REVIEW QUESTIONS
8-1 (OBJECTIVE 8-1) What are the benefits derived from planning audits?
8-2 (OBJECTIVE 8-2) What are the responsibilities of the successor and predecessor auditors when a company is changing auditors?
8-3 (OBJECTIVE 8-2) What is the purpose of an engagement letter? What subjects should be covered in such a letter?
8-4 (OBJECTIVE 8-2) Who is considered the client when auditing public companies?
8-5 (OBJECTIVE 8-3) Explain why auditors need an understanding of the client’s industry. What information sources are commonly used by auditors to learn about the client’s industry?
8-6 (OBJECTIVE 8-3) In recent years, globalization of business and factors such as techno- logical disruption, tax reform, trade policies, and changing demographics in the workforce uncertainty and volatility in stock and bond markets. Why might it be important for you to consider current economic and other events as part of planning an audit?
8-7 (OBJECTIVE 8-3) When a CPA has accepted an engagement from a new client who is a manufacturer, it is customary for the CPA to tour the client’s plant facilities. Discuss the ways in which the CPA’s observations made during the course of the plant tour will be of help in planning and conducting the audit.
8-8 (OBJECTIVE 8-3) Define what is meant by a related party. What are the auditor’s responsibilities for related parties and related party transactions?
8-9 (OBJECTIVE 8-3) For the audit of Radline Manufacturing Company, the audit partner asks you to carefully read the new mortgage contract with the First National Bank and abstract all pertinent information. List the information in a mortgage that is likely to be relevant to the auditor.
8-10 (OBJECTIVE 8-3) Identify two types of information in the client’s minutes of the board
of directors meetings that are likely to be relevant to the auditor. Explain why it is important to read the minutes early in the engagement.
8-11 (OBJECTIVE 8-3) Identify the three categories of client objectives. Indicate how each objective may affect the auditor’s assessment of risk of material misstatement and need for
evidence accumulation.
8-12 (OBJECTIVE 8-3) What is the purpose of the client’s performance measurement system? How might that system be useful to the auditor? Give examples of key performance indicators for the following businesses: (1) a chain of retail clothing stores; (2) an Internet portal; (3) a hotel chain.
8-13 (OBJECTIVE 8-4) Gale Gordon, CPA, has found ratio and trend analysis relatively useless as a tool in conducting audits. For several engagements, he computed the industry ratios for his clients and compared them with industry averages. For most engagements, the client’s business
was significantly different from the industry data, and the client automatically explained away
any discrepancies by attributing them to the unique nature of its operations. In cases in which the client had more than one branch in different industries, Gordon found the ratio analysis to be no help at all. How can Gordon improve the quality of his analytical procedures?
8-14 (OBJECTIVE 8-4) Your client, Harper Company, has a contractual commitment as a part of a bond indenture to maintain a current ratio of 2.0. If the ratio falls below that level on the balance sheet date, the entire bond becomes payable immediately. In the current year, the client’s financial statements show that the ratio has dropped from 2.6 to 2.05 over the past year. How should this situation affect your audit plan?
8-15 (OBJECTIVE 8-5) Define the meaning of the term materiality as it is used in accounting and auditing. What is the relationship between materiality and the phrase obtain reasonable assurance used in the auditor’s report?
8-16 (OBJECTIVES 8-5, 8-6) Explain why materiality is important but difficult to apply in practice.
8-17 (OBJECTIVE 8-6) What is meant by using benchmarks for setting a preliminary
judgment about materiality? How will those benchmarks differ for the audit of a manufacturing company and a government unit such as a school district?
THE AUDIT PROCESS
8-18 (OBJECTIVE 8-6) Assume that Xinran Wang, CPA, is using 5 percent of net income
before taxes, current assets, or current liabilities as her major guideline for evaluating ma-
teriality. What qualitative factors should she also consider in deciding whether misstate-
ments may be material?
8-19 (OBJECTIVE 8-6) How will the conduct of an audit of a medium-sized company be af-
fected by the company’s being a small part of a large conglomerate as compared with it
being a separate entity?
8-20 (OBJECTIVE 8-7) Assume a company with the following balance sheet accounts:
You are concerned only about overstatements of owner’s equity. Set performance materi-
ality for the three relevant accounts such that the preliminary judgment about materiality
does not exceed $5,000. Justify your answer.
Account Amount
Cash $10,000
Fixed assets 60,000
$70,000
Account Amount
Long-term loans $30,000
M. Johnson, proprietor 40,000
$70,000
8-21 (OBJECTIVE 8-7) Provide two examples of when an auditor might set a lower level
of performance materiality for a particular class of transactions, account balance, or
disclosure.
8-22 (OBJECTIVE 8-8) Assume materiality for the financial statements as a whole is $100,000
and performance materiality for accounts receivable is set at $40,000. If the auditor finds
one receivable that is overstated by $55,000, what should the auditor do
