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Flashcards in A3-1 Deck (33)
1

A successor auditor ordinarily should request to review the predecessor's audit documentation relating to:

~Contingencies
~Internal control
a.

No

Yes

b.

Yes

No

c.

Yes

Yes

d.

No

No

Choice "c" is correct. A review of the predecessor's audit documentation related to matters of continuing accounting and auditing significance would be permitted. This would include documentation concerning contingencies and internal controls.

Choice "b" is incorrect. It is appropriate for the successor auditor to review the predecessor's audit documentation relating to internal controls.

Choice "a" is incorrect. It is appropriate for the successor auditor to review the predecessor's audit documentation relating to contingencies as they may have an impact on the current year financial statements.

Choice "d" is incorrect. It is appropriate for the successor auditor to review the predecessor's audit documentation relating to internal controls and contingencies.

2

Which of the following auditor concerns most likely could be so serious that the auditor concludes that a financial statement audit cannot be performed?

a.

Management is dominated by one person who is also the majority stockholder.

b.

There is a substantial risk of intentional misapplication of accounting principles.

c.

Management fails to modify prescribed internal controls for changes in information technology.

d.

Internal control activities requiring segregation of duties are rarely monitored by management.

Choice "b" is correct. Intentional misapplication of accounting principles would indicate that management lacks integrity and as a result, the auditor might conclude that a financial statement audit cannot be performed.

Choice "c" is incorrect. Management's failure to modify prescribed internal controls for changes in information technology would preclude the auditor from relying on those controls but would not prevent the auditor from performing a financial statement audit.

Choice "d" is incorrect. If management rarely monitors segregation of duties, the auditor would not rely on that particular control, but this would not prevent the auditor from performing a financial statement audit.

Choice "a" is incorrect. If management is dominated by one person who is also the majority stockholder, the risk of fraudulent financial reporting is increased, but this would not preclude the auditor from performing a financial statement audit.

3

Which of the following factors most likely would cause a CPA to not accept a new audit engagement?

a.

The prospective client is unwilling to make all financial records available to the CPA.

b.

The prospective client has already completed its physical inventory count.

c.

The CPA makes oral inquiries (only) to the predecessor auditor regarding the prior year's audit.

d.

The CPA lacks an understanding of the prospective client's operations and industry.

Choice "a" is correct. An auditor must consider the availability and adequacy of the client's accounting records and the integrity of management in deciding whether or not to accept a new audit engagement. A prospective client that is unwilling to provide all financial records would give the auditor cause for concern about both of these issues.

Choice "b" is incorrect. The auditor may apply acceptable alternative procedures to audit inventory.

Choice "d" is incorrect. The auditor can accept the engagement and obtain an understanding of the client's operations and industry after acceptance.

Choice "c" is incorrect. The CPA is required to make oral or written inquiries of the predecessor auditor before accepting an engagement. Oral inquiries are sufficient here.

4

Which of the following factors most likely would lead a CPA to conclude that a potential audit engagement should be rejected?

a.

Management has a reputation for consulting with several accounting firms about significant accounting issues.

b.

Internal control activities requiring the segregation of duties are subject to management override.

c.

It is unlikely that sufficient appropriate evidence is available to support an opinion on the financial statements.

d.

The details of most recorded transactions are not available after a specified period of time.

Choice "c" is correct. A CPA cannot render an opinion on financial statements unless he or she has obtained sufficient appropriate audit evidence supporting that opinion. If such evidence were unlikely to be available, the CPA would most likely reject the potential audit engagement.

Choice "d" is incorrect. The auditor takes the availability of information into account when planning the audit, and would need to perform testing throughout the period, but this would not be cause for rejecting a potential audit engagement.

Choice "b" is incorrect. The risk of management override is considered during planning and would not be cause for rejecting a potential audit engagement.

Choice "a" is incorrect. Management may consult with several accounting firms, and this would not be cause for rejecting a potential audit engagement.

5

A scope limitation sufficient to preclude an unmodified opinion always will result when management:

a.

Refuses to acknowledge its responsibility for the fair presentation of the financial statements in conformity with GAAP.

b.

Prevents the auditor from reviewing the audit documentation of the predecessor auditor.

c.

Requests that certain material accounts receivable not be confirmed.

d.

Engages the auditor after the year-end physical inventory is completed.

Choice "a" is correct. The introductory paragraph of the standard unmodified report includes a statement that the financial statements are the responsibility of the company's management. Management's refusal to accept responsibility for the fair presentation of the financial statements therefore precludes issuance of this standard report.

Choices "b" is incorrect. Preventing the review of documentation of the predecessor auditor would be a reason not to accept the engagement.

Choices "d", and "c" are incorrect, as there are generally alternative procedures the auditor can perform to accomplish his or her goals.

6

Which of the following factors most likely would cause a CPA to decide not to accept a new audit engagement?

a.

Management's refusal to permit the CPA to perform substantive tests before the year-end.

b.

The CPA's inability to determine whether related party transactions were consummated on terms equivalent to arm's-length transactions.

c.

Management's disregard of its responsibility to maintain an adequate internal control environment.

d.

The CPA's lack of understanding of the prospective client's internal auditor's computer-assisted audit techniques.

Choice "c" is correct. The control environment is the foundation for all other components of internal control. Management's disregard of its responsibility to maintain an adequate internal control environment therefore compromises its ability to provide reasonable assurance regarding reliable financial reporting. The auditor may conclude that the risk that the financial framework used by the client may be unacceptable is great enough that an audit should not be conducted.

Choice "d" is incorrect. The CPA does not need to understand the internal auditor's techniques in order to accept a new audit engagement.

Choice "b" is incorrect. Related party transactions (by definition) are not considered to be arm's-length transactions, and evaluation of such transactions does not affect the CPA's decision regarding acceptance of new clients.

Choice "a" is incorrect. Substantive tests are generally performed after year-end, since prior to that time the financial statements have not been finalized.

7

Which of the following matters generally is included in an auditor's engagement letter?

a.

Management’s responsibility for the fair presentation of the financial statements.

b.

The auditor's responsibility to search for significant internal control deficiencies.

c.

Management's vicarious liability for violations of laws and regulations committed by its employees.

d.

The factors to be considered in setting preliminary judgments about materiality.

Choice "a" is correct. An understanding with the client should be established regarding management's responsibilities, which include the preparation and fair presentation of the financial statements in accordance with the applicable financial reporting framework. The understanding should be documented through a written communication, such as an engagement letter.

Choice "d" is incorrect. Judgments about materiality are the auditor's responsibility and would not be included in an engagement letter.

Choice "c" is incorrect. Management would not necessarily be responsible for violations of laws and regulations committed by employees.

Choice "b" is incorrect. The auditor is not responsible for searching for significant internal control deficiencies.

8

Before accepting an engagement to audit a new client, a CPA is required to obtain:

a.

The prospective client's consent to make inquiries of the predecessor auditor.

b.

The prospective client's signature to the representation letter.

c.

An understanding of the prospective client's industry and business.

d.

A preliminary understanding of the prospective client's control environment.

Choice "a" is correct. Inquiry of the predecessor auditor is a required pre-acceptance procedure. However, consent of the prospective client must be obtained before a CPA can make such inquiries of the predecessor auditor.

Choice "c" is incorrect. Obtaining an understanding of the client's industry and business is a planning procedure performed after an engagement is accepted.

Choice "b" is incorrect. A management representation letter is not obtained until the end of the audit.

Choice "d" is incorrect. Obtaining a preliminary understanding of the client's control environment is an audit procedure (required by the second standard of fieldwork) that would be performed after an engagement is accepted.

9

A successor auditor most likely would make specific inquiries of the predecessor auditor regarding:

a.

The uncertainty inherent in applying sampling procedures.

b.

Specialized accounting principles of the client's industry.

c.

Disagreements with management as to auditing procedures.

d.

The competency of the client's internal audit staff.

Choice "c" is correct. Inquiries should include specific questions regarding, among other things, facts that might bear on the integrity of management; disagreements with management as to accounting principles, auditing procedures, or other similarly significant matters; communications with those charged with governance regarding fraud, acts of noncompliance with laws and regulations, and matters relating to internal control; and the predecessor's understanding as to the reasons for the change of auditors.

Choice "b" is incorrect. Specialized industry accounting principles might be discussed; however, the successor would be more likely to inquire about items specific to the client.

Choice "d" is incorrect. The competency of the client's internal audit staff might be discussed; however, inquiries of the predecessor auditor regarding the staff are not required.

Choice "a" is incorrect. The uncertainty in applying sampling procedures is not something that is typically discussed with the predecessor auditor.

10

Which of the following statements would least likely appear in an auditor's engagement letter?

a.

After performing our preliminary analytical procedures we will discuss with you the other procedures we consider necessary to complete the engagement.

b.

Our engagement is subject to the risk that material errors or fraud, including defalcations, if they exist, will not be detected.

c.

Fees for our services are based on our regular per diem rates, plus travel and other out-of-pocket expenses.

d.

Arrangements to be made with the predecessor auditor.

Choice "a" is correct. The auditor does not consult with the client about audit procedures that will be performed.

Choice "c" is incorrect. Since the engagement letter serves as a contract between the auditor and client, fee arrangements are typically disclosed in the letter.

Choice "d" is incorrect. The arrangements to contact the predecessor auditor is appropriate for inclusion in an engagement letter.

Choice "b" is incorrect. The fact that audit risk exists and that an audit only provides reasonable assurance of the detection of errors and fraud is typically disclosed in an engagement letter.

11

In auditing the financial statements of Star Corp., Land discovered information leading Land to believe that Star's prior year's financial statements, which were audited by Tell, require substantial revisions. Under these circumstances, Land should:

a.

Notify Tell about the information and make inquiries about the integrity of Star's management.

b.

Request Star to arrange a meeting among the three parties to resolve the matter.

c.

Request Star to reissue the prior year's financial statements with the appropriate revisions.

d.

Notify Star's audit committee and stockholders that the prior year's financial statements cannot be relied on.

Choice "b" is correct. If, during the audit, the successor auditor becomes aware of information indicating that the financial statements reported on by the predecessor auditor may require revision, he or she should request the client to arrange a meeting among the three parties to discuss the information and attempt to resolve the matter.

Choice "d" is incorrect. It is not the successor auditor's responsibility to inform readers that the financial statements, which were audited by another firm, cannot be relied upon.

Choice "c" is incorrect. The prior year's financial statements should not be reissued until the two auditing firms and the client have an opportunity to discuss the matter. There is a reasonable likelihood that the successor firm is unaware of other information that supports the current condition of the prior year financial statements.

Choice "a" is incorrect. The successor firm should not notify the predecessor directly but should request that the client do so.

12

An auditor's engagement letter most likely would include a statement regarding:

a.

Materiality matters that could modify the auditor's preliminary assessment of fraud risk.

b.

Conditions under which the auditor may modify the preliminary judgment about materiality.

c.

Management's responsibility to provide certain written representations to the auditor.

d.

Internal control activities that would reduce the auditor's assessment of risk.

Choice "c" is correct. The auditor is required to establish an understanding with the client, and this understanding should be documented in the form of an engagement letter. The understanding (and therefore the letter) should encompass management's responsibilities, which include providing the auditor with a representation letter at the conclusion of the engagement.

Choices "b", "d", and "a" are incorrect. An understanding generally is not obtained with respect to specific audit procedures, and therefore these items would not be included in an engagement letter.

13

A successor auditor should make specific and reasonable inquiries of the predecessor auditor regarding the predecessor's:

a.

Understanding of the reasons for the change in auditors.

b.

Opinion on subsequent events that have occurred since the balance sheet date.

c.

Methodology used in applying sampling techniques.

d.

Perception of the competency and reliance on the client's internal audit function.

Choice "a" is correct. The successor auditor is required to make inquiries of the predecessor auditor before accepting an engagement. These inquiries should include the predecessor's understanding as to the reasons for the change in auditors.

Choice "c" is incorrect. The successor auditor would not typically inquire regarding audit methodology used during the prior audit.

Choices "b" and "d" are incorrect. The successor auditor is responsible for making his or her own judgments regarding the audit, and would not typically inquire regarding the predecessor auditor's judgments with respect to subsequent events or the internal audit function.

14

Which of the following factors most likely would lead a CPA to conclude that a potential audit engagement should notbe accepted?

a.

There are significant related party transactions that management claims occurred in the ordinary course of business.

b.

Internal control activities requiring the segregation of duties are subject to management override.

c.

It is unlikely that sufficient appropriate audit evidence is available to support an opinion on the financial statements.

d.

Management continues to employ an inefficient system of information technology to record financial transactions.

Choice "c" is correct. If it is unlikely that sufficient appropriate audit evidence will be available to support an opinion on the financial statements, it would be pointless to conduct an audit.

Choice "a" is incorrect. The existence of significant related party transactions would not prevent the auditor from accepting an audit engagement, regardless of the whether or not such transactions occurred in the ordinary course of business. The auditor would simply need to evaluate management's methods for identifying and disclosing related party transactions, and ultimately evaluate financial statement disclosure, as part of the audit.

Choice "b" is incorrect. Internal control activities are often subject to management override, but this is no reason to reject a potential audit engagement. Rather, this risk should be assessed, and audit procedures should be designed only after taking into account the assessed level of risk.

Choice "d" is incorrect. An inefficient system of information technology for recording financial transactions may not be optimal for the company, but as long as it is an effective system (i.e., as long as it provides reliable financial reporting), it will not affect the auditor's decision regarding acceptance of a new audit engagement.

15

Prior to commencing field work, an auditor usually discusses the general audit strategy with the client's management. Which of the following details do management and the auditor usually agree upon at this time?

a.

The specific matters to be included in the communication with those charged with governance.

b.

The schedules and analyses that the client's staff should prepare.

c.

The minimum amount of misstatements that may be considered to be significant deficiencies in internal control.

d.

The effects that inadequate controls may have over the safeguarding of assets.

Choice "b" is correct. Prior to commencing field work, the auditor would likely discuss with management any assistance desired from client staff. This is part of establishing an understanding with the client.

Choice "a" is incorrect. Prior to commencing field work, the auditor likely would be unaware of the specific matters to be included in the communication to those charged with governance.

Choice "c" is incorrect. While the auditor may set a preliminary measure of materiality, this is a matter of auditing judgment and would not typically be discussed with the client. In addition, significant internal control weaknesses are reported because they indicate a potential for material misstatement, regardless of whether any actual misstatements exceed a particular threshold.

Choice "d" is incorrect. Prior to commencing field work, the auditor would be unlikely to have identified inadequate controls or evaluated their possible effects.

16

A successor auditor is required to attempt communication with the predecessor auditor prior to:

a.

Accepting the engagement.

b.

Making a proposal for the audit engagement.

c.

Testing beginning balances for the current year.

d.

Performing test of controls.

Choice "a" is correct. A successor auditor is required to attempt communication with the predecessor auditor prior to accepting a new engagement.

Choice "d" is incorrect. A successor auditor is required to attempt communication with the predecessor auditor prior to accepting a new engagement. This certainly implies that such attempt will be made before any audit tests are performed; however, the requirement is stated in reference to the date of acceptance.

Choice "c" is incorrect. A successor auditor is required to attempt communication with the predecessor auditor prior to accepting a new engagement. This certainly implies that such attempt will be made before any audit tests are performed; however, the requirement is stated in reference to the date of acceptance.

Choice "b" is incorrect. A successor auditor is not required to attempt communication with the predecessor auditor prior to making a proposal for the audit engagement (remember that more than one auditor may be bidding for the engagement and it wouldn't be reasonable to expect the predecessor auditor to respond to all bidders). However, once a successor has been selected, that auditor must attempt communication with the predecessor auditor before actually accepting the engagement.

17

Which of the following factors most likely would influence an auditor's determination of the auditability of an entity's financial statements?

a.

The existence of related party transactions.

b.

The complexity of the accounting system.

c.

The adequacy of the accounting records.

d.

The operating effectiveness of control activities.

Choice "c" is correct. An auditor cannot audit inadequate accounting records (i.e., records that do not exist or are so poor that they cannot be relied upon).

Choices "b" and "a" are incorrect. The following factors would be considered when accepting an audit engagement and might require extensions of audit work, but are not factors that would prevent the financial statements from being audited:

b.

The complexity of the accounting system.

a.

The existence of related party transactions.

Choice "d" is incorrect. The operating effectiveness of control activities does not affect the auditability of financial statements, and it is not considered when accepting an audit engagement.

18

Hill, CPA, has been retained to audit the financial statements of Monday Co. Monday's predecessor auditor was Post, CPA, who has been notified by Monday that Post's services have been terminated. Under these circumstances, which party should initiate the communications between Hill and Post?

a.

Post, the predecessor auditor.

b.

The chairman of Monday's board of directors.

c.

Monday's controller or CFO.

d.

Hill, the successor auditor.

Choice "d" is correct. The initiative to communicate with the predecessor auditor rests with the successor auditor. Note, however, that the successor auditor must first receive permission from the client.

Choice "a" is incorrect. The predecessor auditor should respond promptly and fully to reasonable inquiries. However, the predecessor is not responsible for initiating communications.

Choice "c" is incorrect. The prospective client should authorize the predecessor to respond fully to the successor's inquiries. However, the client is not responsible for initiating communications.

Choice "b" is incorrect. The prospective client should authorize the predecessor to respond fully to the successor's inquiries. However, the client is not responsible for initiating communications.

19

Which of the following auditor concerns most likely could be so serious that the auditor concludes that a financial statement audit cannot be conducted?

a.

Procedures requiring segregation of duties are subject to management override.

b.

The entity has no formal written code of conduct.

c.

The integrity of the entity's management is suspect.

d.

Management fails to modify prescribed controls for changes in conditions.

Choice "c" is correct. An auditor's faith in the integrity of management is of the utmost importance in performing a financial statement audit. When an auditor is concerned that the integrity of management is suspect, the situation is serious enough to prevent the auditor from performing the audit.

Choice "b" is incorrect. A lack of a written code of conduct is not unusual in a small company and certainly would not prevent an audit from being performed.

Choice "a" is incorrect. Procedures requiring segregation of duties are almost always subject to management override, even in the best internal control system.

Choice "d" is incorrect. An auditor would simply modify the appropriate audit procedures when management fails to modify prescribed controls for changes in conditions.

20

Prior to commencing fieldwork, an auditor usually discusses the general audit strategy with the client's management. Which of the following matters do the auditor and management agree upon at this time?

a.

The control weaknesses to be included in the communication with those charged with governance.

b.

The appropriateness of the entity's plans for dealing with adverse economic conditions.

c.

The coordination of the assistance of the client's personnel in data preparation.

d.

The determination of the fraud risk factors that exist within the client's operations.

Choice "c" is correct. Prior to commencing fieldwork, an auditor would establish an understanding with the client as to the services to be performed and the overall audit strategy. This understanding may include arrangements involving the conduct of the engagement, such as timing, client assistance, and the availability of documents.

Choice "b" is incorrect. The auditor does not evaluate the appropriateness of the entity's plans for dealing with adverse economic conditions prior to commencing fieldwork. The auditor might consider this as part of evaluating the client's ability to continue as a going concern, but this would not occur prior to commencing fieldwork.

Choice "d" is incorrect. Determination of existing fraud risk factors is generally made during the fieldwork stage of the audit, as information and evidence is obtained. Also, fraud risk factors are assessed by the auditor, and would not necessarily be agreed upon with management.

Choice "a" is incorrect. Identification and evaluation of control weaknesses generally occurs during the fieldwork stage of the audit, as information and evidence is obtained, not prior to the commencement of fieldwork.

21

An auditor is required to establish an understanding with a client regarding the services to be performed for each engagement. This understanding generally includes:

a.

The auditor's responsibility for ensuring that those charged with governance are aware of any significant deficiencies in internal control that come to the auditor's attention.

b.

The auditor's responsibility for determining the preliminary judgments about materiality and audit risk factors.

c.

Management's responsibility for identifying mitigating factors when the auditor has doubt about the entity's ability to continue as a going concern.

d.

Management's responsibility for providing the auditor with an assessment of the risk of material misstatement due to fraud.

Choice "a" is correct. An understanding between the auditor and the client generally includes the auditor's responsibilities. One of the auditor's responsibilities is to ensure that those charged with governance (e.g., the audit committee) are aware of any significant deficiencies in internal control that come to the auditor's attention.

Choice "b" is incorrect. An understanding between the auditor and the client generally would not include the auditor's responsibility for determining preliminary judgments about materiality and audit risk factors, as an understanding generally is not obtained with respect to audit procedures or specific audit assessments.

Choice "c" is incorrect. Management is not responsible for identifying mitigating factors when the auditor has doubt about the entity's ability to continue as a going concern. The auditor, however, would look for and evaluate mitigating factors to determine if such factors alleviate doubt about the entity's ability to continue as a going concern.

Choice "d" is incorrect. Management is not responsible for providing the auditor with an assessment of the risk of material misstatement due to fraud. The auditor, however, is responsible for making such an assessment.

22

Which of the following statements most likely would be included in an engagement letter from an auditor to a client?

a.

The CPA firm will provide absolute assurance about whether the financial statements are free of material misstatement.

b.

The CPA firm will adjust the financial statements to correct misstatements before issuing a report.

c.

The CPA firm is responsible for ensuring that the client complies with applicable laws.

d.

The CPA firm will involve information technology specialists in the performance of the audit.

Choice "d" is correct. The auditor's understanding with the client often includes discussion of any specialists who will be involved in the engagement.

Choice "a" is incorrect. An audit should be planned and performed to obtain reasonable assurance about whether the financial statements are free of material misstatement. Absolute assurance is not provided.

Choice "c" is incorrect. The client is responsible for ensuring compliance with applicable laws, not the auditor.

Choice "b" is incorrect. The auditor may suggest correcting or adjusting entries, but it is the client who is responsible for actually making any adjustments to the financial statements.

23

A successor auditor's inquiries of the predecessor auditor should include questions regarding:

a.

The predecessor's knowledge of accounting matters of continuing significance.

b.

The predecessor's evaluation of audit risk and judgment about materiality.

c.

The predecessor's understanding as to the reasons for the change in auditors.

d.

Subsequent events that occurred since the predecessor's audit report was issued.

Choice "c" is correct. A successor auditor's inquiries of the predecessor auditor should include questions regarding the predecessor's understanding as to the reasons for the change in auditors.

Choice "b" is incorrect. The successor auditor may not rely on the predecessor's evaluation of audit risk and judgment about materiality, but rather must form his/her own judgments.

Choice "d" is incorrect. The predecessor auditor would not necessarily be aware of subsequent events that occurred since the predecessor's audit report was issued.

Choice "a" is incorrect. The successor auditor generally would not inquire about the predecessor's knowledge of matters of continuing accounting and auditing significance. The successor will, however, review the predecessor's audit documentation related to such matters.

24

Which of the following circumstances would permit an independent auditor to accept an engagement after the close of the fiscal year?

a.

Issuance of a disclaimer of opinion as a result of inability to conduct certain tests required by generally accepted auditing standards due to the timing of acceptance of the engagement.

b.

Assessment of control risk below the maximum level.

c.

Receipt of an assertion from the preceding auditor that the entity will be able to continue as a going concern.

d.

Remedy of limitations resulting from accepting the engagement after the close of the end of the year, such as those relating to the existence of physical inventory.

Choice "d" is correct. An independent auditor may accept an engagement after the close of the fiscal year as long as he or she can address any limitations resulting from accepting the engagement at that time. For example, the auditor may not be able to observe the ending inventory count, but may be able to perform acceptable alternative procedures sufficient to support the year-end inventory balance.

Choice "a" is incorrect. Although the auditor may need to issue a disclaimer of opinion on one or a few financial statements if certain audit tests cannot be conducted, it would not make sense for the auditor to accept an audit engagement, the goal of which is to render an opinion, if an overall disclaimer were going to be issued. 

Choice "b" is incorrect. The assessment of control risk is irrelevant to the auditor's decision as to whether or not to accept an engagement after the close of the fiscal year.

Choice "c" is incorrect. The auditor should not rely on the preceding auditor's assessment in determining whether or not to accept an engagement after the close of the fiscal year.

25

A successor auditor should request the new client to authorize the predecessor auditor to allow a review of the predecessor's:

~Engagement letter
~Working papers
a.

No

No

b.

No

Yes

c.

Yes

No

d.

Yes

Yes

Choice "b" is correct. It is not appropriate for the auditor to request a review of the predecessor auditor's engagement letter. This is a business matter between the client and the predecessor auditor that has no impact on the current period audit. Conversely, review of the predecessor auditor's working papers (audit documentation) is appropriate and customary to facilitate the auditor's audit.

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

26

Which of the following is not a required part of the understanding between the client and the auditor?

a.

Management's responsibility to correct deficiencies in internal control identified by the auditor.

b.

Management's responsibility to adjust the financial statements if the auditor identifies material misstatements.

c.

The auditor's responsibility to obtain reasonable assurance about whether the financial statements are free of material misstatement caused by unintentional error.

d.

The auditor's responsibility to obtain reasonable assurance about whether the financial statements are free of material misstatement caused by deliberate fraud.

Choice "a" is correct. Management may choose not to correct internal control deficiencies due to cost-benefit considerations, and this is not part of the understanding between the auditor and the client.

Choice "b" is incorrect. The understanding should include management's responsibilities, one of which is to adjust the financial statements to correct material misstatements identified by the auditor.

Choices "d" and "c" are incorrect. The understanding should include the auditor's responsibilities, one of which is to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether caused by error or fraud.

27

Which of the following is required before accepting a new audit engagement?

I.

Making inquiries of the predecessor auditor regarding management integrity.

II.

Making inquiries of the predecessor auditor regarding matters that may affect the conduct of the audit.

III.

Understanding the prospective client's business and the industry in which it operates.

a.

I, II, and III.

b.

Only II and III.

c.

I only.

d.

Only I and III.

Choice "c" is correct. Before accepting a new audit engagement, the auditor is required to make inquiries of the predecessor auditor regarding matters that may bear on management integrity. Making inquiries of the predecessor auditor regarding matters that may affect the conduct of the audit and developing an understanding of the prospective client's business and industry are tasks which may be performed after acceptance of the engagement.

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

28

Which of the following conditions most likely would pose the greatest risk in accepting a new audit engagement?

a.

There will be a client-imposed scope limitation.

b.

Staff will need to be rescheduled to cover this new client.

c.

The client's financial reporting system has been in place for 10 years.

d.

The firm will have to hire a specialist in one audit area.


Explanation

Choice "a" is correct. A client-imposed scope limitation indicates that the client might be hiding errors or irregularities that could result in a material misstatement of the financial statements.

Choice "b" is incorrect. Rescheduling staff in response to acceptance of a new audit engagement is a normal activity for CPA firms and does not impact audit risk.

Choice "d" is incorrect. The hiring of a specialist generally decreases risk. 

Choice "c" is incorrect. The fact that the client's financial reporting system has been in place for 10 years might be indicative that system's errors have been resolved and that the system has integrity.

29

An auditor's engagement letter most likely would include a statement that:

a.

Lists potential significant deficiencies discovered during the prior year's audit.

b.

Explains the analytical procedures that the auditor expects to apply.

c.

Limits the auditor's responsibility to detect errors and fraud.

d.

Describes the auditor's responsibility to evaluate going concern issues.

Choice "c" is correct. An auditor's engagement letter typically includes discussion of limitations of the engagement, such as the fact that the auditor will obtain only reasonable assurance, and therefore a material misstatement may remain undetected.

Choice "a" is incorrect. An auditor's engagement letter typically covers the objectives of the engagement, management's responsibilities, the auditor's responsibilities, limitations of the engagement, and other matters involving the conduct of the audit. Potential significant deficiencies discovered during the prior year's audit would not typically be included in the engagement letter.

Choice "b" is incorrect. While the auditor's engagement letter might include a discussion of the overall audit strategy, it typically would not include specific audit procedures. 

Choice "d" is incorrect. While the auditor's engagement letter might include a discussion of the auditor's responsibilities, this is usually discussed in fairly general terms. An engagement letter would not describe the auditor's responsibility with respect to specific issues (such as going concern issues).

30

Before accepting an engagement to audit a new client, a CPA is required to obtain:

a.

The prospective client's signature to a written engagement letter.

b.

The prospective client's consent to make inquiries of the predecessor.

c.

An understanding of the prospective client's industry and business.

d.

An assessment of fraud risk factors likely to cause material misstatements.

Choice "b" is correct. In a new client relationship, it is mandatory to make inquiries of the predecessor auditor. Client permission is needed, however. If the client is unwilling to agree to this procedure, the auditor should consider the implications and decide whether to accept the engagement.

Choice "d" is incorrect. An assessment of fraud risk factors is not required prior to accepting a new client.

Choice "c" is incorrect. An understanding of the client's business would be gained during the planning phase of the audit.

Choice "a" is incorrect. The prospective client's signature to a written engagement letter would be obtained upon the acceptance of an engagement, not prior to the acceptance.

31

The understanding with the client regarding a financial statement audit generally includes which of the following matters?

a.

The preliminary judgment about materiality.

b.

The expected opinion to be issued.

c.

The contingency fee structure.

d.

The responsibilities of the auditor.

Choice "d" is correct. The understanding with the client includes an understanding of both the responsibilities of the audit firm pertaining to the financial statement audit as well as the responsibilities of the entity's management. This understanding is documented in the engagement letter.

Choice "b" is incorrect. The auditor should not provide the client with an expected audit opinion prior to or during a financial statement audit.

Choice "c" is incorrect. Contingent fees are prohibited when performing financial statement audits and would not be part of any discussion with the client.

Choice "a" is incorrect. When developing an audit strategy, the auditor will make a preliminary assessment of materiality using his or her professional judgment. This is part of the planning process and is not included in the understanding with the client.

32

Which of the following would a successor auditor ask the predecessor auditor to provide after accepting an audit engagement?

a.

Facts known to the predecessor auditor that might bear on the integrity of management.

b.

Disagreements between the predecessor auditor and management as to significant accounting policies and principles.

c.

Matters that may facilitate the evaluation of financial reporting consistency between the current and prior years.

d.

The predecessor auditor's understanding of the reasons for the change of auditors.

Choice "c" is correct. Matters that may facilitate the evaluation of financial reporting consistency between the current and prior years should be discussed after accepting an audit engagement.

Choice "b" is incorrect. Disagreements between the predecessor auditor and management as to significant accounting policies and principles should be discussed prior to accepting an audit engagement.

Choice "d" is incorrect. The predecessor auditor's understanding of the reasons for the change of auditors should be discussed prior to accepting an audit engagement.

Choice "a" is incorrect. Information regarding the integrity of management should be discussed prior to accepting an audit engagement.

33

Which of the following is correct regarding the communication between successor and predecessor auditors?

a.

The successor and predecessor auditors should communicate with each other in writing regarding potential problems.

b.

The successor auditor should request permission from the prospective client to make an inquiry of the predecessor auditor.

c.

The successor auditor should contact the predecessor auditor prior to proposing an audit engagement.

d.

The client should be present during the communications between the predecessor auditor and the successor auditor.

Choice "b" is correct. The successor auditor should request permission from the prospective client to make an inquiry of the predecessor auditor.

Choice "a" is incorrect. The successor and predecessor auditors may communicate with each other in any appropriate manner, such as oral or written, regarding potential problems.

Choice "c" is incorrect. The successor auditor does not need to contact the predecessor auditor prior to proposing an audit engagement. However, the auditor does need to contact the predecessor auditor before the auditor accepts the engagement.

Choice "d" is incorrect. The client does not need to be present during the communications between the predecessor auditor and the successor auditor.