not actually on
hand.
b. uses negative accounts receivable confirmations instead of positive
confirmations because the latter require mailing of second requests and
review of subsequent cash collections.
c. compares all cash as of a particular date to avoid performing time-
consuming cash cutoff procedures.
d. eliminates the possibility of counting inventory items more than once by
arranging to make extensive test counts.
47. Early appointment of the independent auditor will enable:

challenging a. a more thorough examination to be performed.
d b. a proper study and evaluation of internal control to be performed.
c. sufficient competent evidential matter to be obtained.
d. a more efficient examination to be planned.
48. Whenever an auditor compares client data to client-prepared budgets, there are
medium two special concerns. Indicate if the two items below are concerns.
a
Assessing whether the budgets Client data may have been altered to
were realistic plans conform to the budget
a. A concern A concern
b. Not a concern Not a concern
c. A concern Not a concern
d. Not a concern A concern
49. An auditor who accepts an audit engagement and does not possess the industry
challenging expertise of the business entity should:
b a. engage financial experts familiar with the nature of the business entity.
b. obtain a knowledge of matters that relate to the nature of the entity’s
business.
c. refer a substantial portion of the audit to another CPA who will act as the
principal auditor.
d. first inform management that an unqualified opinion cannot be issued.
50. Which is a liquidity activity ratio?

medium a. Profit margin
b b. Inventory turnover
c. Return on assets
d. Times interest earned
51. Which is usually included in an engagement letter?
Estimate of hours Dollar estimate of fees to be

medium required to complete billed to the client
audit
d a. Yes Yes
b. No No
c. Yes No
d. No Yes

medium
a A reference to A reference to GAAS
GAAP
a. Yes Yes
b. No No
c. Yes No
d. No Yes

medium
c The financial
statements are the Ratios to be used by the auditor in the
responsibility of the planning phase
company’s
management
a. Yes Yes
b. No No
c. Yes No
d No Yes
54. When may the auditor refer to a specialist in the audit report?
medium
c
Only if the specialist’s report
results in a modification of Only if the specialist assisted in the
the audit opinion audit of an account material to the
financial statements
a. Yes Yes
b. No No
c. Yes No
d No Yes
55. Which is usually included in the engagement letter?

medium
b The projected type of opinion
on the financials statement to Name(s) of the client personnel
be audited responsible for supplying the auditor
with information
a. Yes Yes
b. No No
c. Yes No
d No Yes
56. Which is usually included in the engagement letter?

medium
b List of audit procedures to be
used in inventory observation The auditors’ assessment of Audit Risk
a. Yes Yes
b. No No
c. Yes No
d No Yes
Chapter 9
1. If it is probable that the judgment of a reasonable person would have been

easy changed or influenced by the omission or misstatement of information, then that
a information is, by definition of FASB Statement No. 2:
a. material.
b. insignificant.
c. significant.
d. relevant.
2. The preliminary judgment about materiality is the amount by

easy which the auditor believes the statements could be misstated and still not affect
the decisions of reasonable users.
b a. minimum
b. maximum
c. mean average
d. median average
3. Auditors are responsible for determining whether financial statements are

easy materially misstated, so upon discovering a material misstatement they must
bring it to the attention of:
d a. regulators.
b. the audit firm’s managing partner.
c. no one in particular.
d. the client’s management.
4. The FASB definition of materiality emphasizes what class of financial

statement users?
easy a. Regulators.
c b. Informed investors.
c. Reasonable persons.
d. Potential investors.
5. When auditors allocate the preliminary judgment about materiality to account

easy balances, the materiality allocated to any given account balance is referred to
as:
d a. the materiality range.
b. the error range.
c. tolerable materiality.
d. tolerable misstatement.
6. Why do auditors establish a preliminary judgment about materiality?

easy a. To determine the appropriate level of audit experience required for the
work.
c b. So that the client can know what records to make available to the auditor.
c. To plan the appropriate audit evidence to accumulate and develop an
overall audit strategy.
d. To finalize the assessment of control risk.
7. Auditors are _____ to decide on the combined amount of misstatements in the

easy financial statements that they would consider material early in the audit.
b a. permitted
b. required
c. not allowed
d. strongly encouraged
8. If an auditor establishes a relatively high level for materiality, then the auditor
will:
easy a. accumulate more evidence than if a lower level had been set.
b b. accumulate less evidence than if a lower level had been set.
c. accumulate approximately the same evidence as would be the case were
materiality lower.
d. accumulate an undetermined amount of evidence.
9. The preliminary judgment about materiality and the amount of audit evidence
easy accumulated are _____ related.
d a. directly
b. indirectly
c. not
d. inversely
10. After the preliminary judgment about materiality has been established, auditors
may:
easy a. not adjust it.
d b. adjust it downward only.
c. adjust it upward only.
d. adjust it either downward or upward.
11. In an audit area that has a lower inherent risk, it would be prudent to:
easy a. increase the amount of audit evidence gathered.
c b. assign more experienced staff to that area.
c. increase the tolerable misstatement for the area.
d. expand planning procedures.
12. Which of the following is least likely to be appropriate as the basis for
easy determining the preliminary judgment about materiality in the audit of financial
statements?
d a. Net income before taxes.
b. Current assets.
c. Owners’ equity.
d. Inventory.
13. Auditing standards _____ that the basis used to determine the preliminary
easy judgment about materiality be documented in the audit files.
c a. permit
b. do not allow
c. require
d. strongly encourage
14. Amounts involving fraud are usually considered _____ important than
easy unintentional errors of equal dollar amounts.
d a. less
b. no less
c. no more
d. more
15. Which of the following qualitative factors may significantly influence whether
easy an item is deemed to be material?
a
Misstatements that are
otherwise minor may be Misstatements that are otherwise
material if there are possible immaterial may be material if they
consequences arising from affect a trend in earnings
contractual obligations.
a. Yes Yes
b. No No
c. Yes No
d. No Yes
16. Auditors generally allocate the preliminary judgment about materiality to the:
easy a. balance sheet only.
a b. income statement only.
c. income statement and balance sheet.
d. statement of cash flows.
17. Which of the following statements regarding inherent risk is correct?

easy a. The inherent risk assigned in the audit risk model is unaffected by the
c auditor’s experience with client’s organization.
b. Most auditors set a low inherent risk in the first year of an audit and
increase it if experience shows that it was incorrect.
c. Most auditors set a high inherent risk in the first year of an audit and reduce
it in subsequent years as they gain experience, even when there is inherent
risk.
d. The inherent risk assigned in the audit risk model is dependent upon the
strengths in client’s internal control system.
18. Auditors begin their assessments of inherent risk during audit planning. Which
easy of the following would not help in assessing inherent risk during the planning
phase?
a a. Obtaining client’s agreement on the engagement letter.
b. Obtaining knowledge about the client’s business and industry.
c. Touring the client’s plant and offices.
d. Identifying related parties.
19. Auditors commonly allocate materiality to balance sheet accounts rather than
medium income statement accounts because most income statement misstatements have
b a(n) _____ effect on the balance sheet.
a. reduced
b. equal
c. undetermined
d. increased
20. Which of the following is not a correct statement regarding the allocation of the
medium preliminary judgment about materiality to balance sheet accounts?
b a. Auditors expect certain accounts to have more misstatements than others.
b. The allocation has virtually no effect on audit costs because the auditor
must collect sufficient appropriate audit evidence.
c. Auditors expect to identify overstatements as well as understatements in
the accounts.
d. Relative audit costs affect the allocation.
21. What is the primary means of dealing with risk in planning decisions related to
audit evidence?
medium a. Selection of more effective tests of details of balances.
b b. Application of the audit risk model.
c. Establishing a lower preliminary judgment about materiality.
d. Allocating materiality judgment to segments.
22. The phrase “in our opinion” in the auditor’s report is intended to inform users
that auditors:
medium a. guarantee fair presentation of the financial statements.
d b. act as insurers of the accuracy of the statements.
c. certify the material presented in the statements by management.
d. base their conclusions about the statements on professional judgment.
23. Inherent risk is _______ related to detection risk and _______ related to the
medium amount of audit evidence.
d a. directly, inversely
b. directly, directly
c. inversely, inversely
d. inversely, directly
24. The five steps in applying materiality are listed below in random order.
medium 1. Estimate the combined misstatement.
b 2. Estimate the total misstatement in the segment.
3. Set preliminary judgment about materiality.
4. Allocate preliminary judgment about materiality to segments.
5. Compare combined estimate with preliminary judgment about materiality.
The correct sequence from start to finish would be:
a. 1 2 5 4 3.
b. 3 4 2 1 5.
c. 4 3 1 5 2.
d. 5 1 3 2 4.

medium a. Materiality is a relative rather than an absolute concept.
b b. The most important base used as the criterion for deciding materiality is
total assets.
c. Qualitative factors as well as quantitative factors affect materiality.
d. Given equal dollar amounts, frauds are usually considered more important
than errors.
26. Since materiality is relative, it is necessary to have bases for establishing

medium whether misstatements are material. Normally, the most common base for
deciding materiality is:
a a. net income before taxes.
b. net working capital.
c. net income after taxes.
d. total assets.
27. Certain types of misstatements are likely to be more important than other types
medium to users, even if the dollar amounts are the same. Which of the following
demonstrates this?
a
Amounts involving frauds are Misstatements that are otherwise
considered more important immaterial may be material if they
than errors of equal amount affect a trend in earnings.
a. Yes Yes
b. No No
c. Yes No
d. No Yes
28. Allocating the preliminary judgment about materiality to financial statements

medium segments is necessary because:
b a. evidence is accumulated for the financial statements as a whole so
materiality does not apply to them.
b. evidence is accumulated by segments rather than for the financial
statements as a whole.
c. it is required by the AICPA’s Code of Professional Conduct.
d. it is required by the SEC.

medium a. Either an overstatement of an asset account or an understatement of a
c liability account would have the same effect on the income statement.
b. A misclassification in the balance sheet will have no effect on operating
income.
c. Either an overstatement of an asset account or an overstatement of a
liability account would have the same effect on the income statement.
d. Either an understatement of an asset account or an overstatement of a
liability account would have the same effect on the income statement.
30. Regardless of how the preliminary judgment about materiality is allocated, the
medium auditor must be confident that total combined misstatements in all accounts are:
d a. less than the preliminary judgment.
b. equal to the preliminary judgment.
c. more than the preliminary judgment.
d. less than or equal to the preliminary judgment.
31. Auditors frequently refer to the terms audit assurance, overall assurance, and
medium level of assurance to refer to ________.
c a. detection risk
b. audit report risk
c. acceptable audit risk
d. inherent risk
32. _____ misstatements are those where the auditor can determine the amount of
medium the misstatement in the account.
c a. Potential
b. Likely
c. Known
d. Projected
33. When a different extent of evidence is needed for the various cycles, the
difference is caused by:
medium a. errors in the client’s accounting system.
d b. a client’s need to achieve an unqualified opinion.
c. an auditor’s need to follow auditing standards.
d. an auditor’s expectations of errors and assessment of internal control.
34. If planned detection risk is reduced, the amount of evidence the auditor
accumulates will:
medium a. increase.
a b. decrease.
c. remain unchanged.
d. be indeterminate.
35. Likely misstatements can result from:

Medium
a Projections of
Differences between misstatements based
Computation of the management’s and an on an auditor’s tests
sampling error for auditor’s judgment of a sample from a
the cash account about account balances population
a. No Yes Yes
b. Yes Yes No
c. No No Yes
d. Yes No No
36. When discussing control risk (CR) and the audit risk model, which of the
following is false?
medium a. CR is a measure of the auditor’s assessment of the likelihood that
b misstatements will not be prevented or detected by internal control.
b. If the auditor concludes that internal control is completely ineffective to
prevent or detect errors, he/she would assign a low value (e.g., 0%) to CR.
c. The relationship between control risk and detection risk is inverse.
d. The relationship between control risk and evidence needed to support
account balances is direct.
37. Which of the following is not a good indicator of the degree to which
medium statements are relied on by external users?
d a. Client’s size, as measured by total assets or total revenue.
b. Distribution of ownership among the public.
c. Nature and amount of liabilities.
d. Amount of net income or loss after taxes.
38. If an auditor believes the chance of financial failure is high and there is a
medium corresponding increase in business risk for the auditor, acceptable audit risk
would likely:
a a. be reduced.
b. be increased.
c. remain the same.
d. be calculated using a computerized statistical package.
39. When management has an adequate level of integrity for the auditor to accept
medium the engagement but cannot be regarded as completely honest in all dealings,
auditors normally:
a a. reduce acceptable audit risk and increase inherent risk.
b. reduce inherent risk and control risk.
c. increase inherent risk and control risk.
d. increase acceptable audit risk and reduce inherent risk.
40. One accounting issue that does not require management to use significant
judgments is:
medium a. the allowance for doubtful accounts.
b b. the useful life of equipment for tax purposes.
c. obsolete inventory.
d. the liability for warranty payments.
41. Inherent risk is often low for an account such as:

medium a. inventory.
d b. marketable securities.
c. cash.
d. accounts receivable.
42. The auditor typically does not assess control risk and inherent risk for:
medium a. each audit objective.
d b. each cycle.
c. each account.
d. the overall audit.
43. (Public) To what extent do auditors typically rely on internal controls of their public
company clients?
medium a. Extensively
a b. Only very little
c. Infrequently
d. Never
44. Auditors typically rely on internal controls of their private company clients:
medium a. Only as needed to complete the audit and satisfy Sarbanes-Oxley
requirements.
b b. Only if the controls are determined to be effective.
c. Only if the client asks an auditor to test controls.
d. Only if the controls are sufficient to increase Control Risk to an acceptable
level.
45. Acceptable audit risk is ordinarily set by the auditor during planning and:
medium a. held constant for each major cycle and account.
a b. held constant for each major cycle but varies by account.
c. varies by each major cycle and by each account.
d. varies by each major cycle but is constant by account.
46. When the auditor is attempting to determine the extent to which external users
medium rely on a client’s financial statements, they may consider several factors except
for:
d a. client size.
b. concentration of ownership.
c. types and amounts of liabilities.
d. assessment of detection risk.
47. A major difficulty in the application of the audit risk model is:
medium a. defining the terms of the model.
b b. measuring the components of the model.
c. understanding the effect on other factors in the model when one factor is
changed.
d. the failure of the Audit Standards Board to accept it and incorporate it into
standards.
48. When setting a preliminary judgment about materiality:

medium a. more evidence is required for a low dollar amount than for a high dollar
amount.
a b. less evidence is required for a low dollar amount than for a high dollar
amount.
c. the same amount of evidence is required for either low or high dollar
amounts.
d. there is no relationship between it and the dollar amount of evidence
needed.
49. When allocating materiality, most practitioners choose to allocate to:

challenging a. the income statement accounts because they are more important.
b b. the balance sheet accounts because there are fewer.
c. both balance sheet and income statement accounts because there could be
errors on either.
d. all of the financial statements because there could be errors on other
statements besides the income statement and balance sheet.
50. The risk of material misstatement refers to:

challenging a. control risk and acceptable audit risk.
c b. inherent risk.
c. the combination of inherent risk and control risk.
d. inherent risk and audit risk.
51. Auditors may assess inherent risk and control risk:
medium Jointly to determine the Separately and combine their effects in

a risk of material the audit risk model
misstatement
a. Yes Yes
b. No No
c. Yes No
d. No Yes
52. Which one of the following statements about the cycle approach to auditing is
not correct?
challenging a. There are differences among cycles in the frequency and size of expected
errors.
c b. There are differences among cycles in the effectiveness of internal controls.
c. There are differences among cycles on the auditor’s willingness to accept
risk that material errors exist after the auditing is complete.
d. It is common for auditors to want an equally low likelihood of errors for
each cycle after the auditor is finished.
53. When the auditor has the same level of willingness to risk that material
challenging misstatements will exist after the audit is finished for all financial statement
cycles:
a a. a different extent of evidence will likely be needed for various cycles.
b. the same amount of evidence will be gathered for each cycle.
c. the auditor has not followed generally accepted auditing standards.
d. the level for each cycle must be no more than 2% so that the entire audit
does not exceed 10%.
54. Which of the following statements is not true?

challenging a. Inherent risk is inversely related to detection risk.
b b. Inherent risk is inversely related to evidence.
c. Inherent risk is the susceptibility of the financial statements to material
error, assuming no internal controls.
d. Inherent risk is the auditor’s assessment of the likelihood that errors
exceeding a tolerable amount exist in a segment before considering the
effectiveness of internal controls.
55. Which of the following is not a primary consideration when assessing inherent
risk?
challenging a. Nature of client’s business.
c b. Existence of related parties.
c. Frequency and intensity of management’s review of accounting
transactions and records.
d. Susceptibility to defalcation.
56. Which of the following is an example of the concept of inherent risk?
challenging a. Humans make more errors than computers; therefore, a manual accounting
c system is riskier than a computerized system.
b. Accounting systems with vouchers have many more controls built in, so the
risk that there will be errors on the financial statements is reduced.
c. Loans receivable for a finance company are less likely to be collectible
than those of a bank.
d. Audits with larger sample sizes are less risky than those with smaller
sample sizes.
57. Tolerable misstatement as set by the auditor:

challenging a. decreases acceptable audit risk.
d b. increases inherent risk and control risk.
c. affects planned detection risk.
d. does not affect any of the four risks.
58. Which of the following underlies the application of generally accepted auditing
challenging standards, particularly the standards of fieldwork and reporting?
a a. The elements of materiality and relative risk.
b. The element of internal control.
c. The element of corroborating evidence.
d. The element of reasonable assurance.
Chapter 10
1. Which of the following is responsible for establishing a private company’s

internal control?
easy a. Management.
a b. Auditors.
c. Management and auditors.
d. Committee of Sponsoring Organizations.
2. Which of the following is not one of the three primary objectives of effective
internal control?
easy a. Reliability of financial reporting
d b. Efficiency and effectiveness of operations
c. Compliance with laws and regulations
d. Assurance of elimination of business risk.
3. (Public) The Public Company Accounting Oversight Board states that reasonable
assurance allows a:
easy a. small likelihood of ineffective internal controls.
b b. remote likelihood that material misstatements will not be prevented or
detected by internal control.
c. likelihood that material misstatements will not be prevented or detected by
internal control.
d. high likelihood that material misstatements will not be prevented or
detected by internal control.
4. Two key concepts that underlie management’s design and implementation of

easy internal control are:
c a. costs and materiality.
b. absolute assurance and costs.
c. inherent limitations and reasonable assurance.
d. collusion and materiality.
5. Internal controls can never be considered as absolutely effective because:

easy a. their effectiveness is limited by the competency and dependability of
employees.
a b. not all organizations have internal audit departments.
c. controls are designed to prevent and detect only material misstatements.
d. internal controls prevent separation of duties.
6. A major control available in a small company, which might not be feasible in a

big company, is:
easy a. a wider segregation of duties.
d b. a voucher system.
c. fewer transactions to process.
d. the owner-manager’s personal interest and close relationship with
personnel.
7. (Public) Which of the following is responsible for establishing internal controls for a
public company?
easy a. Management.
a b. The PCAOB.
c. Management and auditors.
d. Committee of Sponsoring Organizations.
8. Which of the following parties provides an assessment of the effectiveness of

medium internal control over financial reporting for public companies?
a
Management Financial statement

auditors
a. Yes Yes
b. No No
c. Yes Yes
d. No No
9. An act of two or more employees to steal assets or misstate records is frequently

referred to as:
easy a. collusion.
a b. a material weakness.
c. a control deficiency.
d. a significant deficiency.
10. When the auditor attempts to understand the operation of the accounting system
easy by tracing a few transactions through the accounting system, the auditor is said
to be:
c a. tracing.
b. vouching.
c. performing a walk-through.
d. testing controls.
11. (SOX) Which section of the Sarbanes-Oxley Act requires management to issue an
easy internal control report?
c a. 202
b. 203
c. 404
d. 408
12. (SOX) Sarbanes-Oxley requires management to issue an internal control report that
easy includes two specific items. Which of the following is one of these two
requirements?
a a. A statement that management is responsible for establishing and
maintaining an adequate internal control structure and procedures for
financial reporting.
b. A statement that management and the board of directors are jointly
responsible for establishing and maintaining an adequate internal control
structure and procedures for financial reporting.
c. A statement that management, the board of directors, and the external
auditors are jointly responsible for establishing and maintaining an adequate
internal control structure and procedures for financial reporting.
d. A statement that the external auditors are solely responsible.
13. (SOX) When management is evaluating the design of internal control, management
easy evaluates whether the control can do which of the following?
c
Detect material Correct material misstatements
misstatements
a. Yes Yes
b. No No
c. Yes No
d. No Yes
14. (SOX) Internal control reports issued by public companies must identify the framework
easy used to evaluate the effectiveness of internal control. Which of the following is
b the most common framework in the U.S.?
a. Effective Internal Control Framework - AICPA
b. Internal Control - Integrated Framework - COSO
c. Enterprise Internal Control - COSO
d. Enterprise Internal Control - AICPA
15. (Public) When one material weakness is present at the end of the year, management of a
easy public company must conclude that internal control over financial reporting is:
c a. insufficient.
b. inadequate.
c. ineffective.
d. inefficient.
16. (Public) The auditor’s tests to understand the client’s internal controls might include
easy which of the following types of procedures?
a
Observation of Inquiries of
employees personnel
a. Yes Yes
b. No No
c. Yes No
d. No Yes
17. Which of management’s concerns with respect to implementing internal

easy controls is the auditor primarily concerned?
b a. Efficiency of operations.
b. Reliability of financial reporting.
c. Effectiveness of operations.
d. Compliance with applicable laws and regulations.
18. Which of the following activities would be least likely to strengthen a

easy company’s internal control?
b a. Separating accounting from other financial operations.
b. Maintaining insurance for fire and theft.
c. Fixing responsibility for the performance of employee duties.
d. Carefully selecting and training employees.
19. (Public) Management must disclose material weaknesses in internal control:

medium a. whenever the weakness is deemed significant to a single class of
transactions.
c b. whenever the weakness is significant to overall financial reporting
objectives.
c. if the weakness exists at the end of the year.
d. only if the auditor identifies the weakness as significant.
20. When auditing a private company, the auditor should obtain an understanding
easy of internal control sufficient to:
b a. provide reasonable protection against client fraud and defalcations by client
employees.
b. assess control risk.
c. provide a basis for suggestions to the client for improving the accounting
system.
d. provide a method for safeguarding assets, checking the accuracy and
reliability of accounting data, promoting operational efficiency, and
encouraging adherence to prescribed managerial policies.
21. (Public) The initial presumption in the audit of a public company is that control risk is:
medium a. low.
a b. moderate.
c. high.
d. low or moderate, but not high.
22. In the audit of a private company, the auditor will test controls when control
risk is initially assessed at:
medium
c Low Moderate High
a. Yes No Yes
b. No No Yes
c. Yes Yes No
d. No Yes No
23. (Public) The auditor’s study of a public company’s internal control is:
medium a. required by GAAS.
c b. required by the AICPA.
c. required by the Sarbanes-Oxley Act.
d. recommended by the AICPA.
24. The auditor’s consideration of a private company’s internal control is:

medium a. required by GAAP.
b b. required by GAAS.
c. required by the IRS.
d. recommended by the SEC.
25. Internal controls can never be regarded as completely effective. Even if

medium company personnel could design an ideal system, its effectiveness depends on
the:
d a. adequacy of the computer system.
b. proper implementation by management.
c. ability of the internal audit staff to maintain it.
d. competency and dependability of the people using it.
26. Even with the most effectively designed internal control, the auditor must
medium obtain audit evidence, beyond testing the controls, for every:
c a. transaction.
b. financial statement account.
c. material financial statement account.
d. financial statement account that will be relied upon by third parties.
27. The essence of an effectively controlled organization lies in the:
medium a. effectiveness of its independent auditor.
d b. effectiveness of its internal auditor.
c. attitude of its employees.
d. attitude of its management.
28. (Public) To issue a report on internal control over financial reporting for a public
medium company, an auditor must:
c a. evaluate management’s assessment process.
b. independently assess the design and operating effectiveness of internal
control.
c. evaluate management’s assessment process and independently assess the
design and operating effectiveness of internal control.
d. test controls over significant account balances.
29. (Public) Which of the stock exchanges require listed companies to have an audit
medium committee composed entirely of independent directors?
a
NYSE NASDAQ
a. Yes Yes
b. No No
c. Yes No
d. No Yes
30. Which of the following factors may increase risks to an organization?

Medium
a Geographic dispersion of
company operations Presence of new information
technologies
a. Yes Yes
b. No No
c. Yes No
d. No Yes
31. Which of the following statements is correct with respect to separation of

duties?
medium a. Employees should not have temporary and permanent custody of assets.
b b. Employees who authorize transactions should not have custody of related
assets.
c. It is permissible to allow an employee to open cash receipts and record
those receipts.
d. Employees who authorize transactions should have recording
responsibility for these transactions.
32. Authorizations can be either general or specific. Which of the following is not
medium an example of a general authorization?
b a. Automatic reorder points for raw materials inventory.
b. A sales manager’s authorization for a sales return.
c. Credit limits for various classes of customers.
d. A sales price list for merchandise.
33. The most important type of protective measure for safeguarding assets is:
medium a. adequate separation of duties among personnel.
c b. proper authorization of transactions.
c. the use of physical precautions.
d. adequate documentation.
34. Which of the following is correct with respect to the design and use of business
documents?
medium a. Not all documents used for internal purposes need to be prenumbered.
a b. Documents should be designed for single purposes only to avoid confusion
in their use.
c. Documents should be designed to be understandable only by those who use
them.
d. Documents designed for external use must be prenumbered.
35. (Public) PCAOB Standard 2 requires auditors to evaluate the effectiveness of the audit
medium committee’s oversight of the company’s:
a
External Efficiency of Internal control over
financial operations financial reporting
reporting
a. Yes No Yes
b. No No Yes
c. Yes Yes No
d. No Yes No
36. Which of the following is correct?

medium a. Approval is a policy decision implemented by employees.
c b. Approval occurs as a matter of general policy and includes significant
transactions only.
c. Authorization is a policy decision for either a general class of transactions
or specific transactions.
d. Approval should be given by the employee responsible for recording the
transaction.
37. Which of the following principles is not necessary for the proper design and use
medium of documents and records?
a a. Designed for a single use to increase efficiency of operations.
b. Constructed in a manner that encourages correct preparation.
c. Prepared at the time a transaction takes place.
d. Designed for multiple uses to increase efficiency of operations.
38. Narratives, flowcharts, and internal control questionnaires are three common
methods of:
medium a. testing the internal controls.
b b. documenting the auditor’s understanding of internal controls.
c. designing the audit manual and procedures.
d. documenting the auditor’s understanding of a client’s organizational
structure.
39. _____ deal with ongoing or periodic assessment of the quality of internal
medium control by management.
b a. Quality monitoring activities
b. Monitoring activities
c. Oversight activities
d. Management activities
40. (Public) Smaller public companies face challenges implementing effective internal
medium control due to ______.
c a. a lack of expertise
b. reduced importance
c. limited resources
d. limited available guidance
41. Which of the following is not one of the levels of an absence of internal
controls?
medium a. Major deficiency.
a b. Material weakness.
c. Significant deficiency.
d. Control deficiency.
42. Which of the following is the correct definition of “control deficiency?”

medium a. A control deficiency exists if the design or operation of controls does not
a permit company personnel to prevent or detect misstatements on a timely
basis.
b. A control deficiency exists if one or more deficiencies exist that adversely
affect a company’s ability to prepare external financial statements
reliably.
c. A control deficiency exists if the design or operation of controls results in a
more than remote likelihood that controls will not prevent or detect
misstatements.
d. A control deficiency exists if the design or operation of controls results in a
more than probable likelihood that controls will prevent or detect
misstatements.
43. A(n) _______ deficiency exists if a necessary control is missing or not properly
formulated.
medium a. control
c b. significant
c. design
d. operating
44. To determine if significant internal control deficiencies are material

medium weaknesses, they must be evaluated on their:
a
Likelihood Significance
a. Yes Yes
b. No No
c. Yes No
d. No Yes
45. The purpose of an entity’s accounting information and communication system

is to ______.
medium
d Record and
Monitor process
transactions transactions Initiate transactions
a. Yes Yes Yes
b. No No No
c. Yes No No
d. No Yes Yes
46. A procedure that would most likely be used by an auditor in performing tests of
medium control procedures that involve segregation of functions and that leave no
transaction trail is:
b a. inspection.
b. observation.
c. reperformance.
d. reconciliation.
47. If the results of tests of controls support the design and operations of controls as
medium expected, the auditor uses ____ control risk as the preliminary assessment.
b a. a lower
b. the same
c. a higher
d. either a lower or higher
48. Internal controls normally include procedures designed to provide reasonable

assurance that:
medium a. employees act with integrity when performing their assigned tasks.
b b. transactions are executed in accordance with management’s authorization.
c. decision processes leading to management’s authorization of transactions
are sound.
d. collusive activities would be detected by segregation of employee duties.
49. Which of the following is correct?

medium a. A significant deficiency is always a material weakness.
d b. A control deficiency is always a material weakness.
c. A material weakness is less significant that a control deficiency.
d. A material weakness is always a significant deficiency.
50. Which of the following is not a likely procedure to support the operating
medium effectiveness of internal controls?
d a. Inquiry of client personnel.
b. Observation of control-related activities.
c. Reperformance of client procedures.
d. Completing an internal control questionnaire.
51. (Public) Before making the final assessment of internal control at the end of an integrated
medium audit, the auditor must:
a
Test controls Perform substantive tests of details
a. Yes Yes
b. No No
c. Yes No
d. No Yes
52. (Public) Significant deficiencies and material weaknesses in internal control of a public
medium company must be reported to which of the following?
c a. The Public Company Accounting Oversight Board.
b. Members of management who are responsible for the related area of the
company.
c. Audit committee of the company’s board of directors.
d. The AICPA.
53. Of the following statements about internal controls, which one is not valid?
medium a. No one person should be responsible for the custodial responsibility and the
d recording responsibility for an asset.
b. Transactions must be properly authorized before such transactions are
processed.
c. Because of the cost-benefit relationship, a client may apply controls on a
test basis.
d. Control procedures reasonably ensure that collusion among employees
cannot occur.
54. Which of the following best describes the inherent limitations that should be
medium recognized by an auditor when considering the potential effectiveness of
internal control?
a a. Procedures that depend on segregation of duties can be circumvented by
collusion.
b. Competent and honest client personnel provide an environment conducive
to accounting control and provide absolute assurance that effective control will
be achieved.
c. Procedures designed to assure the execution and recording of transactions
in accordance with proper authorizations are effective against irregularities
perpetrated by management.
d. The benefits expected to be derived from effective internal accounting
control usually do not exceed the costs of such control.
55. Which of the following is not one of the subcomponents of the control
environment?
medium a. Management’s philosophy and operating style.
c b. Organizational structure.
c. Adequate separation of duties.
d. Commitment to competence.
56. It is important for the CPA to consider the competence of the clients’ personnel
medium because their competence bears directly and importantly upon the:
b a. cost/benefit relationship of the system of internal control.
b. achievement of the objectives of internal control.
c. comparison of recorded accountability with assets.
d. timing of the tests to be performed.
57. Audit evidence concerning proper segregation of duties normally is best

obtained by:
medium a. direct personal observation of the employee who applies control
procedures.
a b. making inquiries of co-workers about the employee who applies control
procedures.
c. preparation of a flowchart of duties performed and available personnel.
d. inspection of third-party documents containing the initials of who applied
control procedures.
58. Proper segregation of functional responsibilities calls for separation of:

medium a. authorization, execution, and payment.
b b. authorization, recording, and custody.
c. custody, execution, and reporting.
d. authorization, payment, and recording.
59. Internal controls are not designed to provide reasonable assurance that:
medium a. all frauds will be eliminated.
a b. transactions are executed in accordance with management’s authorization.
c. access to assets is permitted only in accordance with management’s
authorization.
d. company personnel comply with applicable rules and regulations.
60. Which of the following statements about auditor documentation of the client’s
medium internal controls is correct?
d a. Documentation must include flow charts.
b. Documentation must include procedural write-ups.
c. No documentation is necessary although it is desirable.
d. No one particular form of documentation is necessary.
61. Significant deficiencies are matters that come to an auditor’s attention and
medium should be communicated to an entity’s audit committee because they represent:
b a. material frauds perpetrated by high-level management.
b. internal control deficiencies that could adversely affect a company’s ability
to initiate, record, process, or report external financial statements reliably.
c. flagrant violations of the entity’s documented conflict-of-interest policies.
d. intentional attempts by client personnel to limit the scope of the auditor’s
field work.
62. How must significant deficiencies and material weaknesses be communicated to

medium those charged with governance?
c a. Either oral or written communication is acceptable.
b. Oral communication is required.
c. Written communication is required.
d. Written communication is required for material weaknesses, but oral
communication is allowed for significant deficiencies.
63. Which of the following statements, if any, is correct?

challenging a. The NASDAQ market requires listed companies to have audit committees
a that have only independent directors.
b. The NASDAQ market requires listed companies to have audit committees
that have a minority of the positions held by independent directors.
c. The NASDAQ market recommends, but does not require, listed companies
to have audit committees.
d. The NASDAQ market recommends, but does not require, listed companies
to have audit committees that have a minority of the positions held by
independent directors.
64. (SOX) The Sarbanes-Oxley Act requires:

challenging a. all public companies to issue reports on internal controls.
a b. all public companies to define adequate internal controls.
c. the auditor of public companies to design effective ICFR.
d. the auditor of public companies to provide recommendations to correct
material weaknesses.
65. When considering internal control, an auditor should be aware of the concept of
challenging reasonable assurance, which recognizes that the:
d a. segregation of incompatible functions is necessary to ascertain that internal
control is effective.
b. employment of competent personnel provides assurance that the objectives
of internal control will be achieved.
c. establishment and maintenance of internal control is an important
responsibility of the management and not of the auditor.
d. costs of internal control should not exceed the benefits expected to be
derived from internal control.
66. The financial statements are not likely to correctly reflect GAAP if the:
challenging a. controls affecting the reliability of financial reporting are inadequate.
a b. company’s controls do not promote efficiency.
c. company’s controls do not promote effectiveness.
d. company’s control do not promote compliance with applicable rules and
regulations.
67. The primary emphasis by auditors is on controls over:

challenging a. classes of transactions.
a b. account balances.
c. both a and b, because they are equally important.
d. both a and b, because they vary from client to client.
68. Compared to a public company, the most important difference in a nonpublic

challenging company in assessing control risk is the ability to assess control risk at _______
for any or all control-related objectives.
d a. low
b. moderately low
c. medium
d. high
69. An auditor should consider two key issues when obtaining an understanding of
challenging a client’s internal controls. These issues are:
c a. the effectiveness and efficiency of the controls.
b. the frequency and effectiveness of the controls.
c. the design and utilization of the controls.
d. The implementation and efficiency of the controls.
70. The independent auditor should acquire an understanding of the internal audit
challenging function as it relates to the independent auditor’s study and evaluation of
internal control because the:
c a. audit programs, working papers, and reports of internal auditors can often
be used as a substitute for the work of the independent auditor’s staff.
b. procedures performed by the internal audit staff may eliminate the
independent auditor’s need for an extensive study and evaluation of internal
control.
c. work performed by internal auditors may be a factor in determining the
nature, timing, and extent of the independent auditor’s procedures.
d. understanding of the internal audit function is an important substantive test
to be performed by the independent auditor.
71. To be effective, an internal audit department must be independent of:

challenging a. operating departments.
c b. the accounting department.
c. both a and b.
d. either a or b, but not both.
72. Hanlon Corp. maintains a large internal audit staff that reports directly to the
challenging chief financial officer. Audit reports prepared by the internal auditors indicate
d that the system is functioning as it should and that the accounting records are
reliable. An independent auditor will probably:
a. eliminate tests of controls.
b. increase the depth of the study and evaluation of administrative controls.
c. avoid duplicating the work performed by the internal audit staff.
d. place limited reliance on the work performed by the internal audit staff.
73. External financial statement auditors must obtain evidence regarding what
challenging attributes of an internal audit (IA) department if the external auditors intend to
rely on IA’s work?
d a. Integrity
b. Objectivity
c. Competence
d. All of the above
74. When planning an audit, the auditor’s assessed level of control risk is:
challenging a. determined by using actuarial tables.
c b. calculated by using the audit risk model.
c. an economic issue, trading off the costs of testing controls against the cost
of testing balances.
d. calculated by using the formulas provided in the AICPA’s auditing
standards.
75. When a compensating control exists, the absence of a key control:

challenging a. is no longer a concern because there is no longer a significant deficiency or
a material weakness.
b. is still a major concern to the auditor.
c. could cause a material loss, so it must be tested using substantive
procedures.
d. is magnified and must be removed from the sampling process and
examined in its entirety.
76. After considering a client’s internal controls, an auditor has concluded that it is
challenging well designed and is functioning as intended. Under these circumstances the
auditor would most likely:
c a. perform tests of controls to the extent outlined in the audit program.
b. determine the control procedures that should prevent or detect errors and
irregularities.
c. not increase the extent of predetermined substantive tests.
d. determine whether transactions are recorded to permit preparation of
financial statements in conformity with generally accepted accounting
principles.
Chapter 11
1. Which of the following best defines fraud in a financial statement auditing
context?
easy a. Fraud is an unintentional misstatement of the financial statements.
b b. Fraud is an intentional misstatement of the financial statements.
c. Fraud is either an intentional or unintentional misstatement of the financial
statements, depending on materiality.
d. Fraud is either an intentional or unintentional misstatement of the financial
statements, depending on consistency.
2. One of the earliest frauds occurred at McKesson-Robbins. This company

easy committed fraud by doing which of the following?
b a. Reporting fictitious contributed capital.
b. Reporting fictitious sales and nonexistent inventory.
c. Reporting fictitious fixed assets and underreporting expenses.
d. Reporting expenses as capitalized items.
3. Which of the following is a category of fraud?

easy
a Fraudulent financial reporting Misappropriation of assets
a. Yes Yes
b. No No
c. Yes No
d. No Yes
4. With respect to fraudulent financial reporting, most frauds involve:

easy
d Inventory or liquid asset theft Intentional misstatements of
amounts
a. Yes Yes
b. No No
c. Yes No
d. No Yes
5. ________ is fraud that involves theft of an entity’s assets.

easy a. Fraudulent financial reporting
c b. A “cookie jar” reserve
c. Misappropriation of assets
d. Income smoothing
6. ________ involves deliberate actions taken by management to meet earnings

objectives.
easy a. Expenditure management
b b. Earnings management
c. Top-line management
d. Management-by-objective
7. ________ is a form of earnings management in which revenues and expenses

easy are shifted between periods to reduce fluctuations in earnings.
c a. Fraudulent financial reporting
b. Expense smoothing
c. Income smoothing
d. Each of the above is correct
8. Which of the following is one of the conditions for fraud described in SAS No.
99?
easy
a Attitudes/rationalization Risk Factors Opportunities
a. Yes No Yes
b. No Yes Yes
c. Yes No No
d. No Yes No
9. Fraudulent financial reporting may be accomplished through the manipulation

of:
easy a. assets.
d b. revenues.
c. liabilities.
d. all of the above
10. Who is most likely to perpetrate fraudulent financial reporting?

easy a. Members of the board of directors
c b. Production employees
c. Management of the company
d. The internal auditors
11. Misappropriation of assets is normally perpetrated by:

easy a. members of the board of directors.
b b. employees at lower levels of the organization.
c. management of the company.
d. the internal auditors.
12. Which of the following is not a factor that relates to opportunities to commit
medium fraudulent financial reporting?
c a. Lack of controls related to the calculation and approval of accounting
estimates.
b. Ineffective oversight of financial reporting by the board of directors.
c. Management’s practice of making overly aggressive forecasts.
d. High turnover of accounting, internal audit, and information technology
staff.
13. The most common technique used by management to misstate financial

information is:
medium a. overstatement of expenses.
b b. improper revenue recognition.
c. understatement of liabilities.
d. understatement of assets.
14. Which of the following is a factor that relates to incentives or pressures to

medium commit fraudulent financial reporting?
b a. Significant accounting estimates involving subjective judgments.
b. Excessive pressure for management to meet debt repayment requirements.
d. High turnover of accounting, internal audit, and information technology
staff.
15. Which of the following is a factor that relates to attitudes or rationalization to

medium commit fraudulent financial reporting?
c a. Significant accounting estimates involving subjective judgments.
b. Excessive pressure for management to meet debt repayment requirements.
d. High turnover of accounting, internal audit and information technology
staff.
16. Which of the following statements describes circumstances that underlie

medium employee incentives to misappropriate assets?
a a. Dissatisfied employees may steal from a sense of entitlement.
b. Weak internal controls encourage employees to take chances.
c. If management cheats customers and gets away with it, then employees
believe they can do the same to the company.
d. Employees have a vested interest in making the company’s financial
statements erroneous.
17. Which of the following is not a factor that relates to opportunities to

misappropriate assets?
medium a. Inadequate internal controls over assets.
d b. Presence of large amounts of cash on hand.
c. Inappropriate segregation of duties or independent checks on performance.
d. Adverse relationships between management and employees.
18. Which of the following is a factor that relates to incentives to misappropriate

assets?
medium a. Significant accounting estimates involving subjective judgments.
b b. Significant personal financial obligations.
d. High turnover of accounting, internal audit and information technology
staff.
19. Which of the following issues is normally part of the “brainstorming” session
medium required by SAS No. 99?
a
How assets could Where the entity’s financial statements are
be susceptible to material misstatements due to fraud
misappropriated
a. Yes Yes
b. No No
c. Yes No
d. No Yes
20. In the fraud triangle, fraudulent financial reporting and misappropriation of

assets:
medium a. share little in common.
c b. share most of the same risk factors.
c. share the same three conditions.
d. share most of the same conditions.
21. Sources of information gathered to assess fraud risks usually do not include:
medium a. analytical procedures.
d b. inquiries of management.
c. communication among audit team members.
d. review of corporate charter and bylaws.
22. SAS No. 99 requires auditors to document which of the following matters
medium related to the auditor’s consideration of material misstatements due to fraud?
b a. Reasons supporting a conclusion that there is not a significant risk of
material improper expense recognition.
b. Procedures performed to obtain information necessary to identify and
assess the risks of material fraud.
c. Results of the internal auditor’s procedures performed to address the risk of
management override of controls.
d. Discussions with management regarding separation of duties.
23. Under SAS No. 99, auditors are to presume that there is a significant risk of:
medium a. overstated assets.
c b. understated liabilities.
c. improper revenue recognition.
d. overstated expenses.
24. After fraud risks are identified and documented, the auditor should evaluate
medium factors that ______ fraud risk before developing an appropriate response to the
risk of fraud.
b a. enhance
b. reduce
c. increase
d. increase or decrease
25. Which of the following parties is responsible for implementing internal controls
medium to minimize the likelihood of fraud?
c a. External auditors
b. Audit committee members
c. Management
d. Committee of Sponsoring Organizations
26. The most effective way to prevent and deter fraud is to:
medium a. implement programs and controls that are based on core values embraced
by the company.
a b. hire highly ethical employees.
c. communicate expectations to all employees on an annual basis.
d. terminate employees who are suspected of committing fraud.
27. Fraud awareness training should be:

medium a. broad and all-encompassing
c b. extensive and include details for all functional areas
c. specifically related to the employee’s job responsibility
d. focused on employees understanding the importance of ethics
28. As part of the brainstorming sessions, auditors are directed to emphasize:

medium
a The need for professional The audit team’s response to potential
skepticism fraud risks
a. Yes Yes
b. No No
c. Yes No
d. No Yes
29. Auditor responses to fraud risks include which of the following?

medium
d Perform procedures to result in Perform procedures to address the
the issuance of a qualified risk of management override of
opinion controls
a. Yes Yes
b. No No
c. Yes No
d. No Yes
30. As part of designing and performing procedures to address management

medium override of controls, auditors must perform which of the following procedures?
d
Examine all journal entries
above the level of materiality Review accounting estimates for
biases
a. Yes Yes
b. No No
c. Yes No
d. No Yes
31. Which of the following most accurately defines professional skepticism as it is
medium used in auditing standards?
b a. It either assumes management is honest or slightly dishonest, but neither all
the time.
b. It neither assumes that management is dishonest nor assumes unquestioned
honesty.
c. It assumes management is honest most of the time.
d. It assumes that management is dishonest in only rare instances.
32. Auditors may identify conditions during fieldwork that change or support a
medium judgment about the initial assessment of fraud risks. Which of the following is
a not a condition which should alert an auditor that the initial assessment should
be changed?
a. The auditor’s lack of independence
b. Discrepancies in the accounting records
c. Unusual relationships between the auditor and management
d. Missing or conflicting evidence
33. Which of the following is least likely to uncover fraud?

medium a. External auditors
a b. Internal auditors
c. Internal controls
d. Management
34. For inquiry to be effective, auditors need to be skilled at listening and _______
medium an interviewee’s response to questions.
a a. evaluating
b. recording
c. transcribing
d. remembering
35. Which of the following is not a likely source of information to assess fraud
risks?
challenging a. Communications among audit team members.
d b. Inquiries of management.
c. Analytical procedures.
d. Consideration of fraud risks discovered during recent audits of other
clients.
36. Which of the following is not a category of inquiry used by auditors?

challenging a. Assessment inquiry
b b. Declarative inquiry
c. Interrogative inquiry
d. Informational inquiry
37. ___________ inquiry is used when the auditor seeks responses from the
challenging interviewee about his or her knowledge of an event or circumstance.
c a. Assessment
b. Declarative
c. Interrogative
d. Informational
38. ___________ inquiry is used to obtain details about facts that the auditor does
not have.
challenging a. Assessment
c b. Declarative
c. Interrogative
d. Informational
39. ___________ inquiry is used to ascertain whether information already obtained

challenging is correct, factual or truthful.
a a. Assessment
b. Declarative
c. Interrogative
d. Informational
40. This type of inquiry often elicits “yes” or “no” responses to the auditor’s
questions.
challenging a. Assessment
c b. Declarative
c. Interrogative
d. Informational
41. Which of the following non-verbal cues is a sign of stress?

challenging a. Leaning away from the auditor, usually toward the door or window
b b. Avoiding eye contact
c. Crossing one’s arms or legs
d. Each of the above is a sign of stress
42. Which party has the primary responsibility to oversee an organization’s

challenging financial reporting and internal control processes?
b a. The board of directors
b. The audit committee
c. Management of the company
d. The financial statement auditors
43. When the auditor suspects that fraud may be present, SAS No. 99 requires the
auditor to:
challenging a. terminate the engagement with sufficient notice given to the client.
c b. issue an adverse opinion or a disclaimer of opinion.
c. obtain additional evidence to determine whether material fraud has
occurred.
d. re-issue the engagement letter.
44. With whom should the auditor communicate whenever he or she determines
challenging that senior management fraud may be present, even if the matter might be
considered inconsequential?
b a. PCAOB
b. Audit committee
c. An appropriate level of management that is at least one level above those
involved
d. The internal auditors
45. Management is responsible for:

medium
a Identifying and measuring fraud Taking steps to mitigate identified
risks risks
a. Yes Yes
b. No No
c. Yes No
d. No Yes
Chapter 12
1. IT has several significant effects on an organization. Which of the following

easy would not be important from an auditing perspective?
d a. Organizational changes.
b. The visibility of information.
c. The potential for material misstatement.
d. None of the above; i.e., they are all important.
2. The audit procedure which is least useful in gathering evidence on significant

easy computer processes is:
b a. documentation.
b. observation.
c. test decks.
d. generalized audit software.
3. Which of the following is not a benefit of using IT-based controls?

easy a. Ability to process large volumes of transactions.
d b. Ability to replace manual controls with computer-based controls.
c. Reduction in misstatements due to consistent processing of transactions.
d. Over-reliance on computer-generated reports.
4. One significant risk related to an automated environment is that auditors may

easy ____ information provided by an information system.
b a. not place enough reliance on
b. place too much reliance on
c. reveal
d. not understand
5. Which of the following is not a risk specific to IT environments?

easy a. Reliance on the functioning capabilities of hardware and software.
b b. Increased human involvement.
c. Loss of data due to insufficient backup.
d. Reduced segregation of duties.
6. Which of the following is not an enhancement to internal control that will occur
easy as a consequence of increased reliance on IT?
d a. Computer controls replace manual controls.
b. Higher quality information is available.
c. Computer-based controls provide opportunities to enhance separation of
duties.
d. Manual controls replace automated controls.
7. Which of the following is not a risk to IT systems?

easy a. Need for IT experienced staff
c b. Separation of IT duties from accounting functions
c. Improved audit trail
d. Hardware and data vulnerability
8. Which of the following is not a category of an application control?

easy a. Processing controls.
c b. Output controls.
c. Hardware controls.
d. Input controls.
9. Old and new systems operating simultaneously in all locations is a test approach
known as:
easy a. pilot testing.
d b. horizontal testing.
c. integrative testing.
d. parallel testing.
10. When the client uses a computer but the auditor chooses to use only the non-IT
easy segment of internal control to assess control risk, it is referred to as auditing
a around the computer. Which one of the following conditions need not be
present to audit around the computer?
a. Computer programs must be available in English.
b. The source documents must be available in a non-machine language.
c. The documents must be filed in a manner that makes it possible to locate
them.
d. The output must be listed in sufficient detail to enable the auditor to trace
individual transactions.
11. Which of the following is a category of general controls?

easy a. Processing controls.
c b. Output controls.
c. Physical and online security.
d. Input controls.
12. Which of the following statements related to application controls is correct?

easy a. Application controls relate to various aspects of the IT function including
d software acquisition and the processing of transactions.
b. Application controls relate to various aspects of the IT function including
physical security and the processing of transactions in various cycles.
c. Application controls relate to all aspects of the IT function.
d. Application controls relate to the processing of individual transactions.
13. General controls include all of the following except:

easy a. systems development.
c b. online security.
c. processing controls.
d. hardware controls.
14. Predesigned formats, such as those used for audit documentation, can be created
easy and saved using electronic spreadsheets and word processors. These are called:
b a. desktop publishing.
b. templates.
c. macros.
d. work files.
15. ______ involves implementing a new system in one part of the organization,
easy while other locations continue to use the current system.
c a. Parallel testing
b. Online testing
c. Pilot testing
d. Control testing
16. To determine that user ID and password controls are functioning, an auditor
would most likely:
easy a. attempt to sign on to the system using invalid user identifications and
passwords.
a b. write a computer program that simulates the logic of the client’s access
control software.
c. extract a random sample of processed transactions and ensure that the
transactions were appropriately authorized.
d. examine statements signed by employees stating that they have not
divulged their user identifications and passwords to any other person.
17. When IT programs or files can be accessed from terminals, users should be
easy required to enter a(n):
d a. echo check.
b. parity check.
c. self-diagnosis test.
d. authorized password.
18. An auditor’s flowchart of a client’s system is a graphical representation that

depicts the auditor’s:
easy a. program for tests of controls.
b b. understanding of the system.
c. understanding of the types of errors that are probable given the present
system.
d. documentation of the study and evaluation of the system.
19. Which of the following is not a characteristic of an online processing system?

medium a. Output of the data files is available on request.
d b. Master files are updated at the time the entry is made.
c. Display terminals are used for both input and output purposes.
d. Programming is not allowed online and must be done separately.
20. Typical controls developed for manual systems which are still important in IT
systems include:
medium a. proper authorization of transactions.
d b. competent and honest personnel.
c. careful and complete preparation of source documents.
d. all of the above.
21. ______ controls prevent and detect errors while transaction data are processed.
medium a. Software
c b. Application
c. Processing
d. Transaction
22. A database management system:

medium a. physically stores each element of data only once.
a b. stores data on different files for different purposes, but always knows
where they are and how to retrieve them.
c. allows quick retrieval of data but at a cost of inefficient use of file space.
d. allows quick retrieval of data, but it needs to update files continually.
23. Which of the following is not associated with converting from a manual to an
IT system?
medium a. It usually centralizes data.
d b. It permits higher quality and more consistent controls over operations.
c. It may eliminate the control provided by division of duties of independent
persons who perform related functions and compare results.
d. It may take the recordkeeping function and the document preparation
function away from those who have custody of assets and put those functions
into the IT center.
24. Which of the following statements about general controls is not correct?
medium a. Disaster recovery plans should identify alternative hardware to process
company data.
d b. Successful IT development efforts require the involvement of IT and non-
IT personnel.
c. The chief information officer should report to senior management and the
board.
d. Programmers should have access to computer operations to aid users in
resolving problems.
25. Which of the following statements is correct?

medium a. Auditors should evaluate application controls before evaluating general
controls.
c b. Auditors should evaluate application controls and general controls
simultaneously.
c. Auditors should evaluate general controls before evaluating application
controls.
d. None of these statements is correct.
26. An important characteristic of IT is uniformity of processing. Therefore, a risk

exists that:
medium a. auditors will not be able to access data quickly.
c b. auditors will not be able to determine if data is processed consistently.
c. erroneous processing can result in the accumulation of a great number of
misstatements in a short period of time.
d. all of the above.
27. Auditors should evaluate the ________ before evaluating application controls
medium because of the potential for pervasive effects.
d a. input controls
b. control environment
c. processing controls
d. general controls
28. A control that relates to all parts of the IT system is called a(n):
medium a. general control.
a b. systems control.
c. universal control.
d. applications control.
29. Controls which apply to a specific element of the system are called:
medium a. user controls.
d b. general controls.
c. systems controls.
d. applications controls.
30. Which of the following is not an example of an applications control?

medium a. An equipment failure causes system downtime.
a b. There is a preprocessing authorization of the sales transactions.
c. There are reasonableness tests for the unit selling price of a sale.
d. After processing, all sales transactions are reviewed by the sales
department.
31. Which of the following is least likely to be used in obtaining an understanding

medium of client general controls?
c a. Examination of system documentation
b. Inquiry of client personnel (e.g., key users)
c. Observation of transaction processing
d. Reviews of questionnaires completed by client IT personnel
32. Which of the following is not a general control?

medium a. Reasonableness test for unit selling price of a sale.
a b. Equipment failure causes error messages on monitor.
c. Separation of duties between programmer and operators.
d. Adequate program run instructions for operating the computer.
33. Controls which are built in by the manufacturer to detect equipment failure are
called:
medium a. input controls.
c b. fail-safe controls.
c. hardware controls.
d. manufacturer’s controls.
34. Auditors usually evaluate the effectiveness of:

medium a. hardware controls before general controls.
c b. sales-cycle controls before application controls.
c. general controls before applications controls.
d. applications controls before the control environment.
35. Controls which are designed to assure that the information processed by the
medium computer is authorized, complete, and accurate are called:
a a. input controls.
b. processing controls.
c. output controls.
d. general controls.
36. Programmers should be allowed access to:

medium a. user controls.
d b. general controls.
c. systems controls.
d. applications controls.
37. Programmers should do all but which of the following?

medium a. Test programs for proper performance.
b b. Evaluate legitimacy of transaction data input.
c. Develop flowcharts for new applications.
d. Programmers should perform each of the above.
38. ______ tests determines that every field in a record has been completed.
medium a. Validation
c b. Sequence
c. Completeness
d. Programming
39. In an IT-intensive environment, most processing controls are:

medium a. input controls.
c b. operator controls.
c. programmed controls.
d. documentation controls.
40. Which of the following is not a processing control?

medium a. Control totals.
c b. Logic tests.
c. Check digits.
d. Computations tests.
41. Output controls are not designed to assure that data generated by the computer
are:
medium a. accurate.
d b. distributed only to authorized people.
c. complete.
d. used appropriately by employees in making decisions.
42. Auditors usually obtain information about general and application controls
through:
medium a. interviews with IT personnel.
d b. examination of systems documentation.
c. reading program change requests.
d. all of the above methods.
43. When auditors consider only non-IT controls in assessing control risk, it is
known as:
medium a. the single-stage audit.
c b. the test deck approach.
c. auditing around the computer.
d. generalized audit software (GAS).
44. The auditor’s objective to determine whether the client’s computer programs
medium can correctly handle valid and invalid transactions as they arise is accomplished
through the:
a a. test data approach.
b. generalized audit software approach.
c. microcomputer-aided auditing approach.
d. generally accepted auditing standards.
45. The audit approach in which the auditor runs his or her own program on a
medium controlled basis to verify the client’s data recorded in a machine language is:
c a. the test data approach.
b. called auditing around the computer.
c. the generalized audit software approach.
d. the microcomputer-aided auditing approach.
46. Which of the following is not one of the three categories of testing strategies
medium when auditing through the computer?
a a. Pilot simulation.
b. Test data approach.
c. Parallel simulation.
d. Embedded audit module.
47. Companies with non-complex IT environments often rely on microcomputers to

medium perform accounting system functions. Which of the following is not an audit
d consideration in such an environment?
a. Limited reliance on automated controls.
b. Unauthorized access to master files.
c. Vulnerability to viruses and other risks.
d. Excess reliance on automated controls.
48. Internal control is ineffective when computer personnel:

medium a. participate in computer software acquisition decisions.
c b. design flowcharts and narratives for computerized systems.
c. originate changes in customer master files.
d. provide physical security over program files.
49. When using the test data approach:

medium a. test data should include only exception conditions.
d b. application programs tested must be virtually identical to those used by
employees.
c. select data may remain in the client system after testing.
d. none of the above statements is correct.
50. Because general controls have a _____ effect on the operating effectiveness of
medium application controls, auditors must consider general controls.
b a. nominal
b. pervasive
c. mitigating
d. worsening
51. Errors in data processed in a batch computer system may not be detected
immediately because:
medium a. transaction trails in a batch system are available only for a limited period of
time.
b b. there are time delays in processing transactions in a batch system.
c. errors in some transactions cause rejection of other transactions in the
batch.
d. random errors are more likely in a batch system than in an online system.
52. ______ link equipment in large geographic regions.
medium a. Cosmopolitan area networks (CANs)
c b. Local area networks (LANs)
c. Wide area networks (WANs)
d. Virtual area networks (VANs)
53. Which of the following computer-assisted auditing techniques allows fictitious

medium and real transactions to be processed together without client operating personnel
c being aware of the testing process?
a. Parallel simulation.
b. Generalized audit software programming.
c. Integrated test facility.
d. Test data approach.
54. Firewalls are used to protect:

medium a. erroneous internal handling of data.
d b. against insufficient documentation of transactions.
c. illogical programming commands.
d. unauthorized use of system resources.
55. In an IT system, automated equipment controls or hardware controls are

designed to:
medium a. correct errors in the computer programs.
c b. monitor and detect errors in source documents.
c. detect and control errors arising from the use of equipment.
d. arrange data in a logical sequential manner for processing purposes.
56. If a control total were to be computed on each of the following data items,
medium which would best be identified as a hash total for a payroll IT application?
b a. Gross wages earned.
b. Employee numbers.
c. Total hours worked.
d. Total debit amounts and total credit amounts.
57. What tools do companies use to limit access to sensitive company data?
medium
a Encryption Digital signatures Firewall
techniques
a. Yes Yes Yes
b. Yes No No
c. No Yes Yes
d. Yes Yes No
58. Rather than maintain an internal IT center, many companies use ________ to
medium perform many basic functions such as payroll.
b a. external general service providers
b. external application service providers
c. internal control service providers
d. internal auditors
59. A company uses the account code 669 for maintenance expense. However, one
medium of the company clerks often codes maintenance expense as 996. The highest
d account code in the system is 750. What internal control in the company’s
computer program would detect this error?
a. Pre-data input check.
b. Valid-character test.
c. Sequence check.
d. Valid-code test.
60. Which of the following is not an application control?

challenging a. Preprocessing authorization of sales transactions.
d b. Reasonableness test for unit selling price of sale.
c. Post-processing review of sales transactions by the sales department.
d. Separation of duties between computer programmer and operators.
61. It is common in IT systems to have certain types of transactions initiated

challenging automatically by the computer. Which of the following activities would not be
d an appropriate candidate for automatic computer initialization?
a. In a bank, periodic calculation of interest on customer accounts.
b. In a manufacturing facility ordering inventory at preset order levels.
c. In a hospital, the ordering of oxygen when pre-specified levels are
achieved.
d. In an investment brokerage firm, the sale of pharmaceutical stocks when
the Dow-Jones Industrial Average falls below a certain level.
62. Application controls vary across the IT system. To gain an understanding of

challenging internal control for a private company, the auditor must evaluate the application
controls for every:
d a. every audit area.
b. every material audit area.
c. every audit area in which the client uses the computer.
d. every audit area where the auditor plans to reduce assessed control risk.
63. Many clients have outsourced the IT functions. The difficulty the independent
challenging auditor faces when a computer service center is used is to:
c a. gain the permission of the service center to review their work.
b. find compatible programs that will analyze the service center’s programs.
c. determine the adequacy of the service center’s internal controls.
d. try to abide by the Code of Professional Conduct to maintain the security
and confidentiality of client’s data.
64. An auditor who is testing IT controls in a payroll system would most likely use
challenging test data that contain conditions such as:
a a. time tickets with invalid job numbers.
b. overtime not approved by supervisors.
c. deductions not authorized by employees.
d. payroll checks with unauthorized signatures.
65. Which of the following is not a general control?

challenging a. The plan of organization and operation of IT activity.
c b. Procedures for documenting, reviewing, and approving systems and
programs.
c. Processing controls.
d. Hardware controls.
66. In comparing (1) the adequacy of the hardware controls in the system with (2)
challenging the organization’s methods of handling the errors that the computer identifies,
the independent auditor is:
c a. unconcerned with both (1) and (2).
b. equally concerned with (1) and (2).
c. less concerned with (1) than with (2).
d. more concerned with (1) than with (2).
67. Service auditors do not issue which of the following types of reports?
challenging a. Report on implemented controls
b b. Report on controls that have been implemented and tested for design
effectiveness
c. Report on controls that have been implemented and tested for operating
effectiveness
d. Each of the above is issued.
68. The most important output control is:

challenging a. distribution control, which assures that only authorized personnel receive
b the reports generated by the system.
b. review of data for reasonableness by someone who knows what the output
should look like.
c. control totals, which are used to verify that the computer’s results are
correct.
d. logic tests, which verify that no mistakes were made in processing.
Chapter 17
1. Sampling used for tests of details provides results in terms of:

easy a. exception rates.
c b. percentages.
c. dollars.
d. expectation rates.
2. Both sampling and nonsampling risks are associated with:
Easy
d Tests of controls. Substantive tests of
transactions.
a. Yes Yes
b. No No
c. Yes No
d. No Yes
3. Tolerable misstatements for overstatements and understatements:

easy a. may be different amounts.
a b. must be different amounts.
c. must be set at the same amount.
d. must be expressed in percentages.
4. Monetary-unit sampling is most commonly used when:

easy a. several exceptions are expected.
d b. a dollar result is desired.
c. the population data are maintained on manual files.
d. the auditor is searching for understatements only.
5. Monetary-unit sampling is not particularly effective at detecting:

easy a. overstatements.
b b. understatements.
c. errors in current assets.
d. errors in noncurrent assets.
6. Tests for rates of occurrence are appropriately used in all but which of the
following situations?
Easy
c Testing of Substantive testing of Substantive testing of
internal transactions details of balances
controls
a. Yes Yes Yes
b. No Yes Yes
c. Yes Yes No
d. No No Yes
7. Which of the following is not a type of statistical method that provides results
in dollar terms?
easy a. Variables sampling.
b b. Attributes sampling.
c. Monetary-unit sampling.
d. Sampling with probability proportional to size.
8. Which of the following is not a term relevant to sampling for tests of details?
a. Acceptable risk of incorrect rejection
b. Analysis of misstatements
c. Estimate misstatements in the population
d. Define the exception conditions
9. When auditors sample for tests of details of balances, the objective is to

determine whether the:
easy a. account balance being audited is fairly stated.
a b. transactions being audited are free of misstatements.
c. controls being tested are operating effectively.
d. transactions and account balances being audited are fairly stated.
10. The auditor must consider the possibility that the true population misstatement
easy is greater than the amount of misstatement that is tolerable when the auditor is
performing:
d
Nonstatistical Monetary-unit
sampling. sampling.
a. Yes Yes
b. No No
c. Yes No
d. No Yes
11. What is the purpose of applying stratified sampling to a population?

Easy
d To avoid items that To emphasize certain
may contain items and deemphasize
misstatements others
a. Yes Yes
b. No No
c. Yes No
d. No Yes
12. If an auditor desires a greater level of assurance in auditing a balance, the

medium acceptable risk of incorrect acceptance:
a a. is reduced.
b. is increased.
c. is not changed.
d. may be reduced or increased depending upon other circumstances.
13. Which of the following is not a likely item on which to apply stratification
techniques?
medium a. aging of accounts receivable
c b. dollar value of accounts receivable
c. customer names of account receivables
d. number of sales per customer in a period
14. In estimating the population misstatement, the first step in projecting from the
medium sample to the population is to:
a a. make a point estimate.
b. revise the upper error bound.
c. calculate the precision interval.
d. determine the population mean.
15. Tolerable misstatement is used to:

Medium
cc Determine sample Select the sample. Evaluate results.
size.
a. Yes Yes No
b. No Yes No
c. No No Yes
d. Yes No Yes
16. The relationship between required sample size and the acceptable risk of
incorrect acceptance is:
medium a. inverse.
a b. direct.
c. proportional.
d. indeterminate.
17. The final step in the evaluation of the audit results is the decision to:
medium a. accept the population as fairly stated or to require further action.
a b. determine sampling error and calculate the estimated total population error.
c. project the point estimate.
d. determine the error in each sample.
18. The most commonly used method of statistical sampling for tests of details of
balances is:
medium a. attributes sampling.
d b. systematic sampling.
c. discovery sampling.
d. monetary-unit sampling.
19. Which of the following does not have to be considered in determining the initial
medium sample size of a test of details?
b a. tolerable misstatement
b. acceptable risk of incorrect rejection
c. estimate of misstatements in the population
d. acceptable audit risk
20. If an auditor concludes that internal controls are likely to be effective, the
medium preliminary assessment of control risk can be reduced, leading to a(n) ______
b the acceptable risk of incorrect acceptance.
a. reduction in
b. increase in
c. elimination of
d. increase or decrease
21. When using monetary-unit sampling, the recorded dollar population is a

medium definition of all the items in the:
a a. population.
b. population which the auditor has included in the sample.
c. population which contain errors.
d. sample which contain errors.
22. If acceptable audit risk is increased, ARIA should be:

medium a. increased.
a b. reduced.
c. unaffected.
d. modified.
23. As the acceptable risk of incorrect acceptance is reduced, the required sample
size _________.
medium a. increases
a b. decreases
c. is unaffected
d. increases or decreases
24. The acceptable risk of incorrect acceptance is most related to:

medium a. audit efficiency.
c b. audit results.
c. audit effectiveness.
d. audit estimation.
25. In monetary-unit sampling, the relationship between tolerable misstatement size

medium and required sample size is:
b a. direct.
b. inverse.
c. varied.
d. indeterminable.
26. The risk the auditor is willing to take of accepting a balance as correct when the
medium true misstatement in the balance under audit is greater than the tolerable
misstatement is:
c a. the upper bound.
b. the tolerable risk.
c. the acceptable risk of incorrect acceptance.
d. the lower bound.
27. As the amount of misstatements expected in the population approaches tolerable

medium misstatement, the planned sample size will:
b a. decrease.
b. increase.
c. vary based on characteristics of the population.
d. be unaffected.
28. Which of the following is the auditor least likely to consider when estimating
medium misstatements in the population?
d a. Prior experience with the client.
b. Results of current year tests of controls.
c. Results of analytical procedures already performed.
d. Acceptable audit risk.
29. An accounts receivable population contains a total of four customers. The

medium accounts, the amounts, and the cumulative total are shown below. Monetary-
unit sampling is to be used.
c Account Recorded Cumulative
Name Amount Total
Blue $ 357 $ 357
Brown 281 638
Gray 60 698
Green 574 1,272
Based on the information above, the population size is:
a. 4.
b. 574.
c. 1,272.
d. $2,684.
30. An auditor using nonstatistical sampling cannot formally measure sampling

medium error and therefore must subjectively consider the possibility that the true
a population misstatement exceeds a tolerable amount. Which of the following
factors should be considered by the auditor in making this assessment?
The dollar difference between The extent to which items in the

the point estimate and tolerable population have been audited 100
misstatement. percent.
a. Yes Yes
b. No No
c. Yes No
d. No Yes
31. When using systematic selection procedures with monetary-unit sampling of

medium accounts receivable, the interval is determined by:
b a. consulting a random number table.
b. dividing the population size by the desired sample size.
c. dividing the sample size by the account with the largest dollar value.
d. dividing the population size by the account receivable with the largest
dollar value.
32. In a probability proportional to size (PPS) sample, all population physical audit
medium units with an amount equal to or greater than the amount of the interval will
b automatically be included in the sample if the auditor uses:
a. random selection.
b. systematic selection.
c. block selection.
d. stratified selection.
33. Monetary unit sampling is also referred to as all of the following except:
medium a. attribute sampling.
a b. dollar unit sampling.
c. cumulative monetary amount sampling.
d. sampling with probability proportional to size.
34. The appropriate assumption to make regarding the overall percent of error in
medium those population items containing an error is:
c a. determined using random number tables.
b. set after a quantitative analysis of client’s internal control system.
c. based on the auditor’s personal judgment in the circumstances.
d. based on statistical analysis using confidence limits.
35. When errors are found, a common assumption in practice is to assume:

medium a. a 100% assumption for all errors.
d b. that the population errors are larger than the sample errors.
c. that the population errors are smaller than the sample errors.
d. that the actual sample errors are representative of the population errors.
36. Which of the following does not need to be considered when the auditor
medium generalizes from the sample to the population?
b
Acceptable risk of incorrect Acceptable risk of incorrect
acceptance. rejection.
a. Yes Yes
b. No No
c. Yes No
d. No Yes
37. The auditor must deal with layers of the computed upper deviation rate from the
medium attributes table because there are different error assumptions for each error.
d Assume a sample of 100 had found one error, and the computed upper deviation
rate is shown in the following table:
Number Upper Precision
of Errors Limit from Table
0 .023
1 .038
The precision limit for the layer with one error is:
a. 2.3%.
b. 3.8%
c. 6.1%.
d. 1.5%.
38. Which balance-related audit objective cannot be assessed using monetary unit
sampling?
medium a. Accuracy.
b b. Completeness.
c. Existence.
d. All of the above can be assessed using monetary unit sampling.
39. The confidence limits in variables sampling are similar to the monetary-unit
sampling’s:
medium a. point estimate.
b b. misstatement bounds.
c. standard deviation.
d. standard error of the mean.
40. The method used to measure the estimated total error amount in a population
medium when there is both a recorded value and an audited value for each item in the
sample is:
a a. difference estimation.
b. mean-per-unit estimation.
c. ratio estimation.
41. The variables sampling method which generally results in smaller sample sizes
medium than any other method is:
b a. ratio estimation.
b. difference estimation.
c. monetary-unit sampling.
d. mean-per-unit estimation.
42. The auditor is concerned with the audited value rather than the error amount of
medium each item in the sample when using:
b a. difference estimation.
b. mean-per-unit estimation.
c. ratio estimation.
43. PPS samples can be obtained in an efficient manner using all but which of the
following?
medium a. Hand selection by the auditor.
a b. Computer software.
c. Random number tables.
d. Systematic sampling techniques.
44. Which of the following items is not needed to apply MUS?

medium
a A point estimate for A sample An estimated error
misstatements. size. rate.
a. No Yes No
b. Yes No Yes
c. No Yes Yes
d. Yes No No
45. While performing a substantive test of details during an audit, the auditor
medium determined that the sample results supported the conclusion that the recorded
a account balance was materially misstated. It was, in fact, not materially
misstated. This situation illustrates the risk of:
a. incorrect rejection.
b. incorrect acceptance.
c. assessing control risk too low.
d. assessing control risk too high.
46. While performing a substantive test of details during an audit, the auditor
challenging determined that the sample results supported the conclusion that the recorded
b account balance was materially misstated. Which of the following is not likely
to be an acceptable reaction to this discovery?
a. Perform expanded audit tests in the relevant areas
b. Increase detection risk in the relevant areas
c. Increase the sample size
d. Take no action until tests of other audit areas are completed
47. When selecting a stratified sample, the sample size is:

challenging a. determined for the unstratified population and then apportioned to each
stratum.
b b. determined for each stratum and selected from that stratum.
c. determined for each stratum and selected randomly from the entire
unstratified population.
d. always larger than if unstratified sampling had been used.
48. An auditor using nonstatistical sampling cannot:

Challenging
c determine a point estimate for mathematically measure the
the population. precision of the point estimate.
a. Yes Yes
b. No No
c. Yes No
d. No Yes
49. In monetary-unit sampling, the values of the estimated likely maximum

challenging misstatements are referred to as the:
d a. point estimates.
b. precision intervals.
c. confidence intervals.
d. misstatement bounds.
50. When using monetary-unit sampling, evaluating the likelihood of unrecorded

challenging items in the population is:
b a. unnecessary.
b. impossible.
c. possible but difficult.
d. an automatic outcome of the process.
51. Acceptable risk of incorrect rejection affects auditors’ action only when they
challenging conclude that a population is:
c a. fairly stated.
b. acceptable.
c. not fairly stated.
d. acceptable after certain adjustments.
52. The statistical methods used to evaluate monetary-unit samples:

challenging a. neither exclude nor include units twice.
b b. permit the inclusion of a unit in the sample more than once.
c. do not permit a unit to be included in the sample more than once.
d. ignore the possibility that a unit may be included in a sample more than
once.
53. Which of the following is not a problem with monetary-unit selection?

challenging a. Population items with a zero recorded balance.
b b. Population items that should have a zero balance but do not.
c. Accounts with negative balances.
d. Accounts with small recorded balances that are significantly understated.
54. There are many kinds of statistical estimates that an auditor may find useful, but
challenging basically every accounting estimate is either of a quantity or of an error rate.
b The statistical terms that roughly correspond to “quantities” and “error rate,”
respectively, are:
a. attributes and variables.
b. variables and attributes.
c. constants and attributes.
d. constants and variables.
55. If the auditor believes that there will be more than just a few exceptions
challenging discovered, and desires an accurate estimate of the dollar value of the
exceptions, he or she will use:
d a. attributes sampling.
b. monetary-unit sampling.
c. block sampling.
d. variables sampling.
56. While acceptable risk of incorrect acceptance is always important, the risk of
challenging incorrect rejection is important only when there is a _______ cost to increasing
the sample size.
a a. high
b. low
c. moderate
d. marginal
57. Which of the following is not a disadvantage of monetary-unit-sampling?

challenging a. It may be difficult to select samples from large population without
computer assistance.
b b. The total misstatement bounds resulting when misstatements are found may
be too low to be useful to the auditor.
c. The total misstatement bounds resulting when misstatements are found may
be too high to be useful to the auditor.
d. Each of the above is a disadvantage.
58. Calculating the sample size using monetary-unit-sampling depends on which of

challenging the following factors?
a
assumptions of the average percent of
misstatement for population items that recorded population
contain misstatements value
a. Yes Yes
b. No No
c. Yes No
d. No Yes
59. Stratified sampling is applicable to difference, mean-per-unit, and ratio

challenging estimation, but it is most commonly used with:
d a. ratio estimation.
b. discovery sampling.
c. difference estimation.
d. mean-per-unit estimation.
60. An important statistic to consider when using a statistical sampling audit plan is
challenging the population variability. The population variability is measured by the:
b a. sample mean.
b. standard deviation.
c. standard error of the sample mean.
d. estimated population total minus the actual population.
61. Which of the following sampling plans would be designed to estimate a

challenging numerical measurement of a population, such as a dollar value?
d a. Numerical sampling.
b. Discovery sampling.
c. Sampling for attributes.
d. Sampling for variables.
62. Using statistical sampling to assist in verifying the year-end accounts payable
challenging balance, an auditor has accumulated the following data:
c Balance
Number of Book determined by
accounts balance the auditor
Population: 4,100 $5,000,000 ?
Sample: 200 $ 250,000 $300,000
Using the ratio estimation technique, the auditor’s estimate of year-end
accounts payable balance would be:
a. $5,050,000.
b. $5,125,000.
c. $6,000,000.
d. $6,150,000.
63. Use of the ratio estimation sampling technique to estimated dollar amounts is
challenging inappropriate when:
b a. the total book value is known and corresponds to the sum of all the
individual book values.
b. a book value for each sample item is unknown.
c. there are some observed differences between audited values and book
values.
d. the audited values are nearly proportional to the book values.
64. The major reason that the difference and ratio estimation methods would be
challenging expected to produce audit efficiency is that the:
b a. beta risk may be completely ignored.
b. variability of the populations of differences or ratios is less than that of the
populations of book values or audited values.
c. number of members of the populations of differences or ratios is smaller
than the number of members of the population of book values.
d. calculations required in using difference or ratio estimation are less arduous
and fewer than those required when using direct estimation.
The following information applies to the questions below:
An audit partner is developing an office-training program to familiarize his
professional staff with statistical decision models applicable to the audit of
dollar-value balances. He wishes to demonstrate the relationship of sample sizes
to population size and variability and the auditor’s specifications as to precision
and confidence level. The partner prepared the following table to show
comparative population characteristics and audit specifications of two
populations.
Audit specifications of
Characteristics of a sample from population 1
population 1 relative relative to a sample
to population 2 from population 2
Specified
Specified confidence
Size Variability precision level
Case 1 Equal Equal Equal Higher
Case 2 Equal Larger Tighter Equal
Case 3 Larger Equal Tighter Lower
Case 4 Smaller Smaller Equal
Lower
Case 5 Larger Equal Equal Higher
65. Based on the information presented above, you are to indicate for the specified
challenging case from the table the required sample size to be selected from population 1
a relative to the sample from population 2. In case 1, the required sample from
population 1 is:
a. larger than the required sample size from population 2.
b. equal to the required sample size from population 2.
c. smaller than the required sample size from population 2.
d. indeterminate relative to the required sample size from population 2.
population 1 is:
d relative to the sample from population 2. In case 3, the required sample from
population 1 is:
c relative to the sample from population 2. In case 4, the required sample from
population 1 is:
population 1 is:
70. What is the primary objective of using stratified sampling in auditing?

challenging a. To increase the confidence level at which a decision will be reached from
c the results of the sample selected.
b. To determine the occurrence rate for a given characteristic in the
population being studied.
c. To decrease the effect of variance in the total population.
d. To determine the precision range of the sample selected.
71. In the application of statistical techniques to the estimation of dollar amounts, a

medium preliminary sample is usually taken primarily for the purpose of estimating the
population:
d a. mode.
b. range.
c. median.
d. variability.

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Chapter 8

2. Avoiding misunderstandings with the client is important for:

5. When inherent risk is high, there will need to be:

7. Which of the following is not typically included in initial audit planning?

13. It is easier and more common to implement increased evidence accumulation

15. Which of the following statements is true regarding communications between

17. The purpose of an engagement letter is to:

21. An understanding of a client’s business and industry and knowledge about

23. An official record of meetings of the board of directors and stockholders is

24. Which of the following is not likely to be a related party?

26. An auditor should examine minutes of the board of directors’ meetings:

30. Which of the following is correct with respect to a company’s corporate

31. Corporate bylaws include:

32. In what order should the following steps occur?

35. The purpose of the requirement in SAS No. 84 of having communication

39. Which of the following statements is not correct?

40. Which of the following would not likely be classified as a related-party

45. An auditor searching for related party transactions should obtain an

47. Early appointment of the independent auditor will enable:

50. Which is a liquidity activity ratio?

51. Which is usually included in an engagement letter?

Estimate of hours Dollar estimate of fees to be

52. Which is usually included in an engagement letter?

53. Which is usually included in an engagement letter?

55. Which is usually included in the engagement letter?

56. Which is usually included in the engagement letter?

1. If it is probable that the judgment of a reasonable person would have been

2. The preliminary judgment about materiality is the amount by

3. Auditors are responsible for determining whether financial statements are

4. The FASB definition of materiality emphasizes what class of financial

5. When auditors allocate the preliminary judgment about materiality to account

6. Why do auditors establish a preliminary judgment about materiality?

7. Auditors are _____ to decide on the combined amount of misstatements in the

17. Which of the following statements regarding inherent risk is correct?

25. Which of the following statements is not correct?

26. Since materiality is relative, it is necessary to have bases for establishing

28. Allocating the preliminary judgment about materiality to financial statements

29. Which of the following statements is not correct?

35. Likely misstatements can result from:

41. Inherent risk is often low for an account such as:

48. When setting a preliminary judgment about materiality:

49. When allocating materiality, most practitioners choose to allocate to:

50. The risk of material misstatement refers to:

medium Jointly to determine the Separately and combine their effects in

54. Which of the following statements is not true?

57. Tolerable misstatement as set by the auditor:

1. Which of the following is responsible for establishing a private company’s

4. Two key concepts that underlie management’s design and implementation of

5. Internal controls can never be considered as absolutely effective because:

6. A major control available in a small company, which might not be feasible in a

8. Which of the following parties provides an assessment of the effectiveness of

Management Financial statement

9. An act of two or more employees to steal assets or misstate records is frequently

17. Which of management’s concerns with respect to implementing internal

18. Which of the following activities would be least likely to strengthen a

19. (Public) Management must disclose material weaknesses in internal control:

24. The auditor’s consideration of a private company’s internal control is:

25. Internal controls can never be regarded as completely effective. Even if