Which of the following statements is correct regarding the auditor's consideration of the possibility of illegal acts by clients?
Answer(s): C
Choice "c" is correct. If specific information concerning a possible illegal act comes to the auditor's attention, the auditor should apply additional audit procedures to determine whether an illegal act has in fact occurred.Choice "a" is incorrect. The auditor has a responsibility to plan and perform the audit to obtain reasonable assurance that the financial statements are free of material misstatement. This is a different level of assurance than stating that "no illegal acts" have been committed by clients, since it is possible for an immaterial illegal act (for example a theft of a few dollars from the petty cash fund) to occur and not be identified by the auditor.Choice "b" is incorrect. The auditor's training, experience, and understanding of the client may not be sufficient to provide a basis for the determination as to whether illegal acts (especially indirect effect illegal acts) have occurred.Choice "d" is incorrect. If an illegal act has occurred, but the act has been properly accounted for and/or disclosed, there would be no need to express a qualified opinion or an adverse opinion.Risk Assessment
In an audit of financial statements in accordance with generally accepted auditing standards, an auditor is required to:
Answer(s): A
Choice "a" is correct. The auditor is required to document key elements of the understanding of the entity and its environment, including each of the components of internal control. Choice "b" is incorrect. Auditors are not required to search for significant deficiencies in the operation of internal control. They are merely required to report such conditions discovered during the audit to those charged with governance.Choice "c" is incorrect. Auditors are not required to perform tests of controls unless they plan to place reliance on a particular control. Since auditors are not required to rely on the client's controls, tests of controls are generally not required.Choice "d" is incorrect. The auditor generally is not required to determine whether the client's controls operated effectively to prevent or detect material errors. Such determination would only be required for controls on which the auditor plans to rely.
The audit plan usually cannot be finalized until the:
Choice "a" is correct. The auditor should obtain a sufficient understanding of the entity and its environment, including its internal control, to plan the audit of the entity's financial statements. Choice "b" is incorrect. The representation letter is not obtained until the end of the audit. Choice "c" is incorrect. Informing those charged with governance of significant deficiencies in internal control generally occurs during or at the completion of the audit. It is not required before completion of the audit plan.Choice "d" is incorrect. The search for unrecorded liabilities typically takes places after year-end, while the audit plan is prepared during planning. Information obtained from the search is not needed to finalize the audit plan.
The primary objective of procedures performed to obtain an understanding of the entity and its environment is to provide an auditor with:
Choice "a" is correct. The auditor should obtain an understanding of the entity and its environment sufficient to assess the risk of material misstatement and to design and perform further audit procedures.Choice "b" is incorrect. Assessing inherent risk is not the primary objective of obtaining an understanding of the entity and its environment.Choice "c" is incorrect. Obtaining an understanding of the entity and its environment is not a sufficient basis for issuing an audit opinion.Choice "d" is incorrect. Procedures performed to gain an understanding of the entity and its environment would not ordinarily test the consistency of the application of management's policies. If the auditor intends to rely on a control, its consistency in application would then be tested.
If an auditor's risk assessment is based on the effective operation of controls, the auditor will likely:
Choice "c" is correct. Assessing risk based on the effective operation of controls involves (1) identifying specific internal controls relevant to specific assertions that are likely to prevent or detect material misstatements in those assertions, and (2) performing tests of such controls to evaluate their effectiveness.Choice "a" is incorrect. Analytical procedures are used for planning purposes, as substantive tests, or as a final overall review. They are not used to support a risk assessment based on the effective operation of controls.Choice "b" is incorrect. Tests of details of transactions and account balances to identify potential errors and fraud are substantive tests. They are not used to support a risk assessment based on the effective operation of controls.Choice "d" is incorrect. The auditor may not assess risk based on the effective operation of controls unless tests of controls are performed. However, if the audit effort required to perform tests of controls exceeds the potential reduction in substantive testing, tests of controls will not be performed because doing so would reduce audit efficiency.
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