AUD 4

Question 1

A CPA is required to comply with the provisions of Statements on Standards for Attestation Engagements when engaged to

Provide assurance on investment performance statistics prepared by an investment company on established criteria.

Issue a letter for an underwriter, also known as a comfort letter, to a broker or dealer of securities.

Compile financial statements in conformity with a comprehensive basis of accounting other than GAAP.

Communicate with an audit committee regarding management’s consultations with another CPA.

Answer 1

Provide assurance on investment performance statistics prepared by an investment company on established criteria.

This answer is correct because the Statements on Standards for Attestation Engagements do apply to such investment performance statistics.

Question 2

In connection with his test of the accuracy of inventory counts, a CPA decides to use discovery sampling. Discovery sampling may be considered a special case of

Judgmental sampling.
Sampling for variables.
Stratified sampling.
Sampling for attributes.

Answer 2

Sampling for attributes

This answer is correct because discovery sampling is a special case of sampling for attributes. In discovery sampling there should be no opportunity to observe more than one occurrence, because it is designed to sample for serious or critical errors. Once a critical or serious error is discovered, the sampling plan will probably be abandoned and a more comprehensive examination undertaken.

Question 3

Which of the following computer-assisted auditing techniques processes client input data on a controlled program under the auditor’s control to test controls in the computer system?

Test data.
Review of program logic.
Integrated test facility.
Parallel simulation.

Answer 3

Parallel simulation.

Parallel simulation is a computer-assisted auditing technique in which an auditor-written or auditor-controlled program is used to process client data. The results are then compared to those obtained using the client’s program and differences are investigated.

This technique enables the auditor to test controls in and processing performed by a client program.

Question 4

Proper authorization procedures in the revenue cycle usually provide for the approval of bad debt write-offs by an employee in which of the following departments?

Treasurer.
Sales.
Billing.
Accounts receivable.

Answer 4

Treasurer

This answer is correct because the department responsible for bad debt write-offs should be independent of the sales authorization and recordkeeping functions.

Question 5

A CPA is reporting on comparative financial statements of a nonissuer. The CPA audited the prior year’s financial statements and reviewed those of the current year in accordance with Statements on Standards for Accounting and Review Services (SSARS). The CPA has added a separate paragraph to the review report to describe the responsibility assumed for the prior year’s audited financial statements. This separate paragraph should indicate

The type of opinion expressed previously.

That the CPA did not update the assessment of control risk.

The reasons for the change from an audit to a review.

That the audit report should no longer be relied on.

Answer 5

The type of opinion expressed previously.

This answer is correct because a separate paragraph to the report should indicate (1) that the financial statements of the prior period were audited, (2) the date of the previous report, (3) the type of opinion expressed, (4) if the opinion was other than unmodified , the substantive reasons therefor and (5) that no auditing procedures were performed after the date of the previous report.

Question 6

Which of the following is correct concerning PCAOB guidance that uses the term “should”?

The auditor must fulfill the responsibilities.

The auditor must comply with requirements unless s/he demonstrates that alternative actions were sufficient to achieve the objectives of the standard.

The auditor should consider performing the procedure; whether the auditor performs depends on the exercise of professional judgment in the circumstances.

The auditor has complete discretion as to whether to perform the procedure.

Answer 6

The auditor must comply with requirements unless s/he demonstrates that alternative actions were sufficient to achieve the objectives of the standard.

Question 7

Audit documentation for audits performed under the requirements of the Public Company Accounting Oversight Board should be retained for

The shorter of five years, or the period required by law.

Seven years.

The longer of seven years, or the period required by law.

Indefinitely.

Answer 7

The longer of seven years, or the period required by law.

Question 8

A service organization provides processing services for a client’s sales orders. Which of the following information is relevant when gathering data for the report on the service organization’s internal controls?

The client’s sales manager reviews accounts receivable balances.

The client’s data entry clerk used the sales manager’s password to make unauthorized changes to customer prices.

Credit limits are established and updated by the client’s credit department.

The service organization’s system calculates accounts receivable balances.

Answer 8

The service organization’s system calculates accounts receivable balances.

Correct! This question focuses on matters that are relevant to the service auditor’s report on internal controls at the service organization. Of the answer choices, this is the only one that involves a procedure that is actually performed at the service organization, so it would be relevant to the service auditor’s engagement.

Question 9

Nolan has had a distinguished career as an auditor at the Smith CPA firm. The local art museum would like him to serve on its board as a trustee to lend it prestige. However, Smith audits the art museum. Which of the following would not be a necessary safeguard to ensure that Nolan could serve as a museum trustee?

Nolan should not donate any money to the museum.

The position must be clearly honorary.

Nolan takes no management role in the museum and does not vote on any policies.

All externally circulated materials identify the position as honorary.

Answer 9

Nolan should not donate any money to the museum.

Question 10

An auditor of a nonissuer should design tests of details to ensure that sufficient audit evidence supports which of the following?

The planned level of control risk.

Management’s assertions that internal controls exist and are operating efficiently.

The effectiveness of internal controls.

The planned level of assurance at the relevant assertion level.

Answer 10

The planned level of assurance at the relevant assertion level.

The auditor should consider whether the assessments of the risks of material misstatement at the relevant assertion level in engagement planning are appropriate in light of the auditor’s substantive procedures.

Question 11

An auditor’s report on financial statements prepared on the cash receipts and disbursements basis of accounting should include all of the following except

A reference to the note to the financial statements that describes the cash receipts and disbursements basis of accounting.

A statement that the cash receipts and disbursements basis of accounting is not a comprehensive basis of accounting.

An opinion as to whether the financial statements are presented fairly in conformity with the cash receipts and disbursements basis
of accounting.

A statement that the audit was conducted in accordance with generally accepted auditing standards.

Answer 11

A statement that the cash receipts and disbursements basis of accounting is not a comprehensive basis of accounting.

Question 12

Which of the following items should be included in prospective financial statements issued in an examination engagement performed in accordance with Statements on Standards for

Attestation Engagements?

All significant assertions used to prepare the financial statements.

All significant assumptions used to prepare the financial statements.

Pro forma financial statements for the past two years.
Historical financial statements for the past three years.

Answer 12

All significant assumptions used to prepare the financial statements.

The assumptions underlying prospective financial statements are essential to the reader’s understanding, so any engagement involving prospective financial statements requires disclosure of the summary of significant assumptions.

Question 13

Which of the following is most likely to be considered a material weakness in internal control for purposes of an internal control audit of an issuer (public) company?

An ineffective oversight of financial reporting by the audit committee.

Restatement of previously issued financial statements due to a change in accounting principles.

Inadequate segregation of recordkeeping from accounting.

Weaknesses in control activities.

Answer 13

An ineffective oversight of financial reporting by the audit committee.

Ineffective oversight of financial reporting by the audit committee is among the list of circumstances that PCAOB Standard 5 suggests are strong indicators of the existence of a material weakness.

Question 14

An auditor most likely would apply analytical procedures near the completion of the audit to

Enhance the auditor’s understanding of subsequent events.
Identify auditing procedures omitted by the staff accountants.
Determine whether additional audit evidence may be needed.
Evaluate the effectiveness of the internal control activities.

Answer 14

Determine whether additional audit evidence may be needed.

This answer is correct because these analytical procedures will help the auditor in assessing the conclusions reached and in the evaluation of the overall financial statement presentation; accordingly, results of the overall review may indicate that additional evidence may be needed.

Question 15

When an auditor has been engaged to report on key audit matters, which of the following matters would least likely be addressed in the “Key Audit Matters” section of the auditor’s report?

Significant matters that caused the auditor to have substantial doubt about the entity’s ability to continue as a going concern

Significant unusual transactions identified by the auditor

Elements of the financial statements that involve significant management judgment

Matters that involve complex auditor judgments

Answer 15

Significant matters that caused the auditor to have substantial doubt about the entity’s ability to continue as a going concern

Correct! These issues should be addressed in the “Going Concern” section of the auditor’s report, not the “Key Audit Matters” section.

Question 16

Which of the following procedures most likely would assist an auditor in determining whether management has identified all accounting estimates that could be material to the financial statements?

Inquire about the existence of related party transactions.

Determine whether accounting estimates deviate from historical patterns.

Confirm inventories at locations outside the entity.

Review the lawyer’s letter for information about litigation.

Answer 16

Review the lawyer’s letter for information about litigation.

If the auditor is concerned about identifying all material accounting estimates, the auditor is seeking to discover unrecorded estimates. The auditor is most likely to review the lawyer’s letter for information about litigation. Litigation losses is an area that commonly requires estimates and one in which estimates could be material to the financial statements.

It is also an area that falls outside of the normal financial reporting process and, thus, is more likely to be missed.

Question 17

An auditor is reporting on cash basis financial statements. These statements are best referred to in the opinion by which of the following descriptions?

Financial position and results of operations arising from cash transactions.

Assets and liabilities arising from cash transactions, and revenue collected and expenses paid.

Balance sheet and income statement resulting from cash transactions.

Cash balance sheet and the source and application of funds.

Answer 17

Assets and liabilities arising from cash transactions, and revenue collected and expenses paid.

This answer is correct because the preferable titles when reporting on cash basis financial statements are assets and liabilities arising from cash transactions, and revenue collected and expenses paid.

Question 18

Which of the following internal control procedures would most likely prevent direct labor hours from being charged to manufacturing overhead?

Periodic independent counts of work in process for comparison to recorded amounts.

Comparison of daily journal entries with approved production orders.

Use of time tickets to record actual labor worked on production orders.

Reconciliation of work-in-process inventory with periodic cost budgets.

Answer 18

Use of time tickets to record actual labor worked on production orders.

The most effective control to prevent direct labor hours from being charged to manufacturing overhead is the use of time tickets to record actual labor worked on production orders. The time tickets, in turn, are posted to the work-in-process records, providing greater assurance that direct labor is being properly charged.

Question 19

Which of the following terms would be properly included in an engagement letter signed by audit firm MNO and its client, Magnifica Corporation?

MNO promises to reimburse Magnifica for any losses sustained by the wrongdoing of its own employees that MNO did not detect.

Magnifica promises to reimburse MNO for any damages it must pay to investors caused by MNO’s careless acts in conducting the
Magnifica audit.

Magnifica promises to reimburse MNO for any damages MNO must pay to investors caused by its nonnegligent failure to detect fraud by Magnifica’s management.

Neither MNO nor Magnifica will be liable to investors for any losses caused by their mutual errors that lead to the filing of materially erroneous financial statements.

Answer 19

Magnifica promises to reimburse MNO for any damages MNO must pay to investors caused by its nonnegligent failure to detect fraud by Magnifica’s management.

Correct! It is proper for an engagement letter to require an attest client to indemnify an audit firm for liability and costs resulting from knowing misrepresentations by the client’s management.

Question 20

Some firms which dispose of only a small part of their total output by consignment shipments fail to make any distinction between consignment shipments and regular sales. Which of the following would suggest that goods have been shipped on consignment?

Numerous shipments of small quantities.
Numerous shipments of large quantities and few returns.
Large debits to accounts receivable and small periodic credits.
Large debits to accounts receivable and large periodic credits.

Answer 20

Large debits to accounts receivable and small periodic credits.

This answer is correct because when consignment sales are shipped as regular sales, accounts receivable would be debited for large amounts. However, because the consignee is under no obligation to pay for the goods until they are sold, accounts receivable would be credited in small periodic amounts.

Question 21

In auditing a manufacturing entity, which of the following procedures would an auditor least likely perform to determine whether slow-moving, defective, and obsolete items included in inventory are properly identified?

Test the computation of standard overhead rates.
Tour the manufacturing plant or production facility.
Compare inventory balances to anticipated sales volume.
Review inventory experience and trends.

Answer 21

Test the computation of standard overhead rates.

This answer is correct because the testing of standard overhead rates may provide only very limited assistance since they may be used to arrive at the cost of the item, but provide no real support relating to obsolescence.

Question 22

For a nonpublic company audit report, a statement that the auditor has audited the financial statements followed by the titles of the financial statements is included in the

“Management’s Responsibilities” section of the audit report.
The “Opinion” section of the auditor’s report.
The “Auditor’s Responsibilities” section of the audit report.
The “Basis for Opinion” section of the auditor’s report.

Answer 22

The “Opinion” section of the auditor’s report.

The “Opinion” section at the beginning of the auditor’s report states that the auditor has audited the financial statements and then lists them.

Question 23

Which of the following types of risks most likely would increase if accounts receivable are confirmed three months before year end?

Inherent.
Control.
Detection.
Business.

Answer 23

Detection.

This answer is correct because detection risk, the risk that audit procedures will not detect a material misstatement, increases due to the three months between confirmation and year-end.

Question 24

Which of the following statements is correct concerning the auditor’s use of statistical sampling?

An auditor needs to estimate the dollar amount of the standard deviation of the population to use classical variables sampling.

An assumption of PPS sampling is that the underlying accounting population is normally distributed.

A classical variables sample needs to be designed with special considerations to include negative balances in the sample.

The selection of zero balances usually does not require special sample design considerations when using PPS sampling.

Answer 24

An auditor needs to estimate the dollar amount of the standard deviation of the population to use classical variables sampling.

An estimate of the variation of the population, the standard deviation, is needed to use classical variables sampling (AICPA Audit and Accounting Guide, Audit Sampling).

Question 25

In a properly designed internal control structure, the same employee would most likely match vendors’ invoices with receiving reports and also

Post the detailed accounts payable records.
Recompute the calculations on vendors’ invoices.
Reconcile the accounts payable ledger.
Cancel vendors’ invoices after payment.

Answer 25

Recompute the calculations on vendors’ invoices.

This question pertains to segregation of duties. An employee responsible for matching vendor invoices with receiving reports is performing a step in the authorization process which will result in invoices being approved for payment. The same employee should not have responsibility for posting the accounts payable records, reconciling the accounts payable ledger, or canceling invoices after payment, as each would provide an opportunity for embezzlement or misappropriation to occur. It would be acceptable for the employee to recompute the calculations on vendors’ invoices, which would be an additional step in the same authorization process.

Question 26

For financial statement audits performed in accordance with generally accepted government auditing standards, auditors should report which of the following?

All violations of private grant agreements, regardless of materiality.
Suspected illegal acts.
Significant deficiencies in internal control.
Significant changes in the entity’s internal control policies.

Answer 26

Significant deficiencies in internal control.

Correct! The auditor should report any identified significant deficiencies in internal control and should obtain a response from officials of the entity to be included in the auditor’s report.

Question 27

Which of the following statements about a practitioner’s review report for an attestation engagement is correct?

The Statements on Standards for Attestation Engagements require CPAs to express a review report in a standardized format.

The practitioner should report on the responsible party’s written assertion, not directly on the subject matter.

The practitioner’s review report should include a disclaimer of opinion.

When the subject matter of a review engagement has a misstatement that is material but not pervasive, the practitioner should restrict the distribution of the report to the engaging party.

Answer 27

The practitioner’s review report should include a disclaimer of opinion.

(Correct!) The review report should include a statement that a review is substantially less in scope than an examination, and a disclaimer of opinion should be included.

Question 28

Blake is on his firm’s audit team for the Mignon Corporation audit. He knows that if he has a financial interest in Mignon, it might impair his independence. Which of the following interests would be permissible?

Blake buys a large amount of Mignon preferred shares that do not carry voting rights.

Blake does not buy, but commits to acquire in 3 months’ time, Mignon preferred shares that do not carry voting rights.

Blake buys a very small amount of Mignon common shares with voting rights.

Blake is the beneficiary of a blind trust that owns a small amount of stock in a corporation that has made a small operating loan to Mignon.

Answer 28

Blake is the beneficiary of a blind trust that owns a small amount of stock in a corporation that has made a small operating loan to Mignon.

Correct! This investment is both indirect and apparently immaterial and therefore probably permitted.

Question 29

When performing a substantive test of a random sample of cash disbursements, an auditor is supplied with a photocopy of vendor invoices supporting the disbursements for one particular vendor, rather than the original invoices. The auditor is told that the vendor’s original invoices have been misplaced. What should the auditor do in response to this situation?

Randomly increase the number of items in the substantive test to increase the reliance that may be placed on the overall test.

Reevaluate the risk of fraud and design alternate tests for the related transactions.

Increase testing by agreeing more of the payments to this particular vendor to the photocopies of its invoices.

Count the missing original documents as misstatements and project the total amount of the error based on the size of the population and the dollar amount of the errors.

Answer 29

Reevaluate the risk of fraud and design alternate tests for the related transactions.

Fraud risk increases when copies of documents are provided instead of originals and more so when they are related to a single vendor, rather than multiple vendors. The auditor will need to obtain other evidence to support the transactions in question.

Question 30

The audit plan usually cannot be finalized until the

Consideration of the entity’s internal control structure has been completed.

Engagement letter has been signed by the auditor and the client.

Significant deficiencies have been communicated to the audit committee of the board of directors.

Search for unrecorded liabilities has been performed and documented.

Answer 30

Consideration of the entity’s internal control structure has been completed.

The audit plan (sometimes referred to as the “audit program”) documents the auditing procedures to be performed. It cannot be finalized until consideration of the entity and its environment, including internal control, has been completed. Recall that the auditors are required to obtain a sufficient understanding of the entity and its environment, including its internal control, to assess the risk of material misstatement and to plan the audit and allow determination of the nature, timing, and extent of the tests to be performed. Thus, knowledge of the internal control structure is needed for the auditor to select the auditing procedures and decide when and how extensively to perform them.