After testing a client's internal control activities, an auditor discovers a number of significant deficiencies in the operation of a client's internal controls. Under these circumstances the auditor most likely would:
Answer(s): B
Choice "b" is correct. The auditor uses tests of controls to evaluate control risk. In situations where there are a number of significant deficiencies in the operation of the client's internal controls, the auditor would increase the assessment of control risk (and the risk of material misstatement) and revise substantive testing accordingly (for example, by increasing the extent of substantive tests). Choice "a" is incorrect. An auditor is required to communicate significant deficiencies to management and those charged with governance, and a disclaimer of opinion on the effectiveness of controls would be included in this communication. However, such disclaimer would not be part of the auditor's report on the financial statements.Choice "c" is incorrect. Since the auditor's report provides an opinion on the financial statements (and not on internal control), significant deficiencies in internal control do not result in a qualified opinion.Choice "d" is incorrect. The auditor need not withdraw from an audit simply because internal controls are ineffective, but rather would increase the assessment of control risk and revise substantive testing accordingly.
In which of the following circumstances is substantive testing of accounts receivable before the balance sheet date most appropriate?
Choice "b" is correct. The higher the auditor's risk assessment, the closer to period end substantive procedures should be performed. Conversely, effective controls reduce control risk and reduce the risk of material misstatement, allowing more interim testing to occur. Choice "a" is incorrect. A new sales incentive program results in an increase in the risk of material misstatement, making it less likely that interim testing will be performed.Choice "c" is incorrect. High turnover of senior management results in an increase in the risk of material misstatement, making it less likely that interim testing will be performed. Choice "d" is incorrect. In the first engagement of a new client, the auditor will have less knowledge of the client and therefore would be less inclined to utilize interim testing, which increases audit risk.
What is the most likely course of action that an auditor would take after determining that performing substantive tests on inventory will take less time than performing tests of controls?
Answer(s): C
Choice "c" is correct. If it would take less time to perform substantive tests than it would to perform tests of controls, and if there is no other reason to test controls (i.e., if there is not a high degree of electronic processing), the auditor would not be likely to test controls. Choice "a" is incorrect. In order to assess control risk at a low level, tests of controls would need to be performed. However, if it is more efficient to perform substantive tests, the auditor would not be likely to test controls.Choice "b" is incorrect. If it would take less time to perform substantive tests than it would to perform tests of controls, and if there is no other reason to test controls (i.e., if there is not a high degree of electronic processing), the auditor would not be likely to test controls. Choice "d" is incorrect. Substantive procedures are always be necessary for all assertions relevant to material transaction classes, account balances, and disclosures. Assuming inventory is material, tests of controls alone would not be sufficient.
Which of the following procedures would an auditor least likely perform before the balance sheet date?
Answer(s): A
Choice "a" is correct. The auditor should consider whether the year-end balances of the particular asset or liability accounts that might be selected for interim examination are reasonably predictable with respect to amount, relative significance, and composition. Accounts payable is relatively difficult to predict because it may fluctuate at management's discretion.Choice "b" is incorrect. The auditor should consider whether the year-end balances of the particular asset or liability accounts that might be selected for interim examination are reasonably predictable with respect to amount, relative significance, and composition. Inventory is relatively predictable with respect to amount, composition and relative significance. Choice "c" is incorrect. During planning, the auditor is required to obtain an understanding of the entity and its environment, including its internal control, and to assess risk. Such preliminary planning is often conducted prior to the balance sheet date. Choice "d" is incorrect. Audit testing at interim dates may permit early consideration of significant matters affecting the year-end financial statements, such as the identification of related parties.Supplemental Questions
Which of the following factors are included in an entity's control environment?
Answer(s): D
Choice "d" is correct. Yes - Yes - Yes. An entity's control environment includes participation of those charged with governance, management's philosophy, and the organizational structure.
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