Assessment Questions

Question 1

An accountant may accept an engagement to apply agreed-upon procedures to prospective financial statements provided that:

use of the report is restricted to the specified users.

the prospective financial statements are also examined.

responsibility for the adequacy of the procedures performed is taken by the accountant.

negative assurance is expressed on the prospective financial statements taken as a whole.

Answer 1

use of the report is restricted to the specified users.

Explanation:

The standard of reporting for attestation engagements states the report on an engagement to apply agreed-upon procedures should contain a statement limiting its use to the parties who have agreed upon such procedures. This is true regardless of the type of financial information being tested, be it historical or prospective.

This is also true when an accountant is engaged to apply any agreed-upon procedures to any financial information: distribution of report is restricted to the specified users.

In such an engagement the responsibility for the adequacy of the agreed-upon procedures performed is taken by the specified users. (In other words, the accountant is performing only those procedures that the user requests, not the procedures the auditor considers necessary.) Because agreed-upon procedures are not the equivalent of an examination, the accountant expresses no assurance on the prospective financial statements taken as a whole.

Question 2

An auditor concludes, prior to the audit report release date, that there is a material inconsistency in the other information in an annual report to shareholders containing audited financial statements. If the auditor concludes that the financial statements do not require revision, but the client refuses to revise the other information to eliminate the inconsistency, the auditor should communicate the matter to those charged with governance and may:

revise the auditor’s report to include an other-matter paragraph describing the material inconsistency.

issue a qualified opinion after discussing the matter with the client’s board of directors.

consider the matter closed, because the other information is not in the audited financial statements.

disclaim an opinion on the financial statements.

Answer 2

revise the auditor’s report to include an other-matter paragraph describing the material inconsistency.

Explanation:

If the auditor discovers a material inconsistency in other information accompanying the audited financial statements, the financial statements do not require revision, and the client refuses to eliminate or revise the inconsistency, the auditor should consider (1) revising the report to include a separate paragraph describing the inconsistency, (2) withholding the report, or (3) withdrawing from the engagement.

A qualified opinion is generally not warranted because the financial statements are fairly stated. Even though the auditor has no responsibility to audit or otherwise corroborate other information accompanying the financial statements, the auditor has a responsibility to read the other information accompanying the financial statements for consistency and to identify any material misstatements of fact included therein. A disclaimer of opinion is generally not warranted because there is no scope limitation.

Question 3

Which of the following procedures would a CPA most likely perform when reviewing the financial statements of a nonissuer?

Verify that the accounting estimates that could be material to the financial statements have been developed

Obtain an understanding of the entity’s internal control components

Assess the entity’s ability to continue as a going concern for a reasonable period of time

Make inquiries about actions taken at the board of directors meetings

Answer 3

Make inquiries about actions taken at the board of directors meetings.

Explanation:

AR-C 90.22 lists recommended inquiries that the accountant should consider making when conducting a review of financial statements. The accountant should inquire about “actions taken at meetings of stockholders, board of directors, committees of the board of directors, or comparable meetings that may affect the financial statements.”

Remember that a review is less in scope than an audit. A review does not contemplate an understanding of the entity’s internal control or utilize the concept of materiality. The accountant uses inquiry and analytical procedures when performing a review.

Question 4

Which of the following is an audit procedure that an auditor most likely would perform concerning litigation, claims, and assessments?

Request that the client’s lawyer evaluate whether the client’s pending litigation, claims, and assessments indicate a going concern problem

Examine the legal documents in the client’s lawyer’s possession concerning litigation, claims, and assessments to which the lawyer has devoted substantive attention

Discuss with management its policies and procedures adopted for evaluating and accounting for litigation, claims, and assessments

Confirm directly with the client’s lawyer that all litigation, claims, and assessments have been recorded or disclosed in the financial statements

Answer 4

Discuss with management its policies and procedures adopted for evaluating and accounting for litigation, claims, and assessments

Explanation:

“Management is responsible for adopting policies and procedures to identify, evaluate, and account for litigation, claims, and assessments as a basis for the preparation of financial statements, in accordance with the requirements of the applicable financial reporting framework” (AU-C 501.A41).

Therefore, the audit procedure that an auditor most likely would perform concerning litigation, claims, and assessments would be to discuss with management its policies and procedures adopted for evaluating and accounting for litigation, claims, and assessments.

Although a letter of inquiry to the client’s lawyer is a primary means of obtaining corroborating evidence of litigation, claims, and assessments, the letter only asks the lawyer to evaluate the outcome and estimated range of potential loss of the asserted and unasserted claims as listed by management and to state whether there are any others management should list.

The attorney is not asked if these claims represent a going concern problem, if they are recorded or disclosed in the financial statements, or if the auditor may examine the documents in the lawyer’s possession.

Question 5

Which of the following matters is an auditor required to communicate to an entity’s audit committee?

Adjustments that were suggested by the auditor and recorded by management that have a significant effect on the entity’s financial reporting process

The auditor’s consideration of risk factors in assessing the risk of material misstatement arising from the misappropriation of assets

The results of the auditor’s analytical procedures performed in the review stage of the engagement that indicate significant variances from expected amounts

Changes in the auditor’s preliminary judgment about materiality that were caused by projecting the results of statistical sampling for tests of transactions

Answer 5

Adjustments that were suggested by the auditor and recorded by management that have a significant effect on the entity’s financial reporting process

Explanation:

The auditor should communicate with those charged with governance (the audit committee):

• the auditor’s responsibilities under generally accepted auditing standards,
• an overview of the planned scope and timing of the audit,
• and significant findings from the audit.

The significant findings from the audit that should be communicated include:

• the auditor’s view about qualitative aspects of the entity’s significant accounting practices,
• significant difficulties encountered during the audit,
• uncorrected misstatements (that are not trivial),
• disagreements with management,
• other findings or issues that the auditor believes to be significant or relevant to the audit committee’s oversight of the financial reporting process,
• material, corrected misstatements that were brought to the attention of management as a result of audit procedures,
• representations the auditor is requesting from management,
• management’s consultations with other accountants about accounting and auditing matters, and
• significant issues arising from the audit that were discussed with management.

Accordingly, the correct answer choice is, “Adjustments that were suggested by the auditor and recorded by management that have a significant effect on the entity’s financial reporting process.”

Question 6

Which of the following statements most likely represents a disadvantage for an entity that keeps microcomputer-prepared data files rather than manually prepared files?

Attention is focused on the accuracy of the programming process rather than errors in individual transactions.

It is usually easier for unauthorized persons to access and alter the files.

Random error associated with processing similar transactions in different ways is usually greater.

It is usually more difficult to compare recorded accountability with physical count of

Answer 6

It is usually easier for unauthorized persons to access and alter the files.

Explanation:

Since there is a risk that unauthorized persons can access and alter microcomputer data files, both physical and logical access controls are required. Manually prepared files only need to be physically secured to prevent unauthorized access.

Errors can occur in both programming and individual transactions. The use of a microcomputer can decrease the random errors associated with processing similar transactions in different ways.

Microcomputer recorded transactions can be easily downloaded and compared with a physical count of assets.

Question 7

An auditor uses the assessed level of control risk to:

evaluate the effectiveness of the entity’s internal control.

identify transactions and account balances where inherent risk is at the maximum.

indicate whether materiality thresholds for planning and evaluation purposes are sufficiently high.

determine the acceptable level of detection risk for financial statement assertions.

Answer 7

determine the acceptable level of detection risk for financial statement assertions.

Explanation:

The acceptable level of detection risk for financial statement assertions is determined using the auditor’s assessed level of control risk (along with the assessed level of inherent risk).

Detection risk level is determined in order to plan substantive testing which would detect a material misstatement in a financial statement assertion.

Control risk describes the risk that an entity’s internal control will not prevent or detect a material misstatement in a financial statement assertion.

Tests of controls are used to evaluate the effectiveness of the entity’s internal control activities in place.

An auditor should plan and evaluate an audit (including materiality thresholds) so that audit risk is limited to a low level.

Question 8

In accordance with AU-C 240, Consideration of Fraud in a Financial Statement Audit, an auditor is mainly concerned with two types of fraud: (1) fraudulent financial reporting and (2) misappropriation of assets. These two types of fraud differ in that fraudulent financial reporting is usually committed by:

management.

employees.

both management and employees.

neither management nor employees.

Answer 8

management.

Explanation:

Fraudulent financial reporting is usually committed by management to deceive financial statement users.

Employees are most often involved in fraudulent activities related to misappropriation of assets.

Question 9

If not already performed during the overall review stage of the audit, the auditor should perform analytical procedures relating to which of the following transaction cycles?

Payroll

Revenue

Purchasing

Inventory

Answer 9

Revenue

Explanation:

Analytical procedures are comparisons between the client’s amounts or ratios and the expected amounts or ratios.

Analytical procedures should be performed on the revenue cycle as there is a greater risk of fraud in this cycle.

Question 10

The introductory 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:

indicate a division of responsibility.

assume responsibility for the other auditor.

require a departure from an unmodified opinion.

are an improper form of reporting.

Answer 10

indicate a division of responsibility.

Explanation:

Reference to another auditor’s report reflects division of responsibility and is not a qualification of opinion. It is disclosed in the introductory paragraph and referred to in the opinion paragraph as follows:

“We did not audit the financial statements of B Company, a consolidated subsidiary, which statements reflect total assets and revenues constituting 20 percent and 22 percent, respectively, of the related consolidated totals. These 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 B Company, is based solely upon the report of the other auditors.

“We believe that our audit and the report of the other auditors provide a reasonable basis for our opinion.”

Question 11

As part of the process of observing a client’s physical inventories, an auditor should be alert to:

the inclusion of any obsolete or damaged goods.

any change in the method of pricing from prior years.

the existence of outstanding purchase commitments.

the verification of inventory values assigned to goods in process.

Answer 11

the inclusion of any obsolete or damaged goods.

Observing the physical inventory is an audit procedure that provides evidence of the existence assertion (inventories included in the balance sheet physically exist) and completeness assertion (inventory quantities include all products, materials, and supplies on hand).

As part of the observation, the auditor will be walking through the plant or warehouse and will actually see the inventory. If any items are set aside or obviously damaged, the auditor can inquire about whether the items are defective or obsolete. These items should be identified and properly valued in ending inventory on the balance sheet.

Determining pricing method changes, the existence of outstanding purchase commitments, or the values of inventory assigned to goods in process would be accomplished through inquiry and inspection, rather than observation.

Question 12

During an audit, an auditor discovers a fraudulent expense reimbursement for a low-level manager. The auditor determines that this transaction is inconsequential and several similar transactions would not be material to the financial statements in the aggregate. Which of the following statements best describes the auditor’s required response to the discovery?

The auditor should fully investigate other transactions related to this manager to determine if fraud exists.

The auditor should bring the transaction to the attention of an appropriate level of management.

The auditor should report this finding to those charged with governance.

The auditor’s responsibility is satisfied by documenting that the single transaction is inconsequential.

Answer 12

The auditor should bring the transaction to the attention of an appropriate level of management.

Explanation:

The auditor should communicate, in writing or orally, only to management other deficiencies in internal control identified during the audit that have not been communicated previously, including control deficiencies that are not significant either individually or in the aggregate.

The auditor should not issue a written communication stating that no significant deficiencies were identified during the audit because of the potential for misinterpretation of the limited degree of assurance provided by such a communication.

Question 13

An auditor would most likely be concerned with which of the following controls in a distributed data processing system?

Hardware controls

Systems documentation controls

Access controls

Disaster recovery controls

Answer 13

Access controls

Explanation:

IT poses many specific risks to an entity’s internal control, including the following:

• Reliance on systems or programs that are inaccurately processing data, processing inaccurate data, or both
• Unauthorized access to data that may result in destruction of data or improper changes to data
• The possibility of IT personnel gaining access privileges beyond those necessary to perform their assigned duties
• Unauthorized changes to data in master files
• Unauthorized changes to systems or programs
• Failure to make necessary changes to systems or programs
• Potential loss of data or inability to access data as required

Of the answer choices given, only access controls pose specific risks to the internal controls of an entity. Thus, the auditor would be more concerned with those controls.

Question 14

An auditor’s decision either to apply analytical procedures as substantive tests or to perform tests of transactions and account balances usually is determined by the:

availability of data aggregated at a high level.

relative effectiveness and efficiency of the tests.

timing of tests performed after the balance sheet date.

auditor’s familiarity with industry trends.

Answer 14

relative effectiveness and efficiency of the tests.

Explanation:

In discussing analytical procedures, AU-C 520.A7 notes that the choice of analytical procedures as a substantive test, when compared to the use of the tests of details of transactions and amount balances, depends “on the auditor’s professional judgment about the expected effectiveness and efficiency of the available audit procedures.”

Question 15

If specific information comes to an auditor’s attention that implies the existence of possible noncompliance under applicable law or regulations that could have a material, but indirect, effect on the financial statements, the auditor should next:

apply audit procedures specifically directed to ascertaining whether noncompliance under applicable law or regulations has occurred.

seek the advice of an informed expert qualified to practice law as to possible contingent liabilities.

report the matter to an appropriate level of management at least one level above those involved.

discuss the evidence with the client’s audit committee or others with equivalent authority and responsibility.

Answer 15

apply audit procedures specifically directed to ascertaining whether noncompliance under applicable law or regulations has occurred.

Explanation:

If the auditor has specific information that implies the existence of possible noncompliance under applicable law or regulations that could materially affect the financial statements, the auditor should apply audit procedures specifically directed to ascertaining whether noncompliance under applicable law or regulations has occurred.

Question 16

Which of the following procedures would an auditor most likely use to identify unusual year-end transactions?

Obtaining a client representation letter

Obtaining a legal inquiry letter

Performing analytical procedures

Testing arithmetic accuracy of the accounting records

Answer 16

Performing analytical procedures

Explanation:

During the course of an audit, an auditor should search for business transactions that are outside the normal course of business for the entity, particularly at or near year-end. Performing analytical procedures will assist the auditor in identifying those transactions.

Analytical procedures consist of evaluations of financial information made by a study of plausible relationships among both financial and nonfinancial data.

Analytical procedures may indicate a previously unrecognized risk of material misstatement due to fraud. When these procedures identify an unusual or unexpected relationship that may indicate the potential for fraud, the auditor should use judgment in deciding on the extent of any additional procedures to be performed.

Written representations from management are not a substitute for audit procedures necessary to afford a reasonable basis for an opinion on the financial statements under audit.

A letter of inquiry addressed to the client’s lawyer generally corroborates evidence of litigation, claims, and assessments; it is not the best method to identify unusual year-end transactions. Testing for accuracy will not identify unusual transactions.

Question 17

Which of the following is a conceptual similarity between generally accepted auditing standards and the attestation standards?

Both sets of standards require the CPA to report on the adequacy of disclosure in the financial statements.

All of the generally accepted auditing standards are included in the attestation standards.

The requirement that the CPA be independent in mental attitude is included in both sets of standards.

Both sets of standards are applicable to engagements regarding financial forecasts and projections.

Answer 17

The requirement that the CPA be independent in mental attitude is included in both sets of standards.

Explanation:

Both an audit and an attest engagement require that the auditor be independent in mental attitude.

An attest engagement involves a report on a subject matter, or an assertion about the subject matter, that is the responsibility of another party.

An attest engagement does not necessarily involve financial statements; the subject matter could include the price of a market basket of goods on a certain date, a breakeven analysis, internal control, or human resources practices.

Due to this diversity in types of engagements, the attestation standards do not require the CPA to report on the adequacy of disclosure in the financial statements.

The preparation of prospective financial statements (financial forecasts and projections) is covered under the Statements on Standards for Accounting and Review Services (SSARS).

The standards for attest engagements do not contain any mention of obtaining a sufficient understanding of the entity and its environment, including its internal control. This requirement does, however, appear in generally accepted auditing standards (GAAS).

Question 18

At least how often should the PCAOB inspect a registered public accounting firm that regularly issues audit reports to 50 issuers?

Annually

Every two years

Every three years

As requested by the firm

Answer 18

Every three years

Explanation:

The Public Company Accounting Oversight Board (PCAOB) is a nonprofit corporation established by the Sarbanes-Oxley Act of 2002 (SOX).

The purpose of the PCAOB is to oversee the audits of issuers (public companies) that are subject to the securities laws in order to protect the interests of investors and further the public interest in the preparation of informative, accurate, and independent audit reports.

One of the PCAOB’s duties is to conduct compliance inspections of registered public accounting firms to assess compliance with the Sarbanes-Oxley Act, the rules of the PCAOB, the rules of the Securities and Exchange Commission, and professional standards in connection with the firm’s performance of audits, issuance of audit reports, and related matters involving U.S. companies, other issuers, brokers, and dealers.

Firms that audit more than 100 issuers are inspected annually, and firms that audit 100 or fewer issuers (for example, 50 issuers) are inspected every three years.

Question 19

Which of the following presumptions does not relate to the appropriateness of audit evidence?

The more effective the internal control, the more assurance it provides about the accounting data and financial statements.

An auditor’s opinion, to be economically useful, is formed within a reasonable time and based on evidence obtained at a reasonable cost.

Evidence obtained from independent sources outside the entity is more reliable than evidence secured solely within the entity.

The independent auditor’s direct personal knowledge, obtained through observation and inspection, is more persuasive than information obtained indirectly.

Answer 19

An auditor’s opinion, to be economically useful, is formed within a reasonable time and based on evidence obtained at a reasonable cost.

Explanation:

Appropriate audit evidence is valid and relevant. The validity of evidence increases when it is produced by effective internal control or obtained from independent external sources and the independent auditor’s direct personal knowledge.

The fact that to be economically useful, the auditor’s opinion must be timely and based on evidence obtained at a reasonable cost relates to the sufficiency of evidence.

Question 20

Which of the following procedures would an accountant least likely perform during an engagement to review the financial statements of a nonpublic entity?

Observing the safeguards over access to and use of assets and records

Comparing the financial statements with anticipated results in budgets and forecasts

Inquiring of management about actions taken at the board of directors’ meetings

Studying the relationships of financial statement elements expected to conform to predictable patterns

Answer 20

Observing the safeguards over access to and use of assets and records

Explanation:

A review of financial statements of a nonpublic entity is considerably smaller in scope than an audit. The accountant performing a review obtains a reasonable basis for expressing limited assurance that there are no modifications that should be made to the financial statements for the statements to be in conformity with GAAP. Review procedures are limited to:

• analytical procedures, such as:
  
  • comparing the financial
    statements with anticipated results in
    budgets and forecasts, or
  • studying the relationship of financial
    statement elements expected to
    conform to predictable patterns.
• inquiry, such as inquiring of
  management about actions taken at the
  board of directors’ meetings.

The review specifically relieves the accountant from obtaining an understanding of the entity’s internal control, including the safeguards over access to and use of assets and records.

Question 21

In obtaining an understanding of an entity’s internal control that is relevant to audit planning, an auditor is required to obtain knowledge about the:

design of controls relevant to an audit of financial statements.

effectiveness of controls that have been placed in operation.

consistency with which controls are currently being applied.

control procedures related to each principal transaction class and account balance.

Answer 21

design of controls relevant to an audit of financial statements.

In all audits, the auditor should obtain an understanding of each of the five components of internal control sufficient to assess the risks of material misstatement of the financial statements and to design and perform further audit procedures.

The auditor must perform procedures to understand the design of controls relevant to an audit of financial statements, and whether they have been placed in operation.

Whether a control has been placed in operation is different from its operating effectiveness.

In obtaining knowledge about whether controls have been placed in operation, the auditor determines that the entity is using them.

Operating effectiveness, on the other hand, is concerned with how the control was applied, the consistency with which it was applied, and by whom it was applied.

Question 22

Which of the following procedures would an auditor most likely perform in obtaining evidence about subsequent events?

Examine a sample of transactions that occurred since the year-end to verify the effectiveness of computer controls.

Inquire of management whether there have been significant changes in working capital since the year-end.

Recompute depreciation charges for plant assets sold for substantial gains since the year-end.

Reperform the tests of controls that indicated significant deficiencies in the operation of internal control.

Answer 22

Inquire of management whether there have been significant changes in working capital since the year-end.

Explanation:

Subsequent events are circumstances or events that occur after the balance sheet date, but before the dating of the auditor’s report, that materially affect the financial statements.

Some subsequent events may require an adjustment to the financial statements, while some may require only disclosure in order for the financial statements to not be misleading.

The auditor is required to perform audit procedures to discover if any subsequent events may exist. These procedures do not entail examining the effectiveness of or retesting internal controls. The auditor would not need to recompute depreciation charges. The auditor would:

• closely examine cutoff procedures;
• look at changes in assets and liabilities since the balance sheet date;
• read any interim financial statements;
• inquire of officers regarding:
  
  • substantial contingent liabilities,
  • significant changes in capital stock,
    long-term debt, or working capital
    from the balance sheet date to the
    date of inquiry,
  • any changes in reported items that
    were based on preliminary data, and
  • any unusual adjustments since the
    balance sheet date;
• read minutes of board or stockholders’
  meetings;
• observe events in the subsequent
  period and scan the records for unusual
  transactions;
• extend the legal counsel inquiry to the
  date of the financial statements; and
• ask management to include specific
  mention of subsequent events in the
  representation letter (dated no earlier
  than the auditor’s report date).

Question 23

The usefulness of the standard bank confirmation request may be limited because the bank employee who completes the form may:

not believe that the bank is obligated to verify confidential information to a third party.

sign and return the form without inspecting the accuracy of the client’s bank reconciliation.

not have access to the client’s cutoff bank statement.

be unaware of all the financial relationships that the bank has with the client.

Answer 23

be unaware of all the financial relationships that the bank has with the client.

Explanation:

Bank relationships may be complex and can involve various types of collateral, compensating balances, and other arrangements. Very often confirmation requests are simply completed at the clerical level.

This level of employee may only have access to a specific balance amount with no supporting explanation. Because of this, the bank employee may be unaware of all the financial relationships that the bank has with the client, thereby limiting the usefulness of the standard bank confirmation request.

Question 24

Internal control consists of five interrelated components, which include all of the following except:

control environment.

risk assessment.

monitoring.

materiality.

Answer 24

materiality.

Explanation:

AU-C 315.A57 states that internal controls consist of five interrelated components:

1. The control environment sets the tone
   of the organization.
2. The entity’s risk assessment process is
   the entity’s identification and analysis
   of relevant risks to achievement of its
   objectives.
3. Information and communication
   systems support the identification,
   capture, and exchange of information in
   a form and time frame that enable
   people to carry out their responsibility.
4. Control activities are the policies and
   procedures that help ensure that
   management directives are carried out.
5. Monitoring is a process that assesses
   the quality of internal control
   performance over time.

Materiality is an important component of assessing risk but is not a component of an entity’s internal control.

Question 25

Title IV of the Sarbanes-Oxley Act of 2002 requires which of the following?

That financial statements reflect all material correcting adjustments identified by the registered public accounting firm

That financial statements reflect all material off-balance sheet transactions, arrangements, obligations, and other relationships

That pro forma information, if included, does not contain any untrue statements or omission of material facts

All of the answer choices are correct.

Answer 25

All of the answer choices are correct.

Explanation:

Title IV of Sarbanes-Oxley requires that the financial statements reflect all material correcting adjustments, material off-balance-sheet transactions, arrangements, obligations, and other relationships, and that pro forma information, if included, does not contain untrue statements or omissions of material facts.

Question 26

Reporting standards for financial audits under Government Auditing Standards (the “Yellow Book”) differ from reporting under generally accepted auditing standards in that Government Auditing Standards require the auditor to:

provide positive assurance that control activities regarding segregation of duties are consistent with the entity’s control objectives.

present the results of the auditor’s tests of controls.

provide negative assurance that the auditor discovered no evidence of intentional override of internal controls.

describe the scope of the auditor’s principal substantive tests.

Answer 26

present the results of the auditor’s tests of controls.

Question 27

During an audit of the financial statements of a company, the CFO provides a spreadsheet to the audit team that contains a number of errors that are material to the financial statements. Under what circumstances would this situation be a violation of the rules of the Sarbanes-Oxley Act of 2002 on improper influence on the conduct of audits?

The CFO discovers and corrects most of the errors in the spreadsheet, which was prepared by a staff accountant. One immaterial error remains of which the CFO is aware, and this error remains undetected by the audit team, but the financial statements end up being fairly presented.

The audit team discovers the errors through alternate procedures when they discern that the spreadsheet was improperly manipulated by the CFO. This intentional conduct of the CFO does not succeed in affecting the audit.

The CFO had the spreadsheet prepared by a vendor of the company; the vendor intentionally misstates information in the spreadsheet, and the CFO does not discover the misstatements. The errors remain undetected by the audit team, and the financial statements are materially misleading.

The CFO was unaware of the errors in the spreadsheet, which was prepared by a staff accountant and reviewed by the CFO. The errors remain undetected by the audit team, and the financial statements are materially misleading.

Answer 27

The audit team discovers the errors through alternate procedures when they discern that the spreadsheet was improperly manipulated by the CFO. This intentional conduct of the CFO does not succeed in affecting the audit.

Explanation:

It is prohibited for any issuer’s officer or director to take any action to fraudulently influence, coerce, manipulate, or mislead any independent public or certified accountant engaged in the performance of an audit of the financial statements of that issuer for the purpose of rendering such financial statements materially misleading.

Question 28

Which of the following actions by a CPA most likely violates the profession’s ethical standards?

Using a records-retention agency to store confidential client records

Retaining client records after the client has demanded their return

Arranging with a financial institution to collect notes issued by a client in payment of fees due

Compiling the financial statements of a client that employed the CPA’s spouse as a bookkeeper

Answer 28

Retaining client records after the client has demanded their return.

Explanation:

The ethical standards clearly state that the client records should be returned to the client upon request from the client.

The only reason a client record may be withheld is if the engagement has not been completed.

While AICPA rules allow holding records when an audit or other service has not been paid up by the client, some state laws prohibit this practice.

Question 29

In an engagement to review the financial statements of a nonissuer, the accountant most likely would perform which of the following procedures?

Physical inspection of inventory

Vouching of inventory purchase transactions

Analysis of inventory turnover

Evaluation of internal control over inventory

Answer 29

Analysis of inventory turnover

A review does not involve obtaining an understanding of the entity’s internal control or testing accounting records through vouching or inspection. Each of these procedures would be performed in an audit in order to obtain sufficient, appropriate audit evidence to support the audit opinion.

A review, however, does involve analytical procedures and inquiry. An analysis of inventory turnover would be an analytical procedure.

Question 30

An auditor would least likely initiate a discussion with those charged with governance concerning:

the methods used to account for significant unusual transactions.

the maximum dollar amount of misstatements that could exist without causing the financial statements to be materially misstated.

indications of fraud committed by a corporate officer that were discovered by the auditor.

disagreements with management as to accounting principles that were resolved during the current year’s audit.

Answer 30

the maximum dollar amount of misstatements that could exist without causing the financial statements to be materially misstated.

Explanation:

A determination of the maximum dollar amount of misstatements that could exist without causing the financial statements to be materially misstated is not an issue likely to be discussed with those charged with governance.

AU-C 240.10–.11, .29 and AU-C 260.12

Question 31

Which of the following prospective financial statements is appropriate for general use?
Financial forecast
Financial projection

Both I and II

I only

II only

Neither I nor II

Answer 31

I only

Explanation:

Financial forecasts are prospective financial statements that present, to the best of the responsible party’s knowledge and belief, an entity’s expected financial position, results of operations, and cash flows. A financial forecast is based on the responsible party’s assumptions reflecting the conditions it expects to exist and the course of action it expects to take.

Financial projections are prospective financial statements that present, to the best of the responsible party’s knowledge and belief, given one or more hypothetical assumptions, an entity’s expected financial position, results of operations, and cash flows. A hypothetical assumption is one that is not necessarily expected to occur but that is consistent with the purpose of the projection. A financial projection can be prepared in response to the question, “What would happen if…?”

Only a financial forecast is appropriate for general use; it can be used by a third party with whom the responsible party is not negotiating directly. Because the recipients of prospective financial statements distributed for general use are unable to ask the responsible party directly about the presentation, the presentation most useful to them is one that portrays, to the best of the responsible party’s knowledge and belief, the expected results (not a hypothetical situation).

Either financial forecasts or financial projections are appropriate for limited use by the responsible party alone or by the responsible party and third parties with whom the responsible party is negotiating directly.

Question 32

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

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

Increased effort to search for evidence of management fraud

Performance of audit tests on a continual basis

Increased emphasis on the completeness assertion

Answer 32

Performance of audit tests on a continual basis

Explanation:

Audit tests must be performed on a continual basis throughout the year in an audit of an entity that processes most of its financial data in electronic form without any paper documentation.

Electronic evidence that exists at one point in time may not be available for review and testing after a specified period, making it impossible to test such transactions, for example, at year-end.

Management fraud may be more difficult to detect in a totally electronic system, but the SAS requirements regarding the testing and evaluation of internal controls remain the same as in a traditional setting.

It may be possible to test completeness of processing in an entity that processes most of its financial data in electronic form only at various times throughout the year.

Question 33

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:

increase current dividend distributions.

reduce existing lines of credit.

increase ownership equity.

purchase assets formerly leased.

Answer 33

increase ownership equity.

Explanation:

Management may try to improve the company’s financial position by increasing the ownership equity of the company. This would increase the assets of the company without increasing the liabilities.

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.

Information about conditions or events that raise a question about an entity’s ability to continue as a going concern is obtained from the application of auditing procedures planned and performed to achieve objectives in the financial statements being audited.

Once substantial doubt about an entity’s ability to continue as a going concern surfaces, the auditor should discuss the matter with management and consider management’s plans for dealing with the conditions and events identified. A primary concern of the auditor in assessing management’s plans is an evaluation of management’s ability to accomplish the plans for alleviating the adverse conditions identified.

The auditor’s consideration relating to management’s plans may include the following:

• Plans to dispose of assets
• Plans to borrow money or restructure debt
• Plans to reduce or delay expenditures
• Plans to increase ownership equity

Question 34

Before reissuing a compilation report on the financial statements of a nonissuer for the prior year, the predecessor accountant is required to:

obtain an updated management representation letter from the entity’s management.

compare the prior year’s financial statements with those of the current year.

review the successor accountant’s working papers for matters affecting the prior year.

make inquiries of the entity’s lawyers concerning continuing litigation.

Answer 34

compare the prior year’s financial statements with those of the current year.

Explanation:

Before reissuing a compilation report, the predecessor accountant should:

- read the financial statements of the 
  current period and the successor's 
  report,
- compare the prior year's financial 
  statements with those of the current 
  period, and 
- obtain a letter from the successor 
  accountant that indicates whether he is 
  aware of any matter that might have a 
  material effect on the financial 
  statements, including disclosures, 
  reported on by the predecessor.

It is not necessary to obtain any representations from management or corroborations from the client’s attorney.

It is also not necessary to view the successor accountant’s working papers.

Remember that this is a compilation engagement, not a review or an audit. The letter from the successor accountant will suffice to determine if any matters affect the prior year’s financial statements.

Question 35

An accountant performing a compilation for a nonissuer believes that the financial statements might be materially misstated. The client refuses to provide additional or revised information. How should the accountant respond?

By requesting that the engagement be changed from a compilation to a review or audit

By issuing a compilation report that is qualified for a scope limitation

By withdrawing from the compilation engagement

By issuing an adverse report on the compilation

Answer 35

By withdrawing from the compilation engagement

Explanation:

For a compilation engagement, the accountant may, but is not required to, make inquiries or perform other procedures to verify, corroborate, or review information supplied by the entity.

The results of such inquiries or procedures, knowledge gained from prior engagements, or the financial statements on their face may cause the accountant to become aware that information supplied by the entity is incorrect, incomplete, or otherwise unsatisfactory, or that fraud or an illegal act may have occurred.

Since the client refuses to provide additional or revised information for the misstated material, the accountant should discuss this with management and those charged with governance.

If they still refuse to provide the material, the accountant should withdraw from the compilation engagement.

Question 36

The purpose of tracing a sample of inventory tags to a client’s computerized listing of inventory items is to determine whether the inventory items:

represented by tags were included on the listing.

included on the listing were properly counted.

represented by tags were reduced to the lower of cost or market.

included in the listing were properly valued.

Answer 36

represented by tags were included on the listing.

Explanation:

The purpose of this test is to determine if all inventoried items represented by inventory tags were included in the inventory listing.
This is testing the completeness function of the inventory listing.

Question 37

An auditor’s inquiries of management disclosed that the entity recently invested in a series of energy derivatives to hedge against the risks associated with fluctuating oil prices. Under these circumstances, the auditor should:

perform analytical procedures to determine if the derivatives are properly valued.

examine the contracts for possible risk exposure and the need to recognize losses.

confirm the marketability of the derivatives with a commodity specialist.

document the derivatives in the auditor’s communication with the audit committee.

Answer 37

examine the contracts for possible risk exposure and the need to recognize losses

Explanation:

A derivative is a financial instrument or other contract that has one or more underlyings and one or more notional amounts or payment provisions or both; requires no initial net investment or an initial net investment that is smaller than would be required for other types of contracts that would be expected to have similar response to changes in market factors; and requires or permits net settlement, can readily be settled net by a means outside the contract, or provides for delivery of an asset that puts the recipient in a position not substantially different from net settlement. More information on this definition can be found in FASB ASC 815-10.

These financial contracts used to hedge exposure to changes in fair value or currency exposure can be complicated to understand. The auditor must approach management’s assertions about derivatives in the same manner as the other audit areas. The first step is to obtain an understanding of the economic substance of the derivatives. The auditor should examine the contracts for possible risk exposure and the need to recognize losses.

The auditor can then determine if outside, specialized assistance is needed to audit the derivatives (by discussing the marketability of the derivatives with a commodity specialist), assess the risk of material misstatement for the derivatives, and perform substantive tests (analytical procedures to determine if the derivatives are properly valued).

The auditor would not necessarily discuss the derivatives with the audit committee, unless the auditor made an audit adjustment to the accounts affected, the derivatives were the source of a disagreement between the auditor and management, or the derivatives were a source of difficulties encountered in performing the audit.

Question 38

An auditor’s letter issued on significant deficiencies relating to an entity’s internal control observed during a financial statement audit should:

include a brief description of the tests of controls performed in searching for significant deficiencies and material weaknesses.

indicate that the significant deficiencies should be disclosed in the annual report to the entity’s shareholders.

include a paragraph describing management’s assertion concerning the effectiveness of the internal control.

indicate that the audit’s purpose was to report on the financial statements and not to provide assurance on the internal control.

Answer 38

indicate that the audit’s purpose was to report on the financial statements and not to provide assurance on the internal control.

Explanation:

Any report accompanying the basic financial statements and the auditor’s standard report should state that the audit is made for the purpose of forming an opinion on the basic financial statements taken as a whole and not to provide assurance on internal control.

Question 39

Providing more supervision during an audit of a nonissuer in response to assessed risks of material misstatement at the financial statement level is an example of:

a substantive response.

further audit procedures.

tests of controls.

an overall response.

Answer 39

an overall response.

Explanation:

The auditor’s overall responses to address the assessed risks of material misstatement at the financial statement level may include the following:

-  Emphasizing to the audit team the need 
   to maintain professional skepticism in 
   gathering and evaluating audit 
   evidence
-  Assigning more experienced staff or 
   those with specialized skills such as 
   specialists
-  Providing more supervision
-  Incorporating additional elements of 
   unpredictability in the selection of 
   further audit procedures to be 
   performed

Substantive responses, further audit procedures, and test of controls are specific responses, not an overall response.

Question 40

An auditor traced a sample of purchase orders and the related receiving reports to the purchases journal and the cash disbursements journal. The purpose of this substantive audit procedure most likely was to:

identify unusually large purchases that should be investigated further.

verify that cash disbursements were for goods actually received.

determine that purchases were properly recorded.

test whether payments were for goods actually ordered.

Answer 40

determine that purchases were properly recorded.

Explanation:

The purpose of tracing documents from the detail level to the journal level is to verify whether or not the transactions were properly recorded.