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Flashcards in A1-3 Deck (106)
1

Zag Co. issues financial statements that present financial position and results of operations but Zag omits the related statement of cash flows.  Zag would like to engage Brown, CPA, to audit its financial statements without the statement of cash flows although Brown's access to all of the information underlying the basic financial statements will not be limited.  Under these circumstances, Brown most likely would:

a.

Explain to Zag that the omission requires a qualification of the auditor's opinion.

b.

Prepare the statement of cash flows as an accommodation to Zag and express an unmodified opinion.

c.

Add an emphasis-of-matter paragraph to the auditor's report that justifies the reason for the omission.

d.

Refuse to accept the engagement as proposed because of the client-imposed scope limitation.

Choice "a" is correct. The auditor would explain to the client that in order for the entity's financial statements to be in conformity with GAAP, there must be adequate disclosures of all material matters including all financial statements and the supporting footnotes. As a result, the auditor would tell Zag that without adequate disclosure of the entity's cash flows, the audit report would have to be issued with a qualified or adverse audit opinion.

Choice "c" is incorrect. Missing the statements of cash flows would not result in an unmodified opinion with an additional emphasis-of-matter paragraph because no statement of cash flows is a material departure from GAAP.

Choice "d" is incorrect. The auditor is not required to refuse to accept the engagement, but the client should be made aware that the missing statement of cash flows will result in a qualified or adverse opinion.

Choice "b" is incorrect. The responsibility to prepare the statement of cash flows is solely the client's.

2

Which of the following procedures most likely would assist an auditor in identifying conditions and events that may indicate substantial doubt about an entity's ability to continue as a going concern?

a.

Inspecting title documents to verify whether any real property is pledged as collateral.

b.

Evaluating the entity's procedures for identifying and recording related party transactions.

c.

Performing cutoff tests of sales transactions with customers with long-standing receivable balances.

d.

Inquiring of the entity's legal counsel about litigation, claims, and assessments.

Choice "d" is correct. If a liability is significant enough, it may give rise to a situation in which there is substantial doubt about an entity's ability to continue as a going concern. Inquiring of an entity's legal counsel about litigation, claims, and assessments is one way to determine whether such a liability exists.

Choice "c" is incorrect. Cutoff tests are used to determine whether sales are recorded in the proper period. Applying such tests to customer accounts with long-standing receivable balances would not provide information about the entity's ability to continue as a going concern.

Choice "b" is incorrect. Evaluating the entity's procedures for identifying and recording related party transactions is a means for the auditor to evaluate financial statement presentation and disclosure, but it does not provide information about going concern issues.

Choice "a" is incorrect. Identifying situations in which real property is pledged as collateral is a means for the auditor to evaluate financial statement presentation and disclosure, but it does not provide information about going concern issues.

3

When management does not provide reasonable justification that a change in accounting principle is preferable and it presents comparative financial statements, the auditor should express a qualified opinion:

a.

Only in the year of the accounting principle change.

b.

Each year until management changes back to the accounting principle formerly used.

c.

Only if the change is to an accounting principle that is not generally accepted.

d.

Each year that the financial statements initially reflecting the change are presented.

Choice "d" is correct. When management does not provide reasonable justification that a change in accounting principle is preferable and it presents comparative FS, the auditor should express a qualified opinion each year that the FS initially reflecting the change are presented.

Choices "a", "b", and "c" are incorrect, per the rule stated above.

4

Park, CPA, was engaged to audit the financial statements of Tech Co., a new client, for the year ended December 31, Year 3. Park obtained sufficient audit evidence for all of Tech's financial statement items except Tech's opening inventory. Due to inadequate financial records, Park could not verify Tech's January 1, Year 3, inventory balances. Park's opinion on Tech's Year 3 financial statements most likely will be:

~Balance sheet
~Income statement
a.

Disclaimer

Adverse

b.

Unmodified

Adverse

c.

Disclaimer

Disclaimer

d.

Unmodified

Disclaimer

Choice "d" is correct. When the auditor is unable to satisfy himself or herself regarding the amount of beginning inventory, he or she must disclaim an opinion on the income statement because of the inability to verify the cost of goods sold during the year. The auditor may, however, still be able to issue an unmodified opinion on the balance sheet, since inventory can be verified as of the balance sheet date.

Choices "c", "a", and "b" are incorrect, based on the explanation above.

5

Under International Standards on Auditing, the going concern period is:

a.

Equal to one year from the date of the financial statements being audited.

b.

No more than one year from the date of the financial statements being audited.

c.

At least one year from the date of the financial statements being audited.

d.

May be more or less than one year from the date of the financial statements being audited.

 

Choice "c" is correct. Under ISAs, the going concern period must be at least, but not limited to, twelve months from the date of the financial statements being audited. Under U.S. auditing standards, the going concern period cannot exceed one year from the date of the financial statements being audited.

Choices "b", "a", and"d" are incorrect, based on the above answer.

6

When there has been a change in accounting principles, but the effect of the change on the comparability of the financial statements is not material, the auditor should:

a.

Refer to the change in the opinion paragraph.

b.

Refer to the change in an emphasis-of-matter paragraph.

c.

Not refer to consistency in the auditor's report.

d.

Explicitly concur that the change is preferred.

Choice "c" is correct. If an accounting change has no material effect on the comparability of the financial statements, the auditor does not need to recognize the change in the current year's audit report.

Choice "b" is incorrect. The change would only be referred to in an emphasis-of-matter paragraph if the effect were material.

Choice "d" is incorrect. The auditor does not explicitly concur with the change in the report.

Choice "a" is incorrect. Even if the change had a material effect, the opinion paragraph would not be affected. The emphasis-of-matter paragraph would follow the opinion paragraph.

7

An auditor concludes that there is substantial doubt about an entity's ability to continue as a going concern for a reasonable period of time. If the entity's financial statements adequately disclose its financial difficulties, the auditor's report is required to include an emphasis-of-matter paragraph that specifically uses the phrase(s):

~"Reasonable period of time, not to exceed one year"
~"Going concern"
a.

Yes

No

b.

Yes

Yes

c.

No

Yes

d.

No

No

Choice "c" is correct. The auditor has a responsibility to evaluate whether there is substantial doubt about the entity's ability to continue as a going concern for a reasonable period of time. If the auditor concludes that there is substantial doubt, the auditor should include an emphasis-of-matter paragraph following the opinion paragraph that includes the terms "substantial doubt" and "going concern." The time period is not mentioned in the auditor's report.

Choices "b", "a", and "d" are incorrect, as explained above.

8

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

a.

Significant related party transactions are pervasive.

b.

Arrearages in preferred stock dividends are paid.

c.

Usual trade credit from suppliers is denied.

d.

Restrictions on the disposal of principal assets are present.

 

Choice "c" is correct. Indications of possible financial difficulties, such as denial of usual trade credit from suppliers, may cause an auditor to have substantial doubt about an entity's ability to continue as a going concern. 

Choice "a" is incorrect. The existence of related parties and the occurrence of related party transactions do not indicate doubt about the entity's ability to continue as a going concern.

Choice "b" is incorrect. Payment of preferred stock dividends in arrears might very well indicate an improvement in the entity's financial situation. It is the lack of payment of preferred, cumulative dividends (a possible indication of financial difficulty) that might cause an auditor to have substantial doubt about an entity's ability to continue as a going concern.

Choice "d" is incorrect. Restrictions on the disposal of assets might limit the options available to management as far as mitigating adverse conditions, but it would not in and of itself cause the auditor to have substantial doubt about an entity's ability to continue as a going concern.

9

Which of the following auditing procedures most likely would assist an auditor in identifying conditions and events that may indicate substantial doubt about an entity's ability to continue as a going concern?

a.

Confirming with third parties the details of arrangements to maintain financial support.

b.

Reconciling the cash balance per books with the cut-off bank statement and the bank confirmation.

c.

Inspecting title documents to verify whether any assets are pledged as collateral.

d.

Comparing the entity's depreciation and asset capitalization policies to other entities in the industry.

 

Choice "a" is correct. Confirming with third parties the details of arrangements to provide or "maintain (needed) financial support" is an audit procedure that may identify doubts about an entity's ability to continue as a going concern.

Choice "c" is incorrect. Inspecting title documents provides evidence of ownership of assets but wouldnot necessarily identify conditions affecting an entity's ability to continue as a going concern.

Choice "b" is incorrect. Reconciling the cash balance per books with the cut-off bank statement and the bank confirmation provides evidence of completeness and valuation, but would not necessarily identify conditions affecting an entity's ability to continue as a going concern.

Choice "d" is incorrect. Comparing an entity's policies to other entities in the industry would not necessarily identify conditions affecting an entity's ability to continue as a going concern.

10

In which of the following situations would an auditor ordinarily choose between expressing a qualified opinion or an adverse opinion?

a.

The auditor did not observe the entity's physical inventory and is unable to become satisfied about its balance by other auditing procedures.

b.

Conditions that cause the auditor to have substantial doubt about the entity's ability to continue as a going concern are inadequately disclosed.

c.

There has been a change in accounting principles that has a material effect on the comparability of the entity's financial statements.

d.

The auditor is unable to apply necessary procedures concerning an investor's share of an investee's earnings recognized on the equity method.

Choice "b" is correct. Inadequate disclosure of the substantial doubt about an entity's ability to continue as a going concern is a departure from GAAP, resulting in either a qualified or adverse opinion.

Choices "a" and "d" are incorrect. Scope limitations result in either a qualified opinion or in a disclaimer of opinion, but not in an adverse opinion.

Choice "c" is incorrect. A change in accounting principle results in the use of an emphasis-of-matter paragraph following the opinion paragraph in an unmodified report, as long as the change was accounted for properly.

11

March, CPA, is engaged by Monday Corp., a client, to audit the financial statements of Wall Corp., a company that is not March's client. Monday expects to present Wall's audited financial statements with March's auditor's report to 1st Federal Bank to obtain financing in Monday's attempt to purchase Wall. In these circumstances, March's auditor's report would usually be addressed to:

a.

Monday Corp., the client that engaged March.

b.

Both Monday Corp. and 1st Federal Bank.

c.

1st Federal Bank.

d.

Wall Corp., the entity audited by March.

Choice "a" is correct. The auditors should address their report to the entity that engaged them. In this case, Monday Corp. engaged the auditor to perform an acquisition audit and the report should be addressed to Monday.

Choice "d" is incorrect. Wall Corp. did not engage the auditors and thus the report should not be addressed to them.

Choices "c" and "b" are incorrect. Even though the bank will be relying on the audited financial statements in determining whether to make the loan, the bank did not directly engage the auditing firm and accordingly, the report should not be addressed to them.

12

A CPA concludes that the unaudited financial statements on which the CPA is disclaiming an opinion are not in conformity with generally accepted accounting principles (GAAP) because management has failed to capitalize leases. The CPA suggests appropriate revisions to the financial statements, but management refuses to accept the CPA's suggestions. Under these circumstances, the CPA ordinarily would:

a.

Restrict the distribution of the CPA's report to management and the entity's board of directors.

b.

Issue a qualified opinion or adverse opinion depending on the materiality of the departure from GAAP.

c.

Express limited assurance that no other material modifications should be made to the financial statements.

d.

Describe the nature of the departure from GAAP in the CPA's report and state the effects on the financial statements, if practicable.

Choice "d" is correct. If the client refuses to accept the CPA's suggestions, the CPA should add a paragraph modifying the disclaimer to describe the nature and effect of the departure from GAAP.

Choice "c" is incorrect. If the CPA issues a disclaimer of opinion, no assurance (not even limited assurance) is expressed with respect to the financial statements.

Choice "a" is incorrect. If the client refuses to accept the CPA's suggestions, the CPA should modify the disclaimer to describe the situation, but would not be required to restrict the use of the report.

Choice "b" is incorrect. If the CPA issues a disclaimer of opinion, no assurance is expressed and no opinion is rendered. A qualified or adverse opinion provides a level of assurance beyond that contemplated by a disclaimer.

13

An auditor may reasonably issue an "except for" qualified opinion for a(an):

~Scope limitation
~Unjustified accounting change
a.

Yes

No

b.

No

Yes

c.

No

No

d.

Yes

Yes

Choice "d" is correct. Yes - Yes.

An "except for" qualified opinion is expressed when the "exceptions to GAAP" or scope restrictions are material but not pervasive.

Choices "a", "b", and "c" are incorrect, based on the rule above.

14

An auditor who is unable to form an opinion on a new client's opening inventory balances may issue an unmodified opinion on the current year's:

a.

Income statement only.

b.

Statement of shareholders' equity only.

c.

Balance sheet only.

d.

Statement of cash flows only.

Choice "c" is correct. If the auditor is unable to form an opinion on a new client's opening inventory balances, the auditor will issue an opinion on the closing balance sheet only and will issue a disclaimer of opinion on the statements of income, retained earnings and cash flows.

Choices "a", "d", and "b" are incorrect. The auditor should issue a disclaimer of opinion on these financial statements if the auditor is unable to form an opinion regarding opening inventory balances.

15

Under U.S. auditing standards, in which of the following situations would an auditor ordinarily issue an unmodified audit opinion without an emphasis-of-matter paragraph?

a.

The auditor has substantial doubt about the entity's ability to continue as a going concern, but the circumstances are fully disclosed in the financial statements.

b.

The auditor wishes to emphasize that the entity had significant related party transactions.

c.

The auditor decides to make reference to the audit of a component auditor as a basis, in part, for the auditor's opinion.

d.

The entity issues financial statements that present financial position and results of operations, but omits the statement of cash flows.

Choice "c" is correct. An auditor would generally issue an unmodified audit opinion without an emphasis-of-matter paragraph when the auditor decides to make reference to the audit of a component auditor as a basis, in part, for the auditor's opinion. The auditor would modify his/her report, but would not add an emphasis-of-matter paragraph.

Choices "b" and "a" are incorrect. An auditor ordinarily would issue an unmodified opinion with an emphasis-of-matter paragraph if he or she wishes to emphasize that the entity had significant related party transactions, or if the auditor has substantial doubt about the entity's ability to continue as a going concern (even if the circumstances are fully disclosed in the financial statements).

Choice "d" is incorrect. If the entity issues financial statements that present financial position and results of operations but omit the statement of cash flows, the opinion will be qualified.

16

An auditor was unable to obtain sufficient appropriate audit evidence concerning certain transactions due to an inadequacy in the entity's accounting records. The auditor would choose between issuing a(an):

a.

Adverse opinion and a disclaimer of opinion.

b.

Qualified opinion and an unmodified opinion with an emphasis-of-matter paragraph.

c.

Disclaimer of opinion and a qualified opinion.

d.

Unmodified opinion with an emphasis-of-matter paragraph and an adverse opinion.

 

Choice "c" is correct. Client-imposed restrictions of scope such as those caused by inadequate records would cause the auditor to choose between issuing a disclaimer of opinion and a qualified opinion.

Choice "b" is incorrect. An unmodified opinion would only be justified if the transactions in question were not material, but in such situations, no emphasis-of-matter paragraph would be required.

Choices "d" and "a" are incorrect. An adverse opinion pertains to GAAP and would not be used for reporting restrictions of scope.

17

Management of Edgington Industries plans to disclose an uncertainty as follows:

The Company is a defendant in a lawsuit alleging infringement of certain patent rights and claiming damages. Discovery proceedings are in progress. The ultimate outcome of the litigation cannot presently be determined. Accordingly, no provision for any liability that may result upon adjudication has been made in the accompanying financial statements.

The auditor is satisfied that sufficient audit evidence supports management's assertions about the nature and disclosure of the uncertainty. What type of opinion should the auditor express under these circumstances under U.S. auditing standards?

a.

Unmodified without an emphasis-of-matter paragraph.

b.

Unmodified with an emphasis-of-matter paragraph.

c.

"Except for" qualified.

d.

Disclaimer of opinion.

Choice "a" is correct. The note presented describes an uncertainty that is properly disclosed. An emphasis-of-matter paragraph is not required in the unmodified opinion under U.S. auditing standards.

Choice "b" is incorrect. U.S. auditing standards do not require an emphasis-of-matter paragraph when an uncertainty is properly disclosed.

Choice "c" is incorrect. Since the auditor is satisfied that the assertion and disclosure are supported by the existing evidence, a qualified opinion is not required.

Choice "d" is incorrect. Since the auditor is satisfied that the assertion and disclosure are supported by the existing evidence, there is no need for the auditor to disclaim an opinion.

18

The auditor's report should include reference to the United States as the country of origin of:

I.

The accounting principles used to prepare the financial statements.

II.

The auditing standards the auditor followed in performing the audit.

a.

II only.

b.

Neither I nor II.

c.

Both I and II.

d.

I only.

Choice "c" is correct. The auditor's report should include reference to the United States as the country of origin of both the accounting principles used to prepare the financial statements and the auditing standards the auditor followed in performing the audit.

Choice "d" is incorrect, since the auditor's report should include reference to the country of origin of the auditing standards the auditor followed in performing the audit.

Choice "a" is incorrect, since the auditor's report should include reference to the country of origin of the accounting principles used to prepare the financial statements.

Choice "b" is incorrect, since the auditor's report should include reference to the country of origin of both the accounting principles used to prepare the financial statements and the auditing standards the auditor followed in performing the audit.

19

An auditor is unable to complete a procedure during an audit. Based on this situation, which opinion isleast likely to be rendered?

a.

An adverse opinion.

b.

An unmodified opinion.

c.

A disclaimer of opinion.

d.

A qualified opinion.

Choice "a" is correct. An adverse opinion is rendered when there is a departure from GAAP, which is not the case in this question.

Choice "b" is incorrect. An unmodified opinion would be rendered if the effect on the financial statements were immaterial, or if acceptable alternative procedures could be performed.

Choice "d" is incorrect. A qualified opinion may be issued due to a material scope limitation.

Choice "c" is incorrect. A disclaimer of opinion may be issued due to a highly material scope limitation

20

In which of the following paragraphs of an auditor's report does an auditor communicate the nature of the engagement and the specific financial statements covered by the audit?

a.

Scope paragraph.

b.

Opinion paragraph.

c.

Introductory paragraph.

d.

Emphasis-of-matter paragraph.

 

Choice "c" is correct. The introductory paragraph indicates the nature of the engagement (i.e., audit), the financial statements covered in the (audit) engagement, the name of the entity whose financial statements have been audited, and the dates covered by each financial statement.

Choice "a" is incorrect. There is no scope paragraph.

Choice "b" is incorrect. The opinion paragraph gives the auditor's opinion on the financial statements under audit.

Choice "d" is incorrect. Emphasis-of-matter paragraphs are used when required by SAS or when the auditor believes they are necessary. They are used when referring to a matter that is appropriately presented or disclosed in the financial statements and is of such importance that it is fundamental to the users' understanding of the financial statements. This paragraph does not affect the auditor's opinion.

21

An auditor has substantial doubt about the entity's ability to continue as a going concern for a reasonable period of time because of negative cash flows and working capital deficiencies. Under these circumstances, the auditor would be most concerned about the:

a.

Possible effects on the entity's financial statements.

b.

Control environment factors that affect the organizational structure.

c.

Correlation of detection risk and inherent risk.

d.

Effectiveness of the entity's internal control activities.

Choice "a" is correct. If an auditor has substantial doubt about the entity's ability to continue as a going concern, the auditor would be most concerned about the possible effects on the entity's financial statements.

Choice "b" is incorrect. The control environment factors that affect the organizational structure do not directly relate to going concern.

Choice "c" is incorrect. The auditor is concerned about the correlation between detection risk and inherent risk when deciding the nature, extent, and timing of audit procedures.

Choice "d" is incorrect. When the auditor is concerned about an entity's ability to continue as a going concern, the auditor is concerned about the effects on the entity's financial statements and will identify conditions and events that may be indicative of substantive doubt. The effectiveness of internal controls would not typically provide evidence of substantial doubt.

22

When qualifying an opinion because of an insufficiency of audit evidence, an auditor should refer to the situation in the:

~Basis for Qualified Opinion paragraph
~Notes to the financial statements
a.

Yes

No

b.

No

Yes

c.

No

No

d.

Yes

Yes

Choice "a" is correct. When a qualified opinion results from a limitation on the scope of the audit or an insufficiency of audit evidence, the situation should be described in the Basis for Qualified Opinion paragraph preceding the opinion paragraph and referred to in the opinion paragraph of the auditor's report. It is not appropriate for the scope of the audit to be explained in a note to the financial statements, since the description of the audit scope is the responsibility of the auditor and not that of the client.

Choices "d", "b", and "c" are incorrect based on the above explanation.

23

Which of the following audit procedures most likely would assist an auditor in identifying conditions and events that may indicate substantial doubt about an entity's ability to continue as a going concern?

a.

Comparing the market value of property to amounts owed on the property.

b.

Reviewing lease agreements to determine whether leased assets should be capitalized.

c.

Inspecting title documents to verify whether any assets are pledged as collateral.

d.

Reading the minutes of meetings of the stockholders and the board of directors.

Choice "d" is correct. The auditor should examine any evidence that appears contrary to the basic principle of going concern. Reviewing the minutes from stockholder and board of director meetings is one procedure that is used in this regard.

Choice "a" is incorrect. Comparison of the market value of property to amounts owed on the property determines its net value, but would not necessarily indicate a going concern issue.

Choice "b" is incorrect. Reviewing lease agreements to determine whether leased assets should be capitalized is important in evaluating the financial statements, but it would not provide evidence of going concern issues.

Choice "c" is incorrect. Inspecting title documents to verify whether any assets are pledged as collateral provides information regarding presentation and disclosure, but would not provide evidence of going concern issues.

24

Management believes and the auditor is satisfied that a material loss probably will occur when pending litigation is resolved. Management is unable to make a reasonable estimate of the amount or range of the potential loss, but fully discloses the situation in the notes to the financial statements. If management does not make an accrual in the financial statements, the auditor should express a(an):

a.

Qualified opinion due to a scope limitation.

b.

Qualified opinion due to a material misstatement of the financial statements.

c.

Unmodified opinion with an other-matter paragraph.

d.

Unmodified opinion.

Choice "d" is correct. If a contingent liability is probable, but not estimable, and it is disclosed in the footnotes, the auditor should issue an unmodified opinion.

Choice "a" is incorrect. When a contingent liability is probable, but not estimable, it should be disclosed in the footnotes. A qualified opinion due to a scope limitation results when the auditor is unable to obtain sufficient appropriate audit evidence and the auditor concludes that the possible effects of any undetected misstatements could be material but not pervasive.

Choice "b" is incorrect. A qualified opinion due to a material misstatement of the financial statements would be issued if the client did not disclose the contingent liability in the footnotes to the financial statements and the resulting misstatement was material but not pervasive.

Choice "c" is incorrect. If a contingent liability is probable, but not estimable, and it is disclosed in the footnotes, the auditor should issue an unmodified opinion. An other-matter paragraph would not be used in this situation, although the auditor could choose to add a emphasis-of-matter paragraph describing the uncertainty.

25

After considering an entity's negative trends and financial difficulties, an auditor has substantial doubt about the entity's ability to continue as a going concern. The auditor's considerations relating to management's plans for dealing with the adverse effects of these conditions most likely would include management's plans to:

a.

Purchase assets formerly leased.

b.

Reduce existing lines of credit.

c.

Increase ownership equity.

d.

Increase current dividend distributions.

 

Choice "c" is correct. The auditor considers any of management's plans that might serve to mitigate the adverse effects of particular conditions and events. Typically, plans to increase ownership equity, to borrow money, to restructure debt, to sell assets, and/or to reduce or delay expenditures might all be considered mitigating factors.

Choices "d", "b", and "a" are incorrect. Increasing dividend distributions, reducing lines of credit, and purchasing assets would not improve a weak cash flow situation

26

In which of the following circumstances would an auditor be most likely to express an adverse opinion?

a.

Information comes to the auditor's attention that raises substantial doubt about the entity's ability to continue as a going concern.

b.

The chief executive officer refuses the auditor access to minutes of board of directors' meetings.

c.

The financial statements are not in conformity with the GAAP rules regarding the capitalization of leases.

d.

Tests of controls show that the entity's internal control is so poor that it cannot be relied upon.

Choice "c" is correct. An adverse opinion is issued when the financial statements are not presented in accordance with GAAP.

Choice "b" is incorrect. The client's refusal to provide access to the minutes of the Board of Directors' meetings would result in a disclaimer of opinion.

Choice "d" is incorrect. If internal control is so poor that it cannot be relied upon, the auditor must consider the effect on the audit procedures and subsequent report, but would not issue an adverse opinion.

Choice "a" is incorrect. Substantial doubt with regard to the entity's ability to continue as a going concern should be disclosed in an emphasis-of-matter paragraph appended to an otherwise unmodified opinion.

27

The group auditor decides not to refer to the component auditor who audited a subsidiary of the group auditor's client. In this situation, the group auditor most likely would:

a.

Obtain written permission from the component auditor to omit the reference in the group auditor's report.

b.

Document in the engagement letter that the group auditor assumes no responsibility for the component auditor's work and opinion.

c.

Determine the type of work to be performed by the group auditor on the financial information of the component.

d.

Add an emphasis-of-matter paragraph to the auditor's report indicating that the subsidiary's financial statements are not material to the consolidated financial statements.

Choice "c" is correct. When the group auditor decides not to make reference to the audit of a component auditor, the group auditor assumes responsibility for the work of the component auditor and should determine the type of work to be performed on the financial information of the component. If the component is significant, the component should be audited by the group engagement team or the component auditor.

Choice "d" is incorrect. The group auditor may decide not to make reference to the component auditor even when the portion of the group financial statements audited by the component auditor is material. When the group auditor assumes responsibility for the work of a component auditor, no reference to the component auditor is made in the auditor's report.

Choice "b" is incorrect. The group auditor's decision not to assume responsibility for the component auditor's work need not be included in the engagement letter.

Choice "a" is incorrect. The group auditor does not need permission from the component auditor to assume responsibility. Permission is needed only if the group auditor decides to make reference to the component auditor in the auditor's report and would like to refer to the other auditor by name.

28

Which paragraphs of an auditor's report on financial statements under U.S. auditing standards should refer to generally accepted auditing standards (GAAS) and generally accepted accounting principles (GAAP)?

~GAAS
~GAAP
a.

Introductory

Auditor's

Responsibility

b.

Auditor's

Responsibility

Introductory

c.

Introductory

Introductory

d.

Auditor's

Responsibility

Opinion

 

Choice "d" is correct. Under U.S. auditing standards, the auditor states that the audit was conducted in accordance with GAAS in the Auditor's Responsibility paragraph. The auditor expresses an opinion on the financial statements' conformity with GAAP in the Opinion paragraph.

Choices "b", "a", and "c" are incorrect, per the above explanation.

29

In the first audit of a new client, an auditor was able to extend auditing procedures to gather sufficient evidence about consistency. Under these circumstances, the auditor should:

a.

State that the consistency standard does not apply.

b.

Not report on the client's income statement.

c.

Not refer to consistency in the auditor's report.

d.

State that the accounting principles have been applied consistently.

 

Choice "c" is correct. The auditor's standard report implies that the auditor is satisfied that the comparability of financial statements between periods has not been materially affected by changes in accounting principles and that such principles have been consistently applied between or among periods. Since the auditor has gathered sufficient evidence about consistency, no reference need be made in the report.

Choice "b" is incorrect. If the auditor is able to obtain sufficient evidence about consistency, the auditor may report on the entity's financial statements.

Choice "a" is incorrect. Consistency deals with the comparability of financial statements from year to year. Unless the auditor's report explicitly states otherwise, it implies that the financial statements are comparable between periods.

Choice "d" is incorrect. If the auditor is able to obtain sufficient evidence about consistency, no mention of consistency need be made. Consistency is implied in the auditor's report.

30

The following paragraph was included in an auditor's report to indicate a lack of consistency:

"As discussed in note T to the financial statements, the company changed its method of computing depreciation in Year 2."

How should the auditor report on this matter if the auditor concurred with the change?

~Type of opinion
~Location of paragraph
a.

Qualified

After opinion paragraph

b.

Unmodified

After opinion paragraph

c.

Unmodified

Before opinion paragraph

d.

Qualified

Before opinion paragraph

 

Choice "b" is correct. If the auditor concurred with the change, a lack of consistency in applying GAAP would result in an unmodified opinion with an emphasis-of-matter paragraph following the opinion paragraph.

Choices "c" and "a" are incorrect, based on the above rules.

Choice "d" is incorrect. If the change in accounting principle is not accounted for properly, then a qualified opinion would be appropriate and a paragraph titled "Basis for Qualified Opinion" would be included before the opinion paragraph.

31

If an auditor is unable to determine whether management's estimate of the effects of future events is reasonable, and the effect of those events is believed to be material, he or she should express:

a.

An unmodified opinion with an emphasis-of-matter paragraph following the opinion paragraph.

b.

An unmodified opinion with no additional paragraphs.

c.

A qualified opinion or a disclaimer of opinion.

d.

A qualified opinion or an adverse opinion

If an auditor is unable to determine whether management's estimate of the effects of future events is reasonable, and the effect of those events is believed to be material, he or she should express:

a.

An unmodified opinion with an emphasis-of-matter paragraph following the opinion paragraph.

b.

An unmodified opinion with no additional paragraphs.

c.

A qualified opinion or a disclaimer of opinion.

d.

A qualified opinion or an adverse opinion

32

When a qualified opinion results from a limitation on the scope of the audit, the situation should be described in a Basis for Modification paragraph:

a.

Preceding the opinion paragraph, should have the heading "Basis for Qualified Opinion" and should describe the reasons for the inability to obtain sufficient appropriate audit evidence.

b.

Preceding the opinion paragraph and referred to only in the introductory paragraph of the auditor's report.

c.

Following the opinion paragraph and referred to only in the management's responsibility paragraph of the auditor's report.

d.

Following the opinion paragraph and referred to in both the introductory and opinion paragraphs of the auditor's report.

Choice "a" is correct. When a qualified opinion results from a limitation of scope, it should be described in an Basis for Qualified Opinion paragraph preceding the opinion paragraph and it should describe the reasons for the inability to obtain sufficient appropriate audit evidence. Furthermore, the Opinion paragraph should have the heading "Qualified Opinion."

Choices "b", "d", and "c" are incorrect, as they do not comply with the rule above.

33

A client decides not to make an auditor's proposed adjustments that collectively are not material, and wants the auditor to issue the report based on the unadjusted numbers. Which of the following statements is correct regarding the financial statement presentation?

a.

The financial statements are free from material misstatement, and no disclosure is required in the notes to the financial statements.

b.

The financial statements do not conform with generally accepted accounting principles (GAAP).

c.

The financial statements contain unadjusted misstatements that should result in a qualified opinion.

d.

The financial statements are free from material misstatement, but disclosure of the proposed adjustments is required in the notes to the financial statements.

Choice "a" is correct. An unmodified opinion states that the financial statements are presented fairly, in all material respects. Since the collective effect of the proposed adjustments is immaterial, an unmodified opinion should be expressed. In addition, footnote disclosure of proposed immaterial adjustments is not required.

Choice "b" is incorrect. The AICPA defines fair presentation as reflecting the underlying transactions of a company in a manner that represents the financial statements within a range of acceptable limits. Since the collective effect of the proposed adjustments is immaterial, the financial statements would be considered to conform to generally accepted accounting principles.

Choice "c" is incorrect. An unmodified opinion states that the financial statements are presented fairly, in all material respects. Since the collective effect of the proposed adjustments is immaterial, an unmodified opinion should be expressed. 

Choice "d" is incorrect. The AICPA defines fair presentation as reflecting the underlying transactions of a company in a manner that represents the financial statements within a range of acceptable limits. Since the collective effect of the proposed adjustments is immaterial, the financial statements would be considered to conform to generally accepted accounting principles, and footnote disclosure of the proposed adjustments would not be required

34

Under which of the following circumstances would a disclaimer of opinion not be appropriate?

a.

Management does not provide reasonable justification for a change in accounting principle.

b.

The auditor is unable to determine the amounts associated with an employee fraud scheme.

c.

The chief executive officer is unwilling to sign the management representation letter.

d.

The client refuses to permit the auditor to confirm certain accounts receivable or apply alternative procedures to verify their balances.

Choice "a" is correct. A disclaimer of opinion means that the auditor was unable to obtain sufficient appropriate audit evidence to provide a reasonable basis for an opinion, thus, no opinion is expressed. An unjustified change in accounting principle could result in a material misstatement of the financial statements that would result in a qualified or adverse opinion, not a disclaimer of opinion.

Choice "b" is incorrect. Inability to determine amounts associated with an employee fraud scheme is a scope limitation that may result in a disclaimer of opinion.

Choice "d" is incorrect. Refusal by the client to permit the auditor to confirm accounts receivable is a scope limitation that may result in a disclaimer of opinion.

Choice "c" is incorrect. Refusal of management to sign a management representation letter casts doubt on the audit evidence gathered and is a scope limitation that would likely result in a disclaimer of opinion.

35

A client has capitalizable leases but refuses to capitalize them in the financial statements.  Which of the following reporting options does an auditor have if the amounts pervasively distort the financial statements?

a.

Unmodified opinion.

b.

Disclaimer opinion.

c.

Qualified opinion.

d.

Adverse opinion.

 

Choice "d" is correct. The scenario above indicates a material departure from GAAP that is neither necessary nor justified by the client. When a misstatement is both material and pervasive, the auditor should issue an adverse opinion.

Choice "c" is incorrect. A misstatement that is both material and pervasive is too significant to justify a qualified opinion.

Choice "a" is incorrect. An unmodified opinion cannot be issued because the financial statements are not fairly presented in conformity with GAAP.

Choice "b" is incorrect. A disclaimer opinion would not be used by the auditor for the above scenario as there are no apparent scope limitations to inhibit the auditor from rendering an opinion.

36

An auditor believes that there is substantial doubt about an entity's ability to continue as a going concern for a reasonable period of time. In evaluating the entity's plans for dealing with the adverse effects of future conditions and events, the auditor most likely would consider, as a mitigating factor, the entity's plans to:

a.

Operate at increased levels of production.

b.

Accelerate expenditures for research and development projects.

c.

Extend the due dates of existing loans.

d.

Issue stock options to key executives.

Choice "c" is correct. Plans to delay expenditures, such as extending the due dates of existing loans, would be considered a mitigating factor.

Choice "a" is incorrect. Plans to reduce expenditures would be considered a mitigating factor, but operating at increased levels of production would likely increase expenditures, not reduce them.

Choice "b" is incorrect. Plans to delay expenditures would be considered a mitigating factor. Accelerating expenditures would not be a mitigating factor, as it would tend to reduce cash flow even further.

Choice "d" is incorrect. Issuance of stock options does not provide an inflow of cash, and would not be a mitigating factor. (Remember that options would only provide an inflow of cash if they were exercised.)

37

When an independent CPA is associated with the financial statements of a publicly held entity but hasnot audited or reviewed such statements, the appropriate form of report to be issued must include a(an):

a.

Qualified opinion.

b.

Compilation report.

c.

Unaudited association report.

d.

Disclaimer of opinion.

 

Choice "d" is correct. A "disclaimer of opinion" must be issued when a CPA is "associated" with FS of a publicly held entity, but has not audited or (interim) reviewed such FS.

Choice "b" is incorrect. A "compilation report" refers to a report related to a non-public entity. 

Choice "c" is incorrect. There is no such thing as an "unaudited association report."

Choice "a" is incorrect. The auditor did not audit the FS, so he/she cannot issue an opinion on them.

38

Under which of the following circumstances would the expression of a disclaimer of opinion be inappropriate?

a.

Management refuses to produce documentation verifying the ownership of its equipment and production facilities.

b.

The auditor is unable to determine the extent of or the amounts associated with a pervasive employee fraud scheme.

c.

The company issues financial statements that purport to present financial position and results of operations, but refuses to include the related statement of cash flows.

d.

The chief financial officer and the chief executive officer are unwilling to sign the management representation letter.

Choice "c" is correct. An expression of a disclaimer of opinion would be inappropriate when the company issues financial statements that purport to present financial position and results of operations, but refuses to include the related statement of cash flows. The statement of cash flows is a requirement of GAAP to be considered a complete set of financial statements. A material misstatement of financial statements, such as the omission of information that is required to be presented, would result in a qualified or adverse opinion.

Choice "d" is incorrect. An auditor may express a disclaimer of opinion when, due to a scope limitation, the auditor is unable to perform all the tests necessary to complete an audit. When the CFO and CEO refuse to sign the management representation letter, a client-imposed scope limitation exists, and the auditor would express a disclaimer of opinion.

Choice "b" is incorrect. An auditor may express a disclaimer of opinion when the auditor is unable to obtain sufficient appropriate audit evidence on which to base an opinion. For example, when an auditor is unable to determine the extent of or the amounts associated with a pervasive employee fraud scheme, there is not sufficient appropriate audit evidence, and an expression of disclaimer of opinion may be appropriate.

Choice "a" is incorrect. An auditor may express a disclaimer of opinion when the auditor is unable to obtain sufficient appropriate audit evidence on which to base an opinion. When management refuses to produce documentation verifying the ownership of its equipment and production facilities, a client-imposed scope limitation exists, and an expression of disclaimer of opinion may be appropriate.

39

When an independent CPA assists in preparing the financial statements of a publicly held entity, but has not audited or reviewed them, the CPA should issue a disclaimer of opinion. In such situations, the CPA has no responsibility to apply any procedures beyond:

a.

Documenting that internal control is not being relied on.

b.

Reading the financial statements for obvious material misstatements.

c.

Ascertaining whether the financial statements are in conformity with GAAP.

d.

Determining whether management has elected to omit substantially all required disclosures.

 

Choice "b" is correct. The accountant is only required to read the financial statements for obvious material misstatements.

Choice "a" is incorrect. The accountant need not document that internal control is not being relied on.

Choices "c" and "d" are incorrect. The accountant is not required to evaluate conformity with GAAP, but any known departures (including inadequate disclosure) should be described in the disclaimer.

40

Kane, CPA, concludes that there is substantial doubt about Lima Co.'s ability to continue as a going concern for a reasonable period of time. If Lima's financial statements adequately disclose its financial difficulties, Kane's auditor's report is required to include an emphasis-of-matter paragraph that specifically uses the phrase(s):

~~"Possible discontinuance of operations"
~~"Reasonable period of time, not to exceed one year"
a.

Yes

Yes

b.

No

No

c.

Yes

No

d.

No

Yes

 

Choice "b" is correct. If, after considering identified conditions and events and management's plans, the auditor concludes that substantial doubt about the entity's ability to continue as a going concern for a reasonable period of time remains, the audit report should include an emphasis-of-matter paragraph (following the opinion paragraph) to reflect that conclusion. This conclusion should be expressed through the use of the phrase "substantial doubt about its (the entity's) ability to continue as a going concern" [or similar wording that includes the terms "substantial doubt" and "going concern"]. The "reasonable period...not to exceed one year" is inherent in the definition of going concern under U.S. auditing standards and is not explicitly stated in the audit report. The phrase "possible discontinuation of operations" may be included in the going concern disclosure but is not specifically required.

Choices "a", "c", and "d" are incorrect, as per the above explanation.

41

Foley, CPA, is the group engagement partner for a multinational corporation. Pente, CPA, audits a wholly owned subsidiary of this corporation. Which of the following is true about Foley's decision between assumption and division of responsibility under U.S. GAAS?

a.

If Foley chooses to divide responsibility, she need not evaluate Pente's reputation and independence.

b.

If Foley chooses to assume responsibility, the report will mention this assumption in the auditor's responsibility paragraph.

c.

If Foley chooses to assume responsibility, she must not make reference to the component auditor in her report.

d.

If Foley chooses to divide responsibility, no reference to the work done by Pente will be included in the audit report.

Choice "c" is correct. Under U.S. GAAS, if Foley chooses to assume responsibility, no reference to the component auditor should be made in the auditor's report because to do so may cause a reader to misinterpret the degree of responsibility being assumed. Furthermore, the group engagement team should determine the type of work to be performed on the financial information of the components. Note that division of responsibility is generally not permitted under ISAs.

Choice "d" is incorrect. If Foley chooses to divide responsibility, the report should clearly indicate that the component was not audited by the auditor of the group financial statements but was audited by the component auditor, and should include the magnitude of the portion of the financial statements audited by the component auditor.

Choice "b" is incorrect. If Foley chooses to assume responsibility, no reference to this assumption or to the work done by Pente will be included in the audit report.

Choice "a" is incorrect. Regardless of Foley's decision, she must always become satisfied regarding Pente's reputation and independence.

42

When there has been a change in accounting principles, but the effect of the change on the comparability of the financial statements is not material, the auditor should:

a.

Explicitly state whether the change conforms with GAAP.

b.

Refer to the note in the financial statements that discusses the change.

c.

Refer to the change in an emphasis-of-matter paragraph.

d.

Not refer to the change in the auditor's report.

Choice "d" is correct. If the change in accounting principles has an immaterial effect on the comparability of financial statements, no revision to the audit report is necessary.

Choice "b" is incorrect. The auditor's report would not need to be modified when the effect of the change on comparability is immaterial, therefore, the auditor does not need to refer to the note in the financial statements that discusses the change.

Choice "c" is incorrect. A change in accounting principles, which has a material effect on the comparability of financial statements, would refer to the change in an emphasis-of-matter paragraph.

Choice "a" is incorrect. The auditor does not need to explicitly state whether the change conforms with GAAP because the effect of the change is immaterial. The auditor's standard report implies that the auditor is satisfied that the comparability of financial statements between periods has not been materially affected by changes in accounting principles, and that such principles have been consistently applied between or among periods because either (a) no change in accounting principles has occurred, or (b) there has been a change in accounting principles or in the method of their application, but the effect of the change on the comparability of the financial statements is not material.

43

In which of the following circumstances would an auditor most likely add an emphasis-of-matter paragraph to the report while not affecting the auditor's unmodified opinion?

a.

Management's estimates of the effects of future events are unreasonable.

b.

There is substantial doubt about the entity's ability to continue as a going concern.

c.

The auditor is asked to report on the balance sheet, but not on the other basic financial statements.

d.

Certain transactions cannot be tested because of management's records retention policy.

Choice "b" is correct. If, after considering identified conditions and events and management's plans, the auditor concludes that substantial doubt about the entity's ability to continue as a going concern for a reasonable period of time remains, the audit report should include an emphasis-of-matter paragraph to reflect that conclusion.

Choice "c" is incorrect. Reporting on just the balance sheet is acceptable provided access to financial information is not limited. Such reporting does not require an emphasis-of-matter paragraph.

Choice "a" is incorrect. If the auditor concludes that management's estimate is unreasonable and that its effect is to cause the financial statements to be materially misstated, the auditor should express a qualified or an adverse opinion.

Choice "d" is incorrect. Restrictions on the scope of the audit, whether imposed by the client or by circumstances, may require the auditor to qualify or to disclaim an opinion.

44

Under which of the following circumstances would the expression of a disclaimer of opinion be inappropriate?

a.

Management does not provide reasonable justification for a change in accounting principles.

b.

The auditor is unable to obtain the audited financial statements of a consolidated investee.

c.

The company failed to make a count of its physical inventory during the year and the auditor was unable to apply alternative procedures to verify inventory quantities.

d.

Management refuses to allow the auditor to have access to the company's canceled checks and bank statements.

Choice "a" is correct. If management does not provide reasonable justification for a change in accounting principles, the auditor would issue a qualified or adverse opinion, depending on materiality.

Choice "b" is incorrect. If the auditor is unable to obtain the audited financial statements of a consolidated investee, a qualified opinion or a disclaimer of opinion would be issued, depending on materiality.

Choice "c" is incorrect. If the company failed to make a count of its physical inventory during the year and the auditor was unable to apply alternative procedures to verify inventory quantities, a qualified opinion or a disclaimer of opinion would be issued, depending on materiality.

Choice "d" is incorrect. If management refuses to allow the auditor to have access to the company's canceled checks and bank statements, a qualified opinion or a disclaimer of opinion would be issued, depending on materiality.

45

In the auditor's report under U.S. GAAS, the group engagement partner decides not to make reference to another CPA who audited a client's subsidiary. The group engagement partner could justify this decision if, among other requirements, the group engagement partner:

a.

Is unable to review the audit programs and audit documentation of the component auditor.

b.

Learns that the component auditor issued an unmodified opinion on the subsidiary's financial statements.

c.

Issues an unmodified opinion on the consolidated financial statements.

d.

Is satisfied as to the independence and professional reputation of the component auditor.

In the auditor's report under U.S. GAAS, the group engagement partner decides not to make reference to another CPA who audited a client's subsidiary. The group engagement partner could justify this decision if, among other requirements, the group engagement partner:

a.

Is unable to review the audit programs and audit documentation of the component auditor.

b.

Learns that the component auditor issued an unmodified opinion on the subsidiary's financial statements.

c.

Issues an unmodified opinion on the consolidated financial statements.

d.

Is satisfied as to the independence and professional reputation of the component auditor.

46

Green, CPA, concludes that there is substantial doubt about JKL Co.'s ability to continue as a going concern. If JKL's financial statements adequately disclose its financial difficulties, Green's auditor's report under U.S. auditing standards should:

~Include an emphasis -of-matter paragraph following the opinion paragraph
~Specifically use the words "going concern"
~Specifically use the words "substantial doubt"
a.

No

Yes

Yes

b.

Yes

No

Yes

c.

Yes

Yes

Yes

d.

Yes

Yes

No

Choice "c" is correct. "Yes - Yes - Yes."

When a CPA concludes that there is substantial doubt about an entity's ability to continue as a going concern and the entity adequately discloses its financial difficulties, an unmodified opinion is appropriate. An emphasis-of-matter paragraph (following the opinion paragraph) should be used to highlight the situation. This paragraph should include the phrases "substantial doubt" and "going concern." Under ISAs, the report uses the phrase "significant doubt", rather than "substantial doubt."

Choices "d", "b", and "a" are incorrect, per above.

47

A group engagement partner decides not to refer to the audit of a component auditor.  After making inquiries about the component auditor's professional reputation and independence, the group engagement partner most likely would:

a.

Add an emphasis-of-matter paragraph to the auditor's report indicating that the component's financial statements are not material to the consolidated financial statements.

b.

Contact the component auditor and review the audit programs and working papers pertaining to the component.

c.

Document in the engagement letter that the group engagement partner assumes no responsibility for the other CPA's work.

d.

Obtain written permission from the component auditor to omit the reference in the group engagement auditor's report.

Choice "b" is correct. When the group engagement auditor accepts responsibility for the work performed by a component auditor, the group engagement partner must contact the component auditor and review the audit program and working papers pertaining to the component.

Choice "c" is incorrect. When a group engagement partner decides not to reference a component auditor, the group engagement partner has assumed responsibility for the work performed by the component auditor.

Choice "d" is incorrect. Permission does not need to be obtained to assume responsibility for the work of the other CPA.

Choice "a" is incorrect. When the group engagement partner assumes responsibility for the work of a component auditor, no reference to the component auditor or to the component's financial statements is made in the auditor's report.

48

Davis, CPA, believes there is substantial doubt about the ability of Hill Co. to continue as a going concern for a reasonable period of time. In evaluating Hill's plans for dealing with the adverse effects of future conditions and events, Davis most likely would consider, as a mitigating factor, Hill's plans to:

a.

Purchase equipment and production facilities currently being leased.

b.

Negotiate reductions in required dividends being paid on preferred stock.

c.

Accelerate research and development projects related to future products.

d.

Accumulate treasury stock at prices favorable to Hill's historic price range.

 

Choice "b" is correct. Negotiating reductions in required dividends would conserve cash, which would be a mitigating factor in Davis' concerns about Hill's ability to continue as a going concern.

Choice "c" is incorrect. Accelerating R&D projects would use cash and impair the company's ability to continue as a going concern.

Choice "d" is incorrect. Accumulating treasury stock would consume cash and aggravate the situation.

Choice "a" is incorrect. Purchasing equipment that is currently leased would use cash and impair the company further.

49

For which of the following events would an auditor issue a report that omits any reference to consistency?

a.

A change from an accounting principle that is not generally accepted to one that is generally accepted.

b.

A change in the method of accounting for inventories.

c.

Management's lack of reasonable justification for a change in accounting principle.

d.

A change in the useful life used to calculate the provision for depreciation expense.

Choice "d" is correct. A change in accounting estimate (such as a change in the useful life of a depreciable asset) is accounted for prospectively and does not affect the comparability of financial statements between periods. Since the auditor's unmodified opinion implies that consistency exists, no modification to the report is necessary.

Choices "b", "a", and "c" are incorrect. Assuming the effect is material, a change in accounting principle results in the addition of an emphasis-of-matter paragraph (following the opinion paragraph) in the auditor's report. An emphasis-of-matter paragraph is required even if the previous accounting principle was not GAAP and even if management lacks reasonable justification for the change. (Note: A lack of reasonable justification for the change may also give rise to a report modification based on material misstatement of the financial statements).

50

When an auditor qualifies an opinion because of inadequate disclosure, the auditor should describe the nature of the omission in a separate paragraph and modify the:


~Basis for Opinion paragraph
~Opinion paragraph
a.

No

Yes

b.

Yes

No

c.

Yes

Yes

d.

No

Yes

 

Choice "c" is correct. In a report qualified for inadequate disclosure, the auditor would add a paragraph titled Basis for Qualified Opinion preceding the Opinion paragraph and modify the Opinion paragraph by adding an "except for..." statement.

Choices "d", "b", and "a" are incorrect, as per the above explanation.

51

How does an auditor make the following representations when issuing the unmodified audit opinion on comparative financial statements?

~Consistent application of accounting principles
~Examination of evidence on a test basis
a.

Explicitly

Explicitly

b.

Explicitly

Implicitly

c.

Implicitly

Implicitly

d.

Implicitly

Explicity

 

Choice "c" is correct. Consistency is implicit in the auditor's report, and will be explicitly mentioned in an emphasis-of-a-matter paragraph only if there are issues with consistency. There is no explicit reference to "test basis." The report says "An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements." 

Choices "b", "d", and "a" are incorrect based on the above explanation.

52

Mead, CPA, had substantial doubt about Tech Co.'s ability to continue as a going concern when reporting on Tech's audited financial statements for the year ended June 30, Year 4. That doubt has been removed in Year 5. What is Mead's reporting responsibility if Tech is presenting its financial statements for the year ended June 30, Year 5, on a comparative basis with those of Year 4?

a.

A different emphasis-of-matter paragraph describing Tech's plans for financial recovery should be included.

b.

A different emphasis-of-matter paragraph describing Mead's reasons for the removal of doubt should be included.

c.

The emphasis-of-matter paragraph included in the Year 4 auditor's report should be repeated in its entirety.

d.

The emphasis-of-matter paragraph included in the Year 4 auditor's report should not be repeated.

Choice "d" is correct. If substantial doubt about the entity's ability to continue as a going concern has been removed in the current period, the emphasis-of-matter paragraph included in the prior period auditor's report should not be repeated, and no description of the reasons or plans for recovery need be included.

Choice "c" is incorrect. If doubt about the going concern assumption has been removed in the current period, it is not appropriate to include the emphasis-of-matter paragraph from the prior year in the auditor's report for the current year.

Choice "b" is incorrect. If doubt about the going concern assumption has been removed in the current period, no emphasis-of-matter paragraph is required since the situation no longer exists. The auditor does not have to explain the reason for the change.

Choice "a" is incorrect. If doubt about the going concern assumption has been removed in the current period, no emphasis-of-matter paragraph is required since the situation no longer exists. The entity does not have to describe its plans for the future.

53

When an auditor expresses an adverse opinion, the opinion paragraph should include:

a.

A direct reference to a separate paragraph disclosing the basis for the opinion.

b.

The principal effects of the departure from generally accepted accounting principles.

c.

A description of the uncertainty or scope limitation that prevents an unmodified opinion.

d.

The substantive reasons for the financial statements being misleading.

Choice "a" is correct. The opinion paragraph in an adverse opinion should state that, in the auditor's opinion, because of the significance of the matter(s) described in the basis for adverse opinion paragraph, the financial statements are.... 

Choice "b" is incorrect. The principal effects of the departure from GAAP are not included in the opinion paragraph.

Choice "d" is incorrect. The "substantive reasons for the financial statements being misleading" are discussed in the basis for adverse opinion paragraph, not the opinion paragraph.

Choice "c" is incorrect. Scope limitations pertain to disclaimers of opinion, not adverse opinions.

(It is very important to memorize the qualifying phrases in the qualified, adverse, and disclaimer of opinions.)

54

When there has been a change in accounting principle that materially affects the comparability of the comparative financial statements presented and the auditor concurs with the change, the auditor should:

~Concur explicitly with the change
~Issue an "except for" qualified opinion
~Refer to the change in an emphasis-of-matter paragraph
a.

No

No

Yes

b.

No

Yes

No

c.

Yes

No

Yes

d.

Yes

Yes

No

Choice "a" is correct. No - No - Yes.

When a change in accounting principle materially affects the comparability of the comparative FS, the auditor should refer to the change in an emphasis-of-matter paragraph following the unmodified opinion paragraph. 

Choices "c" and "d" are incorrect. The auditor's concurrence with a change in GAAP is implicit, notexplicit.

Choice "b" is incorrect. An unmodified opinion should be issued, not an "except for" qualified opinion.

55

The Auditor's Responsibility paragraph of an auditor's report contains the following sentences:

We did not audit the financial statements of EZ Inc., a wholly-owned subsidiary, which statements reflect total assets and revenues constituting 27 percent and 29 percent, respectively, of the related consolidated totals. Those statements were audited by other auditors whose report has been furnished to us, and our opinion, insofar as it relates to the amounts included for EZ Inc., is based solely on the report of the other auditors.

These sentences:

a.

Are an improper form of reporting.

b.

Assume responsibility for the other auditor.

c.

Indicate a division of responsibility.

d.

Require a departure from an unmodified opinion.

 

Choice "c" is correct. The paragraph presented is the proper form of disclosure when another auditor performs a substantial portion of the audit. When the group engagement partner makes reference to the audit of another auditor (component auditor), the report should indicate clearly the division of responsibility between the portion of the financial statements covered by each audit.

Choice "b" is incorrect. By making the disclosure that another auditor (component auditor) performed part of the audit, the group engagement partner explicitly does not assume responsibility for the component auditor's work. If the disclosure is omitted, then the group engagement partner implicitly does assume responsibility for the component auditor's work.

Choice "d" is incorrect. Reference in the report of the engagement team partner to the fact that part of the audit was performed by another auditor (the component auditor) is not a qualification of the opinion. It is simply an indication of the divided responsibility between the auditors who conducted the audits of various components of the overall financial statements.

Choice "a" is incorrect. The paragraph presented is the proper form of disclosure when a component auditor performs a substantial portion of the audit.

56

An auditor includes a separate paragraph in an otherwise unmodified report to emphasize that the entity being reported on had significant transactions with related parties. The inclusion of this separate paragraph:

a.

Is considered an "except for" qualification of the opinion.

b.

Necessitates a revision of the opinion paragraph to include the phrase "with the foregoing explanation."

c.

Violates generally accepted auditing standards if this information is already disclosed in footnotes to the financial statements.

d.

Is appropriate and would not negate the unmodified opinion.

Choice "d" is correct. This is an emphasis-of-matter paragraph and should be added to an otherwise unmodified opinion in this case.

Choice "a" is incorrect. An "except for" qualification is used for a scope limitation or a departure from GAAP, but not for emphasis of a matter.

Choice "c" is incorrect. The auditor may emphasize a matter even if it is included in the footnotes.

Choice "b" is incorrect. A phrase such as "with the foregoing explanation" should not be used in an unmodified opinion.

57

An auditor believes that there is substantial doubt about an entity's ability to continue as a going concern for a reasonable period of time. In evaluating the entity's plans for dealing with the adverse effects of future conditions and events, the auditor most likely would consider, as a mitigating factor, the entity's plans to:

a.

Repurchase the entity's stock at a price below its book value.

b.

Lease rather than purchase operating facilities.

c.

Issue stock options to key executives.

d.

Accelerate the due date of an existing mortgage.

Choice "b" is correct. Leasing rather than purchasing operating facilities results in reduced (or at least delayed) expenditures, which is a mitigating factor in a going concern situation.

Choice "a" is incorrect. Mitigating factors in a going concern situation include plans to dispose of assets, plans to borrow money or restructure debt, plans to reduce or delay expenditures, or plans to increase ownership equity. Repurchasing stock is an outflow of cash that would reduce ownership equity; as such, it is not a mitigating factor.

Choice "c" is incorrect. Mitigating factors in a going concern situation include plans to dispose of assets, plans to borrow money or restructure debt, plans to reduce or delay expenditures, or plans to increase ownership equity. Issuing stock options does not fall into any of these categories and would not be considered a mitigating factor.

Choice "d" is incorrect. Mitigating factors in a going concern situation include plans to dispose of assets, plans to borrow money or restructure debt, plans to reduce or delay expenditures, or plans to increase ownership equity. Accelerating the due date of an existing mortgage would increase expenditures, and therefore would not be a mitigating factor.

58

When an entity changes its method of accounting for income taxes, which has a material effect on comparability, the auditor should refer to the change in an emphasis-of-matter paragraph added to the auditor's report. This paragraph should identify the nature of the change and:

a.

State the auditor's explicit concurrence with or opposition to the change.

b.

Describe the cumulative effect of the change on the audited financial statements.

c.

Refer to the financial statement note that discusses the change in detail.

d.

Explain why the change is justified under generally accepted accounting principles.

 

Choice "c" is correct. The paragraph should refer to the note in the financial statements that discusses the change in detail. Following is an example of an appropriate emphasis-of-matter paragraph: "As discussed in Note X to the financial statements, the company changed its method of accounting for income taxes in X2."

Choice "d" is incorrect. The auditor need not explain why a change from one generally accepted accounting principle to another is justified.

Choice "b" is incorrect. The paragraph should not identify the cumulative effect of the change on the audited financial statements.

Choice "a" is incorrect. The auditor should never explicitly state concurrence with a change. If the auditor opposes the change, a qualified or adverse opinion should be issued.

59

Which of the following is true?

a.

When an auditor includes a paragraph after the opinion paragraph emphasizing a significant related party transaction, the opinion would be considered a qualified opinion.

b.

When a material accounting change has been properly accounted for and disclosed, the auditor may not issue an unmodified opinion.

c.

The auditor may issue an unmodified opinion when a material departure from GAAP exists.

d.

If an auditor believes there is substantial doubt about an entity's ability to continue as a going concern, and management has properly disclosed the situation, the auditor may not issue an unmodified opinion.

Choice "c" is correct. Although this situation is unusual, if a departure from GAAP is justified, the auditor may issue an unmodified opinion with an emphasis-of-matter paragraph.

Choice "a" is incorrect. An auditor may decide to use an emphasis-of-matter paragraph, but this does not constitute a qualified opinion. This is still an unmodified form of the opinion.

Choice "b" is incorrect. A lack of consistency that has a material effect must be disclosed in an emphasis-of-matter paragraph. If all the acceptability criteria for the accounting change are met, the auditor may issue an unmodified opinion. In evaluating the acceptability of the accounting change, the auditor should consider whether the newly adopted accounting principle is in accordance with the applicable financial reporting framework, the method of accounting for the change is acceptable, the disclosures related to the change are appropriate and adequate, and the entity has justified that the alternative accounting principle is preferable.

Choice "d" is incorrect. Going concern issues must be disclosed in an emphasis of matter paragraph, but if the auditor is satisfied that the going concern disclosures by management are adequate, an unmodified opinion can be issued.

60

Under which of the following circumstances would an auditor's expression of an unmodified opinion be inappropriate?

a.

Analytical procedures indicate that many year-end account balances are not comparable with the prior year's balances.

b.

There are significant deficiencies in the design and operation of the entity's internal control.

c.

The auditor is unable to obtain the audited financial statements of a significant subsidiary.

d.

The financial statements are prepared on the entity's income tax basis.

Choice "c" is correct. If the auditor is unable to obtain the audited financial statements of a significant subsidiary, a scope limitation exists. Assuming the effect is material, the auditor would issue either a qualified opinion or a disclaimer of opinion.

Choice "d" is incorrect. Financial statements prepared on an entity's income tax basis are "special purpose framework financial statements." The auditor may issue a special report, which can include an unmodified opinion, on special purpose framework financial statements.

Choice "b" is incorrect. Significant deficiencies in the design and operation of an entity's internal control do not preclude issuance of an unmodified opinion, although they do increase the risk of material misstatement and will likely result in modifications to the nature, timing, and extent of the auditor's testing.

Choice "a" is incorrect. An unmodified opinion may still be expressed when there are significant changes in year-end account balances as compared to prior year balances, as long as the auditor has obtained sufficient appropriate audit evidence about the current balances.

61

An auditor would express an unmodified opinion with an emphasis-of-matter paragraph added to the auditor's report for:

~An unjustified accounting change
~A material weakness in internal control
a.

Yes

Yes

b.

No

No

c.

No

Yes

d.

Yes

No

Choice "b" is correct. An unjustified accounting change may cause the auditor to issue a qualified or adverse opinion. A material weakness must be reported to management and those charged with governance, but would not be disclosed in an emphasis-of-matter paragraph added to an otherwise unmodified opinion.

Choices "a", "d", and "c" are incorrect per the above explanation.

62

After considering management's plans, an auditor concludes that there is substantial doubt about a client's ability to continue as a going concern for a reasonable period of time. The auditor's responsibility includes:

a.

Disclaiming an opinion on the financial statements due to the indications of possible financial difficulties.

b.

Considering the adequacy of disclosure about the client's possible inability to continue as a going concern.

c.

Issuing a qualified or adverse opinion, depending upon materiality, due to the possible effects on the financial statements.

d.

Indicating to the client's audit committee whether management's plans for dealing with the adverse effects of the financial difficulties can be effectively implemented.

Choice "b" is correct. When the auditor believes there is substantial doubt about the ability of the entity to continue as a going concern for a reasonable period of time, there is a responsibility to consider the adequacy of the client's disclosure of such circumstances.

Choice "a" is incorrect. There is no requirement to disclaim an opinion solely due to a going concern issue.

Choice "d" is incorrect. The auditor does not have a responsibility to communicate to the audit committee whether management's plans can or cannot be effectively implemented.

Choice "c" is incorrect. A qualified or adverse opinion is only required in situations where there is no adequate disclosure.

63

An auditor may not issue a qualified opinion when:

a.

The auditor lacks independence with respect to the audited entity.

b.

The auditor's report refers to the work of a specialist.

c.

An accounting principle at variance with GAAP is used.

d.

A scope limitation prevents the auditor from completing an important audit procedure.

 

Choice "a" is correct. If the auditor lacks independence with respect to an audit client, the auditor must disclaim an opinion on the financial statements. A qualified opinion is not an option.

Choice "c" is incorrect. A departure from GAAP (which is not sufficiently material to warrant an adverse opinion) may justify a qualification of the auditor's report.

Choice "d" is incorrect. A scope limitation may result in a qualified opinion or a disclaimer of opinion.

Choice "b" is incorrect. The auditor's report may make reference to the use of a specialist only if the specialist's findings result in a change to the auditor's report, such as a qualified opinion.

64

An auditor should disclose the substantive reasons for expressing an adverse opinion in a basis for modification paragraph:

a.

Preceding the opinion paragraph.

b.

Within the notes to the financial statements.

c.

Following the opinion paragraph.

d.

Preceding the introductory paragraph.

Choice "a" is correct. The auditor should disclose the substantive reasons for expressing an adverse opinion in a separate basis for adverse opinion paragraph preceding the opinion paragraph.

Choice "d" is incorrect. There are no circumstances where any paragraph precedes the introductory paragraph.

Choice "c" is incorrect. An emphasis-of-matter paragraph follows the opinion paragraph when there is a change in accounting principle or when there is doubt as to going concern.

Choice "b" is incorrect. The auditor cannot include any type of explanatory material in the financial statements, which are the responsibility of management.

65

During an audit, the auditor notes that the client's financial statements are not in conformity with GAAP regarding the recording of leases. Based on this situation, which opinion is least likely to be rendered?

a.

An unmodified opinion.

b.

A disclaimer of opinion.

c.

An adverse opinion.

d.

A qualified opinion.

Choice "b" is correct. A disclaimer of opinion is issued when there is a significant scope limitation, when the auditor is not independent, or when the financial statements are not audited, which is not the case in this question.

Choice "a" is incorrect. An unmodified opinion may be issued when the effect of the GAAP departure is deemed to be immaterial.

Choice "d" is incorrect. A qualified opinion may be issued when the effect of the GAAP departure is material.

Choice "c" is incorrect. An adverse opinion may be issued when the effect of the GAAP departure is material and pervasive.

66

When qualifying an opinion due to an inability to obtain sufficient appropriate audit evidence, an auditor should refer to the situation in the:

~Management's Responsibility paragraph
~Basis for Qualified Opinion paragraph
a.

Yes

No

b.

No

No

c.

Yes

Yes

d.

No

Yes

Choice "d" is correct. When a qualified opinion results from an inability to obtain sufficient appropriate audit evidence, the situation should be described in a Basis for Qualified Opinion paragraph preceding the Opinion paragraph and should be referred to in the Opinion paragraph. The scope limitation is not mentioned in the Management's Responsibility paragraph.

Choices "b", "a", and "c" are incorrect, per the above explanation.

67

A limitation on the scope of an audit sufficient to preclude an unmodified opinion will usually result when management:

a.

Is unable to obtain audited financial statements supporting the entity's investment in a foreign subsidiary.

b.

Refuses to disclose in the notes to the financial statements related party transactions authorized by the Board of Directors.

c.

Fails to correct a significant deficiency in internal control communicated to those charged with governance after the prior year's audit.

d.

Does not provide the auditor with an engagement letter specifying the responsibilities of both the entity and the auditor.

Choice "a" is correct. Restrictions on the scope of the audit, such as the timing of the work, the inability to obtain sufficient appropriate audit evidence, or an inadequacy in the accounting records, may require the auditor to qualify or disclaim an opinion. Inability to obtain audited financial statements supporting the entity's investment in a foreign subsidiary is such a restriction on the scope of the audit.

Choice "b" is incorrect. Client refusal to disclose related party transactions in the notes to the financial statements is a GAAP problem, not a scope problem. For a GAAP problem, the auditor must either issue a qualified or adverse opinion.

Choice "d" is incorrect. The auditor sends an engagement letter to the client, not vice versa.

Choice "c" is incorrect. Management may choose not to correct a significant deficiency in internal control if the cost of correcting the condition outweighs the benefit.

68

Cooper, CPA, believes there is substantial doubt about the ability of Zero Corp. to continue as a going concern for a reasonable period of time. In evaluating Zero's plans for dealing with the adverse effects of future conditions and events, Cooper most likely would consider, as a mitigating factor, Zero's plans to:

a.

Strengthen internal controls over cash disbursements.

b.

Discuss with lenders the terms of all debt and loan agreements.

c.

Purchase production facilities currently being leased from a related party.

d.

Postpone expenditures for research and development projects.

Choice "d" is correct. When assessing management's plans for dealing with the adverse effects of future conditions and events, mitigating factors would include:

The postponement of expenditures (including R&D),

Plans to dispose of assets,

Plans to borrow money or restructure debt,

Plans to increase ownership equity (sell stock).

Choice "b" is incorrect. Discussions with lenders regarding terms would not be a mitigating factor. Actual agreements regarding restructuring of debt or amendments to covenants would be required.

Choice "a" is incorrect. Strengthening internal controls over cash would not qualify as a management tactic to address going concern issues.

Choice "c" is incorrect. Purchasing facilities which are currently being leased would only further decrease cash flow.

69

When an auditor concludes there is substantial doubt about a continuing audit client's ability to continue as a going concern for a reasonable period of time, the auditor's responsibility is to:

a.

Consider the adequacy of disclosure about the client's possible inability to continue as a going concern.

b.

Reissue the prior year's auditor's report and add an emphasis-of-matter paragraph that specifically refers to "substantial doubt" and "going concern."

c.

Issue a qualified or adverse opinion, depending upon materiality, due to the possible effects on the financial statements.

d.

Report to the client's audit committee that management's accounting estimates may need to be adjusted.

When an auditor concludes there is substantial doubt about a continuing audit client's ability to continue as a going concern for a reasonable period of time, the auditor's responsibility is to:

a.

Consider the adequacy of disclosure about the client's possible inability to continue as a going concern.

b.

Reissue the prior year's auditor's report and add an emphasis-of-matter paragraph that specifically refers to "substantial doubt" and "going concern."

c.

Issue a qualified or adverse opinion, depending upon materiality, due to the possible effects on the financial statements.

d.

Report to the client's audit committee that management's accounting estimates may need to be adjusted.

70

Green, CPA, was engaged to audit the financial statements of Essex Co. after its fiscal year had ended. The timing of Green's appointment as auditor and the start of fieldwork made confirmation of accounts receivable by direct communication with the debtors ineffective. However, Green applied other procedures and was satisfied as to the reasonableness of the account balances. Green's auditor's report most likely contained a(an):

a.

Unmodified opinion with an emphasis-of-matter paragraph.

b.

Qualified opinion due to a departure from generally accepted auditing standards.

c.

Qualified opinion due to a scope limitation.

d.

Unmodified opinion.

Choice "d" is correct. There is a presumption that the auditor will request the confirmation of accounts receivable during an audit unless accounts receivable are immaterial, the use of confirmations would be ineffective, or the assessed inherent risk is so low that the evidence expected to be provided by analytical procedures or other substantive tests of details would be sufficient. In this example, the confirmation of accounts receivable by direct communication with the debtors would be ineffective. If Green was able to apply alternative audit procedures and was satisfied as to the reasonableness of the account balances, then an unmodified opinion could be issued.

Choice "a" is incorrect. Since Green was satisfied as far as the accounts receivable balances, there is no need to add an emphasis-of-matter paragraph.

Choice "c" is incorrect. Since Green was able to perform alternative procedures and was satisfied as far as the reasonableness of the account balances, there is no scope limitation.

Choice "b" is incorrect. Since Green was able to perform alternative procedures and was satisfied as far as the reasonableness of the account balances, there is no departure from generally accepted auditing standards.

71

In which of the following should an auditor's report refer to the lack of consistency when there is a change in accounting principle that is significant?

a.

An emphasis-of-matter paragraph following the opinion paragraph.

b.

An emphasis-of-matter paragraph before the opinion paragraph.

c.

The introductory paragraph.

d.

The opinion paragraph.

Choice "a" is correct.  A justified lack of consistency caused by a material change in GAAP between periods would be reported in an emphasis-of-matter paragraph after the opinion paragraph. Under these circumstances, the auditor issues an unmodified opinion.

Choices "c", "d", and "b" are incorrect. The proper treatment of a justified lack of consistency is to add an emphasis-of-matter paragraph after the opinion paragraph.

72

In which of the following circumstances would an auditor not express an unmodified opinion?

a.

The auditor is unable to obtain audited financial statements of a consolidated investee.

b.

The auditor wishes to emphasize an unusually important subsequent event.

c.

There has been a material change between periods in accounting principles.

d.

Quarterly financial data required by the SEC has been omitted.

In which of the following circumstances would an auditor not express an unmodified opinion?

a.

The auditor is unable to obtain audited financial statements of a consolidated investee.

b.

The auditor wishes to emphasize an unusually important subsequent event.

c.

There has been a material change between periods in accounting principles.

d.

Quarterly financial data required by the SEC has been omitted.

73

In which of the following circumstances would an auditor not express an unmodified opinion?

a.

The auditor is unable to obtain audited financial statements of a consolidated investee.

b.

The auditor wishes to emphasize an unusually important subsequent event.

c.

There has been a material change between periods in accounting principles.

d.

Quarterly financial data required by the SEC has been omitted.

In which of the following circumstances would an auditor not express an unmodified opinion?

a.

The auditor is unable to obtain audited financial statements of a consolidated investee.

b.

The auditor wishes to emphasize an unusually important subsequent event.

c.

There has been a material change between periods in accounting principles.

d.

Quarterly financial data required by the SEC has been omitted.

74

In which of the following circumstances would an auditor not express an unmodified opinion?

a.

The auditor is unable to obtain audited financial statements of a consolidated investee.

b.

The auditor wishes to emphasize an unusually important subsequent event.

c.

There has been a material change between periods in accounting principles.

d.

Quarterly financial data required by the SEC has been omitted.

In which of the following circumstances would an auditor not express an unmodified opinion?

a.

The auditor is unable to obtain audited financial statements of a consolidated investee.

b.

The auditor wishes to emphasize an unusually important subsequent event.

c.

There has been a material change between periods in accounting principles.

d.

Quarterly financial data required by the SEC has been omitted.

75

In which of the following circumstances would an auditor not express an unmodified opinion?

a.

The auditor is unable to obtain audited financial statements of a consolidated investee.

b.

The auditor wishes to emphasize an unusually important subsequent event.

c.

There has been a material change between periods in accounting principles.

d.

Quarterly financial data required by the SEC has been omitted.

Choice "b" is correct. Under U.S. auditing standards, the auditor's audit report includes a statement that "An audit includes evaluating...significant estimates made by management..."

Choice "a" is incorrect. The audit report does not state that disclosures provide reasonable assurance that the financial statements are free of material misstatement. The correct statement is: "...standards require that we plan and perform the audit to obtain reasonable assurance that the financial statements are free of material misstatement." 

Choice "d" is incorrect. The audit report does not state that the auditor evaluated the overall internal control. The correct statement is "In making those risk assessments, the auditor considers internal control relevant to the entity's preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity's internal control."

Choice "c" is incorrect. The audit report does not state "The financial statements are consistent with those of the prior period." Consistency is implicitly reported; only if there is an inconsistency is an explicit statement included.

76

Digit Co. uses the FIFO method of costing for its international subsidiary's inventory and LIFO for its domestic inventory. Under these circumstances, the auditor's report on Digit's financial statements should express an:

a.

Adverse opinion.

b.

Opinion qualified because of a lack of consistency.

c.

Opinion qualified because of a departure from GAAP.

d.

Unmodified opinion.

Choice "d" is correct. GAAP allows a company to use different methods for costing different inventories as long as the methods are disclosed. Thus, the audit report would be unmodified; there is no departure from GAAP.

Choice "b" is incorrect. The consistency standard refers to changes in application of accounting practices between periods, affecting the comparability of financial statements. There is no indication Digit made any change in methods.

Choice "c" is incorrect. Use of different methods for costing inventory is permissible under GAAP, and would not result in a qualification of the auditor's report.

Choice "a" is incorrect. Use of different methods for costing inventory is permissible under GAAP, and would not result in an adverse report.

77

Under U.S. GAAS, in which of the following situations would a group engagement partner least likely make reference to component auditor who audited a subsidiary of the entity?

a.

The component auditor was retained by the group engagement partner and the work was performed under the group engagement partner's guidance and control.

b.

The group engagement partner is unable to be satisfied as to the independence and professional reputation of the component auditor.

c.

The group engagement partner finds it impractical to review the component auditor's work or otherwise be satisfied as to the component auditor's work.

d.

The financial statements audited by the component auditor are material to the consolidated financial statements covered by the group engagement partner's opinion.

Choice "a" is correct. Under U.S. GAAS, when the group engagement partner assumes responsibility for the component auditor's work, the group engagement partner would not mention the component auditor in the audit report (opinion). The group engagement auditor would generally assume responsibility after reviewing the audit documentation of the component auditor and performing supplemental audit tests, or by reputation, e.g., if the component auditor is a correspondent (foreign) firm in which the group engagement partner auditor has developed confidence.

Choices "c" and "d" are incorrect. When the group engagement partner finds it impractical to review the component auditor's work, or when the FS audited by the other auditor are material, it is more likely that the group engagement partner will divide responsibility and make reference to the component auditor.

Choice "b" is incorrect. The group engagement partner should always make inquiries regarding the independence and professional reputation of the component auditor. Inability to become satisfied in this regard would constitute a scope limitation, resulting in a qualified opinion or disclaimer of opinion.

78

When an independent CPA is associated with the financial statements of a publicly held entity but hasnot audited or reviewed such statements, the appropriate form of report to be issued must include a(an):

a.

Report on pro forma financial statements.

b.

Regulation S-X exemption.

c.

Disclaimer of opinion.

d.

Unaudited association report.

Choice "c" is correct. When an accountant is associated with the financial statements of a public entity, but has not audited or reviewed such statements, the accountant must issue a report disclaiming any opinion on the statements.

Choices "b", "a", and "d" are incorrect since a disclaimer is required in this case.

79

For an entity's financial statements to be presented fairly in accordance with an applicable financial reporting framework, the framework selected should:

a.

Be U.S. GAAP, for all audits performed in the United States.

b.

Match the reporting framework used by most other entities within the entity's particular industry.

c.

Be approved by the Auditing Standards Board or the appropriate industry subcommittee.

d.

Include an adequate description of the framework in the financial statements.

Choice "d" is correct. The preparation and fair presentation of the financial statements requires identification of the applicable financial reporting framework and inclusion of an adequate description of the framework, as well as preparation and fair presentation in accordance with the framework.

Choice "a" is incorrect. There may be other financial reporting frameworks, such as IFRS (International Financial Reporting Standards), that are used by companies that are audited in the United States.

Choice "c" is incorrect. The Auditing Standards Board does not establish a financial reporting framework.

Choice "b" is incorrect. There is no requirement that an entity's financial statements be prepared in accordance with prevalent industry practices.

80

Which of the following is true regarding the audit report for an issuer?

a.

PCAOB standards should not be mentioned at all, although their use is implied in the auditor's report.

b.

Reference may be made to either PCAOB standards or generally accepted auditing standards.

c.

Reference should be made to both PCAOB standards and generally accepted auditing standards.

d.

The report should include references to PCAOB standards and generally accepted accounting principles.

Choice "d" is correct. An auditor reporting on the audit of financial statements of an issuer should indicate in the scope paragraph that the engagement was conducted in accordance with PCAOB standards, and should refer to GAAP in the opinion paragraph.

Choice "c" is incorrect. An auditor reporting on the audit of financial statements of an issuer is required to refer to PCAOB standards. There is no requirement to reference GAAS.

Choice "a" is incorrect. An auditor reporting on the audit of financial statements of an issuer should indicate in the audit report that the engagement was conducted in accordance with PCAOB standards. This is an explicit statement in the report; it is not implied or assumed.

Choice "b" is incorrect. An auditor reporting on the audit of financial statements of an issuer should indicate in the scope paragraph that the engagement was conducted in accordance with PCAOB standards. Referring to generally accepted auditing standards instead is not an option, as audits of issuers must follow PCAOB standards.

81

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

a.

Usual trade credit from suppliers is denied.

b.

Significant related party transactions are pervasive.

c.

Arrearages in preferred stock dividends are paid.

d.

Restrictions on the disposal of principal assets are present.

 

Choice "a" is correct. Denial of usual trade credit is one example of a financial difficulty that may be indicative of substantial doubt about an entity's ability to continue as a going concern.

Choice "b" is incorrect. Pervasive significant related party transactions, by themselves, are not necessarily indicative of an entity's ability to continue as a going concern.

Choice "c" is incorrect. The ability to pay arrearages in preferred stock dividends would be indicative of financial health and would not create substantial doubt about an entity's ability to continue as a going concern.

Choice "d" is incorrect. Restrictions on the disposal of principal assets would not cause an auditor to have substantial doubt about an entity's ability to continue as a going concern.

82

Restrictions imposed by a retail entity that is a new client prevent an auditor from observing any physical inventories. These inventories account for 40% of the entity's assets. Alternative auditing procedures cannot be applied due to the nature of the entity's records. Under these circumstances, the auditor should express a(an):

a.

Qualified opinion.

b.

Adverse opinion.

c.

Unmodified opinion with an emphasis-of-matter paragraph.

d.

Disclaimer of opinion.

Choice "d" is correct. Since the auditor is unable to observe inventory or apply alternative audit procedures, a scope limitation exists. Due to the significance of the inventory balance (40% of total assets is quite material), a disclaimer of opinion (rather than simply a qualification) is appropriate.

Choice "a" is incorrect. Since the inventory balance is so material, a qualified opinion is not sufficient in this case.

Choice "b" is incorrect. An adverse opinion is not an appropriate response to a scope limitation.

Choice "c" is incorrect. Since the scope limitation relates to a material balance, an unmodified opinion is not appropriate.

83

Which of the following audit procedures most likely would assist an auditor in identifying conditions and events that may indicate there could be substantial doubt about an entity's ability to continue as a going concern?

a.

Reconciliation of interest expense with debt outstanding.

b.

Confirmation of bank balances.

c.

Review of compliance with terms of debt agreements.

d.

Confirmation of accounts receivable from principal customers.

 

Choice "c" is correct. By reviewing the debt agreements, the auditor may discover that the entity is near or in noncompliance with specific debt (financial) covenants. This may cast doubt on whether the entity will be able to continue as a going concern.

Choice "d" is incorrect. This procedure would not provide information on whether the entity has a going concern issue but instead could detect errors in financial reporting by the entity.

Choice "a" is incorrect. The mere reconciliation of interest expense to the debt outstanding would not provide information regarding the entity's ability to function as a going concern.

Choice "b" is incorrect. Confirming bank balances could detect reporting errors but would not be a procedure to ascertain whether the entity has a going concern issue.

84

Restrictions imposed by a client prohibit the observation of physical inventories, which account for 35% of all assets. Alternative audit procedures cannot be applied, although the auditor was able to examine satisfactory evidence for all other items in the financial statements. The auditor should issue a(an):

a.

Unmodified opinion with an explanation in an emphasis-of-matter paragraph.

b.

Qualified opinion with a basis for modification paragraph.

c.

Disclaimer of opinion.

d.

"Except for" qualified opinion.

Choice "c" is correct. Restrictions of scope imposed on the audit of such a large (35%) asset would require a disclaimer of opinion.

Choices "d" and "b" are incorrect. The asset not audited is too large for a qualified opinion.

Choice "a" is incorrect. An unmodified opinion is not appropriate, given the size of the inventory (35% of assets).

85

Which of the following phrases would an auditor most likely include in the auditor's report when expressing a qualified opinion due to inadequate disclosure?

a.

Do not present fairly.

b.

Except for the omission of the information described in the Basis for Qualified Opinion paragraph.

c.

With the foregoing explanation of these omitted disclosures.

d.

Subject to the departure from generally accepted accounting principles, as described above.

Choice "b" is correct. When inadequate disclosure has a material but not pervasive effect on the financial statements, the auditor's opinion should state "In our opinion, except for the omission of the information described in the Basis for Qualified Opinion paragraph..."

Choice "d" is incorrect. This language is not used. When inadequate disclosure has a material but not pervasive effect on the financial statements, the auditor's opinion should state "In our opinion, except for the omission of the information described in the Basis for Qualified Opinion paragraph..."

Choice "c" is incorrect. This language is not used. When inadequate disclosure has a material but not pervasive effect on the financial statements, the auditor's opinion should state "In our opinion, except for the omission of the information described in the Basis for Qualified Opinion paragraph..."

Choice "a" is incorrect. The statement "do not present fairly" would be used in an adverse opinion, not a qualified opinion.

86

If a publicly held company issues financial statements that purport to present its financial position and results of operations but omits the statement of cash flows, the auditor ordinarily will express a(an):

a.

Disclaimer of opinion.

b.

Review report.

c.

Qualified opinion.

d.

Unmodified opinion with an emphasis-of-matter paragraph.

 

Choice "c" is correct. If a company issues financial statements that purport to present financial position and results of operations but omits the related statement of cash flows, the auditor will normally conclude that the omission requires qualification of the opinion.

Choice "a" is incorrect. If the company fails to present its statement of cash flows, this is considered inadequate disclosure. The auditor would not issue a disclaimer of opinion for inadequate disclosure.

Choice "b" is incorrect. The auditor would not issue a review report when performing an audit.

Choice "d" is incorrect. The auditor cannot issue an unmodified report if the client omits a statement of cash flows from the financial statements.

87

An auditor concludes that there is substantial doubt about an entity's ability to continue as a going concern for a reasonable period of time. The entity's financial statements adequately disclose its financial difficulties. Under these circumstances, the auditor's report is required to include an emphasis-of-matter paragraph that specifically uses the phrase(s):

~"Except for the effects of such adjustments"
~"Possible discontinuance of the entity's operations"
a.

Yes

No

b.

No

Yes

c.

Yes

Yes

d.

No

No

Choice "d" is correct. The wording of the emphasis-of-matter paragraph must include the terms "substantial doubt" and "going concern." The phrases in the above question are not required to be used.

Choices "c", "a", and "b" are incorrect based on the above explanation.

88

When disclaiming an opinion because of an insufficiency of audit evidence, an auditor should refer to the situation in the:

~Auditor's  Responsibility  Paragraph
~Notes to the financial statements
a.

No

Yes

b.

Yes

No

c.

No

No

d.

Yes

Yes

Choice "b" is correct. When a disclaimer of opinion is issued due to a lack of sufficient audit evidence, the lack of evidence should be disclosed in the Auditor's Responsibility paragraph and discussed in an additional paragraph before the opinion paragraph. This paragraph should be titled Basis for Disclaimer of Opinion. 

Choices "d" and "a" are incorrect. Management (and not the auditor) prepares the notes to the financial statements. The auditor therefore would not refer to this (or any other) situation in the notes to the financial statements.

Choice "c" is incorrect. The auditor does refer to the situation in the Auditor's Responsibility paragraph.

89

When single-year financial statements are presented, an auditor ordinarily would express an unmodified opinion with no emphasis of matter or other matter paragraph if the:

a.

Auditor wishes to emphasize an accounting matter affecting the comparability of the financial statements with those of the prior year.

b.

Entity declines to present a statement of cash flows with its balance sheet and related statements of income and retained earnings.

c.

Prior year's financial statements were audited by another CPA whose report, which expressed an unmodified opinion, is not presented.

d.

Auditor is unable to obtain audited financial statements supporting the entity's investment in a foreign affiliate.

Choice "c" is correct. Since only single-year financial statements are presented, the fact that another CPA audited the prior year's financial statements is not relevant. Therefore, the auditor would express an unmodified opinion.

Choice "d" is incorrect. The situation described would result in a qualified opinion or disclaimer of opinion due to a scope limitation.

Choice "b" is incorrect. The situation described would result in an qualified opinion due to inadequate disclosure.

Choice "a" is incorrect. The situation described would result in an unmodified opinion with an emphasis-of-matter paragraph added after the opinion paragraph.

90

An entity changed from the straight-line method to the declining balance method of depreciation for all newly acquired assets. This change has no material effect on the current year's financial statements, but is reasonably certain to have a substantial effect in later years. If the change is disclosed in the notes to the financial statements, the auditor should issue a report with a(an):

a.

Consistency modification.

b.

Unmodified opinion.

c.

Emphasis-of-matter paragraph.

d.

"Except for" qualified opinion.

 

Choice "b" is correct. If an accounting change has no material effect on the financial statements in the current year, but a material future effect, the auditor must ensure that the change is disclosed in the footnotes whenever the financial statements of the change period are presented, but does not have to recognize the change in the current year's audit report.

Choice "d" is incorrect. Accounting changes that are accounted for properly do not result in qualified opinions.

Choices "c" and "a" are incorrect. A consistency modification is not necessary when the effect of a change is immaterial.

91

A CPA firm is completing the fieldwork for an audit of Swenson Co. for the current year ended December 31. The manager in charge of the audit is performing the final steps in the evidence accumulation phase of the audit and notes that there have been several changes in Swenson during the year under audit. Which of the following items would indicate there could be substantial doubt about Swenson's ability to continue as a going concern for a reasonable period of time?

a.

A lack of significant contracts with new customers.

b.

Recurring working capital shortages.

c.

Cash infusion by a venture capital firm.

d.

Term debt refinanced with a new bank.

Choice "b" is correct. Negative trends such as recurring working capital shortages are often indicative of substantial doubt about a company's ability to continue as a going concern.

Choice "c" is incorrect. A cash infusion would improve the company's financial situation.

Choice "a" is incorrect. A lack of significant contracts with new customers might not be cause for concern, as long as the company has a stable and profitable customer base.

Choice "d" is incorrect. Refinancing debt often improves the terms of the debt for the borrower.

92

An auditor decides to issue a qualified opinion on an entity'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.

The possible effects on the financial statements.

c.

Inadequate disclosure of necessary information.

d.

A departure from generally accepted auditing standards.

 

Choice "b" is correct. When an auditor qualifies his opinion because of a scope limitation, the wording in the opinion paragraph should indicate that the qualification pertains to the possible effects on the financial statements and not to the scope limitation itself.

Choice "a" is incorrect. When an auditor qualifies his opinion because of a scope limitation, the wording in the opinion paragraph should indicate that the qualification pertains to the possible effects on the financial statements and not to the scope limitation itself.

Choice "d" is incorrect. A scope limitation is a departure from generally accepted auditing standards. However, when an auditor qualifies his opinion because of a scope limitation, the wording in the opinion paragraph should indicate that the qualification pertains to the possible effects on the financial statements and not to the scope limitation itself.

Choice "c" is incorrect. Inadequate disclosure of necessary information is a departure from GAAP, rather than a scope limitation.

93

An auditor most likely would express an unmodified opinion and would not add emphasis-of-matter or other-matter paragraphs to the report if the auditor:

a.

Concurs with the entity's change in its method of computing depreciation.

b.

Believes that there is a probable likelihood of a material loss resulting from an uncertainty that is sufficiently supported and disclosed.

c.

Wishes to emphasize that the entity had significant transactions with related parties.

d.

Discovers that supplementary information required by FASB has been omitted.

Choice "b" is correct. An auditor most likely would express an unmodified opinion and would not add an additional paragraph to the report if the auditor believes that there is a probable likelihood of a material loss resulting from an uncertainty that is sufficiently supported and disclosed.

Choice "c" is incorrect. Emphasis of a matter, such as the existence of significant transactions with related parties, may result in an additional paragraph added to an otherwise unmodified opinion.

Choice "a" is incorrect. A change in accounting principle does result in an emphasis-of-matter paragraph appended to an otherwise unmodified opinion.

Choice "d" is incorrect. Omission of supplemental information required by GAAP does result in an additional paragraph added to an otherwise unmodified opinion.

94

In which of the following situations would an auditor ordinarily choose between expressing an "except for" qualified opinion or an adverse opinion?

a.

The auditor did not observe the entity's physical inventory and is unable to become satisfied as to its balance by other auditing procedures.

b.

The auditor is asked to report only on the entity's balance sheet and not on the other basic financial statements.

c.

Events disclosed in the financial statements cause the auditor to have substantial doubt about the entity's ability to continue as a going concern.

d.

The financial statements fail to disclose information that is required by generally accepted accounting principles.

Choice "d" is correct. Failure to disclose information that is required by GAAP is a departure from GAAP. Departures from GAAP result in a qualified or an adverse opinion.

Choice "a" is incorrect. If the auditor is unable to observe physical inventory and is unable to become satisfied through alternative means, that is a scope limitation. Scope limitations result in either a qualified opinion or a disclaimer of opinion.

Choice "b" is incorrect. The auditor can report on one financial statement and not the others. This does not preclude issuance of an unmodified opinion.

Choice "c" is incorrect. If, after considering identified conditions and events and management's plans, the auditor concludes that substantial doubt about the entity's ability to continue as a going concern for a reasonable period of time remains, the audit report should include an emphasis-of-matter paragraph (after the opinion paragraph in the unmodified report) to reflect that conclusion.

95

A CPA firm has decided to rely on the audit work performed by another audit firm. Which of the following procedures should the CPA firm perform when taking responsibility for the other firm's audit work?

a.

Reference the reliance on the other firm's work in the first paragraph of the opinion in the audit report.

b.

Review the other firm's audit workpapers and reperform a subset of audit testing to validate the firm's conclusions.

c.

Reference the reliance on the other firm's work in a footnote disclosure to the financial statements.

d.

Obtain and attach a copy of the other firm's representation letter and audit report to the opinion that the CPA firm issues.

Choice "b" is correct. When a CPA firm decides to take responsibility for another firm's audit work, the CPA firm should review the other firm's audit workpapers and reperform a subset of audit testing to validate the firm's conclusions.

Choice "c" is incorrect. The CPA firm would not reference the other's firm's work in a footnote disclosure to the financial statements when a CPA firm decides to take responsibility for another firm's audit work. Furthermore, management is responsible for the financial statements. The auditor may not make their own footnote disclosures in the client's financial statements.

Choice "a" is incorrect. The CPA firm would not reference the other's firm's work in the audit report because the CPA firm decided to take responsibility for another firm's audit work. No reference to the other auditor should be made in the auditor's report because to do so may cause a reader to misinterpret the degree of responsibility assumed.

Choice "d" is incorrect. The CPA firm would not attach a copy of the other firm's representation letter and audit report to the opinion that the CPA firm issues.

96

Reference in a group engagement partner's report to the fact that part of the audit was performed by another auditor most likely would be an indication of the:

a.

Lack of materiality of the portion of the financial statements audited by the other auditor.

b.

Group engagement partner's recognition of the component auditor's competence, reputation, and professional certification.

c.

Divided responsibility between the auditors who conducted the audits of the components of the overall financial statements.

d.

Different opinions the auditors are expressing on the components of the financial statements that each audited.

Choice "c" is correct. Reference to a component auditor indicates division of responsibility for the audits of the components of the overall financial statements.

Choice "a" is incorrect. Reference to a component auditor would not generally be made if the component auditor's portion of the financial statements is immaterial.

Choice "b" is incorrect. The reference in the report is not meant to recognize the qualifications of the other auditor, but simply to divide the responsibility between the two auditors.

Choice "d" is incorrect. The reference to the component auditor would be made regardless of what type of opinion is expressed by each auditor.

97

Pell, CPA, decides to serve as group engagement partner in the audit of the financial statements of Tech Consolidated, Inc. Smith, CPA, audits one of Tech's subsidiaries. In which situation(s) should Pell make reference to Smith's audit under U.S. GAAS?

I.

Pell reviews Smith's audit documentation and assumes responsibility for Smith's work, but expresses a qualified opinion on Tech's financial statements.

II.

Pell is unable to review Smith's audit documentation; however, Pell's inquiries indicate that Smith has an excellent reputation for professional competence and integrity.

a.

Neither I nor II.

b.

II only.

c.

I only.

d.

Both I and II.

Choice "b" is correct. Under U.S. GAAS, the group engagement partner makes reference in the audit report to the work of the component auditor when the group engagement partner is unable to review the component auditor's audit documentation. This is because the group engagement partner will be unable to be satisfied concerning the work performed by the component auditor. Even though the component auditor has an excellent reputation, the group engagement partner must see the work to be able to assume responsibility for it. Note that under ISAs, no reference is made to the component auditor unless required by law or regulation.

Choice "c" is incorrect. When the group engagement partner decides to assume responsibility for the work of the component auditor, no reference is made to the work of the component auditor, regardless of the type of audit report expressed.

Choice "d" is incorrect. When the group engagement partner decides to assume responsibility for the work of the component auditor, no reference is made to the work of the component auditor, regardless of the type of audit report expressed.

Choice "a" is incorrect. The group engagement partner will make reference in the audit report to the work of the component auditor when the group engagement partner is unable to review the component auditor's audit documentation. This is because the group engagement auditor will be unable to be satisfied concerning the work performed by the component auditor. Even though the component auditor has an excellent reputation, the group engagement partner must see the work to be able to assume responsibility for it.

98

Grant Company's financial statements adequately disclose uncertainties that concern future events, the outcome of which are not susceptible of reasonable estimation. The auditor's report should include a (an):

a.

Unmodified opinion.

b.

"Except for" qualified opinion.

c.

Adverse opinion.

d.

"Subject to" qualified opinion.

 

Choice "a" is correct. The auditor should issue an "unmodified opinion" when management adequately discloses future events, the outcome of which are not susceptible of reasonable estimation. Under U.S. auditing standards an emphasis-of-matter paragraph may be added by the auditor if the matter is of such importance that it is fundamental to the users' understanding of the financial statements. International Standards on Auditing recommend the addition of a paragraph describing the significant uncertainty.

Choice "d" is incorrect. "Subject to" qualified opinions are not permitted.

Choice "b" is incorrect. An "except for" qualified opinion would not be used as there is adequate disclosure and there are no scope limitations.

Choice "c" is incorrect. An adverse opinion would not be used because the FS are presented "fairly" in conformity with GAAP.

99

An auditor concludes that a client's illegal act, which has a material effect on the financial statements, has not been properly accounted for or disclosed. Depending on the pervasiveness of the effect on the financial statements, the auditor should express either a(an):

a.

Adverse opinion or a disclaimer of opinion.

b.

Disclaimer of opinion or an unmodified opinion with an emphasis-of-matter paragraph.

c.

Qualified opinion or an adverse opinion.

d.

Unmodified opinion with an other-matter paragraph or a qualified opinion.

Choice "c" is correct. If the financial statements, including accompanying notes, fail to disclose information that is required by generally accepted accounting principles, the auditor should express a qualified or adverse opinion, depending on pervasiveness.

Choice "a" is incorrect. disclaimer of opinion is not an appropriate report for inadequate disclosure or a GAAP departure.

Choice "b" is incorrect. A disclaimer of opinion or an unmodified opinion with an emphasis-of-matter paragraph are not appropriate for a client with a material undisclosed item or GAAP departure.

Choice "d" is incorrect. An unmodified opinion with an other-matter paragraph is not appropriate for a client with a material undisclosed item or GAAP departure.

100

A CPA's report on audited financial statements under U.S. auditing standards would be inappropriate if it referred to:

a.

Significant estimates made by management.

b.

The CPA's assessment of sampling risk factors.

c.

Evaluating the appropriateness of accounting policies used.

d.

Management's responsibility for the financial statements

Choice "b" is correct. The CPA's report on audited financial statements does not include matters related to the auditor's assessment of specific risk factors.

Choice "d" is incorrect. The CPA's report on audited financial statements includes an explanation that management is responsible for the preparation and fair presentation of the financial statements.

Choices "c" and "a" are incorrect. The CPA's audit includes evaluating the appropriateness of the accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the financial statements. This is mentioned in the auditor's responsibility paragraph.

101

When disclaiming an opinion due to a client-imposed scope limitation, an auditor should indicate in a separate paragraph why the audit did not comply with generally accepted auditing standards. The auditor should also omit the:


~Auditor's Responsibility paragraph
~Opinion paragraph
a.

No

No

b.

Yes

Yes

c.

Yes

No

d.

No

Yes

 

Choice "a" is correct. When disclaiming an opinion because of scope limitations, the auditor should indicate in a separate paragraph(s) the reasons that the audit did not comply with GAAS. The Auditor's Responsibility paragraph is revised to mention the disclaimer, but is not omitted. The Opinion paragraph is not omitted; however it indicates that no opinion is expressed.

Choices "d", "b", and "c" are incorrect, as per the above explanation.

102

Under U.S. auditing standards, when an auditor believes there is substantial doubt about the ability of an entity to continue as a going concern, all of the following should be included in the audit documentation, except:

a.

The conditions that gave rise to the substantial doubt.

b.

Management's conclusion regarding whether substantial doubt remains or is alleviated.

c.

The auditor's conclusion about whether substantial doubt remains or is alleviated.

d.

The effect of the auditor's conclusion on the auditor's report.

Choice "b" is correct. Whether substantial doubt remains or is alleviated is a judgment call made by the auditor, and there is no requirement to document management's opinion on the matter under U.S. auditing standards. Under International Standards on Auditing, management must assess the entity's ability to continue as a going concern and the auditor must evaluate this assessment and document the evaluation in the audit workpapers.

Choices "a", "c", and "d" are incorrect. When an auditor believes there is substantial doubt about the ability of an entity to continue as a going concern, the conditions that gave rise to the substantial doubt, the auditor's conclusion about whether substantial doubt remains or is alleviated, and the effect of the auditor's conclusion on the auditor's report should all be documented.

103

An auditor concludes that there is substantial doubt about an entity's ability to continue as a going concern for a reasonable period of time. If the entity's disclosures concerning this matter are adequate, the audit report may include a(an):

~Disclaimer of opinion
~"Except for" qualified opinion
a.

Yes

No

b.

No

No

c.

No

Yes

d.

Yes

Yes

 

Choice "a" is correct. Yes - No.

If an auditor concludes that there is substantial doubt about an entity's ability to continue as a going concern and that the entity's disclosures are adequate, then the audit report may be either:

Unmodified with emphasis-of-matter paragraph, or

Disclaimed.

(Generally, an unmodified opinion is issued, but the auditor is not prohibited from choosing to issue a disclaimer.)

Choice "d" is incorrect. An "except for" qualified opinion would be appropriate if the entity's disclosures were inadequate.

Choice "b" is incorrect. While an unmodified opinion is generally issued, the auditor is not prohibited from choosing to issue a disclaimer; for example, in areas involving a high degree of uncertainty.

Choice "c" is incorrect, based on the explanation above.

104

How does an auditor make the following representations when issuing the auditor's report on comparative financial statements under U.S. auditing standards?

~Obtaining evidence that is sufficient and appropriate
~Consistent application of accounting principles
a.

Explicitly

Explicitly

b.

Explicitly

Implicitly

c.

Implicitly

Explicitly

d.

Implicitly

Implicitly

Choice "b" is correct. Explicitly - Implicitly.

Under U.S. auditing standards, the auditor explicitly states in the Auditor's Responsibility paragraph of the opinion: "We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion." Consistency is implied in the auditor's report.

Choices "a", "d", and "c" are incorrect, as per above explanation.

105

Under which of the following circumstances would a disclaimer of opinion not be appropriate?

a.

The client refuses to permit its attorney to furnish information requested in a letter of audit inquiry.

b.

The auditor is unable to determine the amounts associated with illegal acts committed by the client's management.

c.

The financial statements fail to contain adequate disclosure of related party transactions.

d.

The auditor is engaged after fiscal year-end and is unable to observe physical inventories or apply alternative procedures to verify their balances.

Choice "c" is correct. The failure of the financial statements to contain adequate disclosure of related party transactions, or other required disclosures, would result in a qualified or adverse opinion, not a disclaimer of opinion.

Choice "a" is incorrect. A client's refusal to permit its attorney to furnish information requested in a letter of audit inquiry would generally result in a disclaimer of opinion.

Choice "d" is incorrect. The auditor's inability to observe physical inventories or apply alternative procedures to verify their balances could result in a disclaimer.

Choice "b" is incorrect. The auditor's inability to determine the amounts associated with illegal acts committed by the client's management could result in a disclaimer.

106

An auditor should consider which of the following when evaluating the ability of a company to continue as a going concern?

a.

A lawsuit for which judgment is not anticipated for 18 months.

b.

Future assurance services.

c.

Management's plans for disposal of assets.

d.

Audit fees.

Choice "c" is correct. The nature of management's plan to sell or liquidate assets could provide valuable information to the auditor regarding whether or not the entity can continue to function as a going concern.

Choice "d" is incorrect. Audit fees have no bearing on a client's going concern issue.

Choice "b" is incorrect. This item would not be directly relevant when determining if there is a going concern issue.

Choice "a" is incorrect. The future outcome of a pending lawsuit that is more than one year away is a contingency that would not have a significant impact on a going concern issue for a current audit. Under U.S. GAAP, the going concern period is one year.