Week 5 Homework Questions Questions 1 and 2 were taken directly from the text and I am aware that the answers are available through an internet search. I want to remind you that searching the internet for the answers and using those answers is a violation of UMUC academic integrity policies. In addition, using any outside source without citation is plagiarism. However, just gaining access to the answers will not satisfy the homework assignment because I have added the requirement that you explain your answers, which cannot be found on the internet and needs to be reasoned out from the material in the chapter. In grading, I will place more emphasis you explanation than your selection of the correct alternative. 1) The following are several multiple choice questions adapted from the CPA exam that cover the concept and application of materiality. For each question, selected the best answer and then explain why it is better than all the alternatives. Your explanations should address all the possible alternatives presented in the question. a) Which one of the following statements is correct concerning the concept of materiality? i) Materiality is determined by reference to guidelines established by the AICPA. ii) Materiality depends only on the dollar amount of an item relative to other items in the financial statements. iii) Materiality depends on the nature of an item rather than the dollar amount. iv) Materiality is a matter of professional judgment. Answer: Explanation : b) In considering materiality for planning purposes, an auditor believes that misstatements aggregating $10,000 will have a material effect on an entity's income statement, but that misstatements will have to aggregate $20,000 to materially affect the balance sheet. Ordinarily, it is appropriate to design audit procedures that are expected to detect misstatements that aggregate to i) $10,000 ii) $15,000 iii) $20,000 iv) $30,000 Answer: Explanation : c) A client decides not to record an auditor's proposed adjustments that collectively are not material and wants the auditor to issue the report based on the unadjusted numbers. Which of the following statements is correct regarding the financial statement presentation? i) The financial statements are free from material misstatement, and no disclosure is required in the notes to the financial statements. ii) The financial statements do not conform with generally accepted accounting principles (GAAP). iii) The financial statements contain unadjusted misstatements that should result in a qualified opinion. iv) The financial statements are free from material misstatement, but disclosure of the proposed adjustment is required in the notes to the financial statements. Answer: Explanation : 2) The following are several multiple choice questions adapted from the CPA exam that cover audit risk. For each question, selected the best answer and then explain why it is better than all the alternative.

1. Week 5 Homework Questions
Questions 1 and 2 were taken directly from the text and I am
aware that the answers are available through an internet search.
I want to remind you that searching the internet for the answers
and using those answers is a violation of UMUC academic
integrity policies.
In addition, using any outside source without citation is
plagiarism.
However, just gaining access to the answers will not satisfy the
homework assignment because I have added the requirement
that you explain your answers, which cannot be found on the
internet and needs to be reasoned out from the material in the
chapter.
In grading, I will place more emphasis you explanation than
your selection of the correct alternative.
1)
The following are several multiple choice questions adapted
from the CPA exam that cover the concept and application of
materiality.
For each question, selected the best answer and then explain
why it is better than all the alternatives.
Your explanations should address all the possible alternatives
presented in the question.
a)
Which one of the following statements is correct concerning the

2. concept of materiality?
i)
Materiality is determined by reference to guidelines established
by the AICPA.
ii)
Materiality depends only on the dollar amount of an item
relative to other items in the financial statements.
iii)
Materiality depends on the nature of an item rather than the
dollar amount.
iv)
Materiality is a matter of professional judgment.
Answer:
Explanation
:
b)
In considering materiality for planning purposes, an auditor
believes that misstatements aggregating $10,000 will have a
material effect on an entity's income statement, but that
misstatements will have to aggregate $20,000 to materially
affect the balance sheet.
Ordinarily, it is appropriate to design audit procedures that are
expected to detect misstatements that aggregate to
i)

3. $10,000
ii)
$15,000
iii)
$20,000
iv)
$30,000
Answer:
Explanation
:
c)
A client decides not to record an auditor's proposed adjustments
that collectively are not material and wants the auditor to issue
the report based on the unadjusted numbers.
Which of the following statements is correct regarding the
financial statement presentation?
i)
The financial statements are free from material misstatement,
and no disclosure is required in the notes to the financial
statements.
ii)
The financial statements do not conform with generally
accepted accounting principles (GAAP).
iii)

4. The financial statements contain unadjusted misstatements that
should result in a qualified opinion.
iv)
The financial statements are free from material misstatement,
but disclosure of the proposed adjustment is required in the
notes to the financial statements.
Answer:
Explanation
:
2)
The following are several multiple choice questions adapted
from the CPA exam that cover audit risk.
For each question, selected the best answer and then explain
why it is better than all the alternatives.
Your explanations should address all the possible alternatives
presented in the question.
a)
Some account balances, such as those for pensions and leases,
are the result of complex calculations. The susceptibility to
material misstatements in these types of accounts is defined as
i)
audit risk.
ii)

5. detection risk.
iii)
inherent risk.
iv)
sampling risk.
Answer:
Explanation
:
b)
As the acceptable level of detection risk decreases, the auditor
may do one or more of the following except change the
i)
nature of audit procedures to more effective procedures.
ii)
timing of audit procedures, by perhaps performing them at year-
end rather than an interim date.
iii)
extent of audit procedures, by perhaps using larger sample
sizes.
iv)
assurances provided by audit procedures to a lower level.
Answer:

6. Explanation
:
c)
Inherent risk and control risk differ from planned detection risk
in that they
i)
arise from the misapplication of auditing procedures.
ii)
may be assessed in either quantitative or qualitative terms.
iii)
exist independently of the financial statement audit.
iv)
can be changed at the auditor's discretion
Answer:
Explanation
:
3)
For each of the following independent scenarios, state the

7. effect, if any, on each component of the audit risk model and
explain why you made each selection.
For your answer to the effect portion of the question, select
from I = increase, D = decrease, or N = no effect.
I have included a table for each scenario to help you organize
your answers and be complete.
This question was adapted from the text, but I have altered it to
require explanations.
Also, I disagree with the text solutions manual on some of them
but since the solutions manual doesn't provide an explanation of
their answers, I cannot determine how the authors arrived at
their conclusions.
I will be grading based on my answers.
As I reminder, attempting to access the solutions manual to
answer these questions is a violation of academic integrity.
a)
In discussions with management, you conclude that management
is planning to sell the business in the next few months.
Consequently several key accounting personnel have recently
quit.
In addition, the firm's gross profit margin has significantly
increased since last year.
Risk Model Component
Effect
(I, D, N)
Explanation

8. AAR
IR
CR
PDR
b)
The client began selling products online to customers through
its web page during the year under audit.
The online ordering process has not been integrated with the
firm's accounting system.
The firm's sales staff print out online orders and manually enter
the information into the firms accounting system.
Risk Model Component
Effect
(I, D, N)
Explanation
AAR
IR
CR

9. PDR
c)
An account balance increased by a material amount from last
year without any explanation.
Risk Model Component
Effect
(I, D, N)
Explanation
AAR
IR
CR
PDR
d)
The firm's management materially decreased long-term
contractual debt from what is was last year.
Risk Model Component
Effect
(I, D, N)
Explanation
AAR

10. IR
CR
PDR
e)
This is the second year of the engagement and there were few
misstatements found in the prior year's audit.
Consequently, the auditor has decided to increase reliance on
internal controls.
Risk Model Component
Effect
(I, D, N)
Explanation
AAR
IR
CR
PDR

11. 4)
Read the following description of the Preview Company.
Preview Company Case Description
Preview Company, a diversified manufacturer, has five
divisions that operate throughout the United States and Mexico.
Preview has historically allowed its divisions to operate
autonomously.
Corporate intervention occurred only when planned results were
not obtained.
Corporate management has high integrity, but the board of
directors and audit committee are not very active.
Preview has a policy of hiring competent people.
The company has a code of conduct, but there is little
monitoring of compliance by employees.
Management is fairly conservative in terms of accounting
principles and practices, but employee compensation packages
depend highly on performance.
Preview Company does not have an internal audit department,
and it relies on its external auditor to review the controls in
each division.
Chip Harris is the general manager of the Fabricator Division.
The Fabricator Division produces a variety of standardized parts
for small appliances.

12. Harris has been the general manager for the last seven years,
and each year he has been able to improve the profitability of
the division.
He is compensated based largely on the division's profitability.
Much of the improvement in profitability has come through
aggressive cost cutting, including a substantial reduction in
control activities over inventory.
During the last year, a new competitor has entered Fabricator's
markets and has offered substantial price reductions in order to
grab market share.
Harris has responded to the competitor's actions by matching
the price cuts in the hope of maintaining market share.
Harris is very concerned because he cannot see any other areas
where costs can be reduced so that the division's growth and
profitability can be maintained.
If
profitability is not maintained, his salary and bonus will be
reduced.
Harris has decided that one way to make the division more
profitable is to manipulate inventory because it represents a
large amount of the division's balance sheet.
He also knows that controls over inventory are weak.
He views this inventory manipulation as a short-run solution to
the profit decline due to the competitor's price-cutting.

13. Harris is certain that once the competitor stops cutting prices or
goes bankrupt, the misstatements in inventory can be corrected
with little impact on the bottom line.
a)
The following table includes two columns.
Include a brief phrase or sentence in the first column that
merely describes the strength or weakness.
In in second column, explain why each strength is a strength or
why each weakness is weakness.
In addition, for each weakness you identify, suggest an
improvement that would reduce that weakness.
Finally, include issues that affect financial reporting and not
operational effectiveness.
While the overall definition of internal controls includes
operational effectiveness, auditors primarily are concerned
about the accuracy of the financial statements.
I have included one example for each category to help illustrate
what I am looking for in your answers.
Entity Level Controls
Strength
Reason it is a strength
They hire competent people
The key to any control environment is the quality of the
personnel who carry out the control procedures.

14. Hiring competent people is the first step in insuring that the
employees tasked with executing accounting functions as well
as control activities will do a good job, which will reduce the
risk of material misstatements.
However, it is only the first step in that competent employees
also need the training and other resources, as well as an
incentive, to perform their jobs well.
I listed this because the case mentions it.
I would need to verify that statement by actually reviewing the
policies and procedures to confirm that it really is a strength.
Entity Level Controls
Weakness
Reason it is a weakness
and suggested improvement
Divisions are autonomous
The gives the division managers too much power, particularly
because corporate management only intervenes if operating
results are not met.
This gives managers more latitude to manipulate the accounting
to keep within the corporation's targets.
They should least establish period reviews of each division.

15. I would suggest quarterly, at least.
b)
What factors in Preview Company's control environment led to
and facilitated Harris' manipulation of inventory?
Your answer here may include items you listed above, but you
should relate the specifically to the inventory manipulation in
the question.
5)
The following table contains a list of internal controls.
For each internal control, identify the type(s) of specific control
activity (or activities) to which it applies (such as proper
authorization and adequate documents and records); identify the
transaction-related audit objective(s) to which it applies; and
explain your selection of audit objective.
This question was adapted from the text, but I have altered it to
require explanations.
As I reminder, attempting to access the solutions manual to
answer these questions is a violation of academic integrity.

16. Control
Type(s)
Objective(s)
Explanation
Sales invoices are matched with shipping documents and
customer orders before recording in the sales journal.
Receiving reports are prenumbered and accounted for on a daily
basis.
Amounts on sales invoices are independently verified before
being sent to customers.
Payments by check are received in the mail by the receptionist,
who lists the checks and restrictively endorses them.
Overtime hours for payroll are approved by the employee's
supervisor.
Checks are signed by the company president, who compares the
checks with the underlying supporting documents.
Unmatched shipping documents are accounted for on a daily
basis.

17. All payroll payments must have a valid employee identification
number assigned by the human resources department at the time
of hiring.
The accounts receivable subsidiary ledger is reconciled to the
general ledger on a monthly basis.