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Flashcards in Reporting Deck (143):
1

4 Reporting Standards associated with GAAS (and currently still associated with the PCAOB's auditing standards)

  • TID PIE GCDO!!!

  1. GAAP—"The auditor must state in the auditor's report whether the financial statements are presented in accordance with generally accepted accounting principles (GAAP)."
  2. Consistency—"The auditor must identify in the auditor's report those circumstances in which such principles have not been consistently observed in the current period in relation to the preceding period."
  3. Disclosure—"When the auditor determines that informative disclosures are not reasonably adequate, the auditor must so state in the auditor's report."
  4. Opinion—"The auditor must either express an opinion regarding the financial statements, taken as a whole, or state that an opinion cannot be expressed, in the auditor's report. When the auditor cannot express an overall opinion, the auditor should state the reasons therefore in the auditor's report. In all cases where an auditor's name is associated with financial statements, the auditor should clearly indicate the character of the auditor's work, if any, and the degree of responsibility the auditor is taking, in the auditor's report."

2

For an entity's financial statements to be presented fairly in conformity with generally accepted accounting principles, the principles selected should?

  1. be prepared in accordance with the identified financial reporting framework
  2. be appropriate in the circumstances
  3. provide information about matters that may affect the use, understanding, and interpretation of the financial statements; 
  4. classify and summarize information in a reasonable manner; and 
  5. reflect transactions in a manner that presents the financial position, results of operations, and cash flows stated within a range of reasonable and practicable limits.

3

The presentation of unaudited financial statements in comparative form with audited financial statements requires that?

The unaudited financial statements be clearly differentiated. In addition, the accompanying report should either include a reissued report on the prior year financial statements or a separate EOM paragraph in the report indicating the responsibility assumed for the prior period financial statements.

4

Under what circumstance is the Audit Report not addressed to the entity who's FS are under audit?

While audit reports are ordinarily addressed to the company whose financial statements are being audited, when a CPA audits the financial statements of a company that is not his or her client, the report is addressed to the company that hired the CPA.

5

Jewel, CPA, audited Infinite Co.'s prior year financial statements. These statements are presented with those of the current year for comparative purposes without Jewel's auditor's report, which expressed a qualified opinion. In drafting the current year's auditor's report, Crain, CPA, the successor auditor, should

  1. Not name Jewel as the predecessor auditor.
  2. Indicate the type of report issued by Jewel.
  3. Indicate the substantive reasons for Jewel's qualification.

1, 2 & 3

An other-matter paragraph should be added to the successor's report and it should indicate

  1. that the financial statements of the prior period were audited by another auditor (whose name is not presented),
  2. the date of the predecessor's report,
  3. the type of report issued by the predecessor, and
  4. if the report was other than a standard report, the substantive reasons therefore.

6

A client is presenting comparative (two-year) financial statements. Which of the following is correct concerning reporting responsibilities of a continuing auditor?

  1. The auditor should issue one audit report that is on both presented years.
  2. The auditor should issue two audit reports, one on each year.
  3. The auditor should issue one audit report, but only on the most recent year.
  4. The auditor may issue either one audit report on both presented years, or two audit reports, one on each year.

The auditor should issue one audit report that is on both presented years.

7

When an accountant performs more than one level of service (for example, a compilation and a review, or a compilation and an audit) concerning the financial statements of a nonissuer (nonpublic) entity, the accountant generally should issue the report that is appropriate for?

The highest level of service rendered.

8

In May 20X9, an auditor reissues the auditor's report on the 20X7 financial statements at a continuing client's request. The 20X7 financial statements are not restated and the auditor does not revise the wording of the report. The auditor should

  1. Dual date the reissued report.
  2. Use the release date of the reissued report.
  3. Use the original report date on the reissued report.
  4. Use the current period auditor's report date on the reissued report.

Use the original report date on the reissued report.Use the original report date on the reissued report.

Use of the original date on the reissued audit report removes any implication that records, transactions or events after the date of the audit report have been examined or reviewed.

9

For a nonpublic company, which section (paragraph) of the audit report includes a statement that the auditor believes that the audit evidence obtained is sufficient?

Auditor's Responsibility

10

A CPA wishes to determine how various publicly held companies have complied with the disclosure requirements of a new financial accounting standard. Which of the following information sources would the CPA most likely consult for information?

  1. AICPA Codification of Statements on Auditing Standards.
  2. AICPA Accounting Trends and Techniques.
  3. SEC Quality Control Review.
  4. SEC Statement 10-K Guide.

AICPA Accounting Trends and Techniques, which is issued annually, summarizes such disclosures of 600 industrial and merchandising corporations.

11

A registration statement filed with the SEC contains the reports of two independent auditors on their audits of financial statements for different periods. The predecessor auditor who audited the prior period financial statements generally should obtain a letter of representation from the

  1. Successor independent auditor.
  2. Client's audit committee.
  3. Principal underwriter.
  4. Securities and Exchange Commission.

AU-C 920 requires that the predecessor (1) read pertinent portions of the document, and (2) obtain a letter of representation from the successor auditor.

12

The predecessor auditor, who is satisfied after properly communicating with the successor auditor, has reissued a report because the audit client desires comparative financial statements. The predecessor auditor's report should make

  1. Reference to the report of the successor auditor only in the scope paragraph.
  2. Reference to the work of the successor auditor in the scope and opinion paragraphs.
  3. Reference to both the work and the report of the successor auditor only in the opinion paragraph.
  4. No reference to the report or the work of the successor auditor.

The predecessor auditor should not refer in the reissued report to the report or work of the successor auditor.

13

What Statement Type?

The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note X to the financial statements, the Company has suffered recurring losses from operations and has a net capital deficiency that raise substantial doubt about its ability to continue as a going concern. Management's plans in regard to these matters are also described in Note X. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. Our opinion is not modified with respect to this matter.

Emphasis-of-Matter (presented after the opinion paragraph)

14

What statement type?

In our report dated March 1, 20X1, we expressed an opinion that the 20X0 financial statements did not fairly present the financial position, results of operations, and cash flows of ABC Company in accordance with accounting principles generally accepted in the United States of America because of two departures from such principles: (1) ABC Company carried its property, plant, and equipment at appraisal values, and provided for depreciation on the basis of such values, and (2) ABC Company did not provide for deferred income taxes with respect to differences between income for financial reporting purposes and taxable income. As described in Note X, the Company has changed its method of accounting for these items and restated its 20X0 financial statements to conform with accounting principles generally accepted in the United States of America. Accordingly, our present opinion on the restated 20X0 financial statements, as presented herein, is different from that expressed in our previous report.

Other Matter (presented after the opinion and emphasis-of-matter paragraphs)

15

Emphasis of Matter - Required and Not Required but Possible

Required

  1. Substantial doubt re: going concern
  2. Inconsistency in accounting principles used
  3. FS prepared in accordance with special purpose frameworks

Not required but possible

  1. An uncertainty as to the outcome of unusually important litigation or regulator action;
  2. A major catastrophe or casualty having a significant effect;
  3. Significant transactions with related parties; or
  4. Unusually important subsequent events.

16

Other Matter Paragraph - Auditor's Judgment as to Use

  1. Relevant to users' understanding of the audit — In rare situations, the auditor may add an other-matter paragraph to explain why it was not possible for the auditor to withdraw from an engagement in which a scope limitation that was pervasive resulted in a disclaimer of opinion.
  2. Relevant to users' understanding of the auditor's responsibilities or the auditor's report — For example, when the opinion expressed on the prior year's financial statements is different than the opinion previously expressed (as a result of management's correction of a material departure from the applicable financial reporting framework).

17

Modified Opinion Definition and Types

The auditor's objective is to express clearly an appropriately modified opinion when

  1. the auditor concludes that the financial statements as a whole are misstated; or
  2. the auditor is unable to obtain sufficient appropriate audit evidence to conclude that the financial statements as a whole are free from material misstatement. 

3 Modified Report Types:

  1. A Qualified Opinion
  2. An Adverse Opinion
  3. A Disclaimer of Opinion

18

  • Effects that are not confined to specific elements, accounts or items of the financial statements;
  • effects that, if so confined, represent or could represent a substantial proportion of the financial statements; or
  • regarding disclosures, are fundamental to users' understanding of the financial statements.

Pervasive Concept

19

Opinion Choice for a Scope Limitation - Involves Judgment

  • Impact on Audit Report

  • Qualified opinion  --  The auditor should express a qualified opinion when the auditor is unable to obtain sufficient appropriate audit evidence, and the auditor concludes that the possible effect on the financial statements, if any, could be material, but not pervasive. (This lesson focuses on the qualified opinion in connection with a scope limitation.)
  • Disclaimer of opinion  --  The auditor should express a disclaimer of opinion when the auditor is unable to obtain sufficient appropriate audit evidence, and the auditor concludes that the possible effect on the financial statements, if any, could be material and pervasive. (A separate lesson focuses on the disclaimer of opinion.)

20

What types of circumstances would give rise to a scope limitation on an audit?

  • Circumstances beyond the control of the entity  --  for example, the entity's accounting records have been destroyed.
  • Circumstances related to the nature or timing of the auditor's work  --  for example, the auditor determines that substantive procedures alone are not sufficient and the entity's controls are ineffective; the auditor is unable to obtain audited financial statements of an investee (accounted for using the equity method); or the timing of the auditor's appointment does not permit the auditor to observe the physical counting of inventories.
  • Limitations imposed by management  --  for example, management prevents the auditor from requesting external confirmation of certain account balances. The auditor should request that management remove any such limitation.
    • If management refuses—the auditor should communicate the matter to those charged with governance and determine whether it is possible to perform alternative procedures to obtain sufficient appropriate audit evidence.
    • If unable to obtain sufficient appropriate audit evidence (and if the effects could be both material and pervasive)—the auditor should withdraw from the audit (when practicable) or issue a disclaimer of opinion.

21

Effect of a Qualification for a Scope Limitation on the Auditor's Report

  • No effect on the introductory paragraph or management's responsibility section.
  • Auditor's responsibility section—modify the last sentence to state, "We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our qualified audit opinion."
  • Add a "Basis for Qualified Opinion" paragraph (with such a label) before the opinion paragraph.
  • Qualify the opinion using appropriate language such as: "In our opinion, except for the possible effects of the matter described in the Basis for Qualified Opinion paragraph, the financial statements referred to above present fairly . . ." and label the opinion paragraph "Qualified Opinion."

22

Opinion Choice for a Misstatement (Including Inadequate Disclosure) Involves Judgment

  • Qualified opinion  --  The auditor should express a qualified opinion when the auditor concludes that misstatements are material, but not pervasive to the financial statements
  • Adverse opinion  --  The auditor should express an adverse opinion when the auditor concludes that misstatements are material, and pervasive to the financial statements. (A separate lesson focuses on the adverse opinion.)

23

Effect of a Qualification for a Misstatement on the Auditor's Report

  • No effect on the introductory paragraph or management's responsibility section
  • Auditor's responsibility sectionmodify the last sentence to state, "We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our qualified audit opinion."
  • Add a "Basis for Qualified Opinion" paragraph (with such a label) before the opinion paragraph. The auditor should include a description and quantification of the financial effects of the misstatement (when practicable); likewise, the auditor should include the omitted information (when practicable).
  • Qualify the opinion using appropriate language such as: "In our opinion, except for the effects of the matter described in the Basis for Qualified Opinion paragraph, the financial statements referred to above present fairly . . ." and label the opinion paragraph "Qualified Opinion."

24

Adverse Opinion

Adverse opinion  --  The auditor should express an adverse opinion when the auditor concludes that misstatements are material, and pervasive to the financial statements.

25

Effect of an Adverse Opinion on the Auditor's Report

  • No effect on the introductory paragraph or management's responsibility section.
  • Auditor's responsibility sectionmodify the last sentence to state, "We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our adverse audit opinion."
  • Add a "Basis for Adverse Opinion" paragraph (with such a label) before the opinion paragraph. The auditor should include a description and quantification of the financial effects of the misstatement (when practicable); likewise, the auditor should include the omitted information (when practicable).
  • Express the adverse opinion using appropriate language such as: "In our opinion, because of the significance of the matter discussed in the Basis for Adverse Opinion paragraph, the financial statements referred to above do not present fairly. . ." and label the opinion paragraph "Adverse Opinion."

26

Opinion Choice for a Scope Limitation Involves Judgment

  • Disclaimer of Opinion

Remember - for qualified, unable to obtain SAAE, and it could be material but not pervasive = qualified.  However, 

Disclaimer of opinion  --  The auditor should express a disclaimer of opinion when the auditor is unable to obtain sufficient appropriate audit evidence, and the auditor concludes that the possible effect on the financial statements, if any, could be material and pervasive.

27

Effect of a Disclaimer of Opinion on the Auditor's Report

  • remember that with Disclaimer, the intro paragraph is slightly modified...and
  • the phrase we do not express an opinion on these financial statements

  • Minor effect on the introductory paragraph ("We were engaged to audit ...") and no effect on the management's responsibility section.
  • Auditor's responsibility section -- revise this section to consist of the following 2 sentences: "Our responsibility is to express an opinion on these financial statements based on conducting the audit in accordance with auditing standards generally accepted in the United States of America. Because of the matter described in the Basis for Disclaimer of Opinion paragraph, however, we were not able to obtain sufficient appropriate audit evidence to provide a basis for an audit opinion."
  • Add a "Basis for Disclaimer of Opinion" paragraph (with such a label) before the opinion paragraph.
  • Disclaim an opinion using appropriate language such as: "Because of the significance of the matter described in the Basis for Disclaimer of Opinion paragraph, we have not been able to obtain sufficient appropriate audit evidence to provide a basis for an audit opinion. Accordingly, we do not express an opinion on these financial statements." Add an appropriate title preceding the paragraph, such as "Disclaimer of Opinion."

28

These situations would compel the auditor to issue what?

  • The auditor is unable to determine the amounts associated with an employee fraud scheme.
  • 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.
  • The auditor is engaged after fiscal year-end and is unable to observe physical inventories or apply alternative procedures to verify their balances.
  •  The auditor is unable to determine the amounts associated with illegal acts committed by the client's management.
  •  The client refuses to permit its attorney to furnish information requested in a letter of audit inquiry.
  •  The auditor is unable to obtain the audited financial statements of a consolidated investee.
  • The company failed to make a count of its physical inventory during the year and the auditor was unable to apply alternative procedures to verify inventory quantities.
  • Management refuses to allow the auditor to have access to the company's canceled checks and bank statements.

Disclaimer of Opinion.  A disclaimer is issued when the scope limitations pertaining to the audit are so pervasive that the auditor in unable to express an opinion.

Questions might include a situation where a lack of adequate disclosures in the financial statements, i.e. a GAAP departure, not a scope limitation, is one of the answers - GAAP departures would not result in a disclaimer, but rather a qualified or adverse opinion. 

29

An auditor concludes that extreme doubt exists about the integrity of management and the representations obtained from management relating to the fairness of the financial statements and the completeness of the record of transactions. If the auditor retains the client, which audit report is most likely to be appropriate?

A.  Unmodified with emphasis-of-matter paragraph.
B.  Standard unmodified.
C.  Disclaimer.
D.  Adverse.

Disclaimer - the professional standards consider this as a scope limitation and accordingly its significant nature makes a disclaimer most likely.

30

When the auditor's opinion covers 2 (or more) periods?

The auditor should evaluate the consistency between such periods, as well as the consistency of the earliest period covered by the auditor's opinion with the prior period.

  1. Change in accounting principle
  2. Correction of a material misstatement in previously issued financial statements

31

When an auditor's opinion covers multiple periods, the auditor should evalute for consistency, particularly with regard to:

  1. changes in accounting principle (when criteria are met and when not met)
  2. corrections of material misstatements in previously issued financial statements

The auditor should evaluate a change in accounting principles about 4 matters:

  1. Whether the adopted principle is in accordance with the applicable financial reporting framework;
  2. Whether the method of accounting for the effect of the change is in accordance with the applicable financial reporting framework;
  3. Whether the disclosures about the change are adequate; and
  4. Whether the entity has justified that the alternative adopted is preferable. (The issuance of an accounting pronouncement that requires or expresses a preference for an accounting principle is considered sufficient justification for a change in principle.)

If all 4 of these criteria are met (and the change has a material effect on the FS), the auditor should:

  1. Include the EOM paragraph in subsequent periods until the new principle is applied in all periods presented.
  2. If the change is accounted for by retrospective application to the financial statements, the EOM paragraph is only needed in the period of the change.

If 1 of these criteria fails (and the change has a material effect on the FS), the auditor should:

  1. The auditor should evaluate whether the change results in a material misstatement and consider whether the auditor's report should be modified.

32

When an auditor's opinion covers multiple periods, the auditor should evalute for consistency, particularly with regard to:

  • changes in accounting principle
  • corrections of material misstatements in previously issued financial statements

  1. When the FS are restated to correct a prior material misstatement  --  the auditor should include an EOM paragraph in the auditor's report. (That paragraph need not be included in subsequent periods.) The auditor should state that the auditor's opinion is not modified regarding the matter.
  2. If the financial statement disclosures relating to the restatement are not adequate  --  the auditor should evaluate the inadequacy of disclosure and consider whether the auditor's report should be modified.
  3. A change from an accounting principle that is not in accordance with the applicable financial reporting framework to one that is in accordance is a correction of a misstatement.

33

Other Information

Note: The auditor is not required to reference the other information in the auditor's report, but may choose to include a disclaimer of opinion on it to avoid any confusion.

Information other than the FS and the auditor's report that is included in a document containing audited financial statements and the auditor's report (can be financial and nonfinancial information, but excludes required supplementary information).

  • Financial summaries or highlights,
  • management reports on operations,
  • employment data,
  • financial ratios,
  • selected quarterly data,
  • employment data,
  • names of officers/directors, etc.

34

Inconsistencies

Actions when identified prior and after the audit report date?

Other information (see card) that conflicts with information contained in the audited financial statements (may raise doubt about the auditor's conclusions and the basis for the auditor's opinion).

  • Material inconsistencies identified prior to the report release date
  1. Request that management make appropriate revision.
  2. If management refuses  --  inform those charged with governance and (a) include an other-matter paragraph to the auditor's report, (b) withhold the auditor's report, or (c) withdraw from the engagement (when permitted).
  • Material inconsistencies identified after the report release date 
  1. If management agrees to make the revision  --  the auditor may review steps taken by management to ensure that users of the financial statements and other information are informed of the need for revision.
  2. If management refuses  --  inform those charged with governance and take appropriate action (such as seeking advice from the auditor's legal counsel).

 

 

35

Material Misstatements of Fact

The auditor should discuss the matter with management and, if there is a material misstatement of fact, the auditor should:

  1. Request management to consult with a qualified third party (such as the entity's legal counsel).

If management refuses to correct a material misstatement of fact, the auditor should communicate the matter to those charged with governance.

36

When audited financial statements are presented in a client's document containing other information, the auditor should?

Read the other information to determine that it is consistent with the audited financial statements.

When the audited financial statements are presented in a client's document containing other information, the auditor is required to read the other information to determine whether it is consistent with the audited financial statements.

37

An auditor may issue an unmodified opinion on less than a complete set of financial statements if?

  • Remember - if client presents financial position and results of operations, what else must be presented?

The auditor's scope is not restricted.

However, when a company presents financial statements that purport to present financial position and results of operations (e.g., balance sheet and an income statement) a statement of cash flows must also be presented. 

38

If an auditor is presented with financial position of the company and the results of operations, what also must be presented?

  • Type of report issued if not presented?

Statement of Cash Flows is required! The omission of a statement of cash flows in such a circumstance is a departure from GAAP that requires issuance of a qualified opinion (or possibly an adverse opinion). Additionally, the auditor need not present the missing statement of cash flows in a basis for modification paragraph of the audit report.

39

Which of the following is correct concerning an agreed-upon procedure engagement performed under the attestation standards?

  1. The minimum procedures to be performed include a consideration of internal control.
  2. The use of the report is ordinarily restricted to management.
  3. Mere reading of an assertion ordinarily constitutes a minimum sufficient procedure to issue a report.
  4. A written assertion is generally not required.

A written assertion is generally not required. Agreed-upon procedures engagements ordinarily do not require a written assertion.

40

If supplementary information in a document accompanying the basic financial statements has been subjected to auditing procedures, the auditor may include in the auditor's report on the financial statements an opinion that the accompanying information is fairly stated in

  1. Accordance with generally accepted auditing standards.
  2. Conformity with generally accepted accounting principles.
  3. All material respects in relation to the financial statements as a whole.
  4. Accordance with attestation standards expressing a conclusion about management's assertions.

All material respects in relation to the financial statements as a whole. When an auditor has been engaged to determine whether supplementary information is fairly stated in relation to the financial statements, the auditor may include in the auditor's report on the financial statements an opinion that the accompanying information is fairly stated in all material respects in relation to the financial statements as a whole.

41

If management declines to present supplementary information required by the Governmental Accounting Standards Board (GASB), the auditor should issue a(n)

  1. Adverse opinion.
  2. Qualified opinion with an other-matter paragraph.
  3. Unmodified opinion.
  4. Unmodified opinion with an additional explanatory paragraph.

Unmodified opinion with an additional explanatory paragraph. Failure to include supplementary information required by the Governmental Accounting Standards Board would result in an unmodified opinion with an other-matter paragraph. A qualified opinion would not be appropriate.

42

An alert to restrict the auditor's report is required when:

  1. The auditor's report is modified for a scope limitation that is considered to be material and pervasive.
  2. The subject matter is based on criteria that are suitable and available to all users.
  3. The report is considered to be a by-product to the primary objective of the engagement.
  4. The auditor's report includes an other matter paragraph to clarify the auditor's responsibilities.

The report is considered to be a by-product to the primary objective of the engagement

An alert to restrict the use of the auditor's report is required when (1) the subject matter is based on criteria that are only suitable or available to a limited number of users; or (2) when the matters are presented in a by-product report that is not the primary objective of the engagement.

43

The financial statements of KCP America, a U.S. entity, are prepared for inclusion in the consolidated financial statements of its non-U.S. parent. These financial statements are prepared in conformity with the accounting principles generally accepted in the parent's country and are for use only in that country.

How may KCP America's auditor report on these financial statements?

  1. A U.S.-style report (without revision).
  2. A U.S.-style report revised to reference the accounting principles of the parent's country.
  3. The report form of the parent's country.

2 and 3. Provided that the financial statements prepared in conformity with another country's GAAP are for use only outside the United States, KCP America's auditor may issue either a U.S.-style report revised to reference the accounting principles (financial reporting framework) of the parent's country or the report form of the parent's country.

44

Before reporting on the financial statements of a U.S. entity that have been prepared in conformity with another country's accounting principles, an auditor practicing in the U.S. should:

  1. Understand the accounting principles generally accepted in the other country.
  2. Be certified by the appropriate auditing or accountancy board of the other country.
  3. Notify management that the auditor is required to disclaim an opinion on the financial statements.
  4. Receive a waiver from the auditor's state board of accountancy to perform the engagement.

Understand the accounting principles generally accepted in the other country.

When reporting on financial statements prepared in conformity with another country's accounting principles, an auditor practicing in the U.S. must perform the procedures necessary to comply with the professional standards of U.S. generally accepted auditing standards. The auditor must understand the accounting principles generally accepted in the other country.

45

An auditor may report on condensed financial statements that are derived from complete audited financial statements if the:

  1. Auditor indicates whether the information in the condensed financial statements is consistent in all material respects.
  2. Condensed financial statements are presented in comparative form with the prior year's condensed financial statements.
  3. Auditor describes the additional review procedures performed on the condensed financial statements.
  4. Condensed financial statements are distributed only to management and the board of directors.

Auditor indicates whether the information in the condensed financial statements is consistent in all material respects.

An auditor's report on condensed financial statements should indicate

  1. 1) the auditor has audited and expressed an opinion on the complete financial statements; 
  2. 2) the date of the auditor's report on such statements; 
  3. 3) the type of opinion expressed; and 
  4. 4) whether the information in the condensed financial statements is consistent, in all material respects, with the audited financial statements.

46

Due to a scope limitation, an auditor disclaimed an opinion on the financial statements taken as a whole, but the auditor's report included a statement that the current asset portion of the entity's balance sheet was fairly stated.

The inclusion of this statement is?

 

Not appropriate because it may tend to overshadow the auditor's disclaimer of opinion.

It is inappropriate to issue an opinion regarding one or more elements in the financial statements when the auditor's opinion regarding the financial statements as a whole is a disclaimer or an adverse opinion. This is called a piecemeal opinion and it is barred by the standards because it might overshadow the auditor's disclaimer or adverse opinion.

47

When an independent accountant's report based on a review of interim financial information is presented in a registration statement, a prospectus should include a statement about the accountant's involvement. This statement should clarify that the?

  1. Accountant is not an "expert" within the meaning of the Securities Act of 1933.
  2. Accountant's review report is not a "part" of the registration statement within the meaning of the Securities Act of 1933.
  3. Accountant performed only limited auditing procedures on the interim financial statements.
  4. Accountant's review was performed in accordance with standards established by the American Institute of CPAs.

Accountant's review report is not a "part" of the registration statement within the meaning of the Securities Act of 1933.

A statement about the accountant's involvement with interim financial information presented in a registration statement should clarify that the accountant's review report is not a "report" or "part" of the registration statement within the meaning of Sections 7 and 11 of the Securities Act of 1933.

48

Which of the following applies to an accountant conducting a review of interim financial information?

  1. The accountant must indicate in the report those circumstances in which generally accepted accounting principles have not been consistently observed in the current period in relation to the preceding period.
  2. The accountant must express an opinion on the financial statements taken as a whole.
  3. The accountant must maintain independence in mental attitude in all matters relating to the engagement.
  4. The accountant must obtain sufficient appropriate evidence by performing procedures to afford a reasonable basis for an opinion.

The accountant must maintain independence in mental attitude in all matters relating to the engagement.  The accountant must be independent for a review engagement, since a review results in a form of assurance known as "negative assurance."

49

When a CPA is associated with the preparation of forecasts, all of the following should be disclosed except the

  1. Sources of information.
  2. Character of the work performed by the CPA.
  3. Major assumptions in the preparation of the forecasts.
  4. Probability of achieving estimates.

Probability of achieving estimates. Ethics Rule 201 indicates that a CPA should not vouch for the achievability of forecasts.

  1. An accountant should not be associated with forecasts/projections which do not disclose assumptions.
  2. Forecasts may be for general or limited use, while projections are for limited use only.
  3. Independence is not required for compilations (recall this is also the case for financial statement compilations).
  4. Concerning assurance provided:  Know that a compilation report provides no assurance (again, this is also the case with financial statement compilations); an examination report provides positive assurance with respect to the reasonableness of assumptions; and an agreed-upon procedures report provides a summary of findings.

50

Which of the following titles would be considered suitable for financial statements that are prepared on a cash basis?

  1. Income statement.
  2. Statement of operations.
  3. Statement of revenues collected and expenses paid.
  4. Statement of cash flows.

Statement of revenues collected and expenses paid. The other options are usually interpreted as GAAP financial statements. As a result, they should not be used for financial statements prepared in accordance with a special purpose framework. Statement of revenues collected and expenses paid would be considered a suitable title for a cash basis financial statement.

51

An entity prepares its financial statements on its income tax basis. A description of how that basis differs from GAAP should be included in the?

  1. Notes to the financial statements.
  2. Auditor's engagement letter.
  3. Management representation letter.
  4. Introductory paragraph of the auditor's report.

Notes to the financial statements. 

The financial statements would contain a footnote that describes the basis of the financial statement presentation and how it differs from GAAP.

52

Delta Life Insurance Co. prepares its financial statements on an accounting basis insurance companies use pursuant to the rules of a state insurance commission.

If Wall, CPA, Delta's auditor, discovers that the statements are not suitably titled, Wall should?

  1. Disclose any reservations in an explanatory paragraph and qualify the opinion.
  2. Apply to the state insurance commission for an advisory opinion.
  3. Issue a special statutory basis report that clearly disclaims any opinion.
  4. Explain in the notes to the financial statements the terminology used.

Disclose any reservations in an explanatory paragraph and qualify the opinion.

If financial statements prepared on a comprehensive basis of accounting other than GAAP (i.e., in accordance with a special purpose framework) are not appropriately titled, the auditor must disclose any reservations in an explanatory paragraph and qualify the opinion for the inappropriate title of the statements, which constitutes a departure from the applicable accounting framework (analogous to a GAAP departure).

53

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

  1. Interim financial information of a publicly held company that is subject to a limited review.
  2. Compliance with aspects of regulatory requirements related to audited financial statements.
  3. Application of accounting principles to specified transactions.
  4. Limited use prospective financial statements such as a financial projection.

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.

54

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

  1. The financial statements fail to contain adequate disclosure of related-party transactions.
  2. The client refuses to permit its attorney to furnish information requested in a letter of audit inquiry.
  3. The auditor is engaged after fiscal year-end and is unable to observe physical inventories or apply alternative procedures to verify their balances.
  4. The auditor is unable to determine the amounts associated with illegal acts committed by the client’s management.

The financial statements fail to contain adequate disclosure of related-party transactions.  Failure to contain adequate disclosure of related-party transactions represents a departure from GAAP and disclaimers are not appropriate in such circumstances.

REMEMBER departures from GAAP are not appropriate for Disclaimer!

55

Accepting an engagement to compile a financial projection for a publicly held company most likely would be inappropriate if the projection were to be distributed to

  1. A bank with which the entity is negotiating for a loan.
  2. A labor union with which the entity is negotiating a contract.
  3. The principal stockholder, to the exclusion of the other stockholders.
  4. All stockholders of record as of the report date.

All stockholders of record as of the report date. Projections are limited-use, not general-use statements, and accordingly should only be distributed to the company and third parties with whom the company is negotiating directly.

56

When management refuses to disclose illegal activities which were identified by the independent auditor, the independent auditor may be charged with violating the AICPA Code of Professional Conduct for

  1. Withdrawing from the engagement.
  2. Issuing a disclaimer of opinion.
  3. Failure to uncover the illegal activities during prior audits.
  4. Reporting these activities to the audit committee.

Issuing a disclaimer of opinion.  In such situations in which the auditor knows of the illegal act, a simple disclaimer will not suffice, since the lack of disclosure represents a departure from GAAP. This departure from GAAP will result in a qualified opinion or an adverse opinion.

57

When performing a review of interim financial information, an accountant would typically do each of the following, except

  1. Consider the results from the latest audit.
  2. Test controls related to the preparation of annual financial information.
  3. Perform analytical procedures.
  4. Make inquiries of management.

Test controls related to the preparation of annual financial information.  Reviews consist largely of inquiries of management and analytical procedures and not tests of controls.

58

When the financial statements contain a departure from generally accepted accounting principles, the effect of which is material, the auditor should

  1. Qualify the opinion and explain the effect of the departure from generally accepted accounting principles in a separate paragraph.
  2. Qualify the opinion and describe the departure from generally accepted accounting principles within the opinion paragraph.
  3. Disclaim an opinion and explain the effect of the departure from generally accepted accounting principles in a separate paragraph.
  4. Disclaim an opinion and describe the departure from generally accepted accounting principles within the opinion paragraph.

Qualify the opinion and explain the effect of the departure from generally accepted accounting principles in a separate paragraph. 

The professional standards require an auditor to qualify the opinion paragraph and explain the effect of the departure from GAAP in a separate paragraph (or issue an adverse opinion).
 

59

A modification of the CPA’s report on a review of the interim financial statements of a publicly held company would be necessitated by which of the following?

  1. An uncertainty.
  2. Lack of consistency.
  3. Reference to another accountant.
  4. Inadequate disclosure.

Inadequate disclosure.  Departures from generally accepted accounting principles, which include adequate disclosure, require modification of the accountant’s report.

60

Comfort Letter

A comfort letter from the entity's auditor may help underwriters or others having a statutory due diligence defense under Section 11 of the Act establish a reasonable investigation (that is, due diligence).

  • Not required by and are not filed with the SEC!

Positive Assurance  --  Whether the audited financial statements and schedules comply as to form with the accounting requirements of the Act and the SEC (if a review under GAAS has been performed)

Negative assurance

  • Whether the unaudited condensed interim financial information complies as to form with the requirements of the Act and the SEC;
  • Whether any material modifications should be made to the unaudited condensed consolidated financial statements;
  • Whether there has been any change during a specified period in capital stock, increase in long-term debt, or any decrease in other specified financial statement items

61

Comfort Letters are ordinarily:

  • addressed to the entity's?
  • signed by the entity's?

  • Addressed to the entity's Underwriter of Securities
  • Signed by the entity's Independent Auditor

62

For an entity that does not receive governmental financial assistance, an auditor's standard report on financial statements generally would not refer to?

  1. Significant estimates made by management.
  2. An assessment of the entity's accounting principles.
  3. Management's responsibility for the financial statements.
  4. The entity's internal control structure.

The entity's internal control structure.  

f an entity is receiving governmental financial assistance, it is subject to audits conducted under Government Auditing Standards (the Yellow Book) in addition to GAAS. Government standards require specific consideration of the internal control structure established to ensure compliance with the laws and regulations applicable to the financial assistance and issuance of a separate report on internal control. Thus, an entity which is not receiving governmental assistance would not refer to internal control in the auditor's standard report.

63

An auditor’s report includes the following statement:  “The financial statements do not present fairly the financial position, results of operations, or cash flows in conformity with generally accepted accounting principles.” This auditor’s report was most likely issued in connection with financial statements that are

  1. Inconsistent.
  2. Based on prospective financial information.
  3. Misleading.
  4. Affected by a material uncertainty.

Misleading.  Language such as that quoted in this question is used in an adverse opinion. Such an opinion is appropriate when financial statements are considered to be misleading.

64

Jones, CPA, is auditing an entity’s financial statements in accordance with Government Auditing Standards.  Jones should prepare a written report which describes

  1. The specific plan for obtaining audit evidence from all the applicable governmental agencies.
  2. The scope of the auditor’s testing of compliance with laws and regulations and of internal controls.
  3. The auditor’s independence and lack of any personal biases or external influences regarding the client.
  4. The list of internal controls tested and the results of the testing.

The scope of the auditor’s testing of compliance with laws and regulations and of internal controls.  Government Auditing Standards requires that auditors report on the scope of their testing of compliance with laws and regulations and of internal controls.

65

When planning a review of an audit client's interim financial statements, which of the following procedures should the accountant perform to update the accountant's knowledge about the entity's business and its internal control?

  1. Perform analytical procedures on selected accounts by comparing the interim amounts to the amounts for the previous audited fiscal year-end.
  2. Inquire of the entity's outside legal counsel about the status of a previous pending litigation and any new litigation involving the entity.
  3. Select a sample of material revenue transactions occurring during the interim period and examine supporting documentation.
  4. Consider the results of audit procedures performed with respect to the current year's financial statements.

Consider the results of audit procedures performed with respect to the current year's financial statements.  Auditors will consider results of previous audits and audit procedures performed with respect to the current year's financial statements.

Remember that a review consists primarily of analytical procedures, inquiries, and obtaining representations from management.

66

A financial statement audit report issued for a public company states that the audit was performed in accordance with which of the following standards?

  1. Generally accepted auditing standards.
  2. Public Company Accounting Oversight Board standards.
  3. Securities and Exchange Commission standards.
  4. Sarbanes-Oxley standards.

Public Company Accounting Oversight Board standards.  PCAOB standards requires that the audit report indicate that the audit was performed in accordance with standards of the Public Company Accounting Oversight Board (United States).

The report refers to the standards of the PCAOB rather than generally accepted auditing standards.

67

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

  1. Preceding the scope paragraph.
  2. Preceding the opinion paragraph.
  3. Following the opinion paragraph.
  4. Within the notes to the financial statements.

Preceding the opinion paragraph.  The professional standards require that a basis for adverse opinion disclosing the substantive reasons for expressing an adverse opinion precede the opinion paragraph of the auditor’s report.

Materially misstated financial statements due to departures from GAAP result in either a qualified opinion or an adverse opinion; both types of reports include a basis for modification paragraph preceding the opinion paragraph. Examples of departures from GAAP include the use of an unacceptable inventory valuation method (e.g., current sales value) or incorrectly treating a capital lease as an operating lease.
 

68

A consistency emphasis-of-matter paragraph is not added to an audit report for an accounting change that results from a change in

  1. An accounting principle that is not generally accepted to one that is generally accepted.
  2. An accounting estimate.
  3. The reporting entity.
  4. An accounting principle inseparable from a change in accounting estimate.

An accounting estimate.  A change in accounting estimate does not require the addition of an emphasis-of-matter paragraph on consistency. Accordingly, this change need not be mentioned in the audit report but may require disclosure in the footnotes to the financial statements.

69

Governmental auditing often extends beyond examinations leading to the expression of opinion on the fairness of financial presentation and includes audits of efficiency, economy, effectiveness, and also

  1. Accuracy.
  2. Evaluation.
  3. Compliance.
  4. Internal control.

Compliance.  Governmental audits often require a determination of compliance with prescribed regulations.

Compliance auditing involves testing and reporting on whether an organization has complied with the requirements of various laws, regulations, contracts, and grants.  Congress and various regulatory agencies have adopted compliance auditing requirements for a variety of governmental and other organizations. 

While not a new type of auditing, it has become more significant in the last decade.  A primary purpose of compliance auditing is to provide assurance that requirements of various federal programs have been met.  Currently, the major engagements are (1) compliance attestation engagements, or (2) compliance auditing of federal financial assistance programs.

70

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

  1. Performing cutoff tests of sales transactions with customers with long-standing receivable balances.
  2. Evaluating the entity’s procedures for identifying and recording related-party transactions.
  3. Inspecting title documents to verify whether any real property is pledged as collateral.
  4. Inquiring of the entity’s legal counsel about litigation, claims, and assessments.

Inquiring of the entity’s legal counsel about litigation, claims, and assessments.   inquiry of legal counsel may reveal major litigation, claims, and assessments against the entity that raise substantial doubt about its ability to continue as a going concern.

71

While audits do not contain specific procedures to test the appropriateness of this going concern assumption, procedures performed for other objectives may identify conditions and events indicating substantial doubt as to whether an entity will continue as a going concern. Such procedures include?

  1. Analytical procedures
  2. Review of subsequent events
  3. Review of compliance with debt agreements
  4. Reading of minutes of stockholders, board of directors and other important board committees
  5. Inquiry of legal counsel
  6. Confirmation of arrangements with various organizations to maintain financial support

72

How does Office of Management and Budget Circular A-133, Audits of States, Local Governments, and Nonprofit Organizations, define a subrecipient?

  1. As a nonfederal entity that provides a federal award to another entity to carry out a federal program.
  2. As an individual who receives and expends federal awards received from a pass-through entity.
  3. As a dealer, distributor, merchant, or other seller providing goods or services that are required for the conduct of a federal program.
  4. As a nonfederal entity that expends federal awards received from another entity to carry out a federal program.

As a nonfederal entity that expends federal awards received from another entity to carry out a federal program.

73

Which of the following is not a principle included in Trust Services engagements?

  1. Availability.
  2. Confidentiality.
  3. Independence.
  4. Security.

Independence is not a Trust Services principle.

The CPA reports on whether the system meets one or more of the following principles over a particular reporting period:

  1. Security. The system (infrastructure, software, people, procedures, and data) is protected against unauthorized access (both physical and logical).
  2. Availability. The system is available for operation and use as committed or agreed.
  3. Processing Integrity. System processing is complete, accurate, timely and authorized.
  4. Online Privacy. Private information obtained as a result of electronic commerce is collected, used, disclosed, and retained as committed or agreed.
  5. Confidentiality. Information designated as confidential is protected as committed or agreed.

74

An engagement to express an opinion on a system of internal accounting control will generally?

  1. Require procedures that duplicate those already applied in assessing control risk during a financial statement audit.
  2. Increase the reliability of the financial statements that have already been audited.
  3. Be more extensive in scope than the assessment of control risk made during the financial statement audit.
  4. Be more limited in scope than the assessment of control risk made during a financial statement audit.

Be more extensive in scope than the assessment of control risk made during the financial statement audit.

In a financial statement audit, consideration is given to internal control in terms of its impact on the fair presentation of the financial statements. In an examination of internal control, the purpose of the engagement is to render an opinion specifically on internal control. As a result, the work performed in an attestation engagement on internal control is more extensive in scope than that performed during the control risk assessment in a financial statement audit.

75

When an auditor has substantial doubt about an entity’s ability to continue as a going concern because of the probable discontinuance of operations, the auditor most likely would express a qualified opinion if

  1. The effects of the adverse financial conditions likely will cause a bankruptcy filing.
  2. Information about the entity’s ability to continue as a going concern is not disclosed.
  3. Management has no plans to reduce or delay future expenditures.
  4. Negative trends and recurring operating losses appear to be irreversible.

Information about the entity’s ability to continue as a going concern is not disclosed.  When management does not disclose such information in the financial statements, a departure from GAAP exists; departures from GAAP lead to either a qualified or adverse opinion.

The bankruptcy would lead to an unmodified opinion with explanatory language or a disclaimer of opinion.

76

A group engagement partner (principal auditor) decides not to refer to the audit of a component (other) auditor who audited a subsidiary of the consolidated financial statements. After making inquiries about the component auditor's professional reputation and independence, the group engagement partner most likely would

  1. Document in the engagement letter that the principal auditor assumes no responsibility for the other CPA's work.
  2. Obtain written permission from the other CPA to omit the reference in the principal auditor's report.
  3. Consider the significance of the component and design audit procedures accordingly.
  4. Add an emphasis-of-matter paragraph to the auditor's report indicating that the subsidiary's financial statements are not material to the consolidated financial statements.

Consider the significance of the component and design audit procedures accordingly.  The procedures to be followed by the group engagement partner (and engagement team) require a consideration of the significance of the subsidiary—as it increases in significance more procedures are required.

77

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

  1. Reading the minutes of meetings of the stockholders and the board of directors.
  2. Comparing the market value of property to amounts owed on the property.
  3. Reviewing lease agreements to determine whether leased assets should be capitalized.
  4. Inspecting the documents to verify whether any assets are pledged as collateral.

Reading the minutes of meetings of the stockholders and the board of directors.  The matters considered in the meetings of the stockholders and board of directors may bear on the going concern status of the client.

78

Letters for Underwriters 

  • Name/Purpose of letter?
  • Two types of assurance given by Auditor?

When an issuer (public) company wishes to issue new securities to the public, the underwriters of the securities will generally ask the company’s auditor to provide “comfort” on the financial and accounting data in the prospectus that is not covered by an accountant’s report of some form (e.g., an audit report on the financial statements). 

In comfort letters, the CPAs will provide

  1. positive assurance that they are independent and that their audit followed SEC standards.  
  2. negative assurance or a summary of findings on various types of accounting related matters such as the following:  unaudited summary and summarized interim information, pro forma financial information, change subsequent to the balance sheet date, and on various tables of data.

79

Service Organization Control (SOC) Reports

  • Remember SOC 1 is least related to SysTrust

Service organization provide processing services to customers who decide to outsource their processing of particular data. Examples of service organizations include data centers, flexible spending account servicers, and medical claims processers. The AICPA has established three types of examination services that result in the following three types of CPA reports on service organization controls (SOC):

  1. SOC 1: Restricted use reports on controls at a service organization relevant to a user entity's internal control over financial reporting.
  2. SOC 2: Restricted use reports on controls at a service organization related to security, availability, processing integrity, confidentiality, and/or privacy.
  3. SOC 3: General use SysTrust reports related to security, availability, processing integrity, confidentiality, and/or privacy.

80

If management chooses to place supplementary information required by the FASB in footnotes attached to the financial statements, this information should be clearly marked as

  1. Unaudited.
  2. Supplementary information required by the FASB.
  3. Disclosures required by the FASB.
  4. Audited financial data required by generally accepted accounting principles.

The Professional Standards require that such supplemental information be marked unaudited.

81

Special Purpose Financial Reporting Framework

An audit report on FSs prepared using a SPFRF departs from the standard form in several ways.

  1. Most important, the report should include an emphasis-of-matter paragraph alerting users that the financial statements are prepared in accordance with the special purpose financial reporting framework and refer to the financial statement note that describes the framework.
  2. The paragraph should also state that the special purpose framework is a basis of accounting other than GAAP, and
  3. describe the basis of accounting being used or refer to a financial statement note that provides such a description.

The essence of the report is the expression of an opinion as to whether the financial statements present fairly what they purport to present according to the special purpose framework being used.

82

Which of the following bodies promulgates standards for audits of federal financial assistance recipients?

  1. Governmental Accounting Standards Board.
  2. Financial Accounting Standards Board.
  3. General Accounting Office.
  4. Governmental Auditing Standards Board.

General Accounting Office!  As indicated in Governmental Auditing Standards (the "Yellow Book"), the General Accounting Office promulgates such standards.

Compliance Auditing of Federal Financial Assistance Programs

  • A major factor causing the demand for compliance auditing is the need for accountability over the financial assistance provided by the federal government.  Guidance is provided by Government Auditing Standards (GAS), also referred to as the “Yellow Book,” published by the Comptroller General of the United States (the top executive within the General Accounting Office). GAS presents what it refers to as “generally accepted government auditing standards”; the importance of GAS on the CPA exam is emphasized by its inclusion in Information for CPA Candidates as a publication that should be studied.

83

Inclusion of inaccurate interim information required by the FASB will result in which of the following types of reports?

  1. Standard unmodified.
  2. Unmodified with an emphasis-of-matter paragraph.
  3. Qualified with a basis for modification paragraph.
  4. Adverse.

Unmodified with an emphasis-of-matter paragraph.  Such information is considered unaudited and accordingly an unmodified report with an emphasis-of-matter paragraph is appropriate.

Certain SEC reporting companies are required to include unaudited quarterly information in their annual reports or other documents filed with the SEC that contain audited financial statements.  Auditors are engaged to perform review procedures either at the conclusion of each quarter, or at the end of the year when the information is included with the annual information.  When dealing with the annual financial statements, omission, misstatement, or auditor inability to review the quarterly information all lead to inclusion of an emphasis-of-matter paragraph in the annual audit report.  Be aware that the information is to be reviewed, not audited.  Therefore, its misstatement will not lead to a qualified or an adverse opinion.

84

The integrated audit of a public company resulted in the CPA’s issuance of an adverse opinion on internal control.  Which of the following statements is correct when management believes that the material weakness is eliminated and the auditors, after performing appropriate procedures, agree?

  1. The auditors may issue another report, this one indicating that the material weakness no longer exists.
  2. The adverse opinion may be recalled, and an unqualified report issued.
  3. The adverse opinion may not be reissued as unqualified, but a footnote to that report may be added indicating that the material weakness was subsequently eliminated.
  4. No action can be taken until the next year’s audit, at which time an unqualified report may be issued if appropriate.

The auditors may issue another report, this one indicating that the material weakness no longer exists.

After the existence of a material weakness has led to an adverse opinion in an internal control audit report, the company is ordinarily motivated to eliminate the weakness as quickly as is reasonably possible.  When management believes that the material weakness is eliminated, it may voluntarily engage the auditors to report on whether the material weakness continues to exist.

The overall approach under PCAOB Standard 4 is one in which management gathers evidence, including documentation that the material weakness no longer exists, and then prepares a written report so indicating. The auditors then plan and perform an engagement emphasizing the controls over the material weakness.  The report issued indicates the auditor’s opinion that the material weakness “no longer exists” or “exists” as of the date of management’s assertion. At this point you should study the outline of PCAOB Standard 4.

85

Which of the following is not an example of a company-level control?

  1. Management’s risk assessment process.
  2. Controls over the drafting of financial statements.
  3. Controls to monitor the results of operations.
  4. Segregation of duties.

Segregation of duties is a control activity over a specific type of transaction.

86

Which of the following forms of auditor association are possible relating to management’s discussion and analysis (MD&A)?

  1. Review?
  2. Examination?

BOTH!  professional standards provide for both review and examinations of MD&A. 

The professional standards provide guidance for performing review and examination of MD&A.  MD&A is included in reports filed with the SEC (e.g., Form 10K and 10Q) and in annual reports sent directly to shareholders.  In addition, a number of companies that do not report to the SEC prepare such information.  This service allows a CPA to provide assurance (“negative assurance” for a review, and “reasonable assurance” for an examination) on a client’s MD&A.

87

Miller Co. uses the first-in, first-out method of costing for its international subsidiary’s inventory and the last-in, first-out method of costing for its domestic inventory. Under these circumstances, Miller should issue an auditor’s report with an

  1. "Except for" qualified opinion.
  2. Unmodified opinion.
  3. Emphasis-of-matter paragraph as to consistency.
  4. Opinion modified as to consistency.

Unmodified opinion.  The use of such differing methods may be appropriate due to the circumstances and therefore an unmodified opinion may be issued.

Differing accounting principles may be used for different portions of an account. For example, a client may choose to use FIFO for valuation of a portion of its inventory and LIFO for the remainder. Similarly, for fixed assets, differing depreciation methods may be used for differing classes (types) of assets. No emphasis-of-matter paragraph is necessary in this situation.

88

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

  1. Income statement only.
  2. Statement of cash flows only.
  3. Balance sheet only.
  4. Statement of shareholders' equity only.

Balance sheet only.  Beginning inventory does not affect the year-end balances on the balance sheet; while both prior year and current year income are affected by a misstated prior year ending (current year beginning) inventory, the misstatements counterbalance one another and will cause no misstatement of the current year-end balance sheet.

89

The GAO standards of reporting for governmental financial audits incorporate the AICPA standards of reporting and prescribe supplemental standards to satisfy the unique needs of governmental audits. Which of the following is a supplemental reporting standard for government financial audits?

  1. A written report on the auditor’s understanding of the entity’s internal control and assessment of control risk should be prepared.
  2. Material indications of illegal acts should be reported in a document with distribution restricted to senior officials of the entity audited.
  3. Instances of abuse, fraud, mismanagement, and waste should be reported to the organization with legal oversight authority over the entity audited.
  4. All privileged and confidential information discovered should be reported to the senior officials of the organization that arranged for the audit.

A written report on the auditor’s understanding of the entity’s internal control and assessment of control risk should be prepared. 

Government Auditing Standards, the "Yellow Book," includes a standard for a written report on the auditor’s understanding of the entity’s internal control and an assessment of control risk.

90

Because of the pervasive effects of laws and regulations on the financial statements of governmental units, an auditor should obtain written management representations acknowledging that management has

  1. Identified and disclosed all laws and regulations that have a direct and material effect on its financial statements.
  2. Implemented internal control policies and procedures designed to detect all illegal acts.
  3. Expressed both positive and negative assurance to the auditor that the entity complied with all laws and regulations.
  4. Employed internal auditors who can report their findings, opinions, and conclusions objectively without fear of political repercussion.

Identified and disclosed all laws and regulations that have a direct and material effect on its financial statements.  

in addition to normal representations, auditors should consider obtaining additional representations from management acknowledging that

  1. management is responsible for the entity’s compliance with laws and regulations and
  2. management has identified and disclosed to the auditor all laws and regulations that have a direct and material effect on the financial statements.

91

When the auditor believes substantial doubt exists with regard to the entity's ability to continue as a going concern, what are the two options for the Audit Report if the entity has properly disclosed the issue?

  1. modify report to unmodified with an emphasis-of-matter paragraph following opinion paragraph
  2. or, a disclaimer with a basis for modification paragraph preceding the opinion paragraph that includes the phrase "substantial doubt about its ability to continue as a going concern."

Remember if disclosure is not adequate, you must Qualify or Adverse the opinion depending on materiality and pervasiveness.  

92

What requires recognition in the Auditor's opinion as to consistency?

Changes in:

  1. Reporting entities
  2. Accounting principles
  3. Correction of errors
  4. Principles inseparable from estimates

93

Which of the following is not an assertion embodied in management’s discussion and analysis (MD&A)?

  1. Completeness.
  2. Consistency with the financial statements.
  3. Occurrence.
  4. Rights and obligations.

Rights and obligations. The attestation standards on MD&A do not include an assertion for rights and obligations. Those standards indicate that the four standards are:

  1. Completeness,
  2. Consistency with the financial statements,
  3. Occurrence, and
  4. Presentation and disclosure.

94

Given one or more hypothetical assumptions, a responsible party may prepare, to the best of its knowledge and belief, an entity’s expected financial position, results of operations, and changes in financial position. Such prospective financial statements are known as

  1. Pro forma financial statements.
  2. Financial projections.
  3. Partial presentations.
  4. Financial forecasts.

Financial projections are prospective financial statements that include one or more hypothetical assumptions.

95

An auditor’s report that refers to the use of an accounting principle at variance with generally accepted accounting principles contains the words, “In our opinion, with the foregoing explanation, the financial statements referred to above present fairly...”  This is considered a(n)?

Example of inappropriate reporting.

In our opinion, except for the effects of not capitalizing certain lease obligations as discussed in the preceding paragraph, the financial statements…

96

Which of the following is considered "unaudited" information when included with historical financial statement?

  1. Interim information.
  2. Segmental information.
  3. Notes to the financial statements.
  4. Investment security classifications.

Interim information should be marked "unaudited."  Certain SEC reporting companies are required to include unaudited quarterly information in their annual reports or other documents filed with the SEC that contain audited financial statements. Auditors are engaged to perform review procedures either at the conclusion of each quarter, or at the end of the year when the information is included with the annual information. When dealing with the annual financial statements, omission, misstatement, or auditor inability to review the quarterly information all lead to inclusion of an emphasis-of-matter paragraph in the annual audit report. Be aware that the information is to be reviewed, not audited. Therefore, its misstatement will not lead to a qualified or an adverse opinion.

97

Which of the following would be an appropriate title for a statement of revenue and expenses prepared using an other special purpose financial reporting framework)?

  1. Statement of operations.
  2. Statement of income—regulatory basis
  3. Income statement.
  4. Statement of activities.

Statement of income—regulatory basis

The professional standards state state that a title such as statement of income—regulatory basis is appropriate.  Different titles are used so as to prevent misleading anyone into believing that the statements follow GAAP.  

  • Terms such as statement of financial position, statement of income (or operations), and statement of cash flows should not be used for comprehensive basis statements
  • Examples of appropriate (cash basis) titles: statements of assets and liabilities arising from cash flows, statement of revenue collected and expenses paid

98

When an adverse opinion is expressed, the opinion paragraph should include a direct reference to

  1. A footnote to the financial statements which discusses the basis for the opinion.
  2. The scope paragraph which discusses the basis for the opinion rendered.
  3. A separate paragraph which discusses the basis for the opinion rendered.
  4. The consistency or lack of consistency in the application of generally accepted accounting principles.

A separate paragraph which discusses the basis for the opinion rendered.  An adverse opinion should refer to a separate basis for modification paragraph which discusses the basis for the opinion rendered.

99

Which of the following professional services would be considered an attest engagement?

  1. A management consulting engagement to provide accounting information systems advice to a client.
  2. An engagement to report on compliance with statutory requirements.
  3. An income tax engagement to prepare federal and state tax returns.
  4. Providing human resource utilization advice to the client.

An engagement to report on compliance with statutory requirements.  

A report on compliance with statutory requirements might be structured as an attest engagement in which the required "written assertion" relates to such compliance.

100

Define Attest Engagement

  • Remember that an attest engagement may be performed under GAAP standards or Attest Standards

Attest Function—General Nature 

In an attest engagement a CPA is engaged to issue or does issue an:

  1. examination,
  2. a review, or
  3. an agreed-upon procedures report

on subject matter, or an assertion about subject matter, that is the responsibility of another party.  An attestation engagement may be performed under either generally accepted accounting principles (for historical financial statements and related information) or the attestation standards (for other information).

101

An accountant who accepts an engagement to compile a financial projection most likely would make the client aware that the

  1. Projection may not be included in a document with audited historical financial statements.
  2. Accountant's responsibility to update the projection for future events and circumstances is limited to one year.
  3. Projection omits all hypothetical assumptions and presents the most likely future financial position.
  4. Engagement does not include an evaluation of the support for the assumptions underlying the projection.

Engagement does not include an evaluation of the support for the assumptions underlying the projection.  In a financial projection report the CPA does not include an evaluation of the assumptions underlying the projection and, accordingly, the client should be aware of this limitation.

102

Which of the following is correct concerning an engagement to apply agreed-upon procedures?

  1. A clear understanding of the terms of the engagement must be established through use of an engagement letter.
  2. Independence of the CPA is not required.
  3. The procedures maybe as limited or as extensive as the CPAs desire ranging from a mere reading of the information to performing search and verification procedures.
  4. Use of the report is restricted to the specified users.

Use of the report is restricted to the specified users.  A statement of restriction on the use of the report should be provided if the report is intended to be used solely by the specified users.  

Agreed-upon procedures reports include a list of procedures performed (or reference thereto) and the related findings. Because specified parties have agreed upon the nature of the procedures, the reports for such engagements are intended only for those parties.

Note: the engagement letter is not required for agreed-upon procedures of special elements, accounts, or items of financial statements.

103

A CPA’s report on an examination of a forecast should include all of the following except

  1. A description of what the forecast information is intended to represent.
  2. A caveat as to the ultimate attainment of the forecasted results.
  3. A statement that the CPA assumes no responsibility to update the report for events occurring after the date of the report.
  4. An opinion as to whether the forecast is fairly presented.

An opinion as to whether the forecast is fairly presented.  A forecast examination report presents an opinion concluding whether the forecast meets AICPA guidelines, not on whether the forecast is fairly presented.

104

An auditor is reporting on cash basis financial statements.  These statements are best referred to in his opinion by which of the following descriptions?

  1. Financial position and results of operations arising from cash transactions.
  2. Assets and liabilities arising from cash transactions, and revenue collected and expenses paid.
  3. Balance sheet and income statement resulting from cash transactions.
  4. Cash balance sheet and the source and application of funds.

Assets and liabilities arising from cash transactions, and revenue collected and expenses paid.  The preferable titles when reporting on cash basis financial statements are assets and liabilities arising from cash transactions, and revenue collected and expenses paid.  

The AICPA Professional Standards state that titles such as balance sheet, statement of financial position, statement of operations and income statement are generally understood to be applicable only to financial statements prepared following GAAP.

105

When performing an audit of a city that is subject to the requirements of the Uniform Single Audit Act of 1984, an auditor should adhere to

  1. Governmental Accounting Standards Board General Standards.
  2. Governmental Finance Officers Association Governmental Accounting, Auditing, and Financial Reporting Principles.
  3. General Accounting Office Standards for Audit of Governmental Organizations, Programs, Activities, and Functions.
  4. Securities and Exchange Commission Regulation S-X.

General Accounting Office Standards for Audit of Governmental Organizations, Programs, Activities, and Functions.

While the AICPA’s generally accepted auditing standards must be followed to the extent they are pertinent, the General Accounting Office Standards for Audit of Governmental Organizations, Programs, Activities, and Functions must also be adhered to.

106

When financial statements of a prior period are presented on a comparative basis with financial statements of the current period, the continuing auditor is responsible for

  1. Expressing dual date opinions.
  2. Updating the report on the previous financial statements only if there has not been a change in opinion.
  3. Updating the report on the previous financial statements only if the previous report was qualified and the reasons for qualification no longer exist.
  4. Updating the report on the previous financial statements regardless of the opinion previously issued.

Updating the report on the previous financial statements regardless of the opinion previously issued.

When comparative financial statements are being presented, auditor's "update" their prior year audit report to determine that it is still appropriate. An opinion on the prior period financial statements may differ from the opinion previously issued. For example, an auditor previously may have qualified the opinion on the prior period statements because of a departure from GAAP, and the prior period statements may be restated in the current period to follow GAAP. In such a circumstance the auditor’s updated report on the prior period statements should indicate that the statements have been restated and should express an unmodified opinion with respect to the restated statements.  Whenever an updated report has an opinion different from that previously expressed, the auditor should disclose all substantive reasons for the different opinion in a separate emphasis-of-matter paragraph following the opinion paragraph.

107

When comparative financial statements are presented, which statements are being referred to when the term "taken as a whole" is used in an audit report?

  1. Periods presented plus one preceding period.
  2. Current period only.
  3. Current period and those of the other periods presented.
  4. Current and immediately preceding period only.

Current period and those of the other periods presented.  

The professional standards state that this term should be considered to apply not only to the financial statements of the current period but also to those of one or more prior periods that are presented on a comparative basis with those of the current period.

108

Certain circumstances affecting comparative financial statements

When comparative statements are issued (i.e., financial statements for two or more periods are presented), the auditor must report on the statements for all years presented. One overall report, dated as of the last day of fieldwork for the most recent audit, addressing the years presented, is issued. Two major situations may result in an unmodified report with explanatory language.

109

An auditor concludes that there is a material inconsistency in the other information in an annual report to shareholders containing audited financial statements. The auditor believes that the financial statements do not require revision, but the client is unwilling to revise or eliminate the material inconsistency in the other information.  Under these circumstances, what action would the auditor most likely take?

  1. Consider the situation closed because the other information is not in the audited financial statements.
  2. Issue a qualified opinion after discussing the matter with the client’s audit committee.
  3. Disclaim an opinion on the financial statements after explaining the material inconsistency in a separate emphasis-of-matter paragraph.
  4. Revise the auditor’s report to include a separate paragraph describing the material inconsistency.

Revise the auditor’s report to include a separate paragraph describing the material inconsistency.

The auditor should consider revising the audit report to include a paragraph, withholding use of the report, or withdrawing from the engagement.

110

When an auditor conducts an audit in accordance with generally accepted auditing standards and concludes that the financial statements are fairly presented in accordance with a basis of accounting such as the cash basis of accounting, the auditor should issue a(n)

  1. Disclaimer of opinion.
  2. Review report.
  3. Qualified opinion.
  4. Unmodified opinion with an emphasis-of-matter paragraph.

Unmodified opinion with an emphasis-of-matter paragraph.  Financial statements that follow such a special purpose financial reporting framework result in an audit report with an emphasis-of-matter paragraph.

111

Which of the following items should be included in prospective financial statements issued in an attestation engagement performed in accordance with Statements on Standards for Attestation Engagements?

  1. All significant assertions used to prepare the financial statements.
  2. All significant assumptions used to prepare the financial statements.
  3. Pro forma financial statements for the past two years.
  4. Historical financial statements for the past three years.

All significant assumptions used to prepare the financial statements.  An accountant should not be associated with forecasts/projections that do not disclose assumptions.

112

An investor is reading the financial statements of the Stankey Corporation and observes that the statements are accompanied by an auditor’s unmodified report. From this the investor may conclude that

  1. Any disputes over significant accounting issues have been settled to the auditor’s satisfaction.
  2. The auditor is satisfied that Stankey is financially sound.
  3. The auditor has ascertained that Stankey’s financial statements have been prepared accurately.
  4. Informative disclosures in the financial statements but not necessarily in Stankey’s footnotes are to be regarded as reasonably adequate.

Any disputes over significant accounting issues have been settled to the auditor’s satisfaction. An unmodified audit report indicates that disputes over significant accounting issues have been settled to the auditor’s satisfaction. If any such disputes have not been settled, the auditor must render an opinion other than unmodified.

113

The auditor’s report ordinarily should be dated as of the date on which the

  1. Report is delivered to the client.
  2. Auditor has obtained sufficient appropriate audit evidence.
  3. Fiscal period under audit ends.
  4. Review of the working papers is completed.

Auditor has obtained sufficient appropriate audit evidence.  

The audit report should not be dated earlier than the date on which the auditors have obtained sufficient appropriate audit evidence to support their opinion on the financial statements—ordinarily the last day of fieldwork.

114

An auditor is auditing a mutual fund company that uses a transfer agent to handle accounting for shareholders.  Which of the following actions by the auditor would be most efficient for obtaining information about the transfer agent’s internal control?

  1. Use reports on internal control suitability of design and operating effectiveness produced by the agent’s own auditor.
  2. Review prior year workpapers to determine whether the number of transactions processed by the agent has materially increased.
  3. Perform an audit on the internal control function of the agent.
  4. Perform tests of controls on a sample of the audited firm’s transactions through the agent.

Use reports on internal control suitability of design and operating effectiveness produced by the agent’s own auditor.  

The transfer agent is operating as a service organization, and when a service organization is involved and is to be relied upon, the most efficient approach is for an auditor to obtain that organization’s service auditor report on its internal control. In this situation a "type 2" report will provide information on both the suitability of design control and control operating effectiveness. A "type 1" report only addresses suitability of design.

115

An auditor has previously expressed a qualified opinion on the financial statements of a prior period because of a departure from generally accepted accounting principles. The prior-period financial statements are restated in the current period to conform with generally accepted accounting principles. The auditor’s updated report on the prior-period financial statements should

  1. Express an unmodified opinion concerning the restated financial statements.
  2. Be accompanied by the original auditor’s report on the prior period.
  3. Bear the same date as the original auditor’s report on the prior period.
  4. Qualify the opinion concerning the restated financial statements because of a change in accounting principle.

Express an unmodified opinion concerning the restated financial statements.  The auditor should indicate that the statements have been restated and should express an unmodified opinion with respect to the restated financial statements.

An other-matter paragraph to the report should disclose:

  1. the date of the auditor’s previous report,
  2. the type of opinion previously expressed,
  3. the circumstances or events that caused the auditor to express a different opinion, and
  4. that the updated opinion differs from the previous opinion.

116

Thomas, CPA, has examined the consolidated financial statements of Kass Corporation. Jones, CPA, has examined the financial statements of the sole subsidiary which is material in relation to the total examined by Thomas. It would be appropriate for Thomas to serve as the group engagement partner, but it is impractical for Thomas to review the work of Jones. Assuming an unmodified opinion is expressed by Jones, one would expect Thomas to

  1. Refuse to express an opinion on the consolidated financial statements.
  2. Express an unmodified opinion on the consolidated financial statements and not refer to the work of Jones.
  3. Express an unmodified opinion on the consolidated financial statements and refer to the work of Jones.
  4. Express a qualified opinion on the consolidated financial statements and refer to the work of Jones.

Express an unmodified opinion on the consolidated financial statements and refer to the work of Jones.

When the group engagement partner finds it impractical to review the work of another auditor, he or she will make reference to the examination of the component auditor and issue an unmodified report. This reference will indicate the division of responsibility between that portion of the financial statements covered by the two CPA firms.

117

In which of the following circumstances would an auditor be required to issue a qualified report with a separate basis for qualified opinion paragraph?

  1. The auditor satisfactorily performed alternative accounts receivable procedures because scope limitations prevented performance of normal procedures.
  2. The financial statements reflect the immaterial effects of a change in accounting principles from one period to the next.
  3. A particular note to the financial statements discloses a company accounting method which deviates from generally accepted accounting principles.
  4. The financial statements of a significant subsidiary were examined by another auditor, and reference to the other auditor’s report is to be made in the principal auditor’s report.

A particular note to the financial statements discloses a company accounting method which deviates from generally accepted accounting principles

When the financial statements are affected by a departure from generally accepted accounting principles, the auditor will express a qualified opinion. When the auditor intends to express a qualified report, s/he should disclose all the substantive reasons in a separate emphasis-of-matter paragraph.

118

The following represent areas which a report commissioned by the European Commission (the executive organization of the European Union) suggests there are substantive differences between International and US PCAOB auditing standards:

  1. International standards do not require an audit of internal control, while PCAOB standards do so require.
  2. International standards do not allow reference to another audit firm involved in a portion of the audit, while PCAOB standards allow the principal auditor to so report (i.e., percentages or dollars audited by the other auditor are reported and the opinion is based in part upon the report of the other auditor).
  3. International standards for documentation are less detailed than PCAOB standards, leaving more to professional judgment.
  4. International standards in the area of going concern include a time horizon of at least, but not limited to twelve months, while PCAOB standards limit the foreseeable future for a going concern consideration to up to twelve months.
  5. International standards are based on a risk assessment approach (obtaining a broad understanding of an entity and its environment in order to identify where there may be risks of material misstatements), while the PCAOB standards currently are not. This difference will soon disappear as the PCAOB is in the process of adopting such standards (as has the AICPA Auditing Standards Board).
  6. The audit opinion may indicate that the financial statements present fairly or they give a true and fair view.

119

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

  1. Add an emphasis-of-matter paragraph to the standard auditor's report that justifies the reason for the omission.
  2. Refuse to accept the engagement as proposed because of the client-imposed scope limitation.
  3. Explain to Zag that the omission requires a qualification of the auditor's opinion.
  4. Prepare the statement of cash flows as an accommodation to Zag and express an unmodiified opinion.

Explain to Zag that the omission requires a qualification of the auditor's opinion. Be familiar with a circumstance relating to departures from GAAP: omission of the statement of cash flows.

  • When a company presents financial statements that purport to present financial position and results of operations (e.g., balance sheet and an income statement) GAAP requires that a statement of cash flows also be presented. The omission of a statement of cash flows in such a circumstance is a departure from GAAP. The auditor need not present the missing statement of cash flows in a basis for modification paragraph of the audit report.

120

Attestation Engagement

  • Subject Matter forms

Attestation standards apply to engagements in which CPAs are engaged to issue or do issue

  1. an examination,
  2. a review, or
  3. an agreed-upon procedures report on subject matteror an assertion about subject matter, that is the responsibility of another party

It is important to distinguish between the subject matter and the assertion about the subject matter.

The subject matter of an attestation engagement may take many forms, including

  • Historical or prospective performance or condition (e.g., historical prospective financial information, performance measurements, and backlog data),
  • Physical characteristics (e.g., narrative descriptions, square footage of facilities),
  • Historical events (e.g., price of a market basket of goods on a certain date),
  • Analyses (e.g., breakeven analyses),
  • Systems or processes (e.g., internal control), or
  • Behavior (e.g., corporate governance, compliance with laws and regulations, and human resource practices).

121

In an audit in accordance with Government Auditing Standards an auditor provides what level of assurance?

  1. Positive assurance that internal control tested by the auditor is operating as prescribed.
  2. Reasonable assurance of detecting misstatements that are material to the financial statements.
  3. Negative assurance that significant deficiencies communicated during the audit do not prevent the auditor from expressing an opinion.
  4. Limited assurance that internal control designed by management will prevent or detect errors, fraud, and illegal acts.

Reasonable assurance of detecting misstatements that are material to the financial statements. 

The audit must be designed to provide reasonable assurance that the financial statements are free of material misstatements resulting from violations of laws and regulations that have a direct and material effect on the determination of financial statement amounts.

122

Each of the following types of controls is considered to be an entity-level control, except those

  1. Relating to the control environment.
  2. Pertaining to the company's risk assessment process.
  3. Regarding the company's annual stockholder meeting.
  4. Addressing policies over significant risk management practices.

Regarding the company's annual stockholder meeting.  controls relating to the annual stockholder meeting are directly related to that function and would not be considered entity-level controls.

123

The objective of a review of interim financial information is to provide the CPA with a basis for

  1. Expressing a limited opinion that the financial information is presented in conformity with generally accepted accounting principles.
  2. Expressing a compilation opinion on the financial information.
  3. Reporting whether material modifications should be made to such information to make it conform with generally accepted accounting principles.
  4. Reporting limited assurance to the board of directors.

Reporting whether material modifications should be made to such information to make it conform with generally accepted accounting principles.

The objective of a review of interim information is to provide the accountant with a basis for communicating whether he or she is aware of any material modifications that should be made to the interim financial information for it to conform with the applicable financial reporting framework (e.g., GAAP).

124

Going Concern Issues - Report Options

  1. Adequately Disclosed
  2. Not Adequately Disclosed

  1. Properly Disclosed -
    • unmodified with EOM or
    • disclaimer of opinion
  2. Not Adequately Disclosed = GAAP departure, 
    • Qualified or
    • Adverse

125

When using a service auditor’s report, the user auditor should?

  1. Make inquiries concerning service auditor’s professional reputation.
  2. If necessary, supplement understanding of service auditor’s procedures by discussing them with the service auditor
  3. Not make reference to the report of the service auditor in his/her audit report

126

Service Auditor Reports are used by the User Auditor (auditor of the FS) for what purposes?

Service auditor reports are primarily for a "user auditor" to use in assessing control risk.

127

Which of the following is correct about an audit report under International Standards for Auditing? The audit opinion may assert that the financial statements:

  • Present Fairly?
  • Give a True and Fair View?

128

Which of the following will result in an emphasis-of-matter paragraph as to consistency in the auditor’s report, when that the item is fully disclosed in the financial statements?

  1. A change in accounting estimate.
  2. A change from an unacceptable accounting principle to a generally accepted one.
  3. Changing the life of an asset from 8 to 5 years.
  4. A change in classification.

A change from an unacceptable accounting principle to a generally accepted one. When a client company makes a change in accounting principles the nature of, justification for, and effect of the change are reported in a note to the financial statements for the period in which the change is made. The auditors evaluate such a change by applying "four tests" to determine that (1) the newly adopted principle is generally accepted; (2) the method of accounting for the effect of the change is in conformity with GAAP; (3) the disclosures related to the change are adequate; and (4) management has justified that the new accounting principle is preferable.

129

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

  1. Provide positive assurance that control activities regarding segregation of duties are consistent with the entity’s control objectives.
  2. Present the results of the auditor’s tests of controls.
  3. Provide negative assurance that the auditor discovered no evidence of intentional override of internal controls.
  4. Describe the scope of the auditor’s principal substantive tests.

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

Reporting on internal control. When performing an audit in accordance with GAGAS, this portion of the combined report must disclose any significant deficiencies identified during the audit. The report also includes an identification and discussion of the implications of those significant deficiencies that are considered to be material weaknesses. 

Other items in the report include:

  • An indication that management is responsible for establishing and maintaining internal control
  • A description of the scope of the auditors’ work in obtaining an understanding of internal control and in assessing control risk
  • A description of deficiencies in internal control not significant enough to be significant deficiencies, or a reference to a separate letter to management that reported these conditions

130

An audit of a large public company following International Auditing Standards ordinarily includes an opinion on

  1. Financial statements?
  2. Internal control?

 

YES and NO.  Remember that unlike audits performed following PCAOB requirements, audits performed following the ISAs do not require an opinion on internal control.

131

The AICPA has outlined auditor reports based on three services that may be provided on service organization controls (SOC). The type most directly related to SysTrust is:

  1. SOC 1
  2. SOC SYS
  3. SOC 3
  4. SOC OC

SOC 3.  SOC 3 reports are in essence based on having performed a SysTrust engagement for a service organization.

  • SOC 1: Restricted use reports on controls at a service organization relevant to a user entity's internal control over financial reporting.
  • SOC 2: Restricted use reports on controls at a service organization related to security, availability, processing integrity, confidentiality, and/or privacy.
  • SOC 3: General use SysTrust reports related to security, availability, processing integrity, confidentiality, and/or privacy.

132

When third-party use of prospective financial statements is expected, an accountant may not accept an engagement to

  1. Perform a review.
  2. Perform a compilation.
  3. Perform an examination.
  4. Apply agreed-upon procedures.

Perform a review. the professional standards which present the standards with respect to the accountant’s obligations for prospective financial statements (forecasts and projections), does not allow for the review form of association under any circumstance.

Financial forecasts and projections.  The attestation standards present three forms of accountant association with forecasts or projections—compilation, examination, and application of agreed-upon procedures.

133

When an accountant issues to an underwriter a comfort letter containing comments on data that have not been audited, the underwriter most likely will receive

  1. Positive assurance on supplementary disclosures.
  2. Negative assurance on capsule information.
  3. A disclaimer on prospective financial statements.
  4. A limited opinion on pro forma financial statements.

Negative assurance on capsule information.  when procedures short of an audit are applied to information such as capsule information, a comfort letter will generally provide negative assurance.

Letters for underwriters.  When a public company wishes to issue new securities to the public, the underwriters of the securities will generally ask the company’s auditor to provide “comfort” on the financial and accounting data in the prospectus that is not covered by an accountant’s report of some form (e.g., an audit report on the financial statements).  In comfort letters, the CPAs will provide positive assurance that they are independent and that their audit followed SEC standards.  They will provide negative assurance or a summary of findings on various types of accounting related matters such as the following:  unaudited summary and summarized interim information, pro forma financial information, change subsequent to the balance sheet date, and on various tables of data.

134

Morris, CPA, suspects that a pervasive scheme of illegal bribes exists throughout the operations of Worldwide Import-Export, Inc., a new audit client.  Morris notified the audit committee and Worldwide’s legal counsel, but neither could assist Morris in determining whether the amounts involved were material to the financial statements or whether senior management was involved in the scheme.  Under these circumstances, Morris should

  1. Express an unmodified opinion with a separate other-matter paragraph.
  2. Disclaim an opinion on the financial statements.
  3. Express an adverse opinion on the financial statements.
  4. Issue a special report regarding the illegal bribes.

Disclaim an opinion on the financial statements. the inability to obtain sufficient appropriate audit evidence will lead to a situation in which the auditor generally should disclaim an opinion on the financial statements.

135

A CPA’s report performing an examination of an entity’s internal control identified several material weaknesses and will be published in the entity’s annual report to shareholders.  Management intends to include a statement asserting that the cost of correcting the weaknesses would exceed the benefits of reducing the risk of errors and fraud. The CPA should

  1. Insist that management’s statement not appear in the same document as the CPA’s report.
  2. Investigate whether the cost of correcting the weaknesses would, in fact, exceed the benefits.
  3. Insist that management correct the weaknesses if cost is the only consideration.
  4. Not express any opinion as to management’s statement.

Not express any opinion as to management’s statement. the accountant should not express any opinion as to management’s statement. Additionally, the accountant is not precluded from disclaiming an opinion on any such statement. 

The purpose of the CPA’s examination of the effectiveness of internal control is to express an opinion about whether the entity maintained, in all material respects, effective internal control as of a point in time based on the control criteria.  In contrast, in a financial statement audit, the purpose of an auditor’s consideration of internal control is to enable the auditor to plan the audit and determine the nature, timing, and extent of tests to be performed.

136

An entity's comparative financial statements include the financial statements of the prior year that were audited by a predecessor auditor whose report is not presented. If the predecessor's report was qualified, the successor should

  1. Issue an updated comparative audit report indicating the division of responsibility.
  2. Explain to the client that comparative financial statements may not be presented under these circumstances.
  3. Express an opinion only on the current year's financial statements and make no reference to the prior year's statements.
  4. Indicate the substantive reasons for the qualification in the predecessor auditor's opinion.

Indicate the substantive reasons for the qualification in the predecessor auditor's opinion. when a predecessor auditor's report is not presented, the successor auditor's report should indicate that

  1. (1) the financial statements of the prior period were audited by another auditor,
  2. (2) the date of that report,
  3. (3) the type of report, and
  4. (4) if the report is other than standard, and the reasons therefore.

137

When an auditor concludes there is substantial doubt about an entity’s ability to continue as a going concern for a reasonable period of time, the auditor’s responsibility is to

  1. Prepare prospective financial information to verify whether management’s plans can be effectively implemented.
  2. Project future conditions and events for a period of time not to exceed 1 year following the date of the financial statements.
  3. Issue a qualified or adverse opinion, depending upon materiality, due to the possible effects on the financial statements.
  4. Consider the adequacy of disclosure about the entity’s possible inability to continue as a going concern.

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

After considering management’s plans, the auditor concludes there is substantial doubt, he or she should consider the possible effects on the financial statements, and the adequacy of the related disclosure. In addition, an emphasis-of-matter paragraph should be added to the audit report.

138

The auditor’s judgment concerning the overall fairness of the presentation of financial position, results of operations, and statement of cash flows is applied within the framework of

  1. Quality control.
  2. Generally accepted auditing standards which include the concept of materiality. 
  3. The auditor’s consideration of the audited company’s internal control.
  4. Generally accepted accounting principles.

Generally accepted accounting principles.

139

An auditor’s report on financial statements that are prepared in accordance with a special purpose financial reporting framework should preferably include all of the following, except

  1. Disclosure of the fact that the financial statement basis of accounting is a basis other than generally accepted accounting principles.
  2. An opinion as to whether the use of the disclosed method is appropriate.
  3. An opinion as to whether the financial statements are presented fairly in conformity with the basis of accounting described.
  4. An opinion as to whether the disclosed basis of accounting has been applied in a manner consistent with the preceding period.

An opinion as to whether the use of the disclosed method is appropriate.  

An audit report on financial statements prepared using a special purpose financial reporting framework departs from the standard form in several ways. Most important, the report should include an emphasis-of-matter paragraph alerting users that the financial statements are prepared in accordance with the special purpose financial reporting framework and refer to the financial statement note that describes the framework. The paragraph should also state that the special purpose framework is a basis of accounting other than GAAP, and describe the basis of accounting being used or refer to a financial statement note that provides such a description. The essence of the report is the expression of an opinion as to whether the financial statements present fairly what they purport to present according to the special purpose framework being used.

140

A lawyer limits a response concerning a litigated claim because the lawyer is unable to determine the likelihood of an unfavorable outcome. Which type of opinion should the auditor express if the litigation is adequately disclosed and the range of potential loss is material in relation to the client’s financial statements considered as a whole?

  1. Adverse.
  2. Unaudited.
  3. Qualified.
  4. Unmodified.

Unmodified.  If the contingency has been adequately disclosed by the client, the auditor would issue an unmodified opinion.

Disclosures are to be regarded as reasonably adequate unless otherwise stated in the audit report. When the auditor issues a qualified or an adverse opinion, the report should provide, if practicable, the information causing the departure from an unmodified report. Thus, if the client omits information in the notes concerning a loan agreement’s restriction of future dividends, the auditor would provide the additional information. However, if the client has omitted a statement of cash flows, the auditor would not be required to prepare it, since it is not practicable to easily and directly obtain this information from the client’s records.

141

Whenever reports filed on a printed form designed by authorities, call upon the independent auditor to make an assertion that the auditor believes is not justified, the auditor should?

  1. Submit a short-form report with explanations.
  2. Reword the form or attach a separate report.
  3. Submit the form with questionable items clearly omitted.
  4. Withdraw from the engagement.

Reword the form or attach a separate report.

When a printed report form calls upon an independent auditor to make an assertion that s/he believes is not justified in making, the form should be reworded or attached to a separate report.

142

An auditor reads the letter of transmittal accompanying a county’s comprehensive annual financial report and identifies a material inconsistency with the financial statements.  The auditor determines that the financial statements do not require revision.  Which of the following actions should the auditor take?

  1. Request that the client revise the letter of transmittal.
  2. Include an emphasis-of-matter paragraph in the auditor’s report.
  3. Consider withdrawing from the engagement.
  4. Request a client representation letter acknowledging the inconsistency.

Request that the client revise the letter of transmittal.

The auditor’s first effort must be to request that the client revise the letter.  The emphasis of matter answer is incorrect because that is the next step if the client does not revise the transmittal letter.  

143

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

  1. Provide positive assurance that control activities regarding segregation of duties are consistent with the entity’s control objectives.
  2. Present the results of the auditor’s tests of controls.
  3. Provide negative assurance that the auditor discovered no evidence of intentional override of internal controls.
  4. Describe the scope of the auditor’s principal substantive tests.

Present the results of the auditor’s tests of controls.  When performing an audit in accordance with GAGAS, this portion of the combined report must disclose any significant deficiencies identified during the audit. The report also includes an identification and discussion of the implications of those significant deficiencies that are considered to be material weaknesses.  Other items in the report include:

  • An indication that management is responsible for establishing and maintaining internal control
  • A description of the scope of the auditors’ work in obtaining an understanding of internal control and in assessing control risk
  • A description of deficiencies in internal control not significant enough to be significant deficiencies, or a reference to a separate letter to management that reported these conditions