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Glimpse of a CPA's mind: August 2010

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Glimpse of a CPA's mind

This blog is based on International Financial Reporting Standards, American Institute of Certified Public Accountants, Conceptual Framework of Accounting, and Auditing Assurance & Standards Council, Standards on Review Engagements, International Standards on Auditing, as well as the Corporate Code of Good Governance.
Hello. A warmest greetings to you my fellows!! I have created a blog exclusively for all aspiring CPA's (Certified Public Accountants) to be. This blog is composed of all the fields of the accountancy profession offered in the Philippines, just the same with other countries where they adapted the currently applicable Financial Reporting Standards as well as Auditing Standards. All the questions were have to been updated in accordance with the dynamic changes in the accounting standards just to cope with the changing needs of the FS users. Most of the blogs were modified based on the Philippine CPA board examinations, American CPA board examinations, Certified General Accountants of Canada, National Institute of Accounting Technician of Australia and United Kingdom. So enjoy reading my blog and don't forget to leave a comment. Try to read and answer all the given questions and continue using this site as your tool to success. Hoping that you will become a CPA like me too!! Just keep on practicing your skills and make it permanent. That's all folks, thank you and GOD bless!! I will also include some CPA Board examinations especially made for my beloved classmates, fellow Accounting Bachelor takers, and CPA professors. This includes, test banks and text banks for accounting, taxation, management advisory and auditing courses. Again, thank you for visiting my blog. Thanks a lot!! :) note: to search, just typein the subject and look for the links.
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Thursday, August 26, 2010
Audit Theory CPA Board

1. The third standard of fieldwork states that sufficient competent evidential matter may, in part, be obtained through inspection, observation, inquiries, and confirmations, to afford a reasonable basis for an opinion regarding the financial statements under examination. The evidential matter required by this standard may, in part, be obtained through
a) Analytical procedures. b) Auditor working papers. c) Review of the internal control. d) Proper planning of the audit engagement.
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Answer A is correct. The requirement is to determine which of the listed answers is included in the third fieldwork standard that specifies the need to obtain sufficient competent evidential matter during an audit. Evidential matter required by the third fieldwork standard is obtained through two general classes of auditing procedures: (1) tests of details of transactions and balances and (2) analytical procedures applied to financial information.
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Answer B is incorrect because working papers are used to summarize and document the results of application of audit procedures and not to assist the auditor in obtaining evidence.
Answer C is incorrect because information on internal control pertains to the second fieldwork standard which is on internal control.
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Answer D is incorrect because planning itself does not obtain evidence.
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2. Most of the independent auditors work in formulating an opinion on financial statements consists of a) Considering internal control. b) Obtaining and examining evidential matter. c) Examining cash transactions. d) Comparing recorded accountability with assets.
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Answer A is incorrect because the auditor's consideration of internal control is encompassed in obtaining and examining evidential matter. Thus, obtaining and examining evidential matter requires more work than the study of internal control. Egypt's interim president signs law restricting GMA News protests state TV (Updated 8:45 p.m.) CAIRO Egypt's interim president signed into law on Sunday a bill that rights groups have said sharply curbs the rights of citizens to assemble and protest peacefully. State television reported that Adli Mansour had signed the bill ... Japanese preschooler, 6, donates piggy GMA bank News savings for Yolanda victims ... A sixyearold Japanese preschooler became one of the youngest donors to Philippine efforts to raise funds for victims of Super Typhoon Yolanda (Haiyan). The Philippine Embassy in Japan reported Thursday that Shoichi Kondoh donated his childhood ... A history of storms: 1900s newspaper GMA News reveals devastating Leyte typhoon Outside Tacloban, relief goods are not coming. Children run toward a US military aircraft on Thursday as it arrives to distribute aid to super typhoon Yolanda survivors of Guiuan, Samar. Though aid has started to arrive in Guiuan, residents in the ... Over 100 dead, airport ruined in Tacloban GMA after News Yolanda onslaught MANILA More than 100 bodies are lying in the streets in Tacloban City in Leyte that was hit by Super Typhoon Yolanda (Haiyan), an aviation authority chief said Saturday. John Andrews, deputy director general of the Civil Aviation Authority of the ...
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Answer B is correct because the auditor's report is based upon evidential matter which is obtained through the application of audit procedures to the financial statements and underlying accounting records.
Answer C is incorrect because the examination of cash transactions is a specific substantive test which would not constitute most of the auditor's work in formulating an opinion.
Answer D is incorrect because comparing recorded accountability with assets is a specific test which would not constitute most of the auditor's work in formulating an opinion.
3. Management prepares accounting estimates and the auditor is responsible for evaluating the reasonableness of the estimates. Which of the following would not be an auditors objective when evaluating estimates? a) All accounting estimates which could be material to the financial statements have been developed. b) The accounting estimates developed by management are accurate with 100% certainty. c) The accounting estimates developed by management are reasonable. d) The accounting estimates are presented in accordance with generally accepted accounting principles.
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Answer A is incorrect because the auditor would want to ensure that all estimates material to the financial statements have been developed.
Answer B is correct because no one accounting estimate can be considered accurate with certainty.
Answer C is incorrect because it is the responsibility of the auditor to determine the reasonableness of the estimates.
Answer D is incorrect because an overall objective of the auditor is to ensure that the financial statements are presented in accordance with GAAP.
4. It is the responsibility of the auditor to evaluate the reasonableness of the accounting estimates made by management. Which one of the following approaches would the auditor not use when evaluating the reasonableness of the estimate? a) Review and test managements process to develop the estimate.
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b) Calculate an independent expectation of the estimate. c) Confirm the estimate with independent parties.
d) Review subsequent events or transactions occurring prior to completion of fieldwork.
Answer A is incorrect because this is one of the approaches the auditor may use.
Answer B is incorrect because this is one of the approaches the auditor may use.
Answer C is correct. Confirmation of most estimates (e.g., warranty liabilities) is not an appropriate approach for evaluating the reasonableness of the estimate.
Answer D is incorrect because this is one of the approaches the auditor may use.
5. Of the following, which is the least persuasive type of audit evidence? a) Documents mailed by outsider to the auditor. b) Corresponding between auditor and vendors. c) Copies of sales invoices inspected by the auditor. d) Computations made by the auditor.
Answer A is incorrect because externally generated documents received directly by the auditor are considered more reliable evidence than internally generated evidence.
Answer B is incorrect because information obtained directly by the auditor from a third party source is considered more reliable than internally generated evidence.
Answer C is correct because copies of sales invoices represent internally generated evidence, which is considered less reliable than externally generated evidence received directly by the auditor.
Answer D is incorrect because computations made by the auditor represent direct personal knowledge, which is considered more persuasive than internally generated evidence.
6. Which of the following is the least persuasive documentation in support of an auditors opinion? a) Schedules of details of physical inventory counts conducted by the client. b) Notation of inferences drawn from rations and trends. c) Notation of appraisers conclusions documented in the auditors working papers. d) Lists of negative confirmation requests for which no response was received by the auditor.
Answer A is correct because schedules of details of physical inventory counts conducted by the client is least persuasive because it is developed solely within the entity.
Answer B is incorrect because inferences drawn by the auditor from selfcomputed ratios and trends are more persuasive than those from solely the client's data.
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Answer C is incorrect because an independent third party's conclusions are considered more persuasive than those generated by the client's internal sources.
Answer D is incorrect because no reply to a negative confirmation from an independent third party is considered to be support for the accuracy of the accounts receivable and is more persuasive than internally developed data.
7. Failure to detect material peso errors in the financial statements is a risk which the auditor primarily mitigates by a) Performing substantive tests. b) Performing tests of controls. c) Evaluating internal control. d) Obtaining a client representation letter.
Answer A is correct because substantive tests are used to control the risk of incorrect acceptance of a population which is materially in error. The auditor faces two separate risks. The first risk is that material misstatements may occur in the accounting process, and the second risk is that material misstatements that have occurred will not be detected in the auditor's examination. The auditor relies on internal control to reduce the first risk and substantive tests to reduce the second risk.
Answer B is incorrect because tests of controls relate more directly to the risk of assessing control risk too high or too low rather than the risk of failing to detect material peso errors.
Answer C is incorrect because the auditor relies on internal control to reduce the risk of misstatement occurring, not to detect a misstatement which has already occurred.
Answer D is incorrect because obtaining a client representation letter will not in any way mitigate the risk of failure to detect material misstatements. Representation letters confirm the oral representations which have been made by management to the auditor but are not substitutes for any other audit procedures.
8. Before applying substantive tests to the details of asset accounts at an interim date, an auditor should assess a) Control risk at below the maximum level. b) Inherent risk at the maximum level. c) The difficulty in controlling the incremental audit risk. d) Materiality for the accounts tested as insignificant.
Answer A is incorrect because while control risk will generally be assessed at below the maximum level in such circumstances, this is not required.
Answer B is incorrect because while inherent risk may be at the maximum level, the situation in which it is not is more likely, since a lower level of risk is more likely to lead to interim testing.
Answer C is correct because AU 313 requires that an auditor assess the difficulty in controlling the incremental audit risk. In addition, the auditor should consider the cost of the substantive tests that are necessary to appropriately examine the remaining period.
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Answer D is incorrect because the accounts tested need not be insignificant.
9. An auditors decision either to apply analytical procedures as substantive tests or to perform tests of transactions and account balances usually is determined by the a) Availability of data aggregated at a high level. b) Relative effectiveness and efficiency of the tests. c) Timing tests performed after the balance sheet date. d) Auditors familiarity with industry trends.
Answer A is incorrect because data aggregated at a high level often obscures relationships used by analytical procedures.
Answer B is correct because the decision on the appropriate mix of substantive tests is based on the auditor's judgment on the expected effectiveness and efficiency of the available procedures.
Answer C is incorrect because timing of tests performed after the balance sheet date does not typically affect the decision on whether to apply analytical procedures as substantive tests or to perform tests of transactions and account balances.
Answer D is incorrect because familiarity with industry trends is only one factor involved in using analytical procedures and it does not adequately describe the basis for making this decision.
10. As a result of analytical procedures, the independent auditor determines that the gross profit percentage has declined from 30% in the preceding year to 20% in the current year. The auditor should a) Include an explanatory paragraph in the audit report due to the inability of the client company to continue as a going concern. b) Evaluate managements performance in causing this decline. c) Require footnote disclosure. d) Consider the possibility of a misstatement in the financial statements.
Answer A is incorrect because a decline in the gross profit percentage would not, by itself, require that an explanatory paragraph be added to an unqualified report. The firm may still be in a profitable position and, thus, would not be a candidate for going concern problems.
Answer B is incorrect because the scope of a financial statement audit is not to explicitly evaluate management's performance.
Answer C is incorrect because a footnote may not be necessary and because it is not the role of an auditor to require a footnote; the financial statements are the representations of management.
Answer D is correct because a significant fluctuation in the gross profit percentage might be indicative of a misstatement. Therefore, the auditor must consider the possibility of a misstatement in the financial statements. 11. Which of the following factors would least influence an auditors consideration of the reliability of data for purposes of analytical procedures?
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a) Whether the data were processed in a computerized system or in manual accounting system. b) Whether sources within the entity were independent of those who are responsible for the amount being audited. c) Whether the data were subjected to audit testing in the current or prior year. d) Whether the data were obtained from independent sources outside the entity from sources within the entity.
Answer A is correct because whether the data were processed in a computerized system or in a manual accounting system will not in and of itself influence reliabilityeither type of system may provide reliable (or unreliable) information.
Answer B is incorrect because whether sources within the entity were independent of those who are responsible for the amount being audited does influence the auditor's consideration of the reliability of data for purposes of achieving audit objectives. Answer C is incorrect. It is a factor which influences the auditor's consideration of the reliability of data for purposes of achieving audit objectives.
Answer D is incorrect. It is a factor which influences the auditor's consideration of the reliability of data for purposes of achieving audit objectives.
12. Which of the following is the most reliable analytical procedure to verify the yearend financial statement balances of a wholesale business? a) Verify depreciation expense by multiplying the depreciable asset balances by one divided by the depreciation rate. b) Verify commission expense by multiplying sales revenue by the companys standard commission rate. c) Verify interest expense, which includes imputed interest, by multiplying longterm debt balances by the yearend prevailing interest rate. d) Verify IT tax liability by multiplying total payroll costs by the IT contribution rate in effect during the year.
Answer A is incorrect because depreciation expense would not be determined this way. Therefore, this is not an analytical procedure.
Answer B is correct because if the firm has a standard commission rate, the commission expense would be directly related to the sales revenue. Therefore, this would be a reliable analytical procedure.
Answer C is incorrect because the interest expense, including imputed interest, may not be directly related to the yearend prevailing interest rate. Thus, interest expense could not be verified in this manner.
Answer D is incorrect because the IT tax liability would not be directly related to total payroll costs. Thus, this would not be a reliable analytical procedure.
13. Which of the following statements concerning analytical procedures is correct? a) Analytical procedures may be omitted entirely for some financial statement audits. b) Analytical procedures used in planning the audit should not use nonfinancial information. c) Analytical procedures usually are in effective and efficient for test of controls.
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d) Analytical procedures alone may provide the appropriate level of assurance for some assertions.
Answer A is incorrect because the performance of analytical procedures is required during the planning and overall review stages of audits.
Answer B is incorrect because analytical procedures used in planning the audit may use nonfinancial information (e.g., number of employees, square footage of selling space).
Answer C is incorrect because analytical procedures are not used to test controls.
Answer D is correct. The requirement is to identify the correct statement about analytical procedures. Analytical procedures may in certain circumstances provide the appropriate level of assurance for some assertions.
14. Which of the following is a basic tool used by the auditor to control the audit work and review the progress of the audit? a) Time and expense summary. b) Engagement letter. c) Progress flowchart. d) Audit program.
Answer A is incorrect because the time and expense summary accumulates data concerning hours worked and expenses charged but does not control the audit work.
Answer B is incorrect because the engagement letter provides documentation of the understandings between the auditor and client at the onset of the engagement.
Answer C is incorrect because a progress flowchart is not a legitimate term.
Answer D is correct because the audit program aids in instructing assistants in the work and includes audit procedures to accomplish the objectives of the examination. Thus, it allows the auditor to control the audit work and to review the progress of the audit.
15. Which of the following elements ultimately determines the specific auditing procedures that are necessary in the circumstances to afford a reasonable basis for an opinion? a) Auditor judgment. b) Materiality. c) Relative risk. d) Reasonable assurance.
Answer A is correct because the measure of the validity of evidence for audit purposes is based upon the judgment of the auditor. This audit judgment is used to estimate levels of materiality (Answer B), and relative risk (Answer C).
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Answer B is incorrect because estimating levels of materiality is only one aspect of audit judgment used to determine necessary auditing procedures.
Answer C is incorrect because evaluating relative risk is only one aspect of audit judgment used to determine necessary auditing procedures.
Answer D is incorrect because reasonable assurance is the general concept which states that the cost of internal control should not exceed the expected benefit.
16. Which of the following analyses appearing in a predecessors working papers is the successor auditor least likely to be interested in reviewing? a) Analysis of noncurrent balance sheet accounts. b) Analysis of current balance sheet accounts. c) Analysis of contingencies. d) Analysis of income statement accounts.
Answer A is incorrect because the successor auditor will normally review working papers of continuing accounting significance. The noncurrent balance sheet accounts would be of continuing significance and should be reviewed.
Answer B is incorrect because the successor auditor will normally review working papers relating to matters of continuing accounting significance. The current balance sheet accounts are of continuing significance and should be reviewed.
Answer C is incorrect because the successor auditor will normally review working papers relating to matters of continuing accounting significance. Contingencies are of continuing significance and should be reviewed.
Answer D is correct because the successor will normally review working papers of continuing accounting significance. Prior income statement accounts are less likely to have continuing significance than are balance sheet accounts and contingencies.
17. Which of the following circumstances would most likely cause an auditor to suspect that material fraud exists in a clients financial statements? a) Property and equipment are usually sold at a loss before being fully depreciated. b) Significant fewer responses to confirmation requests are received than expected. c) Monthly bank reconciliation usually includes several intransit items. d) Clerical errors are listed on a computergenerated exception report.
Answer A is incorrect because selling property and equipment at a loss before it is fully depreciated may simply reveal inadequate depreciation policies, as contrasted to material irregularities.
Answer B is correct because receiving significantly fewer responses to confirmation requests than were expected is considered a circumstance that should cause the auditor to consider whether material misstatements exist.
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Answer C is incorrect because for many clients the existence of intransit items is expected and proper.
Answer D is incorrect because the computergenerated report provides assurance to the auditor that internal controls are in place, since it provides a means of detecting errors. The existence of good controls decreases the probability of misstated financials.
18. Which of the following conditions would not normally cause the auditor to question whether material errors or fraud exist? a) Bookkeeping errors are listed on an computergenerated exception report. b) Differences exist between control accounts and supporting subsidiary records. c) Transactions are not supported by proper documentation. d) Differences are disclosed by confirmations.
Answer A is correct since the existence of a computergenerated exception report indicates that the firm is controlling and correcting errors.
Answer B is incorrect because differences between control accounts and subsidiary records indicate that one or both of the records are incorrect.
Answer C is incorrect since lack of proper documentation might indicate either an error or fraud.
Answer D is incorrect because differences on confirmation replies are often indicative of errors and/or fraud.
19. On receiving the bank cutoff statement, the auditor should trace a) Deposits in transit on the yearend bank reconciliation to deposits in the cash receipts journal. b) Checks dated prior to yearend to the outstanding checks listed on the yearend bank reconciliation. c) Deposits listed on the cutoff statement to deposits in the cash receipts journal. d) Checks dated subsequently to yearend to the outstanding checks listed on the yearend bank reconciliation.
Answer A is incorrect because comparing deposits in transit on the bank reconciliation with deposits in the cash receipts journal is a procedure which is not directly related to the bank cutoff statement.
Answer B is correct because comparing checks returned with the cutoff statement which was dated prior to yearend with the list of outstanding checks on the bank reconciliation will provide evidence as to the completeness of the listing of outstanding checks on the bank reconciliation. This step facilitates a search for unrecorded liabilities.
Answer C is incorrect because only deposits for several days prior to and subsequent to yearend are compared.
Answer D is incorrect because checks dated subsequent to yearend would not be listed on the year end bank reconciliation.
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20. An auditor who is engaged to examine the financial statements of a business enterprise will request a cutoff bank statement primarily in order to a) Verify the cash balance reported on the bank confirmation inquiry form. b) Verify reconciling items on the clients bank reconciliation. c) Detect lapping. d) Detect kiting.
Answer A is incorrect because verifying the cash balance reported on the bank confirmation is a secondary objective.
Answer B is correct since a cutoff bank statement will include canceled checks and deposit slips for the period immediately following yearend. The auditor is, therefore, able to test whether the reconciling items at yearend have been handled properly.
Answer C is incorrect because a cutoff bank statement, by itself, will provide limited assistance in detecting lapping. Lapping is an embezzlement scheme in which cash collections from customers are stolen and is detected by the use of confirmations and analytical procedures.
Answer D is incorrect because a cutoff bank statement, by itself, will provide limited assistance in detecting kiting. Kiting is the overstatement of cash by recording a deposit without a corresponding withdrawal at yearend and is best detected through the use of a bank transfer schedule.
21. A sales cutoff test of billings complements the verification of a) Sales returns. b) Cash. c) Account receivable. d) Sales allowance.
Answer A is incorrect because sales returns on cutoff sales will typically occur subsequent to the cutoff period.
Answer B is incorrect because the cash for cutoff sales will not be received until some time after billing.
Answer C is correct because the primary purpose of a sales cutoff test is to obtain reasonable assurance that sales and accounts receivable are recorded in the accounting period during which title has passed.
Answer D is incorrect because sales allowances on cutoff sales will occur subsequent to the cutoff period.
22. An auditor is testing sales transactions. One step is to trace a sample of debit entries from the accounts receivable subsidiary ledger back to the supporting sales invoices. What would the auditor intend to establish by this step?
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a) Sales invoices represent bona fide sales. b) All sales have been recorded.
c) All sales invoices have been properly posted to customer accounts. d) Debit entries in the accounts receivable subsidiary ledger are properly supported by sales invoices.
Answer A is incorrect because the auditor would trace sales invoices to supporting bills of lading in order to conclude that sales invoices represent bona fide sales.
Answer B is incorrect because the auditor would trace bills of lading to entries in the subsidiary ledger in order to conclude that all sales have been properly recorded.
Answer C is incorrect because the auditor will trace sales invoices to the subsidiary ledger in order to conclude that sales invoices have been properly posted to customer accounts.
Answer D is correct because the auditor would appropriately conclude that entries in the accounts receivable subsidiary ledger are properly supported by sales invoices.
23. When auditing a public warehouse, which of the following is the most important audit procedure with respect to disclosing unrecorded liabilities? a) Confirmation of negotiable receipts with holders. b) Review of outstanding receipts. c) Inspection of receiving and issuing procedures. d) Observation of inventory.
Answer A is incorrect because confirmation of negotiable instruments may be impractical due to a problem of identifying the holder of the negotiable receipt.
Answer B is incorrect because a review of outstanding receipts cannot be made because the auditor has no knowledge of who may hold "unrecorded" receipts.
Answer C is correct because inspection of receiving and issuing procedures will permit the auditor to thoroughly evaluate the internal control over the custodial responsibilities of the warehouse employee. If the custodial responsibilities are not properly discharged, there may be significant unrecorded liabilities.
Answer D is incorrect because an observation of inventory will only determine what is on hand. The amount of inventories on hand must be coupled with a review of outstanding warehouse receipts to determine any unrecorded liabilities.
24. Which of the following statements best describes the phrase Philippine Standard on Auditing? a) They identify the policies and procedures for the conduct of the audit. b) They define the nature and extent of the auditors responsibilities. c) They provide guidance to the auditor with respect to planning the audit and writing the audit report. d) They set forth a measure of the quality of the performance of audit procedures.
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Answer A is incorrect because Philippine Standard on Auditing (PSA) give only limited guidance as to specific policies and procedures for the conduct of the audit.
Answer B is incorrect because Philippine Standard on Auditing (PSA) gives only limited guidance as to the nature and extent of the auditor's responsibilities.
Answer C is incorrect because it only relates to the standard concerned with planning the audit and writing the audit report and not to the other standards.
Answer D is correct because Philippine Standards on Auditing (PSA) deal with measures of the quality of the performance of audit procedures. Auditing standards relate not only to the auditor's professional qualities but also to the judgment exercised by the auditor in the performance of the audit.
25. Which of the following publications does not qualify as a source of generally accepted accounting principles? a) Accounting interpretations issued by the FASB. b) PSA Concepts Statements. c) PICPA Practice Bulletins. d) Statements of Financial Standards issued by the FASB
Answer A is incorrect because interpretations issued by the FASB are considered as sources of PAS.
Answer B is correct because the PAS has not issued concepts statements. The concepts statements issued by the FASB are considered "other accounting literatures" and are not sources of generally accepted accounting principles of the Philippines.
Answer C is incorrect because Practice Bulletins are considered as sources of PAS
Answer D is incorrect because FASB statements are considered sources of PAS
26. Which of the following statements best describes the auditors responsibility regarding the detection of material errors and fraud? a) The auditor is responsible for the failure to detect material errors and fraud only when such failure results from the nonapplication of generally accepted accounting principles. b) Auditing procedures may or may not need to be extended if the auditors analysis indicates the existence of fraud risk factors. c) The auditor is responsible for the failure to detect material errors and fraud only when the auditor fails to confirm receivables or observed inventories. d) Extended auditing procedures are required to detect unrecorded transactions even if there is no evidence that material errors and fraud may exist.
Answer A is incorrect. The auditor should design the audit to provide reasonable assurance of detecting errors and fraud that is material to the financial statements. This responsibility for detection is not limited to circumstances arising from the nonapplication of generally accepted accounting principles.
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Answer B is correct. When fraud risk factors exist, the auditor should consider whether already designed procedures adequately consider the existence of fraud. When they do not, audit procedures must be extended.
Answer C is incorrect. The auditor may be held responsible for failures to detect misstatements due to errors and fraud because of inadequate planning, performance or judgment. Not confirming receivables or not observing inventories are only two of the many possible situations in which the auditor may be held responsible for a failure to detect associated errors and fraud.
Answer D is incorrect. The extended auditing procedures are necessary when normal procedures indicate evidence that misstatements due to errors and fraud may exist, not when there is no such evidence.
27. Which of the following is not a procedure performed primarily for the purpose of expressing an opinion on the financial statements, but may bring possible illegal acts to the auditors attention? a) Consideration of internal control. b) Review of policies concerning effectiveness of management decision making policies. c) Test of transactions. d) Test of balances.
Answer A is incorrect because the consideration of internal control is performed to lead to the expression of an opinion on the financial statements.
Answer B is correct because the review of effectiveness of decision making policies is not a procedure when expressing an opinion on the financial statements. External auditors are primarily concerned with internal controls that affect recording, processing, summarizing, and reporting financial data.
Answer C is incorrect because tests of transactions (substantive tests) are performed for the purpose of expressing an opinion on the financial statements.
Answer D is incorrect because tests of balances (substantive tests) are performed for the purpose of expressing an opinion on the financial statements.
28. An auditor of a manufacturer would most likely question whether that client has committed illegal acts if the client has a) Been forced to discontinue operations in a foreign country. b) Been an annual donor to a local political candidate. c) Failed to correct material weakness in internal control that were reported after the priors audit. d) Disclosed several subsequent events involving foreign operations in the notes to the financial statements.
Answer A is correct because being forced to discontinue operations in a foreign country is consistent with the existence of an illegal act, although other conditions may have forced such discontinuance.
Answer B is incorrect because such political contributions made by companies are generally not illegal.
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Answer C is incorrect because failure to correct a material weakness is not necessarily indicative of violation of a law (e.g., the Foreign Corrupt Practices Act).
Answer D is incorrect because disclosure of subsequent events, whether involving foreign operations or other information, is a normal acceptable disclosure which need not directly relate to illegal acts.
29. Hawkins requested permission to communicate with the predecessor auditor and review certain portions of the predecessor auditors working papers. The prospective clients refusal to permit this will bear directly on Hawkins decision concerning the a) Adequacy of the preplanned audit program. b) Ability to establish consistency in application of accounting principles between years. c) Apparent scope limitation. d) Integrity of management.
Answer A is incorrect since such a program will not exist before the prospective client is accepted.
Answer B is incorrect because the availability of prior year financial statements and accounting records normally provides sufficient evidence concerning consistency.
Answer C is incorrect since the potential successor has not yet accepted the prospective client.
Answer D is correct since obtaining evidence relative to the integrity of management is one of the objectives to be accomplished during such a review.
30. The concept of materiality would be least important to an auditor when considering the a) Effects of a direct financial interest in the client upon the CPAs independence. b) Decision whether to use positive confirmations of accounts receivable. c) Adequacy of disclosure of a clients illegal act. d) Discovery of weakness in a clients internal control structure.
Answer A is correct because the auditor may not have any direct financial interest in a client, regardless of materiality.
Answer B is incorrect because auditors generally consider the size (materiality) of account balances when choosing between the use of positive or negative confirmation.
Answer C is incorrect because materiality is considered when evaluating the adequacy of disclosures of illegal acts. Answer D is incorrect because the materiality of internal control weaknesses should be considered by the auditor.
31. While obtaining an understanding of a clients risk assessment policies, an auditor ordinarily considers how management a) Identifies risks.
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b) Eliminates significant risks. c) Assesses the likelihood of occurrence of subsequent events.
d) Relate risk assessment to compliance with marketing objectives.
Answer A is correct. An auditor should obtain sufficient knowledge of the entity's risk assessment process to understand how management considers risks relevant to financial reporting objectives and decide about actions to address those risks; that knowledge might include understanding of how management identifies risks, estimates their significance, and assesses the likelihood of their occurrence, and relates them to financial reporting.
Answer B is incorrect. Refer to the correct answer explanation.
Answer C is incorrect. Refer to the correct answer explanation.
Answer D is incorrect. Refer to the correct answer explanation.
32. Effective internal control requires organizational independence of departments. Organizational independence would be impaired in which of the following situations? a) The internal auditors report to the audit committee of the board of directors. b) The controller reports to the vice president of production. c) The payroll accounting department reports to the chief accountant. d) The cashier reports to the treasurer.
Answer A is incorrect because internal auditors typically report to the audit committee of the board of directors.
Answer B is correct. The requirement is to determine a situation causing the impairment of organizational independence. The controller, who is in charge of accounting, should be independent of the production function. Since the accounting function reports on the production function, there would be a conflict of interest if the controller reported to the vice president of production.
Answer C is incorrect because the payroll department should report to the chief accountant, as the chief accountant has responsibility for the payroll accounting function.
Answer D is incorrect because cashiers typically account and report to the treasurer because the treasurer has responsibility for cash custodianship.
33. An auditor would most likely be concerned with controls that provide reasonable assurance about the a) Efficiency of managements decisionmaking process. b) Appropriate prices the entity should charge for its products. c) Methods of assigning production tasks to employees. d) Entitys ability to process and summarize financial data.
Answer A is incorrect. While important to the company, this item ordinarily does not relate to a financial statement audit.
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Answer B is incorrect. While important to the company, this item ordinarily does not relate to a financial statement audit.
Answer C is incorrect. While important to the company, this item ordinarily does not relate to a financial statement audit.
Answer D is correct. The controls relevant to an audit pertain to the entity's ability to record, process, summarize, and report financial data consistent with the assertions embodied in the financial statements.
34. Which of the following controls would an auditor be least likely to review? a) Segregation of the assethandling and recordkeeping functions. b) Company policy regarding credit and collection efforts. c) Cost records classified by date of product introduction. d) Authorization of addition to plant and equipment.
Answer A is incorrect because the segregation of asset custody (handling) from recordkeeping and authorization functions is essential.
Answer B is incorrect because an auditor will be concerned with credit and collection efforts in testing the adequacy of the allowance for doubtful accounts.
Answer C is correct because an auditor is usually not concerned with the date a product was introduced.
Answer D is incorrect because additions to plant and equipment are major expenditures which need to be properly controlled.
35. The auditor would be least likely to be concerned about internal control as it relates to a) Land and buildings. b) Common stock. c) Shareholder meeting. d) Minutes of board of directors meetings
Answer A is incorrect because the auditor would be concerned with the internal control of land and buildings which may involve a substantial portion of the client's assets.
Answer B is incorrect because the auditor would be concerned with the internal control related to common stock which may involve a substantial portion of the client's equity.
Answer C is correct because a client's internal control will not relate directly to shareholder meetings. CPAs will often attend the shareholder meetings and be aware of what has transpired, but important matters at such meetings are generally publicly available.
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Answer D is incorrect because the minutes of the meetings of the board of directors must be received by the auditor in complete form so that the auditor may be aware of matters of significance.
36. Which of the following would not typically be a control relied upon during an audit? a) Use of the doubleentry system. b) An internal audit staff. c) Competent personnel. d) A comparisonshopping staff.
Answer A is incorrect because use of the doubleentry system is an internal control which aids in more accurate recording of transactions.
Answer B is incorrect because the presence of an internal audit staff is an internal control. An internal audit staff strengthens internal control by determining if controls are functioning effectively.
Answer C is incorrect because competent personnel relate to internal control. Competent personnel would strengthen internal control because they would be less likely to commit errors in performing their duties.
Answer D is correct because a comparisonshopping staff is not generally relevant to recording, processing, summarizing, and reporting financial data.
37. One important reason why a CPA, during the course of an audit engagement, prepares internal control flowcharts is to a) Reduce the need for inquiries of client personnel concerning the operations of internal control. b) Depict the organizational structure and document flow in a single chart for review and reference purposes. c) Assemble the internal control findings into a comprehensible format suitable for analysis. d) Prepare documentation that would be useful in the event of a future consulting engagement.
Answer A is incorrect because flowcharts are prepared as part of the consideration of internal control. The need for inquiries of client personnel would not necessarily be reduced due to the preparation of the flowchart.
Answer B is incorrect because the entire organizational structure and document flow of a large company usually cannot be depicted in a single flowchart.
Answer C is correct because flowcharts are prepared as part of the consideration of internal control. The use of structure flowcharts assembles the internal control findings into a comprehensible format.
Answer D is incorrect because flowcharts are prepared as part of the consideration of internal control. The flowchart is not prepared for the primary reason of obtaining documentation useful for a future consulting engagement.
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38. When preparing a record of a clients internal control, the independent auditor sometimes uses a flowchart, which can best be described as a a) Pictorial presentation of the flow of instruction in a clients internal computer system. b) Diagram which clearly indicates an organizations internal reporting structure. c) Graphic illustration of the flow of operations which is used to replace the auditors internal control questionnaire. d) Symbolic representation of a system or series of sequential processes.
Answer A is incorrect because it refers to processing within the computer rather than the entire internal control structure.
Answer B is incorrect because it deals with reporting structure rather than with internal controls.
Answer C is incorrect because an internal control flowchart depicts the organization and recordkeeping system rather than a flow of operations.
Answer D is correct because the flowchart prepared during the consideration of internal control is a symbolic representation of a system of sequential processes. It can be used in lieu of the internal control questionnaire which has the same purpose (i.e., to prepare a record of prescribed internal control).
39. In connection with the consideration of internal control during an examination of financial statements, the independent auditor a) Must perform tests of controls for all important controls. b) Must issue a written communication on reportable conditions, including situations in which none have been identified. c) Must flowchart major client transaction cycles. d) Must perform tests of controls to assess control risk at a level lower than the maximum.
Answer A is incorrect. Refer to the correct answer explanation.
Answer D is correct. When the auditor assesses control risk at below the maximum level, the auditor believes that specific controls are likely to prevent or detect material misstatements relevant to specific assertions. The auditor must then perform tests of controls to evaluate the effectiveness of such controls.
40. The auditor should perform tests of controls on a) Those controls that the auditor plans to use to support an assessment of control risk below the maximum. b) Those controls in which reportable condition were identified. c) Those controls that have a material effect upon the financial statement balances. d) A random sample of the controls that were reviewed.
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Answer A is correct because tests of controls are only performed on controls that the auditor plans to rely upon as a basis for assessing control risk below the maximum. Performance of tests of controls on these controls may reduce the scope of substantive tests needed.
Answer B is incorrect because the auditor is unlikely to test controls in which reportable conditions exist since they cannot be relied upon.
Answer C is incorrect because even though some controls have a material effect upon financial statement balances, they may not be relied upon if substantive testing may be more efficient.
Answer D is incorrect because the decision of whether or not to perform tests of controls is determined by employing professional judgment based upon the results of assessing control risk, not by a random sample.
41. Which of the following is ordinarily considered a test of a control? a) Send confirmation letters to banks. b) Count and list cash on hand. c) Examine signatures on checks. d) Test the clerical accuracy of inventory listings as of the balance sheet date.
Answer A is incorrect because sending confirmation letters to banks helps substantiate the existence of cash at year end. Therefore, this is a substantive rather than a test of a control.
Answer B is incorrect because a cash count is a test of transactions and balances which is a substantive test rather than a test of a control.
Answer C is correct because tests of controls are directed toward the effectiveness of the design or operation of controls. In this case the control procedure is to determine that only authorized persons sign checks.
Answer D is incorrect because testing the clerical accuracy of inventory listings as of the balance sheet date is primarily a substantive test to determine whether inventory listings are accurately compiled.
42. Which of the following would be least likely to suggest to an auditor that the clients management may have overridden internal control? a) There are numerous delays in preparing timely internal financial reports. b) Management does not correct control weakness that it knows about. c) Differences are always disclosed on a computer exception report. d) There have been two new controllers this year.
Answer A is incorrect because delays in the preparation of financial reports may suggest that inappropriate entries are being made by the client's management.
Answer B is incorrect because the auditor must question why management would choose not to
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eliminate internal control weaknesses. The failure of management to correct weaknesses would be a definite indication that management may have overridden internal control.
Answer C is correct because differences are expected to be disclosed on a computer exception report; disclosing these differences is the primary purpose of the report. Thus, this would not indicate that there are problems in the client's internal control.
Answer D is incorrect because a high turnover of controllers (the position normally responsible for the recordkeeping function) may be indicative of a management override of internal control.
43. Which of the following controls will most likely prevent the concealment of a cash shortage resulting from the improper writeoff of a trade account receivable? a) Writeoffs must be approved by a responsible officer after review of credit department recommendations and supporting evidence. b) Writeoffs must be supported by an aging schedule showing that only receivables overdue several months have been written off. c) Writeoffs must be approved by the cashier who is in a position to know if the receivables have, in fact, been collected. d) Writeoffs must be authorized by company field sales employees who are in a position to determine the financial standing of the customers.
Answer A is correct because if accounts receivable writeoffs must be approved by an officer on the basis of credit department recommendations including supporting evidence, there is very little likelihood of improper writeoffs to conceal cash shortages.
Answer B is incorrect because receivable overdue by several months is not a basis for writeoff; uncollectibility is.
Answer C is incorrect because the cashier could conceal cash shortages by approving the writeoffs of accounts receivable.
Answer D is incorrect because sales employees could accept payments from customers and then authorize the accounts to be written off. 44. Which of the following would be the best protection for a company that wishes to prevent the lapping of trade accounts receivable? a) Segregated duties so that the bookkeeper in charge of the general ledger has no access to incoming mail. b) Segregated duties so that no employee has access to both checks from customers and currently from daily cash receipts. c) Have customers send payments directly to the companys depositary bank. d) Request that customers payment checks be made payable to the company and addressed to the treasurer.
Answer A is incorrect because lapping involves incorrect entries in the accounts receivable subsidiary ledger, not the general ledger.
Answer B is incorrect because lapping occurs by misappropriating mail receipts (checks). Lapping does not necessarily involve abstraction directly from currency.
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Answer C is correct because lapping of trade accounts receivable involves an abstraction of funds and subsequent delay in crediting receipts to accounts receivable. If customers send payments directly to a depository bank, there is no opportunity for abstraction of funds or subsequent misapplication.
Answer D is incorrect because requiring that customer's checks be addressed to the treasurer will not reduce the risk of lapping significantly compared to having the checks directly deposited.
45. Which of the following is not a basic rule for achieving strong internal control over cash? a) Separate the cash handling and recordkeeping functions. b) Decentralized the receiving of cash as much as possible. c) Deposit each days cash receipts by the end of the day. d) Have bank reconciliations performed by employees independent with respect to handling cash.
Answer A is incorrect because separation of cash handling and recordkeeping is a proper segregation of the recordkeeping function from the custodial function.
Answer B is correct because decentralization of cash receipts generally would not increase internal control; in fact, the additional points of cash receipt may well be more difficult to control.
Answer C is incorrect because the daily deposit of cash receipts helps to deter irregularities and theft.
Answer D is incorrect because separating the reconciliation from the handling of cash is a proper segregation of the recordkeeping function from the custodial function.
46. In order to safeguard the assets through proper internal control, accounts receivable that are written off are transferred to a(n) a) Separate ledger. b) Attorney for evidence in collection proceedings. c) Tax deductions files. d) Credit manager since customers may seek to reestablish credit by paying.
Answer A is correct. Once accounts receivable are written off they should be controlled for possible future collection. Accordingly, they should be recorded to maintain accountability in a separate ledger. If they were simply written off and forgotten, there would be no means of maintaining accountability over these contingent assets.
Answer B is incorrect because accounts transferred to an attorney for collection would not be written off (i.e., if they were bad debts, there would be no basis for collection proceedings).
Answer C is incorrect because the requirement is for proper internal control over the receivables rather than information to prepare tax returns.
Answer D is incorrect because credit managers should not have control over accounts that have been written off because there is not sufficient separation of functional responsibilities.
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47. Jackson, the purchasing agent of Judd Hardware Wholesalers, has a relative who owns a retail hardware store. Jackson arranged for hardware to be delivered by manufacturers to the retail store on a COD basis thereby enabling his relative to buy at Judds wholesale prices. Jackson was probably able to accomplish this because of Judds poor internal control over a) Purchase orders. b) Purchase requisitions. c) Cash receipts. d) Perpetual inventory records.
Answer A is correct because proper control over purchases would require that ordered goods only be shipped to authorized locations; proper control would also determine that all ordered goods had been received by the firm. If purchase orders are issued by Judd and the purchases are never received, there is an internal control condition over the purchase orders. All purchase orders should be accounted for (prenumbered) and followed up to assure receipt of orders that are issued.
Answer B is incorrect because purchase requisitions are internal documents which are prepared by user departments and sent to the purchasing department for action.
Answer C is incorrect because the failure to detect purchase orders that were not received has nothing to do with cash receipts.
Answer D is incorrect because perpetual inventory records cannot be relied upon to detect the nonreceipt of purchase orders (i.e., perpetual inventory records are only activated once the goods are received).
48. To avoid potential errors and fraud a welldesigned internal control in the accounts payable area should include a separation of which of the following functions? a) Cash disbursement and invoice verification. b) Invoice verification and merchandise ordering. c) Physical handling of merchandise received and preparation of receiving reports. d) Check signing and cancellation pf payment documentation.
Answer A is correct. The requirements concern internal control in the accounts payable area. The accounts payable function normally includes invoice verification. The important separation should be between authorization of payment and actual cash disbursements. Thus the accounts payable area (including invoice verification) should be separated from cash custodianship and disbursement.
Answer B is incorrect because the accounts payable area does not usually include the purchasing department.
Answer C is incorrect because those receiving merchandise usually prepare the receiving report (e.g., on the loading dock).
Answer D is incorrect because the person signing checks should cancel the supporting documentation as checks are signed.
49. Propex Corporation uses a voucher register and does not record invoices in a subsidiary ledger. Propex will probably benefit most from the additional cost of maintaining an accounts payable subsidiary ledger if
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a) There are usually invoices in an unmatched invoice file.
b) Vendors request for confirmation of receivable often go unanswered for several months until paid invoices can be reviewed. c) Partial payments to vendors are continuously made in the ordinary course fo business. d) It is difficult to reconcile vendors monthly statements.
Answer A is incorrect because the function of an unmatched invoice file is to hold off paying invoices until the receiving report and purchase order are received. There would be invoices in an unmatched invoice file even with the accounts payable subsidiary ledger.
Answer B is incorrect because maintaining an accounts payable subsidiary ledger for the purpose of confirming vendor's confirmation requests would not benefit the company.
Answer C is correct because when partial payments are continuously made to vendors, an accounts payable subsidiary ledger would be very beneficial to the corporation. The subsidiary ledger would be used to keep track of the amounts still outstanding after partial payments. Otherwise, the partial payments would have to be written on the voucher register in order to keep track of the amount still due.
Answer D is incorrect because although an accounts payable subsidiary ledger would aid in this type of a reconciliation, the corporation would benefit more from a subsidiary ledger if partial payments to vendors are continuously made.
50. Which of the following is an effective control that encourages receiving department personnel to count and inspect all merchandise received? a) Quantities ordered are excluded from the receiving department copy of the purchase order. b) Vouchers are prepared by accounts payable department personnel only after they match item count on the receiving report with the purchase order. c) Receiving department personnel are expected to match and reconcile the receiving report with the purchase order. d) Internal auditors periodically examine, on a surprise basis, the receiving department copies of receiving reports.
Answer A is correct. The requirement is to identify the control used to encourage receiving department personnel to count and inspect all merchandise received. If the quantities ordered are not known to the receiving department personnel, they will have to count and inspect the incoming merchandise without prejudice. In other words, they will not count to an expected number.
Answer B is incorrect because it does not relate to the requirement (i.e., counting and inspecting).
Answer C is incorrect because receiving department personnel should only count and inspect and not perform reconciliations.
Answer D is incorrect because an examination of the receiving report will not indicate whether counts were made by receiving department personnel. It will only indicate that numbers were recorded by receiving department personnel.
51. Ordinarily in an attest examination report a CPA may report on
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Managements written assertion Subject matter A Yes Yes B Yes No C No Yes D No No
Answer A is correct because in most circumstances, a CPA may report upon either the written assertion or on the subject matter to which the written assertion relates.
52. In which of the following ways may suitable criteria appropriately be made available?
Publicly available Included with subject matter Included in CPAs report A Yes Yes Yes B Yes Yes No C Yes No No D No Yes Yes
Answer A is correct because suitable criteria should be available in one or more of the following ways: (1) publicly, (2) included with the subject matter or in the assertion, (3) included in the CPA's report, (4) well understood by most users (e.g., the distance between A and B is twenty feet) or (5) available only to specified parties.
53. Which of the following is least likely to include a reference to the use of a specialist? a) Unqualified opinion. b) Adverse opinion. c) Except for qualified opinion. d) Subject to qualified opinion.
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Answer A is correct because when issuing an unqualified opinion, the auditor should not refer to the work or findings of the specialist. When an auditor decides to modify the audit opinion as a result of the report or findings of the specialist, reference to and identification of the specialist may be made in the auditor's report if the auditor believes such reference will facilitate understanding.
54. For an entitys financial statements to be presented fairly in conformity with generally accepted accounting principles, the principles selected should a) Be applied on a basis consistent with those followed in the prior year. b) Be approved by the Auditing Standard Board or the appropriate industry subcommittee. c) Reflect transactions in a manner that presents the financial statements within a range of acceptance limits. d) Match the principles used by most other entities within the entitys particular industry.
Answer A is incorrect because a change in accounting principle may be acceptable and appropriate.
Answer B is incorrect because the Auditing Standards Board generally does not issue accounting principles.
Answer C is correct. The requirement is to determine an implication of financial statements being presented fairly in conformity with generally accepted accounting principles. The principles selected should reflect transactions in a manner that presents the financial statements within a range of acceptable limits.
Answer D is incorrect because the exact principles followed need not be used by most other entities within the entity's particular industry.
55. Which of the following representations does an auditor make explicitly and which implicitly when issuing an unqualified opinion?
Conformity with GAAP Adequacy of disclosure A Explicitly Explicitly B Implicitly Implicitly C Implicitly Explicitly D Explicitly Implicitly
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Answer D is correct. The requirement is to determine whether representations on "conformity with GAAP" and on "adequacy of disclosure" are made explicitly or implicitly in an unqualified audit report. The first standard of reporting requires an explicit statement on conformance with GAAP. However, the third reporting standard results in implicit representations on disclosure since it states that informative disclosures are to be considered adequate, unless otherwise stated.
56. Jojo, an independent auditor, was engaged to perform an examination of the financial statements of ThreeR Incorporated 1 month after its fiscal year had ended. Although the inventory count was not observed by Jojo, and accounts receivable were not confirmed by direct communication with creditors, Jojo was able to gain satisfaction by applying alternative auditing procedures. Jojos auditors report will probably contain a) An except for qualification. b) An unqualified opinion and an explanatory paragraph. c) Either qualified opinion or a disclaimer of opinion. d) A standard unqualified opinion.
Answer A is incorrect because a qualified opinion is not needed since the auditor was able to gain satisfaction by applying alternative auditing procedures.
Answer B is incorrect because an explanatory paragraph would not be required since the auditor was able to gain satisfaction by applying alternative auditing procedures.
Answer C is incorrect because the auditor was able to gain satisfaction by applying alternative auditing procedures. No qualification or disclaimer of opinion is required when the alternative procedures allow the auditor to acquire sufficient evidence regarding the inventory and accounts receivable accounts.
Answer D is correct because, although the auditor was not able to observe the inventory count or confirm accounts receivable, the auditor was able to gain satisfaction through the use of alternative procedures. In these circumstances, an unqualified opinion may be issued.
57. 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 clients financial statements considered as a whole? a) Adverse. b) Unaudited. c) Qualified. d) Unqualified.
Answer A is incorrect because adverse opinions are used when an auditor knows that the statements are misleading.
Answer B is incorrect because "unaudited" is not a type of audit opinion.
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Answer D is correct because if the contingency has been adequately disclosed by the client, the auditor would issue an unqualified opinion.
58. When an auditor submits a document containing audited financial statements to a client, the auditor has a responsibility to report on a) Only the basic financial statements included in the document. b) The basic financial statements and only the additional information required to be presented in accordance with provision of Financial Accounting Standards Board. c) All of the information included in the document. d) Only the portion of the document which was audited.
Answer C is correct because the professional standards require that when an auditor submits a document containing audited financial statements to his/her client or to others, s/he has a responsibility to report on all the information included in the document. Note that while all information is to be reported on, it need not all be audited (some of it may be "unaudited").
59. The auditors 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 a) Quality control. b) Generally accepted auditing standards which include the concept of materiality. c) The auditors consideration of the auditor companys internal control. d) Generally accepted accounting principles.
Answer A is incorrect because quality control relates to the policies and procedures established by a CPA firm to provide reasonable assurance that GAAS are being complied with on all audit engagements.
Answer B is incorrect because GAAS relate to the conduct of audit engagements rather than the framework within which the fairness of financial statement presentation is measured (GAAP).
Answer C is incorrect because the auditor's consideration of internal control, while important, is not as directly related to the overall fairness of financial statement presentation as is the framework of GAAP.
Answer D is correct because the auditor's judgment concerning the fairness of financial statements should be applied within the framework of generally accepted accounting principles.
60. The first standard of reporting requires that, the report shall state whether the financial statements are presented in accordance with generally accepted accounting principles. This should
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be construed to require a) A statement of fact by the auditor. b) An opinion by the auditor. c) An implied measure of fairness. d) An objective measure of compliance.
Answer B is correct because the first standard of reporting is construed to require an opinion as to whether the financial statements are presented in conformity with GAAP.
61. The fourth reporting standard requires the auditors report to either contain an expression of opinion regarding the financial statements, taken as a whole, or an assertion to the effect that an opinion cannot be expressed. The objective of the fourth standard is to prevent a) The CPA from reporting on one basic financial statement and not the others. b) The CPA from expressing different opinions on each of the basic financial statements. c) Misinterpretations regarding the degree of responsibility the auditor is assuming. d) Management from reducing its final responsibility for the basic financial statements.
Answer A is incorrect because the auditor may report on one basic statement and not the other statements (which is not a scope limitation) as long as the auditor has access to information underlying all the statements.
Answer B is incorrect because the auditor may express an unqualified opinion on one of the statements and express a qualified, adverse, or disclaimer on another if circumstances call for this treatment.
Answer C is correct because the objective of the fourth standard of reporting (requiring an expression of opinion on the financial statements as a whole) is to prevent misinterpretation of the degree of responsibility the auditor is assuming when the auditor is associated with financial statements.
Answer D is incorrect because the fourth standard is not directly related to management's responsibility for the financial statements.
62. An investor is reading the financial statements of the Stankey Corporation and observes that the statements are accompanied by an auditors unqualified report. From this the investor may conclude that a) Any disputes over significant accounting issues have been settled to the auditors satisfaction. b) The auditor is satisfied that Stankey is financially sound. c) The auditor has ascertained that Stankeys financial statements have been prepared accurately. d) Informative disclosures in the financial statements but not necessarily in Stankeys footnotes are
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to be regarded as reasonably adequate.
Answer A is correct because an unqualified 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 unqualified.
Answer B is incorrect because the objective of an audit is not to conclude that the client is financially sound. Rather, the auditor renders an opinion on the fairness of the financial statement presentation in accordance with GAAP.
Answer C is incorrect because there is no assertion as to accuracy by the independent auditor. Rather, the auditor renders an opinion on the fairness of the financial statement presentation in accordance with GAAP.
Answer D is incorrect because the footnotes are regarded as an integral part of the financial statements and must contain adequate informative disclosures.
63. Negative assurance is not permissible in a) Letters required by security underwriters for data pertinent to SEC registration statements. b) Reports relating to the results of agreed upon procedures to one or more specified elements, accounts, or items of a financial statement. c) Reports based upon a review engagement. d) Reports based upon an audit of the interim financial statements of a closely held business entity.
Answer A is incorrect because letters required by security underwriters may include negative assurance.
Answer B is incorrect because negative assurance is allowed for specified elements.
Answer C is incorrect because the review report issued includes negative assurance with respect to the financial statements.
Answer D is correct because, when an audit is performed, negative assurance is not to be provided, regardless of whether the financial statements are for a fiscal or interim period.
64. Jovy, CPA, examined the 2005 financial statements of PPSI. and issued an unqualified opinion on March 10, 2006. On April 2, 2006, Jovy became aware of a 2005 transaction that may materially affect the 2005 financial statements. This transaction would have been investigated had it come to Jovys attention during the course of the examination. Jovy should a) Take no action because an auditor is not responsible for events subsequent to the issuance of the auditors report. b) Contact PPSIs management and request their cooperation in investigating the matter. c) Request that PPSIs management disclose the possible effects of the newly discovered transaction by adding an unaudited footnote to the 2005 financial statements. d) Contact all parties who might relies upon the financial statements and advise them that the financial statements are misleading.
Answer A is incorrect because the auditor must take action and is responsible for the subsequent
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discovery of facts existing at the date of the auditor's report.
Answer B is correct. The requirement is to determine an accountant's responsibility when s/he has become aware of a material transaction which may materially affect financial statements on which s/he has already reported. The first step is to contact the firm's management and request cooperation in investigation of the matter.
Answer C is incorrect because the "possible effects" of this newly discovered transaction should be investigated further to determine whether the financials may need revision in lieu of footnote disclosure.
Answer D is impractical because it is impossible to contact all parties who might rely upon the financial statements.
65. A major customer of an audit client suffers a fire just prior to completion of yearend fieldwork. The audit client believes that this event could have a significant direct effect on the financial statements. The auditor should a) Advise management to disclose the event in notes to the financial statements. b) Disclose the event in the auditors report. c) Withhold submission of the auditors report until the extent of the direct effect on the financial statements is known. d) Advise management to adjust the financial statements.
Answer A is correct because conditions which come into existence after yearend which may have a significant direct effect on the financial statements should be disclosed in the notes to the financial statements.
Answer B is incorrect because the auditor may or may not decide to disclose the event in the auditor's report. If the subsequent event has a material impact on the entity, the auditor may wish to include in the report an explanatory paragraph which directs the reader's attention to the event. However, this type of subsequent event is only occasionally disclosed in the auditor's report.
Answer C is incorrect because the exact total effect on the financial statements need not always be known. The auditor cannot wait until the effect is known because this would delay the issuance of the report.
Answer D is incorrect because only conditions coming into existence prior to yearend result in financial statement adjustments.
66. When a contingency is resolved immediately subsequent to the issuance of a report which was qualified with respect to the contingency, the auditor should a) Insist that the client revised financial statements. b) Inform the audit committee that the report cannot be relied upon. c) Take no action regarding the event. d) Inform the appropriate authorities that the report cannot be relied upon.
Answer A is incorrect because resolution of a contingency after the issuance of the report is not subsequent discovery of facts existing at the date of the auditor's report. Since the contingency was disclosed in the financial statements and audit report, the statements were not misleading at the time of issuance and do not have to be revised.
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Answer C is correct because when a contingency is resolved immediately subsequent to the issuance of a report which was qualified with respect to the contingency, the auditor is not required to take any action regarding the event. Resolution of the contingency after the issuance of the report is not subsequent discovery of facts existing at the date of the auditor's report. Because the contingency did result in a qualified report, the auditor was aware of the facts existing at the date of the auditor's report. Also, the auditor's responsibility for continuing inquiry is precluded by AU 561.
67. Under which of the following circumstances may audited financial statements contain a note disclosing a subsequent event which is labeled unaudited? a) When the subsequent event does not require adjustment of the financial statements. b) When the event occurs after completion of fieldwork and before issuance of the auditors report. c) When audit procedures with respect to the subsequent event were not performed by the auditor. d) When the event occurs between the date of the auditors original report and the date of the reissuance of the report.
Answer B is incorrect because if the auditor is aware of a subsequent event that has occurred after the completion of fieldwork but before issuance of the report which should be disclosed, the auditor may either dual date the report or date the report as of the date of the subsequent event and extend the procedures for review of subsequent events to that date. The auditor may not label the note unaudited.
Answer D is correct because when the subsequent event occurs between the date of the original report and the date of the reissuance of the report, the event may be labeled unaudited.
68. Subsequent events affecting the realization of assets ordinarily will require adjustment of the financial statements under examination because such events typically represent a) The culmination of conditions that existed at the balance sheet date. b) The final estimates of losses relating to casualties occurring in the subsequent events period. c) The discovery of new conditions occurring in the subsequent events period. d) The preliminary estimate of losses to new events that occurred subsequent to the balance sheet.
Answer A is correct because subsequent events affecting the realization of assets ordinarily will require adjustment of the financial statements because such events typically represent the culmination of conditions that existed at the balance sheet date.
Answer B is incorrect because a loss related to a casualty that occurred in the subsequent events period would not result in adjustment of the financial statements.
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Answer C is incorrect because the discovery of new conditions occurring in the subsequent events period would not result in adjustment of the financial statements.
69. Which of the following material events occurring subsequent to the December 31, 2005 balance sheet would not ordinarily result in an adjustment to the financial statements before they are issued on March 2, 2006? a) Writeoff of a receivable from a debtor who had suffered from deteriorating financial condition for the past 6 years. The debtor filed for bankruptcy on January 23, 2006. b) Acquisition of a subsidiary on January 23, 2006, negotiation had begun in December 2003. c) Settlement of extended litigation on January 23, 2006, in excess of the recorded yearend liability. d) A 3for5 reserve stock spit consummated on January 23, 2006.
Answer A is incorrect because the debtor's deteriorating financial condition was in existence at year end. Therefore, an adjustment to the financial statements is appropriate.
Answer B is correct because the condition (acquisition of a subsidiary) did not arise until after year end. Footnote disclosure of this transaction, however, is necessary.
Answer C is incorrect because the condition giving rise to the litigation existed at the balance sheet date. Therefore, settlement of the litigation would require an adjustment to the financial statements.
Answer D is incorrect because APB 15 requires retroactive adjustment for such stock splits.
70. Which event that occurred after the end of the fiscal year under audit but prior to issuance of the auditors report would not require disclosure in the financial statements? a) Sale of the bond or capital stock issue. b) Loss of plant or inventories as result of fire or flood. c) A major drop in the quoted market price of the stock of the corporation. d) Settlement of litigation when the event giving rise to the claim took place after the balance sheet date.
Answer A is incorrect because AU 560 indicates that the sale of a bond issue or issuance of capital stock is a subsequent event which should be disclosed.
Answer B is incorrect because AU 560 indicates that a loss of plant or inventories due to a natural catastrophe is a subsequent event which should be disclosed.
Answer C is correct because a major drop in the quoted market price of the corporation's stock would not have financial statement effects and accordingly, need not be disclosed as a subsequent event.
Answer D is incorrect because AU 560 indicates that the settlement of litigation is a subsequent event which should be disclosed.
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71. Which of the following matters is an auditor required to communicate to an entitys audit committee? a) The basis for assessing control risk below the maximum. b) The process used by management in formulating sensitive accounting estimates. c) The auditors preliminary judgments about materiality levels. d) The justification for performing substantive procedures at interim dates.
Answer B is correct because one of the areas listed is the process used by management in formulating sensitive accounting estimates.
72. When an auditor concludes there is substantial doubt about an entitys ability to continue as a going concern for a reasonable period of time, the auditors responsibility is to a) Prepare prospective financial information to verify whether managements plans can be effectively implemented. b) Project future conditions and events for a period of time not to exceed 1 year following the date of the financial statements. c) Issue a qualified or adverse opinion, depending upon materiality, due to the possible effects on the financial statements. d) Consider the adequacy of disclosure about the entitys possible inability to continue going concern.
Answer A is incorrect. The auditor is not required to prepare prospective financial information.
Answer B is incorrect. While an auditor must consider management's plans, he or she does not project future conditions and events.
Answer C is incorrect. Neither a qualified or an adverse opinion is necessary when the disclosures are adequate.
Answer D is correct. When, 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 explanatory paragraph should be added to the audit report.
73. Kane, CPA, concludes that there is substantial doubt about Lima Co.s ability to continue as a going concern for a reasonable period of time. If Limas financial statements adequately disclose its financial difficulties, Kanes auditors report is required to include an explanatory paragraph that specifically uses the phrase(s)
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Possible discontinuance of operations Reasonable period of time no to exceed 1 year A Yes Yes B Yes No C No Yes D No No
Answer D is correct because the explanatory paragraph presented in AU 341 includes neither of the terms.
74. An auditor concludes that there is substantial doubt about an entitys ability to continue as a going concern for a reasonable period of time. If the entitys disclosures concerning this matter are adequate, the audit report may include a(n)
Disclaimer of opinion Except for qualified opinion A Yes Yes B No No C No Yes D Yes No
Answer D is correct. A disclaimer of opinion may be appropriate but an "except for" qualified opinion is never appropriate when substantial doubt about an entity's ability to continue as a going concern has been adequately disclosed.
75. A material change in an accounting estimate a) Requires a consistency modification in the auditors report and disclosure in the financial statements. b) Requires a consistency modification in the auditors report but does not require disclosure in the financial statements. c) Affects comparability and may require disclosure in a note to the financial statements but does not require a consistency modification in the auditors report. d) Involves the acceptability of the generally acceptable accounting principles used.
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Answer A is incorrect because a consistency modification is not necessary.
Answer B is incorrect because a consistency modification is not necessary.
Answer C is correct. The requirement is to determine the auditing and reporting treatment of a material change in an accounting estimate. While a consistency modification is not necessary, footnote disclosure is required.
Answer D is incorrect because a change in accounting principle has not occurred.
76. The objective of the consistency standard is to provide assurance that a) There are no violation in the formal and presentation of financial statements. b) Substantially different transactions and events are not accounted for on identical basis. c) The auditor is consulted before material changes are made in the application of accounting principles. d) The comparability of financial statements between periods is not materially affected by changes in accounting principles without disclosure
Answer A is incorrect since there may be variations in format and presentation of financial statements.
Answer B is incorrect since the consistency standard only requires the communication of the fact that a lack of consistency exists in the handling of items between periods.
Answer C is incorrect because there is no requirement that an auditor be consulted before material changes are made in the application of accounting principles (although this may be done if the client so desires).
Answer D is correct. The requirement is to determine the objective of the consistency standard. The objective is (1) to give assurance that the comparability of financial statements between periods has not been materially affected by changes in accounting principles, or (2) if comparability has been materially affected by such changes, to require appropriate reporting by the independent auditor regarding such changes.
77. Which of the following narrative disclosures appearing in notes to financial statements would an auditor be most likely to consider inappropriate? a) The relatedparty transaction was consummated on terms no less favorable than those that would have been obtained if the transaction had been with an unrelated party. b) The accounts of subsidiaries in which the corporation has more than 50% ownership are fully consolidated. c) Legal and other costs associated with the covenantnottocompete will be amortized using the straightline method during the next 3 years. d) Minor fluctuations in foreign currency exchange rates are reflected in the accompanying financial statements.
Answer A is correct because representations to the effect that a transaction was consummated on terms no less favorable than those that would have been obtained if the transaction had been with an unrelated party are difficult to substantiate and the auditor may be unable to reach a conclusion
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as to the propriety thereof.
Answer B is incorrect because it represents an acceptable practice under generally accepted accounting principles. Refer to the correct answer explanation.
Answer C is incorrect because it represents an acceptable practice under generally accepted accounting principles. Refer to the correct answer explanation.
Answer D is incorrect because minor fluctuations in foreign currency rates need not be reflected in financial statements. Refer to the correct answer explanation.
78. The auditor who wishes to point out that the entity has sufficient transactions with related parties should disclose this fact in a) An explanatory paragraph to the auditors report. b) An explanatory note to the financial statements. c) The body of the financial statements. d) The summary of significant accounting policies section of the financial statements.
Answer A is correct because when the auditor wishes to emphasize such a matter, it should be done in an explanatory paragraph to the auditor's report. The report is still considered unqualified.
Answer B is incorrect because notes are portions of the financial statements in which the client reports, not the auditor.
Answer C is incorrect because the client, not the auditor, reports in the body of the financial statements.
Answer D is incorrect because the "Summary of significant accounting policies" section is a portion of the financial statements in which the client reports, not the auditor.
79. When management refuses to disclose illegal activities which were identified by the independent auditor, the independent auditor may be charged with violating the CPA Code of Professional Conduct for a) Withdrawing from the engagement. b) Issuing a disclaimer of opinion. c) Failure to uncover the illegal activities during prior audits. d) Reporting these activities to the audit committee.
Answer A is incorrect because withdrawing from the engagement is appropriate in certain instances such as when the client refuses to accept the issued audit report and when the client continues the illegal act.
Answer B is correct because 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.
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Answer C is incorrect because an audit cannot be expected to provide assurance that illegal acts will be detected.
Answer D is incorrect because the board of directors and/or its audit committee may need to be notified of such situations by the auditor.
80. 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 a) Identified and disclosed all laws and regulations that have a direct material effect on its financial statements. b) Implemented internal control policies and procedures designed to detect all illegal acts. c) Expressed both positive and negative assurance to the auditor that the entity complied with all laws and regulations. d) Employed internal auditor who can report their findings, opinion, and conclusions objectively without fear of political repercussion.
Answer A is correct because, 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.
Answer D is incorrect. Refer to the correct answer explanation. Posted by Markie Grabillo at 3:40 AM No comments:
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Glimpse of a CPA's mind: August 2010

Glimpse of a CPA's mind

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Answer D is incorrect because planning itself does not obtain evidence.

BS Accountancy Dean's Lister High School Valedictorian

Glimpse of a CPA's mind: August 2010

Glimpse of a CPA's mind: August 2010

d) Review subsequent events or transactions occurring prior to completion of fieldwork.

Glimpse of a CPA's mind: August 2010

Glimpse of a CPA's mind: August 2010

Answer D is incorrect because the accounts tested need not be insignificant.

Glimpse of a CPA's mind: August 2010

Glimpse of a CPA's mind: August 2010

Answer C is incorrect because a progress flowchart is not a legitimate term.

Glimpse of a CPA's mind: August 2010

Glimpse of a CPA's mind: August 2010

Glimpse of a CPA's mind: August 2010

Glimpse of a CPA's mind: August 2010

Glimpse of a CPA's mind: August 2010

Answer C is incorrect because Practice Bulletins are considered as sources of PAS

Answer D is incorrect because FASB statements are considered sources of PAS

Glimpse of a CPA's mind: August 2010

Glimpse of a CPA's mind: August 2010

Glimpse of a CPA's mind: August 2010

d) Relate risk assessment to compliance with marketing objectives.

Answer B is incorrect. Refer to the correct answer explanation.

Answer C is incorrect. Refer to the correct answer explanation.

Answer D is incorrect. Refer to the correct answer explanation.

Glimpse of a CPA's mind: August 2010

Glimpse of a CPA's mind: August 2010

Glimpse of a CPA's mind: August 2010

Answer A is incorrect. Refer to the correct answer explanation.

Answer B is incorrect. Refer to the correct answer explanation.

Answer C is incorrect. Refer to the correct answer explanation.

Glimpse of a CPA's mind: August 2010

Glimpse of a CPA's mind: August 2010

Glimpse of a CPA's mind: August 2010

Glimpse of a CPA's mind: August 2010

Glimpse of a CPA's mind: August 2010

51. Ordinarily in an attest examination report a CPA may report on

Glimpse of a CPA's mind: August 2010

Managements written assertion Subject matter A Yes Yes B Yes No C No Yes D No No

Answer B is incorrect. Refer to the correct answer explanation.

Answer C is incorrect. Refer to the correct answer explanation.

Answer D is incorrect. Refer to the correct answer explanation.

Answer B is incorrect. Refer to the correct answer explanation.

Answer C is incorrect. Refer to the correct answer explanation.

Answer D is incorrect. Refer to the correct answer explanation.

Glimpse of a CPA's mind: August 2010

Answer B is incorrect. Refer to the correct answer explanation.

Answer C is incorrect. Refer to the correct answer explanation.

Answer D is incorrect. Refer to the correct answer explanation.

Answer A is incorrect. Refer to the correct answer explanation.

Answer B is incorrect. Refer to the correct answer explanation.

Glimpse of a CPA's mind: August 2010

Answer C is incorrect. Refer to the correct answer explanation.

Answer B is incorrect because "unaudited" is not a type of audit opinion.

Answer C is incorrect. Refer to the correct answer explanation.

Glimpse of a CPA's mind: August 2010