Chapter 1

Question 1

What are some mitigating factors about an entity’s ability to continue as a going concern?

Answer 1

Plans to increase ownership equity, to borrow money, to restructure debt, to sell assets, and/or to reduce or delay expenditures (such as R&D) might all be considered mitigating factors.

Question 2

What are the effects of going concern issues on the auditor’s report?

Answer 2

If there is adequate disclosure of going concern, the auditor would issue an unmodified opinion with emphasis-of-matter paragraph. If there is inadequate disclosure of going concern (GAAP), the auditor would either issue a qualified or adverse opinion. If there is significant going concern uncertainty (GAAS), the auditor would issue a disclaimer opinion.

Question 3

When would a group engagement partner make reference to the work of a component auditor in the audit report?

Answer 3

Under U.S. GAAP, the group engagement partner makes reference in the audit report to the work of a component auditor when the group engagement partner is unable to review the component auditor’s audit documentation. This is because the group engagement partner will be unable to be satisfied concerning the work performed by the component auditor. Even though the component auditor has an excellent reputation, the partner must see the work to be able to assume responsibility for it. When the group engagement partner decides to assume responsibility for the work of the component auditor, no reference is made to the work of the component auditor, regardless of the type of audit report expressed. Note that under ISAs, no reference is made to the component auditor unless required by law or regulation.

Question 4

What type of opinion is issued when there is no or little material (immaterial) misstatement?

Answer 4

Unmodified opinion (for both GAAP and GAAS purposes).

Question 5

What type of opinion is issued if there is a material misstatement, but not pervasive?

Answer 5

If the effect would result in materially misstated financial statements (GAAP), the auditor would issue a qualified opinion. If the effect would result in an inability to continue as a going concern (GAAS), the auditor would issue a qualified opinion.

Question 6

What type of opinion is issued if there is a material and pervasive misstatement?

Answer 6

If the effect would result in material misstated financial statements (GAAP), the auditor would issue an adverse opinion. If the effect would result in an inability to continue as a going concern (GAAS), the auditor would issue a disclaimer of opinion.

Question 7

How is consistency expressed in an auditor’s report?

Answer 7

Consistency is implicit in the auditor’s report, and will be explicitly mentioned in an emphasis-of-matter paragraph only if there are issues with consistency.

Question 8

When would an “except for” qualification be used?

Answer 8

It is used for a scope limitation or a departure from GAAP, but not for emphasis-of-matter.

Question 9

Which paragraphs of an auditor’s report on financial statements under U.S. auditing standards should refer to GAAS and GAAP?

Answer 9

Under U.S. auditing standards, the auditor states that the audit was conducted in accordance with GAAS in the Auditor’s Responsibility paragraph. The auditor expresses an opinion on the financial statements’ conformity with GAAP in the Opinion paragraph.

Question 10

When an auditor qualifies his opinion because of a scope limitation, the opinion paragraph of the auditor’s report should state the qualification pertains to:

Answer 10

The possible effects no the financial statements, not to the scope limitation itself.

Question 11

When should an auditor disclose the substantive reasons for expressing an adverse opinion in a basis for modification paragraph?

Answer 11

Preceding the Opinion paragraph.

Question 12

Under International Standards on Auditing, the going concern period is:

Answer 12

must be at least, but not limited to, one year from the date of the financial statements being audited. Under US auditing standards, the going concern period cannot exceed one year from the date of the financial statements being audited.

Question 13

What is an auditor’s responsibility for supplementary information which is outside the basic financial statements, but required by FASB?

Answer 13

The auditor should apply certain limited procedures to the required supplementary information, and add an other-matter paragraph to the financial statement audit report.

Question 14

What is meant by the term generally accepted auditing standards (GAAS)?

Answer 14

GAAS are measures of the quality of the auditor’s performance, and guide the auditor in the performance of a properly planned and executed audit.

Question 15

Which phrase should be included in the opinion paragraph when an auditor expresses a qualified opinion?

Answer 15

A qualified opinion phrase is “in our opinion, except for [explanation of problem] as discussed in the preceding paragraph…”

Question 16

What is required of the auditor in obtaining reasonable assurance?

Answer 16

In order to obtain reasonable assurance, the auditor must (a) plan the work and properly supervise any assistants; (b) determine and apply appropriate materiality levels; © identify and assess risks of material misstatement, whether due to fraud or error; and (d) obtain sufficient audit evidence.

Question 17

How would a division of responsibility affect the auditor’s report?

Answer 17

A division of responsibility affects the Auditor’s Responsibility paragraph and the Opinion paragraph, but does not require the inclusion of a Basis for Opinion paragraph.

Question 18

Which of the following statements is a basic element of the auditor’s report under U.S. auditing standards?

Answer 18

An audit includes evaluating significant estimates made by management. Under U.S. auditing standards, the auditor’s report includes a statement that “An audit includes evaluating…significant estimates by management…”

Question 19

State the primary purpose of an audit.

Answer 19

To provide financial statement users with an opinion on whether the financial statements are fairly presented, in all material respects, in accordance with the applicable financial reporting framework.

Question 20

Identify three inherent limitations of an audit.

Answer 20

1. The nature of financial reporting
2. The nature of audit procedures
3. Timeliness of financial reporting and the balance between benefit and cost

Question 21

Which standards provide the most authoritative U.S. auditing guidance for nonissuers and issuers, and who issues those standards?

Answer 21

Nonissuers: Statements on Auditing Standards (SASs), issued by the AICPA Auditing Standards Board.

Issuers: Auditing Standards (ASs), issued by the Public Company Accounting Oversight Board (PCAOB) plus all SAS adopted by the PCAOB.

Question 22

Describe the role of the International Auditing and Assurance Standards Board (IAASB) and the use of International Standards of Auditing (ISAs).

Answer 22

IAASB is a standard-setting board of the International Federation of Accountants (IFAC) that establishes ISAs.

Currently, over 100 countries are using or are in the process of adopting ISAs.

ISAs do not override local laws/regulations or national standards that govern the audits of financial statements in a given country.

Question 23

What are the five general GAAS requirements related to the conduct of an audit?

Answer 23

Professional skepticism
Ethical requirements
Professional judgment
Sufficient and Appropriate audit evidence
Compliance with GAAS

Question 24

List in order the primary sections of an unmodified audit opinion.

Answer 24

Title: Independent Auditor’s Report
Addressee: Based on the circumstances of the engagement
Management’s Responsibility for the Financial Statements: Management is responsible for the preparation and fair presentation of the financial statements…
Auditor’s Responsibility: Our responsibility is to express an opinion on these financial statements based on our audit.
Opinion: In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position…
Report on Other Legal and Regulatory Requirements: If applicable

Question 25

What should be included in the introductory paragraph of the unmodified audit opinion?

Answer 25

The introductory paragraph should include:

1. The entity whose financial statements have been audited
2. A statement that the financial statements were audited
3. The title of each financial statement audited
4. Dates or periods covered by each financial statement

Question 26

What should be included in the Management’s Responsibility paragraph of the unmodified audit opinion?

Answer 26

1. An explanation that management is responsible for the preparation and fair presentation of the financial statements.
2. A statement that this responsibility includes the design, implementation, and maintenance of internal control.

Question 27

What should be included in the Auditor’s Responsibility paragraph of the unmodified audit opinion?

Answer 27

1. A statement that it is the auditor’s responsibility to express an opinion on the financial statements based on the audit.
2. A statement that the audit was conducted in accordance with auditing standards generally accepted in the United States of America.
3. A statement that standards require that the auditor plan and perform an audit to obtain reasonable assurance about whether the financial statements are free of material misstatement
4. A description of the audit.

Question 28

What should be included in the opinion paragraph of the unmodified audit opinion?

Answer 28

1. A statement that the financial statements present fairly, in all material respects, the financial position of the entity as of the balance sheet date and the results of operations and its cash flows for the period then ended, in accordance with the applicable financial reporting framework.
2. Identification of the applicable financial reporting framework and its origin.

Question 29

Where in the standard unmodified opinion does the auditor refer to (1) the applicable financial reporting framework (i.e., GAAP or IFRS) and (2) generally accepted auditing standards?

Answer 29

1. The applicable financial reporting framework is referred to in the management’s responsibility paragraph and opinion paragraph.
2. GAAs is referred to in the auditor’s responsibility paragraph.

Question 30

Identify the key differences in the auditor’s report under U.S. GAAS and the ISAs.

Answer 30

Requirements in Auditor’s Report under ISAs (not GAAS):
1. The introductory paragraph refers to the summary of significant accounting policies and other explanatory information.
2. The report may refer to “the preparation and fair presentation of the financial statements” (consistent with GAAS) or “the preparation of financial statement that give a true and fair view” (not allowed under GAAS).
3. The auditor’s responsibility paragraph must include a statement that the auditing standards require that the auditor comply with ethical requirements.
Requirements in Auditor’s Report under GAAS (not ISAs):
1. Sufficient appropriate audit evidence should include evidence that the audit documentation has been reviewed.
2. The description of management responsibilities for the financial statements in the auditor’s report should not be referenced to a separate statement by management if such a statement is included in a document containing the auditor’s report.

Question 31

Define a component auditor.

Answer 31

A component auditor is an auditor who performs work on the financial information of a component that will be used as audit evidence for the group audit. The component auditor may be part of the group engagement partner’s firm, a network firm, or another firm.

Question 32

Identify the two requirements that are necessary to reference a component auditor in the auditor’s report.

Answer 32

Reference to the component auditor in the auditor’s report can be made if the following requirements are met:

1. The component auditor has performed an audit in accordance with GAAS, or when required, the PCAOB.
2. The component auditor’s report is not restricted use.

Question 33

What are the responsibilities of a group engagement partner (team) when it assumes responsibility for the work of a component auditor?

Answer 33

No reference to the component auditor is made in the auditor’s report.

If the component is a significant component due to its individual financial significance, it should be audited by the group engagement team or the component auditor.

When a component is deemed significant because of significant risks of material misstatement to the group financial statements, the group engagement team or component auditor should perform additional audit procedures pertaining to the potential risks identified.

Question 34

When should an auditor’s opinion be modified?

Answer 34

A modification to the auditor’s report is necessary when:
1. The auditor determines that the financial statements as a whole are materially misstated (GAAP issue); or 2. The auditor is unable to obtain sufficient appropriate audit evidence to conclude that the financial statements as a whole are free from material misstatement (GAAS issue).

Question 35

What is the purpose of an emphasis-of-matter paragraph?

Answer 35

The purpose of an emphasis-of-matter paragraph is to reference a matter that is appropriately presented in the financial statements, but is of such importance that it is fundamental to the user’s understanding of the financial statements.

Question 36

What are the reporting requirements for an emphasis of matter paragraph?

Answer 36

1. Placing the paragraph immediately after the opinion paragraph.
2. Using the heading “emphasis-of-matter” or another appropriate heading.
3. Describing the matter being emphasized and the location of relevant disclosures in the financial statements.
4. Indicating that the auditor’s opinion is not modified with respect to the matter emphasized.

Question 37

Under what circumstances would an emphasis of matter paragraph be required in an auditor’s report?

Answer 37

1. The auditor determines there is substantial doubt regarding the entity’s ability to continue as a going-concern for a reasonable time period
2. there is a need to describe a justified change in accounting principle that has a material effect on the entity’s financial statements
3. facts are subsequently discovered that lead to a change in the auditor’s opinion (note: an other matter paragraph may also be appropriate)
4. the financial statements are prepared in accordance with an applicable special purpose framework, other than regulatory basis financial statements intended for general use.

Question 38

What are the reporting requirements for an other-matter paragraph?

Answer 38

1. Placing the paragraph immediately after the opinion paragraph and after any emphasis of matter paragraph
2. Using the heading “other-matter” or another appropriate heading
3. Describing the matter being emphasized and the location of relevant disclosures, if applicable, in the financial statements.

Question 39

Under what circumstances would an auditor use an other-matter paragraph in an auditor’s report?

Answer 39

1. the auditor includes an alert in the audit report that restricts its use
2. facts are subsequently discovered that lead to a change in auditor’s opinion (note: an emphasis of matter paragraph may also be appropriate).
3. prior period financial statements were audited by a predecessor auditor and the predecessor’s audit report is not reissued
4. current period financial statements are audited and presented in comparative form with compiled or reviewed financial statements for the prior period
5. Prior to the release date, the auditor identifies a material inconsistency in other information included in a document with audited financial statements that requires revision and management refuses to make the revision
6. The auditor chooses (or is required) to report on supplementary information presented with financial statements in auditor’s report
7. special purpose financial statements are prepared in accordance with a contractual/regulatory basis of accounting (requiring a restriction on the use of the auditor’s report); or
8. the auditor’s report on the financial statements includes a compliance report.

Question 40

Evidence from what auditing procedures may lead the auditor to conclude that there is significant doubt about an entity’s ability to continue as a going concern? Hint: ADMITS

Answer 40

Evidence from the following procedures may reveal going concern issues:
Analytical procedures
Debt compliance (review compliance)
Minutes (review from board meetings)
Inquiry of client’s legal counsel
Third parties (review financial support arrangements)
Subsequent events review.

Question 41

What conditions and events may indicate substantial doubt about an entity’s ability to continue as a going concern? Hint: FINE

Answer 41

Financial difficulties
Internal matters, such as labor difficulties, substantial dependence on a particular project, etc.
Negative trends
External matters, such as legal proceedings, new legislation, loss of a principal customer, natural disasters, etc.

Question 42

According to U.S. Auditing Standards, what phrases must be included in a going concern emphasis of matter paragraph?

Answer 42

“substantial doubt” and “going concern”

Question 43

What is the going concern period for (1) U.S. GAAS and (2) ISA?

Answer 43

1. The going concern period should not exceed one year under US auditing standards
2. The going concern period may be greater than or equal to one year under ISAs.

Question 44

When there is a year-to-year lack of comparability (consistency) in an entity’s financial statements due to an acceptable change in accounting principle, how does the auditor reflect this in the current year’s auditor’s report?

Answer 44

When the auditor concludes that the change in accounting principle is acceptable (justified), the auditor should include an emphasis of matter paragraph in the report describing the change in accounting principle and provide a reference to the entity’s disclosure of the change.

If the justified change in accounting principle is deemed immaterial, no revision to the report is necessary.

Question 45

How is an alert that restricts the use of the auditor’s written communication reflected in the auditor’s report and what items should be included in the alert?

Answer 45

An other matter paragraph is used to restrict the use of the auditor’s report when required by GAAs or when auditor deems necessary.

The alert that restricts the use of the auditor’s written communication includes:

1. a statement that the auditor’s written communication is intended solely for the information and use of the specified parties;
2. identification of the specified parties for whom use is intended; and
3. a statement that the auditor’s written communication is not intended to be and should not be used by anyone other than the specified parties.

Question 46

When would an auditor use professional judgment to determine whether to issue a qualified opinion or an adverse opinion?

Answer 46

When audit evidence indicates that there is material misstatement of the financial statements.

A qualified opinion is issued when the auditor concludes that misstatements, individually or in the aggregate, are material but not pervasive to the financial statements.

An adverse opinion is issued when the auditor concludes that misstatements individually or in the aggregate, are both material and pervasive to the financial statements.

Question 47

Describe the circumstances in which a material misstatement of the financial statements may arise.

Answer 47

Misstatements may arise in relation to:

1. The appropriateness of accounting policies
2. The application of accounting policies
3. The appropriateness of the financial statement presentation
4. The appropriateness or adequacy of disclosures in the financial statements

Question 48

When would an auditor use professional judgment to determine whether to issue a qualified opinion or a disclaimer of opinion?

Answer 48

When there is a limitation on the scope of the audit.

A qualified opinion is issued when an auditor is unable to obtain sufficient appropriate audit evidence on which to base an opinion and the auditor determines that the possible effects could be material but not pervasive.

A disclaimer of opinion is expressed when the auditor is unable to obtain sufficient appropriate audit evidence on which to base an opinion and the auditor determines that the possible effects could be both material and pervasive.

Question 49

If an opinion is modified, where does the paragraph explaining the modification appear?

Answer 49

The paragraph explaining the modification would appear prior to the opinion paragraph. The “basis for modification” paragraph should use the appropriate heading. Appropriate headings include:
Basis for qualified opinion, basis for adverse opinion, and basis for disclaimer of opinion

Question 50

Identify some causes of scope limitations.

Answer 50

Restrictions on the auditor’s ability to perform auditing procedures may be caused by:
circumstances, management, inability to observe inventory, inability to confirm receivables, refusal of the client’s attorney to respond to inquiry, and/or refusal of management to provide a representation letter

Question 51

The auditor’s report should not be dated earlier than the date on which the auditor has obtained sufficient appropriate audit evidence. This should include evidence that what three things have occurred?

Answer 51

Evidence that:

1. audit documentation has been reviewed;
2. financial statements have been prepared; and
3. management has taken responsibility for the financial statements.

Question 52

What situations may result in a disclaimer of opinion in an audit report?

Answer 52

1. pervasive inability to obtain sufficient appropriate audit evidence
2. lack of independence (always results in disclaimer)
3. going concern uncertainty (note: if adequate disclosure of going concern exists, the auditor may choose between an unmodified opinion with an emphasis-of-matter paragraph or a disclaimer of opinion).

Question 53

Compared to a standard unmodified opinion, determine the paragraphs that are modified in an audit report when the following opinions are issued: qualified, adverse, disclaimer.

Answer 53

Qualified: standard intro, standard mgmt responsibility paragraph, Name type of modified opinion in auditor’s responsibility paragraph, add a Basis for opinion, and “except for” to the opinion paragraph

Adverse: standard intro, standard mgmt responsibility paragraph, name type of modified opinion in auditor’s responsibility paragraph, add basis for opinion, and “do not present fairly” to the opinion paragraph

Disclaimer: “Engaged to audit” intro, standard mgmt responsibility paragraph, “not able to obtain” auditor responsibility paragraph, add a basis for opinion, and disclaimer of opinion

Question 54

According to US GAAP, when are contingencies (such as pending litigation) required to be accrued and disclosed or disclosed only?

Answer 54

If auditor can estimate a loss amount and it is probable, accrue and disclose. All other options are disclosed only. Exception, if remote, auditor may ignore, unless a “guarantee type” contingency, then disclose.

Question 55

If during the current examination of comparative financial statements, the auditor discovers evidence that affects the prior statements and the opinion that was expressed, what action should be taken? HINT: only DORCS change their mind!

Answer 55

The auditor should update the opinion in the current year’s report. If the opinion differs from the previous opinion, the reasons should be disclosed in a separate emphasis of matter or other matter paragraph following the opining paragraph.

The explanatory paragraph should disclose the:
Date of the auditor's previous report
Opinion type previously issued
Reason for prior opinion
Changes that have occurred
Statement "opinion...is different."

Question 56

The predecessor auditor should take what steps before reissuing an audit report on prior period financial statements?

Answer 56

Read the statements for the current period.
Compare the previous audited statements with the current period statements.
Obtain a letter of representation from the successor auditor.
Obtain a letter of representation from management at or near the date of reissuance.
If unrevised, use original report date; if revised, dual date the report.

Question 57

What statements should be included in the auditor’s report in an other matter paragraph when comparative financial statements are presented and the prior auditor’s report is not reissued?

Answer 57

1. A statement that the financial statements of the prior period were audited by the predecessor auditor.
2. The type of opinion expressed by the predecessor auditor. If the opinion was modified, include the reasons for the modification.
3. The nature of any emphasis of matter or other matter paragraph included in the predecessor’s report.
4. The date of the predecessor’s report.

Question 58

What is the effect on the audit report when the current period financial statements are audited and presented in comparative format with prior period financial statements that were not audited?

Answer 58

If the prior period financial statements were reviewed or compiled, an other matter paragraph is added that includes:

1. a description of the service performed in the prior period
2. the date of the prior period report
3. a description of any material modifications in the report; and
4. a statement that the service was less in scope than an audit and does not provide a basis for expressing an opinion on the financial statements.

If the prior period financial statements were not audited, reviewed, or compiled, the other matter paragraph should indicate this and state that the auditor assumes no responsibility for the financial statements.

Question 59

Define the two types of subsequent events.

Answer 59

A recognized subsequent event relates to a condition that existed on or before the balance sheet date. Recognized subsequent events require financial statement adjustment.

A nonrecognized subsequent even occurs after the balance sheet date. Nonrecognized subsequent events generally do not require financial statement adjustment, but may require a footnote disclosure.

Question 60

What procedures should the auditor perform during the subsequent period?

Answer 60

Between the date of the financial statements and the date of the auditor’s report (subsequent period), the auditor should:
Review post balance sheet transactions.
Obtain a representation letter from mgmt describing events that occurred during the subsequent period requiring adjustment to the financial statements.
Inquire with mgmt or those charged with governance whether subsequent events occurred that could impact financial statements.
Review minutes of board and committee meetings.
Examine current interim financial statements and compare to financial statements under audit.

Question 61

After the date of the auditor’s report, what actions should an auditor take regarding subsequent events?

Answer 61

None. Although the auditor is responsible for investigating subsequent events until the date of the auditor’s report, the auditor has no active responsibility to make inquiries or perform auditing procedures after that date.

Question 62

When and why is dual dating used?

Answer 62

Dual dating is used when subsequent events requiring financial statement adjustment or disclosure come to the auditor’s attention after the original date of the audit report. Dual dating extends the auditor’s responsibility only for the particular subsequent event. The original date of the report is retained for the rest of the financial statements.

Question 63

After issuance of the report, what actions should an auditor take upon discovering information that materially affects the report?

Answer 63

Determine whether there are persons relying or likely to rely on the financial statements.

Advise the client to immediately disclose the new information to persons currently relying or likely to rely on the financial statements. This disclosure may take the form of revised financial statements, disclosures and revisions to any imminent financial statements, or notification that the financial statements and report should not be relied upon.

Advise the client to discuss the new disclosures or revisions with the SEC, stock exchanges, and appropriate regulatory agencies.

Ensure that appropriate steps have been taken by the client.

Question 64

What actions should an auditor take upon discovering omitted audit procedures?

Answer 64

The auditor should:

1. Determine whether other procedures were adequate to compensate for the omitted procedures.
2. If not, and if there are people likely to be relying on the report, apply the omitted (or alternative) procedures.
3. If facts emerge that support a different opinion, advise the client to make appropriate disclosure and notification.

Question 65

What is the auditor’s responsibility with respect to information accompanying the basic financial statements in a client-prepared document?

Answer 65

The auditor should read the other information to determine that it is consistent with audited financial statements and that there are no material inconsistencies or material misstatements of fact.

The auditor may (but is not required to) report on the other information.

Question 66

What are the two objectives of engagements to report on supplementary information?

Answer 66

1. To evaluate the presentation of the supplementary information in relation to the financial statements as a whole.
2. To report on whether the supplementary information is fairly stated, in all material respects, in relation to the financial statements as a whole.

Question 67

What procedures would an auditor perform related to supplementary information that accompanies the financial statements and is required by a designated accounting standards setter, such as the FASB?

Answer 67

Apply limited procedures, which includes:

Inquiry regarding how the supplementary information was prepared including changes from prior years and significant assumptions used.
Determining whether the methods used are consistent with mgmt’s responses, audited financial statements, and other knowledge.
Obtaining written mgmt representations regarding the required supplemental information.
The auditor may (but is not required to) issue an opinion on the information.

Question 68

List several features of a report on the application of the requirements of an applicable financial reporting framework.

Answer 68

Description of engagement, entity, and transaction
Reference to AICPA standards
Description of the appropriate application of the requirements of the applicable financial reporting framework to the specific transaction or type of report
Preparers are responsible for proper accounting
Differences in facts, circumstances, or assumptions may change the report
Restricted use paragraph

Question 69

When accepting an engagement to audit financial statements prepared in accordance with a financial framework generally accepted in another country, the auditor should obtain an understanding of:

Answer 69

The purpose for which the financial statements are prepared.
Whether the financial reporting framework is a fair presentation framework.
The intended users of the financial statements.
The steps taken by mgmt to ensure that the applicable financial reporting framework is acceptable under the circumstances.
The legal responsibilities involved (if using the form and content of another country’s audit report)

Question 70

What are the reporting options for financial statements prepared in accordance with a financial reporting framework generally accepted in another country when the financial statements will be distributed outside the US only? What if the financial statements are also intended for use within the US?

Answer 70

Distributed outside the US only:
1. Report form of the other country or the report sent out in the ISAs (if applicable); or
2. US style report modified to refer to the financial reporting framework generally accepted in another country.
Distributed Within the US: Standard US report with an emphasis of matter paragraph that:
1. Identifies the financial reporting framework
2. Refers to the note in the financial statements describing the framework
3. Indicates the framework differs from accounting principles generally accepted in the USA.