Assessment 2

Question 1

Analytical procedures performed in the overall review stage of an audit suggest that several accounts have unexpected relationships. The results of these procedures most likely would indicate that:

misstatements exist among the relevant account balances.

internal control activities are not operating effectively.

additional tests of details are required.

the communication with the audit committee should be revised.

Answer 1

additional tests of details are required.

Explanation:

Analytical procedures are performed both at the beginning and at the review stages of an audit. At the review stage, the objective is to assess the conclusions reached about the overall financial statement presentation. If unexpected relationships still exist at this point after a significant amount of evidence has been gathered, then more testing is necessary.

Question 2

A cooling-off period of how many years is required before a member of an issuer’s audit engagement team may begin working for the registrant in a key position?

One year

Two years

Three years

Four years

Answer 2

One year

Explanation:

The Securities and Exchange Commission (SEC) requires a cooling-off period of one year for a former member of an audit client engagement team before he or she can be employed in a financial oversight role for that same client. This requirement is necessary to preserve auditor (firm) independence.

Question 3

Which of the following auditor concerns most likely could be so serious that the auditor concludes that a financial statement audit cannot be performed?

Management fails to modify prescribed internal controls for changes in information technology.

Internal control activities requiring segregation of duties are rarely monitored by management.

Management is dominated by one person who is also the majority stockholder.

There is a substantial risk of intentional misapplication of accounting principles.

Answer 3

There is a substantial risk of intentional misapplication of accounting principles.

Explanation:

Some circumstances may arise during the audit and bring into question the auditor’s ability to continue performing the audit. The circumstances include the following:

• The entity does not take appropriate action regarding fraud that the auditor considers necessary in the circumstances.
• The auditor’s consideration of the risks of material misstatement due to fraud and the results of the audit tests indicated a significant risk of material and pervasive fraud.
• The auditor has significant concern about the competence or integrity of management or those charged with governance.

In addition, fraudulent financial reporting may be accomplished by the following:

• Manipulation, falsification, or alteration of the accounting records or supporting documents
• Misrepresentation in or intentional omission from the financial statements of events, transactions, or other significant information
• Intentional misapplication of accounting principles relating to amounts, classification, manner of presentation, or disclosure

Question 4

The phrase “generally accepted accounting principles” is an accounting term that:

includes broad guidelines of general application but not detailed practices and procedures.

encompasses the conventions, rules, and procedures necessary to define accepted accounting practice at a particular time.

provides a measure of conventions, rules, and procedures governed by the AICPA.

is included in the audit report to indicate that the audit has been conducted in accordance with generally accepted auditing standards (GAAS).

Answer 4

encompasses the conventions, rules, and procedures necessary to define accepted accounting practice at a particular time.

Explanation:

Generally accepted accounting principles (GAAP) are not broad guidelines, but the conventions, rules, and procedures (methods of applying the principles and practices) that govern how financial statements are prepared and presented. The principles are dynamic, and updates are regularly published.

GAAP is not just set forth in AICPA rules; GAAP comes from many different sources including, but not limited to, the FASB Codification and rules and interpretive releases from the Securities and Exchange Commission.

The objective of an audit is to state whether the financial statements are presented fairly in conformity with GAAP. However, the mention of GAAP in the report does not indicate that the audit has been conducted in accordance with GAAS.

Question 5

An auditor obtains knowledge about a new client’s business and its industry to:

make constructive suggestions concerning improvements to the client’s internal control.

develop an attitude of professional skepticism concerning management’s financial statement assertions.

evaluate whether the aggregation of known misstatements causes the financial statements taken as a whole to be materially misstated.

understand the events and transactions that may have an effect on the client’s financial statements.

Answer 5

understand the events and transactions that may have an effect on the client’s financial statements.

Explanation:

Question 6

While performing interim audit procedures of accounts receivable, numerous unexpected errors are found resulting in a change of risk assessment. Which of the following audit responses would be most appropriate?

Move detailed analytical procedures from year-end to interim

Increase the dollar threshold of vouching customer invoices

Send negative accounts receivable confirmations instead of positive accounts receivable confirmations

Use more experienced audit team members to perform year-end testing

Answer 6

Use more experienced audit team members to perform year-end testing

Explanation:

Numerous unexpected errors found while performing interim audit procedures of accounts receivable would cause the auditor to consider whether a client’s financial statements contain a greater risk of material misstatements.

AU-C 330.A1 states: “Overall responses to address the assessed risks of material misstatement at the financial statement level may include:

• “emphasizing to the audit team the need to maintain professional skepticism.
• “assigning more experienced staff or those with specialized skills or using specialists.
• “providing more supervision.
• “incorporating additional elements of unpredictability in the selection of further audit procedures to be performed.
• “making general changes to the nature, timing, or extent of audit procedures (for example, performing substantive procedures at period-end instead of at an interim date or modifying the nature of audit procedures to obtain more persuasive audit evidence).”

Moving detailed analytical procedures from year-end to interim is the opposite of the timing of audit procedures recommended in AU-C 330.

Increasing the dollar threshold of vouching customer invoices would decrease the number of invoices selected in a sample and would result in less persuasive audit evidence.

Sending negative accounts receivable confirmations instead of positive accounts receivable confirmations would result in less persuasive audit evidence.

Question 7

An auditor is determining the sample size for an inventory observation using mean-per-unit estimation, which is a variables sampling plan. To calculate the required sample size, the auditor usually determines:

the variability in the dollar amounts of inventory items

the risk of incorrect acceptance.

both the variability in the dollar amounts of inventory items and the risk of incorrect acceptance.

neither the variability in the dollar amounts of inventory items nor the risk of incorrect acceptance.

Answer 7

both the variability in the dollar amounts of inventory items and the risk of incorrect acceptance.

Explanation:

The auditor must use professional judgment to determine the sample size, whether the auditor is using statistical or nonstatistical sampling.

In statistical sampling, the auditor will quantify the relevant factors.

The nature (or characteristics) of the population affects the sample size. As the variation within the population increases, the sample size must increase.
.
Also, to reduce the level of risk of incorrect acceptance (the risk that the sample supports the conclusion that the recorded account balance is not materially misstated when it is materially misstated), it is necessary to increase the size of the sample.

Question 8

According to the AICPA Code of Professional Conduct, under which of the following circumstances may a CPA receive a contingent fee for services?

Examining a client’s prospective financial information

Preparing a client’s federal income tax return

Representing a client in an IRS examination of the client’s federal income tax return

Reviewing a client’s financial statements

Answer 8

Representing a client in an IRS examination of the client’s federal income tax return

Explanation:

A member in public practice may not receive a contingent fee for any professional services from a client for whom the firm prepares an audit, review, compilation (for use by a third party, and lack of independence has not been disclosed), or an examination of prospective financial information. They also may not prepare an original or amended tax return or claim for refund for a contingent fee for any client.

However, a fee is not considered contingent if it is fixed by the courts or other public authorities, or in tax matters, if it is determined based on the results of judicial processing or finding of a governmental agency.

Therefore, representing a client in an IRS examination by a revenue agent of the client’s federal or state income tax return is an example of where a contingent fee would be permitted.

Question 9

In evaluating the reasonableness of an accounting estimate, an auditor most likely would concentrate on key factors and assumptions that are:

consistent with prior periods.

similar to industry guidelines.

objective and not susceptible to bias.

deviations from historical patterns.

Answer 9

deviations from historical patterns.

Explanation:

In evaluating the reasonableness of an accounting estimate, the auditor focuses on the key factors and assumptions that are deviations from historical patterns.

Also of concern to the auditor are key factors and assumptions that are significant, sensitive to variations, and subjective and susceptible to misstatement and bias.

Estimates are more likely to be reasonable if they are consistent with prior periods, similar to industry guidelines, and objective and not susceptible to bias.

Question 10

An accountant may compile a nonissuer’s financial statements that omit all of the disclosures required by GAAP only if the omission is:

I. clearly indicated in the accountant’s report.
II. not undertaken with the intention of misleading the financial statement users.

I only

II only

Both I and II

Either I or II

Answer 10

Both I and II

Explanation:

Financial statements that omit all of the disclosures required by GAAP may be compiled only if the omission is clearly indicated in the accountant’s report and not undertaken with the intention of misleading the financial statement users.

Question 11

Which of the following controls is not usually performed in the vouchers payable department?

Matching the vendor’s invoice with the related receiving report

Approving vouchers for payment by having an authorized employee sign the vouchers

Indicating the asset and expense accounts to be debited

Accounting for unused prenumbered purchase orders and receiving reports

Answer 11

Accounting for unused prenumbered purchase orders and receiving reports

Explanation:

The vouchers payable department should not account for unused prenumbered purchase orders and receiving reports; this is the responsibility of the purchasing and receiving departments, respectively.

Access to unused purchase orders and receiving reports and also to payables constitutes an inadequate segregation of duties. Consider what could happen: a vouchers payable clerk could write a fake purchase order, confirm receipt of the nonexistent goods, and then authorize payment to him or herself.

The vouchers payable department should:

• match vendor’s invoice with the related receiving report, which ensures that goods billed were received (i.e., that voucher is valid).
• approve vouchers for payment by having an authorized employee sign the vouchers (authorization).
• indicate the asset and expense accounts to be debited (ensuring proper classification).

Question 12

When an auditor assesses control risk at the maximum level, the auditor is required to document:

the auditor’s understanding of the entity’s accounting system.

the auditor’s basis for concluding that control risk is at the maximum level.

both the auditor’s understanding of the entity’s accounting system and the auditor’s basis for concluding that control risk is at the maximum level.

neither the auditor’s understanding of the entity’s accounting system nor the basis for concluding that control risk is at the maximum level.

Answer 12

both the auditor’s understanding of the entity’s accounting system and the auditor’s basis for concluding that control risk is at the maximum level.

Explanation:

An auditor assesses control risk (and the risk of material misstatement) after obtaining an understanding of the internal control.

The auditor is required to document, in a way that provides a reasonable record, how the auditor has complied with the standards of fieldwork, one of which is gaining a sufficient understanding of internal control.

This would include an understanding of the entity’s accounting system, part of the Information and Communication component.

Regardless of control risk assessment, the auditor should document his or her understanding of the entity’s accounting system.

The auditor must document the assessment of the risks of material misstatement and the basis for the assessment.

Control risk is part of the risk of material misstatement. The auditor, therefore, should document the assessment (that it was assessed at maximum) and why (the basis for the assessment).

Question 13

In assessing the competence and objectivity of an entity’s internal auditor, an independent auditor least likely would consider information obtained from:

discussions with management personnel.

external quality reviews of the internal auditor’s activities.

previous experience with the internal auditor.

the results of analytical procedures.

Answer 13

the results of analytical procedures.

Explanation:

The internal auditor’s competence and objectivity are assessed by using information from discussions with management personnel, external quality reviews, and previous experience with the internal auditor.

The information concerns the internal auditor’s education, professional experience, professional certification (e.g., CIA), work performed (review of audit programs, workpapers, reports, etc.), organizational status, and selection of audit areas.

Analytical procedures (used in planning the audit, as a substantive test, and in the overall review stage of the audit) depend upon the availability of a relationship between or among financial and nonfinancial data.

The relationship must be predictable enough for the auditor to develop an expectation.

Obviously, the internal auditor’s competence and objectivity cannot be assessed by using analytical procedures.

Question 14

Which of the following is not a quality control policy or procedure related to engagement supervision?

Tracking the progress of the engagement

Scheduling vacations and other paid time off

Addressing significant issues arising during the engagement

Identifying matters for consultation or consideration by more experienced team members

Answer 14

Scheduling vacations and other paid time off

Explanation:

Policies and procedures for engagement supervision might include the following:

• Tracking the progress of the engagement
• Considering the capabilities and competence of individual members of the engagement team, whether they have sufficient time to carry out their work, whether they understand their instructions, and whether the work is being carried out in accordance with the planned approach to the engagement
• Addressing significant findings and issues arising during the engagement, considering their significance, and modifying the planned approach appropriately
• Identifying matters for consultation or consideration by more experienced engagement team members during the engagement

QC 10.A34

Scheduling vacations and other paid time off is an administrative function, not engagement performance.

Question 15

Which of the following describes a weakness in accounts payable procedures?

The accounts payable clerk files invoices and supporting documentation after payment.

The accounts payable clerk manually verifies arithmetic on the vendor invoice.

The accounts payable system compares the receiving report to the vendor invoice.

The accounts payable manager issues purchase orders.

Answer 15

The accounts payable manager issues purchase orders.

Explanation:

An individual in the purchasing department should issue purchase orders with the appropriate supervisory approval.

The accounts payable clerk is responsible for verifying the arithmetic on the vendor invoice, comparing the vendor invoice to the receiving report and purchase order, processing the payment for the invoice, sending the check elsewhere for signature and mailing, and then filing all of the supporting documentation after payment.

If the accounts payable manager were able to issue purchase orders, he could order items for personal use (or for resale through his own side business) and then process payment for them through the company’s records.

Question 16

Which of the following services would constitute a management function under Government Auditing Standards and result in the impairment of a CPA’s independence if performed by the CPA?

Developing entity program policies

Providing methodologies, such as practice guides

Providing accounting opinions to a legislative body

Recommending internal control procedures

Answer 16

Developing entity program policies

Explanation:

Government Auditing Standards (i.e., the Yellow Book) consider developing entity program policies to be a management function. As such, developing such policies would impair a CPA’s independence.

Providing methodologies (such as practice guides), providing accounting opinions to a legislative body, or recommending internal control procedures would not impair independence.

Question 17

Which of the following disagreements between the auditor and management do not have to be communicated by the auditor to those charged with governance?

Disagreements regarding management’s judgment about accounting estimates for goodwill

Disagreements about the scope of the audit

Disagreements in the application of accounting principles relating to software development costs

Disagreements of the amount of the LIFO inventory layer based on preliminary information

Answer 17

Disagreements of the amount of the LIFO inventory layer based on preliminary information

Explanation:

The auditor needs to communicate any disagreements any matters, whether resolved or not, that individual or in the aggregate could be significant to the financial statements or the auditor’s report. Disagreements based on preliminary or incomplete information that were later resolved do not need to be disclosed.

Question 18

The primary objective of procedures performed to obtain an understanding of internal control is to provide an auditor with:

knowledge necessary for audit planning.

audit evidence to use in assessing inherent risk.

a basis for modifying tests of controls.

an evaluation of the consistency of application of management’s policies.

Answer 18

knowledge necessary for audit planning.

Explanation:

The primary objective of procedures performed to obtain an understanding of internal control is to provide an auditor with knowledge necessary for audit planning.

The general objective of the auditor’s involvement with the client’s internal control is to obtain a sufficient understanding of the entity and its environment, including its internal control; to assess the risk of material misstatement of the financial statements whether due to error or fraud; and to design the nature, timing, and extent of further audit procedures.

The assessment of inherent risk assumes that there are no internal controls in place.

Question 19

When assessing control risk at below the maximum level, an auditor is required to document the auditor’s understanding of the:

I. entity’s control activities that help ensure management directives are carried out.
II. entity’s control environment factors that help the auditor plan the engagement.

I only

II only

Both I and II

Neither I nor II

Answer 19

Both I and II

Explanation:

There is a risk associated with assessing control risk below the maximum level because this assessment shows reliance on the internal control structure.

In order to support this assessment, the auditor is required to document her understanding of both the control activities that help ensure management directives are carried out and the control environment factors that help the auditor plan the engagement.

Question 20

An auditor’s tests of controls for completeness for the revenue cycle usually include determining whether:

each receivable is collected subsequent to the year-end.

an invoice is prepared for each shipping document.

each invoice is supported by a customer purchase order.

each credit memo is properly approved.

Answer 20

an invoice is prepared for each shipping document.

Explanation:

The completeness assertion deals with whether or not all of the transactions and events that should have been recorded have been recorded.

If an order was shipped, were the corresponding revenue and receivable recorded? In order to determine that the control is in place, the auditor would make sure that an invoice has been prepared for each shipping document.

Determining whether each receivable is collected subsequent to the year-end would provide evidence about the valuation of the accounts receivable balance. This procedure would be a substantive test, not a test of controls.

Ensuring that each invoice is supported by a purchase order may help the auditor determine if the sale is from a valid customer, but the revenue still would not be recorded until the order has been shipped.

Examining the approval of credit memos would assist the auditor with testing the controls over the existence of sales returns.

Question 21

A CPA purchased stock in a client corporation and placed it in a trust as an educational fund for the CPA’s minor child. The trust securities are not material to the CPA’s wealth but are material to the child’s personal net worth. According to the AICPA Code of Professional Conduct, would this action impair the CPA’s independence with the client?

No, because the CPA would not have a direct financial interest in the client

Yes, because the stock would be a direct financial interest and materiality is a factor

Yes, because the stock would be an indirect financial interest and materiality is not a factor

Yes, because the stock would be a direct financial interest and materiality is not a factor

Answer 21

Yes, because the stock would be a direct financial interest and materiality is not a factor

Explanation:

If the CPA has any direct or material indirect financial interest in the client, independence is impaired.

A direct financial interest is a financial interest:

owned directly by an individual or entity, or
under the control of an individual or entity, or
beneficially owned through an investment vehicle, estate, trust, or other intermediary when the beneficiary:
controls the intermediary or
has the authority to supervise or participate in the intermediary’s investment decisions.
This investment would qualify as a direct financial interest.

Question 22

Detection risk differs from both control risk and inherent risk in that detection risk:

exists independently of the financial statement audit.

can be changed at the auditor’s discretion.

arises from risk factors relating to fraud.

should be assessed in nonquantitative terms.

Answer 22

can be changed at the auditor’s discretion.

Explanation:

Detection risk is the risk that the auditor will not detect a misstatement that exists in a relevant assertion that could be material, either individually or when aggregated with other misstatements.

It is managed by the auditor’s response to the risk of material misstatement. In other words, if inherent and control risk are high, the auditor must lower detection risk by performing more tests of details or substantive analytical procedures.

The auditor has control over detection risk, as she can alter the nature, timing, and extent of procedures to raise or lower it.

Inherent risk and control risk exist independently of the financial statements; they are the entity’s risks. The risk of material misstatement arises, in part, from risk factors relating to fraud.

Inherent risk and control risk make up the risk of material misstatement. The components of audit risk (including detection risk) can be assessed in quantitative terms (percentages) or nonquantitative terms (high, medium, or low).

Question 23

Which of the following procedures is ordinarily performed by an accountant in a compilation engagement of a nonissuer?

Reading the financial statements to consider whether they are free of obvious mistakes in the application of accounting principles

Obtaining written representations from management indicating that the compiled financial statements will not be used to obtain credit

Making inquiries of management concerning actions taken at meetings of the stockholders and the board of directors

Applying analytical procedures designed to corroborate management’s assertions that are embodied in the financial statement components

Answer 23

Reading the financial statements to consider whether they are free of obvious mistakes in the application of accounting principles

Explanation:

Of all the responses listed, the only procedures ordinarily performed when a CPA has been retained to compile financial statements of a nonissuer is reading the financial statements and determining if they are appropriate in form and free from obvious material errors and considering whether all disclosures required by the applicable financial reporting framework are provided.

Question 24

In the first audit of a new client, an auditor was able to extend auditing procedures to gather sufficient evidence about consistency. Under these circumstances, the auditor should:

not report on the client’s income statement.

not refer to consistency in the auditor’s report.

state that the consistency standard does not apply.

state that the accounting principles have been applied consistently.

Answer 24

not refer to consistency in the auditor’s report.

Explanation:

The auditor’s standard report does not include an expression related to the consistent application of an applicable financial reporting framework if (a) no change in accounting principles has occurred, or (b) there has been a change in accounting principles or the method of their application, but the effect of the change is not material.

Question 25

Reference in a principal auditor’s report to the fact that part of the audit was performed by another auditor most likely would be an indication of the:

divided responsibility between the auditors who conducted the audits of the components of the overall financial statements.

lack of materiality of the portion of the financial statements audited by the other auditor.

principal auditor’s recognition of the other auditor’s competence, reputation, and professional certification.

different opinions the auditors are expressing on the components of the financial statements that each audited.

Answer 25

divided responsibility between the auditors who conducted the audits of the components of the overall financial statements.

Explanation:

A division of responsibility between the auditors who conducted the audits of the components of the overall financial statements is shown by referring in the principal auditor’s report to the fact that part of the audit was performed by another auditor.

If the portion of the financial statements audited by the other auditor is immaterial, then it is most likely that no reference would be made in the principal auditor’s report.

The principal auditor should satisfy himself as to the competence, reputation, and professional certification of the other auditor, regardless of whether or not a division of responsibility is reported.

Expressing different opinions on the components of the financial statements would result in piecemeal opinions, which is prohibited by AU-C 600.28.

Question 26

Which of the following groups is considered a subgroup ordinarily charged with assisting the board of directors in fulfilling its oversight responsibilities?

Audit committee

Secured creditors

Internal auditors

Senior management

Answer 26

Audit committee

Explanation:

Those charged with governance include the person(s) or organization(s) (e.g., a corporate trustee) with responsibility for overseeing the strategic direction of the entity, the financial reporting process, and the obligations related to the accountability of the entity.

In larger organizations this is the audit committee, a subgroup of the board of directors.

Section 204 of SOX (the Sarbanes-Oxley Act) requires that each registered public accounting firm that performs an audit of issuer financial statements timely report to the issuer’s audit committee all critical accounting policies and practices to be used; all alternative treatments of financial information within GAAP that have been discussed with management officials of the issuer, ramifications of the use of such alternative disclosures and treatments, and the treatment preferred by the registered public accounting firm; and other material written communications between the registered public accounting firm and the management of the issuer, such as any management letter or schedule of unadjusted differences.

Question 27

An accountant is not precluded from issuing a report with respect to financial statements for an entity with respect to which the accountant is not independent of which type of engagement?

Compilation of financial statements
Review of financial statements

I only

II only

Both I and II

Neither I nor II

Answer 27

I only

Explanation:

AR-C 80.A6 states “that the accountant modify the accountant’s compilation report when the accountant is not independent of the entity whose financial statements…”

AR-C 90.07 states, “The accountant must be independent of the entity when performing a review of financial statements…”

Question 28

In planning an integrated audit, which of the following matters does the auditor not evaluate as to whether they are important to the company’s financial statements and internal control over financial reporting?

Previously communicated control deficiencies

Knowledge obtained in the course of other engagements

Complexity of the company’s operation

The entity having an operating and effective audit committee

Answer 28

The entity having an operating and effective audit committee

The audit should be properly planned and assistants should be properly supervised. When planning an integrated audit, the auditor should evaluate the following matters:

• • Knowledge of the company’s internal control over financial reporting obtained during other engagements performed by the auditor
• • Matters affecting the industry in which the company operates, such as financial reporting practices, economic conditions, laws and regulations, and technological changes
• • Matters relating to the company’s business, including its organization, operating characteristics, and capital structure
• • The extent of recent changes, if any, in the company, its operations, or its internal control over financial reporting
• • The auditor’s preliminary judgments about materiality, risk, and other factors relating to the determination of material weaknesses
• • Control deficiencies previously communicated to the audit committee or management
• • Legal or regulatory matters of which the company is aware
• • The type and extent of available evidence related to the effectiveness of the company’s internal control over financial reporting
• • Public information about the company relevant to the evaluation of the likelihood of material financial statement misstatements and the effectiveness of the company’s internal control over financial reporting
• • Knowledge about risks related to the company evaluated as part of the auditor’s client acceptance and retention evaluation
• -The relative complexity of the company’s operations

Question 29

Obtaining an understanding of an internal control involves evaluating the design of the control and determining whether the control has been:

authorized.

implemented.

tested.

monitored.

Answer 29

implemented.

Explanation:

The purpose of performing risk assessment procedures, including the audit evidence obtained in evaluating the design of controls and determining whether they have been implemented, is to obtain evidence to support the risk assessment.

Internal controls are only effective at mitigating risk if they are implemented.

Internal controls are not effective in mitigating risk if they are only authorized, tested, or monitored.

Question 30

Proper segregation of duties reduces the opportunities to allow persons to be in positions to:

journalize entries and prepare financial statements.

record cash receipts and cash disbursements.

establish internal controls and authorize transactions.

perpetrate and conceal errors and fraud.

Answer 30

Duties should be segregated among the authorizing of transactions, recording of transactions, and custody of assets to reduce the opportunities for persons to be able to both perpetrate and conceal errors and fraud.

Specific following combinations of duties are not incompatible:

• • Journalize entries and preparing financial statements (both are recording functions)
• • Recording cash receipts and cash disbursements (recording functions)
• • Establishing internal controls and authorizing transactions (authorization functions)

Question 31

Which of the following circumstances would generally require an accountant to decline to perform a compilation of financial statements under the Statements on Standards for Accounting and Review Services (SSARS)?

A substantial portion of generally accepted accounting principles disclosures was omitted.

There was a lack of independence between the accountant and client.

The accountant had no prior experience with similar organizations within the industry.

The accountant was not able to come to an understanding with representatives of the organization for services to be performed.

Answer 31

The accountant was not able to come to an understanding with representatives of the organization for services to be performed.

Explanation:

The accountant should establish an understanding with management regarding the services to be performed for compilation engagements and should document the understanding through a written communication with management. Failure to do so is noncompliance with SSARS (Statements on Standards for Accounting and Review Services).

An accountant may compile financial statements that omit substantially all disclosures, provided the omission, to his or her knowledge, is not untaken with the intention of misleading those who might reasonably be expected to use such financial statements.

An accountant may issue a compilation report on financial statements for an entity, with respect to which the accountant is not independent, provided the report is modified to disclose his or her lack of independence.

An accountant may accept a compilation engagement for an entity in an industry with which the accountant has no previous experience provided he or she obtains a sufficient level of knowledge to compile financial statements that are appropriate in form for an entity operating in that industry.

Question 32

Which of the following procedures would an auditor most likely perform regarding litigation?

Confirm directly with the clerk of the court that the client’s litigation is properly disclosed.

Discuss with management its policies and procedures for identifying and evaluating litigation.

Inspect the legal documents in the client’s lawyer’s possession regarding pending litigation.

Confirm the details of pending litigation with the client’s adversaries’ legal representatives.

Answer 32

Discuss with management its policies and procedures for identifying and evaluating litigation.

Explanation:

The auditor should discuss with management the controls adopted to identify, evaluate, and account for litigation.

The clerk of the court would not have any information regarding whether or not litigation is properly disclosed in the financial statements.

The auditor does not generally inspect documents held by the client’s lawyer, but rather relies on the lawyer’s written response to the audit inquiry letter. It would be inappropriate for the auditor to contact the legal representatives of the client’s adversaries.

Question 33

Which of the following laws requires that benefits be provided to employees after they leave a position?

Health Insurance Portability and Accountability Act

Family and Medical Leave Act

Employee Retirement Income Security Act

Comprehensive Budget Omnibus Reconciliation Act

Answer 33

Comprehensive Budget Omnibus Reconciliation Act

Explanation:

The Comprehensive Budget Omnibus Reconciliation Act (COBRA) requires employers to offer former employees continued benefits after they leave a position for a certain period of time. However, employees are normally responsible for the insurance premiums.

Question 34

In performing tests concerning the granting of stock options, an auditor should:

confirm the transaction with the Secretary of State in the state of incorporation.

verify the existence of option holders in the entity’s payroll records or stock ledgers.

determine that sufficient treasury stock is available to cover any new stock issued.

trace the authorization for the transaction to a vote of the board of directors.

Answer 34

trace the authorization for the transaction to a vote of the board of directors.

Stock options are granted by an entity as additional compensation to key employees.

The primary audit concern is that the options were properly authorized. Thus, the auditor should trace the authorization for the transaction to a vote of the board of directors.

It is not necessary for an entity to register the issuance of additional shares of stock with the Secretary of State once the shares have been authorized; even if it were, this is a legal concern, not an audit concern.

Since only the right to acquire stock has been given, the entity’s payroll records or stock ledgers would not record the options.

Additional treasury stock could be acquired or new shares of stock could be issued upon the exercise of stock options. It is not necessary that the entity have sufficient treasury stock on hand to cover the exercise of all the options.

Question 35

When auditing an entity’s financial statements in accordance with Government Auditing Standards (the “Yellow Book”), an auditor is required to report on:

I. recommendations for actions to improve operations.
II. the scope of the auditor’s tests of compliance with laws and regulations.

I only

II only

Both I and II

Neither I nor II

Answer 35

II only

Explanation:

In accordance with the “Yellow Book,” an auditor is required to report on the scope of the auditor’s testing of internal controls and on the scope of the auditor’s tests of compliance with laws and regulations.

Question 36

Which of the following statements is most accurate regarding sufficient and appropriate documentation?

Accounting estimates are not considered sufficient and appropriate documentation.

Sufficient and appropriate documentation should include evidence that the audit working papers have been reviewed.

If additional evidence is required to document significant findings or issues, the original evidence is not considered sufficient and appropriate, and therefore should be deleted from the working papers.

Audit documentation is the property of the client, and sufficient and appropriate copies should be retained by the auditor for at least five years.

Answer 36

Sufficient and appropriate documentation should include evidence that the audit working papers have been reviewed.

Explanation:

The auditor must prepare audit documentation in connection with each engagement in sufficient detail to provide a clear understanding of the work performed and the audit evidence obtained and its source, and the conclusions reached.

Audit documentation assists the engagement team in planning and performing an audit; enables the engagement team to demonstrate that it is accountable for its work by documenting the procedures performed, the audit evidence examined, and the conclusions reached; assists in future audits of the same entity by retaining a record of matters of continuing significance; enables quality control reviews and peer reviews; and assists an auditor to understand the work performed in the prior year as an aid in planning and performing the current engagement.

Question 37

Uncertainties in the financial markets and the current economic environment may create questions about which of the following?

Valuation of certain assets

Recoverability of certain assets

Completeness or valuation of certain liabilities

All of the answer choices are correct.

Answer 37

All of the answer choices are correct.

Explanation:

PCAOB Staff Audit Practice Alert 3 (page 1) states:

“Recent events in the financial markets and the current economic environment may affect companies’ operations and financial reporting and, in turn, may have implications for audits of financial statements and internal control over financial reporting.

Audit risks that may have been identified previously may become more significant or new risks may exist due to current events (e.g., those affecting the economy, credit, and liquidity).

Among other things, the current uncertainties in the market and economy may create questions about the valuation, impairment, or recoverability of certain assets and the completeness or valuation of certain liabilities reflected in financial statements.” (Emphasis added)

Question 38

Comfort letters ordinarily are signed by the client’s:

independent auditor.

underwriter of securities.

audit committee.

senior management.

Answer 38

independent auditor.

Explanation:

A comfort letter is a letter issued to underwriters concerning the financial information contained in registration statements filed with the SEC in connection with the issuance of securities.

A comfort letter is sent (and signed) by the independent auditor to the underwriter.

Question 39

The primary purpose of establishing quality control policies and procedures for deciding whether to accept a new client is to:

enable the CPA firm to attest to the reliability of the client.

satisfy the CPA firm’s duty to the public concerning the acceptance of new clients.

minimize the likelihood of association with clients whose management lacks integrity.

anticipate before performing any fieldwork whether an unmodified opinion can be expressed.

Answer 39

minimize the likelihood of association with clients whose management lacks integrity.

Explanation:

Quality control policies and procedures should be established for deciding whether to accept a new client to minimize the likelihood of association with clients whose management lacks integrity.

A CPA firm attests to the assertions of management, not the reliability of the client, and has no duty to the public concerning the acceptance of new clients. However, prudence suggests that a firm should be selective in determining its professional relationships.

Whether or not an unmodified opinion can be expressed cannot be determined by quality control policies and procedures established for deciding whether to accept a client. The purpose of these policies and procedures is to determine the auditability of the client.

Question 40

Negative confirmation of accounts receivable is less effective than positive confirmation of accounts receivable because:

a majority of recipients usually lack the willingness to respond objectively.

some recipients may report incorrect balances that require extensive follow-up.

the auditor cannot infer that all nonrespondents have verified their account information.

negative confirmations do not produce audit evidence that is statistically quantifiable.

Answer 40

the auditor cannot infer that all nonrespondents have verified their account information.

Explanation:

With negative confirmations, customers are asked to reply only if their records show a different account balance.

No reply, however, does not necessarily indicate that the customer agrees with the balance.

Therefore, the auditor cannot infer that all nonrespondents have verified their account information.

Question 41

According to the profession’s standards, which of the following is not required of a CPA performing a con­sulting engagement?

Complying with Statements on Standards for Consulting Services

Obtaining an understanding of the nature, scope, and limitations of the engagement

Supervising staff who are assigned to the engagement

Maintaining independence from the client

Answer 41

Maintaining independence from the client

Explanation:

The appearance of independence is not required in the case of consulting and tax engagements.

Consulting is not connected to preparing financial statements, and therefore independence is not required.

Question 42

Which of the following factors is most likely to affect the extent of the documentation of the auditor’s understanding of a client’s system of internal controls?

The industry and the business and regulatory environments in which the client operates

The degree to which information technology is used in the accounting function

The relationship between management, the board of directors, and external stakeholders

The degree to which the auditor intends to use internal audit personnel to perform substantive tests

Answer 42

The degree to which information technology is used in the accounting function

Explanation:

The more complex the entity and its environment, including its internal control, and the more extensive the audit procedures performed by the auditor, the more extensively the auditor should document his or her work.

If routine business transactions are performed with little or no manual intervention (the accounting function is highly automated), it may not be possible to design and perform substantive testing that will provide sufficient appropriate audit evidence by itself.

The appropriateness and sufficiency of the audit evidence (in electronic form) is determined by the effectiveness of controls over the data’s accuracy and completeness.

In this case, the auditor must thoroughly understand the design and determine the implementation of the controls over those activities.

The extent of documentation of the auditor’s understanding would be greater in this circumstance.

Question 43

Which of the following most likely would be an advantage in using classical variables sampling rather than probability-proportional-to-size (PPS) sampling?

An estimate of the standard deviation of the population’s recorded amounts is not required.

The auditor rarely needs the assistance of a computer program to design an efficient sample.

Inclusion of zero and negative balances generally does not require special design considerations.

Any amount that is individually significant is automatically identified and selected.

Answer 43

Inclusion of zero and negative balances generally does not require special design considerations.

Explanation:

Probability-proportional-to-size (PPS) sampling excludes zero and negative balances in its sample selections and in evaluating results.

Therefore, classical variables sampling would have an advantage over PPS sampling because variables sampling does not require special design considerations for inclusion of zero and negative balances.

That is, PPS sampling would require a special design to include negative and zero balances while variables sampling would not.

Question 44

When threats to independence are identified, the GAO requires that auditors:

apply safeguards.

ignore the threats.

access the materiality of the threats.

Independence is not required by GAO standards.

Answer 44

apply safeguards.

Explanation:

When threats to independence are identified, Government Auditing Standards require auditors to apply safeguards to eliminate or reduce threats to an acceptable level. Safeguards include controls designed to eliminate or mitigate threats to an acceptable level. GAS 3.17–.19 provides examples of safeguards in the work environment.

Question 45

Which of the following auditing procedures most likely would assist an auditor in identifying related party transactions?

Retesting ineffective internal control procedures previously reported to the audit committee

Sending second requests for unanswered positive confirmations of accounts receivable

Reviewing accounting records for nonrecurring transactions recognized near the balance sheet date

Inspecting communications with law firms for evidence of unreported contingent liabilities

Answer 45

Reviewing accounting records for nonrecurring transactions recognized near the balance sheet date

Explanation:

Nonrecurring transactions recognized in the accounting records near the balance sheet date should be reviewed by the auditor as possible related party transactions.

These types of transactions may indicate related party relationships not previously disclosed to the auditor.

The identification of related parties would not be detected by retesting ineffective internal control procedures, confirming accounts receivable, or in unreported contingent liabilities.