Exam 3

Question 1

The audit objective that all transactions and accounts that should be presented in the financial statements are in fact included is related to which of the following assertions?
A) Existence.
B) Rights and obligations.
C) Completeness.
D) Valuation.

Answer 1

C) Completeness.

Question 2

An auditor selected items from the client’s detailed inventory listing (that agreed to the financial statements). During the physical inventory observation, the auditor then found each item selected and counted the number of units on hand. This procedure most likely intends to test which of the following management assertions?
A) completeness.
B) valuation.
C) presentation and disclosure.
D) existence.
E) rights and obligations.

Answer 2

D) existence.

Question 3

Holding all else constant, which of the following statement is correct about materiality?
A) A decrease in materiality leads to a less precise audit and a decrease in audit scope
B) An increase in materiality leads to a less precise audit and a decrease in audit scope
C) A change in materiality has no effect on the precision of an audit or on audit scope
D) A decrease in materiality leads to a more precise audit and a decrease in audit scope

Answer 3

B) An increase in materiality leads to a less precise audit and a decrease in audit scope

Question 4

Assuming that the materiality threshold is $900,000, which of the following most likely constitutes a material misstatement?
A) The accounting clerk did not book a $600,000 sale transaction because related the shipping documents was not forwarded to her before the year-end.
B) An accountant books $50,000 revenue for a fictitious sale in order to meet earnings target .
C) An accountant understates the depreciation expense by $500,000 due to misunderstanding of the depreciation method.
D) A warehouse employee stole $900,000 of inventory. To cover up the theft, he made a journal entry by debiting inventory obsolescence expense account and crediting the inventory account by $900,000.

Answer 4

B) An accountant books $50,000 revenue for a fictitious sale in order to meet earnings target .

Question 5

The audit client’s gross margin percentage was unchanged from the prior year although gross margin increased from the prior year. Which of the following provides the best explanation?
A) Sales increased while costs of goods sold decreased compared to the prior year.
B) Sales decreased while costs of goods sold increased compared to the prior year.
C) Sales increased at the same percentage as cost of goods sold compared to the prior year.
D) Sales decreased at the same percentage as cost of goods sold compared to the prior year.

Answer 5

C) Sales increased at the same percentage as cost of goods sold compared to the prior year.

Question 6

When using confirmations to provide evidence about the completeness assertion for accounts payable, the appropriate population most likely would be
A) vendors with whom the entity has previously done business.
B) amounts recorded in the accounts payable subsidiary ledger.
C) payees of checks drawn in the month after the year-end.
D) invoices filed in the entity’s open invoice file.

Answer 6

A) vendors with whom the entity has previously done business.

Question 7

Which of the following audit procedures is best for identifying unrecorded accounts payable?
A) Reviewing cash disbursements recorded subsequent to the balance sheet date to determine whether the related payables apply to the prior period.
B) Investigating payables recorded just prior to and just subsequent to the balance sheet date to determine whether they are supported by receiving reports
C) Examining unusual relationships between monthly accounts payable balances and recorded cash payments
D) Reconciling vendors’ statements to the file of receiving reports to identify items received just prior to the balance sheet date

Answer 7

A) Reviewing cash disbursements recorded subsequent to the balance sheet date to determine whether the related payables apply to the prior period.

Question 8

Before the year end physical inventory, the final receiving report is #R387. Which of the following statement is correct?
A) All receipts with receiving report number less than #R387 should be included in the year end inventory; and all receipts with receiving report number greater than #R387 should be excluded from the year end inventory;
B) All receipts with receiving report number less than #R387 should be excluded from the year end inventory; and all receipts with receiving report number greater than #R387 should be included in the year end inventory;
C) All receipts with receiving report number less than #R387 should be included in the year end inventory; and all receipts with receiving report number greater than #R387 should be included in the year end inventory;
D) All receipts with receiving report number less than #R387 should be excluded from the year end inventory; and all receipts with receiving report number greater than #R387 should be excluded in the year end inventory;

Answer 8

A) All receipts with receiving report number less than #R387 should be included in the year end inventory; and all receipts with receiving report number greater than #R387 should be excluded from the year end inventory;

Question 9

Before the physical inventory, the final shipping report is #S980. Which of the following statement is correct?
A) All shipments with shipping report number less than #S980 should be included in the year end inventory; and all shipments with shipping report number greater than #S980 should be excluded from the year end inventory;
B) All shipments with shipping report number less than #S980 should be excluded from the year end inventory; and all shipments with shipping report number greater than #S980 should be included in the year end inventory;
C) All shipments with shipping report number less than #S980 should be excluded from the year end inventory; and all shipments with shipping report number greater than #S980 should be excluded from the year end inventory;
D) All shipments with shipping report number less than #S980 should be included in the year end inventory; and all shipments with shipping report number greater than #S980 should be included in the year end inventory;

Answer 9

B) All shipments with shipping report number less than #S980 should be excluded from the year end inventory; and all shipments with shipping report number greater than #S980 should be included in the year end inventory;

Question 10

The audit committee of a public company is primary responsible for which of the following tasks?
A) Prepare the financial statements to be audited by the external auditor;
B) Design and maintain effective internal controls over financial reporting;
C) To improve the effectiveness and efficiency of the operation of the company;
D) Oversight of the financial reporting process of the company, including hiring and compensating the external auditor and communicating with the external auditor on issues that arise from the audit process;

Answer 10

D) Oversight of the financial reporting process of the company, including hiring and compensating the external auditor and communicating with the external auditor on issues that arise from the audit process;

Question 11

For which of the following tasks may an independent auditor share responsibility with an entity’s internal auditor who is assessed to be both competent and objective?
A) Set the performance materiality for accounts receivable, yes; check the mathematical accuracy of the accounts receivable aging schedule, yes.
B) Select customer accounts from the accounts receivable subsidiary ledger for confirmation, yes; record customers’ responses from the accounts receivable confirmation, yes.
C) Calculate the fluctuation in allowance for uncollectible accounts receivable from the prior to current year, yes; assess whether current-year allowance for uncollectible accounts receivable appears reasonable, no;
D) For a client with 50 retail stores, select the stores to observe the physical inventory at the year end, no; perform test count during physical inventory, no.

Answer 11

C) Calculate the fluctuation in allowance for uncollectible accounts receivable from the prior to current year, yes; assess whether current-year allowance for uncollectible accounts receivable appears reasonable, no;

Question 12

If tests of controls induce the auditor to change the assessed level of control risk from 0.2 to 0.6, and audit risk (0.05) and inherent risk remain constant, the acceptable level of detection risk:
A) would most likely change from 0.1 to 0.3.
B) would most likely change from 0.3 to 0.1.
C) would most likely change from 0.12 to 0.04.
D) would be unchanged, because the auditor has control over detection risk.
E) cannot be determined because inherent risk is not given.

Answer 12

B) would most likely change from 0.3 to 0.1.

Question 13

An auditor selected a product recorded in the finished goods perpetual inventory subsidiary account. The auditor went to the warehouse and counted the product and compared this amount with the amount in the finished goods perpetual inventory subsidiary account. Which assertion is the auditor most likely testing?
A) Existence
B) Completeness
C) Rights and obligations
D) Valuation

Answer 13

A) Existence

Question 14

While observing a client’s annual physical inventory, an auditor recorded test counts for several items and noticed that certain test counts were higher than the recorded quantities in the client’s perpetual records. This situation could be the result of the client’s failure to record
A) purchase discounts.
B) purchase returns.
C) sales.
D) sales returns.

Answer 14

D) sales returns.

Question 15

Your client plans to count inventory at several locations on the same day. No location is material in amount, but the total of inventory is quite material. How is an auditor likely to plan to observe?
A) Observe all counts at all locations by using the required number of auditors.
B) Insist the inventory be counted on separate days so the auditor can be present at all locations.
C) Work with the client to determine which locations to observe.
D) Observe a sample of locations on a surprise basis.

Answer 15

D) Observe a sample of locations on a surprise basis.

Question 16

Counting different parts of inventory at different times of the year is called
A) LIFO inventory.
B) inventory cutoff.
C) cycle counting.
D) just-in-time inventory.

Answer 16

C) cycle counting.

Question 17

Inventory count tags are controlled
A) to prevent counting errors.
B) to test cutoff.
C) to prevent subsequent addition of goods to the inventory.
D) for reasons specified in all of the choices.

Answer 17

C) to prevent subsequent addition of goods to the inventory.

Question 18

An auditor will usually trace the details of the test counts made during the observation of physical inventory counts to a final inventory compilation. This audit procedure is undertaken to provide evidence that items physically present and observed by the auditor at the time of the physical inventory count are
A) owned by the client.
B) not obsolete.
C) physically present at the time of the preparation of the final inventory schedule.
D) included in the final inventory schedule.

Answer 18

D) included in the final inventory schedule.

Question 19

The audit procedures used in an observation of the client’s physical inventory are designed primarily to
A) observe and test the client’s physical count of inventory.
B) verify independently all the physical counts obtained by the client.
C) assist the client in taking counts of year-end inventory.
D) determine whether inventory contains obsolete goods.

Answer 19

A) observe and test the client’s physical count of inventory.

Question 20

Which of the following internal control activities most likely addresses the completeness assertion for inventory?
A) The work-in-process account is periodically reconciled with subsidiary inventory records.
B) Employees responsible for custody of finished goods do not perform the receiving function.
C) Receiving reports are prenumbered and the numbering sequence is checked periodically.
D) There is a separation of duties between the payroll department and inventory accounting personnel.

Answer 20

C) Receiving reports are prenumbered and the numbering sequence is checked periodically.

Question 21

When auditing inventories, an auditor would least likely verify that
A) all inventory owned by the client is on hand at the time of the count.
B) the client has used proper inventory pricing.
C) the financial statement presentation of inventories is appropriate.
D) damaged goods and obsolete items have been properly accounted for.

Answer 21

A) all inventory owned by the client is on hand at the time of the count.

Question 22

Which of the following auditing procedures probably would provide the most reliable evidence concerning the entity’s assertion of rights and obligations related to inventories?
A) Trace test counts noted during the entity’s physical count to the entity’s summarization of quantities.
B) Inspect agreements to determine whether any inventory is pledged as collateral or subject to any liens.
C) Select the last few shipping documents used before the physical count and determine whether the shipments were recorded as sales.
D) Inspect the open purchase order file for significant commitments that should be considered for disclosure.

Answer 22

B) Inspect agreements to determine whether any inventory is pledged as collateral or subject to any liens.

Question 23

Roll-forward work normally occurs between the ________ and the ________.
A) beginning of the year under audit; audit report release date
B) date of the financial statements; audit report release date
C) beginning of the year under audit; date of the financial statements
D) date of financial statement; date of the auditors’ report

Answer 23

D) date of financial statement; date of the auditors’ report

Question 24

Why should auditors be particularly concerned with “miscellaneous,” “other,” and “clearing” accounts classified as revenues or expenses?
A) These accounts are likely to relate to going-concern matters.
B) These accounts are often more difficult to audit using normal substantive procedures.
C) These accounts may represent attempts of earnings management.
D) These accounts are likely to require the assistance of a specialist.

Answer 24

C) These accounts may represent attempts of earnings management.

Question 25

Which of the following is typically not included in the inquiry letter sent to the client’s attorneys?
A) A disclaimer regarding the likelihood of settlement of pending litigation
B) A listing of pending or threatened litigation, claims, or assessments
C) An evaluation of the likelihood of an unfavorable outcome
D) An estimate of the range of potential loss

Answer 25

A) A disclaimer regarding the likelihood of settlement of pending litigation

Question 26

What is the primary purpose of obtaining written representations?
A) To provide auditors with substantive evidence of important assertions
B) To impress upon management its primary responsibility for the financial statements
C) To allow auditors to communicate important internal control deficiencies to management
D) To allow auditors to communicate important suggestions for improvement to management

Answer 26

B) To impress upon management its primary responsibility for the financial statements

Question 27

Which of the following reporting options is available if the client refuses to provide auditors with written representations?
A) Unmodified or qualified opinion
B) Qualified or adverse opinion
C) Qualified opinion or disclaimer of opinion
D) Disclaimer of opinion or adverse opinion

Answer 27

C) Qualified opinion or disclaimer of opinion

Question 28

Which of the following subsequent events would represent an event that provides information about conditions that arose following the date of the financial statements?
A) Settlement of long outstanding litigation
B) Collection of a past due accounts receivable
C) Loss of inventory as a result of a flood
D) An additional tax assessment on prior income

Answer 28

C) Loss of inventory as a result of a flood

Question 29

The Landsman Corporation was audited for the year ended December 31. The audit report was dated on January 31; prior to the release of the report on February 3, auditors learned of a fire that destroyed the inventory in the warehouse on February 2, causing $800,000 damage, which is material to the client. Which of the following course of actions is not appropriate for the auditor?
A) Extend the audit report date to February 2 for every line item on the F/S;
B) Use February 2 as the date for inventory and January 31 for all other matters;
C) Require the client to disclose the fire in the footnotes to the F/S;
D) Require the client to recognize the $800,000 loss caused by the fire in the current-year F/S;

Answer 29

D) Require the client to recognize the $800,000 loss caused by the fire in the current-year F/S;

Question 30

Auditors have a responsibility to evaluate whether financial statements properly reflect all known events through the:
A) date of the financial statements.
B) date of the auditors’ report.
C) audit report release date.
D) subsequent year’s date of the financial statements.

Answer 30

C) audit report release date.

Question 31

Which of the following best describes auditors’ responsibilities with respect to evaluating the going-concern status of the entity?
A) Auditors are required to specifically gather evidence with respect to going-concern status and separately report on the entity’s ability to continue as a going concern.
B) Auditors are required to specifically gather evidence with respect to going-concern status and modify their audit opinion on the financial statements if substantial doubts exist.
C) Auditors are required to consider evidence obtained during the audit that may provide information with respect to going-concern status and separately report on the entity’s ability to continue as a going concern.
D) Auditors are required to consider evidence obtained during the audit that may provide information with respect to going-concern status and add an emphasis-of-matter paragraph in their report if substantial doubts exist.

Answer 31

D) Auditors are required to consider evidence obtained during the audit that may provide information with respect to going-concern status and add an emphasis-of-matter paragraph in their report if substantial doubts exist.

Question 32

If the date of an entity’s financial statements is December 31, 20X1, the date of the auditor’s report is February 20, 20X2, and the audit report release date is February 22, 20X2, which of the following is considered a subsequent event?
A) A significant acquisition that was announced on February 1, 20X2 and will be finalized on October 1, 20X2.
B) A court settlement on March 3, 20X2 related to a case that was pending on December 31, 20X1.
C) Losses from a fire on February 21, 20X2.
D) The entity’s announcement of a major restructuring plan on December 30, 20X1 that will be implemented during the upcoming year.

Answer 32

A) A significant acquisition that was announced on February 1, 20X2 and will be finalized on October 1, 20X2.

Question 33

A report that acknowledges reliance on the reports of component auditors is a type of report modification known as a(n)
A) qualification.
B) division of responsibility.
C) expansion of scope.
D) scope limitations.

Answer 33

B) division of responsibility.

Question 34

In which of the following circumstances may auditors issue the standard (unmodified) report on the entity’s financial statements?
A) The entity changed accounting principles having an immaterial effect on the entity’s financial position, results of operations, and cash flows.
B) The auditors wish to emphasize a related-party transaction which has material impact on the financial statements.
C) The auditors reference component auditors who examined a subsidiary of group financial statements.
D) The auditors have not been able to audit a substantial portion of the balance sheet because of a circumstance-imposed scope limitation.

Answer 34

A) The entity changed accounting principles having an immaterial effect on the entity’s financial position, results of operations, and cash flows.

Question 35

The auditors conclude that there is a material inconsistency in the “other information” in an annual report to shareholders containing audited financial statements. If the auditors conclude that the financial statements do not require revision, but the entity refuses to revise or eliminate the material inconsistency, the auditors may
A) issue a qualified opinion on the entity’s financial statements, citing a departure from generally accepted accounting principles.
B) consider the matter closed since the other information is not included in the audited financial statements.
C) issue an adverse opinion on the entity’s financial statements due to inadequate disclosure.
D) revise the report on the entity’s financial statements to include an other-matter paragraph describing the material inconsistency.

Answer 35

D) revise the report on the entity’s financial statements to include an other-matter paragraph describing the material

Question 36

When auditors lack independence, which of the following is true about the report on the entity’s financial statements that should be issued?
A) The auditors should disclaim an opinion and should state specifically that they are not independent.
B) The auditors should disclaim an opinion but not mention that they are not independent.
C) The auditors should issue an unmodified opinion with an other-matter paragraph stating that they are not independent.
D) The auditors should issue a qualified opinion with an other-matter paragraph stating that they are not independent.

Answer 36

A) The auditors should disclaim an opinion and should state specifically that they are not independent.

Question 37

Auditors should disclose the substantive reasons for expressing an adverse opinion on the entity’s financial statements in an additional paragraph
A) after the critical audit matter section.
B) preceding the opinion paragraph.
C) following the opinion paragraph.
D) within the footnotes to the financial statements.

Answer 37

C) following the opinion paragraph.

Question 38

Restrictions imposed by an entity prohibited the observation of physical inventories, which accounted for 35 percent of total assets. Alternative auditing procedures were not feasible, although the auditors were able to examine satisfactory evidence for all other items in the financial statements. The auditors would most likely express
A) a qualified opinion on the entity’s financial statements, referring to a departure from generally accepted accounting principles.
B) a disclaimer of opinion on the entity’s financial statements.
C) an unmodified opinion on the entity’s financial statements with an additional paragraph.
D) an unmodified opinion on the entity’s financial statements with a modification of the Auditor’s Responsibility section.

Answer 38

B) a disclaimer of opinion on the entity’s financial statements.

Question 39

If management fails to provide adequate justification for a change from one generally accepted accounting principle to another, the auditors should
A) add an additional paragraph and express a qualified or an adverse opinion on the entity’s financial statements for lack of conformity with generally accepted accounting principles.
B) disclaim an opinion on the entity’s financial statements because of uncertainty.
C) disclose the matter in an additional paragraph but not modify the opinion paragraph on the entity’s financial statements.
D) neither modify the opinion on the entity’s financial statements nor disclose the matter because both principles are generally accepted accounting principles.
.

Answer 39

A) add an additional paragraph and express a qualified or an adverse opinion on the entity’s financial statements for lack of conformity with generally accepted accounting principles.

Question 40

Independent auditors must consider whether the entity has the ability to continue as a going concern. If a substantial doubt exists but disclosure is adequate and no other basis exists for modifying the report, the auditors would normally
A) disclaim an opinion.
B) express an adverse opinion.
C) qualify the opinion.
D) express an unmodified opinion with an emphasis-of-matter paragraph describing the going-concern uncertainty.

Answer 40

D) express an unmodified opinion with an emphasis-of-matter paragraph describing the going-concern uncertainty.

Question 41

Under which of the following circumstances would a disclaimer of opinion on the entity’s financial statements not be appropriate?
A) The financial statements fail to contain adequate disclosure of related-party transactions.
B) The entity refuses to permit its attorney to furnish information requested in an attorney letter.
C) The auditors are engaged after the date of the financial statements and are unable to observe physical inventories or apply alternative procedures to verify their balances.
D) The auditors are unable to determine the amounts associated with illegal acts committed by the entity’s management.

Answer 41

A) The financial statements fail to contain adequate disclosure of related-party transactions.

Question 42

The auditors include an emphasis-of-matter paragraph in an otherwise unmodified report on the entity’s financial statements to emphasize that the entity being reported on had significant transactions with related parties. The inclusion of this separate paragraph
A) is considered a qualification of the opinion.
B) violates generally accepted auditing standards if this information is already disclosed in footnotes to the financial statements.
C) necessitates a revision of the opinion paragraph to include the phrase “with the foregoing explanation.”
D) is appropriate and would not otherwise affect the unmodified opinion.

Answer 42

D) is appropriate and would not otherwise affect the unmodified opinion.