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Chapter 1
Multiple-Choice Questions

1.
easy
c

Recording, classifying, and summarizing economic events in a logical manner for the purpose
of providing financial information for decision making is commonly called:
a. finance.
b. auditing.
c. accounting.
d. economics.

2.
easy
c

In the audit of historical financial statements, which of the following accounting bases is the
most common?
a. Regulatory accounting principles.
b. Cash basis of accounting.
c. Generally accepted accounting principles.
d. Liquidation basis of accounting.

3.
easy
b

Any service that requires a CPA firm to issue 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. assurance 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 Sarbanes-Oxley Act applies 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 $500 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

An audit of historical financial statements most commonly includes the:

a. balance sheet, the income statement, and the statement of cash flows.
b. income statement, the statement of cash flows, and the statement of net working capital.
c. statement of cash flows, the balance sheet, and the retained earnings statement.
d. balance sheet, the income statement, and the statement of cash flows.

9.
medium
c

The ___________ rate may be defined as approximately the rate a bank could earn by investing
in U.S. treasury notes for the same length as the length of a business loan.
a. nominal
b. stated
c. risk-free
d. prevailing

10.
medium
b

The use of the Certified Public Accountant title is regulated by:

a. the federal government.
b. state law through a licensing department or agency of each state.
c. the American Institute of Certified Public Accountants through the licensing departments
of the tax and auditing committees.
d. the Securities and Exchange Commission.

11.
medium
c

An operational audit has as one of its objectives 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 historical financial statements is most often performed 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. management team is fulfilling its fiduciary responsibilities to shareholders.
d. none of these choices.

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.

15.
medium
d

Which of the following is a type of audit evidence?

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.

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16.
medium
a

Which of the following services provides the lowest level of assurance on a financial statement?
a. A review.
b. An audit.
c. Neither service provides assurance on financial statements.
d. Each service provides the same level of assurance on financial statements.

17.
medium
c

The three requirements for becoming a CPA include all but which of the following?
a. Uniform CPA examination requirement.
b. Educational requirements.
c. Character requirements.
d. Experience requirement.

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
d

Financial statement users often receive unreliable financial information from companies. Which
of the following is not a common reason for this?
a. Complex business transactions.
b. Large amounts of data.
c. Lack of firsthand knowledge about the business.
d. Each of these choices is a common reason for unreliable financial information.

20.
challenging
d

Which of the following is not a Trust Services principle as defined by the AICPA or CICA?
a. Online privacy.
b. Availability.
c. Processing integrity.
d. Operational integrity.

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. Tax services.

23.
challenging
a

Which of the following audits can be regarded as generally being a compliance audit?
a. IRS agents examinations of taxpayer returns.
b. GAO auditors evaluation of the computer operations of governmental units.
c. An internal auditors review of a companys payroll authorization procedures.
d. A CPA firms audit of the local school district.

24.
challenging

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

a. Business risk.

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b.
c.
d.

Information risk.
The risk-free interest rate.
Inherent risk.

25.
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.

26.
challenging
b

Attestation services on information technology include WebTrust services and SysTrust

services. Which of the following statements most accurately describes SysTrust services?
a.
SysTrust services provide assurance on business processes, transaction integrity and
information processes.
b.
SysTrust services provide assurance on system reliability in critical areas such as security
and data integrity.
c.
ysTrust services provide assurance on internal control over financial reporting.
d.
SysTrust services provide assurance as to whether accounting personnel are following
procedures prescribed by the company controller.

Essay Questions
27.
easy

Discuss the three primary requirements for becoming a CPA.

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 with 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.

28.
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:
Two primary types of attestation services are: audits of historical financial statements and
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.

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29.
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.

30.
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 the degree of correspondence
between those financial statements 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.

31.
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.

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32. (SOX)
medium

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

Answer:
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.

33.
challenging

To do an audit, it is necessary for information to be 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 most commonly used criteria are
accounting principles generally accepted in the United States.
(B) The information used by an IRS auditor is the financial information in the companys
federal tax return. The criteria are the internal revenue code and interpretations.
(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.

34.
challenging

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.

35.
challenging

Attestation services fall into five categories. What are these categories?
Answer:
The five categories of attestation services include:
audits of historical financial statements,
attestation on internal control over financial reporting,
reviews of historical financial statements,
attestation services on information technology, and
other attestation services that may be applied to a broad range of subject matter.

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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

37.
easy
a

The criteria by which an auditor evaluates the information under audit may vary with 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
b

Only companies that file annual statements with the Securities and Exchange Commission are
required to have an annual external audit.
a. True
b. False

42.
easy
b

The financial statements most commonly audited by external auditors are the balance sheet, the
income statement, and the statement of changes in retained earnings.
a. True
b. False

43.
medium
b

The primary purpose of a compliance audit is to determine whether the financial statements are
prepared 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)
medium
a

Section 404 of the Sarbanes-Oxley Act requires public companies to have an external auditor
attest to their internal control over financial reporting.
a. True
b. False

48. (SOX)
challenging
b

The Sarbanes-Oxley Act requires a companys chairman of the board of directors, CEO, and
CFO to certify the companys financial statements.
a. True
b. False

49. (SOX)
challenging
b

The criterion 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 the Enterprise
Risk Management framework.
a. True
b. False

50.
challenging
a

Most public companies audited financial statements are available on the SECs EDGAR
database.
a. True
b. False

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