Audit Flashcards
A1
When opining on whether supplementary information presented with audited financial statements is fairly stated in all material respects and in relation to the financial statements as a whole, an auditor of a nonissuer must ensure that:
A. The board of directors has reviewed the supplementary information. B. Neither an adverse opinion nor a disclaimer of opinion was issued on the financial statements. C. The supplementary information complies with applicable federal and state laws. D. The supplementary information is measurable.
In order to issue an opinion on supplementary information, the auditor must determine that, along with other conditions, neither an adverse opinion nor a disclaimer of opinion was issued on the financial statements.
A1
An entity’s comparative financial statements include the financial statements of the prior year that were audited by a predecessor auditor whose report is not presented. If the predecessor’s report was qualified, the successor should:
A. Issue an updated comparative audit report indicating the division of responsibility. B. Express an opinion only on the current year's financial statements and make no reference to the prior year's statements. C. Explain to the client that comparative financial statements may not be presented under these circumstances. D. Indicate the substantive reasons for the qualification in the predecessor auditor's opinion.
When a predecessor auditor’s report is not presented, the successor auditor should indicate the following items:
- That the statements were audited by a predecessor auditor. The predecessor auditors should not be named unless the practice of the predecessors was acquired by or merged with that of the successor.
- The type of opinion expressed by the predecessor auditor and, if the opinion was modified, the reason for the modification.
- The nature of any emphasis-of-matter, other-matter, or explanatory paragraph included in the predecessor auditor’s report.
- The date of the predecessor auditor’s report.
A1
March, CPA, is engaged by Monday Corp., a client, to audit the financial statements of Wall Corp., a company that is not March’s client. Monday expects to present Wall’s audited financial statements with March’s auditor’s report to 1st Federal Bank to obtain financing in Monday’s attempt to purchase Wall. In these circumstances, March’s auditor’s report would usually be addressed to:
A. Monday Corp., the client that engaged March. B. Wall Corp., the entity audited by March. C. 1st Federal Bank. D. Both Monday Corp. and 1st Federal Bank.
The auditors should address their report to the entity that engaged them. In this case, Monday Corp. engaged the auditor to perform an acquisition audit and the report should be addressed to Monday.
A2
Which of the following components (elements) of an entity’s system of internal control includes the development of personnel manuals documenting employee promotion and training policies?
A. Monitoring. B. Control environment. C. Quality control system. D. Information and communication system.
The control environment element of an entity’s system of internal control relates to the tone of the organization, which includes human resource policies and practices.
A2
Which of the following statements is correct concerning an auditor’s responsibility to report fraud?
A. The disclosure of material management fraud to principal stockholders is required when both senior management and the board of directors fail to acknowledge the fraudulent activities. B. The disclosure of fraudulent activities to parties other than the client's senior management and those charged with governance is not ordinarily part of the auditor's responsibility. C. The auditor is required to communicate to those charged with governance all minor fraudulent acts perpetrated by low-level employees, even if the amounts involved are inconsequential. D. Fraudulent activities involving senior management of which the auditor becomes aware should be reported directly to the SEC.
The disclosure of fraudulent activities to parties other than the client’s senior management and those charged with governance is not ordinarily part of the auditor’s responsibility.
A2
Proper supervision of assistants is required for all of the following reasons, except:
A. To stay informed regarding significant accounting and auditing questions, new developments, and material problems. B. To ensure that the work performed by assistants provides the professional development they will need to advance within the firm. C. To ensure that the work performed by assistants is consistent with the conclusions presented in the report. D. To ensure that the work performed by assistants is adequate to accomplish the objectives of the engagement.
Although it is beneficial when assistants receive the experience they need for professional development, this is not the purpose of supervision.
A2
Communication related to the inherent limitations of internal control of a nonissuer is required in which of the following documents?
A. An engagement letter B. A review report C. A letter of inquiry sent to the client's attorney D. A management letter
The engagement letter should include a statement saying that, because of the inherent limitations of an audit, together with the inherent limitations of internal control, an unavoidable risk exists that some material misstatements may not be detected, even if the audit is properly planned and performed.
A3
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:
A. Irregularities exist among the relevant account balances. B. The communication with those charged with governance should be revised. C. Control activities are not operating effectively. D. Additional tests of details are required.
If analytical procedures suggest unexpected relationships, the auditor would perform additional tests of details of the accounts involved
A3
Which of the following statements extracted from a client’s lawyer’s letter concerning litigation, claims, and assessments most likely would cause the auditor to request clarification?
A. "I believe that the plaintiff will have problems establishing any liability." B. "I believe that the company will be able to defend this action successfully." C. "I believe that this action has only a remote chance in establishing any liability." D. "I believe that the plaintiff's case against the company is without merit."
The lawyer’s comment that the plaintiff “will have problems establishing any liability” is vague…it does not provide an evaluation of the likelihood of an unfavorable outcome. Does “will have problems” mean a loss is probable, reasonably possible, or remote? The auditor would likely want to request clarification to ensure that the situation has been properly accounted for and disclosed.
A3
Auditors try to identify predictable relationships when using analytical procedures. Relationships involving transactions from which of the following accounts most likely would yield the highest level of evidence?
A. Payroll expense. B. Accounts receivable. C. Accounts payable. D. Advertising expense.
Auditors try to identify predictable relationships when using analytical review procedures. Payroll expense is predictable because it is based on objective information (number of employees and pay rates). It can generally be computed directly by the auditor.
A3
Which of the following best describes the primary purpose of an auditor performing audit procedures and gathering evidence related to potential litigation, claims, and assessments of the client?
A. To determine if management has adequately accounted for and recorded any amounts that are considered probable and reasonably estimable and to verify that amounts that are remote and not reasonably estimable are adequately disclosed. B. To determine if management has adequately accounted for and recorded any amounts that are considered possible and reasonably estimable and to verify that amounts that are uncertain or remote but reasonably estimable are adequately disclosed. C. To determine if management has adequately accounted for and recorded any amounts that are considered possible and reasonably estimable and to verify that amounts that are possible but not reasonably estimable are adequately disclosed. D. To determine if management has adequately accounted for and recorded any amounts that are considered probable and reasonably estimable and to verify that amounts that are probable but not reasonably estimable or that are reasonably possible are adequately disclosed.
Choice “D” is correct. The primary purpose of an auditor’s procedures around potential litigation, claims, and assessments is to ensure that management has appropriately recorded items that are considered probable and reasonably estimable and that management has disclosed items that are probably but not reasonably estimable or that are reasonably possible.
A4
According to PCAOB standards which one of the following statements does not reflect a qualitative standard that should be considered when evaluating the materiality of an uncorrected misstatement?
A. The cost of the correction. B. The dollar amount of the error. C. The significance of the misstatement relative to the needs of users. D. The effects of misclassifications, for example, between operating and nonoperating.
The dollar amount of the error is a quantitative standard, not a qualitative standard.
A4
Which of the following statements is correct concerning an auditor’s required communication of significant deficiencies in internal control noted during a financial statement audit of a nonissuer?
A. A significant deficiency previously communicated during the prior year's audit that remains uncorrected causes a scope limitation. B. An auditor's report on significant deficiencies should include a restriction on the distribution of the report. C. An auditor should perform tests of controls on significant deficiencies before communicating them to the client. D. An auditor should communicate significant deficiencies after tests of controls, but before commencing substantive tests.
The report should state that the communication is intended solely for the use of management, those charged with governance, and others within the organization.
A4
An auditor most likely would limit substantive audit tests of sales transactions when control risk is assessed as low for the occurrence assertion concerning sales transactions and the auditor has already gathered evidence supporting:
A. Shipping and receiving activities. B. Cutoffs of sales and purchases. C. Cash receipts and accounts receivable. D. Opening and closing inventory balances.
Examination of accounts receivable and cash receipts provides the auditor with evidence with respect to both the completeness and the occurrence of sales transactions, thus limiting the need to test sales transactions.
A4
In auditing payroll, an auditor most likely would:
A. Observe entity employees during a payroll distribution. B. Compare payroll costs with entity standards or budgets. C. Verify that checks representing unclaimed wages are mailed. D. Trace individual employee deductions to entity journal entries.
The analytical procedure comparing payroll to standards or budgets is the substantive procedure most likely used for payroll.
A5
When an accountant compiles projected financial statements, the accountant’s report should include a statement that:
A. Evaluates the hypothetical assumptions used to prepare the projection. B. Disclaims any form of assurance on the historical financial statements. C. Expresses limited assurance that the results will be within the projected range. D. Describes the limitations on the usefulness of the projection.
A compilation of a financial projection report describes the limitations on the usefulness of the projection by including a caveat that the prospective results may not be achieved.
A5
A subsequent event related to an entity’s internal control was discovered before the date of the auditor’s report. Which of the following is not an auditor’s responsibility regarding subsequent events in an integrated audit?
A. Obtain written representations from management. B. Perform tests of controls on the subsequent event. C. Inquiry of management. D. Examine documentation related to the subsequent event.
The auditor is not required to perform tests of controls specifically related to the subsequent event. The auditor should inquire of management, obtain written representations from management, and inquire about and examine documentation for the subsequent period.
A6
Kar, CPA, is a staff auditor participating in the audit engagement of Fort, Inc. Which of the following circumstances impairs Kar’s independence?
A. Kar's friend, an employee of another local accounting firm, prepares Fort's tax returns. B. During the period of the professional engagement, Fort gives Kar tickets to a football game worth $75. C. Kar owns stock in a corporation that Fort's 401(k) plan also invests in. D. Kar's sibling is an internal auditor employed part-time by Fort.
Independence of a member is impaired if the CPA’s spouse, parent, child, sibling, etc. are employed by the client in a position that is audit sensitive (i.e., internal auditor, cashier, accounting supervisor, etc.).
A6
An independent accountant’s report is based on a review of interim financial information. If this report is presented in a registration statement, a prospectus should include a statement clarifying that the:
A. Accountant obtained corroborating evidence to determine whether material modifications are needed for such information to conform with GAAP. B. Accountant assumes no responsibility to update the report for events and circumstances occurring after the date of the report. C. Accountant's review report is not a part of the registration statement within the meaning of the Securities Act of 1933. D. Accountant's review was performed in accordance with standards established by the Securities and Exchange Commission.
If a report on a review of interim financial information is presented in a registration statement, the prospectus should include a statement that the report is not a “report” or “part” of the registration statement. The accountant should also read the other portions of the registration statement to ensure that his or her name is not used in a way that indicates greater responsibility than he or she intends.
A6
Each of the following statements is true with regard to disclosures about an issuer’s audit committee financial expert except:
A. An issuer is prohibited from disclosing that it does not have an audit committee financial expert if the board has determined that such an expert serves on the audit committee. B. If an issuer discloses that it has an audit committee financial expert, it also must disclose the expert's name. C. An issuer may disclose that it has an audit committee financial expert by virtue of the fact that the audit committee members collectively possess all of the attributes of such an expert. D. An issuer is required to disclose whether the person identified as the audit committee financial expert is independent of management.
At least one member of the audit committee should be a financial expert. All of the members together do not make a single expert that can be named and disclosed as the expert.
A5
An auditor is preparing a report on internal control over financial reporting for a governmental entity. If the auditor identified significant deficiencies and material weaknesses in the entity’s internal control over financial reporting, then the auditor should:
A. Report as findings the material weaknesses identified but not the significant weaknesses. B. Report as findings both the significant deficiencies and the material weaknesses. C. Report as findings the significant deficiencies identified but not the material weaknesses. D. Report as findings neither the significant deficiencies nor the material weaknesses identified.
The GAGAS require a written report on the auditor’s understanding of internal control. The auditor should report all significant deficiencies and material weaknesses in internal control.
A2
If an auditor is obtaining an understanding of an issuer’s information and communication component of internal control, which of the following factors should the auditor assess?
A. The integrity and ethical values of top management. B. The oversight responsibility over financial reporting and internal control by the board or audit committee. C. The philosophy and operating style of management to promote effective internal control over financial reporting. D. The classes of transactions in the issuer’s operations that are significant to the issuer’s financial statements.
The classes of transactions in the issuer’s operations that are significant to the issuer’s financial statements are typically assessed when the auditor is obtaining an understanding of the information and communication component of internal control.
A4
To determine whether internal control relative to the revenue cycle of a wholesaling entity is operating effectively in minimizing the failure to prepare sales invoices, an auditor most likely would select a sample of transactions from the population represented by the:
A. Sales order file. B. Shipping document file. C. Customer order file. D. Sales invoice file.
Shipping documents provide evidence that a sale occurred, and therefore selecting from a population of shipping documents allows the auditor to test whether corresponding invoices exist for each sale.
A4
Which of the following fraudulent activities most likely could be perpetrated due to the lack of effective internal controls in the revenue cycle?
A. Obsolete items included in inventory balances are rarely reduced to the lower of cost or market value. B. The write-off of receivables by personnel who receive cash permits the misappropriation of cash. C. Fictitious transactions are recorded that cause an understatement of revenue and overstatement of receivables. D. Merchandise received is not promptly reconciled to the outstanding purchase order file.
The function of cash receipts is part of the treasurer’s department and should be separate from the role of writing off receivables. Failure to separate the recordkeeping function from the custodial function allows an individual to misappropriate cash and then cover up the theft by writing off the related receivable balance.
A4
When the shipping department returns nonconforming goods to a vendor, the purchasing department should send to the accounting department the:
A. Credit memo. B. Vendor invoice. C. Debit memo. D. Unpaid voucher.
When nonconforming goods are returned to a vendor, the purchasing department should send a debit memo to the accounting department to ensure that the accounts payable balance is reduced appropriately.
A3
Which of the following would not represent audit evidence obtained through the auditor’s direct personal knowledge?
A. The auditor observes a year-end inventory count by the client. B. Accounts payable confirmations are sent out by and returned to the auditor. C. The auditor re-computes a sample of vendor invoices. D. A sample of investment transactions is examined by the auditor to determine if the transactions were recorded in the proper accounts.
When confirmations are sent out by the auditor and received back directly, this represents a form of external evidence. While external evidence is considered the second most reliable evidence, an auditor’s direct personal knowledge (obtained through examination, re-computation, inspection, and observation) is the most reliable form of evidence.
A2
An auditor is required to establish an understanding with a client regarding the services to be performed for each engagement. This understanding generally includes:
A. Management's responsibility for identifying mitigating factors when the auditor has doubt about the entity's ability to continue as a going concern. B. Management's responsibility for providing the auditor with an assessment of the risk of material misstatement due to fraud. C. The auditor's responsibility for ensuring that those charged with governance are aware of any significant deficiencies in internal control that come to the auditor's attention. D. The auditor's responsibility for determining the preliminary judgments about materiality and audit risk factors.
An understanding between the auditor and the client generally includes the auditor’s responsibilities. One of the auditor’s responsibilities is to ensure that those charged with governance (e.g., the audit committee) are aware of any significant deficiencies in internal control that come to the auditor’s attention.
A4
On receiving a client’s bank cutoff statement, an auditor most likely would trace:
A. Prior-year checks listed in the cutoff statement to the year-end outstanding checklist. B. Deposits recorded in the cash receipts journal after year-end to the cutoff statement. C. Checks dated after year-end listed in the cutoff statement to the year-end outstanding checklist. D. Deposits in transit listed in the cutoff statement to the year-end bank reconciliation.
The auditor should obtain bank cutoff statements that include transactions for 10 to 15 days after year-end. The outstanding checks and deposits in transit at year-end on the bank reconciliation should agree with the information in the bank cutoff statement.
A6
When financial statements that an accountant has compiled in accordance with Statements on Standards for Accounting and Review Services omit substantially all disclosures required by generally accepted accounting principles, the accountant’s report should include:
A. No modification of the standard compilation report because compilations do not require disclosures that are required for audited financial statements. B. Management’s justification for its decision to elect to omit substantially all the disclosures. C. Information alerting readers about omission of the disclosures and notification that the omission may influence the user’s conclusions about the financial statements. D. A separate paragraph in the compilation report stating that the financial statements are misleading due to the lack of disclosures by management.
An accountant may compile financial statements that omit substantially all disclosures required by GAAP as long as the compilation report includes a separate paragraph which alerts readers about omission of the disclosures and includes notification that the omission may influence the user’s conclusions about the financial statements. In addition, the accountant should be satisfied that the omission is not intended to mislead users of the financial statements.
A3
Which of the following best explains why an analytical procedure might be used as a substantive test?
A. To determine the adequacy of evidence gathered in response to unusual or unexpected balances. B. To assess the conclusions reached by staff auditors. C. To assist in planning the nature, timing, and extent of the auditing procedures to be performed. D. To achieve audit objectives in the most effective and efficient manner possible.
For some assertions, analytical procedures are more effective and efficient at providing an appropriate level of assurance than are tests of details.
A2
Which of the following is not a provision of the Sarbanes-Oxley Act of 2002?
A. The auditor of an issuer may not provide internal audit outsourcing services for the issuer. B. Audit documentation must be maintained for five years. C. The lead and reviewing partners must rotate off the audit after five years. D. Tax services must be preapproved by the audit committee.
The Sarbanes-Oxley Act of 2002 requires registered firms to maintain audit documentation for seven years, not five years.
A5
A CPA was engaged to calculate the rate of return on a specified investment according to an agreed- upon formula and verify that the resultant percentage agrees to the percentage in an identified schedule. The CPA’s report on these agreed-upon procedures should contain:
A. A disclaimer of opinion on the fair presentation of the financial statements. B. An opinion about the fairness of the agreed-upon procedures. C. A separate paragraph describing the effectiveness of the internal controls. D. A disclaimer of responsibility for the sufficiency of those procedures.
A report on agreed-upon procedures should include a disclaimer of responsibility for the sufficiency of the procedures.
A2
In a financial statement audit, inherent risk is evaluated to help an In a financial statement audit, inherent risk is evaluated to help an auditor assess which of the following?
A. The susceptibility of a financial statement assertion to a material misstatement assuming there are no related controls. B. The internal audit department's objectivity in reporting a material misstatement of a financial statement assertion it detects to the audit committee. C. The risk that the internal control system will not detect a material misstatement of a financial statement assertion. D. The risk that the audit procedures implemented will not detect a material misstatement of a financial statement assertion.
Inherent risk is the susceptibility of a relevant assertion to a material misstatement, assuming there are no related controls.
Descriptive analytics
describe what happens within data
Predictive analytics
provide expected or predicted outcomes based on historical data
Diagnostic analytics
explain why something happened
Prescriptive analytics
prescribe or recommend actions to be taken based on advanced analytics to reach a desired goal
A2
Which of the following statements is true regarding the communication with a predecessor auditor?
A. Contact with the predecessor auditor before client acceptance is mandatory and based on this requirement, client permission is not required prior to communication. B. Contact with the predecessor auditor before client acceptance is not mandatory, but encouraged, and client permission is required. C. Contact with the predecessor auditor should not take place prior to engagement acceptance, but such communications may take place after testwork has begun. D. Contact with the predecessor auditor before client acceptance is mandatory, but client permission is required.
Prior to accepting a new client, the auditor must communicate with the predecessor auditor, but the client is required to grant permission before such communications take place. If the client will not grant such permission, the client should not accept the engagement.
A2
Which of the following statements is most accurate regarding audit documentation requirements?
A. The auditor should document findings that could result in a modification of the auditor's report. B. If the results of audit procedures indicate a need to revise the previous assessment of risk, the new assessment should be documented and the original assessment should be removed. C. If different audit procedures were performed due to a lack of responsiveness by the client, the lack of responsiveness should not be included in the working papers. D. If an oral explanation serves as sufficient support for the work the auditor performed, the explanation should be documented in the working papers.
The auditor should document findings that could result in a modification of the auditor’s report.
A3
When applying analytical procedures during an audit, which of the following is the best approach for developing expectations?
A. Identifying reasonable explanations for unexpected differences before talking to client management. B. Considering the pattern of several unusual changes without trying to explain what caused them. C. Considering unaudited account balances and ratios to calculate what adjusted balances should be. D. Comparing client data with client-determined expected results to reduce detailed tests of account balances.
Identifying reasonable explanations for unexpected differences before talking to client management helps the auditor in assessing if management’s explanation is reasonable. Management’s explanation should always be corroborated with other evidence.
A2
Which of the following would an auditor most likely consider in evaluating the control environment of an audit client?
A. The entity's process to regularly monitor control performance. B. Management reviews of monthly financial statements. C. Management's operating style. D. Overall employee satisfaction with assigned duties.
An auditor most likely would consider the management’s operating style when evaluating the control environment of an audit client. The management’s philosophy and operating style include the management’s approach to taking and managing business risks, attitudes and actions toward financial reporting, and attitudes toward information processing and accounting functions and personnel.
A4
Which of the following items should not be included in the communication of the planned scope and timing of a financial statement audit for an issuer?
A. Potential use of internal audit staff. B. Factors affecting materiality. C. Probable high-risk audit procedures. D. Planned approach toward internal control.
The auditor should communicate with those charged with governance regarding the planned scope and timing of the audit. The auditor may also communicate how significant risks of material misstatement will be addressed, the planned approach toward internal control, factors affecting materiality, and any potential use of internal audit staff. The auditor should be careful not to compromise the effectiveness of audit procedures by making them too predictable. Thus, communication of probable high-risk audit procedures is not appropriate.
A5
During an integrated audit, management’s written representation letter should provide all of the following, except:
A. A description of key employee fraud. B. A statement that there were no significant changes to internal control before the as-of date of the report. C. An affirmation that management did not rely on the auditor’s procedures as the basis for its assessment. D. A statement that management has performed an evaluation on the effectiveness of the entity’s internal control.
Management’s written representation letter should state whether there were any significant changes to internal control after the as-of date of the report, not before the as-of date of the report.
A6
Before reissuing a compilation report on the financial statements of a nonissuer for the prior year, the predecessor accountant is required to:
A. Review the successor accountant's working papers for matters affecting the prior year. B. Make inquiries of the entity's lawyers concerning continuing litigation. C. Compare the prior year's financial statements with those of the current year. D. Obtain an updated management representation letter from the entity's management.
Before reissuing a compilation report on the financial statements of a nonissuer for the prior year, the predecessor accountant is required to compare the prior year’s financial statements with those of the current year.
A4
Which of the following procedures would an auditor most likely perform in searching for unrecorded liabilities?
A. Scan the cash disbursements entries recorded just before year-end for indications of unusual transactions. B. Compare a sample of purchase orders issued just after year-end with the year-end accounts payable trial balance. C. Vouch a sample of accounts payable entries recorded just before year-end to the unmatched receiving report file. D. Vouch a sample of cash disbursements recorded just after year-end to receiving reports and vendor invoices.
The auditor is able to detect liabilities not recorded at year-end by comparing cash payments made after the balance sheet date to the related receiving reports and vendor invoices; any payments made on transactions dated before year-end reflect a liability that should have been recorded.
A2
In addition to descriptions of the nature, timing, and extent of planned risk assessment procedures and planned further audit procedures, which of the following additional pieces of information should be documented in the audit plan?
A. Issues with management integrity that could affect the decision to continue the audit engagement. B. Procedures performed to assess independence and the ability to perform the engagement. C. The understanding of the terms of the engagement, including scope, fees, and resource allocation. D. Other audit procedures to be performed to comply with generally accepted auditing standards.
The audit plan should include documentation of specific audit procedures (including other audit procedures) to be performed to comply with generally accepted auditing standards.
A6
According to the Sarbanes-Oxley Act (SOX), the assertions on financial reports that the CEO and the CFO must make regarding internal controls include all of the following, except:
A. Any identified internal control weaknesses will be rectified within 60 days after the report is issued. B. The assurance that the controls were set up to ensure that material information is available. C. Conclusions as to the effectiveness of the controls per their evaluation. D. The controls have been evaluated for effectiveness within 90 days prior to the report issuance.
SOX does not require an assertion that any identified internal control weaknesses will be rectified within 60 days after the report is issued.
A6
In which of the following circumstances would a covered member’s independence be impaired with respect to a nonissuer client?
A. The member owns municipal utility bonds issued by a client, and the bonds are not material to the member's wealth. B. The member belongs to a client golf club that requires members to acquire a share of the club's debt securities. C. The member is designated to serve as guardian of a friend's children if the need arises, and the friend's estate, which would be held in trust for the children, holds significant stock ownership in a client entity. D. The member's spouse qualifies because of geographical residence to belong to a client's credit union, and all transactions with the credit union are conducted under normal operating practices.
Although the bonds are not material in relation to the member’s total wealth, independence is still impaired because the ownership of the bonds represents a direct financial interest in the client and a violation of the Independence Rule.
A3
When applying analytical procedures during an audit, which of the following is the best approach for developing expectations?
A. Considering the pattern of several unusual changes without trying to explain what caused them. B. Comparing client data with client-determined expected results to reduce detailed tests of account balances. C. Identifying reasonable explanations for unexpected differences before talking to client management. D. Considering unaudited account balances and ratios to calculate what adjusted balances should be.
Choice “C” is correct. Identifying reasonable explanations for unexpected differences before talking to client management helps the auditor in assessing if management’s explanation is reasonable. Management’s explanation should always be corroborated with other evidence.
A2
Which of the following statements best describes how a detailed audit plan of a CPA who is engaged to audit the financial statements of a large publicly held company compares with the audit client’s comprehensive internal audit program?
A. The comprehensive internal audit plan is substantially identical to the audit plan used by the CPA because both cover substantially identical areas. B. The comprehensive internal audit plan is less detailed and covers fewer areas than would normally be covered by the CPA. C. The comprehensive internal audit plan is more detailed and covers areas that would normally not be covered by the CPA. D. The comprehensive internal audit plan is more detailed although it covers fewer areas than would normally be covered by the CPA.
Choice “C” is correct. “Internal auditors” are part of the system of internal control. Their audits would cover more areas in greater depth than those of the “independent auditors,” whose concerns are limited to areas materially affecting the “financial statements taken as a whole.” For example, internal auditors would be more involved in analyzing and reporting on the actual operations of the entity of which they are a part.
A4
In evaluating the adequacy of the allowance for doubtful accounts, an auditor most likely reviews the entity’s aging of receivables to support management’s financial statement assertion of:
A. Completeness. B. Rights and obligations. C. Existence. D. Valuation and allocation.
Choice “D” is correct. In evaluating the adequacy of the allowance for doubtful accounts, an auditor most likely reviews the entity’s aging of receivables to support the assertion of valuation and allocation (i.e., to determine whether the allowance for doubtful accounts properly adjusts the receivables balance to net realizable value).
A2
The Gotham Corporation regularly produces budget vs. actual data for its managers. The company is particularly sensitive to personnel costs, and division variances of greater than five percent for any period are promptly investigated to determine if budgeted positions have not been filled or if there has been extraordinary overtime. Timely exception resolution of this character illustrates the information and communication principles typically associated with:
A. External Communication. B. Financial Reporting Information. C. Internal Communication. D. Obtain and Use Information.
Choice “D” is correct.The principle of obtain and use information is applied when the organization obtains or generates and uses relevant, high-quality information to support the functioning of the control. In this case, management is using the exception report (information) to support the control of monitoring overtime costs.
A2
The Gotham Corporation regularly produces budget vs. actual data for its managers. The company is particularly sensitive to personnel costs, and division variances of greater than five percent for any period are promptly investigated to determine if budgeted positions have not been filled or if there has been extraordinary overtime. Timely exception resolution of this character illustrates the information and communication principles typically associated with:
A. External Communication. B. Financial Reporting Information. C. Internal Communication. D. Obtain and Use Information.
Choice “D” is correct.The principle of obtain and use information is applied when the organization obtains or generates and uses relevant, high-quality information to support the functioning of the control. In this case, management is using the exception report (information) to support the control of monitoring overtime costs.
A2
Which statement is true with respect to discussion among engagement personnel regarding the risk of material misstatement due to fraud?
A. All key members of the audit team should be brought to a single location to facilitate communication. B. Audit documentation must include a description of the discussion. C. The discussion should occur only during the planning stage of the audit. D. Discussion among engagement personnel regarding the risk of material misstatement due to fraud is recommended but not required.
Choice “B” is correct. Audit documentation is required to include a description of the discussion among engagement personnel regarding the risk of material misstatement due to fraud.
A4
Which of the following statements is correct concerning an auditor’s required communication of significant deficiencies in internal control noted during a financial statement audit of a nonissuer?
A. An auditor's report on significant deficiencies should include a restriction on the distribution of the report. B. A significant deficiency previously communicated during the prior year's audit that remains uncorrected causes a scope limitation. C. An auditor should perform tests of controls on significant deficiencies before communicating them to the client. D. An auditor should communicate significant deficiencies after tests of controls, but before commencing substantive tests.
Choice “A” is correct. The report should state that the communication is intended solely for the use of management, those charged with governance, and others within the organization.
A4
An auditor that is performing tests of details on sales transactions decides to examine a sample of sales invoices to determine if they are recorded in the proper revenue accounts. This audit procedure is performed to determine:
A. Valuation, allocation, and accuracy. B. Completeness. C. Existence and occurrence. D. Understandability of presentation and classification.
Choice “D” is correct. Examining a sample of sale invoices for proper classification into the appropriate revenue accounts is an audit procedure used to test the understandability of presentation and classification assertion for sales transactions.
A1
Delta Life Insurance Co. prepares its financial statements on an accounting basis insurance companies use pursuant to the rules of a state insurance commission. If Wall, CPA, Delta’s auditor, discovers that the statements are not suitably titled, Wall should:
A. Apply to the state insurance commission for an advisory opinion. B. Issue a special statutory basis report that clearly disclaims any opinion. C. Explain in the notes to the financial statements the terminology used. D. Disclose any reservations in a basis for modification paragraph and qualify the opinion.
Choice “D” is correct. Financial statements prepared in accordance with a comprehensive basis of accounting other than GAAP that are not suitably titled require a qualified opinion with a basis for modification paragraph.
A4
An auditor is in the process of planning procedures to test the client’s accounts receivable balances. Assuming the auditor decides not to use accounts receivable confirmations for the client, which of the following would be the least compelling reason to eliminate this method of testing?
A. Inherent and control risk are very low and other procedures can be used to reduce audit risk to a low level. B. Using accounts receivable confirmations would be an ineffective method. C. The client’s accounts receivables are deemed immaterial. D. Last year’s audit resulted in relatively low response rate from the client’s customers.
Choice “D” is correct. This represents the least compelling reason to decide not to use accounts receivable confirmations in the current year’s audit. Even if this year’s response rate is again low for the first confirmations sent, the auditor should send second and third confirmation requests to customers. Other follow up procedures can be performed if the second and third confirmations are not returned from the client’s customers.
Candidate Note: The use of accounts receivable confirmations is a required generally accepted audit procedure unless choices “B”, “A”, or “C” below apply. When accounts receivable confirmations are not used, the auditor must document the alternative procedures used for testing.
A4
Which of the following audit procedures is best for identifying unrecorded trade accounts payable?
A. Investigating payables recorded just prior to and just subsequent to the balance sheet date to determine whether they are supported by receiving reports. B. Reconciling vendors' statements to the file of receiving reports to identify items received just prior to the balance sheet date. C. Reviewing cash disbursements recorded subsequent to the balance sheet date to determine whether the related payables apply to the prior period. D. Examining unusual relationships between monthly accounts payable balances and recorded cash payments.
Choice “C” is correct. Unrecorded trade accounts payable are best identified by reviewing cash disbursements recorded subsequent to the balance sheet date to determine whether the related payables apply to the prior period.
A4
After making inquiries about credit granting policies, an auditor selects a sample of sales transactions and examines evidence of credit approval. This test of controls most likely supports management’s financial statement assertion(s) of:
Rights and
obligations
Allocation and
valuation
A.
Yes
Yes
B. Yes
No
C. No
Yes
D. No
No
Choice “C” is correct. By ensuring that credit approval is obtained before goods are shipped to customers, the auditor is testing management’s assertion that accounts receivable are collectible (allocation and valuation). Ensuring that credit approval is obtained before goods are shipped does not support the rights and obligations assertion.
A2
As part of developing an audit strategy for an existing client, the auditor may determine a materiality level for all the following, with the exception of:
A. Transaction cycles with misstatements in the prior year’s audit. B. Certain classes of transactions. C. Performance materiality. D. Financial statements as a whole.
Choice “A” is correct. While developing an audit strategy, the auditor determines the level of materiality for the client’s financial statements as a whole, performance materiality, and if necessary, for certain account balances, transactions, and disclosures. A separate materiality level would not be established for specific transaction cycles that contained misstatements in the prior year’s audit.
A3
Which of the following statements is correct with respect to the testing of controls in an audit of an issuer’s financial statements?
A. Tests of controls are not required to be performed on assertions for which substantive procedures alone provide insufficient audit evidence. B. The evidence necessary to support an auditor's control risk assessment usually does not depend on the degree of reliance the auditor plans to place on the effectiveness of a control. C. An auditor must obtain evidence that controls are operating effectively during the entire period of reliance if the auditor plans to assess control risk at less than the maximum. D. An auditor should assess control risk at less than the maximum for all relevant assertions.
Choice “C” is correct. To assess control risk below the maximum, the auditor does need to perform tests to prove that the controls were operating effectively throughout the period.
A2
In planning the audit, the auditor obtains a sufficient understanding of the existing system of internal control. Which one of the following is not among the auditor’s primary objectives for obtaining such knowledge?
A. Make constructive suggestions to the client for improvement. B. Design effective substantive tests. C. Consider the factors that affect the risk of material misstatement. D. Identify types of material misstatements.
Choice “A” is correct. Making constructive suggestions to the client is not a primary objective for obtaining an understanding of an entity’s system of internal control, although it may be a desirable by-product of an audit engagement.
A3
The purpose of applying analytical procedures in the overall review stage of an audit includes assisting the auditor in all of the following except:
A. Assessing conclusions reached. B. Evaluating the overall financial statement presentation. C. Evaluating the going concern assessment. D. Enhancing the understanding of the client's business.
Choice “D” is correct. During planning (not during review), the focus of analytical procedures is on enhancing the understanding of the client’s business.
A4
In auditing long-term bonds payable, an auditor most likely would:
A. Confirm the existence of individual bondholders at year-end. B. Perform analytical procedures on the bond premium and discount accounts. C. Examine documentation of assets purchased with bond proceeds for liens. D. Compare interest expense with the bond payable amount for reasonableness.
Choice “D” is correct. Comparing interest expense with the bond payable amount for reasonableness provides evidence that all interest expense was included and that the outstanding balance of the bonds payable is reasonable, as well as providing limited evidence concerning the amortization of bond discounts or premiums.
A6
An accountant has been engaged to review a nonissuer’s financial statements that contain several departures from GAAP. If the financial statements are not revised and modification of the standard review report is not adequate to indicate the deficiencies, the accountant should:
A. Determine the effects of the departures from GAAP and issue a special report on the financial statements. B. Inform management that the engagement can proceed only if the accountant's report is restricted to internal use. C. Withdraw from the engagement and provide no further services concerning these financial statements. D. Issue a modified review report provided the entity agrees that the financial statements will not be used to obtain credit.
Choice “C” is correct. If an accountant believes that modification of the standard report is not adequate to indicate the deficiencies in the financial statements, he or she should withdraw from the review engagement and provide no additional services with respect to the financial statements.
A3
In addition to making management inquiries, an auditor should perform the following procedures to identify client contingencies with the exception of:
A. Discussing sales contracts with the sales manager. B. Reviewing derivative transactions reflected on the quarter-end balance sheet. C. Reviewing the status of long-term leases. D. Obtaining a client representation letter.
Choice “B” is correct. A client is expected to report material contingencies in the footnotes as they have not yet happened and are not reflected in the actual financial statements. Derivatives that are actually reflected on the client’s balance sheet at quarter end are not contingencies (the amount is provided and there is no possible or probable outcome). As a result, reviewing any type of transaction that is already recorded on the balance sheet will not identify a contingency.
A1
In which of the following sections of an auditor’s report for a nonissuer does an auditor communicate the nature of the engagement and the specific financial statements covered by the audit?
A. Basis for Opinion B. Opinion C. Emphasis-of-matter D. Scope
Choice “B” is correct. The auditor’s Opinion section indicates the nature of the engagement (i.e., audit), the financial statements covered in the (audit) engagement, the name of the entity whose financial statements have been audited, and the dates covered by each financial statement.
A3
The reliability of evidence gathered by an auditor of a nonissuer is most influenced by:
A. The auditor's assessment of the risk of misstatement. B. The relevance of evidence obtained through the auditor's procedures. C. The quantity of evidence obtained through the auditor's procedures. D. The source and nature of the evidence and the circumstances under which it is obtained.
Choice “D” is correct. The reliability of audit evidence is dependent on the circumstances under which it is gathered. The reliability of evidence is also influenced by its source and nature.
A3
In the audit of financial statements, an auditor applied analytical procedures as a substantive test but did not detect a material misstatement in an account balance. Which of the following is the most likely reason the auditor failed to detect the misstatement?
A. The auditor did not document additional auditing procedures performed in response to significant unexpected differences arising from the analytical procedures. B. The expectations used by the auditor were very precise and so led to a wide range of expected differences from expectations. C. The auditor developed expectations at a detailed line of business level rather than at a broad, company-wide level. D. The misstatement was obscured by offsetting factors resulting from the diversified nature of the entity's operations.
Choice “D” is correct. Substantive analytical procedures are often used when there is a large volume of predictable transactions. If the entity has diversified operations, the auditor likely should have disaggregated the population and performed multiple analytical procedures to avoid offsetting factors in the different aspects of the entity’s operations.
A5
An accountant’s report on a review of pro forma financial information should include a:
A. Disclaimer of opinion on the financial statements from which the pro forma financial information is derived. B. Caveat that it is uncertain whether the transaction or event reflected in the pro forma financial information will ever occur. C. Statement that the entity's internal control was not relied on in the review. D. Reference to the financial statements from which the historical financial information is derived.
Choice “D” is correct. The accountant’s report on a review of pro forma financial information should include a reference to the financial statements from which the historical information is derived and a statement as to whether such financial statements were audited or reviewed.
A4
A nonissuer client has a material investment in the securities of another entity that is valued on the basis of the investee’s financial results. The auditor has learned that the investee’s financial statements are not audited. What should the auditor do first in this situation?
A. Modify the auditor's report. B. Withdraw from the engagement. C. Ask the client to obtain the services of an independent business valuation specialist. D. Ask the client to arrange with the investee to have another auditor apply the appropriate auditing procedures to the investee's financial statements.
Choice “D” is correct. If the client has a material investment in the securities of another entity that is valued on the basis of the investee’s financial results, the auditor should perform procedures to obtain audit evidence regarding the investee’s financial results. If the financial statements are not audited, the auditor may request that the client arrange with the investee to have the financial statements audited.
A2
In an audit of financial statements for which an auditor’s assessment of risk is judgmental and may not be sufficiently precise to identify all risks of material misstatement, the auditor should take which of the following actions?
A. Discuss strategies to eliminate such risks with top management or those with equivalent authority and responsibility. B. Consider whether risk assessment procedures are appropriate given preliminary levels of materiality and tolerable misstatement. C. Determine the effectiveness of general controls over classes of transactions characterized by high transaction volume. D. Perform substantive procedures for all relevant assertions related to each significant class of transactions.
Choice “D” is correct. In an audit of financial statements, substantive procedures will always be necessary for all relevant assertions related to significant transaction classes.
A2
Regardless of the assessed level of control risk, an auditor would perform some:
A. Analytical procedures to verify the design of internal control. B. Substantive tests to restrict detection risk for significant transaction classes. C. Dual purpose tests to evaluate both the risk of material misstatement and preliminary control risk. D. Tests of controls to determine the effectiveness of internal control.
Choice “B” is correct. Regardless of the assessed level of control risk, an auditor would perform some level of substantive tests to restrict detection risk for significant transaction classes. Even with the lowest possible assessed level of control risk, substantive testing cannot be entirely eliminated for significant transaction classes or balances.
A5
Management’s written representation to the auditor in connection with a governmental audit would most likely include:
A. Identification of management's interpretation of compliance requirements that are subject to different interpretations. B. Representation that all known noncompliance had been reported or negative assurance that other noncompliance likely does not exist. C. Negative assurance that the government has complied with compliance requirements. D. A statement that management had identified and disclosed all material government programs to the auditor.
Choice “A” is correct. The management letter will include identification of management’s interpretation of compliance requirements that are subject to different interpretations.
A6
Which of the following statements would not normally be included in a representation letter for a review of interim financial information?
A. We understand that a review consists principally of performing analytical procedures and making inquiries about the interim financial information. B. We acknowledge our responsibility for the design and implementation of programs and controls to prevent and detect fraud. C. We have made available to you all financial records and related data. D. To the best of our knowledge and belief, no events have occurred subsequent to the balance sheet and through the date of this letter that would require adjustment to or disclosure in the interim financial information.
Choice “A” is correct. This statement would likely be found in an engagement letter, not a management representation letter.
A3
Which of the following errors most likely would be detected by analyzing financial totals?
A missing digit in an invoice number in a batch of daily sales.
A purchase order mistakenly entered into two different batches.
A transposition error on one employee’s paycheck on a weekly payroll run.
Malfeasance resulting from a receivable clerk.
Choice “C” is correct. A manual total will be calculated for each transaction file and compared to a computer-generated batch control total. Any financial discrepancies (such as an error on an employee paycheck) will be identified and resolved as part of this process.
A2
Which of the following circumstances would permit an independent auditor to accept an engagement after the close of the fiscal year?
A. Issuance of a disclaimer of opinion as a result of inability to conduct certain tests required by generally accepted auditing standards due to the timing of acceptance of the engagement. B. Assessment of control risk below the maximum level. C. Remedy of limitations resulting from accepting the engagement after the close of the end of the year, such as those relating to the existence of physical inventory. D. Receipt of an assertion from the preceding auditor that the entity will be able to continue as a going concern.
Choice “C” is correct. An independent auditor may accept an engagement after the close of the fiscal year as long as he or she can address any limitations resulting from accepting the engagement at that time. For example, the auditor may not be able to observe the ending inventory count, but may be able to perform acceptable alternative procedures sufficient to support the year-end inventory balance.
A6
A CPA who is not in public practice is obligated to follow which of the following rules of conduct?
A. Integrity and objectivity. B. Independence. C. Contingent fees. D. Commissions.
Choice “A” is correct. A CPA must maintain objectivity and integrity in the performance of any professional service.
A4
Which of the following controls most likely would be effective in offsetting the tendency of sales personnel to maximize sales volume at the expense of high bad debt write-offs?
A. Shipping documents and sales invoices are matched by an employee who does not have authority to write off bad debts. B. Employees responsible for authorizing sales and bad debt write-offs are denied access to cash. C. Subsidiary accounts receivable records are reconciled to the control account by an employee independent of the authorization of credit. D. Employees involved in the credit-granting function are separated from the sales function.
Choice “D” is correct. Sales personnel will have a tendency to maximize sales volume by selling to customers that may not be creditworthy, thereby resulting in high bad debt write-offs. To prevent sales to customers that may not be creditworthy, employees involved in the credit-granting function are separated from the sales function.
A6
An accountant’s working papers for an engagement to review the financial statements of a nonpublic entity would be least likely to include which of the following forms of documentation?
A. Study and evaluation of internal control. B. Explanation of analytical procedures performed. C. A copy of the engagement letter. D. Copies of representation letters from client management.
Choice “A” is correct. For a review engagement, the accountant is not required to obtain an understanding of internal control or to assess control risk. The accountant should possess an understanding of the client’s business and the accounting principles and practices used by the client, but an understanding of internal control or testing of controls is not required in a review.
A6
When preparing a nonissuer’s financial statements, an accountant would be least likely to:
A. Advise management on alternative accounting policies that are significant to the financial statements. B. Assist management in making judgments for impairment expense. C. Perform control testing around the cash disbursement process. D. Omit substantially all of the disclosures required by generally accepted accounting principles.
Choice “C” is correct. A preparation engagement does not require the accountant to perform control testing. A preparation engagement involves the accountant preparing financial statements using the records, documents, explanations, and other information provided by management. An accountant does not need to test controls or perform substantive procedures.
A3
Which of the following would be a consideration in planning an auditor’s sample for a test of controls?
A. The auditor's allowable risk of assessing control risk too low. B. The level of detection risk for the account. C. The auditor's allowable risk of assessing control risk too high. D. Preliminary judgments about materiality levels.
Choice “A” is correct. The auditor’s allowable risk of assessing control risk too low has an inverse relationship with sample size when planning a sample for a test of controls.
A6
Which of the following inquiry or analytical procedures ordinarily is performed in an engagement to review a nonissuer’s financial statements?
A. Analytical procedures designed to test the accounting records by obtaining corroborating evidential matter. B. Inquiries of the entity's attorney concerning contingent liabilities. C. Analytical procedures designed to test management's assertions regarding continued existence. D. Inquiries concerning the entity's procedures for recording and summarizing transactions.
Choice “D” is correct. When reviewing a nonissuer’s financial statements, an accountant ordinarily makes inquiries concerning the entity’s procedures for recording and summarizing transactions.
A2
Obtaining a signed engagement letter would most likely help the auditor to avoid which of the following?
A. The auditor believed that management intended to correct an identified material misstatement, however, management determined that the misstatement should be left as uncorrected. B. Management needed to obtain an audit report in accordance with a special purpose framework other than U.S. GAAP, but the auditor does not have the appropriate training and knowledge to perform the required engagement. C. The auditor assumed that all subsequent events had been disclosed by management, but management failed to communicate a transaction that closed just before the audit report was issued. D. A disagreement between management and the auditor on the terms of the contingent portion of the audit fee agreement.
Choice “B” is correct. The main purpose of the engagement letter is to establish an agreement between the auditor and the client and to reduce the risk of misinterpretation. The engagement letter should include the identification of the applicable financial reporting framework to be used for the report.
A4
When an entity uses a trust company as custodian of its marketable securities, the possibility of concealing fraud most likely would be reduced if the:
A. Interest and dividend checks are mailed directly to an entity employee who is authorized to sell securities. B. Trust company has no direct contact with the entity employees responsible for maintaining investment accounting records. C. Trust company places the securities in a bank safe-deposit vault under the custodian's exclusive control. D. Securities are registered in the name of the trust company, rather than the entity itself.
Choice “B” is correct. When an entity uses a trust company as custodian of its marketable securities, the possibility of concealing fraud would be reduced if the trust company deals only with the person reconciling the accounts, and not with the employees responsible for maintaining investment records.
A4
Which of the following controls most likely would help ensure that all credit sales transactions of an entity are recorded?
A. The billing department supervisor sends copies of approved sales orders to the credit department for comparison to authorized credit limits and current customer account balances. B. The accounting department supervisor independently reconciles the accounts receivable subsidiary ledger to the accounts receivable control account monthly. C. The accounting department supervisor controls the mailing of monthly statements to customers and investigates any differences reported by customers. D. The billing department supervisor matches prenumbered shipping documents with entries in the sales journal.
Choice “D” is correct. Selecting prenumbered shipping documents and matching them with entries in the sales journal is a control that would help ensure that all credit sales transactions are recorded. (Shipping documents without corresponding sales journal entries might indicate unrecorded sales).
A1
An auditor’s report on financial statements prepared on the cash receipts and disbursements basis of accounting should include all of the following, except:
A. A reference to the note to the financial statements that describes the cash receipts and disbursements basis of accounting. B. A statement that the auditor is responsible for determining that the cash receipts and disbursements basis of accounting is an acceptable basis for the preparation of the financial statements. C. An opinion as to whether the financial statements are presented fairly in conformity with the cash receipts and disbursements basis of accounting. D. A statement that the audit was conducted in accordance with auditing standards generally accepted in the United States of America.
Choice “B” is correct. The auditor’s report on financial statements prepared in conformity with a basis of accounting other than GAAP would include a statement that management, not the auditor, is responsible for determining that the cash receipts and disbursements basis of accounting is appropriate in the circumstances.
A4
Which of the following procedures best addresses the adequacy of presentation and disclosure for inventory of a nonissuer?
A. Obtaining confirmation of inventories that are pledged under loan agreements. B. Examining the inventory turnover ratio and determining whether it is in line with similar companies in the industry. C. Observing the company's physical inventory-taking procedures. D. Tracing the test counts during the physical inventory to the final inventory listing.
Choice “A” is correct. In addressing the adequacy of presentation and disclosure for inventory, the auditor should determine that inventory-related obligations, such as inventory pledged under loan agreements, have been properly disclosed.
A3
Which of the following audit techniques ordinarily would provide an auditor with the least assurance about the operating effectiveness of a control activity?
A. Preparation of system flowcharts. B. Inspection of documents and reports. C. Observation of client personnel. D. Inquiry of client personnel.
Choice “A” is correct. Preparation of system flowcharts may aid in the auditor’s understanding of the system of internal control, but would not indicate whether controls were actually operating as designed.
A5
The GAO standards of reporting for governmental financial audits incorporate the AICPA standards of reporting and prescribe supplemental standards to satisfy the unique needs of governmental audits. Which of the following is a supplemental reporting standard for governmental financial audits?
A. Any privileged or confidential information discovered should be reported to the organization that arranged for the audit. B. All changes in the audit program from the prior year should be reported to the entity's audit committee. C. Material indications of illegal acts should be reported in a document distributed only to the entity's senior officials. D. Auditors should report the scope of their testing of compliance with laws and regulations and of internal controls.
Choice “D” is correct. The auditor’s report on compliance and on internal control over financial recording (based on an audit) must include the scope of testing of compliance and internal control.
A6
Which of the following statements is incorrect regarding the SEC’s partner rotation rules?
A. All audit partners must rotate off the audit engagement after five years. B. Small firms may be exempted from the partner rotation requirement. C. The lead and concurring partners are subject to a five-year time-out period. D. Other audit partners are subject to a two-year time-out period.
Choice “A” is correct. This statement is incorrect. Under the SEC’s rules, the lead and concurring partner must rotate off the engagement after five years and other audit partners must rotate after seven years.
A3
Economic indicators are often used to try to predict or explain economic activity. Which of the following is not an example of a leading economic indicator?
A. Manufacturing and trade sales. B. Building permits for residential properties. C. Orders for goods. D. Price changes of materials.
Choice “A” is correct. Manufacturing and trade sales tend to be coincident indicators, as the increases or decreases tend to occur at the same time as the increases or decreases in overall economic activity.
A5
An auditor is auditing a mutual fund company that uses a transfer agent to handle accounting for shareholders. Which of the following actions by the auditor would be most efficient for obtaining information about the transfer agent’s internal controls?
A. Review a report on the design, implementation, and effectiveness of the transfer agent's internal controls produced by the agent's own auditor. B. Perform an audit on the internal control function of the agent. C. Review prior-year workpapers to determine whether the number of transactions processed by the agent has materially increased. D. Perform tests of controls on a sample of the audited firm's transactions through the agent.
Choice “A” is correct. Reports on the design, implementation, and operating effectiveness of the transfer agent’s internal controls (SOC 1® Type 2 Report) produced by the agent’s own auditor would be an efficient means of obtaining information about the transfer agent’s internal controls.
A1
An entity prepares its financial statements on its income tax basis. A description of how that basis differs from GAAP should be included in the:
A. Emphasis-of-matter paragraph of the auditor's report. B. Management representation letter. C. Auditor's engagement letter. D. Notes to the financial statements.
Choice “D” is correct. A description of how the income tax basis differs from GAAP should be included in the notes to the financial statements.
A5
Which of the following is a documentation requirement that an auditor should follow when auditing in accordance with Government Auditing Standards?
A. Audit documentation should contain sufficient information so that supplementary oral explanations are not required. B. The auditor should document the procedures that assure discovery of all illegal acts and contingent liabilities resulting from noncompliance. C. Audit documentation should contain a caveat that all instances of material errors and fraud may not be identified. D. The auditor should obtain written representations from management acknowledging responsibility for correcting instances of fraud, abuse, and waste.
Choice “A” is correct. Per Government Auditing Standards, audit documentation should contain sufficient information so that supplementary oral explanations are not required.
A3
Which of the following is a preventive supervisory and monitoring control?
A. Mandatory vacations B. Hiring guidelines C. Audits D. Performance reviews
Choice “B” is correct. Hiring guidelines are considered a preventive supervisory and monitoring control. Organizations develop strict hiring guidelines so that only competent and capable employees are hired to perform key business processes.
A3
Which of the following is least appropriately considered a condition or event that indicates that there could be substantial doubt about an entity’s ability to continue as a going concern?
A. Arrearages in dividends. B. An uninsured or underinsured catastrophe. C. Uneconomic long-term commitments. D. Issuance of bonds at the prevailing interest rate.
Choice “D” is correct. Issuance of bonds at the prevailing interest rate is not indicative of financial difficulties as the bonds are consistent with the current market conditions.
A2
The nature and extent of a CPA firm’s quality control policies and procedures depend on:
The CPA
firm’s size
The nature
of the CPA
firm’s practice
Cost-benefit
considerations
A.
No
Yes
Yes
B. Yes
No
Yes
C. Yes
Yes
No
D. Yes
Yes
Yes
Choice “D” is correct. The nature and extent of a CPA firm’s quality controls depend on a number of factors, such as its size, the degree of operating autonomy allowed its personnel and its practice offices, the nature of its practice, its organization, and appropriate cost-benefit considerations.
A2
When there is a group audit, the group engagement team should make a preliminary assessment of materiality. Which of the following is not an accurate statement of the engagement team’s responsibilities when assessing materiality?
A. Determine component materiality for those components on which the group engagement team will perform an audit. B. Ascertain materiality levels for specific classes of transactions, balances, or disclosures for group financial statements for which misstatements of lesser amounts than the group financial statements taken as a whole could influence user’s economic decisions. C. Assess materiality for the group financial statements as a whole, without an assessment of performance materiality. D. Develop a threshold at which anything above would not be considered trivial to the group financial statements.
Choice “C” is correct. The group engagement team should assess the materiality of the group financial statements as a whole as well as performance materiality.
A3
Which of the following is an inaccurate statement as it pertains to the auditor’s consideration of significant risks during an audit?
A. Inherent risk is the only consideration. B. The impact of the client’s controls related to the perceived risk is a determinant for deciding the level of significance. C. It exists when the inherent risk is exceptionally high. D. The auditor uses professional judgment to identify whether a particular risk of material misstatement is a significant risk.
Choice “B” is correct. This represents a false statement. When determining whether a risk is significant or not, the auditor should ignore the impact of the client’s controls related to that risk.
A3
Which of the following audit techniques ordinarily would provide an auditor with the least assurance about the operating effectiveness of a control activity?
A. Inspection of documents and reports. B. Preparation of system flowcharts. C. Inquiry of client personnel. D. Observation of client personnel.
Choice “B” is correct. Preparation of system flowcharts may aid in the auditor’s understanding of the system of internal control, but would not indicate whether controls were actually operating as designed.
A4
Which of the following controls would be most effective in assuring that the proper custody of assets in the investing cycle is maintained?
A. The purchase and sale of investments are executed on the specific authorization of the board of directors. B. The recorded balances in the investment subsidiary ledger are periodically compared with the contents of the safety deposit box by independent personnel. C. Direct access to securities in the safety deposit box is limited to only one corporate officer. D. Personnel who post investment transactions to the general ledger are not permitted to update the investment subsidiary ledger.
Choice “B” is correct. An independent person comparing the contents of the safety deposit box with the recorded balances in the investment subsidiary ledger is an effective control for assuring that the proper custody of assets in the investing cycle is maintained.
A2
Which of the following statements is most accurate regarding the existing control activities component of the Integrated Framework?
A. Segregation of duties is a critical preventive control activity. B. Preventive control activities require automated processes. C. Policies are used to put procedures into action. D. A detective control activity is designed to identify risks before they occur.
Choice “A” is correct. Segregation of duties is designed to mitigate some of the risks associated with having individuals responsible for multiple activities within an overall process, which makes it preventive in nature.
A1
The client’s financial reporting includes supplementary financial information outside the basic financial statements but required by the Financial Accounting Standards Board (FASB). Which of the following statements is correct regarding the auditor’s responsibility for this supplementary financial information?
A. The auditor should read the supplementary financial information. B. The auditor is not required to report omissions. C. The auditor should apply tests of details of transactions. D. The auditor should perform limited procedures.
Choice “D” is correct. An auditor should perform limited procedures on required supplementary information.
A6
If, while performing a review engagement, an accountant has reason to believe that a material misappropriation of assets might have occurred, what should the accountant do?
A. Require an investigation to determine whether the misappropriation actually occurred. B. Document communications with senior management about the matter. C. Disclose the potential misappropriation as supplementary information in the accountant's report. D. Assess whether controls are in place to deter similar misappropriations.
Choice “B” is correct. If, while performing a review engagement, an accountant has reason to believe that fraud, such as material misappropriation of assets, might have occurred, the accountant should document communications with senior management about the matter.
A1
An annual shareholders’ report includes audited financial statements and contains a report by management on operations. The audited financial statements are fairly stated. The auditor is not engaged to report on the other information included in the annual report, but the auditor notices that there is a material inconsistency between the amount of revenue reported by management in the report on operations and the amount of revenue reported in the audited financial statements. If management refuses to make the revision to the revenue included in management’s report on operations, the auditor least likely would:
A. Withhold the use of the auditor’s report. B. Withdraw from the engagement. C. Modify the opinion on the audited financial statements to a qualified or adverse opinion. D. Include in the auditor’s report a separate section with the heading "Other Information" describing the inconsistency.
Choice “C” is correct. The auditor’s opinion on the audited financial statements relates to the basic financial statements and related footnotes. The information included in the financial statements is fairly stated; therefore, the opinion related to these financial statements and footnotes should not be modified.
A3
Which of the following is not a procedure the auditor would use in evaluating the reasonableness of an accounting estimate?
A. Use subsequent events to determine whether the estimate was reasonable. B. Determine how management developed their estimate and test the procedures they used. C. Develop an independent estimate and compare it to management's estimate. D. Confirm via the management representation letter that management has disclosed all significant estimates.
Choice “D” is correct. While the auditor might obtain such a representation from management, confirmation that all significant estimates have been disclosed would not be enough to substantiate the reasonableness of the estimates.
A2
Which of the following auditor concerns most likely could be so serious that the auditor concludes that a financial statement audit cannot be performed?
A. Management is dominated by one person who is also the majority stockholder. B. There is a substantial risk of intentional misapplication of accounting principles. C. Management fails to modify prescribed internal controls for changes in information technology. D. Internal control activities requiring segregation of duties are rarely monitored by management.
Choice “B” is correct. Intentional misapplication of accounting principles would indicate that management lacks integrity and as a result, the auditor might conclude that a financial statement audit cannot be performed.
A2
An auditor prepares an unmodified opinion on financial statements that are materially misstated due to fraud. Which of the following is true?
A. The auditor will be considered to have met his or her responsibility provided the audit was planned and performed appropriately, including a specific assessment of the risk of material misstatement due to fraud. B. If all three fraud risk factors were observed during the audit, the auditor should not have issued an unmodified opinion. C. The auditor will be considered to have met his or her responsibility provided none of the three fraud risk factors were observed during the audit. D. If the client deliberately concealed the fraud from the auditor, the auditor will not be responsible for the erroneous opinion.
Choice “A” is correct. The auditor’s responsibility is to plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether caused by error or fraud. This includes a specific assessment of the risk of material misstatement due to fraud.
A4
In a group audit of a nonissuer, which of the following matters should the group engagement team include in a communication to group management?
A. A listing of significant audit procedures to be performed by the component auditors B. The auditor's conclusion that fraud does not exist in the financial statements C. Significant deficiencies in internal control identified in the audit D. Results of inquiries about the professional reputation and standing of each component auditor
Choice “C” is correct. In a group audit of a nonissuer, the group engagement team is responsible for the required communications to group management and those charged with governance for the group. For all audits, significant deficiencies must be communicated in writing to management.
A2
Which of the following internal control procedures would prevent an employee from being paid an inappropriate hourly wage?
A. Limiting access to employee master files to authorized employees in the personnel department. B. Giving payroll data entry clerks the ability to change any suspicious hourly pay rates to a reasonable rate. C. Using real-time posting of payroll so there can be no after-the-fact data manipulation of the payroll register. D. Having the supervisor of the data entry clerk verify that each employee's hours worked are correctly entered into the system.
Choice “A” is correct. Limiting access to employee master files to authorized employees in the personnel department will minimize the entry of and thus the processing with an inappropriate hourly wage (rate). Master files should be under the control of a data librarian so that only authorized personnel have access to those files.
A3
Elaine is currently auditing the payroll process at Vanderman Retailers. Vanderman currently outsources its payroll function to Pay Services. Elaine has decided to run a drill-down analysis on changes in values throughout the year and obtains all the necessary data from Pay Services. Which of the following would be the best way to evaluate the reliability of the data obtained for this analytic?
A. Perform validation of sourced data through review of batch totals, hash totals, and record counts. B. Perform summary statistics on the data and review outcomes to learn whether they tie to auditor expectations. C. Use confirmations to verify balances. D. Request a SOC 1® report for Pay Services.
Choice “D” is correct. Because the client uses Pay Services as a service provider, it is important to ensure that Pay Services has appropriate controls around the data being utilized in the audit data analytic. SOC 1® reports contain assurance from the service provider’s management that controls are in place around their processes.
A3
Audit data analytics provide many benefits during the course of an audit. Which of the following is not a benefit of applying audit data analytics?
A. Insights gained from evaluating metadata and relationships among data both internal and external to the firm. B. Simplifying the creation and documentation of workpapers. C. Expanded audit coverage through testing of full populations. D. Enhanced fraud detection.
Choice “B” is correct. Although technology may assist in the documentation process, audit data analytics do not simplify workpapers. Audit data analytics may require additional documentation concerning the rationale of the analytic applied in addition to details concerning the data and technique employed.
A2
According to the Committee of Sponsoring Organizations (COSO) of the Treadway Commission, which of the following components of the internal control integrated framework addresses the dissemination of information regarding control objectives and responsibilities?
A. Control environment. B. Control activities. C. Risk assessment. D. Information and communication.
Choice “D” is correct. The information and communication component of the internal control integrated framework includes principles such as internal and external communication as well as obtaining and using information.
A2
The Internal Control—Integrated Framework contains objectives that cover each of the following, except:
A. High-level goals established by leadership to develop the entity’s mission. B. Ensuring all applicable laws and regulations are followed. C. The safeguarding of the entity’s assets against potential losses. D. The transparency of internal and external financial reporting.
Choice “A” is correct. High-level goals established as part of the development of the entity’s mission are considered strategic objectives, which are a part of enterprise risk management rather than the Internal Control—Integrated Framework.
A1
Prepared under U.S. auditing standards, an auditor’s report that refers to a material misstatement contains the words, “In our opinion, because of the significance of the matter . . . the accompanying consolidated financial statements do not present fairly the financial position . . . .” This is considered a(n):
A. Example of inappropriate wording B. Adverse opinion C. Qualified opinion D. Disclaimer of opinion
Choice “B” is correct. An adverse opinion would include the phrase, “In our opinion, because of the significance of the matter discussed in the Basis for Adverse Opinion section of our report, the accompanying consolidated financial statements do not present fairly the financial position…”
A6
Which of the following procedures ordinarily should be applied when an independent accountant conducts a review of interim financial information of a publicly held entity?
A. Verify changes in key account balances. B. Read the minutes of the board of directors' meetings. C. Inspect the open purchase order file. D. Perform cut-off tests for cash receipts and disbursements.
Choice “B” is correct. An independent accountant will generally read the minutes of the board of directors’ meetings when conducting a review of interim financial information of a publicly held entity.
A4
In a financial statement audit of a nonissuer, a previously communicated significant deficiency that has not been corrected, ordinarily should be communicated again:
A. Only if the deficiency has a material effect on the auditor's assessment of control risk. B. In writing, during the current audit. C. Only if the deficiency is considered a material weakness. D. Unless the entity accepts that degree of risk because of cost-benefit considerations.
Choice “B” is correct. A previously communicated significant deficiency that has not been corrected ordinarily should be communicated again in writing, during the current audit.
A4
Which of the following is not an example of a deficiency in the design of internal controls that may be a significant deficiency or material weakness?
A. Insufficient control consciousness. B. Lack of appropriate qualifications or training of client personnel. C. Inadequate documentation of the components of internal control. D. An observed deviation rate that exceeds the auditor’s expected rate.
Choice “D” is correct. An observed deviation rate that exceeds the auditor’s expected rate is an example of a deficiency in the operation of controls, not in the design of controls.
A3
In assessing the tolerable rate of deviations of a test of controls that was performed using statistical sampling, an auditor should consider that:
A. Deviations from pertinent controls do not affect the risk of material misstatement in the accounting records. B. Deviations from pertinent controls at a given rate ordinarily result in misstatements at a lower rate. C. When the degree of assurance desired in a sample is high, the auditor should allow for a high level of sampling risk. D. Increasing the number of items selected for the test of controls usually increases the tolerable rate of deviations.
Choice “B” is correct. In assessing the tolerable rate of deviations of a test of controls that was performed using statistical sampling, an auditor should consider that deviations from pertinent controls at a given rate ordinarily result in misstatements at a lower rate. In other words, sometimes the control is not working but that does not mean there is a dollar misstatement. Therefore, the actual misstatement rate could be lower than the control deviation rate.
A3
Which of the following spreadsheets most likely has the highest risk of data integrity errors?
A. A spreadsheet into which the controller enters summary daily sales data from a printed report of an automated accounting system. B. A spreadsheet that captures time and attendance transactions from an automated time clock system. C. A spreadsheet that displays imported comma-delimited text files from the check payment module and is reviewed by the accounts payable administrator. D. A spreadsheet the CFO uses that is directly linked to the company's accounting system database.
Choice “A” is correct. Data integrity relates to the assurance that data is consistent and accurate. Spreadsheets with manual inputs carry a higher risk of errors than those produced from automated processes. A spreadsheet with manual entry inputs from a printed report carries a high risk of data integrity errors.
A3
Which of the following levels would most likely address the risk of material misstatement by the auditor’s consideration of an entity’s control environment?
A. Disclosures. B. Classes of transactions. C. Financial statements. D. Specific account balances.
Choice “C” is correct. The control environment is pervasive and reflects the overall tone of the organization. Therefore, the auditor is most likely to focus on the highest level of risk of material misstatement, which is risk assessed at the financial statement level.
A3
Which of the following best explains why an analytical procedure might be used as a substantive test?
A. To achieve audit objectives in the most effective and efficient manner possible. B. To assess the conclusions reached by staff auditors. C. To assist in planning the nature, timing, and extent of the auditing procedures to be performed. D. To determine the adequacy of evidence gathered in response to unusual or unexpected balances.
Choice “A” is correct. For some assertions, analytical procedures are more effective and efficient at providing an appropriate level of assurance than are tests of details.
A3
Which of the following factors is most relevant when an auditor considers the client’s organizational structure in the context of control risk?
A. The organization's recruiting and hiring practices. B. Physical proximity of the accounting function to upper management. C. The suitability of the client's lines of reporting. D. Management's attitude toward information processing and accounting departments.
Choice “C” is correct. The suitability of the client’s lines of reporting is an important part of the organizational structure, which in turn is a key component of the control environment. Since the control environment has a pervasive effect on the auditor’s risk assessment, consideration of the suitability of the client’s lines of reporting is quite relevant in evaluating control risk.
A3
If interim substantive procedures for an account identified no exceptions, which of the following would the auditor not perform on that account at year-end?
A. Tests of details of activity during the period since the interim testing date. B. Substantive analytical procedures of the period since the interim testing date. C. Tests of details for the entire year under audit. D. Reconciliation of year-end balances to interim balances.
Choice “C” is correct. If interim substantive procedures for an account identified no exceptions, then the auditor does not need to test details for the entire year under audit at year-end.
A5
Identify the types of testing methods that are appropriate when testing the design effectiveness of controls in an integrated audit.
Inquiry
Observation
Inspection
Recalculation
Reperformance
A. Yes
Yes
Yes
Yes
Yes
B. Yes
Yes
Yes
Yes
No
C. Yes
Yes
Yes
No
No
D. Yes
Yes
Yes
No
Yes
Choice “C” is correct. In an integrated audit, design effectiveness can be tested through inquiry, observation, and inspection of documentation. Recalculation and reperformance are appropriate testing methods when testing operating effectiveness.
A5
Which of the following items should be included in prospective financial statements issued in an attestation engagement performed in accordance with Statements on Standards for Attestation Engagements?
A. All significant assumptions used to prepare the financial statements. B. Historical financial statements for the past three years. C. Pro forma financial statements for the past two years. D. All significant assertions used to prepare the financial statements.
Choice “A” is correct. When performing an attestation engagement related to a client’s prospective financial statements, the accountant should ensure that the client discloses all significant assumptions that are used for the prospective financial statements.
A4
Which of the following statements concerning material weaknesses and significant deficiencies is correct with respect to a financial statement audit of a nonissuer?
A. An auditor need not identify and communicate material weaknesses separately from significant deficiencies. B. An auditor should report immediately material weaknesses and significant deficiencies discovered during an audit. C. All significant deficiencies are material weaknesses. D. All material weaknesses are significant deficiencies.
Choice “D” is correct. Since a material weakness in internal control is important enough to merit attention by those charged with governance, it would also be considered a significant deficiency.
A1
Which of the following is true regarding the audit report for an issuer?
A. The report should include references to PCAOB standards and generally accepted accounting principles. B. Reference may be made to either PCAOB standards or generally accepted auditing standards. C. Reference should be made to both PCAOB standards and generally accepted auditing standards. D. PCAOB standards should not be mentioned at all, although their use is implied in the auditor's report.
Choice “A” is correct. An auditor reporting on the audit of financial statements of an issuer should indicate in the Basis for Opinion section that the engagement was conducted in accordance with PCAOB standards, and should refer to GAAP in the Opinion on the Financial Statements section.
A4
Which of the following controls should prevent an invoice for the purchase of merchandise from being paid twice?
A. An individual independent of cash operations prepares a bank reconciliation. B. The check signer reviews and cancels the voucher packets. C. Two check signers are required for all checks over a specified amount. D. The check signer accounts for the numerical sequence of receiving reports used in support of each payment.
Choice “B” is correct. Having the check signer review and cancel the voucher packet is a preventive control to ensure the same voucher is not presented and paid a second time. Additionally, because this control is implemented prior to processing (paying for) the original invoice, it functions as a preventive control of avoiding duplicate payments.
A4
In testing long-term investments, an auditor ordinarily would use analytical procedures to ascertain the reasonableness of the:
A. Valuation of marketable equity securities. B. Classification between balance sheet portfolios. C. Completeness of recorded investment income. D. Existence of unrealized gains or losses in the portfolio.
Choice “C” is correct. In testing long-term investments, an auditor ordinarily would use analytical procedures to ascertain the reasonableness of the completeness of recorded investment income. These procedures would probably include a comparison of the recorded investment income with the expected amount (based upon the related interest rate, dividends declared, etc.) and the income balance audited in the prior year.
A2
The monitoring component of internal control excludes:
A. Improving controls that are not operating effectively. B. Eliminating controls that are not operating effectively. C. Assessing the quality of control performance over time. D. Assessing information derived from external parties.
Choice “B” is correct. Monitoring is the process of assessing the quality of internal control performance over time and taking necessary corrective actions. Eliminating a control that is not operating effectively would not be an appropriate corrective action.
A4
Which of the following tests of details most likely would help an auditor determine whether accounts payable have been misstated?
A. Reviewing bank transfers recorded as cash received from customers. B. Searching for customer-returned goods that were not reported as returns. C. Examining reported purchase returns that appear too low. D. Examining vendor statements for amounts not reported as purchases.
Choice “D” is correct. Examining vendor invoices for amounts not reported as purchases is a procedure to determine if accounts payable have been understated (completeness assertion). Accounts payable would be understated for the amounts of purchases that were not reported.
A2
In an engagement to examine management’s discussion and analysis (MD&A), which of the following best defines control risk?
A. The risk of detecting misstatements that are material to the MD&A presentation taken as a whole. B. The risk that an assertion within the MD&A will lead to a material misstatement. C. The risk that the practitioner will not uncover a material misstatement within an MD&A assertion. D. The risk that material misstatements in the MD&A presentation will not be prevented in a timely manner.
Choice “D” is correct. Control risk is the risk that a material misstatement that could occur in an assertion within MD&A will not be prevented or detected on a timely basis.
A4
An auditor suspects that a client is fraudulently overstating revenue by recording fictitious sales. Which of the following audit procedures would most likely be used to identify this situation?
A. Select a sample of entries in the sales journal and trace to the related sales invoices. B. Select a sample of sales invoices and trace into the sales journal. C. Select a sample of sales invoices and trace to the related shipping documents. D. Select a sample of shipping documents and trace to the related sales invoices.
Choice “C” is correct. In recording fictitious sales, the client will likely have created phony sales invoices, but no related shipment will have occurred.
A2
According to PCAOB standards, the nature and extent of required planning activities for an issuer audit are influenced by all of the following factors, except for:
A. The changes in circumstances that occur during the audit. B. The audit firm’s previous experience with the client. C. The number of auditors that will assist in the client audit engagement. D. The size and complexity of the client.
Choice “C” is correct. Although the engagement partner and other key audit members are involved in planning activities for a client audit, it is specific client (company) factors and the audit firm’s previous relationship with the client that determines the nature and extent of required planning activities under PCAOB standards.
A3
The most likely explanation why the auditor’s examination cannot reasonably be expected to bring all acts of noncompliance with laws and regulations by the client to the auditor’s attention is that:
A. Acts of noncompliance with laws and regulations may be perpetrated by the only person in the client's organization with access to both assets and the accounting records. B. The client's system of internal control may be so strong that the auditor performs only minimal substantive testing. C. Acts of noncompliance with laws and regulations are perpetrated by management override of controls. D. Acts of noncompliance with laws and regulations by clients often relate to operating aspects rather than accounting aspects.
Choice “D” is correct. The audit should be designed to identify material misstatements due to acts of noncompliance with laws and regulations, but acts of noncompliance with laws and regulations that relate to operating aspects rather than accounting aspects may not directly affect the financial statements, and therefore they may be less likely to be discovered by the auditor.
A4
Which of the following controls most likely would be effective in offsetting the tendency of sales personnel to maximize sales volume at the expense of high bad debt write-offs?
A. Employees responsible for authorizing sales and bad debt write-offs are denied access to cash. B. Subsidiary accounts receivable records are reconciled to the control account by an employee independent of the authorization of credit. C. Shipping documents and sales invoices are matched by an employee who does not have authority to write off bad debts. D. Employees involved in the credit-granting function are separated from the sales function.
Choice “D” is correct. Sales personnel will have a tendency to maximize sales volume by selling to customers that may not be creditworthy, thereby resulting in high bad debt write-offs. To prevent sales to customers that may not be creditworthy, employees involved in the credit-granting function are separated from the sales function.
A6
The standard compilation report on the financial statements of a nonissuer that omit substantially all disclosures should:
I.
Include a paragraph disclosing such omissions.
II.
Include a disclaimer of opinion.
III.
State that if the omitted disclosures were included, they might influence the user’s conclusions.
A. I, II, and III. B. III only. C. I only. D. I and III only.
Choice “A” is correct. The standard compilation report includes a disclaimer, indicating that the accountant does not express an opinion, a conclusion, nor provide any assurance with respect to financial statement presentation. When substantially all disclosures are omitted, the report should also include a paragraph disclosing such omissions and stating that if the omitted disclosures were included, they might influence the user’s conclusions.
A3
If an organization decides to use regression, which is a forecasting model, what type of data analytic process would it be implementing?
A. Predictive analytics B. Descriptive analytics C. Diagnostic analytics D. Prescriptive analytics
Choice “A” is correct. Predictive analytics use statistical techniques and forecasting models to predict what could happen.
A1
An auditor decides to issue a qualified opinion on an entity’s financial statements because a major inadequacy in its computerized accounting records prevents the auditor from applying necessary procedures. The opinion paragraph of the auditor’s report should state that the qualification pertains to:
A. The possible effects on the financial statements. B. A departure from generally accepted auditing standards. C. Inadequate disclosure of necessary information. D. A client-imposed scope limitation.
Choice “A” is correct. When an auditor qualifies his opinion because of a scope limitation, the wording in the opinion paragraph should indicate that the qualification pertains to the possible effects on the financial statements and not to the scope limitation itself.
A3
Which of the following is a true statement regarding documentation requirements for analytical procedures?
A. When an analytical procedure is used as the principal substantive test of a significant financial statement assertion, the auditor is required to document the reasons analytical procedures were performed instead of tests of details. B. When an analytical procedure is used as the principal substantive test of a significant financial statement assertion, the auditor is required to document both the auditor's expectation and the factors considered in developing that expectation. C. When an analytical procedure is used during the overall review stage of the audit, the auditor is required to document the auditor's expectation and any additional procedures performed to investigate significant unexplained differences. D. When an analytical procedure is used as the principal substantive test of a significant financial statement assertion, the auditor is required to document his or her expectation and management's concurrence with that expectation.
Choice “B” is correct. When an analytical procedure is used as the principal substantive test of a significant financial statement assertion, the auditor is required to document both the auditor’s expectation and the factors considered in developing that expectation.
A1
Which of the following provides the most authoritative guidance for the auditor of a nonissuer?
A. An AICPA audit and accounting guide that provides specific guidance with respect to the accounting practices in the client's industry. B. General guidance provided by a Statement on Auditing Standards. C. Specific guidance provided by an interpretation of a Statement on Auditing Standards. D. A Journal of Accountancy article discussing implementation of a new standard.
Choice “B” is correct. General guidance provided by a Statement on Auditing Standards is the most authoritative of level of auditing guidance for audits of nonissuers. Auditors are required to comply with SASs, and should be prepared to justify any departures therefrom.
A3
In which of the following situations would an auditor ordinarily choose between expressing a qualified opinion or an adverse opinion?
A. The auditor did not observe the entity's physical inventory and is unable to become satisfied about its balance by other auditing procedures. B. The auditor is unable to apply necessary procedures concerning an investor's share of an investee's earnings recognized on the equity method. C. Conditions that cause the auditor to have substantial doubt about the entity's ability to continue as a going concern are inadequately disclosed. D. There has been a change in accounting principles that has a material effect on the comparability of the entity's financial statements.
Choice “C” is correct. Inadequate disclosure of the substantial doubt about an entity’s ability to continue as a going concern is a departure from GAAP, resulting in either a qualified or adverse opinion.
A3
While auditing a client’s accounting estimates used for their specific elements and accounts, the auditor has certain responsibilities. Which of the following is not a required audit procedure that the auditor would perform when evaluating the client’s accounting estimates?
A. Determine if the accounting estimates used are consistent with the client’s primary competitors. B. Evaluate the degree of uncertainty that is associated with the client’s accounting estimates. C. Verify that all material accounting estimates have been developed. D. Ensure that the accounting estimates used are properly disclosed in accordance with GAAP.
Choice “A” is correct. The auditor is required to determine if the client’s accounting estimates are reasonable, which may include a comparison with industry standards. However, the auditor is not required to determine if the accounting estimates are consistent with the client’s primary competitors. Although in the same industry, the client’s businesses could have unique features that may impact the rationale behind the accounting estimates used by the client.
A2
An auditor intends to use the work of an actuary who has a relationship with the client. Under these circumstances, the auditor:
A. Should assess the risk that the actuary's objectivity might be impaired. B. Is not permitted to rely on the actuary because of a lack of independence. C. Is required to disclose the contractual relationship in the auditor's report. D. Should communicate this matter to those charged with governance as a significant deficiency in internal control.
Choice “A” is correct. While a specialist who is unrelated to the client will provide the auditor with greater assurance of reliability, a specialist who is related to the client may be acceptable in certain circumstances. In such situations, the auditor would likely perform additional procedures to verify objectivity.
A6
A CPA concludes that the unaudited financial statements on which the CPA is disclaiming an opinion are not in conformity with generally accepted accounting principles (GAAP) because management has failed to capitalize leases. The CPA suggests appropriate revisions to the financial statements, but management refuses to accept the CPA’s suggestions. Under these circumstances, the CPA ordinarily would:
A. Describe the nature of the departure from GAAP in the CPA's report and state the effects on the financial statements, if practicable. B. Express limited assurance that no other material modifications should be made to the financial statements. C. Restrict the distribution of the CPA's report to management and the entity's board of directors. D. Issue a qualified opinion or adverse opinion depending on the materiality of the departure from GAAP.
Choice “A” is correct. If the client refuses to accept the CPA’s suggestions, the CPA should add a paragraph modifying the disclaimer to describe the nature and effect of the departure from GAAP.
A4
An auditor scans a client’s investment records for the period just before and just after the year-end to determine that any transfers between categories of investments have been properly recorded. The primary purpose of this procedure is to obtain evidence about management’s financial statement assertions of:
A. Valuation and accuracy, and rights and obligations. B. Understandability of presentation and classification, and valuation and accuracy. C. Existence, and understandability of presentation and classification. D. Rights and obligations, and existence.
Choice “B” is correct. Investments may be classified as trading, available-for-sale, or held-to-maturity. The classification of each investment into one of these three categories determines how it will be shown on the balance sheet (understandability of presentation and classification) and whether it will be valued at market or at amortized cost (valuation and accuracy).
A3
Analytical procedures are most appropriate when testing which of the following types of transactions?
A. Long-term debt transactions. B. Payroll and benefit liabilities. C. Acquisitions and disposals of fixed assets. D. Operating expense transactions.
Choice “D” is correct. Relationships involving income statement accounts tend to be more predictable than relationships involving only balance sheet accounts because income statement accounts represent transactions over a period of time, whereas balance sheet accounts represent amounts as of a point in time. As a result, analytical procedures are more appropriate for operating expense accounts.
A5
Auditors conducting an audit in accordance with the Single Audit Act use a risk-based approach designed to:
A. Reduce audit risk by providing an equal opportunity for all grants to be tested. B. Reduce audit risk by providing an equal opportunity for all expended federal dollars to be tested. C. Focus the audit on high-risk programs. D. Focus the audit on grants related to large federal programs.
Choice “C” is correct. The risk-based approach of the Single Audit Act is designed to focus the auditor’s tests of federal financial assistance on the programs with the highest risk.
A3
With respect to accounting estimates, an auditor:
A. Is not responsible for auditing estimated amounts, since they may be based on subjective determinations made by management. B. Should focus on assumptions that are objective, insensitive to variation, and don't deviate from historical patterns. C. Bears responsibility for making reasonable estimates and including them in the financial statements. D. Should verify that all material estimates required by generally accepted accounting principles have been developed.
Choice “D” is correct. The auditor should verify that all material estimates required by GAAP have been developed.
A4
Under properly designed internal control, the same employee most likely would match vendors’ invoices with receiving reports and also:
A. Cancel vendors' invoices after payment. B. Recompute the calculations on vendors' invoices. C. Reconcile the accounts payable ledger. D. Post the detailed accounts payable records.
Choice “B” is correct. Matching vendor’s invoices with receiving reports provides authorization for payment and is generally performed in the accounts payable department. Recalculation of vendor invoices is compatible with this authorization function.
A4
Sally, CPA, is performing cutoff testing for inventory for the calendar year-end Year 2 audit. She noticed that the company shipped merchandise valued at $36,000 to a consignee on December 26, Year 2, and recorded the relief of inventory and sale on that date. The consignee sold the merchandise on January 4, Year 3. The merchandise is sold to the consignee at a profit margin of 20 percent. The company refuses to book any adjusting journal entry. Which of the following entries is Sally likely to include on the summary of uncorrected misstatements?
A. Debit (Dr) Credit (Cr) Sales 45,000
Inventory
36,000
Accounts receivable
45,000
Cost of goods sold
36,000
B. Debit (Dr) Credit (Cr) Accounts receivable 45,000
Cost of goods sold
36,000
Sales
45,000
Inventory
36,000
C. Debit (Dr) Credit (Cr) Accounts receivable 36,000
Cost of goods sold
28,800
Sales
36,000
Inventory
28,800
D. Debit (Dr) Credit (Cr) Sales 36,000
Inventory
28,800
Accounts receivable
36,000
Cost of goods sold
28,800
Choice “A” is correct. The consignee did not sell the merchandise before year-end; therefore, the inventory should be recorded on the books. Because the company recorded the relief and sale of inventory, reverse those journal entries.
The question states the merchandise (aka inventory) is valued at $36,000, which is sold with a 20 percent profit margin.
Sales
100 percent
− $36,000
80 percent
Profit
20 percent
Sales value is $45,000 (calculation $36,000 / 0.8).
(Double check: $9,000 = 20 percent profit on the sales amount of $45,000.)
A2
Which of the following is required before accepting a new audit engagement?
I.
Making inquiries of the predecessor auditor regarding management integrity.
II.
Making inquiries of the predecessor auditor regarding matters that may affect the conduct of the audit.
III.
Understanding the prospective client’s business and the industry in which it operates.
A. Only II and III. B. I, II, and III. C. Only I and III. D. I only.
Choice “D” is correct. Before accepting a new audit engagement, the auditor is required to make inquiries of the predecessor auditor regarding matters that may bear on management integrity. Making inquiries of the predecessor auditor regarding matters that may affect the conduct of the audit and developing an understanding of the prospective client’s business and industry are tasks which may be performed after acceptance of the engagement.
A1
Under U.S. GAAS, in which of the following situations would a group engagement partner least likely make reference to component auditor who audited a subsidiary of the entity?
A. The financial statements audited by the component auditor are material to the consolidated financial statements covered by the group engagement partner's opinion. B. The group engagement partner finds it impractical to review the component auditor's work or otherwise be satisfied as to the component auditor's work. C. The group engagement partner is unable to be satisfied as to the independence and professional reputation of the component auditor. D. The component auditor was retained by the group engagement partner and the work was performed under the group engagement partner's guidance and control.
Choice “D” is correct. Under U.S. GAAS, when the group engagement partner assumes responsibility for the component auditor’s work, the group engagement partner would not mention the component auditor in the audit report (opinion). The group engagement auditor would generally assume responsibility after reviewing the audit documentation of the component auditor and performing supplemental audit tests, or by reputation, e.g., if the component auditor is a correspondent (foreign) firm in which the group engagement partner auditor has developed confidence.
A5
Smith CPAs found multiple material weaknesses in internal control during an audit of an issuer. Management failed to report two of the three material weaknesses identified. Which of the following should not be included in the auditor’s report:
A. The definition of a material weakness. B. A disclaimer of opinion. C. A statement that material weaknesses have been identified. D. A statement that management failed to report two material weaknesses identified by the auditor with a description of the omitted weaknesses.
Choice “B” is correct. A material weakness requires the auditor to issue an adverse opinion.
A2
In an engagement to examine management’s discussion and analysis (MD&A), which of the following best defines control risk?
A. The risk of detecting misstatements that are material to the MD&A presentation taken as a whole. B. The risk that material misstatements in the MD&A presentation will not be prevented in a timely manner. C. The risk that an assertion within the MD&A will lead to a material misstatement. D. The risk that the practitioner will not uncover a material misstatement within an MD&A assertion.
Choice “B” is correct. Control risk is the risk that a material misstatement that could occur in an assertion within MD&A will not be prevented or detected on a timely basis.
A3
Which of the following explanations best describes why an auditor may decide to reduce tests of details for a particular audit objective?
A. The audit is being performed soon after the balance sheet date. B. Audit staff are experienced in performing the planned procedures. C. Analytical procedures have revealed no unusual or unexpected results. D. There were many transactions posted to the account during the period.
Choice “C” is correct. If analytical procedures have revealed no unusual or unexpected results, the auditor may decide to reduce tests of details for a particular audit objective. Substantive analytical review procedures may be sufficient to reduce the planned level of detection risk to an acceptably low level.
A1
An auditor’s report under U.S. auditing standards that refers to a scope limitation that is material but not pervasive contains the words, “In our opinion, except for the below-mentioned limitation on the scope of our audit . . . .” This is considered a(n):
A. Disclaimer of opinion B. Adverse opinion C. Qualified opinion D. Example of inappropriate wording
Choice “D” is correct. “In our opinion, except for the below-mentioned limitation on the scope of our audit . . .” is an example of inappropriate wording. When the auditor expresses a qualified opinion due to a scope limitation, the auditor should state in the opinion paragraph that the qualification pertains to the possible effects of the matter on the financial statements and not to the scope limitation itself. The wording used should be, “In our opinion, except for the possible effects of the matter described in the Basis for Qualified Opinion section . . . .”
A4
Under properly designed internal control, the same employee most likely would match vendors’ invoices with receiving reports and also:
A. Recompute the calculations on vendors' invoices. B. Reconcile the accounts payable ledger. C. Post the detailed accounts payable records. D. Cancel vendors' invoices after payment.
Choice “A” is correct. Matching vendor’s invoices with receiving reports provides authorization for payment and is generally performed in the accounts payable department. Recalculation of vendor invoices is compatible with this authorization function.
A5
Which of the following is least likely to be included in an examination report related to a financial projection?
A. An opinion that the projection is presented in conformity with AICPA guidelines. B. An indication that had the accountants performed additional procedures, other matters might have come to their attention that would have been reported. C. A statement that the report is intended solely for the information and use of specified parties. D. An opinion that the underlying assumptions are suitably supported and provide a reasonable basis for management's projection.
Choice “B” is correct. This statement would be included in an agreed-upon procedures report, not an examination report.
A4
Which of the following sets of information does an auditor usually confirm on one form?
A. Inventory on consignment and contingent liabilities. B. Accounts receivable and accrued interest receivable. C. Accounts payable and purchase commitments. D. Cash in bank and collateral for loans.
Choice “D” is correct. The standard AICPA bank confirmation form includes spaces for the bank to confirm both cash balances on deposit at the bank and collateral pledged on loans originating from the bank.
A4
When the shipping department returns nonconforming goods to a vendor, the purchasing department should send to the accounting department the:
A. Credit memo. B. Unpaid voucher. C. Debit memo. D. Vendor invoice.
Choice “C” is correct. When nonconforming goods are returned to a vendor, the purchasing department should send a debit memo to the accounting department to ensure that the accounts payable balance is reduced appropriately.
A1
Subsequently discovered facts that lead to a change in an audit opinion may be presented in:
Emphasis-of-Matter
Paragraph
Other-Matter
Paragraph
A. Yes
Yes
B. Yes
No
C. No
No
D. No
Yes
Choice “A” is correct. Subsequently discovered facts that lead to a change in an audit opinion may be presented in an emphasis-of-matter paragraph or other-matter paragraph.
A3
An auditor of a nonissuer should design tests of details to ensure that sufficient audit evidence supports which of the following?
A. The planned level of control risk. B. The effectiveness of controls. C. The planned level of assurance at the relevant assertion level. D. Management's assertions that controls exist and are operating efficiently.
Choice “C” is correct. An auditor of a nonissuer should design tests of details to ensure that sufficient audit evidence supports the planned level of assurance at the relevant assertion level.
A6
The auditor should determine whether providing a nonaudit service would create a threat to independence, either by itself or in aggregate with other nonaudit services provided, with respect to any audit it performs in accordance with Generally Accepted Government Auditing Standards. A critical component of this determination is:
A. Ability of a professional staff member who was not a member of the audit team to review the work performed. B. Ability to remove the auditor involved in the nonaudit service from the audit team. C. Ability of outside auditors to independently review the nonaudit service. D. Consideration of management’s ability to effectively oversee the nonaudit service to be performed.
Choice “D” is correct. A critical component of the determination of whether providing a nonaudit service would create a threat to independence is consideration of management’s ability to effectively oversee the nonaudit service to be performed.
A3
Which of the following is not a reason justifying the use of accounting estimates?
A. The valuation or measurement of some accounts is uncertain pending the outcome of future events. B. Data about past events cannot be accumulated in a cost-effective manner. C. Data about past events cannot be accumulated in a timely manner. D. Data about future events cannot be accumulated in a cost-effective manner.
Choice “D” is correct. Accounting estimates are not used to measure future events. (Although, the measurement of some accounts may be uncertain pending the outcome of future events.)
A6
A CPA is considering whether to accept an engagement to prepare financial statements for a new client. Which of the following statements is correct regarding the independence of the CPA?
A. The CPA is required to disclose in the engagement report any relationships with the client's personnel. B. The CPA should be independent of the client. C. The CPA is not required to make a determination of whether the CPA is independent of the client. D. The CPA should obtain management's understanding regarding the benefits of an accountant being independent of a client.
Choice “C” is correct. A CPA is not required to make a determination of whether the CPA is independent of the client for a preparation engagement because it is a nonattest service.
A4
On receiving a client’s bank cutoff statement, an auditor most likely would trace:
A. Prior-year checks listed in the cutoff statement to the year-end outstanding checklist. B. Deposits recorded in the cash receipts journal after year-end to the cutoff statement. C. Checks dated after year-end listed in the cutoff statement to the year-end outstanding checklist. D. Deposits in transit listed in the cutoff statement to the year-end bank reconciliation.
Choice “A” is correct. The auditor should obtain bank cutoff statements that include transactions for 10 to 15 days after year-end. The outstanding checks and deposits in transit at year-end on the bank reconciliation should agree with the information in the bank cutoff statement.
A2
The monitoring component of internal control excludes:
A. Improving controls that are not operating effectively. B. Eliminating controls that are not operating effectively. C. Assessing the quality of control performance over time. D. Assessing information derived from external parties.
Choice “B” is correct. Monitoring is the process of assessing the quality of internal control performance over time and taking necessary corrective actions. Eliminating a control that is not operating effectively would not be an appropriate corrective action.
A2
Which of the following statements is true regarding the risk assessment component of internal control?
A. An auditor's evaluation of an entity's risk assessment may not be applicable to the audit of every entity. B. An auditor evaluates an entity's risk assessment because it is a component of overall audit risk in a financial statement audit. C. An auditor evaluates an entity's risk assessment to understand how management addresses risks relevant to financial reporting. D. An auditor need not consider an entity's risk assessment because he or she is primarily concerned with audit risk in a financial statement audit.
Choice “C” is correct. The auditor needs to understand how management addresses risks relevant to financial reporting in order to properly plan the audit.
A4
Which of the following procedures most likely would be considered a weakness in an entity’s internal controls over payroll?
A. A voucher for the amount of the payroll is prepared in the general accounting department based on the payroll department's payroll summary. B. Payroll checks are prepared by the payroll department and signed by the treasurer. C. The personnel department sends employees' termination notices to the payroll department. D. The employee who distributes payroll checks returns unclaimed payroll checks to the payroll department.
Choice “D” is correct. If the employee who distributes payroll checks returns unclaimed checks to the payroll department, an unscrupulous payroll department employee might be able to set up a fictitious employee and convert the checks once they are returned to the payroll department. Unclaimed checks should be turned over to the cashier in the treasurer’s department.
A4
According to PCAOB standards, what should an auditor do to evaluate the potential effect of management bias due to management’s selective correction of misstatements?
A. Obtain an understanding of the reasons that management decided not to correct misstatements communicated by the auditor. B. Reperform the substantive audit procedures that identified the uncorrected misstatements to evaluate their validity. C. Perform additional audit procedures to identify further uncorrected misstatements. D. Consider whether other forms of management bias could offset the selective correction of misstatements.
Choice “A” is correct. When evaluating audit findings, the auditor should consider any potential bias in management’s judgments about the amounts and disclosures in the financial statements. This bias can be demonstrated by selective correction of misstatements brought to management’s attention during the audit. Therefore, the auditor should understand why management decided not to correct misstatements.
A4
Which of the following is not considered evidence of failure in the operation of internal controls?
A. Management override of controls. B. Insufficient control consciousness. C. Undue bias or lack of objectivity. D. Misrepresentation by client personnel to the auditor.
Choice “B” is correct. Insufficient control consciousness is an example of a deficiency in the design of controls, not evidence of failure in the operation of internal controls.
A5
Which of the following statements is least likely to be included in a report on the examination of a financial projection?
A. This report is not intended to be and should not be used by anyone other than these specified parties. B. The accompanying projection is presented in conformity with guidelines for presentation of a projection established by the Public Company Accounting Oversight Board. C. The underlying assumptions are suitably supported and provide a reasonable basis for management’s projection. D. Differences will usually exist between the projected and actual results.
Choice “B” is correct. An examination of a financial projection should state: “We plan and perform the examination to obtain reasonable assurance about whether the projection is presented in accordance with the guidelines for the presentation of a projection established by the American Institute of Certified Public Accountants.”
A4
To establish the existence and ownership of a long-term investment in the common stock of a publicly traded company, an auditor ordinarily performs a security count or:
A. Confirms the number of shares owned with the issuing company. B. Confirms the number of shares owned that are held by an independent custodian. C. Relies on the client's internal accounting controls if the auditor has reasonable assurance that the control activities are being applied as prescribed. D. Determines the market price per share at the balance sheet date from published quotations.
Choice “B” is correct. Auditors obtain a confirmation (safekeeping list) indicating the number of shares of stocks held by an outside independent custodian.
A5
A public accounting firm was performing an integrated audit for Lenon Co., a nonissuer. The audit team noted the following control deficiencies during the audit. Which of these control deficiencies would not be considered a material weakness?
A. Fraud committed by senior management. B. Audit team identification of a material misstatement that Lenon Co.’s controls would not have detected. C. Ineffective oversight by those charged with governance. D. Inadequate design of an IT control.
Choice “D” is correct. Inadequate design of an IT control in and of itself would be an example of a deficiency in the design of control but does not necessarily indicate a material weakness.
A1
An auditor concludes that there is a material inconsistency in the other information in an annual report to shareholders containing audited financial statements. The auditor believes that the financial statements do not require revision, but the client is unwilling to revise or eliminate the material inconsistency in the other information. Under these circumstances, what action would the auditor most likely take next?
A. Disclaim an opinion on the financial statements after explaining the material inconsistency in a other-matter paragraph. B. Communicate this matter with those charged with governance. C. Issue an "except for" qualified opinion after discussing the matter with the client's audit committee. D. Consider the situation closed because the other information is not in the audited financial statements.
Choice “B” is correct. If the auditor discovers a material inconsistency in other information accompanying the audited financial statements, the financial statements do not require revision, and the client refuses to eliminate or revise the inconsistency, the auditor should communicate the matter with those charged with governance and then consider 1) revising the report to include a separate “Other Information” section describing the material inconsistency, 2) withholding the use of the report, or 3) withdrawing from the engagement and consulting with legal counsel.
A3
Which of the following most accurately describes the process of a walkthrough?
A. Observation of an entity's activities and operations. B. Following a transaction from its origination until it is reflected in the financial statements. C. Inspection of selected documents, records, and internal control documentation. D. Testing and documenting the results of tests of selected controls.
Choice “B” is correct. A walkthrough follows a transaction from its origination until it is reflected in the financial statements. This description “most accurately” describes the process of a walkthrough.
A5
When an accountant compiles projected financial statements, the accountant’s report should include a statement that:
A. Expresses limited assurance that the results will be within the projected range. B. Describes the limitations on the usefulness of the projection. C. Evaluates the hypothetical assumptions used to prepare the projection. D. Disclaims any form of assurance on the historical financial statements.
Choice “B” is correct. A compilation of a financial projection report describes the limitations on the usefulness of the projection by including a caveat that the prospective results may not be achieved.
Which of the following procedures would an auditor most likely perform to obtain evidence about the occurrence of subsequent events?
A. Inquiring as to whether any unusual adjustments were made after year-end. B. Confirming a sample of material accounts receivable established after year-end. C. Comparing the financial statements being reported on with those of the prior period. D. Investigating personnel changes in the accounting department occurring after year-end.
Choice “A” is correct. An auditor would most likely inquire as to whether any unusual adjustments were made after year-end that would require adjustment to and/or disclosure in the year-end financial statements.
A5
Which of the following procedures should an accountant perform during an engagement to compile prospective financial statements?
A. Compare the prospective financial statements with the entity's historical results for the prior year. B. Make inquiries prior to the date of the report about possible future transactions that may impact the forecast once the report is issued. C. Make inquiries about the accounting principles used in the preparation of the prospective financial statements. D. Test the entity's internal controls to determine if adequate controls exist so that financial projections can be reasonably achieved.
Choice “C” is correct. An accountant performing an engagement to compile prospective financial statements should make inquiries about the accounting principles used in the preparation of the prospective financial statements.
A1
Which of the following is a true statement regarding other information included in documents containing audited financial statements?
A. The auditor is not required to reference the other information in the audit report on the financial statements. B. The auditor may choose to add an emphasis-of-matter paragraph, which includes a disclaimer of opinion on other information, in the audit report on the financial statements. C. The auditor has no responsibility for other information as long as it is outside the basic financial statements. D. The auditor should add a separate section with the heading "Other Information," which includes a disclaimer of opinion on other information, in the audit report on the financial statements.
Choice “D” is correct. The auditor should add a separate section with the heading “Other Information,” which includes a disclaimer of opinion on other information, in the audit report on the financial statements. Disclaimer of opinion means to deny providing an opinion. The section will include the statement, “we do not express an opinion . . . .”
A3
The objective of tests of details of transactions performed as tests of controls is to:
A. Detect material misstatements in the account balances of the financial statements. B. Determine whether controls have been implemented. C. Evaluate whether controls operated effectively. D. Monitor the design and use of entity documents such as prenumbered shipping forms.
Choice “C” is correct. The objective of tests of details used as tests of controls is to evaluate whether a control operated effectively.
A2
Which of the following matters generally is included in an auditor’s engagement letter?
A. The factors to be considered in setting preliminary judgments about materiality. B. Management’s responsibility for the fair presentation of the financial statements. C. The auditor's responsibility to search for significant internal control deficiencies. D. Management's vicarious liability for violations of laws and regulations committed by its employees.
Choice “B” is correct. An understanding with the client should be established regarding management’s responsibilities, which include the preparation and fair presentation of the financial statements in accordance with the applicable financial reporting framework. The understanding should be documented through a written communication, such as an engagement letter.
A6
An accountant compiles unaudited financial statements that are not expected to be used by a third party. The accountant may decline to issue a compilation report provided:
I.
Each page of the financial statements is clearly marked to restrict its use.
II.
A written engagement letter is used to document the understanding with the client.
III.
A written representation letter is obtained from the client’s management.
Choice “C” is correct. SSARS requires compiled financial statements to be accompanied by a compilation report even if the financial statements are not expected to be used by a third party.
A4
n auditor most likely would limit substantive audit tests of sales transactions when control risk is assessed as low for the occurrence assertion concerning sales transactions and the auditor has already gathered evidence supporting:
A. Cutoffs of sales and purchases. B. Shipping and receiving activities. C. Cash receipts and accounts receivable. D. Opening and closing inventory balances.
Choice “C” is correct. Examination of accounts receivable and cash receipts provides the auditor with evidence with respect to both the completeness and the occurrence of sales transactions, thus limiting the need to test sales transactions.
A3
If an organization decides to use regression, which is a forecasting model, what type of data analytic process would it be implementing?
A. Diagnostic analytics B. Predictive analytics C. Descriptive analytics D. Prescriptive analytics
Choice “B” is correct. Predictive analytics use statistical techniques and forecasting models to predict what could happen.
A2
If the auditor is in the process of identifying client risks that may result in a material misstatement due to fraud, all of the following attributes should be considered with the exception of which of the following items?
A. Recurrence of risk identified in prior audit. B. Significance of the risk. C. Type of risk. D. Pervasiveness of the risk.
Choice “A” is correct. This does not represent one of the four attributes used by the auditor to identify material misstatement as a result of client fraud. When identifying attributes associated with fraud risk, the auditor should be focused on the current year’s audit. Although not included as one of the answer choices, the likelihood of the risk is the fourth attribute that should be assessed by the auditor.
A2
Davis, CPA, accepted an engagement to audit the financial statements of Tech Resources, a nonissuer. Before the completion of the audit, Tech requested Davis to change the engagement to a compilation of financial statements. Before Davis agrees to change the engagement, Davis is required to consider the:
Additional audit
effort necessary to
complete the audit
Reason given
for Tech’s request
A.
Yes
Yes
B. Yes
No
C. No
No
D. No
Yes
Choice “A” is correct. When an auditor is requested to change the engagement from an audit to a compilation, the auditor must consider the effort needed to complete the audit, the cost of completing the audit, and the reasons for the client’s request. If the audit is substantially complete or an insignificant effort is needed to complete the audit, the auditor should consider the propriety of agreeing to the request.
In addition, if the reason for the request is to limit the scope of the auditor’s examination, the auditor must consider whether the information affected by the scope limitation is incorrect, incomplete, or otherwise unsatisfactory.
A change in circumstance (e.g., an audit is no longer necessary) or a misunderstanding as to the nature of an audit would, on the other hand, be considered a reasonable basis for the change.
A6
Which of the following is true about the AICPA code of professional conduct?
A. It applies only to members of the AICPA in public practice. B. It includes both rules, which provide an overall framework, and principles, which govern performance. C. Rules surrounding independence apply to all AICPA members. D. It applies to compilations and reviews of the financial statements of nonissuers.
Choice “D” is correct. The AICPA code of professional conduct governs any service that a member of the AICPA performs, including compilations and reviews.
A3
Which of the following is not true about accounting estimates?
A. Accounting estimates measure the effects of past transactions or events that cannot be determined in a timely cost-effective manner. B. Accounting estimates are monetary values within the financial statements for which there is an inherent lack of precision. C. An accounting estimate is an approximation of an account pending the outcome of a future event. D. An accounting estimate is an approximation of past events that can be determined on a timely cost-effective basis.
Choice “D” is correct. An accounting estimate pertains to determining the approximation of past events that cannot be determined on a timely, cost-effective basis. If the effect of a past event can be determined on a timely, cost-effective basis, there would be no reason to make an estimate.
A1
When there has been a change in accounting principles, but the effect of the change on the comparability of the financial statements is not material, the auditor should:
A. Explicitly state whether the change conforms with GAAP. B. Refer to the note in the financial statements that discusses the change. C. Not refer to the change in the auditor's report. D. Refer to the change in an emphasis-of-matter paragraph.
Choice “C” is correct. If the change in accounting principles has an immaterial effect on the comparability of financial statements, no revision to the audit report is necessary.
A2
An auditor uses the assessed level of control risk to:
A. Indicate whether materiality thresholds for planning and evaluation purposes are sufficiently high. B. Evaluate the effectiveness of the entity's system of internal control. C. Determine the acceptable level of detection risk for financial statement assertions. D. Identify transactions and account balances where inherent risk is at the maximum.
Choice “C” is correct. An auditor uses the assessed level of control risk to determine the risk of material misstatement, which in turn determines the acceptable level of detection risk for financial statement assertions. Detection risk should bear an inverse relationship to control risk. For example, the less control risk an auditor believes exists, the greater the level of detection risk he or she can accept.
A4
An auditor’s inquiries of management disclosed that the entity recently invested in a series of energy derivatives to hedge against the risks associated with fluctuating oil prices. Under these circumstances, the auditor should:
A. Document the derivatives in the auditor's communication with those charged with governance. B. Examine the contracts for possible risk exposure and the need to recognize losses. C. Confirm the marketability of the derivatives with a commodity specialist. D. Perform analytical procedures to determine if the derivatives are properly valued.
Choice “B” is correct. Generally accepted accounting principles specify that, in order to qualify for hedge treatment, the entity must demonstrate and disclose a number of transaction features including risk exposure. The auditor would therefore need to examine the contracts to evaluate the character of the hedge and the degree to which losses should be recognized in the determination of income, as well as the character of any disclosures.
A5
With respect to the expression of an opinion regarding whether a client maintained effective internal control over financial reporting:
A. The auditor of a nonissuer must express an opinion whenever significant deficiencies or material weaknesses are noted. B. The auditor of a nonissuer may express an opinion as a result of a financial statement audit. C. The auditor of a nonissuer may express an opinion as a result of an audit engagement. D. The auditor of a nonissuer must express an opinion in every financial statement audit.
Choice “C” is correct. The auditor of a nonissuer may be engaged to express an opinion on the design and/or operating effectiveness of the entity’s internal control. This is considered an audit engagement. Note that an audit of internal control should be integrated with an audit of the financial statements.
A3
In trying to predict how long the economy will be in its current recovery phase before entering an expansionary phase, economists will look at all of the following indicators except:
A. The length of time, on average, that job seekers are unemployed. B. Building permits for new home construction. C. Prices for materials used in production. D. Data regarding new claims for unemployment.
Choice “A” is correct. Average time for unemployment is a lagging indicator, which means it follows economic activity and provides signals after the fact. If economists are trying to predict the length of business cycles, they will look to leading indicators.
A3
Which of the following procedures most likely could assist an auditor in identifying related party transactions?
A. Performing tests of controls concerning the segregation of duties. B. Reviewing confirmations of compensating balance arrangements. C. Scanning the accounting records for recurring transactions. D. Evaluating the reasonableness of management's accounting estimates.
Choice “B” is correct. Compensating balance arrangements may be maintained by or for related parties.
A1
A scope limitation sufficient to preclude an unmodified opinion always will result when management:
A. Prevents the auditor from reviewing the audit documentation of the predecessor auditor. B. Requests that certain material accounts receivable not be confirmed. C. Engages the auditor after the year-end physical inventory is completed. D. Refuses to acknowledge its responsibility for the fair presentation of the financial statements in conformity with GAAP.
Choice “D” is correct. The management’s responsibility paragraph of the standard unmodified report includes a statement that the financial statements are the responsibility of the company’s management. Management’s refusal to accept responsibility for the fair presentation of the financial statements therefore precludes issuance of this standard report.
