2017 Released

Question 1

Audit engagement team members should remain alert for evidence of noncompliance with which of the following relevant ethical requirements?

A. Maintaining a suspicious attitude, presuming that the client is dishonest until evidence proves
otherwise.

B. Performing professional responsibilities with the highest sense of integrity.

C. Performing audit procedures efficiently and within expected time budgets.

D. Maintaining confidentiality of client information by not including it in the audit documentation.

Answer 1

A. Incorrect. Audit team members should maintain an attitude of professional skepticism, rather than a
suspicious attitude presuming that the client is dishonest until evidence proves otherwise.

B. Correct! Integrity involves maintaining confidentially of client information, performing audit procedures
efficiently, and maintaining profession skepticism. Audit team members should maintain an attitude of
professional skepticism, rather than a suspicious attitude presuming that the client is dishonest until
evidence proves otherwise. Audit team members should strive to perform procedures efficiently; however, more time than budgeted may be required by evidence uncovered during the audit. Some client
information must be included in audit documentation for it to be complete. An auditor maintains client
confidentiality by safeguarding client information, including the information in audit documentation.

C. Incorrect. Audit team members should strive to perform procedures efficiently; however, more time
than budgeted may be required by evidence uncovered during the audit.

D. Incorrect. Some client information must be included in audit documentation for it to be complete. An
auditor maintains client confidentiality by safeguarding client information, including the information in audit
documentation.

Question 2

According to the AICPA Code of Professional Conduct, which of the following records must a CPA return to the client when requested?

A. Client-provided records, even if fees are due to the CPA for the engagement and are unpaid.

B. Client-provided records requested for a second time because the client misplaced the first set of
records.

C. Supporting records prepared by the CPA consisting of adjusting, closing, combining, or consolidating entries prior to the completion of the engagement.

D. The CPA’s working papers consisting of analyses and schedules prepared by the client at the CPA’s request.

Answer 2

A. Correct! Client records belong to the client regardless of whether fees for the related engagement are unpaid; however, a CPA need not provide records more than once. Supporting records prepared by the
CPA prior to the completion of the engagement might be incomplete. As they are not a finished product
and could reveal information the CPA would prefer not to release to an employee potentially committing
fraud or theft, the CPA may be especially reluctant to share them with the client. The CPA’s records need
not be supplied to the client unless there is some agreement to do so or the client’s records are
incomplete without them. Even if the client’s records are incomplete without the records, they need not be
supplied during the engagement or until fees are paid. Typically, the CPA’s working papers belong to the
CPA and need not ever be supplied to the client.

B. Incorrect. Client records belong to the client regardless of whether fees for the related engagement are unpaid; however, a CPA need not provide records more than once.

C. Incorrect. Supporting records prepared by the CPA prior to the completion of the engagement might be
incomplete. As they are not a finished product and could reveal information the CPA would prefer not to
release to an employee potentially committing fraud or theft, the CPA may be especially reluctant to share
them with the client. The CPA’s records need not be supplied to the client unless there is some
agreement to do so or the client’s records are incomplete without them. Even if the client’s records are incomplete without the records, they need not be supplied during the engagement or until fees are paid.

D. Incorrect. Typically, the CPA’s working papers belong to the CPA and need not ever be supplied to
the client.

Question 3

Which of the following is a requirement for accepting an attestation engagement to report on the controls at a service organization?

A. The description of the controls is completed prior to the signing of the engagement letter.

B. The service auditor has the competence and capability to perform the engagement.

C. The suitability of the evaluation criteria is reviewed by a third party.

D. Management agrees that the service auditor will be responsible for documenting the controls.

Answer 3

A. Incorrect. The description of the controls need not be complete prior to the signing of the engagement
letter as long as the auditor has a reasonable expectation that the engagement can be completed. The auditor’s examination may result in suggestions to management about changes to the description.

B. Correct! An auditor must have competence and capability to perform any engagement accepted.
The description of the controls need not be complete prior to the signing of the engagement letter as long
as the auditor has a reasonable expectation that the engagement can be completed. The auditor’s
examination may result in suggestions to management about changes to the description. The criteria for
each attestation engagement is not reviewed by a third party. A CPA uses professional judgment to
determine appropriate criteria and discloses the criteria in the report on the controls. Readers of the
report may decide if the criteria is suitable for their needs. If a CPA is responsible for documenting the
controls, the CPA is not independent with regard to them and, thus, may not also attest regarding them.

C. Incorrect. The criteria for each attestation engagement is not reviewed by a third party. A CPA uses professional judgment to determine appropriate criteria and discloses the criteria in the report on the
controls. Readers of the report may decide if the criteria is suitable for their needs.

D. Incorrect. If a CPA is responsible for documenting the controls, the CPA is not independent with regard
to them and thus may not also attest regarding them.

Question 4

An accountant agreed to perform a compilation of a company’s financial statements under Statements of Standards for Accounting and Review Services (SSARS). During fieldwork, the accountant decided to perform some analytical procedures. Which of the following would the accountant do related to the compilation engagement?

A. Issue a review report because review procedures were performed.

B. Issue an audit report because audit procedures were performed.

C. Withdraw from the engagement because review procedures were performed on a compilation
engagement.

D. Issue a compilation report even though review procedures were performed on the engagement.

Answer 4

A. Incorrect. As a compilation was performed, a compilation report should be issued. There is no
prohibition against performing analytical procedures for a compilation. The performance of some
analytical procedures do not constitute a review.
B. Incorrect. As a compilation was performed, a compilation report should be issued. There is no
prohibition against performing analytical procedures for a compilation. The performance of some
analytical procedures do not constitute an audit.
C. Incorrect. As a compilation was performed, a compilation report should be issued. There is no
prohibition against performing analytical procedures for a compilation.
D. Correct! As a compilation was performed, a compilation report should be issued. There is no
prohibition against performing analytical procedures for a compilation. The performance of some
analytical procedures do not constitute a review nor an audit.

Question 5

Which of the following constitutes a potential risk associated with the use of information technology in an entity’s internal control structure?

A. A reduction in the ability to monitor the entity’s activities.

B. The facilitation of additional analyses.

C. A reduction in the circumvention of controls.

D. Unauthorized changes to systems.

Answer 5

A. Incorrect. Information technology can be designed to increase monitoring activities; monitoring
activities generally reduce risk.
B. Incorrect. Additional analyses generally reduce risk.
C. Incorrect. A reduction in the circumvention of controls generally reduces risk.
D. Correct! Information technology results in additional potential for unauthorized changes to systems, as
changes might not be detected readily. Information technology can be designed to increase monitoring
activities; monitoring activities generally reduce risk. Additional analyses generally reduce risk. A
reduction in the circumvention of controls generally reduces risk.

Question 6

In planning an audit, an auditor should document in the working papers the auditor’s risk assessment of a material misstatement of the financial statements due to fraud. Which of the following should be included in workpaper documentation if risk factors are identified as being present?

A. A copy of the report of the risk factor to the company’s legal counsel.

B. Discussion of the risk factor with the client.

C. Investigation of the risk factor.

D. Those risk factors identified.

Answer 6

A. Incorrect. An auditor generally does not report risk factors to the company’s legal counsel.
B. Incorrect. In the planning stage particularly, discussion of risk factors with the client might not be
warranted, especially if the auditor believes that management potentially is involved in fraud. Later, some
identified risk factors may be considered immaterial or already understood by the client and thus not
require discussion.
C. Incorrect. While investigation of risk factors might be documented, identified risk factors must be
documented—making this a second-best answer. Further, risk factors might not be investigated.
D. Correct! The auditor is required to document the consideration of fraud, including, the brainstorming
session; procedures performed to obtain information used to identify risks of material misstatement due to
fraud; identified risks of material misstatement; reasons revenue recognition was not considered a fraud
risk factor, if appropriate; results of procedures performed in response to risk of management override of
controls; other factors drawing the auditor to the conclusion that additional procedures were required; and
the nature of communication about fraud. An auditor generally does not report risk factors to the
company’s legal counsel. In the planning stage particularly, discussion of risk factors with the client
might not be warranted, especially if the auditor believes that management potentially is involved in fraud.
Later, some identified risk factors may be considered immaterial or already understood by the client and
thus not require discussion. While investigation of risk factors might be documented, identified risk
factors must be documented. Further, risk factors might not be investigated.

Question 7

If new information becomes available that could require a reevaluation of the quantitative level of materiality applied during an audit of an issuer, then the auditor should

A. Not change the materiality level once it has been established.

B. Lower the materiality level, but not raise it.

C. Raise the materiality level, but not lower it.

D. Raise or lower the materiality level as appropriate to the situation.

Answer 7

A. Incorrect. The quantitative level of materiality should be appropriate given the auditor’s whole
understanding of the circumstances. An initial determination of the materiality level could have been
either too high or too low.
B. Incorrect. The quantitative level of materiality should be appropriate given the auditor’s whole
understanding of the circumstances. An initial determination of the materiality level could have been
either too high or too low.
C. Incorrect. The quantitative level of materiality should be appropriate given the auditor’s whole
understanding of the circumstances. An initial determination of the materiality level could have been
either too high or too low.
D. Correct! The quantitative level of materiality should be appropriate given the auditor’s whole
understanding of the circumstances. An initial determination of the materiality level could have been
either too high or too low.

Question 8

If an auditor of a nonissuer discovers an unexpectedly high number of deviations during procedures
performed on a sample to test management’s review and approval of time sheets, then the auditor would most appropriately

A. Increase the tolerable rate of deviation.

B. Extrapolate the impact of the exceptions on other key controls requiring management review.

C. Propose an audit adjustment.

D. Increase the assessed risks of material misstatement.

Answer 8

A. Incorrect. An unexpectedly high number of deviations during procedures performed on a sample to test management’s review and approval of time sheets suggests the control is not performed as designed. The tolerable rate of deviation is the standard by which a control is evaluated; to increase the tolerable rate of deviation would be to lower the standard to accept sub-par performance.
B. Incorrect. An unexpectedly high number of deviations during procedures performed on a sample to test management’s review and approval of time sheets suggests the control is not performed as designed; it does not necessarily mean that other key controls requiring management review are not performed as designed.
C. Incorrect. An unexpectedly high number of deviations during procedures performed on a sample to test management’s review and approval of time sheets suggests the control is not performed as designed, but it does not necessarily mean that there are actually any errors or fraud present requiring an audit adjustment. Further investigation is required before an audit adjustment is proposed.
D. Correct! An unexpectedly high number of deviations during procedures performed on a sample to test
management’s review and approval of time sheets suggests the control is not performed as designed.
This would tend to increase the risk of material misstatement, but does not necessarily mean that other controls are not performed as designed or that there are actually any errors or fraud present. Further
investigation is required before an audit adjustment is proposed. Rather than extrapolating the impact of
the exceptions on other key controls, the auditor increases the assessed risk of material misstatement,
resulting in increased tests of key controls or increased substantive tests or both. The tolerable rate of
deviation is the standard by which a control is evaluated; one does not lower the standard to accept subpar performance.

Question 9

During the review of work performed for a review engagement, the supervising accountant becomes aware that information provided by management is incorrect. In this situation, the accountant should

A. Make inquiries of management regarding the intent to commit fraud.

B. Conclude that the financial statements are misstated.

C. Disclaim an opinion due to a scope limitation.

D. Request that management consider the effect of the related matters on the financial statements.

Answer 9

A. Incorrect. Incorrect information received by management does not necessarily imply that management
intends to commit fraud; thus, such inquiries would be inappropriate.
B. Incorrect. Before concluding that the financial statements are misstated, the accountant would inquire
as to the accuracy of the information. Practically speaking, management will revise the financial
statements or bear the cost of the review as wasted expense, because the accountant could not provide
limited assurance on the financial statements, negating the point of the review. Generally, an accountant
should conclude that the financial statements are misstated only after getting a refusal to amend the
financial statements.
C. Incorrect. As a review involves providing limited assurance rather than expressing an opinion,
regardless of whether the information provided by management is correct or incorrect. Also, there is no
scope limitation—information is available, it merely is incorrect.
D. Correct! Before concluding that the financial statements are misstated, the accountant would inquire
as to the accuracy of the information and request that management consider the effect of the related
matters on the financial statements. Practically speaking, management will revise the financial statements
or bear the cost of the review as wasted expense, because the accountant could not provide limited
assurance on the financial statements, negating the point of the review. Generally, an accountant should
conclude that the financial statements are misstated only after getting a refusal to amend the financial
statements. Incorrect information received by management does not necessarily imply that management
intends to commit fraud; thus, such inquiries would be inappropriate. As a review involves providing
limited assurance rather than expressing an opinion, regardless of whether the information provided by
management is correct or incorrect. Also, there is no scope limitation—information is available, it merely
is incorrect

Question 10

When determining whether uncorrected misstatements are material, individually or in the aggregate, an auditor of a nonissuer would consider each of the following, except

A. The particular circumstances of each misstatement.

B. The cost of correcting the misstatements.

C. The effect of uncorrected misstatements related to prior periods.

D. The size and nature of the misstatements.

Answer 10

A. Incorrect. The particular circumstances of a misstatement affect its materiality (i.e., the relative
importance of the misstatement).
B. Correct! Misstatements and omissions are considered material if they are expected to influence the
decisions a user will make based on the financial statements. The cost of correcting misstatements has
no bearing on whether they are material. The particular circumstances of a misstatement affect its
materiality. The effect of uncorrected misstatements related to prior periods could either cancel out the
current misstatements or magnify them. The size and nature of a misstatement affects its materiality. For
instance, if a misstatement occurred due to a misapplication of principle, the qualitative impact is
considerably different than if the misstatement occurred due to fraud.
C. Incorrect. The effect of uncorrected misstatements related to prior periods could either cancel out the
current misstatements or magnify them.
D. Incorrect. The size and nature of a misstatement affects its materiality (i.e., the relative importance of
the misstatement). For instance, if a misstatement occurred due to a misapplication of principle, the
qualitative impact is considerably different than if the misstatement occurred due to fraud.

Question 11

Management should address written representations about a firm’s annual audit to the

A. Board of directors.

B. Firm’s attorneys.

C. Shareholders.

D. Auditor.

Answer 11

A. Incorrect. Management’s representation letter about a firm’s annual audit is not addressed to the board
of directors. The firm’s board of directors generally do not even see the representation letter.
B. Incorrect. Management’s representation letter about a firm’s annual audit is not addressed to firm’s
attorneys. The firm’s attorneys generally do not even see the representation letter.
C. Incorrect. Management’s representation letter about a firm’s annual audit is not addressed to the
shareholders. The firm’s shareholders generally do not even see the representation letter.
D. Correct! Management’s representation letter about a firm’s annual audit is addressed to the auditor.
The firm’s board of directors, attorneys, or shareholders generally do not even see the representation letter.

Question 12

Before reissuing a company’s prior-year review report, an accountant becomes aware of information that may have a material effect on the prior-year’s financial statements. Which of the following actions would be most appropriate for the accountant to take?

A. Make inquiries to determine how the information will affect the prior-year financial statements.

B. Withdraw from the engagement and collect all outstanding fees.

C. Reissue the review report without performing any additional procedures.

D. Reissue the review report after obtaining management’s assurance that the information does not
affect the prior-year’s financial statements.

Answer 12

A. Correct! After becoming aware of information that may have a material effect on the prior-year’s
financial statements, an accountant must make inquiries to determine how the information will affect the
prior-year financial statements before re-issuing a review report. Withdrawal from the engagement would
be an excessive response. To ignore information that may have a material effect on the prior-year’s
financial statements and reissue the review report without performing any additional procedures to
determine their effect would be unethical. Management’s assurance that the information does not affect
the prior-year’s financial statements is insufficient to determine whether the information has a material
effect.
B. Incorrect. Withdrawal from the engagement would be an excessive response.
C. Incorrect. To ignore information that may have a material effect on the prior-year’s financial statements
and reissue the review report without performing any additional procedures to determine their effect
would be unethical.
D. Incorrect. Management’s assurance that the information does not affect the prior-year’s financial
statements is insufficient to determine whether the information has a material effect

Question 13

If a nonissuer refuses to give permission to the auditor to communicate with its external legal counsel, then the auditor should modify which of the following?

A. The audit plan.

B. The management representation letter.

C. The attorney’s letter of inquiry.

D. The opinion in the auditor’s report.

Answer 13

A. Incorrect. While not contacting the attorney may in itself be a change to the audit plan, this is not the
best answer.
B. Incorrect. An auditor would seek the same representations from management regardless of whether
the client gives or refuses to give permission to the auditor to communicate with its external legal counsel.
C. Incorrect. If a nonissuer refuses to give permission to the auditor to communicate with its external legal
counsel, then it is pointless for the auditor to send a letter of inquiry to an attorney—the attorney will not
respond without the client’s permission.
D. Correct! If a nonissuer refuses to give permission to the auditor to communicate with its external legal
counsel, then the auditor must qualify or disclaim an opinion due to a scope limitation. While not
contacting the attorney may in itself be a change to the audit plan, this is not the best answer. An auditor
would seek the same representations from management regardless of whether the client gives or refuses
to give permission to the auditor to communicate with its external legal counsel. If a nonissuer refuses to
give permission to the auditor to communicate with its external legal counsel, then it is pointless for the
auditor to send a letter of inquiry to an attorney—the attorney will not respond without the client’s
permission.

Question 14

A nonissuer engaged a practitioner to perform agreed-upon procedures on specified matters. The date of the practitioner’s report would ordinarily be determined by the occurrence of which of the following events?

A. The receipt of the signed engagement letter from the client.

B. The completion of the agreed-upon procedures.

C. The client’s review and approval of the contents of a draft report.

D. The delivery of the final report to the client.

Answer 14

A. Incorrect. The engagement letter typically is received before most of the engagement is performed; this
is too early for the date of the report on the engagement.
B. Correct! A practitioner’s report on the results of agreed-upon procedures is dated at completion of the
agreed-upon procedures. The engagement letter typically is received before most of the engagement is
performed; this is too early for the date of the report on the engagement. The practitioner accepts
responsibility for everything through the report date, but no more. The client’s review and approval of the
contents of a draft report is merely one step in the engagement. The completion of the agreed-upon
procedures occurs before the delivery of the final report to the client. While this could occur on the same
day, it is the completion of the agreed-upon procedures that determines the report date.
C. Incorrect. The practitioner accepts responsibility for everything through the report date, but no more.
The client’s review and approval of the contents of a draft report is merely one step in the engagement.
D. Incorrect. The practitioner accepts responsibility for everything through the report date, but no more.
The completion of the agreed-upon procedures occurs before the delivery of the final report to the client.
While this could occur on the same day, it is the completion of the agreed-upon procedures that
determines the report date.

Question 15

If an accountant is performing a review engagement for a nonissuer and considers it necessary to communicate a matter that is not presented in the financial statements, then the accountant should include this information in which of the following paragraphs in the review report?

A. The opinion paragraph.

B. The introductory paragraph.

C. The other-matter paragraph.

D. The emphasis-of-matter paragraph.

Answer 15

A. Incorrect. There is a conclusion paragraph, but no opinion paragraph, in a review report.
B. Incorrect. The introductory paragraph of a review report identifies the entity and the financial
statements and explains what a review is and states that the accountant is not expressing an opinion.
The introductory paragraph is not the appropriate paragraph for an other matter, which would get its own
paragraph.
C. Correct! As the accountant is discussing matters not disclosed in the financial statements, an othermatter
paragraph is appropriate. There is a conclusion paragraph, but no opinion paragraph, in a
review report. The introductory paragraph of a review report identifies the entity and the financial
statements and explains what a review is and states that the accountant is not expressing an opinion. An
introductory paragraph is not an appropriate place for presenting an other matter, which would get its own
paragraph. An emphasis-of-matter paragraph is for matters appropriately disclosed in the financial
statements that the practitioner merely wants to emphasize. It is not for a matter that is omitted from the
financial statements.
D. Incorrect. An emphasis-of-matter paragraph is for matters appropriately disclosed in the financial
statements that the practitioner merely wants to emphasize. It is not for a matter that is omitted from the
financial statements.

Question 16

According to PCAOB standards, each of the following items of information should be included in the
documentation of an engagement quality review, except

A. Identification of the engagement quality reviewer and others who assisted the reviewer.

B. Identification of the documents reviewed by the engagement quality reviewer and others who assisted
the reviewer.

C. The date on which the engagement quality reviewer provided concurring approval of issuance.

D. An assessment by the engagement quality reviewer of the instances of fraud identified by the audit
team.

Answer 16

A. Incorrect. The engagement quality review documentation should include identification of the
engagement quality reviewer and his or her assistants.
B. Incorrect. The engagement quality review documentation should include identification of the
documents reviewed by the engagement quality reviewer and his or her assistants.
C. Incorrect. The engagement quality review documentation should include the date on which the
engagement quality reviewer provided concurring approval of issuance.
D. Correct! The audit team should document instances of suspected fraud, but the engagement quality
reviewer need not document an assessment of these instances. The engagement quality review
documentation should include identification of the engagement quality reviewer and his or her assistants,
the documents reviewed, and the date on which the engagement quality reviewer provided concurring
approval of issuance.

Question 17

During planning, an auditor of a nonissuer should communicate which of the following to those charged with governance at an entity?

A. The auditor is responsible for preparing financial statements in conformity with the applicable financial
reporting framework.

B. The audit does not relieve management of its responsibilities for the financial statements.

C. The auditor will express an opinion on the effectiveness of internal controls over compliance with laws and regulations.

D. All audit findings will be communicated in writing to those charged with governance.

Answer 17

A. Incorrect. Management is responsible for preparing financial statements in conformity with the
applicable financial reporting framework.
B. Correct! An audit does not relieve management of its responsibilities for the financial statements.
Management is responsible for preparing financial statements in conformity with the applicable financial
reporting framework. The auditor will express an opinion on the effectiveness of internal controls over
compliance with financial reporting, not laws and regulations. Immaterial audit findings typically are not
communicated in writing to those charged with governance.
C. Incorrect. The auditor will express an opinion on the effectiveness of internal controls over compliance
with financial reporting, not laws and regulations.
D. Incorrect. Immaterial audit findings typically are not communicated in writing to those charged with
governance

Question 18

While conducting an audit in accordance with Government Auditing Standards (the Yellow Book), an
auditor determines that fraud has been committed in one of the client’s government contracts. The auditor reports the fraud to the client’s audit committee, which takes no action to report the fraud to appropriate parties. To which of the following entities is the auditor required to report this situation?

A. The counterparty to the contract.
B. The Association of Certified Fraud Examiners.
C. The client’s CEO.
D. The client’s board of directors.

Answer 18

A. Correct! The auditor is required to inform the counter party to the contract if the client’s audit
committee fails to take appropriate action with regard to reported fraud. The Association of Certified
Fraud Examiners does not concern itself so closely with its members’ clients—or the clients of
nonmembers. It is a nonprofit organization that promulgates standards and supports advancements in
forensic auditing. If the audit committee does not fulfill its duties, it is questionable that the board of
directors or CEO will rectify the situation.
B. Incorrect. The Association of Certified Fraud Examiners does not concern itself so closely with its
members’ clients—or the clients of nonmembers. It is a nonprofit organization that promulgates standards
and supports advancements in forensic auditing.
C. Incorrect. If the audit committee does not fulfill its duties, it is questionable that the CEO will rectify the
situation.
D. Incorrect. If the audit committee does not fulfill its duties, it is questionable that the board of directors
will rectify the situation.

Question 19

Which of the following is an example of an inherent risk that an auditor should consider?

A. Technological developments that may render inventory obsolete.

B. Posting of unauthorized journal entries.

C. An incorrect formula in a worksheet used to calculate a LIFO inventory reserve.

D. Inaccurate physical inventory count.

Answer 19

A. Correct! Technological developments that may render inventory obsolete are unavoidable—no
amount of internal controls will offset this risk; thus, this is an inherent risk. Posting of unauthorized
journal entries, an incorrect formula in a worksheet used to calculate a LIFO inventory, and an inaccurate
physical inventory count can all be avoided when strong internal controls are present.
B. Incorrect. Posting of unauthorized journal entries frequently is avoided by strong internal controls; thus,
this is not an inherent risk.
C. Incorrect. An incorrect formula in a worksheet used to calculate a LIFO inventory reserve frequently is
avoided by strong internal controls; thus, this is not an inherent risk.
D. Incorrect. An inaccurate physical inventory count frequently is avoided by strong internal controls; thus,
this is not an inherent risk.

Question 20

In an entity under audit, employees have the opportunity to change their time worked after their timecards have been approved. This is an example of which of the following types of deficiency?

A. Accounting.

B. Operating.

C. Design.

D. Procedural.

Answer 20

A. Incorrect. Accounting deficiency is not a commonly used term when describing deficiencies in internal
control.
B. Incorrect. An operating deficiency occurs when an internal control is designed appropriately, but not
implemented according to the design. This example is an instance of a design deficiency, not poor
implementation of an appropriate design.
C. Correct! An operating deficiency occurs when an internal control is designed appropriately, but not
implemented according to the design. This example is an instance of a design deficiency, not poor
implementation of an appropriate design. Accounting deficiency and procedural deficiency are not
commonly used terms when describing deficiencies in internal control.
D. Incorrect. Procedural deficiency is not a commonly used term when describing deficiencies in internal
control.

Question 21

Which of the following factors would the independent auditor most likely consider in assessing the objectivity of an internal auditor?

A. The internal auditor has obtained the Certified Internal Auditor designation.

B. The audit committee reviews employment decisions related to the director of internal auditing.

C. The internal auditor was previously an employee of the auditor’s public accounting firm.

D. The internal auditor attends a number of comprehensive continuing professional education courses each year.

Answer 21

A. Incorrect. The Certified Internal Auditor designation addresses the internal auditor’s competence, not
objectivity.
B. Correct! The fact that the audit committee reviews employment decisions related to the director of
internal auditing indicates a direct relationship between the audit committee and the internal auditor,
which allows the internal auditor to perform their work independently and objectively. The internal auditor
would be more hesitant to report suspect behavior of upper management if upper management made
such decisions. The Certified Internal Auditor designation, previous employment, and annual continuing
professional education courses address the internal auditor’s competence, not objectivity.
C. Incorrect. Previous employment by the auditor’s public accounting firm addresses the internal auditor’s
competence, not objectivity.
D. Incorrect. Annual continuing professional education courses addresses the internal auditor’s
competence, not objectivity.

Question 22

Regarding a nonissuer’s compliance with laws and regulations, an auditor performing an audit of the
entity’s financial statements is responsible for

A. Obtaining a general understanding of the legal and regulatory framework applicable to the entity and
how the entity is complying with that framework.

B. Preventing noncompliance with existing applicable laws and regulations that determine reported
amounts and disclosures in the entity’s financial statements.

C. Determining whether an act performed by the entity being audited constitutes noncompliance with
existing applicable laws and regulations.

D. Ensuring that the entity’s operations are conducted in accordance with the provisions of laws and
regulations relevant to the entity’s financial statements.

Answer 22

A. Correct! An auditor performing an audit of a nonissuer entity’s financial statements is responsible for
obtaining a general understanding of the legal and regulatory framework applicable to the entity and how
the entity is complying with that framework. Management is responsible for the prevention of
noncompliance with laws and regulations. An auditor is not expected to be a lawyer with the expertise to
determine whether an act performed by the entity being audited constitutes noncompliance with existing
applicable laws and regulations. Management is responsible for ensuring that the entity’s operations are
conducted in accordance with the provisions of laws and regulations.
B. Incorrect. Management is responsible for the prevention of noncompliance with laws and regulations.
C. Incorrect. An auditor is not expected to be a lawyer with the expertise to determine whether an act
performed by the entity being audited constitutes noncompliance with existing applicable laws and
regulations.
D. Incorrect. Management is responsible for ensuring that the entity’s operations are conducted in
accordance with the provisions of laws and regulations.

Question 23

Which of the following types of sampling allows an auditor to quantify sampling risk?

A. Stratified nonstatistical.

B. Haphazard.

C. Attribute.

D. Block

Answer 23

A. Incorrect. Stratified nonstatistical sampling is nonstatistical sampling, which doesn’t allow an auditor to
quantify sampling risk.
B. Incorrect. Haphazard sampling is nonstatistical sampling, which doesn’t allow an auditor to quantify
sampling risk.
C. Correct! Attribute sampling is statistical sampling. Statistical sampling allows an auditor to quantify
sampling risk. Stratified nonstatistical sampling, haphazard sampling, and block sampling are all
nonstatistical sampling, which doesn’t allow an auditor to quantify sampling risk.
D. Incorrect. Block sampling is nonstatistical sampling, which doesn’t allow an auditor to quantify
sampling risk.

Question 24

During a recent audit of the revenue cycle, a CPA found the client had $1 million in accounts receivable recorded for fictitious customers. Which of the following tests most likely facilitated identification of the fraud?

A. Reviewing the segregation of duties for staff who had responsibility for sales, shipping, and invoicing.

B. Reviewing the support for open sales orders not yet shipped at December 31.

C. Sending positive confirmations to all of the client’s customers with balances on December 31.

D. Examining the reconciliation between the subsidiary ledger and the general ledger control account.

Answer 24

A. Incorrect. While review of internal controls may identify some opportunities to commit fraud, it is
unlikely to identify actual fraud.
B. Incorrect. Open sales orders not yet shipped at year end typically would not be included in accounts
receivable; thus, review of the open sales orders is unlikely to identify accounts for fictious customers.
C. Correct! Evidence from outside sources generally is more persuasive than evidence from internal
sources. Positive confirmations request a response from an outside source regardless of whether the
client’s customers agree with the client’s records of their accounts. If confirmation requests yield no
response, follow-up procedures (additional requests, phone calls, etc.) are implemented that typically
detect fictitious customers. While review of internal controls may identify some opportunities to commit
fraud, it is unlikely to identify actual fraud. Open sales orders not yet shipped at year end typically would
not be included in accounts receivable; thus, review of the open sales orders is unlikely to identify
accounts for fictious customers. A fraudster likely would make sure the subsidiary ledger and the general
ledger control account reconcile. Evidence from outside sources generally is more persuasive than
evidence from internal sources.
D. Incorrect. A fraudster likely would make sure the subsidiary ledger and the general ledger control
account reconcile. Evidence from outside sources generally is more persuasive than evidence from
internal sources.

Question 25

How should an auditor verify the valuation of marketable securities at the balance sheet date?

A. Confirm all securities with the related custodians and test interest income.

B. Observe the inventory count of all securities at the balance sheet date.

C. Compare the prices of the securities to published closing prices at the balance sheet date.

D. Inquire of management that securities are valued at fair value.

Answer 25

A. Incorrect. Confirming all securities with the related custodians and testing interest income verifies
existence and ownership more than valuation.
B. Incorrect. Observing the inventory count of all securities at the balance sheet date verifies existence
more than valuation.
C. Correct! Published closing prices are objective, independent values; thus, comparing the prices of the
securities to published closing prices at the balance sheet date would verify the valuation of marketable
securities at the balance sheet date. Confirming all securities with the related custodians and testing
interest income verifies existence and ownership more than valuation. Observing the inventory count of
all securities at the balance sheet date verifies existence more than valuation. Management assurance
that the securities are valued at fair value is evidence from an internal source, rather than an outside
source, and, at best, may be subject to bias.
D. Incorrect. Management assurance that the securities are valued at fair value is evidence from an
internal source, rather than an outside source, and, at best, may be subject to bias. Evidence from
outside sources generally is more persuasive than evidence from internal sources.

Question 26

Under which of the following circumstances would an entity be expected to accrue a loss contingency for the period under audit?

A. The entity recorded the amount of an asset impaired as of the balance sheet date.

B. A reasonable estimate was determined for a liability incurred after the balance sheet date.

C. Legal counsel communicated that an unfavorable judgment from current litigation was reasonably
possible.

D. The entity estimated the amount of a claim with a probable adverse outcome before issuance of the
audit report.

Answer 26

A. Incorrect. The impairment of an asset is not a loss contingency; it is an actual loss.
B. Incorrect. A liability incurred after the balance sheet date is reported in the subsequent period, not in
the current period’s financial statements.
C. Incorrect. The criteria for the accrual of a loss contingency is probable and reasonable estimable, not
merely possible.
D. Correct! An entity accrues a loss contingency due to events occurring on or before the balance sheet
date when the loss is probable and reasonably estimable. The impairment of an asset is not a loss
contingency; it is an actual loss. A liability incurred after the balance sheet date is reported in the
subsequent period, not in the current period’s financial statements. The criteria for the accrual of a loss
contingency is probable and reasonable estimable, not merely possible.

Question 27

Which of the following events requires adjustment to the financial statements for the year ended December 31, year 1?

A. Loss on an accounts receivable as the result of a customer suffering a major loss from a flood in
January, year 2.

B. Loss on an accounts receivable as the result of a customer suffering a deteriorating financial condition that led to bankruptcy filing in January, year 2.

C. Loss of inventory due to an earthquake in January, year 2.

D. Sale of a major bond issue in January, year 2.

Answer 27

A. Incorrect. The customer’s flood loss occurred in the subsequent period. If material, this should be
disclosed, but no adjustment would be made to the current financial statements.
B. Correct! Events in subsequent periods reflective of conditions in the current period require adjustment
to the current financial statements. Material events occurring in subsequent periods occurring before the
financial statements are issued should be disclosed, but the current financial statements are not adjusted.
As the events that led to the customer’s bankruptcy occurred before or on the balance sheet date, an
adjustment should be made to the current financial statements. The customer’s flood loss, loss of
inventory due to an earthquake, and the sale of a major bond issue occurred in the subsequent period
and are not reflective of conditions in the current period.
C. Incorrect. The loss of inventory due to an earthquake occurred in the subsequent period. If material,
this should be disclosed, but no adjustment would be made to the current financial statements.
D. Incorrect. The sale of a major bond issue occurred in the subsequent period. This should be disclosed,
but no adjustment would be made to the current financial statements.

Question 28

When an audit firm includes a report on compliance with aspects of contractual agreements in the auditor’s report on the nonissuer’s financial statements, in which paragraph of the audit report should the report on compliance be included?

A. Auditor’s responsibility paragraph.

B. Opinion paragraph.

C. Other-matter paragraph.

D. Emphasis-of-matter paragraph.

Answer 28

A. Incorrect. The auditor’s responsibility paragraph outlines the auditor’s responsibilities, not the auditor’s
findings or conclusions.
B. Incorrect. The opinion paragraph of an auditor’s report states the auditor’s opinion on the financial
statements, not other matters.
C. Correct! As the accountant is discussing matters not disclosed in the financial statements, an othermatter
paragraph is appropriate. The auditor’s responsibility paragraph outlines the auditor’s
responsibilities, not the auditor’s findings or conclusions. The opinion paragraph of an auditor’s report
states the auditor’s opinion on the financial statements, not other matters. An emphasis-of-matter
paragraph is for matters appropriately disclosed in the financial statements that the practitioner merely
wants to emphasize. It is not for a matter that is omitted from the financial statements.
D. Incorrect. An emphasis-of-matter paragraph is for matters appropriately disclosed in the financial
statements that the practitioner merely wants to emphasize. It is not for a matter that is omitted from the
financial statements.

Question 29

A former client requests a predecessor auditor to reissue the prior-year’s audit report in connection with the issuance of comparative financial statements by the client. What is the predecessor auditor’s responsibility?

A. Review the previous report and make the necessary changes.

B. Consult with the client’s legal counsel to determine available remedies.

C. Read the current report, compare it to the previous report, and obtain a letter of representation from
the successor auditor.

D. Audit the current statements.

Answer 29

A. Incorrect. Reviewing only the previous report is insufficient.
B. Incorrect. The client’s management may consult with the its legal counsel as needed; the predecessor
auditor would consult with his or her own legal counsel, if needed.
C. Correct! At a minimum, the predecessor auditor must read the current report, compare it to the
previous report, and obtain a letter of representation from the successor auditor before re-issuing the
prior-year’s audit report. Reviewing only the previous report is insufficient. The client’s management
may consult with the its legal counsel as needed; the predecessor auditor would consult with his or her
own legal counsel, if needed. Auditing the current statements is beyond the predecessor auditor’s
required actions.
D. Incorrect. Auditing the current statements is beyond the predecessor auditor’s required actions.

Question 30

Which of the following statements best serves as management’s assertion of consistency in an MD&A presentation?

A. Information included in the presentation is properly classified and described.

B. Nonfinancial data have been accurately derived from related records.

C. Reported transactions took place during a given period.

D. Descriptions of transactions are included to understand financial condition.

Answer 30

A. Incorrect. While properly classifying and describing information in the MD&A is important, this does not
address consistency.
B. Correct! MD&A is not focused on classification and description, but rather conveying financial and
nonfinancial information about the state of the company that is best presented in a narrative, rather than
in financial statements. If nonfinancial data have been accurately derived from related records, this
supports consistency between the MD&A and the financial statements. While properly classifying and
describing information in the MD&A is important, this does not address consistency. While it is important
that transactions discussed in the MD&A took place during a given period, this does not address
consistency. Descriptions of transactions may be included in an MB&A to understand financial
condition, but this does not address consistency.
C. Incorrect. While it is important that transactions discussed in the MD&A took place during a given
period, this does not address consistency.
D. Incorrect. Descriptions of transactions may be included in an MB&A to understand financial condition,
but this does not address consistency