Auditing, 12e (Arens)
Chapter 5 Audit Responsibilities and Objectives
5.1 Describe the objective of conducting an audit of financial statements
1) The objective of the audit of financial statements by the auditor is the expression of an opinion
on
A) the accuracy of the financial statements.
B) the balance sheet and income statement.
C) the fairness of the financial statements.
D) the annual report.
2) CAS 200 explains that the purpose of the financial statement audit is to express an opinion on
the financial statements. This opinion is an assessment of whether the financial statements are
presented fairly using
A) Canadian generally accepted accounting principles (GAAP) only.
B) an applicable financial reporting framework.
C) Management’s assertions.
D) Rules of professional conduct.
3) The reason auditors accumulate evidence is to
A) defend themselves in the event of a lawsuit.
B) justify the conclusions they have otherwise reached.
C) satisfy the requirements of the relevant provincial securities regulations.
D) enable them to reach conclusions about the fairness of the financial statements and issue an
appropriate audit report.
4) The auditor gives an audit opinion on the fair presentation of the financial statements and
associates his or her name with it when, on the basis of adequate evidence, the auditor concludes
that the financial statements are unlikely to mislead
A) a prudent user.
B) management.
C) the reader.
D) investors.
5) The responsibility for adopting a sound and appropriate financial reporting framework and
corresponding accounting policies, maintaining adequate internal controls, and making fair
representations in the financial statements rests
A) with management.
B) with the auditor.
C) equally with management and the auditor.
D) with the internal audit department.
6) The audit process has three categories of audit phases: risk assessment, risk response and
reporting. Which of the following are the phases that are part of the risk assessment process?
A) preplanning, design further audit procedures, tests of control
B) client risk profile, plan the audit, design further audit procedures
C) preplanning, client risk profile, plan the audit
D) preplanning, plan the audit, design further audit procedures
7) There are three phases in the risk response category of the audit process (design further audit
procedures, tests of control, substantive tests). When will the auditor conduct tests of controls?
A) when there are poor internal controls
B) if the auditor plans to rely upon them
C) when a substantive audit approach is selected
D) when there are low risks of material error
8) The responsibility for the preparation of the financial statements and the accompanying
footnotes belongs to
A) the auditor.
B) management.
C) both management and the auditor equally.
D) management for the statements and the auditor for the notes.
9) Professional skepticism during the financial statement audit requires an appropriate state of
mind, being impartial and objective and continuing to be throughout the whole audit
engagement. Which of the following illustrates an appropriate state of mind?
A) not having any ownership in the client’s shares or being a debt-holder
B) carefully assessing documents and not being the company’s advocate
C) matching documents to make sure that they are accurate and fair
D) being aware that there could be material misstatements in the financial statements
10) The requirement for an attitude of skepticism means that the auditor should
A) not be blind to evidence that suggests the documents, books or records have been altered or
are incorrect.
B) plan and conduct the audit with an attitude of distrust in management.
C) perform additional tests of controls to increase the probability of discovering fraud or errors.
D) not consider management’s explanation as evidence on any subject.
11) The auditor has considerable responsibility for notifying users whether the financial
statements are fairly stated. This imposes upon the auditor a duty to
A) be an insurer of the fairness in the statements.
B) be a guarantor of the fairness in the statements.
C) be equally responsible with management for the preparation of the financial statements.
D) provide reasonable assurance that material misstatements will be detected.
12) The factor which distinguishes an error from fraud and other irregularity is
A) materiality.
B) intent.
C) whether it is a dollar amount or a process.
D) whether it is a caused by the auditor or the client.
13) Which of the following is an example of fraudulent financial reporting (management fraud)?
A) intentional overstatement of sales to increase reported earnings
B) managers or others taking bribes from accounts payable suppliers
C) the purchasing manager submitting travel expenses twice (i.e. duplicate payment)
D) a clerk taking cash at the time a sale is made and not recording the sale
14) In comparing management fraud with employee fraud, the auditor’s risk of failing to discover
the fraud is greater for
A) employee fraud because of the larger number of employees in the organization.
B) employee fraud because of the higher crime rate among blue collar workers.
C) management fraud because of management’s ability to override existing internal controls.
D) management fraud because managers are inherently smarter than employees.
15) If the auditor were responsible for making certain that all the assertions of management in
the statements were correct,
A) bankruptcies could no longer occur.
B) bankruptcies would be reduced to a very small number.
C) audits would be much easier to complete.
D) audits would not be economically feasible.
16) When comparing the auditor’s responsibility for detecting employee fraud and for detecting
errors, the profession has placed the responsibility
A) more on discovering errors than employee fraud.
B) more on discovering employee fraud than errors.
C) equally on discovering either one.
D) on the senior auditor for detecting errors and on the manager for detecting employee fraud.
17) The auditor’s evaluation of the likelihood of material employee fraud is normally done
initially as a part of
A) the assessment of whether to accept the audit engagement.
B) understanding the entity’s internal controls.
C) the tests of controls.
D) the tests of transactions.
18) What is the auditor’s role in the detection of computer fraud?
A) use computer assisted audit techniques to make sure that the computer programs do not have
any unauthorized processing
B) use test data to make sure that the computer programs are functioning as described by the
client
C) investigate unusual relationships or patterns, conduct the audit properly, and report to
management
D) only detect fraud if it has been ongoing for a long period of time and leaves many different
types of evidence
19) Auditing standards regarding the detection of illegal acts clearly state that the auditor
provides
A) no assurance that they will be detected.
B) the same reasonable assurance provided for other items.
C) assurance that they will be detected, if material.
D) assurance that they will be detected, if highly material.
20) Which of the following is an example of a direct-effect illegal act that could be performed by
a client? Violation of
A) environmental protection laws for the production facility.
B) insider securities trading regulations by senior management.
C) employment equity laws for a large group of non-unionized employees.
D) income tax laws and incorrect calculation of income taxes payable.
21) What is one of the first things that an auditor would do upon discovering an illegal act at an
audit client?
A) resign from the audit
B) inform the Board of Directors
C) consult with a lawyer
D) call the police
22) A financial statement audit typically consists of three sections. Identify each of the three
sections of an audit and discuss the major activities performed by the auditor in each section.
23) In May 2012, the firm of Chang and Crown (C&C) became the auditors of Laua Limited
(LL) for the fiscal year ended December 31, 2011. LL’s shareholders and Board approved the
change from its previous audit firm on the recommendation of LL’s senior management. One of
the new board members is a bit confused about management’s role with respect to the financial
statements and thought that Chang and Crown would be preparing the financial statements. He
was also glad that the auditors would be able to help prevent illegal acts and fraud.
Required:
A) Distinguish between management’s responsibility and the auditor’s responsibility for the
financial statements under audit.
B) Explain to the board member why the auditor does NOT help prevent illegal acts and fraud.
What is the role of the auditor with respect to illegal acts and fraud?
24) Frank has come to you because he is worried about recovering the cost of his share of a law
firm partnership. His partner, Jennifer, is exercising the “shotgun” clause in their partnership
agreement, and wants to buy him out. Over the last two years, Frank and Jennifer have had
numerous battles over the way that Frank handles his accounts receivable. Frank is lenient with
his customers, and has converted many of his accounts into long term notes extending two and
three years into the future. He is confident that these amounts are collectible, because every one
of his clients continues to make small monthly payments.
Frank thinks that Jennifer may have been hiding profits from him and collecting some of her
accounts in cash. He wants you to audit the books so that he can figure out what the ‘true’ profits
are and how much Jennifer should pay him for his share of the partnership.
Required:
A) Explain to Frank what you would be able to do during the audit engagement.
B) List the management assertions that may have been violated. Justify your answer.
25) Your PA firm has been auditing Ontario Pulp Company for three years. Two years ago, a
letter was received from the provincial government informing them that they needed to reduce
the level of contaminants that they were releasing into the air and into local waterways. The
deadline for this reduction is three months from today. The letter indicates significant fines
(several hundred thousand dollars) if the targets are not met. Alternatively, the Company will
need to shut down operations until the targets are met.
During your audit planning process management informed you that they have not taken any
action, but plan to start construction of the new pollution devices next month.
Required:
Explain the impact the above situation has upon your audit planning process.
26) The controller who had been with Bianca Limited for six years was fired last month,
allegedly for pocketing cash. Unfortunately, there was a fire in the accounting department the
week before he was fired, destroying the accounting records, including the computer equipment
and current backup disks.
The only records available for the current year is a copy of the computer system that is a month
old. There are also disks for the year ends going back three years. These were at the president’s
home, the place where the company kept archival records.
Required:
Explain how this situation might affect the audit process.
1) At what point during the audit should the auditor conduct an independence threat analysis?
A) after the audit evidence assessment and collection process
B) prior to the acceptance of the engagement
C) after gathering sufficient knowledge of the client’s business
D) prior to signing the audit report
2) The decision to continue doing the audit of an existing client is
A) as important as deciding whether or not to accept a new client.
B) less important than deciding whether or not to accept a new client.
C) more important than deciding whether or not to accept a new client.
D) only to be reconsidered if the client’s operations or upper management has changed.
5.3 Describe the eight phases of a financial statement audit and provide an overview of the
audit process
1) Your PA firm has just obtained a new client and you have been assigned the task of preparing
the knowledge of business section of the file. Which of the following best describes the process
of gathering the knowledge of business for a client?
A) discussing processes and business objectives with company employees
B) gathering information about the industry and regulatory environment
C) understanding the client’s business, industry, and regulatory environment
D) examining the legal expenses file for possible regulatory infractions
2) Analytical procedures are those that
A) evaluate the accuracy of the account balances.
B) assess the overall reasonableness of account balances or other data.
C) review the effectiveness of internal controls.
D) analyze the effect of management procedures on the accounting system.
3) Where the auditor has decided to rely upon internal controls, he or she will then
A) eliminate the need to gather evidence in that area.
B) test the effectiveness of the controls in that area.
C) proceed to expand the sample sizes in that area.
D) negotiate with management to determine which controls will be tested in that area.
4) Tests of details of balances are specific procedures intended to
A) identify the details of internal controls.
B) prove that the accounts with material balances are classified correctly.
C) test for monetary errors in the financial statements.
D) prove that the trial balance is in balance.
5) After the auditor has completed all the procedures, it is necessary to combine the information
obtained to reach an overall conclusion as to whether the financial statements are fairly
presented. This is a highly subjective process that relies heavily on
A) generally accepted auditing standards.
B) the provincial institutes’ Rules of Professional Conduct.
C) generally accepted accounting principles.
D) the auditor’s professional judgment.
6) You have been assigned the in-charge-auditor for a new client, Beltair House. Beltair House is
a non-profit charitable organization which operates a home for unwed mothers who have decided
that they would like to keep their child. In the past, the organization had been almost fully
funded by the provincial government. However, due to recent budget cut-backs, Beltair has to
raise operating funds from public donations.
Because of financial constraints, there is now only one full time manager, Joan Ng. Joan has the
help of several volunteers, and the residents help out with the chores and with maintenance and
cleaning. Ng has been able to arrange for a local food bank to provide a large portion of the food
required for meals. Door-to-door canvassers have been able to raise money to keep the House
going, but Ng is concerned that this will change.
Required:
Identify issues that you will need to consider that affect the risk of this audit engagement.
7) Sean Clem has done a review engagement and prepared the tax return for your web design
business for the last five years. The books and records have always been well organized,
although year end adjusting entries have been required. You do some of the accounting yourself
and the rest of the accounting records are handled by your wife, who is also an employee of the
business.
This year, you would like to expand your business to provide ISP (internet service provider)
services to your clients. This would entail you purchasing additional computer equipment and
software. You are also considering hiring an additional employee (you currently have three), and
you are looking at obtaining a loan for $100,000 from the bank. The bank says that you should
have your records audited, but you are not sure what this will mean.
Required:
A) What would Sean say to you about the differences between an audit and a review?
B) Identify the issues that Sean needs to consider during the planning of the audit.