TABLE OF CONTENTS

I.

THE AUDITING PROFESSION.

1. The Demand for Audit and Other Assurance Services.
2. The CPA Profession.
3. Audit Reports.
4. Professional Ethics.
5. Legal Liability.

II.

THE AUDIT PROCESS.

6. Audit Responsibilities and Objectives.
7. Audit Evidence.
8. Audit Planning and Analytical Procedures.
9. Materiality and Risk.
10. Internal Control and Control Risk.
11. Fraud Auditing
12. The Impact of Information Technology on the Audit Process.
13. Overall Audit Plan and Audit Program.

III.

APPLICATION OF THE AUDIT PROCESS TO THE SALES AND COLLECTION

CYCLE.
14. Audit of the Sales and Collection Cycle: Tests of Controls and Substantive Tests of
Transactions.
15. Audit Sampling for Tests of Controls and Substantive Tests of Transactions.
16. Completing the Tests in the Sales and Collection Cycle: Accounts Receivable.
17. Audit Sampling for Tests of Details of Balances.

IV.

APPLICATION OF THE AUDIT PROCESS TO OTHER CYCLES.

18. Audit of the Payroll and Personnel Cycle.
19. Audit of the Acquisition and Payment Cycle: Tests of Controls, Substantive Tests of
Transactions, and Accounts Payable.
20. Completing the Tests in the Acquisition and Payment Cycle: Verification of Selected
Accounts.
21. Audit of the Inventory and Warehousing Cycle.
22. Audit of the Capital Acquisition and Repayment Cycle.
23. Audit of Cash Balances.

V.

COMPLETING THE AUDIT.

24. Completing the Audit.

VI.

OTHER ASSURANCE AND NONASSURANCE SERVICES.

25. Other Assurance Services.
26. Internal and Governmental Financial Auditing and Operational Auditing.

Note to Instructors
This test bank includes selected questions that relate only to the audits of public companies and to
the Sarbanes-Oxley Act. These questions are denoted by (Public) and (SOX) to the right of
the question number. Unless otherwise stated, all other questions are applicable to audits of public
and private companies.

CHAPTER 1
Multiple-Choice Questions
1.
easy
c

The process of recording, classifying, and summarizing economic events in a logical manner
for the purpose of providing financial information for decision-making is
a. finance.
b. auditing.
c. accounting.
d. economics.

2.
easy
b

To be independent of other business functions, internal auditors should report to any but which
of the following?
a. Company president.
b. Vice president of sales.
c. Audit committee of the board of directors.
d. Board of directors.

3.
easy
b

Any service in which the CPA firm issues a report about the reliability of an assertion that is
made by another party is a(n)
a. accounting and bookkeeping service.
b. attestation service.
c. management advisory service.
d. tax service.

4.
easy
a

Three common types of attestation services are

a. audits, reviews, and other attestation services.
b. audits, verifications, and other attestation services.
c. reviews, verifications, and other attestation services.
d. audits, reviews, and verifications.

5. (SOX)
easy
d

The organization that is responsible for providing oversight for auditors of public companies is
called the ________.
a. Auditing Standards Board.
b. American Institute of Certified Public Accountants.
c. Public Oversight Board.
d. Public Company Accounting Oversight Board.

6. (SOX)
easy
c

The provisions of the Sarbanes-Oxley Act apply to which of the following companies?
a. All companies.
b. Privately-held companies.
c. Public companies.
d. All public companies and privately-held companies with assets greater than $250 million.

7.
medium
d

Providing quantitative information that management and others can use to make decisions is
the function of
a. management information systems.
b. auditing.
c. finance.
d. accounting.

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8.
medium
d

The statements most commonly included in an audit of financial statements are the
a. statement of financial position, the income statement, and the statement of changes in
financial position.
b. income statement, the statement of changes in financial position, and the statement of net
working capital.
c. statement of changes in financial position, the statement of cash flows, and the retained
earnings statement.
d. statement of financial position, the income statement, and the statement of cash flows.

9.
medium
d

Certified public accounting (CPA) firms provide audit services for all, but which of the
following entities?
a. Privately-held companies.
b. Corporations listed on the New York Stock Exchange.
c. Public companies.
d. CPA firms provide audit services for all of these entity types.

10.
medium
b

The use of the title Certified Public Accountant (CPA) is regulated by

a. the federal government through the licensing department of the Commerce Department.
b. state law through a licensing department/agency of each state.
c. the American Institute of Certified Public Accountants (AICPA) through the licensing
departments of the tax and auditing committees.
d. the Securities and Exchange Commission (SEC).

11.
medium
c

A typical objective of an operational audit is to

a. determine whether the financial statements fairly present the entitys operations.
b. evaluate the feasibility of attaining the entitys operational objectives.
c. make recommendations for improving performance.
d. report on the entitys relative success in attaining profit maximization.

12.
medium
d

An audit of financial statements is conducted to determine whether the

a. organization is operating efficiently and effectively.
b. entity is following specific procedures or rules set down by some higher authority.
c. members of the management team are fulfilling their fiduciary responsibilities to
shareholders.
d. none of the above.

13.
medium
a

An examination of part of an organizations procedures and methods for the purpose of

evaluating efficiency and effectiveness is what type of audit?
a. Operational audit.
b. Compliance audit.
c. Financial statement audit.
d. Production audit.

14.
medium
b

An audit to determine whether an entity is following specific procedures or rules set down by
some higher authority is classified as a(n)
a. audit of financial statements.
b. compliance audit.
c. operational audit.
d. production audit.

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15.
medium
d

Evidence may take which of the following forms?

a. Oral responses to the auditor from employees of the company under audit.
b. Written communications from company employees or outsiders.
c. Observations made by an auditor.
d. Evidence may take any of the above forms.

16.
medium
a

Which of the following services provides the lowest level of assurance about a companys
financial statements?
a. Review of financial statements.
b. Audit of financial statements.
c. These services provide no assurance about a companys financial statements.
d. These services provide the same level of assurance about a companys financial
statements.

17.
medium
a

The criteria for evaluating quantitative information vary. For example, in the audit of historical
financial statements by CPA firms, the criteria are usually
a. accounting principles generally accepted in the United States.
b. auditing standards generally accepted in the United States.
c. regulations of the Internal Revenue Service.
d. regulations of the Securities and Exchange Commission.

18.
medium
a

In auditing financial accounting data, the primary concern is with

a. determining whether recorded information properly reflects the economic events that
occurred during the accounting period.
b. determining if fraud has occurred.
c. determining if taxable income has been calculated correctly.
d. analyzing the financial information to be sure that it complies with government
requirements.

19.
medium
a

The Special Committee on Assurance Services was formed by the AICPA to

a. research and develop new assurance services opportunities for CPAs.
b. identify methods of reducing the incidence of lawsuits against CPAs.
c. investigate methods of increasing audit effectiveness and efficiency.
d. discover methods of reducing the expectation gap.

20.
challenging
c

Which of the following services is not a Trust Services Principle as developed by the AICPA
and CICA?
a. Online privacy.
b. Availability.
c. Functional integrity.
d. Security.

21.
challenging
c

Which one of the following is more difficult to evaluate objectively?

a. Presentation of financial statements in accordance with generally accepted accounting
principles.
b. Compliance with government regulations.
c. Efficiency and effectiveness of operations.
d. All three of the above are equally difficult.

22. (SOX)
challenging
c

The Sarbanes-Oxley Act prohibits a CPA firm that audits a public company from providing
which of the following types of services to that company?
a. Reviews of quarterly financial statements.
b. Preparation of corporate tax returns.
c. Most consulting services.
d. All of above are prohibited services.
Which of the following audits can be regarded as being solely a compliance audit?
a. Internal Revenue Service Agents examinations of the returns of taxpayers.
b. GAO auditors evaluation of the computer operations of governmental units.

23.
challenging
a

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c.
d.

An internal auditors review of his employers payroll authorization procedures.

An independent CPA firms audit of the local school district.

24.
challenging
b

Which of the following can be significantly affected by an audit?

a. Business risk.
b. Information risk.
c. The risk-free interest rate.
d. All of these.

25.
challenging
a

To operate effectively, an internal auditor must be independent of

a. the line functions of the organizations.
b. the entity.
c. the employer-employee relationship which exists for other employees in the organization.
d. all of the above.

26.
challenging
d

The trait that distinguishes auditors from accountants is the

a. auditors ability to interpret accounting principles generally accepted in the United States.
b. auditors education beyond the Bachelors degree.
c. auditors ability to interpret FASB Statements.
d. auditors accumulation and interpretation of evidence related to a companys financial
statements.

27
challenging
a

Other assurance services are similar to, yet differ somewhat from, attestation services. When
performing other assurance services, the CPA
a. is not required to issue a written report, and the assurance is about the reliability and
relevance of information.
b. is required to issue a written report, and the assurance is about the reliability and
relevance of information.
c. is not required to issue a written report, and the assurance is about the completeness and
sufficiency of information.
d. is required to issue a written report, and the assurance is about the completeness and
sufficiency of information.

Essay Questions
28.
easy

Discuss the three primary requirements for becoming a CPA.

29.
easy

Two types of attestation services provided by CPA firms are audits and reviews. Discuss the
similarities and differences between these two types of attestation services. Which type
provides the least assurance?

Answer:
The three primary requirements for becoming a CPA are:
Educational requirement. An undergraduate degree with a major in accounting is
required. Most states now require 150 semester hours for licensure and some states
require 150 semester hours before taking the CPA exam.
Uniform CPA examination requirement. This is a four part exam that is comprised of
components on auditing and attestation, financial accounting and reporting,
regulation, and business environment and concepts.
Experience requirement. The experience requirement varies from state to state with
some states requiring no experience, while other states require up to two years of
audit experience.

Answer:
Two primary types of attestation services are: audits of historical financial statements and

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reviews of historical financial statements. While both services involve the accumulation
and evaluation of evidence regarding assertions made by management in the companys
financial statements, a review involves a less extensive examination and provides a lower
level of assurance about the clients financial statements than an audit.
30.
medium

Discuss the differences and similarities between the roles of accountants and auditors. What
additional expertise must an auditor possess beyond that of an accountant?
Answer:
The role of accountants is to record, classify, and summarize economic events in a logical
manner for the purpose of providing financial information for decision-making. To do
this, accountants must have a sound understanding of the principles and rules that
provide the basis for preparing the financial information. In addition, accountants are
responsible for developing systems to ensure that the entitys economic events are
properly recorded on a timely basis and at a reasonable cost.
The role of auditors is to determine whether the financial information prepared by
accountants properly reflects the economic events that occurred. To do this, the auditor
must not only understand the principles and rules that provide the basis for preparing
financial information, but must also possess expertise in the accumulation and evaluation
of audit evidence. It is this latter expertise that distinguishes auditors from accountants.

31.
medium

Discuss the similarities and differences between financial statement audits, operational audits,
and compliance audits. Give an example of each type.
Answer:
Financial statement audits, operational audits, and compliance audits are similar in that
each type of audit involves accumulating and evaluating evidence about information to
ascertain and report on the degree of correspondence between the information and
established criteria. The differences between each type of audit are the information being
examined and the criteria used to evaluate the information. An example of a financial
statement audit would be the annual audit of IBM Corporation, in which the external
auditors examine IBMs financial statements to determine whether those financial
statements are stated in accordance with U.S. and generally accepted accounting
principles. An example of an operational audit would be an internal auditors evaluation
of whether the companys computerized payroll-processing system is operating efficiently
and effectively. An example of a compliance audit would be an IRS auditors examination
of an entitys federal tax return to determine the degree of compliance with the Internal
Revenue Code.

32.
medium

Discuss the similarities and differences between the roles of independent auditors, GAO
auditors, internal revenue agents, and internal auditors.
Answer:
The roles of all four types of auditors are similar in that they involve the accumulation
and evaluation of evidence about information to ascertain and report on the degree of
correspondence between the information and established criteria. The differences in their
roles center around the information audited and the criteria used to evaluate that
information. Independent auditors primarily audit companies financial statements. GAO
auditors primary responsibility is to perform the audit function for Congress. IRS
auditors are responsible for the enforcement of federal tax laws. Internal auditors
primarily perform operational and compliance audits for their employing company.

33. (SOX)
medium

What is an engagement to attest on internal control over financial reporting?

Answer:

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Section 404 of the Sarbanes-Oxley Act requires public companies to report managements
assessment of the effectiveness of internal control over financial reporting. The Act
further requires auditors to attest to the effectiveness of internal control over financial
reporting. This evaluation, which is integrated with the audit of financial statements,
provides forward-looking information, because effective internal controls reduce the
likelihood of future misstatements in the financial statements.
34.
challenging

To do an audit, it is necessary for there to be information in a verifiable form and some criteria
by which the auditor can evaluate the information. (A) What information and criteria would an
independent CPA firm use when auditing a companys historical financial statements? (B)
What information and criteria would an Internal Revenue Service auditor use when auditing
that same companys tax return? (C) What information and criteria would an internal auditor
use when performing an operational audit to evaluate whether the companys computerized
payroll processing system is operating efficiently and effectively?
Answer:
(A) The information used by a CPA firm in a financial statement audit is the financial
information in the companys financial statements. The criteria used are accounting
principles generally accepted in the United States.
(B) The information used by an IRS auditor is the financial information in the auditees
federal tax return. The criteria are the internal revenue code and interpretations.

35.
challenging

(C) The information used by an internal auditor when performing an operational audit of
the payroll system could include various items such as the number of errors made, costs
incurred by the payroll department, and number of payroll records processed each month.
The criteria would consist of company standards for departmental efficiency and
effectiveness.
Explain what is meant by information risk, and discuss the four causes of this risk.
Answer:
Information risk is the possibility that information upon which a business decision is
made is inaccurate. Four causes of information risk are:
remoteness of information,
biases and motives of the provider,
voluminous data, and
complex exchange transactions.

36.
challenging

Discuss four factors that are likely to significantly reduce information risk in the next five to
ten years.
Answer:
Four factors that are likely to significantly reduce information risk in the next five to ten
years are:
technological advances,
more companies will go on-line, reducing the risk of investors obtaining outdated
information,
new accounting and auditing standards, and
auditors will find more efficient and effective audit techniques.

Other Objective Answer Format Questions

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37.
easy
b

The criteria by which an auditor evaluates the information under audit may not vary regardless
of the information being audited.
a. True
b. False

38.
easy
b

The criteria used by an external auditor to evaluate published financial statements are known
as generally accepted auditing standards.
a. True
b. False

39. (SOX)
easy
b

The Sarbanes-Oxley Act establishes standards related to the audits of privately-held

companies.
a. True
b. False

40. (SOX)
easy
a

The Sarbanes-Oxley Act is widely viewed as having ushered in sweeping changes to auditing
and financial reporting.
a. True
b. False

41.
easy
a

All companies filing annually with the Securities and Exchange Commission are required to
have an annual external audit.
a. True
b. False

42.
medium
a

The financial statements most commonly audited by external auditors are the balance sheet,
the income statement, and the statement of cash flows.
a. True
b. False

43.
medium
b

The primary purpose of an operational audit is to determine whether the overall financial
statements are in compliance with generally accepted accounting principles.
a. True
b. False

44.
medium
a

Results of compliance audits are typically reported to someone within the organizational unit
being audited rather than to a broad spectrum of outside users.
a. True
b. False

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45.
medium
b

The primary role of the United States General Accounting Office is the enforcement of the
federal tax laws as defined by Congress and interpreted by the courts.
a. True
b. False

46.
medium
b

CPA firms are never allowed to provide bookkeeping services for audit clients.
a. True
b. False

47. (SOX)
challenging
a

The Sarbanes-Oxley Act requires a companys CEO and CFO to certify the companys
financial statements.
a. True
b. False
The criteria that is most likely to be used as a framework in evaluating a companys internal
control over financial reporting under Section 404 of the Sarbanes-Oxley Act is Internal
Control - Integrated Framework.
a. True
b. False

48. (SOX)
challenging
a

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