AUD 3

Question 1

When an auditor qualifies an opinion because of inadequate disclosure, the auditor should describe the nature of the omission in a separate “Basis for Qualified Opinion” section and modify the

“Management’s Responsibilities” “Opinion” section
section
No No
Yes No
Yes Yes
No Yes

Answer 1

No Yes

An opinion qualified because of inadequate disclosure would include a separate “Basis for Qualified Opinion” section and a modification of the “Opinion” section. No modification of the “Management’s Responsibilities” section would be required.

Question 2

A company employs three accounts payable clerks and one treasurer. Their responsibilities are as follows:

Employee Responsibility
Clerk 1 Reviews vendor invoices for proper signature approval.
Clerk 2 Enters vendor invoices into the accounting system and verifies payment terms.
Clerk 3 Posts entered vendor invoices to the accounts payable ledger for payment and mails checks.
Treasurer Reviews the vendor invoices and signs each check.
Which of the following would indicate a weakness in the company’s internal control?

Clerk 1 opens all of the incoming mail.

Clerk 2 reconciles the accounts payable ledger with the general ledger monthly.

Clerk 3 mails the checks and remittances after they have been signed.

The treasurer uses a stamp for signing checks.

Answer 2

Clerk 3 mails the checks and remittances after they have been signed.

This is correct because Clerk 3’s mailing of the signed checks provides that individual both with recordkeeping responsibility over the payments and custody of the signed checks—authorization, custody, and recordkeeping should be segregated.

Question 3

What is the primary objective of using stratification as a sampling method in auditing?

To increase the confidence level at which a decision will be reached from the results of the sample selected.

To determine the occurrence rate for a given characteristic in the population being studied.

To decrease the effect of variance in the total population.

To determine the precision range of the sample selected.

Answer 3

To decrease the effect of variance in the total population.

Stratified sampling is a technique of breaking the population down into subpopulations and applying different sample selection methods to the subpopulations. Stratified sampling is used to minimize the variance within the overall population.

Question 4

Which of the following statements is correct concerning statistical sampling in tests of controls?

As the population size increases, the sample size should increase proportionately.

Deviations from specific internal control procedures at a given rate ordinarily result in misstatements at a lower rate.

There is an inverse relationship between the expected population deviation rate and the sample size.

In determining tolerable rate, an auditor considers detection risk and the sample size.

Answer 4

Deviations from specific internal control procedures at a given rate ordinarily result in misstatements at a lower rate.

The requirement is to identify the correct statement concerning statistical sampling in tests of controls. Answer (b) is correct because while deviations from pertinent control procedures increase the risk of material misstatements, any specific deviation need not necessarily result in a misstatement. For example, a recorded disbursement that does not show evidence of required approval might nevertheless be a transaction that is properly authorized and recorded (AICPA Audit Sampling Guide). Answer (a) is incorrect because increases in population size result in small increases in sample size. Answer (c) is incorrect because a direct relationship, not an inverse relationship, exists between the expected population deviation rate and the sample size—that is, increases in the expected population deviation rate result in an increase in the required sample size. Answer (d) is incorrect because when determining the tolerable rate, the auditor does not yet have the required sample size.

Question 5

What is an auditor’s evaluation of a statistical sample for attributes when a test of 50 documents results in 3 deviations if tolerable rate is 7%, the expected population deviation rate is 5%, and the allowance for sampling risk is 2%?

Modify the planned assessed level of control risk because the tolerable rate plus the allowance for sampling risk exceeds the expected population deviation rate.

Accept the sample results as support for the planned assessed level of control risk because the sample deviation rate plus the allowance for sampling risk exceeds the tolerable rate.

Accept the sample results as support for the planned assessed level of control risk because the tolerable rate less the allowance for sampling risk equals the expected population deviation rate.

Modify the planned assessed level of control risk because the sample deviation rate plus the allowance for sampling risk exceeds the tolerable rate.

Answer 5

Modify the planned assessed level of control risk because the sample deviation rate plus the allowance for sampling risk exceeds the tolerable rate.

This is correct because when the deviation rate plus the allowance for sampling risk exceeds the tolerable rate, the assessed level of control risk may increase. Here the deviation rate of 6% (3 deviations/50 documents) plus the allowance for sampling risk of 2% equals 8% and exceeds the tolerable rate of 7%.

Question 6

A portion of a client’s inventory is in public warehouses. Evidence of the existence of this merchandise can most efficiently be acquired through which of the following methods?

Observation.
Confirmation.
Calculation.
Inspection.

Answer 6

Confirmation

Question 7

Stratified mean per unit (MPU) sampling is a statistical technique that may be more efficient than unstratified MPU because it usually

May be applied to populations where many monetary errors are expected to occur.

Produces an estimate that has a desired level of precision with a smaller sample size.

Increases the variability among items in a stratum by grouping sampling units with similar characteristics.

Yields a weighted sum of the strata standard deviations that is greater than the standard deviation of the population.

Answer 7

Produces an estimate that has a desired level of precision with a smaller sample size.

Stratification of the population enables the auditor to separate the population into size-related classes. For example, all transactions over $50,000 may be grouped into a class.

Applying MPU sampling to these strata or classes will then result in a higher level of precision for a smaller sample size.

Question 8

An advantage that using statistical sampling methods have over nonstatistical sampling methods in tests of controls is that the statistical methods

Can more easily convert the sample into a dual-purpose test useful for substantive testing.

Eliminate the need to use judgment in determining appropriate sample sizes.

Afford greater assurance than a nonstatistical sample of equal size.

Provide an objective basis for quantitatively evaluating sample risk.

Answer 8

Provide an objective basis for quantitatively evaluating sample risk.

The use of statistical methods assists the auditor in designing an efficient sample, measuring the sufficiency of the evidence, and evaluating the sample results. Thus, this provides an objective basis for quantitatively evaluating sample risk.

Question 9

A CPA is required to comply with the provisions of Statements on Standards for Accounting and Review Services when
Processing financial data for clients of other CPA firms
Consulting on accounting matters
Yes Yes
Yes No
No Yes
No No

Answer 9

No No

The Statements on Standards for Accounting and Review Services are not applicable when: 1) preparing a working trial balance; 2) assisting in adjusting the books of account; 3) consulting on accounting, tax, and similar matters; 4) preparing tax returns ; 5) providing bookkeeping or data processing services, and 6) processing financial data for clients of other accounting firms.

Question 10

Which of the following is correct about reporting on compliance with laws and regulations in a financial audit under Government Auditing Standards (the Yellow Book)?

Auditors are not required to report fraud, illegal acts, and other material noncompliance in the audit report.

In some circumstances, auditors are required to report fraud and illegal acts directly to parties external to the audited entity.

The auditor’s key findings of the audit of the financial statements should be communicated in a separate report.

The reporting standards in a governmental audit modify the auditor’s responsibilities under generally accepted auditing standards.

Answer 10

In some circumstances, auditors are required to report fraud and illegal acts directly to parties external to the audited entity.

This answer is correct because in certain circumstances auditors should report fraud and illegal acts to external parties (often regulatory agencies).

Question 11

Which of the following procedures would an auditor most likely perform to identify unusual sales transactions?

Tracing credits in the accounts receivable ledger to source documentation

Performing a trend analysis of quarterly sales

Examining duplicate sales invoices for credit approval by the credit manager

Tracing cash receipt entries to the bank statement deposit for amount and date

Answer 11

Performing a trend analysis of quarterly sales

Correct! Performing a trend analysis of quarterly sales is an analytical procedure that would be relevant to identifying unusual sales activities.

Question 12

Which of the following would be the best protection for a company that wishes to prevent the “lapping” of trade accounts receivable?

Segregate duties so that the bookkeeper in charge of the general ledger has no access to incoming mail.

Segregate duties so that no employee has access to both checks from customers and currency from daily cash receipts.

Have customers send payments directly to the company’s depository bank.

Request that customers’ payment checks be made payable to the company and addressed to the treasurer.

Answer 12

Have customers send payments directly to the company’s depository bank.

This answer is correct because lapping of trade accounts receivable involves an abstraction of funds and subsequent delay in crediting receipts to accounts receivable. If customers send payments directly to a depository bank, there is no opportunity for abstraction of funds or subsequent misapplication.

Question 13

When the financial statements contain a departure from generally accepted accounting principles, the effect of which is material, the auditor should

Qualify the opinion and explain the effect of the departure from generally accepted accounting principles in a separate section.

Qualify the opinion and describe the departure from generally accepted accounting principles within the “Opinion” section.

Disclaim an opinion and explain the effect of the departure from generally accepted accounting principles in a separate section.

Disclaim an opinion and describe the departure from generally accepted accounting principles within the “Opinion” section.

Answer 13

Qualify the opinion and explain the effect of the departure from generally accepted accounting principles in a separate section.

Question 14

An auditor may issue the standard audit report when the

Auditor refers to the findings of a specialist.

Financial statements are derived and summarized from complete audited financial statements that are filed with a regulatory agency.

Financial statements are prepared on the cash receipts and disbursements basis of accounting.

Group engagement partner assumes responsibility for the work of a component auditor.

Answer 14

Group engagement partner assumes responsibility for the work of a component auditor.

Question 15

In auditing through a computer, the test data method is used by auditors to test the

Accuracy of input data.

Validity of the output.

Procedures contained within the program.

Normalcy of distribution of test data.

Answer 15

Procedures contained within the program.

This answer is correct because the auditor, when using test data, prepares a set of dummy transactions to determine if the controls purported to be in effect in a program are functioning as intended.

Question 16

Which of the following matters would an auditor most likely include in a management representations letter?

Communications with the audit committee concerning weaknesses in internal control structure.

The completeness and availability of minutes of stockholders’ and directors’ meetings.

Plans to acquire or merge with other entities in the subsequent year.

Management’s acknowledgment of its responsibility for the detection of all employee fraud.

Answer 16

The completeness and availability of minutes of stockholders’ and directors’ meetings.

The management representations letter typically includes a comment along the following lines: “We have provided you with access to all information, of which we are aware that is relevant to the preparation and fair presentation of the financial statements such as records, documentation and other matters, and additional information that you have requested from us for the purpose of the audit.” The foregoing passage encompasses the completeness and availability of all minutes of any meetings of stockholders and the board of directors.

Question 17

Which type of report on a service organization controls (SOC) is presented in the Professional Standards, but is least related to SysTrust?

SOC 1
SOC 2
SOC 3
SOC 4

Answer 17

SOC 1

This answer is correct because an SOC 1 engagement is based on an entity’s internal control over financial reporting more directly than upon SysTrust Principles.

Question 18

Miller Co. uses the first-in, first-out method of costing for its international subsidiary’s inventory and the last-in, first-out method of costing for its domestic inventory. Under these circumstances, Miller should issue an auditor’s report with an

“Except for” qualified opinion.

Unmodified opinion.

Emphasis-of-matter paragraph as to consistency.

Opinion modified as to consistency.

Answer 18

Unmodified opinion.

This answer is correct because the use of such differing methods may be appropriate due to the circumstances and therefore an unmodified opinion may be issued.

Question 19

Which of the following is correct relating to service organization control (SOC) reports referred to as “SOC 2” reports?

They are primarily to assist financial statement auditors when processing services have been outsourced to a service provider.

They are generally available to anyone.

They relate most directly to internal control over financial reporting.

They are meant for management of service organizations, user entities, and certain other specified entities.

Answer 19

They are meant for management of service organizations, user entities, and certain other specified entities.

Question 20

Which of the following procedures would an auditor most likely perform in the planning stage of an audit?

Make a preliminary judgment about materiality.

Confirm a sample of the entity’s accounts payable with known creditors.

Obtain written representations from management that there are no unrecorded transactions.

Communicate management’s initial selection of accounting policies to the audit committee.

Answer 20

Make a preliminary judgment about materiality.

This is correct because when planning the audit the auditor should determine a materiality level for the financial statements when establishing the overall audit strategy for the audit.

Question 21

How large must the actual loss identified by the auditor be for a control deficiency to possibly be considered a material weakness?
Immaterial Material
Yes Yes
Yes No
No Yes
No No

Answer 21

Yes yes

A material weakness is determined by whether there is more than a remote likelihood of a material loss occurring due to the control deficiency; the actual loss identified need not be material.

Question 22

Which of the following procedures would an auditor most likely perform in searching for unrecorded payables?

Reconcile receiving reports with related cash payments made just prior to year-end.

Contrast the ratio of accounts payable to purchases with the prior year’s ratio.

Vouch a sample of creditor balances to supporting invoices, receiving reports, and purchase orders.

Compare cash payments occurring after the balance sheet date with the accounts payable trial balance.

Answer 22

Compare cash payments occurring after the balance sheet date with the accounts payable trial balance.

In searching for unrecorded payables, the auditor would look at disbursements made after year-end to see if they should have been, and were, properly recorded as payables at year-end.

Question 23

Once satisfied that the balance sheet and income statement are fairly presented in accordance with generally accepted accounting principles, an auditor who is examining the statement of cash flows would be most concerned with details of transactions in

Cash.
Trade receivables.
Notes payable.
Accounts payable

Answer 23

Notes payable

This answer is correct because the auditor would examine notes payable (a noncurrent account) to determine financing and investing activities that occurred (i.e., by examining changes in the noncurrent accounts). Each transaction involving notes payable is generally considered a financing and investing activity which requires disclosure.

Question 24

Which of the following should a predecessor auditor perform before reissuing a report on financial statements when those financial statements are to be presented on a comparative basis with financial statements audited by another auditor?

Obtain representation letters from management of the former client and the successor auditor.

Change the date of the reissued report to match the date on which additional procedures were performed.

Request attorney’s responses to identify any significant litigation subsequent to the original date of the report.

Review minutes of board meetings held since the original date of the audit report.

Answer 24

Obtain representation letters from management of the former client and the successor auditor.

Question 25

Which of the following material events occurring subsequent to the December 31, 20X5 balance sheet would not ordinarily result in an adjustment to the financial statements before they are issued on March 2, 20X6?

Write-off of a receivable from a debtor who had suffered from deteriorating financial condition for the past 6 years. The debtor filed for bankruptcy on January 23, 20X6.

Acquisition of a subsidiary on January 23, 20X6. Negotiations had begun in December of 20X5.

Settlement of extended litigation on January 23, 20X6, in excess of the recorded year-end liability.

A 3-for-5 reverse stock split consummated on January 23, 20X6.

Answer 25

Acquisition of a subsidiary on January 23, 20X6. Negotiations had begun in December of 20X5.

This answer is correct because the condition (acquisition of a subsidiary) did not arise until after year-end. Footnote disclosure of this transaction, however, is necessary.

Question 26

The objective of the tolerable rate in sampling for tests of controls of internal control is to

Determine the probability of the auditor’s conclusion based upon reliance factors.

Determine that financial statements taken as a whole are not materially in error.

Estimate the reliability of substantive tests.

Estimate the range of procedural deviations in the population.

Answer 26

Estimate the range of procedural deviations in the population.

Question 27

Accepting an engagement to examine an entity’s financial projection most likely would be appropriate if the projection were to be distributed to

All employees who work for the entity.

Potential stockholders who request a prospectus or a registration statement.

A bank with which the entity is negotiating for a loan.

All stockholders of record as of the report date.

Answer 27

A bank with which the entity is negotiating for a loan.

The requirement is to identify the appropriate distribution of an entity’s financial projection. A financial projection is sometimes prepared to present one or more hypothetical courses of action for evaluation in response to a question such as “What would happen if…?” It is based on a responsible party’s assumptions reflecting conditions it expects would exist and the course of action it expects would be taken, given one or more hypothetical assumptions. Projections are “limited use” financial statements meant for the responsible party (generally management) and third parties with whom the responsible party is negotiating directly. Answer (c) is correct because a bank might be expected to receive such a projection. Answers (a), (b), and (d) are all incorrect because projections are meant for “limited use” and not to be broadly distributed to groups such as all employees or potential or current stockholders. AT 301 provides overall guidance on the area of financial forecasts and projections.

Question 28

Which of the following actions is an analytical procedure that an auditor most likely would use while auditing a company’s notes payable?

Multiplying the average outstanding loan balance by the interest rate and comparing the result to interest expense actually recorded.

Performing calculations to determine if the company is in compliance with debt covenants.

Sending a confirmation to the lender requesting verification of the loan’s outstanding balance.

Reviewing the details of the company’s loan and interest expense accounts to determine that all payments were properly recorded.

Answer 28

Multiplying the average outstanding loan balance by the interest rate and comparing the result to interest expense actually recorded.

This answer is correct because analytical procedures involve an assumption of the existence of a plausible relationship among financial and nonfinancial information and such a relationship would seem to exist between the average outstanding loan balance, the interest rate, and the resulting interest expense.

Question 29

Detection risk differs from both control risk and inherent risk in that detection risk

Exists independently of the financial statement audit.

Can be changed at the auditor’s discretion.

Arises from risk factors relating to fraud.

Should be assessed in nonquantitative terms.

Answer 29

Can be changed at the auditor’s discretion.

This answer is correct because auditors determine an appropriate level of detection risk based on their assessment of the risk of material misstatement composed of inherent risk and control risk.

Question 30

Quality control policies and procedures that are established to decide whether to accept a new client should provide the CPA firm with reasonable assurance that

The CPA firm’s duty to the public concerning the acceptance of new clients is satisfied.

The likelihood of associating with clients whose management lacks integrity is minimized.

Client-prepared schedules that are necessary for the engagement are completed on a timely basis.

Sufficient corroborating evidence to support the financial statement assertions is available.

Answer 30

The likelihood of associating with clients whose management lacks integrity is minimized.