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Auditing: An International Approach Seventh Canadian Edition Test Bank

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    Exam Name___________________________________ MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) Which of the following best describes the main reason that independent auditors report on a company's financial statements? 1) _______ A) The accounting system from which the financial statements are derived may have a poorly designed system of internal control. B) Management fraud may exist within the company and it is likely that the independent auditors will detect it. C) Users of financial statements need confidence in the numbers they base their decisions on. D) Misstated account balances may be corrected as the result of the independent audit work. 2) Reducing information risk means the same as ________. 2) _______ A) serving the public interest B) improving the credibility of information C) ensuring generally accepted accounting principles are used to measure profit D) monitoring economic activities 3) Three - party accountability is a special case of which economic theory problem? 3) _______ A) independence B) forensics C) agency D) business risk 4) The agency problem can be mitigated by ________. 4) _______ A) internal auditing B) design of contracts C) a higher degree of independence D) greater transparency 5) The underlying conditions that create demand by users for reliable financial information include the fact that ________. 5) _______ A) governments rely on such information to create tax policies B) there is a need for the expression of an opinion as to the fairness of financial statements C) more reliable information will allow investors to calculate the rate of return on their investment D) users are separated from accounting records by distance and time 6) The auditee is the person or company ________. 6) _______ A) who will use the audited information B) who pays the audit fee C) who performs an audit D) whose information is being audited 7) Professional judgment is a widely used concept in accounting and auditing. How is it defined in the audit standards? 7) _______ A) Professional judgment includes consideration of key principles and concepts of disciplines underlying the professional standards, such as economics, psychology, law, finance, statistics and philosophy. B) Professional judgment involves specialized concepts and language integrating several disciplines in order to provide appropriate justification for audit decisions. C) There is no definition of professional judgment in the auditing standards. D) Professional judgment means reaching a complex decision by incorporating auditing standards, accounting standards, and rules of professional ethics in a

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    coherent manner. 8) What is the primary role and responsibility of independent external auditors? 8) _______ A) to provide business consulting advice to audit clients. B) to obtain an understanding of a client's internal control system and prepare a report for management about control weaknesses. C) to perform an audit and provide an opinion on the financial statements of a company. D) to prepare a company's annual financial statements and notes. 9) Since financial decision makers usually obtain accounting information from companies wanting loans or selling stock, this creates a potential ________. 9) _______ A) agency problem B) harmonization problem C) expectations gap D) conflict of interest 10) The difference between what the public expects of auditors and what auditors can actually deliver is known as ________. 10) ______ A) an expectations gap B) an information risk C) a business risk D) forensics 11) The risk that financial statements may be materially false and misleading is called ________. 11) ______ A) business risk B) risk assessment C) client risk D) information risk 12) In operational auditing, the auditor studies business operations and makes recommendations about all of the following EXCEPT ________. 12) ______ A) compliance with company policies B) effective achievement of business objectives C) the fairness of the financial statements D) economic and efficient use of resources 13) Auditors on staff in the Office of the Auditor General of Canada (OAG) are considered to be external auditors with respect to the government agencies they audit because the OAG is ________. 13) ______ A) guided by standards similar to GAAS B) organizationally independent C) funded by the federal government D) the accounting and auditing agency of the Canadian Senate 14) In addition to the audit of financial statements, comprehensive governmental auditing may also include audits of efficiency, effectiveness, and ________. 14) ______ A) adequacy B) economy C) accuracy D) fraud 15) An example of a forensic accounting assignment might be ________. 15) ______ A) to provide assurance about the fairness of prospective financial information included in an initial public offering document B) to estimate the value of inventory lost in a warehouse fire C) to ensure compliance with specific legislation D) to provide an opinion about the effectiveness of a government program

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    16) International harmonization is also known as ________. 16) ______ A) independence B) harmony C) critical thinking D) convergence TRUE/FALSE. Write 'T' if the statement is true and 'F' if the statement is false. 17) The concept of three - party accountability means that the auditor is expected to act in the interests of the party paying the audit fee. 17) ______ 18) The role of the auditor is to satisfy users' demand for reliable information. 18) ______ 19) The three underlying conditions affecting users' demand for accounting information are complexity, reliability, and completeness. 19) ______ 20) The assurance function involves the lending of credibility to financial information. 20) ______ 21) An attest engagement involves a public accountant affirming the validity of an assertion. 21) ______ 22) Business risk is the risk that the financial statements do not reflect the economic substance of business activities. 22) ______ 23) A material misstatement is one that would affect a user's decision making. 23) ______ 24) Accounting risk is the part of information risk that is due to incorrectly predicting future events. 24) ______ 25) Forensic accounting does not include fraud auditing. 25) ______ 26) Internal auditing is an independent activity designed to add value and improve an organization's operations. 26) ______ 27) Value - for - money (VFM) audits include testing of compliance with laws and regulations. 27) ______ 28) There are no restrictions on the type of business advisory services a PA firm can provide to a non - audit client. 28) ______ SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question. 29) Why is three - party accountability an important distinguishing feature of auditing? 29) _____________ 30) When does an agency problem occur? 30) _____________ 31) Discuss the underlying conditions affecting users' demand for accounting information. 31) _____________ 32) What is the difference between the American Accounting Association's (AAA) definition of auditing and the Chartered Professional Accountants of Canada (CPA Canada) objectives of financial statement auditing? 32) _____________ 33) What is an attest engagement? 33) _____________ 34) What is a direct reporting engagement? 34) _____________ 35) What is information risk? 35) _____________

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    36) What is operational auditing and who performs it? 36) _____________ 37) Discuss the nature of value - for - money (VFM) audits and give three examples of its application. 37) _____________ 38) Discuss the conflict between the need for an audit firm to perform quality services and its desire to make a profit in the context of the investor's need for reliable information. 38) _____________

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    1) C 2) B 3) C 4) B 5) D 6) D 7) D 8) C 9) D 10) A 11) D 12) C 13) B 14) B 15) B 16) D 17) FALSE 18) TRUE 19) FALSE 20) TRUE 21) TRUE 22) FALSE 23) TRUE 24) TRUE 25) FALSE 26) TRUE 27) FALSE 28) TRUE 29) In three - party accountability, accountability is represented as a three - point relationship among the auditor of the financial information, the management preparing the financial information, and the users of the financial information. This triangle reflects an accountability relationship because management is accountable to the users. However, the users cannot rely on the financial statements because they do not completely trust management. They demand that the financial statements be verified by a competent, independent auditor. Thus, the auditor is also accountable to the user. 30) An agency problem occurs when three conditions are present in an agency relationship: (a) the agent has objectives that are different from those of the principal, (b) the agent has more information than the principal does, and (c) the contract between the two is incomplete in that not every possible contingency can be anticipated. 31) There are three key conditions: complexity of information, remoteness or distance between users from management, and the consequences of bad decisions. First, a company's transactions are increasingly numerous and complicated. Users of financial information are not trained to collect and compile it themselves. They need the services of professional accountants. Second, users of financial information are increasingly separated from a company's accounting records by distance and time as a result of global financial markets. Users need full - time professional accountants to do the work they cannot do for themselves. Finally, financial decisions are important to the state of investors' and other users' wealth, including investors in companies that provide loans or trade credit to other companies. Decisions can involve large dollar amounts, the loss of which may cause a cascade of bankruptcies. Good information, obtained through the financial reports prepared by accountants, is an absolute necessity to reduce the risk of loss. 32) The AAA definition is broad and general - it encompasses external, internal, and governmental auditing. The CICA has not defined auditing per se but has outlined a set of objectives specific to the external audit

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    of fina ncial state ment s. The CPA Canada objectives do not focus on broad assertions about economic events but state that the main objective of an audit is the expression of an opinion on the financial statements. The objectives further assert that the audit of financial statements must be performed in accordance with GAAS (generally accepted auditing standards). The AAA definition does not refer to auditor qualifications and does not specifically addresses either how an audit is performed or how the results are communicated. The first of the eight auditing standards defined by the CPA Canada, the general standard, outlines the qualifications the auditor must have; the next three, the examination standards, outline how the auditor must perform the audit; and the last four, the reporting standards, outline how the auditor should communicate the results. 33) When a public accountant is hired to perform procedures and issue a report resulting from those procedures that affirms the validity of an assertion, this is known as an attest engagement. 34) A type of assurance engagement in which the assertions are implied and not written down in some form. 35) Information risk is the risk that a set of financial statements will be materially false or misleading. As a result, information risk includes failure to properly disclose business risk. 36) Operational auditing is the study of an entity, or a specific unit within an entity, in order to evaluate its performance. The operational auditor reports on whether the entity uses its resources economically and efficiently and whether it achieves its business objectives effectively. Internal auditors normally perform operational audits. However, independent accounting firms as part of their management advisory services also may conduct operational audits. 37) Value - for - money audits involve studies of the management of government organizations, programs, activities, and functions. Their goal is to improve the government's accountability to taxpayers for the effective use of tax dollars. Examples of findings include: 1. Health care: Stronger efforts needed to control undesirable practices by unregulated health - care providers. 2. Education: Need to improve availability of programs for exceptional children. 3. Young offenders: Suggested improved documentation before releasing young offenders. 38) An audit firm needs to be able to pay its staff in line with their abilities. Otherwise, more qualified staff will seek opportunities elsewhere. If they leave, only less qualified people will remain, thus reducing the quality of audit possible. With less qualified people, the audit firm may be unable to express the correct opinion on the fairness of the financial statements. This would tend to increase investors' information risk. One way to have more money to pay staff appropriately is to reduce the amount of time spent on each assignment. More assignments each with less time spent would permit more profit on each assignment. However, reducing the amount of time spent on each audit engagement would also increase the risk that a material error would be missed in the audit. This increases the information risk to investors, which decreases the value of the audit to them and increases the likelihood that they will sue the auditors to recover any investment losses. A constant demand by investors for reduction in information risk means that except in the short term, an auditor cannot reduce the quality of its services. By the same token, there is an equilibrium level of profit for audit firms, and compensation for its staff and partners that investors are willing to provide in exchange for their desired reduction in information risk.

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    Exam Name___________________________________ MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) According to generally accepted auditing standards (GAAS), the overall objective of a financial statement audit is ________. 1) _______ A) to reduce audit risk to an acceptably low level B) to determine whether the financial principles adopted by management in preparing the financial statements are acceptable C) to enable the auditor to express an opinion as to whether the financial statements are prepared in accordance with generally accepted accounting principles D) to obtain reasonable assurance that the financial statements taken as a whole are free from misstatement, whether due to fraud or error 2) Which of the following is the first task that the auditor must accomplish to demonstrate proficiency in auditing? 2) _______ A) Evaluate the evidence gathered in the performance of the audit program and decide whether management's assertions conform to generally accepted accounting principles and reality. B) Identify the evidence relevant for the audit of assertions that are made by management in its unaudited financial statements and notes. C) Recognize the underlying assertions made by management in the financial statements and notes. D) Design an audit program to obtain sufficient appropriate evidence about assertions management makes in financial statements and notes. 3) Auditors try to achieve independence in appearance in order to ________. 3) _______ A) become independent in appearance and in fact B) comply with the generally accepted auditing standards C) maintain an unbiased mental attitude D) maintain public confidence in the profession 4) Control risk is ________. 4) _______ A) the risk that the auditor will not be able to complete the audit on a timely basis B) the risk that the auditor will not properly control the staff on the audit engagement C) the probability that a material misstatement could occur and not be prevented or detected by the company's internal control policies and procedures D) the probability that a material misstatement could occur and not be detected by the auditor's audit procedures 5) The primary purpose of obtaining an understanding of the company's internal controls in the financial statement audit is ________. 5) _______ A) to determine whether the company has changed any accounting principles B) to obtain direct sufficient appropriate audit evidence to afford a reasonable basis for an opinion on the financial statements C) to help the auditors develop the audit program D) to make suggestions to management to improve internal controls 6) An external auditor is conducting an audit of the financial statements of Camden Corporation. The external auditor is expected to ________. 6) _______ A) certify the correctness of Camden's financial statements

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    B) give an opinion on whether Camden's financial statements are fairly presented in all material respects C) give an opinion on the attractiveness of Camden for investment purposes and critique the wisdom and legality of its business decisions D) make a 100% examination of Camden's records 7) Which of the following statements best explains an unmodified report opinion? 7) _______ A) The auditor was not aware of any reasons not to believe the statements are correct. B) Based on the evidence obtained, the auditor believes the statements are free of material error. C) The financial statements contain a departure from GAAP. D) The auditor was unable to complete the work necessary to form a complete opinion. 8) A standard unmodified audit report should be dated ________. 8) _______ A) as at the end of the year the audit work was done B) no earlier than the date when the auditor obtained sufficient appropriate audit evidence supporting the auditor's opinion C) no later than the date when the auditor obtained sufficient appropriate audit evidence supporting the auditor's opinion D) as at the end of the year being reported on 9) Several sources of GAAP consulted by an auditor are in conflict as to the application of an accounting principle. Which of the following should the auditor consider to be the most authoritative? 9) _______ A) Federal legislation. B) Industry practice. C) CPA Canada Exposure Drafts . D) CPA Canada Handbook . 10) The reporting standards require that the auditor explicitly report on whether the financial statements ________. 10) ______ A) used principles that are appropriate for the circumstances B) are in accordance with GAAP C) were prepared on a consistent basis with the comparative year D) contain adequate disclosure of all material matters 11) Because of the risk of material misstatement, an audit of financial statements in accordance with generally accepted auditing standards should be planned and performed with an attitude of ________. 11) ______ A) professional skepticism B) objective judgment C) independent integrity D) impartial conservatism 12) Three - Party Accountability includes all of the following parties except ________. 12) ______ A) Audit Committee B) users C) practitioners D) management 13) Key features of SOX include all of the following except ________. 13) ______ A) increased penalties for corporate wrongdoers B) more timely and extensive financial disclosures C) increased oversight of auditors D) fewer options of recourse for aggrieved shareholders 14) Which of the following has been established to oversee the auditors of public co mpani

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    es? 14) ___ ___ A) Canadian Public Accountability Board. B) Canadian Coalition for Good Governance. C) The SOX Board. D) The Canadian Securities Commission. 15) An assurance engagement is one in which a CPA is engaged to ________. 15) ______ A) provide tax advice or prepare a tax return based on financial information the CPA has not audited or reviewed B) assemble prospective financial statements based on the assumptions of the entity's management without expressing any assurance C) issue a written communication expressing a conclusion concerning a subject matter for which an accountable party is responsible D) testify as an expert witness in accounting, auditing, or tax matters, given certain stipulated facts 16) All of the following are examples of assurance engagements except ________. 16) ______ A) financial statements review B) tax planning C) internal controls statement D) financial statements audit 17) The GAAS general standard relating to the audit of financial statements focuses on all of the following except ________. 17) ______ A) due professional care B) independence C) planning D) competence 18) According to IFAC, which of the following is not one of the elements of quality control? 18) ______ A) Independence. B) Due professional care. C) Acceptance and continuance of clients. D) Supervision. 19) In establishing a quality control system, which area should be of a secondary nature? 19) ______ A) Creating an internal review process. B) Controlling access to client files. C) Creating an independence and objectivity checklist. D) Creating a program for continuing professional education. 20) Williams & Co., a large international CPA firm, will be subject to an external peer review. The peer review will most likely be performed by ________. 20) ______ A) peer review staff of the Ontario Securities Commission B) employees and partners of another CPA firm C) employees and partners of Williams & Co. who are not associated with the particular audits being reviewed D) peer review staff of CPA Canada 21) A report giving conclusions about a firm's compliance with quality control standards is typical of which of the following? 21) ______ A) Quality review. B) Quality inspection. C) Peer review. D) Practice inspection. TRUE/FALSE. Write 'T' if the statement is true and 'F' if the statement is false.

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    22) Practice standards are a general set of standards intended to guide the audits of financial statements. 22) ______ 23) The CPA Canada Handbook recommendations are a step - by - step list of procedures auditors have to complete for each engagement. 23) ______ 24) The general standard of GAAS relates primarily to the personal integrity and professional qualifications of auditors. 24) ______ 25) Control risk is the risk that an accounting firm's quality control standards will not be adequate. 25) ______ 26) The fourth reporting standard requires the audit report to comment on the consistency of the accounting principles used in preparing the financial statements. 26) ______ 27) Audit risk is the risk that an auditor expresses an inappropriate audit opinion when the financial statements are materially misstated. 27) ______ 28) Reliance on self - regulation of the accounting profession has changed as a result of its perceived failure to detect the problems leading to the corporate scandals of 2002/2003. 28) ______ 29) Appropriate audit evidence, to be reliable and relevant, must be quantitative, objective, and absolutely compelling. 29) ______ 30) A prospectus is the information, usually including financial information, about a firm that accompanies any new issuance of shares in a regulated securities market. 30) ______ 31) The assessment of materiality has a pervasive impact on the audit. 31) ______ 32) Audit committees monitor management's financial reporting responsibilities. 32) ______ 33) Practice inspection is something a new auditor does as part of his or her training program. 33) ______ SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question. 34) Alan Fallon was recently promoted to senior accountant. He was put in charge of the Mellow Markets audit because of his experience with other grocery clients. Mellow Markets has a small, but growing chain of natural food stores. This is the first year Mellow Markets has been audited. Because of its growth, Mellow needs additional capital. Mellow intends to take its audited financial statements to a bank to secure a loan. Alan has been assigned two inexperienced staff assistants for the audit. Because this is his first audit as a senior, he intends to bring the job in on budget. To save time, he gave the assistants the audit program for Happy Time Food Stores. He told his staff that this would make things go more quickly. He also told them that he could not spend much time with them at the client's place of business because "my time is billed out at such a high rate, we'll go right over budget." He did call them once a day from another audit on which he was working. The assistants told Alan that the audit program did not always match up with what they found at Mellow Markets. Alan responded, "Just cross out whatever is not relevant in the au dit pro gra m an d do n't ad d an yth ing - it wil l only make us go over the budget." When Alan came out near the end of fieldwork, one assistant communicated her concern that they had not attended the inventory counts at any of the

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    out - of - t own location s of Mellow Markets . The audit program had stipulate d that inventor y should be observe d for in - town stores only. Happy Time had only one store not in town while Mellow Markets had three of their five stores in other cities. Alan told the assistant to get inventor y sheets from the client for the other stores. He added, "Make sure that the inventory balance in the general ledger agrees with the total for all the inventory sheets." The next day, Alan reviewed all work papers and submitted the job for review by the manager. Required: A. Describe three GAAS examination standards. B. Do you believe that the Mellow Markets audit is in compliance with these standards? Explain. 34) _____________

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    35) What is the difference between audit procedures and audit standards? 35) _____________ 36) What is a quality inspection? 36) _____________

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    1) C 2) C 3) D 4) C 5) C 6) B 7) B 8) B 9) D 10) B 11) A 12) A 13) D 14) A 15) C 16) B 17) C 18) B 19) A 20) B 21) C 22) TRUE 23) FALSE 24) TRUE 25) FALSE 26) FALSE 27) TRUE 28) TRUE 29) FALSE 30) TRUE 31) TRUE 32) TRUE 33) FALSE 34) A. The examination standards are outlined below. 1. The work should be adequately planned and properly executed using sufficient knowledge of the entity's business as a basis. If assistants are employed, they should be properly supervised. 2. A sufficient understanding of internal control should be obtained to plan the audit. When control risk is assessed below maximum, sufficient appropriate audit evidence should be obtained through tests of controls to support the assessment. 3. Sufficient appropriate audit evidence should be obtained, by such means as inspection, observation, enquiry, confirmation, computation, and analysis, to afford a reasonable basis to support the content of the report. B . 1. The Mellow Markets audit is not in compliance with these standards. A proper audit program was not prepared. This, along with the emphasis on cutting time, means that it is also doubtful that a meaningful knowledge of the client's business was obtained. It appears that the planning portion of the first

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    exa mina tion stan dard was clear ly viola ted. The lack of time and attention the inexperienced staff received from Alan Fallon is indicative of a violation of the supervision part of the first examination standard. 2. There is no indication of any steps taken to understand, evaluate, or test the internal control of Mellow Markets. This is a violation of the second examination standard. 3. The third examination standard also seems to have been violated. First, the deficiencies in meeting the first two examination standards suggest that the auditors could not have obtained sufficient appropriate evidence. In addition, the failure to observe any of the inventory counts in other cities is an additional deficiency - particularly since Mellow is a new client. Finally, ensuring that the inventory sheets agree with the balance in the general ledger account is merely a first step in the audit of inventory. By itself it is not sufficient appropriate evidence. 35) Audit standards are audit - quality recommendations that remain the same over time for all audits. Audit procedures, on the other hand, are quite different and include the particular specialized actions auditors take to obtain evidence in a specific audit engagement. 36) A quality inspection is an examination and evaluation of the quality of the overall practice. It is thus aimed at the firm level rather than at individuals. It involves extensive study of a firm's quality control document and includes interviews with audit personnel as well as a detailed study of the quality of work, adherence to GAAS, and quality control standards on a selection of audit engagements.

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    Exam Name___________________________________ MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) Which of the following philosophical principles in ethics places emphasis on the importance of following rules rather than on weighing the consequences of actions? 1) _______ A) Moral principle. B) Utilitarian principle. C) Kantian principle. D) Consequentialism principle. 2) Which of the following philosophical principles of ethics places emphasis on the consequences of action, rather than on following the rules? 2) _______ A) Moral principle. B) Imperative principle. C) Utilitarianism principle. D) Generalization principle. 3) What is a key characteristic of critical thinking? 3) _______ A) It requires making the right assumptions to support an argument. B) It requires a questioning mind. C) It is a means of picking out things wrong with another person's argument. D) It is a means of eliminating alternatives to arrive at one right answer. 4) The goal of the critical - thinking framework reflects ________. 4) _______ A) skepticism B) independence C) ideal audit virtues D) ethics 5) What is the meaning of the rule of professional conduct that requires an auditor to be objective? 5) _______ A) The auditor has an obligation to CPA Canada to not use his or her training for personal advantage. B) The auditor must have an attitude of professional skepticism toward an auditee's management. C) The auditor may have a material, indirect financial interest in a client's business as long as it does not affect his or her judgment. D) The auditor has an obligation to serve the needs of the audit client. 6) The CPA Ontario Rules of Professional Conduct contain both general ethical principles that are idealistic in character and also a ________. 6) _______ A) list of specific acts discreditable to the profession B) description of the procedures to be followed by a member who must respond to an inquiry from the disciplinary committee C) set of specific, mandatory rules describing minimum levels of conduct required of members D) list of violations that would cause the automatic suspension of a member's license 7) Which of the following items is the most important principle in the "fundamental statements of accepted conduct"? 7) _______ A) Maintain independence. B) Act with professional courtesy. C) Maintain the reputation of the profession. D) Act with due care. 8) A complaint has been made against a member for an audit failure. If this complaint is fo und to

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