CH 9 & 10

Question 1

Which of the following expressions is least likely to be
included in a client’s representation letter?
a. No events have occurred subsequent to the balance sheet
date that require adjustment to, or disclosure in,
the financial statements.
b. The company has complied with all aspects of
contractual agreements that would have a material
effect on the financial statements in the event of
noncompliance.
c. Management acknowledges responsibility for illegal
actions committed by employees.
d. Management has made available all financial statements
and related data.

Answer 1

c. Management acknowledges responsibility for illegal actions committed by employees.

Question 2

When reviewing working papers, an audit supervisor will be
primarily concerned with determining whether the
a. Audit programs have been carried out without deviation.
b. Working papers adequately support the audit findings,
conclusions, and reports.
c. Working papers reflect adherence to budget constraints.
d. Auditing department’s standard formats and tick marks
have been used consistently.

Answer 2

b. Working papers adequately support the audit findings,
conclusions, and reports.

Question 3

A written representation from a client’s management which, among other matters, acknowledges responsibility for the fair presentation of financial statements, should normally be signed by the
a. Chief executive officer and the chief financial
officer.
b. Chief financial officer and the chairman of the board of directors.
c. Chairman of the audit committee of the board of directors.
d. Chief executive officer, and the chairman of the board of directors, and the client’s lawyer.

Answer 3

a. Chief executive officer and the chief financial
officer.

Question 4

Generally accepted auditing standards require the auditor to apply analytical procedures in both the planning and review stages of the audit. The major reason for applying analytical procedures as part of audit review is
a. To identify abnormalities that warrant audit attention.
b. To assist the auditor in establishing materiality thresholds.
c. To ascertain that the auditor has gathered adequate evidence to resolve suspicions arising during the planning stages of the audit.
d. To provide documentary evidence in the event of future
litigation.

Answer 4

c. To ascertain that the auditor has gathered adequate evidence to resolve suspicions arising during the planning stages of the audit.

Question 5

The existence of a related party transaction may be
indicated when another entity
a. Sells real estate to the corporation at a price that
is comparable to its appraised value.
b. Absorbs expenses of the corporation.
c. Borrows from the corporation at a rate of interest
which equals the current market rate.
d. Lends to the corporation at a rate of interest which
equals the current market rate.

Answer 5

b. Absorbs expenses of the corporation.

Question 6

The main purpose of the auditor/client conference held at
the close of audit field work is to
a. Discuss unresolved matters and audit fee arrangements.
b. Review proposed audit adjustments, internal control
weaknesses, and needed disclosures, and agree on the
type of audit report to be rendered.
c. Discuss areas of major audit risk and use of client
personnel to assist in high risk areas.
d. Arrange for a meeting with outside legal counsel for
the purpose of discussing pending litigation.

Answer 6

b. Review proposed audit adjustments, internal control
weaknesses, and needed disclosures, and agree on the
type of audit report to be rendered.

Question 7

After discovering that a related party transaction exists,
the auditor should be aware that the
a. Substance of the transaction could be significantly
different from its form.
b. Adequacy of disclosure of the transaction is secondary
to its legal form.
c. Transaction is assumed to be outside the ordinary
course of business.
d. Financial statements should recognize the legal form
of the transaction rather than its substance.

Answer 7

a. Substance of the transaction could be significantly
different from its form.

Question 8

Which of the following matters describes a “reportable
condition” that should be included in the auditor’s
communication of the same?
a. A significant audit adjustment was required because a
major year-end adjustment was inadvertently overlooked
by the client.
b. The client’s recently installed on-line real-time
computer system lacks necessary input editing features.
c. A major customer of the client is verging on
bankruptcy.
d. The auditors do not agree with the economic feasibility
of the client’s proposed acquisition of a new
subsidiary.

Answer 8

b. The client’s recently installed on-line real-time
computer system lacks necessary input editing features.

Question 9

An attorney is responding to an independent auditor as a
result of the audit client’s letter of inquiry. The
attorney may appropriately limit the response to
a. Asserted claims and litigation.
b. Matters to which the attorney has given substantive
attention in the form of legal consultation or
representation.
c. Asserted, overtly threatened, or pending claims and
litigation.
d. Items which have an extremely high probability of
being resolved to the client’s detriment.

Answer 9

b. Matters to which the attorney has given substantive
attention in the form of legal consultation or representation.

Question 10

An auditor is verifying a company’s ownership of equipment
What is the best evidence of ownership?
a. The current year’s depreciation expense journal entry.
b. A canceled check written to acquire the equipment.
c. An interview with the equipment custodian verifying
company ownership.
d. The presence of the equipment on the company’s balance
sheet.

Answer 10

b. A canceled check written to acquire the equipment.

Question 11

If a lawyer refuses to furnish corroborating information
regarding litigation, claims, and assessments, the auditor
should
a. Honor the confidentiality of the client-lawyer
relationship.
b. Consider the refusal to be tantamount to a scope limitation.
c. Seek to obtain the corroborating information from
management.
d. Disclose this fact in a footnote to the financial
statements.

Answer 11

b. Consider the refusal to be tantamount to a scope limitation.

Question 12

In auditing investments for proper valuation, the auditor
should do all but the following:
a. Confirm securities held in safekeeping off the client’s
premises.
b. Vouch purchases and sales of securities by tracing to
brokers’ advices and canceled checks.
c. Compare cost and market by reference to year end market
values for selected securities.
d. Recalculate gain or loss on disposals.

Answer 12

a. Confirm securities held in safekeeping off the client’s
premises.

Question 13

When examining a client’s statement of cash flows for audit
evidence, an auditor will rely primarily upon
a. Determination of the amount of working capital at
year-end.
b. Cross-referencing to balances and transactions reviewed in connection with the examination of the other
financial statements.
c. Analysis of significant ratios of prior years as
compared to the current year.
d. The guidance provided by the APB Opinion on the
statement of cash flows.

Answer 13

b. Cross-referencing to balances and transactions reviewed in connection with the examination of the other
financial statements.

Question 14

A limitation on the scope of the auditor’s examination
sufficient to preclude an unqualified opinion will always
result when management
a. Prevents the auditor from reviewing the working papers
of the predecessor auditor.
b. Engages the auditor after the year-end physical
inventory count is completed.
c. Fails to correct a material internal control weakness
that had been identified during the prior year’s audit.
d. Refuses to furnish a client representation letter to the auditor.

Answer 14

d. Refuses to furnish a client representation letter to the auditor.

Question 15

When an audit is made in accordance with generally accepted auditing standards, the auditor should always
a. Test control procedures by reprocessing a representative sample of completed transactions.
b. Examine all negotiable and nonnegotiable securities,
regardless of location.
c. Obtain certain written representations from management.
d. Observe the taking of the physical inventory on the
balance sheet date.

Answer 15

c. Obtain certain written representations from management.

Question 16

Which of the following audit procedures provides the best
evidence about the collectability of notes receivable?
a. Confirmation of note receivable balances with the
debtors.
b. Examination of notes for appropriate debtors’
signatures.
c. Examination of cash receipts records to determine promptness of interest and principal payments.
d. Reconciliation of the detail of notes receivable and
the provision for uncollectible amounts to the general
ledger control.

Answer 16

c. Examination of cash receipts records to determine promptness of interest and principal payments.

Question 17

An audit program for the examination of the retained
earnings account should include a step that requires
verification of the
a. Market value used to charge retained earnings for a
two-for-one stock split.
b. Approval of the adjustment to the beginning balance as
a result of a write-down of an account receivable.
c. Authorization for both cash and stock dividends.
d. Gain or loss resulting from disposition of treasury
shares.

Answer 17

c. Authorization for both cash and stock dividends.

Question 18

In testing the reasonableness of interest income, an auditor
could most effectively use analytical tests involving
a. The beginning balance in the investments account for
fixed income securities.
b. The average monthly balance in the investments account
for fixed income securities.
c. The ending balance in the investments accounts for
fixed income securities.
d. Documentary support of specific entries in the account.

Answer 18

b. The average monthly balance in the investments account
for fixed income securities.

Question 19

Which of the following would provide the best form of
evidential matter pertaining to the annual valuation of a
long-term investment in which the independent auditor’s
client owns a 30% voting interest?
a. Market quotations of the investee company’s stock.
b. Current fair value of the investee company’s assets.
c. Historical cost of the investee company’s assets.
d. Audited financial statements of the investee company.

Answer 19

d. Audited financial statements of the investee company.

Question 20

Which of the following is a “Type I” subsequent event?
a. The client’s Long Island warehouse was destroyed by
fire two weeks following the balance sheet date. The
warehouse and its contents were uninsured and
represented 15% of the client’s total assets.
b. As the result of an uninsured flood loss, one of the
client’s major customers declared bankruptcy. The
client doesn’t expect to recover more than 5% of the
outstanding receivable which accounts for 30% of total
accounts receivable. The flood and bankruptcy
declaration both occurred after the balance date but
before the release of the audit report. No additional
provision for loss had been made as of year end.
c. Three weeks after the balance sheet date, a major
strike was called by the labor union representing 80%
of the client’s work force.
d. After the balance sheet date, but prior to release of
the audit report, a product liability judgment against
the client was rendered by a judge. The judgment
assessed damages and fines totaling 30% of audited net
income. The events giving rise to the judgment
occurred prior to the balance sheet date. The client
does not plan to appeal the decision.

Answer 20

d. After the balance sheet date, but prior to release of
the audit report, a product liability judgment against
the client was rendered by a judge. The judgment
assessed damages and fines totaling 30% of audited net
income. The events giving rise to the judgment
occurred prior to the balance sheet date. The client
does not plan to appeal the decision.

Question 21

Which of the following statements regarding the audit of
negotiable notes receivable is not correct?
a. The auditor should confirm all notes receivable as of
the balance sheet date.
b. Materiality of the amount involved is a factor
considered when selecting the accounts to be confirmed.
c. Physical inspection of a note by the auditor does not
provide conclusive evidence.
d. Notes receivable discounted with recourse need to be
confirmed.

Answer 21

a. The auditor should confirm all notes receivable as of
the balance sheet date.

Question 22

Which of the following matters should not be included in the
auditor’s letter of communication with the client’s audit
committee?
a. An audit adjustment was required reducing inventory by
40%.
b. Management was reluctant to answer the auditor’s
questions concerning the economic substance of material
related party transactions.
c. Contrary to a previous understanding, the client did
not have an adjusted trial balance completed prior to
the commencing of audit field work. Moreover, several
errors were detected by the audit team as a result of
significant weaknesses in internal control.
d. An internal control weakness discovered during the
previous year’s audit was corrected during the current
year.

Answer 22

d. An internal control weakness discovered during the
previous year’s audit was corrected during the current
year.

Question 23

Apex, Incorporated issued common stock to acquire another
company, in an acquisition that was accounted for as a
pooling of interests. The auditor examining this
transaction would be least interested in
a. The net book value of the acquired company.
b. The par value of the stock that was issued.
c. Whether or not the acquisition was approved by the
board of directors of Apex, Incorporated.
d. Whether the fair market value of the acquired assets
were independently appraised.

Answer 23

d. Whether the fair market value of the acquired assets
were independently appraised.

Question 24

An internal auditor discovered an error in a receivable due
from a major stockholder. The receivable’s balance accounts
for less than one percent of the company’s total
receivables. Would the auditor be likely to consider the
error material?
a. Yes, if relative risk is low.
b. No, if there will be further transactions with
this stockholder.
c. Yes, because a related party is involved.
d. No, because a small dollar amount is in error.

Answer 24

c. Yes, because a related party is involved.

Question 25

Two months before the year end, the bookkeeper erroneously
recorded the receipt of a long-term bank loan by a debit to
cash and a credit to sales. Which of the following is the
most effective procedure for detecting this type of error?
a. Analyze the notes payable journal.
b. Analyze bank confirmation information.
c. Prepare a year-end bank reconciliation.
d. Prepare a year-end bank transfer schedule.

Answer 25

b. Analyze bank confirmation information.

Question 26

Of the following statements regarding further analysis of
materiality thresholds during audit review, which one is
true?
a. Audit adjustments reducing net income may suggest a
need to lower individual item and aggregate materiality
thresholds.
b. Audit adjustments reducing net income may suggest a
need to lower the individual item threshold, but
should not affect aggregate materiality thresholds.
c. Audit adjustments that increase net income may suggest
a need to lower aggregate materiality thresholds.
d. An increase in the assessment of control risk suggests
a need to lower the individual item materiality
threshold.

Answer 26

a. Audit adjustments reducing net income may suggest a
need to lower individual item and aggregate materiality
thresholds.

Question 27

A written understanding between the auditor and the client
concerning the auditor’s responsibility for the discovery of
illegal acts is usually set forth in a(an)
a. Client representation letter.
b. Letter of audit inquiry.
c. Management letter.
d. Engagement letter.

Answer 27

d. Engagement letter.

Question 28

A letter from the company’s attorney in response to
inquiries about possible litigation is best described as:
a. Confirmation evidence.
b. Analytical evidence.
c. Documentary evidence.
d. Physical evidence.

Answer 28

a. Confirmation evidence.

Question 29

The auditor can best verify a client’s bond sinking fund
transactions and year-end balance by
a. Confirmation with individual holders of retired bonds.
b. Confirmation with the bond trustee.
c. Recomputation of interest expense, interest payable,
and amortization of bond discount or premium.
d. Examination and count of the bonds retired during the
year.

Answer 29

b. Confirmation with the bond trustee.

Question 30

Which of the following procedures would an auditor
ordinarily perform during the review of subsequent
events?
a. An analysis of related party transactions for the
discovery of possible fraud.
b. A review of the cut-off bank statements for the period
after the year-end.
c. An inquiry of the client’s legal counsel concerning
litigation.
d. An investigation of material weaknesses in internal
control previously communicated to the client.

Answer 30

c. An inquiry of the client’s legal counsel concerning
litigation.

Question 31

Which of the following is not an audit procedure which the
independent auditor would perform with respect to
litigation, claims, and assessments.
a. Inquire of and discuss with management the policies
and procedures adopted for identifying, evaluating, and
accounting for litigation, claims, and assessments.
b. Obtain from management a description and evaluation
of litigation, claims, and assessments that existed at
the balance sheet date.
c. Obtain assurance from management that it has disclosed
all unasserted claims that the lawyer has advised are
probable of assertion and must be disclosed.
d. Confirm directly with the client’s lawyer that all
claims have been recorded in the financial statements.

Answer 31

d. Confirm directly with the client’s lawyer that all
claims have been recorded in the financial statements.

Question 32

The auditee has acquired another company by purchase. Which
of the following would be the best audit procedure to test
the appropriateness of the allocation of cost to tangible
assets?
a. Determine whether assets have been recorded at their
book value at the date of purchase.
b. Evaluate procedures used to estimate and record fair
market values for purchased assets.
c. Evaluate the reasonableness of recorded values by use
of replacement cost data.
d. Evaluate the reasonableness of recorded values by
discussion with operating personnel.

Answer 32

b. Evaluate procedures used to estimate and record fair
market values for purchased assets.

Question 33

A CPA has received an attorney’s letter in which no
significant disagreements with the client’s assessments of
contingent liabilities were noted. The resignation of the
client’s lawyer shortly after receipt of the letter should
alert the auditor that
a. Undisclosed unasserted claims may have arisen.
b. The attorney was unable to form a conclusion with
respect to the significance of litigation, claims, and
assessments.
c. The auditor must begin a completely new examination of
contingent liabilities.
d. An adverse opinion will be necessary

Answer 33

a. Undisclosed unasserted claims may have arisen.

Question 34

An audit procedure that provides evidence about proper
valuation of marketable securities arising from a short-term
investment of excess cash is
a. Comparison of carrying value with current market
quotations.
b. Confirmation of securities held by broker.
c. Recalculation of investment carrying value by applying
the equity method.
d. Calculation of premium or discount amortization.

Answer 34

a. Comparison of carrying value with current market
quotations.

Question 35

Hall accepted an engagement to audit the 2002 financial
statements of XYZ Company. XYZ completed the preparation of
the 2002 financial statements on February 13, 2003, and Hall
began the field work on February 17, 2003. Hall completed
the field work on March 24, 2003, and completed the report
on March 28, 2003. The client’s representation letter
normally would be dated
a. February 13, 2003
b. February 17, 2003
c. March 24, 2003
d. March 28, 2003

Answer 35

c. March 24, 2003

Question 36

The auditee has just acquired another company by purchasing
all its assets. As a result of the purchase, “goodwill” has
been recorded on the auditee’s books. Which of the
following comparisons would be the most appropriate audit
test for the amount of recorded goodwill?
a. The purchase price and the book value of assets
purchased.
b. The figure for goodwill specified in the contract for purchase.
c. Earnings in excess of 15% of net assets for the past
five years.
d. The purchase price and the fair market value of assets
purchased.

Answer 36

d. The purchase price and the fair market value of assets
purchased.

Question 37

All corporate capital stock transactions should ultimately
be traced to the
a. Minutes of the Board of Directors.
b. Cash receipts journal.
c. Cash disbursements journal.
d. Numbered stock certificates.

Answer 37

a. Minutes of the Board of Directors.

Question 38

A logical substantive test for accrued interest receivable
would be to
a. Compare the interest income with published interestinvestment records.
b. Verify the interest income by a calculation based on
the face amount of notes and the nominal interest rate.
c. Verify the cost, carrying value, and market value of
notes receivable.
d. Recalculate interest earned and compare it to the
amounts received.

Answer 38

d. Recalculate interest earned and compare it to the
amounts received.

Question 39

In verifying the amount of goodwill recorded by a client,
the most convincing evidence which an auditor can obtain is
by comparing the recorded value of assets acquired with the
a. Assessed value as evidenced by tax bills.
b. Seller’s book value as evidenced by financial
statements.
c. Insured value as evidenced by insurance policies.
d. Appraised value as evidenced by independent appraisals.

Answer 39

d. Appraised value as evidenced by independent appraisals.

Question 40

An auditor who wishes to substantiate the gross balance of
the account “Trade Notes Receivable” is considering the
advisability of performing the four procedures listed below.
Which pair of procedures is best suited to this objective?
I. Age the receivables.
II. Confirm the notes with the makers.
III. Inspect the notes.
IV. Trace a sample of postings from the sales journal to
the notes receivable ledger.
a. I and III.
b. I and IV.
c. II and III.
d. II and IV.

Answer 40

c. II and III.

Question 41

Jones was engaged to examine the financial statements of
Gamma Corporation for the year ended June 30, 2002. Having
completed an examination of the investment securities, which
of the following is the best method of verifying the
accuracy of recorded dividend income?
a. Tracing recorded dividend income to cash receipts
records and validated deposit slips.
b. Utilizing analytical review techniques and statistical
sampling.
c. Comparing recorded dividends with amounts appearing on
federal information forms 1099.
d. Comparing recorded dividends with a standard financial reporting service’s record of dividends.

Answer 41

d. Comparing recorded dividends with a standard financial reporting service’s record of dividends.

Question 42

An auditor’s program to examine long-term debt most likely
would include steps that require
a. Comparing the carrying amount of the debt to its yearend market value.
b. Correlating interest expense recorded for the period
with outstanding debt.
c. Verifying the existence of the holders of the debt by
direct confirmation.
d. Inspecting the accounts payable subsidiary ledger for
unrecorded long-term debt.

Answer 42

b. Correlating interest expense recorded for the period
with outstanding debt.

Question 43

Two alternative means for determining that recorded
securities exist are ____ and ____. be compared with the client’s investment record for
agreement. In this regard, the auditor tests for existence
of securities by tracing from ____ ____ (investment
record or count sheet) to the ___ ___ (investment
record or count sheet); and the auditor tests for completeness by tracing from the ___ ___ to
the ___ ___.

Answer 43

INSPECTION (EXAMINATION), CONFIRMATION

INVESTMENT RECORD, COUNT SHEET, COUNT
SHEET, INVESTMENT RECORD

Question 44

Auditing intracompany transactions for consistency and completeness is known as a test for _____ _____.

Answer 44

ACCOUNTING SYMMETRY

Question 45

If investments in unconsolidated subsidiaries are accounted
for under the equity method, the auditor may need to insist
that the financial statements of these subsidiaries be

Answer 45

AUDITED

Question 46

Examining long-term debt agreements helps the auditor
identify necessary _____ and _____

Answer 46

ACCRUALS, DISCLOSURES

Question 47

Although a Type II subsequent event does not require
adjustment, it may require

Answer 47

disclosure

Question 48

An audit workpaper listing unresolved matters and the
ultimate disposition of these matters is commonly referred
to as a(n) _____ _____ workpaper.

Answer 48

OPEN ITEMS

Question 49

The vehicle that is designed to make management more aware
of their primary responsibility for fairness of financial
presentation is known as the _____ _____ _____.

Answer 49

CLIENT REPRESENTATION LETTER