Contemporary Auditing II Exam
Contemporary Auditing II expands on key audit concepts, focusing on financial reporting, internal controls, and Electronic Data Processing (EDP) systems. The course emphasizes auditing critical cycles, such as personnel and payroll, inventory, and capital acquisitions. Auditors evaluate internal controls to prevent fraud, ensuring payroll accuracy and inventory protection through segregation of duties.
A major aspect of the course is assessing financial statements and related accounts, including accounts payable, depreciation, and revenue recognition. Audit procedures involve substantive testing, confirmations, and reconciliations to detect misstatements. Auditors also examine management representation letters, working papers, and forensic auditing techniques to identify fraud risks and material weaknesses.
Audit opinions are issued based on findings, including unmodified, qualified, adverse, or disclaimers. Assurance services provide varying confidence levels, with audits offering the highest assurance. Ethics and legal responsibilities guide audit practices, ensuring compliance with regulatory standards. The course strengthens analytical skills to assess financial integrity and mitigate risks effectively.
Sample Questions and Answers
Which of the following controls is most effective in detecting payroll fraud?
A) Segregation of duties between payroll preparation and distribution
B) Allowing only one employee to prepare and authorize payroll
C) Relying on employees to report payroll errors
D) Not reviewing payroll registers regularly
Answer: A) Segregation of duties between payroll preparation and distribution
Explanation: Segregating duties reduces the risk of fraud and errors by ensuring that no single employee controls all aspects of payroll.
What is the auditor’s primary responsibility concerning internal controls in an integrated audit?
A) To design the company’s internal control framework
B) To provide absolute assurance that controls are effective
C) To assess and report on the effectiveness of internal controls over financial reporting
D) To monitor internal control implementation daily
Answer: C) To assess and report on the effectiveness of internal controls over financial reporting
Explanation: Auditors evaluate internal controls to determine whether they provide reasonable assurance regarding financial reporting accuracy.
Which document is most important for verifying the completeness of inventory during an audit?
A) Sales invoice
B) Receiving report
C) Bank reconciliation
D) Fixed asset ledger
Answer: B) Receiving report
Explanation: Receiving reports help ensure that all inventory received is recorded in financial statements.
Which of the following is an example of an inherent risk in auditing the revenue cycle?
A) Overstated revenues to meet earnings targets
B) Errors in bank reconciliations
C) Ineffective IT security controls
D) Lack of proper authorization for expense payments
Answer: A) Overstated revenues to meet earnings targets
Explanation: Management may have incentives to manipulate revenue figures, increasing the inherent risk of misstatement.
Which of the following procedures would be most useful in detecting fictitious employees on the payroll?
A) Reviewing employee background checks
B) Comparing payroll records to HR files
C) Conducting an internal survey
D) Increasing salaries based on seniority
Answer: B) Comparing payroll records to HR files
Explanation: Comparing records ensures that all employees being paid are legitimate and exist in HR records.
What is the primary purpose of an audit engagement letter?
A) To provide a detailed audit report
B) To outline the scope, timing, and responsibilities of the audit
C) To replace management’s responsibilities for financial reporting
D) To provide legal protection for the company against auditor errors
Answer: B) To outline the scope, timing, and responsibilities of the audit
Explanation: The engagement letter defines expectations and responsibilities for both the auditor and the client.
Which of the following is an example of an assurance service provided by auditors?
A) Bookkeeping services
B) Compilation of financial statements
C) Internal control audits
D) Tax preparation
Answer: C) Internal control audits
Explanation: Assurance services, such as internal control audits, provide confidence about an entity’s processes and compliance.
In which scenario would an auditor issue a disclaimer of opinion?
A) When financial statements are materially misstated
B) When sufficient audit evidence cannot be obtained
C) When management disagrees with the auditor’s findings
D) When the auditor finds minor misstatements
Answer: B) When sufficient audit evidence cannot be obtained
Explanation: A disclaimer is issued when an auditor is unable to obtain enough evidence to form an opinion.
Which of the following best describes a key element of professional ethics for auditors?
A) Confidentiality in client relationships
B) Accepting contingent fees for audit services
C) Always following client instructions
D) Prioritizing client relationships over regulatory compliance
Answer: A) Confidentiality in client relationships
Explanation: Auditors must maintain confidentiality and act with integrity and objectivity.
Which procedure is most effective in detecting an overstated ending inventory balance?
A) Confirming accounts payable balances
B) Performing an analytical review of inventory turnover
C) Reviewing depreciation schedules
D) Tracing transactions to the sales journal
Answer: B) Performing an analytical review of inventory turnover
Explanation: An unusually low inventory turnover rate may indicate overstatement.
Which of the following laws governs auditors’ responsibilities in financial fraud cases?
A) The Sarbanes-Oxley Act
B) The Federal Reserve Act
C) The Securities Act of 1933
D) The Uniform Commercial Code
Answer: A) The Sarbanes-Oxley Act
Explanation: SOX establishes auditor responsibilities in financial fraud prevention and reporting.
Which audit procedure is best for verifying the accuracy of payroll expenses?
A) Tracing payroll register amounts to bank statements
B) Sending confirmations to customers
C) Reviewing stock purchase agreements
D) Examining marketing expense accounts
Answer: A) Tracing payroll register amounts to bank statements
Explanation: This ensures payroll transactions are properly recorded and processed.
Which assertion is most at risk when management has an incentive to overstate earnings?
A) Completeness
B) Valuation
C) Existence
D) Occurrence
Answer: D) Occurrence
Explanation: Management may record fictitious transactions to overstate revenue, affecting the occurrence assertion.
What is the primary objective of substantive testing in an audit?
A) To assess internal controls
B) To detect material misstatements in financial statements
C) To evaluate employees’ ethical behavior
D) To improve management decision-making
Answer: B) To detect material misstatements in financial statements
Explanation: Substantive tests are performed to gather evidence regarding the accuracy of financial statement assertions.
Which of the following procedures would best identify unrecorded liabilities?
A) Reviewing cash disbursements after year-end
B) Examining expense reports of executives
C) Sending confirmations to customers
D) Tracing sales transactions to shipping documents
Answer: A) Reviewing cash disbursements after year-end
Explanation: Payments made after year-end may indicate liabilities that were not recorded before the period closed.
An auditor discovers that inventory records are overstated. What is the likely impact on financial statements?
A) Understated revenue
B) Overstated net income
C) Overstated accounts payable
D) Understated assets
Answer: B) Overstated net income
Explanation: Overstated inventory reduces cost of goods sold, leading to an inflated net income.
Which of the following best describes an auditor’s responsibility when fraud is suspected?
A) Report the fraud to regulatory authorities immediately
B) Discuss concerns with management and those charged with governance
C) Modify the audit opinion to an adverse opinion
D) Ignore minor fraud cases if they don’t affect financial statements
Answer: B) Discuss concerns with management and those charged with governance
Explanation: Auditors must report suspected fraud to the appropriate level of management unless it involves senior executives, in which case it is reported to the board or audit committee.
Which type of audit evidence is generally considered the most reliable?
A) Inquiry of company personnel
B) Observation of inventory counting
C) Bank confirmations
D) Analytical procedures
Answer: C) Bank confirmations
Explanation: Third-party confirmations provide independent verification, making them highly reliable.
Which of the following is an example of a control activity in the inventory cycle?
A) Performing a bank reconciliation
B) Authorizing purchase orders before procurement
C) Using separate accounts for payroll processing
D) Performing year-end journal entry reviews
Answer: B) Authorizing purchase orders before procurement
Explanation: Pre-authorization ensures inventory purchases are valid and approved.
What is the main purpose of an auditor’s test of controls?
A) To determine if controls are effectively designed and operating
B) To identify all fraud cases within the company
C) To detect errors in financial statements
D) To prepare management reports
Answer: A) To determine if controls are effectively designed and operating
Explanation: Control testing assesses the effectiveness of internal controls in preventing and detecting errors or fraud.
Which of the following is an example of a detection control?
A) Password requirements for accessing financial data
B) Performing reconciliations of accounts
C) Management pre-approving all purchases
D) Setting spending limits for employees
Answer: B) Performing reconciliations of accounts
Explanation: Reconciliations identify discrepancies and help detect misstatements or fraud.
Which of the following statements best describes the auditor’s responsibility regarding a company’s compliance with laws and regulations?
A) The auditor is responsible for preventing illegal acts
B) The auditor must identify and report all violations
C) The auditor considers the effect of noncompliance on financial statements
D) The auditor must provide legal advice on compliance issues
Answer: C) The auditor considers the effect of noncompliance on financial statements
Explanation: Auditors focus on the financial impact of noncompliance rather than enforcing laws.
Which of the following would most likely be considered a material weakness in internal control?
A) An overstatement of petty cash by $50
B) Lack of segregation of duties in cash handling
C) Minor discrepancies in supplier invoices
D) Late reporting of minor errors in accounts receivable
Answer: B) Lack of segregation of duties in cash handling
Explanation: Weak segregation of duties increases the risk of fraud and material misstatements.
Which of the following best describes an adverse audit opinion?
A) The auditor lacks sufficient evidence to form an opinion
B) The financial statements contain material misstatements that make them unreliable
C) The financial statements are fairly presented
D) The financial statements are mostly correct, but there are some exceptions
Answer: B) The financial statements contain material misstatements that make them unreliable
Explanation: An adverse opinion is issued when financial statements are misleading and do not comply with GAAP.
Which of the following is a key component of the revenue cycle that auditors must examine?
A) Inventory valuation methods
B) Customer order processing
C) Payroll tax calculations
D) Fixed asset depreciation schedules
Answer: B) Customer order processing
Explanation: The revenue cycle includes order processing, invoicing, and collection of payments.
An auditor finds that a company’s accounts receivable are significantly overstated. Which assertion is most directly affected?
A) Rights and obligations
B) Completeness
C) Existence
D) Classification
Answer: C) Existence
Explanation: Overstated accounts receivable may indicate fictitious transactions, affecting the existence assertion.
Which of the following would be a red flag for potential financial statement fraud?
A) A sudden increase in cash reserves
B) Management’s excessive focus on meeting earnings targets
C) Strong internal control measures
D) Conservative revenue recognition policies
Answer: B) Management’s excessive focus on meeting earnings targets
Explanation: Pressure to meet earnings targets can lead to fraudulent financial reporting practices.