Performing Specific Procedures to Obtain Evidence -- External Confirmations

Question 1

A client uses a suspense account for unresolved questions whose final accounting has not been deter­mined. If a balance remains in the suspense account at year end, the auditor would be most concerned about

A. Suspense debits that management believes will benefit future operations

B. Suspense debits that the auditor verifies will have realizable value to the client

C. Suspense credits that management believes should be classified as “Current liability”

D. Suspense credits that the auditor determines to be customer deposits

Answer 1

A.

Suspense debits that management believes will benefit future operations are assets. The auditor is most concerned that assets are not overstated and that liabilities are not understated. Suspense debits that the auditor verifies will have realizable value to the client are, insofar as the auditor knows, correct. Thus, for these items, there would be no overstatement. The other two answer options contain items that, if incorrect, would overstate liabilities.

Question 2

Which of the following procedures most likely could assist an auditor in identifying related-party transac­tions?

A. Performing tests of controls concerning the segregation of duties

B. Evaluating the reasonableness of management’s accounting estimates

C. Reviewing confirmations of compensating balance arrangements

D. Scanning the accounting records for recurring transactions

Answer 2

C.

Business structure and operating style occasionally are designed deliberately to obscure relation­ships. Because compensating balance arrangements and non monetary transactions obscure the form of trans­actions,they are suspect. Compensating balance arrangements involve related parties more often than the other answer options. Segregation of duties applies whether the parties to a transaction are related or not. Reason­able and unreasonable accounting estimates both exist with and without related parties present. Entities fre­quently have recurring transactions with independent entities.

Question 3

When an entity is required or permitted to disclose segment information in the financial statements

A. The auditor should obtain an understanding of the related industry standards as the applicable financial reporting framework may not include requirements for this level of presentation

B. The auditor is unlikely to perform analytical procedures on segment information

C. The auditor’s responsibility regarding the presentation and disclosure of segment information is in relation to the financial statements as a whole

D. The auditor is required to perform audit procedures that would be necessary to express an opinion on the segment information presented on a stand-alone basis

Answer 3

C.

The auditor’s responsibility regarding the presentation and disclosure of segment information is in relation to the financial statements as a whole. Accordingly(regarding incorrect answer d.), the auditor is not required to perform audit procedures that would be necessary to express an opinion on the segment information presented on a stand-alone basis.Regarding incorrect answer a., the applicable financial reporting framework (AFRF) is the likely source of guidance for management and the auditor. The AFRF may include requirements to disclose segment information; thus, the auditor should, rather than looking to industry standards, obtain an understanding of the methods used by management in determining segment information and evaluate whether such methods are likely to result in disclosure and presentation in accordance with the AFRF. When appropri­ate, the auditor should test the application methods and perform audit procedures. For example, when obtaining an understanding of management’s methods to determine segment information, the auditor may look at (1) the allocation of assets and costs among segments or (2) sales, transfers, and charges between segments and the elimination of inter segment amounts.Regarding incorrect answer b., the auditor may find it appropriate to per­form analytical procedures or other audit procedures appropriate in the circumstances. Analytical procedures may help identify inconsistencies with prior period information.

Question 4

According to the standards of the profession, which of the following events would require a CPA performing a consulting services engagement for a non-audit client to withdraw from the engagement?

I.The CPA has a conflict of interest that is disclosed to the client and the client consents to the CPA continuing the engagement.

II.The CPA fails to obtain a written understanding from the client concerning the scope of the engagement

A. I only

B. II only

C. Both I and II

D. Neither I nor II

Answer 4

The correct answer is (D).

According to the standards of the profession, a CPA is not required to be independent for consulting engagements with non-audit clients. The CPA need not withdraw from the engagement if there arises a conflict of interest that is fully disclosed to the client and the client consents to it. The understanding of the scope of the engagement may be written or oral.

Options (A), (B) and (C) are incorrect based on the above explanation.

Question 5

According to the AICPA Code of Professional Conduct, under which of the following circumstances may a CPA receive a contingent fee for services?

A. Examining a client’s prospective financial information

B. Preparing a client’s federal income tax return

C. Representing a client in an IRS examination of the client’s federal income tax return

D. Reviewing a client’s financial statements

Answer 5

C.

Rule 302 states that a member in public practice shall not offer or render services under an agreement whereby the fee is contingent upon the findings or results. Specified services include an audit or review of a financial statement, a compilation of a financial statement when the member reasonably might expect that a third party will use the statement, an examination of prospective financial information; or preparing an original or amended tax return or claim for a tax refund. Contingent fees in certain tax matters are permitted, including: a member representing a client in an examination by a revenue agent of the client’s federal or state income tax return; a member representing a client in connection with obtaining a private letter ruling, filing an amended return based on a tax issue that is the subject of a test case involving a different taxpayer or on which the taxing authority is developing a position.

Question 6

In which of the following engagements would a practitioner provide limited assurance about the possible significant effects on the historical financial statements if a change in capitalization had occurred at an earlier date?

A. A compilation of a financial projection.

B. A review of pro-forma financial information.

C. An examination of Management’s Discussion and Analysis.

D. An audit of condensed interim financial information.

Answer 6

The correct answer is (B).

Pro-forma financial statements are used to demonstrate the effect of a future or hypothetical event by showing how it would have affected the historical financial statements if it had occurred during the period covered by those financial statements. The practitioner may either examine or review pro-forma financial statements and provide reasonable or limited assurance as to the assumptions and presentations of pro-forma data being reasonable. The practitioner providing limited assurance about the possible significant effects on the historical financial statements if a change in capitalization had occurred at an earlier date is a review of pro-forma financial information.

Question 7

Which of the following statements is correct with regard to management use of a broker’s quotation to support a fair value estimate?

A. If the quotation is from the broker who initially sold the instrument, the evidence might be less objective and might need supplementation.

B. A broker’s quotation that is based on a cash flow methodology cannot be accepted.

C. The auditor is not required to obtain an understanding of the broker’s methodology for obtaining the fair value estimate.

D. A broker’s quotation that is based on a combination of methodologies cannot be accepted.

Answer 7

The correct answer is (A).

To audit management use of a broker’s quotation to support a fair value estimate auditor should obtain an understanding of how the broker developed the fair value, evaluate the degree of uncertainty associated with the fair value. The fair value must be reasonable and not subjective & susceptible to bias. A quotation from the broker who initially sold the instrument is less objective and must need supplementation.

A broker’s quotation that is based on a cash flow methodology can be accepted. The auditor is required to obtain an understanding of the broker’s methodology for obtaining the fair value estimate. A broker’s quotation that is based on a combination of methodologies can be accepted.

Question 8

Which of the following procedures would be most appropriate for testing the completeness assertion as it applies to inventory?

A. Scanning perpetual inventory, production, and purchasing records

B. Examining paid vendor invoices

C. Tracing inventory items from the tag listing back to the physical inventory quantities

D. Performing cutoff procedures for shipping and receiving

Answer 8

D.

Performing cutoff procedures for shipping and receiving would be the best test for the completeness assertion as it applies to inventory. The completeness assertion means that all transactions that should have been recorded have been recorded. Many procedures test multiple assertions, so candidates must select the best answer—some of the other answers are better tests of other assertions. Scanning perpetual inventory, production, and purchasing records test accuracy. Examining paid vendor invoices tests accuracy and occur­rence. Tracing inventory items from the tag listing back to the physical inventory quantities tests accuracy and existence.

Question 9

Which of the following is usually a benefit of using electronic funds transfer for international cash transactions?

A. Improvement of the audit trail for cash receipts and disbursements

B. Creation of self-monitoring access controls

C. Reduction of the frequency of data entry errors

D. Off-site storage of source documents for cash transactions

Answer 9

C.

With EDI, information is entered into a system once and transmitted to other parties. These other parties do not have to re-enter the information into their systems, eliminating an opportunity for errors to occur. Using EDI, audit trails typically are less clear, if anything. Creation of self-monitoring access controls and off-site storage of source documents for cash transactions could occur with or without EDI.

Question 10

To measure how effectively an entity employs its resources, an auditor calculates inventory turnover by dividing average inventory into

A. Net sales

B. Cost of goods sold

C. Operating income

D. Gross sales

Answer 10

B.

The formula for inventory turnover is cost of goods sold divided by average inventory. Cost of goods sold includes only inventory related expenses and thus is the best value to use to compare to average inventory to calculate inventory turnover. Net sales, operating income, and gross sales are all based on the prices the entity charged the customers, not the actual costs to the company for the goods that were sold, and thus are not as closely related to the costs associated with inventory

Question 11

When an accountant examines a financial forecast that fails to disclose several significant assumptions used to prepare the forecast, the accountant should describe the assumptions in the accountant’s report and issue a(an)

A. Unqualified opinion with a separate explanatory paragraph

B. “Subject to” qualified opinion

C. “Except for” qualified opinion

D. Adverse opinion

Answer 11

D.

When a CPA examines a financial forecast that fails to disclose several assumptions that appear to be significant the CPA should describe the assumptions in the report and issue an adverse opinion.

Question 12

Which of the following statements best explains why the CPA profession has found it essential to promulgate ethical standards and to establish means for ensuring their observance?

A. A distinguishing mark of a profession is its acceptance of responsibility to the public.

B. A requirement for a profession is to establish ethical standards that stress primary responsibility to clients and colleagues.

C. Ethical standards that emphasize excellence in performance over material rewards establish a reputation for competence and character.

D. Vigorous enforcement of an established code of ethics is the best way to prevent unscrupulous acts.

Answer 12

A.

The AICPA’s Code of Professional Conduct states that a distinguishing mark of a profession is its acceptance of responsibility to the general public.

Question 13

Regarding a non-issuer’s compliance with laws and regulations, an auditor performing an audit of the entity’s financial statements is responsible for

A. Obtaining a general understanding of the legal and regulatory framework applicable to the entity and how the entity is complying with that framework

B. Preventing noncompliance with existing applicable laws and regulations that determine reported amounts and disclosures in the entity’s financial statements

C. Determining whether an act performed by the entity being audited constitutes noncompliance with existing applicable laws and regulations

D. Ensuring that the entity’s operations are conducted in accordance with the provisions of laws and regulations relevant to the entity’s financial statements

Answer 13

The correct answer is (A).

In the absence of identified or suspected non-compliance, the auditor is not required to perform audit procedures regarding the entity’s compliance with laws and regulations, But auditor should obtain a general understanding of the following:

Legal & regulatory framework applicable to the entity and its industry or sector

How the entity is complying with that framework

(B) is incorrect because the auditor is not responsible for preventing any non-compliance, but only for reporting any non-compliance, material misstatements, fraud, etc. Prevention is the duty of management and the internal audit team.

(C) is incorrect because the auditor is not responsible for determining whether an act performed by the entity being audited constitutes non-compliance with existing applicable laws and regulations.

(D) is incorrect because the auditor is not responsible for ensuring that the entity’s operations are conducted in accordance with the provisions of laws and regulations as the auditor is not required to perform audit procedures regarding the entity’s compliance with laws and regulations.

Question 14

To provide assurance that each voucher is submitted and paid only once, an auditor most likely would examine a sample of paid vouchers and determine whether each voucher is

A. Stamped paid by the check signer

B. Returned to the vouchers payable department

C. Supported by a vendor’s invoice and purchase order

D. Prenumbered and accounted for

Answer 14

A.

The voucher and all supporting documents should be canceled (stamped paid) by the check signer to avoid duplicate payments. The return of the voucher to the vouchers payable department provides no control to prevent it from being paid more than once. Confirmation that each voucher is supported by a vendor’s invoice and purchase order provides evidence that the payment is based on a valid purchase, but would not stop a duplicate payment. Prenumbering and accounting for vouchers allows confirmation that all vouchers were recorded and should allow the discovery of a duplicate payment, but it would not prevent it.

Question 15

When an auditor tests a computerized accounting system, which of the following is true of the test data approach?

A. Several transactions of each type must be tested.

B. Test data are processed by the client’s computer programs under the auditor’s control.

C. Test data must consist of all possible valid and invalid conditions.

D. The program tested is different from the program used throughout the year by the client.

Answer 15

B.

In the test data approach to testing a computerized accounting system, test data are processed by the client’s computer programs under the auditor’s control. The auditor will determine how many transactions and what types of transactions to test which may or may not include several transactions of each type. The auditor need not include test data for all possible valid and invalid conditions. The object is to test the client’s program that is used throughout the year and the auditor must take steps to make sure that the program being tested is the one that is actually used in routine processing; thus, a different program would not be tested.

Question 16

An auditor who is testing IT controls in a payroll system would most likely use test data that contain conditions such as

A. Deductions not authorized by employees

B. Overtime not approved by supervisors

C. Payroll checks with unauthorized signatures

D. Time tickets with invalid job numbers

Answer 16

D.

An auditor testing IT controls in a payroll system most likely would use test data containing time tickets with invalid job numbers. The computer should be programmed to compare job numbers on the time tickets with a list of valid authorized job numbers. IT controls would not detect a lack of authorization, lack of approval, or unauthorized signatures.

Question 17

To gain assurance that all inventory items in a client’s inventory listing schedule are valid, an auditor most likely would vouch

A. Inventory tags noted during the auditor’s observation to items listed in the inventory listing schedule

B. Inventory tags noted during the auditor’s observation to items listed in receiving reports and vendors’ invoices

C. Items listed in the inventory listing schedule to inventory tags and the auditor’s recorded count sheets

D. Items listed in receiving reports and vendors’ invoices to the inventory listing schedule

Answer 17

The correct answer is (C).

To gain assurance that all items in a client’s inventory listing schedule are valid, an auditor most likely would vouch items listed in the listing schedule to inventory tags and the auditor’s recorded count sheets.

To trace the inventory tags to the listing schedule and to trace items listed in receiving reports and vendors’ invoices to the listing schedule, would provide assurance that all the inventory items are on the schedule, but would not give assurance that all of the items on the schedule are valid; some items on the schedule may not exist.

Tracing tags to the receiving reports and vendors’ invoices does not involve the inventory listing schedule and therefore does not provide any assurances related to the listing schedule.

Note:

Inventory Tags to Inventory Listing Schedule = Tracing = Completeness

Inventory Listing Schedule to Inventory Tags = Vouching = Existence (Validity)

Question 18

Which of the following is an engagement attribute for an audit of an entity that processes most of its financial data in electronic form without any paper documentation?

A. Discrete phases of planning, interim, and year-end fieldwork

B. Increased effort to search for evidence of management fraud

C. Performance of audit tests on a continuous basis

D. Increased emphasis on the completeness assertion

Answer 18

C.

When a client processes financial data in electronic form without paper documentation, the auditor may audit on a more continuous basis than a traditional system, as a convenience, and may be required to audit on a more continuous basis to obtain sufficient, competent evidence as documentation for some transactions may only be available for a limited time. This is the opposite of discreet phases of planning, interim, and year-end fieldwork. The level of effort to search for management fraud and emphasis on the completeness assertion likely would not be affected significantly.

Question 19

An entity engaged an accountant to review its financial statements in accordance with Statements on Standards for Accounting and Review Services. The accountant determined that the entity maintained its accounts on a comprehensive basis of accounting other than generally accepted accounting principles (GAAP). In this situation, the accountant most likely would have taken which of the following actions?

A. Withdrawn from the engagement because the entity has not been following GAAP

B. Advised management to make the adjustments necessary for the account balances to conform with GAAP

C. Modified the review report to reflect the fact that the financial statements were presented on another comprehensive basis of accounting

D. Requested that management justify the use of the other comprehensive basis of accounting in the management representation letter

Answer 19

C.

The review report should reflect the basis of accounting used in the corresponding financial state­ments. There is no requirement that financial statements be prepared in accordance with GAAP; nor must man­agement justify the use of a comprehensive basis of accounting other than GAAP to the accountant (hence the phrase “generally accepted” accounting principles).

Question 20

The scope of audits of recipients of federal financial assistance in accordance with federal audit regulations varies. Which of the following elements do these audits have in common?

A. The auditor is required to disclose all situations and transactions that could be indicative of fraud, abuse, and illegal acts to the federal inspector general.

B. The materiality levels are higher and are determined by the government entities that provide the federal financial assistance to the recipients.

C. The auditor is required to document an understanding of internal control established to ensure compliance with the applicable laws and regulations.

D. The accounts should be 100% verified by substantive tests because certain statistical sampling applications are not permitted.

Answer 20

C.

All audits of recipients of federal financial assistance require the auditor to obtain and document an understanding of internal control established to ensure compliance with the laws and regulations applicable to the federal award. The auditor is not required to disclose all situations and transactions that could be indicative of fraud, abuse, and illegal acts to the federal inspector general. Materiality levels are determined by the auditor in relation to an entity’s federal programs, not the government entities that provide the federal financial assis­tance to the recipients. Accounts need not be 100% verified by substantive tests because certain statistical sampling applications are in fact permitted.

Question 21

According to the U.S. Department of Labor, an auditor of an employee benefit plan would be considered independent if

A. The auditor is committed to acquire a material indirect financial interest in the plan sponsor.

B. An actuary associated with the auditor’s firm renders services to the plan.

C. A member of the auditor’s firm is an investment advisor to the plan.

D. The auditor’s firm maintains financial records for the plan.

Answer 21

The correct answer is (B).

An auditor of an employee benefit plan would be considered independent if an actuary associated with the auditor’s firm renders services to the plan.

(A) is incorrect because financial interest, direct or indirect, in the plan will lead to impairment of independence.

(C) is incorrect because a member of the auditor’s firm cannot be an investment advisor to the plan. This would be considered consulting services to an audit client.

(D) is incorrect because the auditor cannot maintain financial records for the plan, as this is considered a service provided to an audit client. The auditor’s firm can modify the financial records if given the power and hence wouldn’t be independent.

Question 22

An auditor usually obtains evidence of stockholders’ equity transactions by reviewing the entity’s

A. Minutes of board of directors meetings

B. Transfer agent’s records

C. Canceled stock certificates

D. Treasury stock certificate book

Answer 22

A.

One of the auditor’s objectives in the examination of owners’ equity is to determine that all transactions during the year affecting owners’ equity accounts were properly authorized and recorded. In the case of a corporation, changes in capital stock accounts should receive formal advance approval by the board of directors. A transfer agent’s records show detail about the owners of the stock, and do not focus on the total outstanding. Canceled stock certificates and a treasury stock certificate book are less reliable than the minutes, as they would be updated only after the transaction is complete.

Question 23

US GAAS are written in the context of

A. An audit of financial statements by an auditor

B. An audit of historical financial information by an auditor

C. An audit in accordance with applicable legislation or regulations by an auditor

D. An audit in accordance with financial statements of an issuer by an auditor

Answer 23

A.

US GAAS are written in the context of an audit of financial statements by an auditor.

Regarding incorrect answer B., US GAAS are to be adapted as necessary in the circumstances when applied to audits of other historical financial information; however, they are written in the context of an audit of financial statements.

Regarding incorrect answer C., US GAAS do not address the responsibilities of the auditor that may exist in legislation or regulations. Such responsibilities may differ from those established in US GAAS. (Accordingly, although the auditor may find aspects of US GAAS helpful in such circumstances, it is the responsibility of the auditor to ensure that the audit is conducted in compliance with all relevant legal, regulatory, or professional obligations.)

Regarding incorrect answer D., US GAAS are written in the context of an audit in accordance with financial statements of an entity that is a nonissuer. Audits of issuers are conducted in accordance with auditing standards promulgated by the Public Company Accounting Oversight Board.

Question 24

An auditor decides to issue a qualified opinion on a public company’s financial statements because a major inadequacy in its computerized accounting records prevents the auditor from applying necessary procedures. The opinion paragraph of the auditor’s report should state that the qualification pertains to

A. A client-imposed scope limitation

B. A departure from the standards of the Public Company Accounting Oversight Board (United States)

C. The possible effects on the financial statements

D. Inadequate disclosure of necessary information

Answer 24

C.

The question describes a scope limitation. When an auditor qualifies an opinion because of a scope limitation, the opinion paragraph should indicate that the qualification pertains to the possible effects on the financial statements rather than to the scope limitation itself—the auditor’s opinion is on the financial statements.

Regarding incorrect answer a., references in the opinion paragraph to a client-imposed scope limitation bases the exception on the restriction itself, rather than on the possible effects on the financial statements and, thus, is unacceptable.

Incorrect answer b., indicates the auditor failed to conduct the audit in accordance with PCAOB auditing standards which is not what is described in the question. Per the question, the auditor was unable to apply the necessary procedures. Thus, the auditor was unable to obtain sufficient appropriate evidential matter due to the scope limitation which resulted in the qualified opinion.

Incorrect answer d., inadequate disclosure, describes a departure from GAAP; the question describes a scope limitation.