Question 1

The first step in applying materiality is

Accepted Answer

A)  estimating the misstatement in a segment for each functional cycle.
B)  setting a judgment about materiality for the financial statements as a whole.
C)  estimating the combined effects of errors.
D)  comparing the error estimate with the materiality levels. B

Question 2

Your preliminary discussion with European Real Estate Management (EREM)Corporation indicated that the company was owned by three Swedish individuals who sold limited liability partnerships of shopping malls,office buildings,and large residential apartment buildings to European investors.Often,a single shopping mall was broken up into several limited liability partnerships to make the ownership pieces small enough to sell easily.
In some cases these partnership units were sold to European companies,who diversified and bought units in several buildings.Other units were purchased by individuals.If a property looked particularly promising,the owners of EREM occasionally purchased units or advised their wives and family members to purchase units.
Required:
Explain why it is important for the auditor to identify related party transactions.Why are related party transactions a high-risk area for the EREM audit?

Accepted Answer

It is assumed that all transactions in the financial statements take place at arms length.If they do not take place at arms length,then it is critical that the related party transactions be disclosed in the notes to the financial statements so that financial statement users can take this into account.If disclosure did not occur,then management could manipulate net income when related parties are involved and users of the financial statements could make poor decisions due to biased information.Transactions with related parties must be disclosed in the financial statements if they are material.
This is a high-risk area for the EREM audit,because it appears that there are a variety of potentially complex transactions among many individuals and corporations that are related.This relationship may be familial (i.e.among family members)or based upon being able to exert influence.The auditor will need to carefully audit this area and request management to provide a detailed breakdown of common ownership,including the ownership of the foreign companies,to see if the foreign companies are also related parties.

Question 3

Jibbery Company has numerous transactions with related parties.For example,it has borrowed money from shareholders,purchases raw materials from a subsidiary company,and sells finished goods to its parent company.Which of the following describes one of the impacts of these transactions on risk assessment ?

Accepted Answer

A)  inherent risk would be set as low
B)  inherent risk would be set as high
C)  control risk would be set as low
D)  audit risk would be decreased B

Question 4

If the auditor sets a low dollar amount as materiality,

Accepted Answer

A)  more evidence is required than for a high amount.
B)  less evidence is required than for a high amount.
C)  the same amount of evidence is required as for a high dollar amount.
D)  it has no effect on the amount of evidence required.

Question 5

Lauralye Leasing Limited (LLL)provides lease financing to companies and individuals for equipment other than automobiles.Leases on commercial signs make up 50% of total leases;computer and telecommunications equipment are 30%;and restaurant equipment makes up most of the remainder.LLL's customers arrange to buy new equipment from equipment dealers,then contact LLL to arrange lease financing.
LLL was founded over thirty years ago by Laura and Al Ye.It is now run by Mr.and Mrs.Ye's daughter,Betsy,who is the President of LLL.LLL owns a small building downtown,where the offices of the business are located.Unused office space is rented out to other commercial tenants.
Betsy was a classmate of yours at in university and you have kept loosely in touch over the years.This year,she moved LLL's audit to your firm (a local firm with five partners),after deciding that the firm her parents had hired many years ago did not really understand her business needs.
LLL has a small loan that is used to cover blips in working capital.The company has two salespeople.Most loans are received from stores throughout the city with whom LLL has standing agreements.If customers require financing,they fill in an application and fax it to LLL for approval.LLL will reply within two business days.
The company has been profitable for many years.There are no extraordinary items in the current year's financial statements.
Selected financial information is as follows:
  
Required: A)Which base would you use to calculate materiality? Why? B)Calculate materiality.Choose a specific number and explain why you chose that amount.

Accepted Answer

The answer of Lauralye Leasing Limited (LLL)provides lease financing to...

Question 6

When an auditor allocates materiality to segments,then the materiality amount for different accounts under audit will

Accepted Answer

A)  potentially differ from each other.
B)  require the same level of unanticipated misstatements.
C)  require the same amount of audit work.
D)  be the same for each account audited.

Question 7

When the auditor has properly planned and performed the audit to reduce risk to an acceptably low level that is consistent with the objective of the audit,this means that the auditor has conducted enough work to

Accepted Answer

A)  reduce inherent risks to an acceptable level.
B)  increase detection risk to a satisfactory level.
C)  detect errors in internal controls so that control risk can be set higher.
D)  detect material misstatements to the targeted level of assurance.

Question 8

The purpose of allocating planning materiality to balance sheet accounts is to

Accepted Answer

A)  assess the appropriate evidence to accumulate for each account on the balance sheet.
B)  assess the appropriate evidence to accumulate for each account on both the balance sheet and income statement.
C)  reduce the amount of procedures done in the course of the audit.
D)  increase the possibility that fraud or illegal activities would be detected by audit procedures.

Question 9

Analytical procedures are generally used to produce evidence from

Accepted Answer

A)  physical observation of inventories.
B)  relationships among current financial balances and prior balances,forecasts,and nonfinancial data.
C)  detailed examination of external and internal documents.
D)  confirmations mailed directly to the auditors by auditee customers.

Question 10

If management and salespeople are compensated on the basis of achieving high sales targets,there is increased incentive to record sales before they have been earned.In such a situation,the auditor will increase the extent of testing for which of the following transaction-related audit objectives for sales?

Accepted Answer

A)  cut-off and classification
B)  classification and occurrence
C)  occurrence and cut-off
D)  completeness and cut-off

Question 11

What are the possible scope limitations that would cause the auditor to decline an audit engagement?

Accepted Answer

The answer of What are the possible scope limitations that...

Question 12

How is lack of understanding of a client's knowledge and industry linked to the auditor's business risk?

Accepted Answer

A)  sales and collection processes need to be carefully documented so that the auditor can assess the value of accounts receivable.
B)  failure to fully understand the nature of the client's transactions could result in litigation should the client fail.
C)  the auditor may not be adequately trained to understand the nature of the client's business and thus may conduct a poor quality audit.
D)  there may not be sufficient expertise assigned to the audit engagement,resulting in a lack of understanding of complex issues.

Question 13

Anna performed a trend analysis of accounts receivable (AR)balances and computed the days to collect AR ratio.When she compared the results of her analysis with industry averages,she found the results were unusually low compared to the industry norm.Anna can conclude that

Accepted Answer

A)  the accounts receivable balance is wrong.
B)  the accounts receivable has an increased risk of misstatement.
C)  the integrity of the company's management is questionable.
D)  she will not be able to rely on internal controls for accounts receivable for audit purposes.

Question 14

Which of the following types of misstatements has the highest level of certainty?

Accepted Answer

A)  identified misstatements
B)  likely misstatements
C)  likely aggregate misstatements
D)  further possible misstatements

Question 15

Simon owns a clothing store,Simonello.Simonello recently purchased a material amount of fabric from Simonique Inc. ,a textile company also owned by Simon.With regards to this transaction,the auditors should

Accepted Answer

A)  request a confirmation from Simonique that the transaction took place.
B)  inspect the textile received in the warehouse to ensure that the amount sent equals the amount ordered.
C)  qualify the audit report,as this puts management's integrity into question.
D)  verify that the business relationship is disclosed in the financial statements.

Question 16

A)Discuss each of the six steps in applying materiality in an audit and identify the audit phase(s)in which each step is performed.B)Discuss the three main factors that affect an auditor's preliminary judgment about materiality.

Accepted Answer

The answer of A)Discuss each of the six steps in...

Question 17

Organizations with a good control environment are able to document their positive "tone at the top" with a clear code of ethics.How would the auditor include the presence of such a code of ethics in the risk assessment process?

Accepted Answer

A)  increase inherent risks associated with violations of laws and regulations
B)  lower inherent risks associated with violations of laws and regulations
C)  increase control risks associated with violations of laws and regulations
D)  lower control risks associated with violations of laws and regulations

Question 18

During discussion and inquiry with management,the auditor determined that the company has started a new line of business that requires a substantial investment in manufacturing equipment.The company has also implemented wireless scanning for its warehouse and inventory.Which of the following techniques will the auditor likely use to corroborate these statements?

Accepted Answer

A)  further inquiry of the accounting personnel
B)  inspection of recent sales invoices for types of sales
C)  use of analytical procedures,comparing last year to this year
D)  observation during the plant tour

Question 19

With respect to clients,business risk increases when conditions,events,circumstances,or inactions

Accepted Answer

A)  adversely affect the entity's ability to achieve its objectives.
B)  cause employees to not do their job properly.
C)  result in the company continuing profitable operations.
D)  result in an assessment of poor internal controls.

Question 20

Risks associated with specific industries may affect the auditor's assessment of client business risk and acceptable audit risk,and even influence client acceptance decisions.Which of the following businesses would be the most risky for the auditor to accept as a new client?

Accepted Answer

A)  a small manufacturer of metal and plastic parts that has steady profits and has been in business for 15 years
B)  a client who is developing a computer game that is expected to be ready in three years and has no other products
C)  a retail company in the clothing industry that has mid-range pricing and appeals to a large population sector
D)  a firm consisting of a partnership of ten lawyers that operates out of three different cities in one province

Exam 6: Client Acceptance,Planning,and Materiality