2.21.19

Question 1

Which of the following conditions or events is most likely to cause an auditor to have substantial doubt about an entity’s ability to continue as a going concern?

Answer 1

Cash flows from operating activities are negative.

The significance of conditions or events depends on circumstances, and some conditions or events may be significant only in conjunction with others. Such conditions and events include negative trends, financial difficulties, internal matters, and external matters. Negative cash flows from operating activities provide evidence of negative trends and financial difficulties.

Question 2

When compiling the financial statements of a nonissuer, an accountant should

Answer 2

Understand the accounting principles and practices of the entity’s industry.

The accountant should obtain an understanding of (1) the applicable reporting framework and (2) the significant accounting policies intended to be used to prepare the financial statements (AR-C 80).

Question 3

How would an increase in tolerable misstatement and an increase in the risk of material misstatement (RMM) affect the sample size in a substantive test of details?

Increase in Tolerable Misstatement:
Increase in the RMM:

Answer 3

decrease
increase

An increase in tolerable misstatement or the level of materiality decreases the sample size necessary to collect sufficient appropriate audit evidence. An increase in the RMM increases the assurance to be provided by substantive procedures and therefore the necessary sample size.

Question 4

An accountant compiles the financial statements of a nonissuer and issues the compilation report. Although not specifically stated in this report, it is implied that

Answer 4

Substantially all disclosures required by GAAP are included in the financial statements.

An accountant may compile financial statements that omit substantially all disclosures required by an applicable reporting framework if the omission is not, to his or her knowledge, made to mislead users of the statements. When reporting on such statements, the accountant should include in the compilation report a paragraph with the following statements: (1) Management has elected to omit substantially all disclosures; (2) if the omitted disclosures were included, they might influence the user’s conclusions; and (3) the statements are not designed for those who are not informed about such matters. Accordingly, the compilation report implies that substantially all disclosures required by GAAP are included in the financial statements because it does not mention disclosures.

Question 5

Which of the following procedures is an accountant required to perform before issuing a compilation report under Statements on Standards for Accounting and Review Services (SSARSs)?

Answer 5

Read the financial statements and consider whether such financial statements appear to be free from obvious material errors.

The accountant should read the statements after obtaining an understanding of the framework and significant accounting policies. The accountant then considers whether the statements appear to be appropriate in form and free from obvious material misstatements.

Question 6

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?

Answer 6

Parallel simulation.

Parallel simulation is a test of the controls in a client’s application program. An auditor-developed program, not the client’s program, is used to process actual client data and compare the outputs and exceptions report with those of the client’s application program. If the client’s programmed controls are operating effectively, the two sets of results should be reconcilable.

Question 7

Which of the following combinations of procedures would an auditor most likely perform to obtain evidence about fixed asset additions?

Answer 7

Inspecting documents and physically examining assets.

The auditor’s direct observation of fixed assets is one means of determining whether additions have been made. Tracing to the detailed records determines whether additions have been recorded. Inspection of deeds, lease agreements, insurance policies, invoices, canceled checks, and tax notices may also reveal additions.

Question 8

Auditors’ reports issued in connection with which of the following are not considered to be on financial statements based on a special purpose framework?

Answer 8

Compiled financial statements prepared in accordance with appraised liquidation values.

AU-C 800 identifies special purpose frameworks for financial statements as frameworks other than GAAP. They are (1) the cash basis, (2) the tax basis, (3) a regulatory basis, (4) a contractual basis, and (5) a definite set of logical and reasonable criteria applied to all items in the statements. Compiled statements are not audited, and appraised value is not a special purpose framework.

Question 9

An audit of owners’ equity normally would not include

Answer 9

Detail checking from the dividend payment list to the capital stock records.

An auditor normally does not perform detail checking from the dividend payment list to the capital stock records. (S)he may test certain large dividend payments but, because the amount of each dividend is usually small, detail checking is minimal. The need for extensive checking is reduced when the entity uses an independent financial institution as its agent for dividend payments. The stock transfer agent often performs this function because it maintains detailed records of shareholders. The arrangement substantially decreases the risks of material misstatement.

Question 10

Field is an employee of Gold Enterprises. Thomas Hardy, CPA, is asked to express an opinion on Field’s profit participation in Gold’s net income. Hardy may accept this engagement only if

Answer 10

Hardy also performs procedures on Gold’s financial position and results of operations.

If the auditor does not audit the complete set of statements, (s)he should determine whether it is feasible to (1) audit the profit participation and (2) perform procedures on interrelated items. If a specified element, account, or item is, or is based upon, an entity’s net income or the equivalent, the auditor should perform the procedures needed to express an opinion on financial position and results of operations. The reason is that the profit participation interrelates with balance sheet and income statement accounts.

Question 11

An accountant performing a nonissuer’s review engagement is considering the appropriateness of a client’s balance for accrued wages. The accountant should perform each of the following procedures except

Answer 11

Testing the process used by management to determine the balance.

Substantive procedures are not typically used in a review engagement. Thus, the accountant need not test the process used by management to determine the balance. A review engagement primarily uses inquiries and analytical procedures.

Question 12

William Halsey is auditing the consolidated financial statements of Rex, Inc. Abbey Lincoln is the auditor who has audited and reported on the financial statements of a wholly owned subsidiary of Rex, Inc. Halsey’s first concern with respect to the Rex financial statements is to decide whether he

Answer 12

May serve as the group auditor and report as such on the consolidated financial statements of Rex, Inc.

The first objective of the group engagement partner is to determine whether to serve as the auditor of the group statements. If so, the objectives are to (1) determine whether to refer to the component auditor’s report, (2) communicate clearly with the component auditor or auditors, and (3) obtain sufficient appropriate evidence about the financial information of the components and the consolidation process. Thus, the group engagement partner should evaluate whether sufficient appropriate evidence can be obtained to serve as the auditor of the group statements. Factors relevant to the decision to act as the group auditor also include (1) the financial significance of individual components for which responsibility will be assumed, (2) the significant risks of material misstatement of the group statements from assuming responsibility for components, and (3) the group engagement team’s knowledge of the overall financial statements.

Question 13

When considering the use of management’s written representations as audit evidence about the completeness assertion, an auditor should understand that such representations

Answer 13

Complement, but do not replace, substantive procedures designed to support the assertion.

AU-C 580 states that written representations provide necessary audit evidence that complements other audit procedures. However, they do not, by themselves, provide sufficient appropriate evidence about the matters to which they are relevant. Moreover, obtaining reliable written representations has no effect on the nature and extent of other procedures applied regarding (1) fulfillment of management’s responsibilities or (2) specific assertions.

Question 14

When planning a sample for a substantive test of details, an auditor should consider tolerable misstatement for the sample. This consideration should

Answer 14

Be related to preliminary judgments about materiality levels.

When planning a sample for a test of details, the auditor should consider how much monetary misstatement in the related account balance or class of transactions may exist without causing the financial statements to be materially misstated. This maximum misstatement is the tolerable misstatement for the sample. It is used in audit planning to determine the necessary precision and sample size. Tolerable misstatement, combined for the entire audit plan, should not exceed the auditor’s preliminary judgments about materiality.
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Question 15

Krim, president and CEO of United Co., engaged Smith, CPA, to audit United’s financial statements so that United could secure a loan from First Bank. Smith expressed an unmodified opinion on May 20, but the loan was delayed. On August 5, on inquiry to Smith by First Bank, Smith, relying on Krim’s written representation, made assurances that United’s financial status had not changed materially. Krim’s representation was untrue because of a material change after May 20. First relied on Smith’s assurances of no change. Shortly afterward, United became insolvent. If First sues Smith for negligent misrepresentation, Smith will likely be found

Answer 15

Liable, because Smith should have obtained sufficient appropriate audit evidence to verify the status of United.

Written representations are necessary evidence that complements evidence obtained by performing other procedures. But they do not constitute sufficient appropriate evidence about relevant matters. Moreover, the auditor ordinarily has no responsibility for events after the date of the report. If the auditor decides to assume such responsibility, (s)he must comply with GAAS, including AU-C 580. Accordingly, the auditor is liable for negligent misrepresentation. Smith (1) made a false representation (2) of a material fact (3) not known to be false (4) but intended to induce reliance (5) that was reasonably relied upon (6) to the detriment of the plaintiff.

Question 16

When using confirmations to provide evidence about the completeness assertion for accounts payable, the appropriate population most likely is

Answer 16

Vendors with whom the entity has previously done business.

When sending confirmations for accounts payable, the population of accounts should include small and zero balances as well as large balances. The auditor should use the activity in the account as a gauge for sample selection. That is, if orders are placed with a vendor on a consistent basis, a confirmation should be sent to that vendor regardless of the recorded balance due.

Question 17

Which of the following is a control activity that most likely could help prevent employee payroll fraud?

Answer 17

The human resources department promptly sends employee termination notices to the payroll supervisor.

The human resources department should forward personnel changes to payroll promptly to ensure that proper authorizations are used to calculate the payroll.

Question 18

Fact Pattern: Sales procedures that were encountered during the regular annual audit of Marvel Wholesale Distributing Company are described below.
Customer orders are received by the sales-order department. A clerk computes the dollar amount of the order and sends it to the credit department for approval. Credit approval is stamped on the order and returned to the sales-order department. An invoice is prepared in two copies, and the order is filed in the customer order file. The customer copy of the invoice is sent to the billing department and held in the pending file, awaiting notification that the order has been shipped. The shipping copy of the invoice is routed through the warehouse, and the shipping department has authority for the respective departments to release and ship the merchandise. Shipping department personnel pack the order and prepare a three-copy bill of lading: The original copy is mailed to the customer, the second copy is sent with the shipment, and the other is filed in sequence in the bill of lading file. The invoice shipping copy is sent to the billing department. The billing clerk matches the received shipping copy with the customer copy from the pending file. Both copies of the invoice are priced, extended, and footed. The customer copy is then mailed directly to the customer, and the shipping copy is sent to the accounts receivable clerk. The accounts receivable clerk enters the invoice data in a sales-accounts receivable journal, posts the customer’s account in the subsidiary customers’ accounts ledger, and files the shipping copy in the sales invoice file. The invoices are numbered and filed in sequence.

Question: 18 To determine whether Marvel Company’s internal control operated effectively to minimize errors of failure to invoice a shipment, the auditor should select a sample of transactions from the population represented by the

Answer 18

Bill of lading file.

The auditor should match bill of lading file copies relating to customer shipments to sales invoices (or possibly to the accounts receivable subsidiary ledger) to determine whether shipments were not billed.

Question 19

Which of the following are not directly involved in the revenue cycle?

Answer 19

Receiving department clerk.

The receiving department clerk is involved in the purchases-payables cycle. The clerk counts the goods and prepares receiving reports that provide partial authorization for invoice payment.

Question 20

Which of the following procedures would most likely be included in a review engagement of a nonissuer?

Answer 20

Inquiring about related party transactions.

The accountant’s understanding of the entity’s business should include a general understanding of (1) the entity’s organization; (2) its operating characteristics; and (3) the nature of its assets, liabilities, revenues, and expenses. This would ordinarily involve a general knowledge of the entity’s production, distribution, and compensation methods, types of products and services, operating locations, and material transactions with related parties.