NEW AUD 3

Question 1

In connection with a proposal to obtain a new client, an accountant in public practice is asked to prepare a written report on the application of accounting principles to a specific transaction.

The accountant’s report should include a statement that

Any difference in the facts, circumstances, or assumptions presented may change the report.

The engagement was performed in accordance with Statements on Standards for Consulting Services.

The guidance provided is for management use only and may not be communicated to the prior or continuing auditors.

Nothing came to the accountant’s attention that caused the accountant to believe that the accounting principles violated GAAP.

Answer 1

Any difference in the facts, circumstances, or assumptions presented may change the report.

An accountant’s report on the application of accounting principles to a specific transaction would NOT include a statement indicating that nothing came to the accountant’s attention that caused the accountant to believe that the accounting principles violated GAAP. This type of wording is used in the review report, not in a report on the application of accounting principles.

Question 2

Which of the following items should be included in an auditor’s report for financial statements prepared using a special-purpose framework?

A sentence stating that the auditor is responsible for the financial statements.

A title that includes the word “independent.”

The signature of the company controller.

A paragraph stating that the audit was conducted in accordance with the special-purpose framework.

Answer 2

A title that includes the word “independent.”

A special-purpose framework is used in preparing the entity’s financial statements. An audit is never conducted in accordance with a special purpose framework.

Question 3

An auditor’s report would be designated a special report when it is issued in connection with

Interim financial information of a publicly held company that is subject to a limited review.

Compliance with aspects of regulatory requirements related to audited financial statements.

Application of accounting principles to specified transactions.

Limited use prospective financial statements such as a financial projection.

Answer 3

Compliance with aspects of regulatory requirements related to audited financial statements.

Auditors’ reports issued in connection with requirements to comply with contractual agreements or regulatory requirements other than GAAP are designated as special reports.

Question 4

Payroll Data Co. (PDC) processes payroll transactions for a retailer.

Cook, CPA, is engaged to express an opinion on a description of PDC’s internal controls placed in operation as of a specific date. These controls are relevant to the retailer’s internal control, so Cook’s report may be useful in providing the retailer’s independent auditor with information necessary to plan a financial statement audit.

Cook’s report should

Contain a disclaimer of opinion on the operating effectiveness of PDC’s controls.

State whether PDC’s controls were suitably designed to achieve the retailer’s objectives.

Identify PDC’s controls relevant to specific financial statement assertions.

Disclose Cook’s assessed level of control risk for PDC.

Answer 4

Contain a disclaimer of opinion on the operating effectiveness of PDC’s controls.

A report on controls placed in operation should include a disclaimer on operating effectiveness as this type of engagement does not include any tests of controls. It is not intended to provide a user auditor with a basis for reducing control risk below maximum.

Question 5

The authoritative body designated to promulgate standards concerning an accountant’s association with unaudited financial statements of an entity that is not required to file financial statements with an agency regulating the issuance of the entity’s securities is the

Financial Accounting Standards Board.

General Accounting Office.

Accounting and Review Services Committee.

Auditing Standards Board.

Answer 5

Accounting and Review Services Committee.

The standards that address unaudited financial statements are the Statements on Standards for Accounting and Review Services. These standards are issued by the AICPA Accounting and Review Services Committee.

The General Accounting Office issues governmental auditing standards.

Question 6

The clarified SSARSs applicable to preparation engagements (AR‐C 70) do not apply to the following engagements, except for

Preparing financial statements to be presented alongside a personal financial plan.

Preparing financial statements for submission to taxing authorities.

Preparing financial statement in connection with litigation services.

Assisting with preparing financial statements by performing bookkeeping services.

Answer 6

Preparing financial statements to be presented alongside a personal financial plan.

AR‐C 70 does not apply to an engagement to prepare financial statements for submission to taxing authorities.

Question 7

A CPA is reporting on comparative financial statements of a nonissuer. The CPA audited the prior year’s financial statements and reviewed those of the current year in accordance with Statements on Standards for Accounting and Review Services (SSARS). The CPA has added a separate paragraph to the review report to describe the responsibility assumed for the prior year’s audited financial statements. This separate paragraph should indicate

The type of opinion expressed previously.

That the CPA did not update the assessment of control risk.

The reasons for the change from an audit to a review.

That the audit report should no longer be relied on.

Answer 7

The type of opinion expressed previously.

Question 8

According to PCAOB auditing standards, a “stated control objective” is best described as

The specific control objective that management has failed to identify and that, therefore, constitutes a material weakness.

The specific control objective identified by management that, if achieved, would result in the material weakness no longer existing.

A strategic objective of those charged with governance.

The related internal control activities that make it probable that the auditor can assess control risk as low.

Answer 8

The specific control objective identified by management that, if achieved, would result in the material weakness no longer existing.

AS Section 6115 (para. 16) states: “A stated control objective in the context of an engagement to report on whether a material weakness continues to exist is the specific control objective identified by management that, if achieved, would result in the material weakness no longer existing.”

Question 9

Sally is an auditor at PWC’s Chicago office. She is on the audit team for the Anchorage Peninsula Corporation (APC). Under which of the following circumstances would there be an independence problem under the new AICPA rules?

I. Sally’s mother inspects labels on jars for APC.
II. Sally’s grown son, who is not dependent on her, is director of financial reporting for APC.
III. Sally’s sister Suzy has a material financial interest in APC of which Sally is aware, but it does not allow her to exert significant influence over APC.

I only

II only.

III only.

II and III.

Answer 9

II and III.

Because both the II and III answers create independence problems, this is the best answer.

Question 10

The risk of incorrect acceptance and the likelihood of assessing control risk too low relate to the

Effectiveness of the audit.

Efficiency of the audit.

Preliminary estimates of materiality levels.

Allowable risk of tolerable error.

Answer 10

Effectiveness of the audit.

The risk of incorrect acceptance and the likelihood of assessing control risk too low are both related to the effectiveness of the audit. The risk of incorrect rejection and the risk of assessing control risk too high pertain to the efficiency of the audit.

Question 11

Which of the following types of audit evidence provides the least assurance of reliability?

Receivable confirmations received from the client’s customers.

Prenumbered receiving reports completed by the client’s employees.

Prior months’ bank statements obtained from the client.

Municipal property tax bills prepared in the client’s name.

Answer 11

Prenumbered receiving reports completed by the client’s employees.

Bank statements are generated by an independent source and are more reliable than evidence obtained from within the client entity (such as receiving reports). The auditor would prefer that such evidence be obtained directly from the bank, but, in the absence of any indication of alteration, the bank statement would be viewed as pretty reliable even if obtained from the client entity.

Question 12

Under the ethical standards of the profession, which of the following is a “permitted loan” regardless of the date it was obtained?

Home mortgage loan.

Student loan.

Secured automobile loan.

Personal loan.

Answer 12

Secured automobile loan.

This answer is incorrect because a home mortgage loan is not acceptable (unless “grandfathered” in when the current standard was established).

Question 13

The clarified SSARSs deal with each of the following engagements involving nonissuers, except for

Performing reviews.

Preparing financial statements.

Performing compilations.

Performing agreed‐upon procedures on financial statement items.

Answer 13

Performing agreed‐upon procedures on financial statement items.

Question 14

Which of the following procedures is more likely to be performed in a review engagement of a nonpublic entity than in a compilation engagement?

Gaining an understanding of the entity’s business transactions.

Making a preliminary assessment of control risk.

Obtaining a representation letter from the chief executive officer.

Assisting the entity in adjusting the accounting records.

Answer 14

Obtaining a representation letter from the chief executive officer.

The accountant is required to gain an understanding of the entity’s business transactions for both a compilation and a review.

Question 15

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

Adverse opinion or a disclaimer of opinion.

Qualified opinion or an adverse opinion.

Disclaimer of opinion or an unmodified opinion with a separate explanatory paragraph.

Unmodified opinion with a separate emphasis‐of‐matter paragraph or a qualified opinion.

Answer 15

Qualified opinion or an adverse opinion.

Failure to properly account for or disclose an illegal act that has a material effect on the financial statements is a generally accepted accounting principle (GAAP) departure. Material GAAP departures result in either a qualified or an adverse opinion. It is not appropriate to issue a disclaimer for a GAAP departure. A disclaimer results from a pervasive scope limitation.

Question 16

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

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

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

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

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

Answer 16

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

You need to be careful on negatively worded questions. Here, they are looking for the cases in which a disclaimer would NOT be appropriate. A disclaimer is issued when a pervasive scope limitation exists. The failure of the chief executive officer to sign the management representation letter represents a scope limitation that would likely result in a disclaimer of opinion.

Question 17

Elimination of a material weakness several months prior to year‐end is most likely to result in what form of audit opinion?

Adverse.

Disclaimer.

Qualified.

Unqualified.

Answer 17

Unqualified.

This answer is incorrect because an adverse opinion is appropriate when a material weakness exists at year‐end.

Question 18

Which of the following is not a duty owed by a member in business?

To be candid and truthful when communicating with an employer’s external auditor.

To correct inaccurate financial statements or entries.

To be independent in fact and appearance.

To decline gifts or entertainment that would violate an employer’s rules or be unreasonable in the circumstances.

Answer 18

To be independent in fact and appearance.

Question 19

Which of the following best describes what is meant by the term “generally accepted auditing standards”?

Procedures to be used to gather evidence to support financial statements.

The ten specific criteria that measure the quality of the auditor’s performance.

The Statements on Auditing Standards issued by the Auditing Standards Board.

Rules acknowledged by the accounting profession because of their universal application.

Answer 19

The Statements on Auditing Standards issued by the Auditing Standards Board.

Generally accepted auditing standards are measures of the quality of the auditor’s performance. While specific auditing procedures may be required by GAAS, the procedures alone are not the best description of GAAS.

Question 20

What is an auditor’s responsibility for supplementary information required by the GASB that is placed outside the basic financial statements?

Label the information as unaudited and expand the auditor’s report to include a disclaimer on the information.

Add an other‐matter paragraph to the auditor’s report and refer to the information as “required supplementary information.”

Apply limited procedures to the information and report deficiencies in, or the omission of, the information.

Audit the required supplementary information in accordance with generally accepted governmental auditing standards.

Answer 20

Apply limited procedures to the information and report deficiencies in, or the omission of, the information.

The auditor’s responsibility for supplementary information required by the GASB that is placed outside the basic financial statements is limited to applying certain procedures to the information and reporting deficiencies in, or the omission of, the information. The auditor is not required to audit the required supplementary information in accordance with Government Auditing Standards.

Question 21

ABC Company is audited by the Albuquerque office of Whitt CPAs. Which of the following individuals would be least likely to be considered a “covered member” by the AICPA Code of Professional Conduct independence standard?

Staff assistant on the audit.

An audit partner in the Silver Springs office who performs no attest services for ABC Company.

A tax partner in Albuquerque who performs no attest services for ABC Company or for any other firm clients.

The partner in charge of Whitt CPAs (she does not work on the ABC Company audit).

Answer 21

An audit partner in the Silver Springs office who performs no attest services for ABC Company.

This answer is incorrect because all partners in the practice office in which the audit is performed are considered covered members.

Question 22

In obtaining written representations from management, materiality limits ordinarily would apply to representations related to

Amounts concerning related party transactions.

Fraud involving members of management.

The availability of financial records.

The completeness of minutes of directors’ meetings.

Answer 22

Amounts concerning related party transactions.

Management states that all financial records have been made available. Materiality is not a consideration.

Question 23

Which of the following analyses appearing in a predecessor’s working papers is the successor auditor least likely to be interested in reviewing?

Analysis of noncurrent balance sheet accounts.

Analysis of current balance sheet accounts.

Analysis of contingencies.

Analysis of income statement accounts.

Answer 23

Analysis of income statement accounts.

This answer is incorrect because the successor auditor will normally review working papers relating to matters of continuing accounting significance. Contingencies are of continuing significance and should be reviewed.

Question 24

Which of the following is correct concerning a CPA firm’s preparation of financial statements engagement?

The statements should only be used by management and not third parties.

A written engagement letter or oral agreement is required.

No accountant’s report ordinarily accompanies the financial statements.

At a minimum, the accountant preparing the financial statements must comply with the compilation standards.

Answer 24

No accountant’s report ordinarily accompanies the financial statements.

This answer is incorrect because a written agreement is required.

Question 25

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

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

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

Reconciling the cash balance per books with the cutoff bank statement and the bank confirmation.

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

Answer 25

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

The pledging of assets as collateral is a normal business transaction and it need not necessarily indicate a question of going concern status.

Question 26

In a properly designed accounts payable system, a voucher is prepared after the invoice, purchase order, requisition, and receiving report are verified. The next step in the system is to

Cancel the supporting documents.

Enter the check amount in the check register.

Approve the voucher for payment.

Post the voucher amount to the expense ledger.

Answer 26

Approve the voucher for payment.

This answer is incorrect because the voucher must first be approved before a liability and expense are recorded.

Question 27

An auditor should ordinarily add an explanatory paragraph to the auditor’s report to identify a material matter related to

A change in reporting entity resulting from a specific transaction or event.

A change in classification in previously issued financial statements.

A correction of a material misstatement in previously issued financial statements.

All of the above.

Answer 27

A correction of a material misstatement in previously issued financial statements.

The PCAOB identifies two specific matters that affect the auditor’s evaluation of consistency of financial statements: (1) a change in accounting principle; and (2) an adjustment to correct a misstatement in previously issued financial statements (i.e., a “restatement”).

Question 28

Which of the following factors most likely would cause a CPA to decline to accept a new audit engagement?

The CPA does not understand the entity’s operations and industry.

Management acknowledges that the entity has had recurring operating losses.

The CPA is unable to review the predecessor auditor’s working papers.

Management is unwilling to permit inquiry of its legal counsel.

Answer 28

Management is unwilling to permit inquiry of its legal counsel.

This answer is incorrect because valid reasons may exist making it impossible to review the predecessor’s working papers and because such a review is not required.

Question 29

An auditor would issue an adverse opinion if

The audit was begun by other independent auditors who withdrew from the engagement.

A qualified opinion cannot be given because the auditor lacks independence.

The restriction on the scope of the audit was significant.

The statements taken as a whole do not fairly present the financial condition and results of operations of the company.

Answer 29

The statements taken as a whole do not fairly present the financial condition and results of operations of the company.

This answer is incorrect because a scope restriction will lead to either a qualified opinion or a disclaimer of opinion.

Question 30

The sampling distribution should approximate the normal distribution.

Overstated units have a lower probability of sample selection than units that are understated.

The auditor controls the risk of incorrect acceptance by specifying that risk level for the sampling plan.

The sampling interval is calculated by dividing the number of physical units in the population by the sample size.

Answer 30

The auditor controls the risk of incorrect acceptance by specifying that risk level for the sampling plan.

This answer is incorrect because PPS sampling does not assume a normal distribution.

Question 31

Which of the following internal control procedures would most likely be used to maintain accurate inventory records?

Perpetual inventory records are periodically compared with the current cost of individual inventory items.

A just‐in‐time inventory ordering system keeps inventory levels to a desired minimum.

Requisitions, receiving reports, and purchase orders are independently matched before payment is approved.

Periodic inventory counts are used to adjust the perpetual inventory records.

Answer 31

Periodic inventory counts are used to adjust the perpetual inventory records.

The comparison of perpetual inventory records with the current cost of individual items ensures that the items are priced at the lower of cost or market. It does not provide a control over the accuracy of the inventory records.

Question 32

An auditor is performing substantive tests of pricing and extensions of perpetual inventory balances consisting of a large number of items. Past experience indicates numerous pricing and extension errors. Which of the following statistical sampling approaches is most appropriate?

Unstratified mean‐per‐unit.

Probability‐proportional‐to‐size.

Stop or go.

Ratio estimation.

Answer 32

Ratio estimation.

The unstratified mean‐per‐unit method will typically provide a larger sample size than the ratio estimation method to achieve the same level of sampling risk.

Question 33

When assessing internal auditors’ objectivity, an independent auditor should

Consider the policies that prohibit the internal auditors from auditing areas where they were recently assigned.

Review the internal auditors’ reports to determine that their conclusions are consistent with the work performed.

Verify that the internal auditors’ assessment of control risk is comparable to the independent auditor’s assessment.

Evaluate the quality of the internal auditors’ working paper documentation and their recent audit recommendations.

Answer 33

Consider the policies that prohibit the internal auditors from auditing areas where they were recently assigned.

This answer is incorrect because the professional standards do not address reviewing internal auditors’ reports to determine that conclusions are consistent with work performed for purposes of considering independence.

Question 34

Which of the following is not an objective of a CPA’s examination of a client’s management discussion and analysis (MD&A) prepared pursuant to Securities and Exchange Commission rules and regulations?

The historical amounts have been accurately derived, in all material respects, from the entity’s financial statements.

The presentation is in conformity with rules and regulations adopted by the Securities and Exchange Commission.

The underlying information, determinations, estimates and assumptions of the entity provide a reasonable basis for the disclosures contained herein.

The presentation includes the required elements of MD&A.

Answer 34

The presentation is in conformity with rules and regulations adopted by the Securities and Exchange Commission.

You Answered Incorrectly.
This is one of three objectives of an MD&A examination agreement.

Question 35

Difference between when a litigation loss is “reasonably possible” versus “probable”

Answer 35

Reasonably possible - just note it in the financial statements
Probable - book an adjusting journal entry

Question 36

A journal entry is appropriate because the loss is considered probable and estimable. When all points in a range such as that presented in the question are equally probable, its low end is selected

Answer 36

Example - probable estimated loss is between $3M and $5M, you would book a $3M adjusting JE

Question 37

Consigned goods were recorded at their sales value of $6K in Consigned Inventory. The cost of the inventory is $4K. Accordingly, proper accounting for this transaction is:
[Original text] to establish a receivable as of year‐end for $6,000.
[Delete Text]
to establish a receivable for $4,000.
to establish a receivable for $9,000.
to establish consigned inventory for $4,000.
to establish consigned inventory for $6,000.
to establish consigned inventory for $9,000.

Answer 37

to establish consigned inventory for $4,000.

Inventory items consigned to a customer should be recorded at their cost (or market if lower) until the customer sells those goods, at which time a receivable may be established.

Question 38

An underlying feature of random‐based selection of items is that each

Stratum of the accounting population be given equal representation in the sample.

Item in the accounting population be randomly ordered.

Item in the accounting population should have an opportunity to be selected.

Item must be systematically selected using replacement.

Answer 38

Item in the accounting population should have an opportunity to be selected.

Every item in the accounting population should have an opportunity to be selected.

Question 39

If the auditor is concerned that a population may contain exceptions, the determination of a sample size sufficient to include at least one such exception is a characteristic of

Discovery sampling.

Variables sampling.

Random sampling.

Dollar‐unit sampling.

Answer 39

Discovery sampling.

Discovery sample sizes and related discovery sampling tables are constructed to measure the probability of at least one error occurring in a sample if the error rate in the population exceeds the tolerable rate.

Question 40

If certain forms are not consecutively numbered

Selection of a random sample probably is not possible.

Systematic sampling may be appropriate.

Stratified sampling should be used.

Random number tables cannot be used.

Answer 40

Systematic sampling may be appropriate.

Systematic sampling is a procedure where a random start is obtained and then every nth item is selected. For example, a sample of forty from a population of a thousand would require selecting every 25th item after obtaining a random start between items 1 through 25.