Reports on Auditing Engagements -- Forming an Audit Opinion, Including Modification of an Auditor’s Opinion Flashcards
In which of the following situations would an auditor of a public company ordinarily choose between expressing a qualified opinion and an adverse opinion?
A. The auditor did not observe the entity’s physical inventory and is unable to become satisfied about its balance by other auditing procedures.
B. Conditions that cause the auditor to have substantial doubt about the entity’s ability to continue as a going concern are inadequately disclosed.
C. There has been a change in accounting principles that has a material effect on the comparability of the entity’s financial statements.
D. The auditor is unable to apply necessary procedures concerning an investor’s share of an investee’s earnings recognized on the equity method.
B.
If the accompanying notes to the financial statements fail to disclose information that is required by GAAP, the auditor should express a qualified or an adverse opinion.
Incorrect answers a. and d., describe scope limitations which cause an auditor to consider either a qualified opinion or a disclaimer of opinion; not an adverse opinion.
Incorrect answers c., a change in accounting principle, if handled appropriately and adequately disclosed, would result in an unqualified opinion; not an adverse opinion
Under which of the following circumstances would a disclaimer of opinion on the financial statements of a public company not be appropriate?
A. The auditor is unable to determine the amounts associated with an employee fraud scheme.
B. Management does not provide reasonable justification for a change in accounting principles.
C. The client refuses to permit the auditor to confirm certain accounts receivable or apply alternative procedures to verify their balances.
D. The chief executive officer is unwilling to sign the management representation letter.
B.
If the company does not provide reasonable justification that the alternative accounting principle is preferable, the auditor should consider the accounting change to be a departure from GAAP and, if the effect of the change in accounting principle is material, should issue a qualified or adverse opinion; not a disclaimer of opinion.
All of the other answer alternatives describe conditions (scope limitations) that could result in a disclaimer of opinion. (A restriction of the scope of the audit, whether imposed by the client or other circumstances, may require the auditor to express a qualified opinion or a disclaimer of opinion.)
According to PCAOB auditing standards, a company’s critical accounting policies and practices are those that
A. Are both most important to the portrayal of the company’s financial condition and results, and require management’s most difficult, subjective, or complex judgments
B. Form the basis of a company’s accounting structure and thus, other accounting policies and practices are dependent on them for their execution
C. Form the basis of a company’s accounting structure and thus, remain critical from one year to the next
D. Have been identified in past audits as requiring special attention from the engagement partner
A.
According to PCAOB auditing standards, critical accounting policies and practices are a company’s accounting policies and practices that are both most important to the portrayal of the company’s financial condition and results, and require management’s most difficult, subjective, or complex judgments, often as a result of the need to make estimates about the effects of matters that are inherently uncertain.
Critical accounting policies and practices are tailored to specific events in the current year, and the accounting policies and practices that are considered critical might change from year to year.
Which of the following would most likely be a weakness in internal control of a client that utilizes microcomputers rather than a larger computer system?
A. Employee collusion possibilities are increased because microcomputers from one vendor can process the programs of a system from a different vendor.
B. The microcomputer operators may be able to remove hardware and software components and modify them at home.
C. Programming errors result in all similar transactions being processed incorrectly when those transactions are processed under the same conditions.
D. Certain transactions may be automatically initiated by the microcomputers and management’s authorization of these transactions may be implicit in its acceptance of the system design.
B.
Both large computer systems and microcomputers are vulnerable to employee collusion and programming errors. Microcomputer hardware and software could more readily be removed from a place of business than large computer systems.
Which of the following statements is not true of both an engagement to review interim financial statements according to PCAOB auditing standards and SSARS?
A. The objective of a review differs significantly from that of an audit.
B. A review includes primarily applying analytical procedures and making inquiries.
C. A review requires obtaining an understanding of the entity’s internal control over financial reporting.
D. The CPA should possess an understanding of the entity’s industry, including the accounting principles and practices generally used.
C.
A review performed in accordance with SSARS does not contemplate obtaining an understanding of the entity’s internal control.
All of the following describe the pervasive effects of misstatements on the financial statements of a nonissuer except
A. Pervasive effects are not confined to specific elements, accounts, or items of the financial statements.
B. Pervasive effects, with regard to disclosures, are fundamental to users’ understanding of the financial statements.
C. Pervasive effects, with regard to disclosures, would cause a reasonable person to misunderstand the nature of a significant component of the financial statements.
D. Pervasive effects, if confined to specific elements, accounts, or items of the financial statements, represent or could represent a substantial proportion of the financial statements.
C.
Pervasive, used in the context of misstatements, is used to describe the effects on the financial statements of misstatements (or the possible effects on the financial statements of misstatements, if any), that are undetected due to an inability to obtain sufficient appropriate audit evidence. Pervasive effects on the financial statements are those that, in the auditor’s professional judgment (1) are not confined to specific elements, accounts, or items of the financial statements; (2) if so confined, represent or could represent a substantial proportion of the financial statements; or (3) with regard to disclosures, are fundamental to users’ understanding of the financial statements. Answer c., pervasive effects, with regard to disclosures, would cause a reasonable person to misunderstand the nature of a significant component of the financial statements is not part of the definition of pervasive per US GAAS.
Editor’s note: A “reasonable” person would not be able to understand a significant nature of the financial statements, whether pervasive or not.
Which of the following representations does an auditor make explicitly and which implicitly when issuing an unqualified opinion on a public company’s financial statements?
- Conformity with GAAP
- Adequacy of disclosure
A. Implicitly Implicitly
B. Explicitly Explicitly
C. Implicitly Explicitly
D. Explicitly Implicitly
D.
An unqualified opinion states explicitly that the financial statements present fairly, in all material respects, the financial position, results of operations, and cash flows in conformity with US GAAP.
Adequacy of disclosure, per the third standard of reporting, is not explicitly mentioned, i.e., is implicit, unless it is found to be inadequate.
Which of the following audit techniques most likely would provide an auditor with the most assurance about the effectiveness of the operation of an internal control procedure?
A. Confirmation with outside parties
B. Inquiry of client personnel
C. Recomputation of account balance amounts
D. Observation of client personnel
D.
more assurance than audit evidence obtained indirectly.
Editor note: In designing and performing tests of controls, the auditor should
perform other audit procedures in combination with inquiry to obtain audit evidence about the operating effectiveness of the controls, including
how the controls were applied at relevant times during the period under audit;
the consistency with which they were applied; and
by whom or by what means they were applied, including, when applicable, whether the person performing the control possesses the necessary authority and competence to perform the control effectively, and
determine whether the controls to be tested depend upon other controls (indirect controls) and, if so, whether it is necessary to obtain audit evidence supporting the operating effectiveness of those indirect controls.
Answer a., confirmation with outside parties, is not as effective as the auditor’s direct observation of client personnel performing the control procedure. Further, it is not nearly as likely as observation is to be a relevant procedure for testing the operating effectiveness of controls.
Answer b., inquiry of client personnel, should be performed in combination with other audit procedures to obtain audit evidence about the operating effectiveness of the controls; so it is not the best answer.
Answer c., recomputation of account balance amounts, is not as effective as the auditor’s direct observation of client personnel performing the control procedure. Further, it is not nearly as likely as observation is to be a relevant procedure for testing the operating effectiveness of controls.
Editor note: Per GAAS, the audit procedures of inspection, observation, external confirmation, recalculation, reperformance, analytical procedures, and inquiry may be used as risk assessment procedures, tests of controls, or substantive procedures, depending on the context in which they are applied by the auditor. However, you need to use judgment when answering exam questions in that some procedures will generally be more commonly used for one type of audit procedure than another, for example, recomputation of account balances, will be used most often as a substantive test of details because it is effective for that purpose.
more assurance than audit evidence obtained indirectly.
Editor note: In designing and performing tests of controls, the auditor should
perform other audit procedures in combination with inquiry to obtain audit evidence about the operating effectiveness of the controls, including
how the controls were applied at relevant times during the period under audit;
the consistency with which they were applied; and
by whom or by what means they were applied, including, when applicable, whether the person performing the control possesses the necessary authority and competence to perform the control effectively, and
determine whether the controls to be tested depend upon other controls (indirect controls) and, if so, whether it is necessary to obtain audit evidence supporting the operating effectiveness of those indirect controls.
Answer a., confirmation with outside parties, is not as effective as the auditor’s direct observation of client personnel performing the control procedure. Further, it is not nearly as likely as observation is to be a relevant procedure for testing the operating effectiveness of controls.
Answer b., inquiry of client personnel, should be performed in combination with other audit procedures to obtain audit evidence about the operating effectiveness of the controls; so it is not the best answer.
Answer c., recomputation of account balance amounts, is not as effective as the auditor’s direct observation of client personnel performing the control procedure. Further, it is not nearly as likely as observation is to be a relevant procedure for testing the operating effectiveness of controls.
Editor note: Per GAAS, the audit procedures of inspection, observation, external confirmation, recalculation, reperformance, analytical procedures, and inquiry may be used as risk assessment procedures, tests of controls, or substantive procedures, depending on the context in which they are applied by the auditor. However, you need to use judgment when answering exam questions in that some procedures will generally be more commonly used for one type of audit procedure than another, for example, recomputation of account balances, will be used most often as a substantive test of details because it is effective for that purpose.
D.
The best answer is to establish policies to ensure that the audit work meets applicable professional standards. Compliance with the Sarbanes-Oxley Act is too limited; is not applicable to all firms; and does not encompass the AICPA’s quality control standards. The other answers are not on point. GAAS require a firm of independent auditors to adopt a system of quality control in conducting an audit practice. Thus, a firm should establish quality control policies and procedures to provide it with reasonable assurance that its personnel comply with GAAS in its audit engagements. Further, the AICPA’s quality control standards require that a CPA firm establish a system of quality control designed to provide the firm with reasonable assurance that the firm and its personnel comply with professional standards and applicable regulatory and legal requirements, and that the firm or engagement partners issue reports that are appropriate in the circumstances. A system of quality control consists of policies designed to achieve these objectives and the procedures necessary to implement and monitor compliance with those policies.
An auditor is engaged to report on supplementary information in relation to the financial statements as a whole that is included in a client-prepared document containing audited financial statements. Under these circumstances, the auditor has elected to report on the supplementary information in an other-matter paragraph in the audit report on the financial statements. The other-matter paragraph should
A. State that the presentation is a comprehensive basis of accounting other than GAAP
B. State that the supplementary information has not been subjected to the auditing procedures
C. State that the information is limited to data derived from records used to prepare the entity’s financial statements
D. Restrict the use of the report to appropriate specified parties
C.
When an auditor is engaged to report on supplementary information that is included in a client-prepared document containing audited financial statements,the other-matter paragraph or separate report should include a statement that the supplementary information is the responsibility of management and was derived from, and relates directly to, the underlying accounting and other records used to prepare the financial statements. The auditor’s primarily responsibility here is to ensure that the supplementary information is consistent with the financial statements it accompanies. In addition, none of the other answers are required report elements. Regarding incorrect answer a., supplementary information is presented outside the basic financial statements; thus, an explanation concerning the framework is not required. And, the basis of accounting used for supplementary information is not necessarily other than GAAP. Supplementary information may be prepared in accordance with various criteria or other requirements. Regarding incorrect answer b., the report should state that the supplementary information has been subjected to the auditing procedures applied in the audit of the financial statements and certain additional procedures, including comparing and reconciling such information directly to the underlying accounting and other records used to prepare the financial statements or to the financial statements themselves and other additional procedures, in accordance with US GAAS. Regarding incorrect answer d., note that the question stipulates that the selected financial data is in a document containing the financial statements and the auditor is reporting via an other-matter paragraph included in the audit report on the financial statements. If the auditor had elected to issue a separate report on the supplementary information (or had been required to report separately because the audited financial statements were not presented with the supplementary information), the auditor may consider including an alert that restricts the use of the separate report solely to the appropriate specified parties to avoid potential misinterpretation or misunderstanding of the supplementary information that is not presented with the financial statements.
Editor Note: When the entity presents the supplementary information with the financial statements, the auditor should report on the supplementary information in either an other-matter paragraph in the audit report on the financial statements or in a separate report. When the audited financial statements are not presented with the supplementary information, the auditor should report on the supplementary information in a separate report. When reporting separately, the report should include a reference to the report on the financial statements, the date of that report, the nature of the opinion expressed on the financial statements, and any report modifications
An auditor may decide to increase the risk of incorrect rejection when
A. Increased reliability from the sample is desired.
B. Many differences (audit value minus recorded value) are expected.
C. Initial sample results do not support the planned level of control risk.
D. The cost and effort of selecting additional sample items is low.
D.
The risk of incorrect rejection is the risk that the sample supports the conclusion that the recorded account balance is materially misstated when, in fact, it is not materially misstated. Thus, the risk of incorrect rejection relates to the efficiency of the audit. If the auditor’s evaluation of the audit sample leads him to the initial erroneous conclusion that a balance is materially misstated when it is not, the application of additional audit procedures and consideration of other audit evidence would ordinarily lead the auditor to the correct conclusion. The cost of this mistake is the cost of the additional procedures necessary to discover that the original conclusion was erroneous. If however, the cost and effort of those additional procedures is low, the auditor may well decide to use a high risk of incorrect rejection because doing so will reduce original sample size. If the desired results are achieved with the original small sample, overall audit cost will be lowered. If an incorrect rejection occurs, however, the incremental cost incurred would not be excessive. An increase in the desired reliability would likely result in a decrease (not increase) in the risk of incorrect rejection. The number of differences expected should have no bearing on the risk of incorrect rejection specified. The ‘risk of incorrect rejection’ is not a concept associated with test of controls. ‘Risk of underreliance’ would be the corresponding risk that is associated with control testing.
Which explanation best describes how an auditor determines (as required by US GAAS) if a financial statement assertion is relevant for each significant class of transactions, account balance, and disclosure?
A. By exercising professional judgment for the particular nature and characteristics of the entity
B. By exercising professional skepticism, recognizing that circumstances may exist that cause the financial statements to be materially misstated
C. By determining the source of likely potential misstatements in each significant class of transactions, account balance, and disclosure
D. By performing walk-throughs of the related systems
C.
Identifying relevant assertions includes determining the source of likely potential misstatements in each significant class of transactions, account balance, and disclosure. Attributes indicating the potential relevance of an assertion include the nature of the assertion; volume of transactions or data related to the assertion; and the nature and complexity of the systems, including the use of information technology (IT), by which the entity processes and controls information supporting the assertion.
While performing procedures in planning an audit, the auditor’s comparison of expectations with recorded amounts yield unusual and unexpected relationships. The auditor should consider the results of the analytical procedures in which of the following?
A. Determining planning materiality and acceptable error.
B. Identifying the risks of material misstatement due to fraud.
C. Identifying significant accounts.
D. Determining which controls to test.
The correct answer is (B).
Comparison of expectations with recorded amounts is an analytical procedure. Analytical procedures are an important tool used by the auditor during risk assessment, in order to identify any unusual or unexpected relationships understanding client’s business and changes in the business to identify potential areas of risk including risks of material misstatement due to fraud.
Analytical procedures are used to assist in planning the nature, timing, and extent of audit. To accomplish this, the analytical procedures used in planning should
Enhancing the auditor’s understanding of the client’s business and the transactions and events that have occurred since the last audit date
Identifying areas that may represent specific risks relevant to the audit including risks of material misstatement due to fraud.
A description of the significant deficiencies and material weaknesses and an analysis of their effects, including the magnitude expressed as a percentage of the applicable accounts
B. A description of the significant deficiencies and material weaknesses and an explanation of their effect on the auditor’s overall risk assessment
C. Not include suggestions for remedial action on the deficiencies as this may tend to overshadow the reporting of the deficiencies
D. A description of the significant deficiencies and material weaknesses and an explanation of their potential effects
D.
The auditor should include in the auditor’s written communication of significant deficiencies and material weaknesses a description of the significant deficiencies and material weaknesses and an explanation of their potential effects. In explaining the potential effects of the significant deficiencies and material weaknesses, the auditor need not quantify those effects. The potential effects may be described in terms of the control objectives and types of errors the control was designed to prevent, or detect and correct; or in terms of the risk of misstatement that the control was designed to address. The purpose of the communication is to report matters to management and those charged with governance that merit their attention in meeting their responsibilities; not how it relates to the audit. Thus, the auditor should not communicate their effect on the auditor’s overall risk assessment. The auditor may also include in the written communication suggestions for remedial action on the deficiencies, management’s actual or proposed responses, and a statement about whether the auditor has undertaken any steps to verify whether management’s responses have been implemented.
Which of the following steps should an auditor perform first to determine the existence of related parties?
A. Examine invoices, contracts, and purchasing orders
B. Request a list of related parties from management
C. Review the company’s business structure
D. Review proxy and other materials filed with the SEC
B.
One of the first steps an auditor should perform to determine the existence of related parties is to request a list of related parties from management. Reviewing proxy and other material filed with the SEC is a close second choice, but it is usually best to start with inquiries to management and then corroborate those results with the SEC and other regulatory agencies. Reviewing the company’s business structure should be done to determine the scope of work to be performed with respect to possible transactions with related parties rather than determining their existence. Examining invoices, contracts, and purchase orders would be done after related-party transactions have been identified rather than to determine their existence. It would be done to obtain satisfaction or evidence concerning the purpose, nature, and extent of related-party transactions and their effect on the financial statements.
