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Chapter 8
Multiple-Choice Questions
1.
easy
a

Which of the following is not one of the three main reasons why the auditor should properly
plan engagements?
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.
easy
a

Avoiding misunderstandings with the client is important for:
Good client relations
Yes
No
Yes
No

a.
b.
c.
d.
3.

Easy

When inherent risk is high, there will need to be:
d
a.
b.
c.
d.

6.
easy
a

More evidence accumulated by the auditor
Yes
No
No
Yes

The auditor is likely to accumulate more evidence when the audit is for a company:

a.
b.
c.
d.
7.
easy
d

A lower assessment of audit risk


8.
easy
b

Initial audit planning involves four matters. Which of the following is not one of these?
a. Develop an overall audit strategy.
b. Request that bank balances be confirmed.
c. Schedule engagement staff and audit specialists.
d. Identify the client’s reason for the audit.

9.
easy
b

Most auditors assess inherent risk as high for related parties and related-party transactions
because:
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.
easy
a

Which of the following is not correct regarding the communications between successor and
predecessor auditors?
a. The burden of initiating the communication rests with the predecessor auditor.
b. The burden of initiating the communication rests with the successor auditor.

12.
medium
b

Which of the following is not a potential effect of an auditor’s decision that a lower acceptable
audit risk is appropriate?
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.
medium
a

It is easier and more common to implement increased evidence accumulation for inherent risk
than for acceptable audit risk because:
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)
medium
d

If an auditor is requested to perform nonaudit services for a public company audit client, who is
responsible for agreeing to those services with the audit firm?
a. The client’s management.

d. financial risk.

17.
medium
b

The purpose of an engagement letter is to:
a. document the CPA firm’s responsibility to external users of the audited 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.
medium
a

One means of informing the client that the auditor is not responsible for the discovery of all acts
of fraud is the:
a. engagement letter.
b. representation letter.
c. responsibility letter.
d. client letter.

19.
medium
d

Which of the following normally signs the engagement letter for an audit of a public company?


The least effective method of identifying related parties for a public company would be a(n):
a. inquiry of management.
b. review of SEC filings.
c. distribution of the engagement letter to all stockholders.
d. examination of stockholders’ listings to identify principal stockholders.

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23.
medium
c

An official record of meetings of the board of directors and stockholders is included in the
corporate:
a. bylaws.
b. charter.
c. minutes.
d. license.

24.
medium
c

Which of the following is not likely to be a related party?
a. Affiliated companies.
b. A major stockholder of the company.

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.
medium
d

The corporate minutes are the official record of the meetings of the board of directors and
stockholders. The minutes typically include authorizations related to:

a.
b.
c.
d.

The CPA’s use of outside specialists
Yes
No
Yes
No

Management compensation
Yes
No
No
Yes

d

The corporate charter must be annually reviewed by the PCAOB.

Corporate bylaws include:

a.
b.
c.
d.

The types and amounts of capital stock
the corporation is authorized to issue
Yes
No
Yes
No

The rules and procedures used to
operate the corporation
Yes
No
No
Yes

32.
medium
b

In what order should the following steps occur?

35.
challenging
b

The purpose of the requirement in SAS No. 84 of having communication between the
predecessor and successor auditor is to:
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.
challenging

The predecessor auditor is required to respond to the request of the successor auditor for
information, but the response can be limited to stating that no information will be provided
when:
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.

c

37.
challenging
d

Which of the following is correct with respect to the use of analytical procedures?
a. Analytical procedures may be used in evaluating balances in the testing phase as long as

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.
medium
a

Which of the following would not likely be classified as a related-party transaction?
a. An advance of one week’s salary to an employee.
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.
challenging
d

Which of the following would not be found in the corporate charter?
a. The kinds and amount of capital stock authorized.
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.


c. type of nonfinancial data.
d. presence of multiple sources of nonfinancial data.

45.

An auditor searching for related party transactions should obtain an understanding of each

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challenging
b

subsidiary’s relationship to the total entity because:
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.
challenging
a

The first standard of fieldwork requires, in part, that audit work be properly planned. Proper
planning as intended by the first standard of fieldwork would occur when the auditor:


Assessing whether the budgets were
realistic plans
A concern
Not a concern
A concern
Not a concern

Client data may have been altered to conform
to the budget
A concern
Not a concern
Not a concern
A concern

49.
challenging
b

An auditor who accepts an audit engagement and does not possess the industry expertise of the
business entity should:
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.
medium
b


the client
Yes
No
No


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d.
52.
medium
a

A reference to GAAP
Yes
No
Yes
No

The financial statements are
the responsibility of the
company’s management
Yes
No
Yes
No

56.
medium
b


Which is usually included in an engagement letter?

a.
b.
c.
d
54.
medium
c

Yes

Which is usually included in an engagement letter?

a.
b.
c.
d.
53.
medium
c

No

Only if the specialist assisted in the audit of an
account material to the financial statements
Yes
No
No

Yes
d
No

Essay Questions

Arens/Elder/Beasley

The auditors’ assessment of Audit Risk
Yes
No
No
Yes


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57.
easy

Discuss the factors an auditor should consider before accepting a company as an audit client.
Answer:
The auditor should investigate and consider the prospective client’s standing in the
business community, financial stability, management’s integrity, and relations with its
bankers, attorneys, and previous CPA firm. The auditor should also determine whether he
or she possesses the required competence and independence to do the audit.

58.
easy


To avoid misunderstandings with the client. This is important for good client
relations.

61.
medium

Discuss the essential activities involved in the initial planning of an audit.
Answer:
There are four essential activities involved in the initial planning of an audit. These
are:
1. Client acceptance or continuation. In the case of a new client, the auditor must
determine whether the client is one with which (s)he wishes to be associated. In the
case of a continuing client, an auditor must determine whether continuing the
relationship is appropriate and in the firm’s best interest.
2. Determine reason for the audit. The auditor should determine the reason for the audit
as soon as practical. The remainder of the planning activities may be impacted by the
client’s reason for requesting the audit.
3. Obtain an understanding with the client. An understanding with the client should be
obtained to avoid misunderstandings. Auditors are required to obtain an understanding

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with their clients. This understanding must be written.
4. Develop an overall audit strategy. The strategy should consider the reasons for the
audit, including areas where there is greater risk of significant misstatements. Setting a
strategy helps the auditor determine the resources required for the engagement.


4.
5.

64.
medium

Previous conflicts over accounting issues, scope of the audit, type of opinion, or fees.
Management integrity may be deemed to be insufficient.
Legal action initiated by either the auditor or client related to prior audit services.
If fees remain unpaid for services performed more than one year prior to the date of
the current year’s audit report.
The presence of excessive risk.

Discuss four of the matters that should be specified in an engagement letter.
Answer:
Matters that should be specified in the engagement letter include:
Whether the auditor will perform an audit, a review, or a compilation, plus any other
services such as tax returns or management advisory services.
Any restrictions to be imposed on the auditor’s work.
Deadlines for completing the audit.
Assistance to be provided by the client’s personnel in obtaining records and
documents, and schedules to be prepared for the auditor.
Agreement on fees.
The letter should state that the auditor is not responsible for the discovery of all acts
of fraud.

65.
medium

What documents do auditors routinely obtain to aid in their understanding of a client’s

customers, and vendors. Auditors must understand the risks associated with this
increased connectivity.
Companies have expanded operations to have global reaches, often through joint
ventures and strategic alliances.
Information technology affects internal control processes, improving the quality and
timeliness of accounting information.
The increased importance of human capital and other intangible assets has increased
accounting complexity and the importance of management judgments and estimates.
Auditors need a better understanding of the client’s business and industry to provide
additional value-added services.
The auditor can obtain a sound understanding of the client’s business and industry through
several means, including discussions with previous auditors and by reviewing the
permanent files for the client; conferences with the client’s personnel; studying AICPA
industry audit guides, textbooks, technical magazines, and specialized journals; and by
participating in industry associations and training programs.

67.
medium

There are three primary reasons for obtaining a thorough understanding of the client’s industry
and external environment. What are these reasons?
Answer:
The three reasons are:
Risks associated with specific industries may affect the auditor’s assessment of client
business risk and acceptable audit risk.
Certain inherent risks are typically common to all clients in certain industries.
Familiarity with those risks aids the auditor in assessing their relevance to the client.
Many industries have unique accounting requirements that the auditor must
understand to evaluate whether the client’s financial statements are in accordance
GAAP.

Competence of management,
Ability to maintain sufficient cash flows and secure financing, and
Successful implementation of business strategies.

70.
challenging

Auditors routinely conduct analytical procedures in the planning, testing, and completion phases
of the audit. Identify the primary and secondary purposes of performing analytical procedures
in each phase of the audit.
Answer:
Planning – The primary purposes are to understand the client’s business and industry
and indicate areas of possible misstatements. The secondary purposes are to assess
going concern and reduce the extent of detailed tests.
Testing – The primary purpose is to reduce the extent of detailed tests, while the
secondary purpose is to indicate areas of possible misstatements.
Completion –The primary purpose is to indicate areas of possible misstatements,
while the secondary purpose is to assess going concern.

71.
challenging

Three types of legal documents and records that auditors examine in the planning phase of an
audit are the corporate charter and bylaws, corporate minutes of meetings of the board of
directors and stockholders, and contracts. Discuss the audit-relevant information contained in
each of these three types of documents that an auditor should be aware of early in the audit.
Answer:
Corporate charter and bylaws. This includes the amounts of capital stock the corporation
is authorized to issue, its par or stated value, preferences and conditions for dividends, and
information concerning voting rights of each class of stock. The bylaws specify such

a. True
b. False

74.
easy
b

Before accepting a new client, most CPA firms investigate the company to determine its
acceptability. However, AICPA confidentiality requirements prohibit CPA firms from
contacting certain parties—namely the company’s attorneys and bankers—during this
investigation.
a. True
b. False

75.
easy
b

For prospective clients that have previously been audited by another CPA firm, the predecessor
auditor is required to communicate with the successor auditor.
a. True
b. False

76.
easy
b

When a successor auditor contacts a company’s previous auditor, the predecessor auditor is
required to respond fully and without limit to the request for information.
a. True

b. False

80.
medium
b

To evaluate a specialist’s work the auditor must himself/herself be considered a specialist.
a. True
b. False

81.
medium
a

An engagement letter establishes a clear understanding of the terms of the engagement between
the client and the auditor, but it is optional for private companies.
a. True
b. False

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82.
easy
b

Because of the requirements of Rule 201 of the AICPA’s Code of Professional Conduct which
state that auditors should ―undertake only those professional services that the member or the

statements and the likelihood of issuing an unqualified audit opinion.
a. True
b. False

86.
medium
b

A major consideration in assigning staff to an audit engagement is the experience levels
required for the work, while a less important consideration is maintaining staff continuity on the
engagement.
a. True
b. False

87.
medium
b

Inherent risks typically vary across industries.
a. True
b. False

88.
medium
a

Transactions with related parties must be disclosed in the financial statements if they are
deemed to be material.
a. True
b. False


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92.
medium
b

Ordinarily, the auditor should review and abstract copies of contracts during the later stages of
an audit.
a. True
b. False

93.
medium
a

When a successor auditor requests information from a company’s previous auditor, and there
are legal problems or disputes between the client and the predecessor auditor, the predecessor
auditor’s response to the new auditor may be limited to stating that no information will be
provided.
a. True
b. False

94.
medium
b

One purpose of performing preliminary analytical procedures in the planning phase of an audit
is to help the auditor make a preliminary assessment of control risk.
a. True