Chapter 17 (ALL)

Question 1

An auditor would be most likely to identify a contingent liability by obtaining an)
a) Accounts payable confirmation.
b) Bank confirmation of the entity’s cash balance.
c) Letter from the entity’s general legal counsel.
d) List of subsequent cash receipts.

Answer 1

c) Letter from the entity’s general legal counsel.

Question 2

An auditor should request that an audited entity send a letter of inquiry to those attorneys who have been consulted concerning litigation, claims, or assessments. The primary reason for this request is to provide:
a) The opinion of a specialist as to whether loss contingencies are possible, probable, or remote.
b) A description of litigation, claims, and assessments that have a reasonable possibility of unfavorable outcome.
c) An objective appraisal of management’s policies and procedures adopted for identifying and evaluating legal matters.
d) Corroboration of the information furnished by management concerning litigation, claims, and assessments.

Answer 2

d) Corroboration of the information furnished by management concerning litigation, claims, and assessments.

Question 3

An auditor issued an audit report that was dual dated for a subsequent event occurring after the date on which the auditor has obtained sufficient appropriate audit evidence but before issuance of the financial statements. The auditor’s responsibility for events occurring subsequent to the date on which the auditor has obtained sufficient appropriate audit evidence was:
a) Limited to the specific event referenced.
b) Extended to include all events occurring since the date on which the auditor has obtained sufficient appropriate audit evidence.
c) Extended to subsequent events occurring through the date of issuance of the report.
d) Limited to events occurring up to the date of the last subsequent event referenced.

Answer 3

a) Limited to the specific event referenced.

Question 4

Which of the following procedures would an auditor most likely perform to obtain evidence about the occurrence of any changes in internal control that might affect financial reporting between the end of the reporting period and the date of the auditor’s report?
a) Review a fire insurance settlement during the subsequent period.
b) Examine relevant internal audit reports issued during the subsequent period.
c) Inquire of the entity’s legal counsel concerning litigation, claims, and assessments arising after year-end.
d) Confirm bank accounts established after year-end.

Answer 4

b) Examine relevant internal audit reports issued during the subsequent period.

Question 5

Final analytical procedures are generally intended to:
a) Provide the auditor with a final, overall evaluation of the relationships among financial statement balances.
b) Test transactions to corroborate management’s financial statement assertions.
c) Gather evidence concerning account balances that have not yet been investigated.
d) Retest control activities that appeared to be ineffective during the assessment of control risk.

Answer 5

a) Provide the auditor with a final, overall evaluation of the relationships among financial statement balances.

Question 6

Which of the following audit procedures is most likely to assist an auditor in identifying conditions and events that may indicate substantial doubt about an entity’s ability to continue as a going concern?
a) Review compliance with the terms of debt agreements.
b) Review management’s plans to dispose of assets.
c) Evaluate management’s plans to borrow money or restructure debt.
d) Consider management’s plans to reduce or delay expenditures.

Answer 6

a) Review compliance with the terms of debt agreements.

Question 7

Auditing standards primarily encourage which of the following conversations between the auditor and another party about financial reporting?
a) A conversation with those charged with governance to discuss matters pertaining to financial reporting.
b) A conversation with only management to discuss matters pertaining to financial reporting.
c) A conversation with the head of the entity’s internal audit department and those charged with governance to discuss matters pertaining to financial reporting.
d) A conversation in which those charged with governance report on management’s views on matters pertaining to financial reporting.

Answer 7

a) A conversation with those charged with governance to discuss matters pertaining to financial reporting.

Question 8

Which of the following matters should an auditor communicate to those charged with governance?
a) Significant Audit Adjustments = Yes & Management’s Consultations with Other Accountants = Yes
b) Significant Audit Adjustments = Yes & Management’s Consultations with Other Accountants = No
c) Significant Audit Adjustments = No & Management’s Consultations with Other Accountants = Yes
d) Significant Audit Adjustments = No & Management’s Consultations with Other Accountants = No

Answer 8

a) Significant Audit Adjustments = Yes & Management’s Consultations with Other Accountants = Yes

Question 9

Which of the following events occurring after the issuance of a set of financial statements and the accompanying auditor’s report would be most likely to cause the auditor to make further inquiries about the financial statements?
a) A technological development in the industry that could affect the entity’s future ability to continue as a going concern.
b) The entity’s sale of a subsidiary that accounts for 30 percent of the entity’s consolidated sales.
c) The discovery of information regarding a contingency that existed before the financial statements were issued
d) The final resolution of a lawsuit explained in a separate paragraph of the auditor’s report.

Answer 9

c) The discovery of information regarding a contingency that existed before the financial statements were issued

Question 10

Define contingent liability. What three categories are used to classify contingent liabilities?

Answer 10

contingent liability is defined as an existing condition, situation, or set of circumstances involving uncertainty as to possible loss to an entity that ultimately will be resolved when some future event occurs or fails to occur.

FASB ASC Topic 450, “Contingencies,” classifies uncertainties into three categories:
1. Probable: The future event is likely to occur.
2. Reasonably possible: The chance of the future event occurring is more than remote but less than likely. 3. 3. Remote: The chance of the future event occurring is slight.

Question 11

Give 6 examples of contingent liabilities.

Answer 11

1) Pending or threatened litigation
2) Actual or possible claims and assessments
3) Income tax disputes
4) Product warranties or defects
5) Guarantees of obligations to others
6) Agreements to repurchase receivables that have been sold

Question 12

What information does a letter of audit inquiry ask the attorney to provide?

Answer 12

The auditor requests that the attorney provide the following information on pending or threatened litigation:
* A list and evaluation of any pending or threatened litigation to which the attorney has devoted substantial
attention. The client may provide the list.
* A listing of unasserted claims and assessments considered by management to be probable of assertion and
reasonably possible of unfavorable outcome.
* A description and evaluation of the outcome of each pending or threatened litigation. This should include the
progress of the case, the action the entity plans to take, the likelihood of unfavorable outcome, and the amount
or range of potential loss.
* Identification of any pending or threatened litigation or claims not included in management’s list or a statement
that the list is complete.
* Comments on unasserted claims where his or her views differ from management’s evaluation. * Indication if his or her response is limited and the reasons for such limitations.

Question 13

Provide two examples of commitments. Under what conditions would such commitments result in a decrease in Other Comprehensive Income?

Answer 13

Two examples of long-term commitments are the purchase of raw materials or the sale of products at a fixed price. When the fair market value of the good is less than the purchase price included in the purchase contract, the entity will have to recognize a loss on a long-term commitment even though there has been no exchange of goods.

Question 14

Name and describe the two types of subsequent events relevant to financial statement audits. Give one example of each type of subsequent event that might materially affect the financial statements.

Answer 14

Type I: Events that provide additional evidence about conditions that existed at the date of the balance sheet and affect the estimates that are part of the financial statement preparation process. These types of events require adjustment of the financial statements.

Type II: Events that provide evidence about conditions that did not exist at the date of the balance sheet but arose subsequent to that date. These types of events usually require disclosure in the notes to the financial statements. In some instances, where the effect of the event or transaction is very significant, pro forma financial statements may be necessary in order to prevent the financial statements from being misleading.

Examples of Type I events or conditions are:
* An uncollectible account receivable resulting from continued deterioration of a customer’s financial condition
leading to bankruptcy after the balance sheet date, where the bankruptcy is the event that reveals the customer’s
poor financial condition at the balance sheet date.
* The settlement of a lawsuit after the balance sheet date for an amount different from the amount recorded in the year-end financial statements.

Examples of Type II events or conditions are:
* Purchase or disposal of a business by the entity after the balance sheet date.
* Sale of a capital stock or bond issue by the entity after the balance sheet date.
* Loss of the entity’s manufacturing facility or assets resulting from a casualty such as a fire or flood occurring after
the balance sheet date.
* Losses on receivables arising from conditions such as a casualty arising subsequent to the balance sheet date.

Question 15

Under what circumstances would the auditor dual date an audit report?

Answer 15

The auditor would consider dual dating the audit report when a subsequent event is recorded or disclosed in the financial statements after the date on which the auditor has obtained sufficient appropriate audit evidence but before the issuance of the financial statements.

In this case, the auditor will choose to dual date if they want to limit their responsibility for events subsequent to the date on which they auditor has obtained sufficient appropriate audit evidence to the disclosed subsequent event.

Question 16

Are analytical procedures required as part of the final overall review of the financial statements? What is the purpose of such analytical procedures?

Answer 16

Auditing standards, require that the auditor perform analytical procedures at the final review stage of the audit.

The objective of conducting final analytical procedures near the end of the engagement is to help the auditor assess the conclusions reached on the financial statement components and to help the auditor evaluate the overall financial statement presentation.

Question 17

What is the purpose of the representation letter that the auditor obtains from management?

Answer 17

The auditor obtains a representation letter in order to corroborate significant oral representations made to the auditor and to document the continued appropriateness of those representations.

The representation letter also reduces the possibility of misunderstanding between management and the auditor.

Question 18

Describe the purposes of an independent engagement quality review by a quality review partner.

Answer 18

A quality review partner is generally not associated with the details of the engagement and is expected to provide an independent review of the audit.

The quality review partner can protect the firm from an inappropriate or non- independent relationship between the audit partner and the client.

The engagement quality control reviewer performs an objective evaluation of the significant judgments made by the engagement team and the conclusions reached in formulating the auditor’s report.

He or she discusses significant findings or issues with the engagement partner and reads the financial statements and the proposed auditor’s report.

The engagement quality reviewer reviews selected audit documentation relating to the significant judgments the engagement team made and the related conclusions it reached, and evaluates the conclusions reached in formulating the auditor’s report.

Finally, he or she considers whether the proposed auditor’s report is appropriate.

Question 19

List and describe the four overall steps in the auditor’s going-concern evaluation process.

Answer 19

1) Independently evaluate whether the results of audit procedures performed during the planning, performance, and completion of the audit indicate whether there is substantial doubt about the entity’s ability to continue as a going concern for a reasonable period of time not to exceed one year from the issuance of the financial statements.

2) If there is substantial doubt, the auditor should obtain information about management’s plans to mitigate the going concern problem and assess the likelihood that such plans can be implemented.

3) Conclude, in light of management’s plans, whether it is probable that the entity will be able to continue as a going concern; if not, consider the adequacy of the disclosures about the entity’s ability to continue and include a separate section in the auditor’s report disclosing the going-concern issue under the heading “Substantial Doubt About Entity’s Ability to Continue as a Going Concern.”

4) Assess management’s going-concern evaluation and related disclosures.

Question 20

What four major categories of events or conditions may indicate going concern problems? Give two examples for each category.

Answer 20

1) Financial conditions:
* Recurring operating losses
* Current-year deficit
* Accumulated deficits
* Negative net worth
* Negative working capital
* Negative cash flow
* Negative income from operations
* Inability to meet interest payments

2) Other financial difficulties:
* Default on loans
* Dividends in arrears
* Restructuring of debt
* Denial of trade credit by suppliers * No additional sources of financing

3) Internal matters:
* Work stoppages
* Uneconomic long-term commitments
* Dependence on the success of one particular project

4) External matters:
* Legal proceedings
* Loss of a major customer or supplier
* Loss of a key franchise, license, or patent

Question 21

What are the three categories of topics that auditors should discuss with those charged with governance (i.e., the audit committee or similar group)? For each category, give two examples of items that the auditor should communicate to the audit committee.

Answer 21

The items to be communicated are organized into three categories: (1) appointment and retention of the auditor, (2) obtaining information relevant to the audit and communicating the audit strategy, and (3) communicating the results of the audit.

The auditor’s communication with those charged with governance would normally take place at or near the end of the engagement. However, if a significant event occurs, such as fraudulent activities by senior management, the auditor would normally contact those charged with governance immediately.

Question 22

What types of events would generally require restatement of the issued financial statements? What procedures should the auditor follow when the entity refuses to cooperate and make the necessary disclosures?

Answer 22

Generally, when previously issued financial statements contain material misstatements due to unintentional or intentional actions by management, the financial statements will require revision. If the client refuses to cooperate and make the necessary disclosures, the auditor should notify the board of directors and take the following steps, if possible:

1. Notify the client that the auditor’s report must no longer be associated with the financial statements.
2. Notify any regulatory agencies having jurisdiction over the client that the auditor’s report can no longer be relied
   upon.
3. Notify each person known to the auditor to be relying on the financial statements. Usually, notification to a
   regulatory agency, such as the SEC, is the only practical way to provide appropriate disclosure.

Question 23

Analytical Procedures

Answer 23

Evaluations of financial information made by an analysis of plausible relationships among both financial and nonfinancial data.

Question 24

Audit Data Analytics

Answer 24

Using analysis, modeling, and visualization to discover and analyze patterns, anomalies, and other information in data in the context of the audit.

Question 25

Contingent Liability

Answer 25

An existing condition, situation, or set of circumstances involving uncertainty as to possible loss to an entity that will ultimately be resolved when some future event occurs or fails to occur.

Question 26

Engagement Quality Review (EQR)

Answer 26

A review by a quality review partner of the financial statements and audit report to ensure the audit was properly conducted and an appropriate report issued.

Question 27

Going Concern

Answer 27

An entity that is expected to continue in existence on an ongoing basis. The entity’s responsibility is to determine whether there is substantial doubt about its ability to continue as a going concern; the auditor independently evaluates management’s assessment.

Question 28

Letter of Audit Inquiry

Answer 28

An audit inquiry sent to the entity’s attorneys in order to obtain or corroborate information about litigation, claims, and assessments for the purpose of corroborating management’s identification and assessment of potential contingent liabilities.

Question 29

Management Letter

Answer 29

A letter from the auditor to management making recommendations to the entity based on observations during the audit; the letter may include topics relating to organizational structure and efficiency issues.

Question 30

Management Representation Letter

Answer 30

A letter that corroborates oral representations made to the auditor by management or by other auditors and documents the continued appropriateness of such representations.

Question 31

Subsequent Event

Answer 31

An event or transaction that occurs after the balance sheet date but prior to the issuance of the financial statements and the auditor’s reports that may materially affect the financial statements.

Question 32

Work Papers

Answer 32

The auditor’s record of the work performed and the conclusions reached on the audit.

Question 33

Completing the Audit Engagement Steps: (5)

Answer 33

1. Review for contingent liabilities
2. Review for subsequent events
3. Final evidential evaluation processes
4. Communications with “those charged with governance”
5. Archiving and retention

Question 34

Contingent Liability

Answer 34

A contingent liability represents a potential obligation to outside parties that arose from past events but for which the final resolution is uncertain, depending on the outcome of future events.

Question 35

What is the primary assertion associated with searching for contingent liabilities?

Answer 35

Completeness (worried they did not record stuff- understatement)

Question 36

Examples of contingent liability

Answer 36

1. pending or threatened litigation.
2. actual or possible claims, fines, or assessments stemming from regulatory or other disciplinary action.
3. income tax disputes.
4. product warranties or defects.
5. guarantees of obligations to others.
6. agreements to repurchase receivables that have been sold.

Question 37

How to identify continent liabilities are completed? (6)

Answer 37

1. Read board minutes
2. Review contract agreements and correspondence from involved parties and government agencies
3. Review tax liability, returns and correspondence with IRS
4. Confirm guarantees and letters of credit with banks
5. Talk with management (obtain written representation)
6. Confirm legal counsel (lawyer)

Question 38

Why are continent liabilities difficult to audit? (4)

Answer 38

1. You are looking for something which is not recorded, which is more difficult than evaluating supporting evidence of what is recorded.
2. Legal confirmations are not always informative.
3. There is judgment involved in the evaluation of a contingent liability.
4. Inquiry of the client is not very reliable.

Question 39

Evaluate contingent liabilities based on what 2 dimensions?

Answer 39

1. Estimable
2. Likelihood

Question 40

Remote =

Answer 40

The chance of the future event occurring is slight.

Question 41

If Likelihood is remote and it IS estimable, what action do you take?

Answer 41

NO action

Question 42

If Likelihood is remote and it is NOT estimable, what action do you take?

Answer 42

NO action

Question 43

If Likelihood is reasonably possible and it IS estimable, what action do you take?

Answer 43

Footnote Disclosure

Question 44

If Likelihood is reasonably possible and it is NOT estimable, what action do you take?

Answer 44

Footnote Disclosure

Question 45

If Likelihood is probable and it IS estimable, what action do you take?

Answer 45

Accrual Required & Footnote Disclosure

Question 46

If Likelihood is probable and it is NOT estimable, what action do you take?

Answer 46

Footnote Disclosure

Question 47

Reasonably Possible =

Answer 47

The chance of the future event occurring is more than remote but less than likely.

Question 48

Probable =

Answer 48

The future event is likely to occur.

Question 49

Subsequent Events

Answer 49

Are events or transactions that occur after the balance sheet date, but before the issuance of the financial statements, that materially affect the financial statements.

Question 50

Subsequent Events -> Management’s Responsibility

Answer 50

Identifying subsequent events and disclose the date through which they have considered subsequent events (management rep letter).

Question 51

Subsequent Events -> Auditor’s Responsibility

Answer 51

Evaluating the entity’s handling of subsequent events in the financial statements.

Question 52

Subsequent Events 2 Types

Answer 52

1. Type I Event
2. Type II Event

Question 53

Type I Event

Answer 53

Conditions existed before the balance sheet date and affect estimates that are part of financial statements

• Require adjustment of the financial statements

Question 54

Type II Event

Answer 54

Conditions did not exist at the balance sheet date and do not affect the accuracy of the financial statements

• Require disclosure and possibly pro forma financial statements (if significant)

Question 55

Subsequent Events Period: (3)

Answer 55

1. Financial Statement Date (12/31/1)
2. Audit Report Date (02/15/2) -> (substantially done with the audit, received management rep. letter, financial statements are prepared)
3. Issue Financial Statements (03/15/2)

Auditor’s Responsibility:
1. Actively search for subsequent events between FS date and Audit Report Date.
2. Examine items made aware of from Audit Report Date to Issuance Date.

Question 56

When a subsequent event is recorded or disclosed in the financial statements after sufficient, appropriate audit evidence has been obtained but before the issuance of the financial statements, the auditor considers the following options for dating the auditor’s report: (2)

Answer 56

1. “Dual date” the report (original date of report plus date of subsequent event—limits liability).
2. Change the date of the auditor’s report to the date of the subsequent event—extends liability.

Question 57

Dual Dating Issue is when:

Answer 57

Between audit report date & issue financial statements

Question 58

Income Taxes Special Rules

Answer 58

ASC 740-10-25-8, Income Taxes, prescribes special rules for resolutions of income tax matters after the balance sheet date. According to ASC 740-10-25-8, “a change in facts subsequent to the reporting date but prior to the issuance of the financial statements shall be recognized in the period in which the change in fact occurs.”

*if material, disclose in financial statements of previous year (similar to type II)

Question 59

Examples of audit procedures to Look for Subsequent Events: (5)

Answer 59

1. Inquire of management.
2. Read minutes of meetings.
3. Read interim financial statements.
4. Inquire of legal counsel.
5. Examine the books of original entry for the subsequent events period and look for unusual transactions or information.

Question 60

Auditors of public companies are responsible to report on….

Answer 60

any changes in internal control that might adversely affect financial reporting between the end of the reporting period and the date of the auditor’s report.

Question 61

The auditor should also inquire about and examine, for this subsequent period, the following: (4)

Answer 61

1. Relevant internal audit reports issued during the subsequent period
2. Internal audit reports of significant deficiencies
3. Regulatory agency reports on ICFR
4. Information about the effectiveness of ICFR obtained from other engagements

Question 62

Subsequent Discovery of Facts Existing at the Date of the Auditor’s Report- 3 steps:

Answer 62

1. Notify the entity that the auditor’s report must no longer be associated with the financial statements.
2. Notify any regulatory agency having jurisdiction over the entity that the auditor’s report can no longer be relied upon.
3. Notify each person known to the auditor to be relying on the financial statements.

Question 63

Final Evidential Evaluation Processes: (7)

Answer 63

1. Perform final analytical procedures.
2. Obtain a management representation letter.
3. Review working papers.
4. Final evaluation of audit results.
5. Evaluate financial statement presentation and disclosure.
6. Obtain an independent review of the engagement.
7. Evaluate entity’s ability to continue as a going concern.

Question 64

Perform final analytical procedures

Answer 64

The objective of conducting analytical procedures near the end of the engagement is to help the auditor assess the conclusions reached on the financial statement components and evaluate the overall financial statement presentation.

Question 65

Obtain a management representation letter

Answer 65

Auditing standards require that the auditor obtain a representation letter from management.

The purpose of this letter is to document, in writing, significant oral representations made to the auditor by management.

Question 66

Review working papers

Answer 66

All audit work should be reviewed by an audit team member who is senior to the person preparing the working papers.

Question 67

Final evaluation of audit results -> concerned with 2 issues:

Answer 67

1. The sufficiency of the audit evidence and
2. The effects of detected misstatements in the financial statements

Question 68

Evaluate financial statement presentation and disclosure

Answer 68

Auditor reviews the financial statements to ensure compliance with GAAP, proper presentation of accounts, and inclusion of all necessary disclosures.

Question 69

Obtain an independent review of the engagement

Answer 69

An engagement quality review for publicly traded companies and for privately held companies whose financial statements are expected to be widely distributed.

Question 70

Engagement quality reviewer =

Answer 70

Is a partner who is not associated with the details of the engagement and is expected to provide an independent, objective review

Question 71

“Substantial Doubt” =

Answer 71

“probable”

Question 72

“Reasonable Period of Time” =

Answer 72

Look forward period one year from the date of ISSUANCE of the financial statements.

Question 73

“Concern” (entity) is ___ to keep “going”

Answer 73

Likely

Question 74

Balance Sheet Date: 12/31/x0
End of Fieldwork: 01/31/x1
Audit Report Date: 02/14/x1
Financial Statement Issue Date: 03/01/x1
Additional Information: On 1/10/x1, the auditor discovered an uninsured lawsuit against the client that had originated on 10/31/x0. Any amount of potential loss is not estimable.

What type of continent liability?
What is the likelihood & is it estimable ?
What actions do you take?

Answer 74

• Contingent Liability
• Lawsuit happened before year end
• Amount is not estimable
• Disclose in the footnotes

(Uninsured = more than remote)

Question 75

Balance Sheet Date: 12/31/x0
End of Fieldwork: 01/21/x1
Audit Report Date: 01/31/x1
Financial Statement Issue Date: Note yet issued.
Additional Information: Board of directors voted to increase substantially the advertising budget for the coming year and to change advertising agencies on 1/5/x1.

What type of continent liability?
What is the likelihood & is it estimable?
What actions do you take?

Answer 75

Nothing

Not a subsequent event for financial statement purposes

Question 76

Balance Sheet Date: 12/31/x0
End of Fieldwork: 01/31/x1
Audit Report Date: 2/14/x1
Financial Statement Issue Date: 03/01/x1
Additional Information: On 2/6/x1, the auditor discovered that a customer of the client went bankrupt on 2/1/x1. The most recent sale to the customer was 4/1/x0 and no payments had been made.

What type of continent liability?
What is the likelihood & is it estimable?
What actions do you take?

Answer 76

• Adjust the 12/31/x0 financial statements
• Type 1 Event

Question 77

Balance Sheet Date: 12/31/x4
End of Fieldwork: 01/21/x5
Audit Report Date: 01/31/x5
Financial Statement Issue Date: Not yet issued
Additional Information: The tax court ruled in favor of client on 1/25/x5. Case involved deductions claimed in ‘x1 and ‘x2 tax returns. Full amount was accrued in taxes payable, including potential disallowances. IRS is not challenging through appeal.

What type of continent liability?
What is the likelihood & is it estimable?
What actions do you take?

Answer 77

• Conditions existed as of 12/31/x4
• Type I event?
  ASC 740-10-25-8, Income Taxes
  “Change in facts subsequent to YE recognized when change in fact occurs”
• Type II event
  Disclose in the footnotes, adjust for favorable ruling in ‘x5

Question 78

Balance Sheet Date: 12/31/x0
End of Fieldwork: 01/31/x1
Audit Report Date: 02/14/x1
Financial Statement Issue Date: 03/01/x1
Additional Information: The auditor finds out on 2/28/x1 that the client has agreed to purchase a subsidiary that is material to the client’s financial statements.

What type of continent liability?
What is the likelihood & is it estimable?
What actions do you take?

Answer 78

• Conditions did not exist at YE
• Type II Event
• Disclose in the footnotes ; likely pro-forma FS necessary due to acquisition of subsidiary.
• After audit report date&raquo_space; dual date the report

Question 79

Balance Sheet Date: 12/31/x0
End of Fieldwork: 01/21/x1
Audit Report Date: 01/31/x1
Financial Statement Issue Date: Not yet issued
Additional Information: Major investment advisor issued a negative report on client’s long-term prospects on 1/15/x1. Market price of common stock declined by 40%.

What type of continent liability?
What is the likelihood & is it estimable?
What actions do you take?

Answer 79

Nothing

Not a subsequent event for financial statement purposes

Question 80

Balance Sheet Date: 12/31/x0
End of Fieldwork: 01/21/x1
Audit Report Date: 01/31/x1
Financial Statement Issue Date: Not yet issued
Additional Information: The auditor finds out that Agro, a major customer whose AR balance was material at year-end, suffered a plant explosion on 1/25/x1. Argo was uninsured, so it is unlikely that the account will be paid.

What type of continent liability?
What is the likelihood & is it estimable?
What actions do you take?

Answer 80

• Explosion led to un-collectability
• Event did not exist as of 12/31/x0
• Type II event
• Disclose in the footnotes.

Question 81

Balance Sheet Date: 12/31/x0
End of Fieldwork: 01/21/x1
Audit Report Date: 01/31/x1
Financial Statement Issue Date: Not yet issued
Additional Information: Client sold a division whose assets constituted 45% of its total assets as of 12/31/x0. Was sold on 2/1/x1. New owner assumed debt associated with division.

What type of continent liability?
What is the likelihood & is it estimable?
What actions do you take?

Answer 81

• “Conditions did not exist as of 12/31/x0”
• Type II event
• Disclose in the footnotes; likely pro-forma statements necessary due to size of division
• After audit report date&raquo_space; dual date

Question 82

SAS 132: Convergence of Accounting & Auditing Standards: (Going Concern) (5)

Answer 82

1. Management will “go first” in providing evaluation of own going concern status & determining appropriate disclosures.
2. Auditor performs separate, independent assessment
3. Auditor evaluates management’s assessment, plan & disclosures
4. FS opinion and disclosures are impacted if there is a going concern issue
5. Evaluation period: at least one year from the ISSUANCE of the financial statements

Question 83

How do you assess the company’s going concern?

Answer 83

This assessment is based on general knowledge of the business and information evaluated during the audit.

Question 84

(Going Concern) Financial condition that indicate financial distress: (8)

Answer 84

1. Recurring operating losses.
2. Current year deficits.
3. Accumulated deficits.
4. Negative net worth.
5. Negative working capital.
6. Negative cash flow.
7. Negate income from operations.
8. Inability to meet interest payments.

Question 85

(Going Concern) Ratios that indicate financial distress: (6)

Answer 85

1. Net worth/total liabilities.
2. Working capital from operations/total liabilities.
3. Current assets/current liabilities.
4. Total long-term liabilities/total assets.
5. Total liabilities/total assets.
6. Net income before taxes/net sales.

Question 86

Other Conditions and Events Indicating a Problem with the Going Concern Assumption -> Other financial difficulties: (5)

Answer 86

1. Default on loans.
2. Dividends in arrears.
3. Restructuring of debt.
4. Denial of trade credit by suppliers.
5. Lack of additional sources of financing.

Question 87

Other Conditions and Events Indicating a Problem with the Going Concern Assumption -> Internal Matters: (3)

Answer 87

1. Work stoppages.
2. Uneconomic long-term commitments.
   3.Dependence on the success of one particular project.

Question 88

Other Conditions and Events Indicating a Problem with the Going Concern Assumption -> External Matters: (3)

Answer 88

1. Legal proceedings.
2. Loss of major customer or supplier.
3. Loss of key franchise, license, or patent.

Question 89

Examples of Communication with Those Charged with Governance (3):

Answer 89

1. Appointment and Retention of the Auditor.
2. Obtaining Information Relevant to the Audit and Communicating the Audit Strategy.
3. Communicating Results of the Audit.

Question 90

Sarbanes-Oxley Act and PCAOB’s Documentation Standard:

Answer 90

• Require audit firms to archive their public-company audit files for retention within 45 days following the time the auditor grants permission to use the auditor’s report in connection with the issuance of the company’s financial statements.
• Require audit firms to retain audit documentation for 7 years from the date of completion of the engagement, as indicated by the date of the auditor’s report, unless a longer period of time is required by law.
  Require audit firms to retain all documents that “form the basis of the audit or review.”
• Require audit firms to include in the audit file for significant matters any document created, sent, or received, including documents that are inconsistent with a final conclusion.

-Significant changes in audit plans or conclusions must also be documented.

Question 91

For the following item, assume that Josh Feldstein, CPA, is expressing an opinion on Scornick Company’s financial statements for the year ended December 31, 2021; that he completed fieldwork on January 21, 2022; and that he now is preparing his opinion to accompany the financial statements.

In the subsequent event is described. This event was disclosed to the CPA either in connection with his review of subsequent events or after the date on which the auditor has obtained sufficient appropriate audit evidence. Describe the financial statement effects, if any, of the following subsequent event.

Subsequent Event: A large account receivable from Agronowitz Company (material to financial statement presentation) was considered fully collectible at December 31, 2021. Agronowitz suffered a plant explosion on January 25, 2022. Because Agronowitz was uninsured, it is unlikely that the account will be paid.

Answer 91

The explosion in Agronowitz’s plant that led to the uncollectibility of Scornick Company’s accounts receivable was an event whose conditions did not exist at the balance sheet date. Thus, the event is a Type II event, and should be disclosed in the financial statements of the year just ended.

Question 92

For the following item, assume that Josh Feldstein, CPA, is expressing an opinion on Scornick Company’s financial statements for the year ended December 31, 2021; that he completed fieldwork on January 21, 2022; and that he now is preparing his opinion to accompany the financial statements.

In the subsequent event is described. This event was disclosed to the CPA either in connection with his review of subsequent events or after the date on which the auditor has obtained sufficient appropriate audit evidence. Describe the financial statement effects, if any, of the following subsequent event.

Subsequent Event: The tax court ruled in favor of the company on January 25, 2022. Litigation involved deductions claimed on the 2018 and 2019 tax returns. In accrued taxes payable, Scornick had provided for the full amount of the potential disallowances. The Internal Revenue Service will not appeal the tax court’s ruling.

Answer 92

The tax court ruling in favor of Scornick Company is an event whose conditions existed at the balance sheet date but were clarified later, and which involves the revision of an estimate.

Thus, under normal circumstances the event would be considered a Type I event, and the financial statements of the year just ended would be adjusted to reflect the favorable ruling.

However, ASC 740-10-25-8, Income Taxes, prescribes special rules for resolutions of income tax matters after the balance sheet date.

According to ASC 740-10-25-8, “a change in facts subsequent to the reporting date but prior to the issuance of the financial statements shall be recognized in the period in which the change in fact occurs.”

Accordingly, the adjustment to reflect the favorable ruling would be recognized in 2019, and not in the financial statements for the year ended December 31, 2018.

Question 93

For the following item, assume that Josh Feldstein, CPA, is expressing an opinion on Scornick Company’s financial statements for the year ended December 31, 2021; that he completed fieldwork on January 21, 2022; and that he now is preparing his opinion to accompany the financial statements.

In the subsequent event is described. This event was disclosed to the CPA either in connection with his review of subsequent events or after the date on which the auditor has obtained sufficient appropriate audit evidence. Describe the financial statement effects, if any, of the following subsequent event.

Subsequent Event: Scornick’s Manufacturing Division, whose assets constituted 45 percent of Scornick’s total assets at December 31, 2021, was sold on February 1, 2022. The new owner assumed the bonded indebtedness associated with this property.

Answer 93

The sale of Scornick’s Manufacturing Division is an event whose conditions did not exist at the balance sheet date and is thus a Type II event.

This event, at a minimum, requires disclosure in the financial statements of the year just ended.

However, due to the size of the division being sold, pro-forma financial statements may be necessary.

Question 94

For the following item, assume that Josh Feldstein, CPA, is expressing an opinion on Scornick Company’s financial statements for the year ended December 31, 2021; that he completed fieldwork on January 21, 2022; and that he now is preparing his opinion to accompany the financial statements.

In the subsequent event is described. This event was disclosed to the CPA either in connection with his review of subsequent events or after the date on which the auditor has obtained sufficient appropriate audit evidence. Describe the financial statement effects, if any, of the following subsequent event.

Subsequent Event: On January 15, 2022, R. E. Fogler, a major investment adviser, issued a negative report on Scornick’s long-term prospects. The market price of Scornick’s common stock subsequently declined by 40 percent.

Answer 94

This is not an event that is considered a subsequent event for financial statement purposes.

Question 95

For the following item, assume that Josh Feldstein, CPA, is expressing an opinion on Scornick Company’s financial statements for the year ended December 31, 2021; that he completed fieldwork on January 21, 2022; and that he now is preparing his opinion to accompany the financial statements.

In the subsequent event is described. This event was disclosed to the CPA either in connection with his review of subsequent events or after the date on which the auditor has obtained sufficient appropriate audit evidence. Describe the financial statement effects, if any, of the following subsequent event.

Subsequent Event: At its January 5, 2022 meeting, Scornick’s board of directors voted to increase substantially the advertising budget for the coming year and authorized a change in advertising agencies.

Answer 95

This is not an event that is considered a subsequent event for financial statement purposes.

Question 96

The following item is either unrelated statements, questions, excerpts, and comments taken from various parts of an auditor’s work paper file. What is the most likely source for each item?

Item: During our audit we discovered evidence of the company’s failure to safeguard inventory from loss, damage, and misappropriation.

Answer 96

Auditor’s communications on significant deficiencies and material weakness.

Question 97

The following item is either unrelated statements, questions, excerpts, and comments taken from various parts of an auditor’s work paper file. What is the most likely source for each item?

Item: The company considers the decline in value of equity securities classified as available-for-sale to be temporary.

Answer 97

Management representation letter.

Question 98

The following item is either unrelated statements, questions, excerpts, and comments taken from various parts of an auditor’s work paper file. What is the most likely source for each item?

Item: There have been no communications from regulatory agencies concerning noncompliance with or deficiencies in financial reporting practices

Answer 98

Management representation letter.

Question 99

The following item is either unrelated statements, questions, excerpts, and comments taken from various parts of an auditor’s work paper file. What is the most likely source for each item?

Item: It is our opinion that the possible liability to the company in this proceeding is nominal in amount.

Answer 99

Lawyer’s response to audit inquiry letter.

Question 100

The following item is either unrelated statements, questions, excerpts, and comments taken from various parts of an auditor’s work paper file. What is the most likely source for each item?

Item: As discussed in Note 4 to the financial statements, the company experienced a net loss for the year ended July 31, 2021 and is currently in default under substantially all of its debt agreements. In addition, on September 25, 2021, the company filed a prenegotiated voluntary petition for relief under [ Chapter 11 of the U.S. Bankruptcy Code.
These matters raise substantial doubt about the company’s ability to continue as a going concern.

Answer 100

Explanatory paragraph of an auditor’s report on financial statements

Question 101

The following item is either unrelated statements, questions, excerpts, and comments taken from various parts of an auditor’s work paper file. What is the most likely source for each item?

Item: During the year under audit, we were advised that management consulted with Gonzales & Ramirez, CPAs. The purpose of this consultation was to obtain another CPA firm’s opinion concerning the company’s recognition of certain revenue that we believe should be deferred to future periods. Gonzales & Ramirez’s opinion was consistent with our opinion, so management did not recognize the revenue in the current year.

Answer 101

Auditor’s communication to those charged with governance (other than with respect to significant deficiencies and material weakness).

Question 102

The following item is either unrelated statements, questions, excerpts, and comments taken from various parts of an auditor’s work paper file. What is the most likely source for each item?

Item: The company believes that all material expenditures that have been deferred to future periods will be recoverable.

Answer 102

Management representation letter.

Question 103

The following item is either unrelated statements, questions, excerpts, and comments taken from various parts of an auditor’s work paper file. What is the most likely source for each item?

Item: Our use of professional judgment and the assessment of audit risk and materiality for the purpose of our audit mean that matters may have existed that would have been assessed differently by you. We make no representation as to the sufficiency or appropriateness of the information in our work papers for your purposes.

Answer 103

Predecessor auditor’s communication with successor auditor.

Question 104

The following item is either unrelated statements, questions, excerpts, and comments taken from various parts of an auditor’s work paper file. What is the most likely source for each item?

Item: Indicate in the space provided below whether this information agrees with your records. If there are exceptions, please provide any information that will assist the auditor in reconciling the difference.

Answer 104

Accounts receivable confirmation request.

Question 105

The following item is either unrelated statements, questions, excerpts, and comments taken from various parts of an auditor’s work paper file. What is the most likely source for each item?

Item: Blank checks are maintained in an unlocked cabinet along with the check-signing machine. Blank checks and the check-signing machine should be locked in separate locations to prevent the embezzlement of funds.

Answer 105

Auditor’s communications on significant deficiencies and material weakness.

Question 106

The following item is either unrelated statements, questions, excerpts, and comments taken from various parts of an auditor’s work paper file. What is the most likely source for each item?

Item: The company has insufficient expertise and controls over the selection and application of accounting policies that are in conformity with GAAP

Answer 106

Auditor’s communications on significant deficiencies and material weakness.

Question 107

The following item is either unrelated statements, questions, excerpts, and comments taken from various parts of an auditor’s work paper file. What is the most likely source for each item?

Item: The timetable set by management to complete our audit was unreasonable considering the failure of the company’s personnel to complete schedules on a timely basis and delays in providing necessary information.

Answer 107

Auditor’s communication to those charged with governance (other than with respect to significant deficiencies and material weakness).

Question 108

The following item is either unrelated statements, questions, excerpts, and comments taken from various parts of an auditor’s work paper file. What is the most likely source for each item?

Item: Several employees have disabled the antivirus detection software on their PCs because the software slows the processing of data and occasionally rings false alarms. The company should obtain antivirus software that runs continuously at all system entry points and that cannot be disabled by unauthorized personnel.

Answer 108

Auditor’s communications on significant deficiencies and material weakness.

Question 109

The following item is either unrelated statements, questions, excerpts, and comments taken from various parts of an auditor’s work paper file. What is the most likely source for each item?

Item: In connection with an audit of our financial statements, please furnish to our auditors a description and evaluation of any pending or probable litigation against our company of which you are aware.

Answer 109

Audit inquiry letter to legal counsel.

Question 110

The following item is either unrelated statements, questions, excerpts, and comments taken from various parts of an auditor’s work paper file. What is the most likely source for each item?

Item: The company has no plans or intentions that may materially affect the carrying value or classification of assets and liabilities.

Answer 110

Management representation letter.

Question 111

The following item is either unrelated statements, questions, excerpts, and comments taken from various parts of an auditor’s work paper file. What is the most likely source for each item?

Item: In planning the sampling application, was appropriate consideration given to the relationship of the sample to the assertion and to planning materiality?

Answer 111

Partner’s engagement review notes.

Question 112

Medical Products. Inc. (MPI) was created in 2016 and entered the optical equipment industry. Its made-to-order optical equipment requires large investments in research and development. To fund these needs, MPI made a public stock offering, which was completed in 2020. Although the offering was moderately successful, MPI’s ambitious management is convinced that it must report a good profit this year (2021) to maintain the current market price of the stock. MI’s president recently stressed this point when he told his controller, Pam Adams, “If we don’t make $1.25 million pretax this year, our stock will tank.”

Adams was pleased that even after adjustments for accrued vacation pay, 2021 pretax profit was $1.35 million. However, MI’s auditors, Hammer & Bammer (HB), proposed an additional adjustment for inventory valuation that would reduce this profit to $900,000. HB’s proposed adjustment had been discussed during the 2020 audit.

An additional issue discussed in 2020 was MP’s failure to accrue executive vacation pay. At that time HB did not insist on the adjustment because the amount ($20,000) was not material to the 2020 results and because MI agreed to begin accruing vacation pay in future years. As of the end Gf 2021, the cumulative accrued executive vacation pay amounts to $300,000.

The inventory issue arose in 2019 when MPI purchased $450,000 of specialized computer components to be used with
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its optical scanners for a special order. The order was subsequently canceled, and HB proposed to write down this inventory in 2020. MPI explained, however, that the components could easily be sold without a loss during 2021, and no adjustment was made. However, the equipment was not sold by the end of 2021, and prospects for future sales were considered nonexistent. HB proposed a write-off of the entire $450,000 in 2021.

The audit partner, Johanna Schmidt, insisted that Adams make the inventory adjustment. Adams tried to convince her that there were other alternatives, but Schmidt was adamant. Adams knew the inventory was worthless, but she reminded Schmidt of the importance of this year’s reported income. Adams continued her argument, “You can’t make us take both the write-down and the vacation accrual in one year; it doesn’t fairly present our performance this year. If you insist on making us take that write-down, I’m taking back the accrual. Actually, that’s a good idea because the executives are such workaholics, they don’t take their vacations anyway.”

As Adams calmed down, she said, “Johanna, let’s be reasonable; we want to continue our good working relationship with your firm into the future. But we won’t have a future unless we put off this accrual for another year.”

Required:
-Should the auditor insist that the inventory adjustment be made despite the impact on MI’s pre-tax profits?

Answer 112

The issue is the possible obsolescence of the specialized computer components for the special-order optical scanner.

The auditors identified these components as possible obsolete items in the prior year.

The client explained that the items could be sold without a loss. The components were not sold during the prior year or in the year just ended, and there appear to be no prospects of a future sale.

Based on these facts, the auditor should insist that the components be written down to their fair market value, which appears to be zero.

Question 113

Medical Products. Inc. (MPI) was created in 2016 and entered the optical equipment industry. Its made-to-order optical equipment requires large investments in research and development. To fund these needs, MPI made a public stock offering, which was completed in 2020. Although the offering was moderately successful, MPI’s ambitious management is convinced that it must report a good profit this year (2021) to maintain the current market price of the stock. MI’s president recently stressed this point when he told his controller, Pam Adams, “If we don’t make $1.25 million pretax this year, our stock will tank.”

Adams was pleased that even after adjustments for accrued vacation pay, 2021 pretax profit was $1.35 million. However, MI’s auditors, Hammer & Bammer (HB), proposed an additional adjustment for inventory valuation that would reduce this profit to $900,000. HB’s proposed adjustment had been discussed during the 2020 audit.

An additional issue discussed in 2020 was MP’s failure to accrue executive vacation pay. At that time HB did not insist on the adjustment because the amount ($20,000) was not material to the 2020 results and because MI agreed to begin accruing vacation pay in future years. As of the end Gf 2021, the cumulative accrued executive vacation pay amounts to $300,000.

The inventory issue arose in 2019 when MPI purchased $450,000 of specialized computer components to be used with
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its optical scanners for a special order. The order was subsequently canceled, and HB proposed to write down this inventory in 2020. MPI explained, however, that the components could easily be sold without a loss during 2021, and no adjustment was made. However, the equipment was not sold by the end of 2021, and prospects for future sales were considered nonexistent. HB proposed a write-off of the entire $450,000 in 2021.

The audit partner, Johanna Schmidt, insisted that Adams make the inventory adjustment. Adams tried to convince her that there were other alternatives, but Schmidt was adamant. Adams knew the inventory was worthless, but she reminded Schmidt of the importance of this year’s reported income. Adams continued her argument, “You can’t make us take both the write-down and the vacation accrual in one year; it doesn’t fairly present our performance this year. If you insist on making us take that write-down, I’m taking back the accrual. Actually, that’s a good idea because the executives are such workaholics, they don’t take their vacations anyway.”

As Adams calmed down, she said, “Johanna, let’s be reasonable; we want to continue our good working relationship with your firm into the future. But we won’t have a future unless we put off this accrual for another year.”

Required:
-Irrespective of your decision regarding the inventory adjustment, what is your reaction to Adams’s suggestion to release the vacation accrual? Should the auditor insist on keeping the accrual of the executives’ vacation pay?

Answer 113

In the prior year, the auditors waived the adjustment of $20,000 for accrued vacation pay based on materiality considerations.

By the end of the next year, the amount of accrued vacation pay amounted to $300,000. Since GAAP requires accrual of such expense and the amount is material, the auditor should insist on accruing the executives’ vacation pay.

Question 114

Medical Products. Inc. (MPI) was created in 2016 and entered the optical equipment industry. Its made-to-order optical equipment requires large investments in research and development. To fund these needs, MPI made a public stock offering, which was completed in 2020. Although the offering was moderately successful, MPI’s ambitious management is convinced that it must report a good profit this year (2021) to maintain the current market price of the stock. MI’s president recently stressed this point when he told his controller, Pam Adams, “If we don’t make $1.25 million pretax this year, our stock will tank.”

Adams was pleased that even after adjustments for accrued vacation pay, 2021 pretax profit was $1.35 million. However, MI’s auditors, Hammer & Bammer (HB), proposed an additional adjustment for inventory valuation that would reduce this profit to $900,000. HB’s proposed adjustment had been discussed during the 2020 audit.

An additional issue discussed in 2020 was MP’s failure to accrue executive vacation pay. At that time HB did not insist on the adjustment because the amount ($20,000) was not material to the 2020 results and because MI agreed to begin accruing vacation pay in future years. As of the end Gf 2021, the cumulative accrued executive vacation pay amounts to $300,000.

The inventory issue arose in 2019 when MPI purchased $450,000 of specialized computer components to be used with
Page 591
its optical scanners for a special order. The order was subsequently canceled, and HB proposed to write down this inventory in 2020. MPI explained, however, that the components could easily be sold without a loss during 2021, and no adjustment was made. However, the equipment was not sold by the end of 2021, and prospects for future sales were considered nonexistent. HB proposed a write-off of the entire $450,000 in 2021.

The audit partner, Johanna Schmidt, insisted that Adams make the inventory adjustment. Adams tried to convince her that there were other alternatives, but Schmidt was adamant. Adams knew the inventory was worthless, but she reminded Schmidt of the importance of this year’s reported income. Adams continued her argument, “You can’t make us take both the write-down and the vacation accrual in one year; it doesn’t fairly present our performance this year. If you insist on making us take that write-down, I’m taking back the accrual. Actually, that’s a good idea because the executives are such workaholics, they don’t take their vacations anyway.”

As Adams calmed down, she said, “Johanna, let’s be reasonable; we want to continue our good working relationship with your firm into the future. But we won’t have a future unless we put off this accrual for another year.”

Required:
-Consider the conflict between Adams and Schmidt. Assuming that Schmidt believes the inventory adjustment and vacation pay accrual must be made and that she does not want to lose the audit fee from the MPI audit. What should she do?

Answer 114

It is difficult to provide detailed guidance on how Schmidt should handle the client’s demands.

Schmidt should try to explain to Adams that GAAP requires that such adjustments are required in order for the financial statements to present fairly.

She should also point out that shareholders might react very negatively if they were to discover that management was manipulating earnings from period to period in order to maintain the stock’s price.

The potential for stockholders’ lawsuits could increase significantly. Regardless, if Schmidt believes that both adjustments are necessary, she must require the client to make the adjustments or resign from the engagement.

Question 115

According to FASB ASC Topic 450, “Contingencies,” which of the following terms means that the future event is “likely to occur”?
a) Probable.
b) Likely.
c) Reasonably possible.
d) More than remote.

Answer 115

a) Probable.

Question 116

Management should request that the attorneys provide information about all of the following except: a) A list of any pending or threatened litigation.
b) A request that the attorney describe and evaluate each pending or threatened litigation.
c) A list of litigation which has been settled prior to the current year under audit.
d) A request that the attorney comment on unasserted claims where his or her views differ from management’s evaluation.

Answer 116

c) A list of litigation which has been settled prior to the current year under audit.

Question 117

To which of the following matters would an auditor not apply materiality limits when obtaining specific written management representations?
a) Disclosure of compensating balance arrangements involving restrictions on cash balances.
b) Information concerning related-party transactions and related amounts receivable or payable.
c) Fraud involving employees with significant roles in the internal control system.
d) The absence of errors and unrecorded transactions in the financial statements.

Answer 117

c) Fraud involving employees with significant roles in the internal control system.

Question 118

All of the following are typical audit procedures used to identify subsequent events except:
a) Inquiring of management as to their knowledge of subsequent events.
b) Reading available interim financial statements from after year end.
c) Reading board meeting minutes for meetings held after year end.
d) Extending the search for unrecorded liabilities to the report date.

Answer 118

d) Extending the search for unrecorded liabilities to the report date.

Question 119

With respect to the issuance of an audit report that is dual dated because of an event occurring after the date on which the auditor has obtained sufficient appropriate audit evidence but before the audit report was issued, the auditor’s responsibility for events occurring after the completion of fieldwork is
a) Extended to include all events occurring before the audit report is issued.
b) Nonexistent- auditors have no responsibility for subsequent events.
c) Extended to cover the period up to the issuance of the next audit report.
d) Limited to the specific event referred to.

Answer 119

d) Limited to the specific event referred to.

Question 120

Smith & Jones accept an engagement to audit the 20X1 financial statements of Georgia Company and begin fieldwork in September 20X1. Georgia (December 31st year-end) gives the unaudited financial statements to the auditors on 1/17/20X2. The auditors completed the fieldwork on 3/12/20X2 and distributed the audit report on 3/23/20X2. The entity’s letter of representation should be dated _____________ and the audit report should be dated _____________.
a) March 23rd; March 12th.
b) January 17th; March 23rd.
c) March 12th; March 12th.
d) March 23rd; March 23rd.

Answer 120

c) March 12th; March 12th.

OR

d) March 23rd; March 23rd. &laquo_space;the Key only references “C” as the correct answer, but I think this would potentially be acceptable as well based on the information given. “A” and “B” are clearly wrong.

Question 121

Which of the following is an example of a subsequent event that requires disclosure in the notes to the financial statements (but not adjustments to the financial statements)?
a) An entity’s customer, who has been experiencing financial difficulty for several months, declares bankruptcy. The customer is one of over 1000 customers of the entity and appropriate reserves for any related accounts receivable have been properly maintained.
b) The entity completes an environmental cleanup. The liability for the clean-up was recorded as a contingent liability at the balance sheet date.
c) An event that confirms the auditor’s belief that a large portion of the entity’s inventory is obsolete. The issue was documented prior to the end of the fiscal year and appropriate inventory adjustments were made at the balance sheet date.
d) A chemical explosion at a customer’s warehouse occurs after the client’s balance sheet date and causes all accounts receivable from that customer to be uncollectible.

Answer 121

d) A chemical explosion at a customer’s warehouse occurs after the client’s balance sheet date and causes all accounts receivable from that customer to be uncollectible.

Question 122

Which of the following is an example of a contingent liability?
a) Accounts payable.
b) Long term debt.
c) Warranty payable.
d) All liabilities are “contingent.”

Answer 122

c) Warranty payable.

Question 123

When auditing contingent liabilities, which of the following procedures would generally be least effective?
a) Reading the minutes of the board and other committee meetings.
b) Examining all IRS documentation related to possible tax disputes.
c) Examining letters of audit inquiry.
d) Examining accounts payable confirmations.

Answer 123

d) Examining accounts payable confirmations.

Question 124

Which of the following material events occurring after the issuance of an auditor’s report would most likely cause the auditor to make further inquiries about the previously issued financial statements to determine if they may need to be restated?
a) An uninsured flood occurs that may affect the entity’s ability to continue as a going concern.
b) A major contingency is resolved that had been disclosed in the audited financial statements.
c) New information is discovered leading the auditor to believe that lease transactions during the audit
period should have been accounted for as finance leases rather than operating leases.
d) A subsidiary is sold that accounts for 25% of the entity’s consolidated revenues.

Answer 124

c) New information is discovered leading the auditor to believe that lease transactions during the audit
period should have been accounted for as finance leases rather than operating leases.