2.11.19

Question 1

If statistical sampling methods are used by a client in the taking of its physical inventory, the auditor must

Answer 1

Observe such test counts as (s)he deems necessary and be satisfied that the sampling plan has statistical validity, that it was properly applied, and that the resulting precision and reliability are reasonable in the circumstances.

When the client uses statistical sampling to determine inventory quantities, the auditor should become satisfied by performing alternative audit procedures. Attending a year-end inventory count is obviously impractical when the entity measures its inventory using statistical methods. The auditor is required to attend and observe at least some counts and should evaluate whether the methods applied and results are appropriate.

Question 2

Which of the following procedures should an auditor ordinarily perform regarding subsequent events?

Answer 2

Read the latest subsequent interim financial statements.

Subsequent events procedures include (1) reading the latest subsequent interim statements, if any; (2) inquiring of management and those charged with governance about the occurrence of subsequent events and various financial and accounting matters; (3) reading the minutes of meetings of owners, management, and those charged with governance; (4) obtaining a letter of representations from management; (5) inquiring of client’s legal counsel; and (6) obtaining an understanding of management’s procedures for identifying subsequent events.

Question 3

A client is holding securities as collateral for an outstanding account receivable. During the course of the audit engagement, the CPA should

Answer 3

Examine the securities and determine their fair value.

When an entity holds an asset of another entity as security for an outstanding debt, the auditor should examine the collateral and estimate its fair value to determine the reasonableness of the arrangement. The auditor may refer to published data such as current market quotations to determine the value of securities.

Question 4

Which of the following sets of information does an auditor usually confirm on one form?

Answer 4

Cash in bank and collateral for loans.

The AICPA Standard Form to Confirm Account Balance Information with Financial Institutions is used by auditors to confirm the deposit balance held by the bank for a client. In addition, this confirmation requests loan information, such as a description of the collateral securing the loan.

Question 5

Which of the following is a computer program that appears to be legitimate but performs some illicit activity when it is run?

Answer 5

Trojan horse.

A Trojan horse is a computer program, for example, a game, that appears friendly but that actually contains an application destructive to the computer system.

Question 6

The permanent file of an auditor’s audit documentation generally would not include

Answer 6

A working trial balance.

Audit documentation is usually classified into permanent and current files. Current files include schedules and analyses that relate to the current year under audit. The working trial balance is maintained in the current file.

Question 7

Which of the following events occurring after the issuance of the financial statements most likely would cause the auditor to make further inquiries about the previously issued financial statements?

Answer 7

New information is discovered concerning undisclosed lease transactions of the audited period.

Subsequently discovered facts become known to the auditor after the date of the auditor’s report. Had they been known to the auditor at that date, they might have caused the auditor to revise the auditor’s report. If a subsequently discovered fact becomes known to the auditor after the report release date, the auditor should (1) discuss the matter with management and, if appropriate, those charged with governance and (2) determine whether the financial statements need revision and, if so, inquire how management intends to respond.

Question 8

During the audit of internal controls integrated with the audit of the financial statements, the auditor discovered a material weakness in internal control. The auditor most likely will express a(n)

Answer 8

Adverse opinion on internal control.

Material weaknesses are significant control deficiencies that result in more than a remote chance that a material misstatement will result in the financial statements. A material weakness requires the auditor to express an adverse opinion on the effectiveness of internal control.

Question 9

Which of the following is usually included or shown in the audit documentation?

Answer 9

A summary of how significant findings were addressed.

Auditors may document a summary, or completion memorandum, describing the significant findings or issues identified and how they were addressed. This summary facilitates (1) reviews of the audit documentation, (2) the auditor’s consideration of significant findings and issues, and (3) determination of whether any individual audit objective cannot be achieved that will prevent achievement of the overall audit objectives.

Question 10

Which of the following are elements of a CPA firm’s quality control that should be considered in establishing its quality control policies and procedures?

HR:
Monitoring:
Engagement Performance:

Answer 10

Yes
Yes
Yes

The quality control element of human resources relates to providing reasonable assurance that the firm has sufficient personnel with the necessary capabilities, competence, and commitment to ethics. The quality control element of monitoring relates to providing reasonable assurance that the firm has a quality control system that is relevant, adequate, effective, and complied with. The quality control element of engagement performance relates to providing reasonable assurance that (1) engagements are consistently performed in accordance with applicable requirements and (2) issued reports are appropriate (QC 10).

Question 11

Which of the following representations should not be included in a written report on internal control related matters identified in an audit under the AICPA’s auditing standards?

Answer 11

There are no significant deficiencies or material weaknesses in the design or operation of internal control.

No report should be issued indicating that no significant deficiencies were noted. The potential for misinterpretation would exist if the auditor issued such a report (AU-C 265).

Question 12

Some subsequent events provide evidence of conditions not in existence at the balance sheet date. Under U.S. GAAP, some of these events are of such a nature that disclosure is required to keep the financial statements from being misleading. Adequate disclosure of these events may include

Answer 12

Pro forma financial statement presentation.

Under U.S. GAAP, subsequent events related to conditions that did not exist at the date of the balance sheet should not result in adjustments of (recognition in) the financial statements. These events are disclosed, if necessary, to keep the financial statements from being misleading. Occasionally, such an event may be so significant that disclosure can best be made by means of pro forma financial data. Such data make the event seem as if it had occurred on the date of the balance sheet. In some cases, U.S. GAAP suggest presentation of pro forma statements, usually a balance sheet only, in columnar form on the face of the historical statements. But firms usually incorporate the pro forma balance sheets in notes.

Question 13

During an audit, Mr. Wick learns that the audit client was granted a 3-month waiver of the repayment of principal on the installment loan with Blank Bank without an extension of the maturity date. With respect to this loan, the audit program used by Mr. Wick is least likely to include a verification of the

Answer 13

Balloon payment.

The auditor’s primary concern is that the liability is reported correctly at the balance sheet date. The balloon payment pertains to the next period’s results of operations, financial position, and cash flows.

Question 14

A client is a defendant in a patent infringement lawsuit against a major competitor. Which of the following items would least likely be included in legal counsel’s response to the auditor’s letter of inquiry?

Answer 14

An evaluation of the ability of the client to continue as a going concern if the verdict is unfavorable and maximum damages are awarded.

An inquiry letter response from the client’s legal counsel will normally include information or comment about each pending or threatened litigation, claim, or assessment. Legal counsel should (1) address the progress of the case, (2) describe the action the company plans to take, (3) evaluate the likelihood of an unfavorable outcome, and (4) estimate (if possible) the range of any potential loss. Legal counsel does not have the expertise or appropriate information to make a judgment about the client’s ability to continue as a going concern. The auditor normally makes that judgment.

Question 15

Which of the following procedures would an auditor most likely perform to assist in the evaluation of loss contingencies?

Answer 15

Obtaining a letter of audit inquiry from the client’s lawyer.

Auditors obtain an inquiry letter from legal counsel as a primary means of corroborating the information management provides about litigation, claims, and assessments.

Question 16

Which of the following factors most likely affects an auditor’s judgment about the nature and extent of the auditor’s audit documentation?

Answer 16

The risks of material misstatement of an assertion.

The form, content, and extent of documentation are determined by the following: (1) risks of material misstatement, (2) extent of judgment involved in performing the work and evaluating the results, (3) nature of the auditing procedures, (4) significance of the evidence obtained, (5) nature and extent of exceptions identified, (6) need to document a conclusion or the basis for a conclusion not readily determinable from other documentation of the work, (7) size and complexity of the entity, and (8) audit methods.

Question 17

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

Answer 17

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

Prior-period amounts recorded for notes payable should be compared with current amounts. A key procedure to detect unrecorded debt is to recalculate interest expense based on recorded debt and compare it with recorded interest expense. Significant unexpected interest expense recorded in the general ledger suggests the existence of unrecorded debt. The debt-to-equity ratio, which equals total liabilities divided by total equity, also can be calculated and compared with previous periods.

Question 18

Which of the following would an auditor ordinarily consider the greatest risk regarding an entity’s use of electronic data interchange (EDI)?

Answer 18

Improper distribution of EDI transactions.

Transactions in an EDI system are communicated from computer to computer, often without human intervention. In some cases an EDI system uses a value-added network (VAN) that forwards transactions from the sender to the receiver. Both of these situations increase the risk of miscommunications and improper distribution of messages.

Question 19

An auditor most likely would make inquiries of production and sales personnel concerning possible obsolete or slow-moving inventory to support the relevant assertion about

Answer 19

Valuation and allocation.

The valuation and allocation assertion is directed towards whether inventory is recorded at lower of cost or market. The discovery of slow-moving, excess, defective, or obsolete inventory suggests that the cost of inventory be written down to market.

Question 20

The accounts receivable turnover ratio increased significantly over a two-year period. This trend could indicate that

Answer 20

The company is more aggressively collecting customer accounts.

The accounts receivable turnover ratio equals net credit sales divided by average accounts receivable. Thus, the ratio increases if the entity more effectively collects accounts while holding other factors, such as credit policy, constant.