EXAM 3 (FINAL) Flashcards
An auditor would be most likely to identify a contingent liability by obtaining a(n)
Letter from the entity’s general legal counsel
An auditor should request that an audit client send a letter of inquiry to those attorneys who have been consulted concerning litigation, claims, or assessments. The primary reason for this request is to provide
Corroboration of the information furnished by management concerning litigation, claims, and assessments
An auditor issued an audit report that was dual dated for a subsequent event occurring after the date on which the auditor has obtained sufficient appropriate audit evidence but before issuance of the financial statements. The auditor’s responsibility for events occurring subsequent to the date on which the auditor has obtained sufficient appropriate audit evidence was
Limited to the specific event referenced
Which of the following procedures would an auditor most likely perform to obtain evidence about the occurrence of any changes in internal control that might affect financial reporting between the end of the reporting period and the date of the auditor’s report?
Examine relevant internal audit reports issued during the subsequent period
Final analytical procedures are generally intended to
Provide the auditor with a final, overall evaluation of the relationships among financial statement balances
Which of the following audit procedures is most likely to assist an auditor in identifying conditions and events that may indicate substantial doubt about an entity’s ability to continue as a going concern?
Review compliance with the terms of debt agreements
Auditing standards primarily encourage which of the following conversations about financial reporting?
A conversation with those charged with governance to discuss matters pertaining to financial reporting
Which of the following matters should an auditor communicate to those charged with governance?
Significant audit adjustments = yes; management’s consultations with other accountants = yes
Which of the following events occurring after the issuance of a set of financial statements and the accompanying auditor’s report would be most likely to cause the auditor to make further inquiries about the financial statements?
The discovery of information regarding a contingency that existed before the financial statements were issued
During the audit we discovered evidence of the company’s failure to safeguard inventory from loss, damage, and misappropriation.
Auditor’s communications on significant deficiencies and material weakness.
The company considers the decline in value of equity securities classified as available-for-sale to be temporary.
Management representation letter.
There have been no communications from regulatory agencies concerning noncompliance with or deficiencies in financial reporting practices.
Management representation letter.
It is our opinion that the possibly liability to the company in this proceeding is nominal in amount.
Lawyer’s response to audit inquiry letter.
As discussed in Note 4 to the financial statements, the company experienced a net loss for the year ended July 31, 2011, and is currently in default under substantially all of its debt agreements. In addition, on September 25, 2011, the company filed a prenegoitated voluntary petition for relief under Chapter 11 of the U.S. Bankruptcy Code. These matters raise substantial doubt about the company’s ability to continue as a going concern.
Explanatory paragraph of an auditor’s report on financial statements.
During the year under the audit, we were advised that management consulted with Gonzales & Ramirez, CPAs. The purpose of this consultation was to obtain another CPA firm’s opinion concerning the company’s recognition of certain revenue that we believe should be deferred to future periods. Gonzales & Ramirez’s opinion was consistent with our opinion, so management did not recognize the revenue in the current year.
Auditor’s communication to those charged with governance (other than with respect to significant deficiencies and material weakness).
The company believes that all material expenditures that have been deferred to future periods will be recoverable.
Management representation letter.
Our use of professional judgment and the assessment of audit risk and materiality for the purpose of our audit mean that matters may have existed that would have been assessed differently by you. We make no representation as to the sufficiency or appropriateness of the information in our working papers for your purposes.
Predecessor auditor’s communication with successor auditor.
Indicate in the space provided below whether this information agrees with your records. If there are exceptions, please provide any information that will assist the auditor in reconciling the difference.
Accounts receivable confirmation request.
Blank checks are maintained in an unlocked cabinet along with the check-signing machine. Blank checks and the check-signing machine should be locked in separate locations to prevent the embezzlement of funds.
Auditor’s communications on significant deficiencies and material weakness.
The company has insufficient expertise and controls over the selection and application of accounting policies that are in conformity with GAAP.
Auditor’s communications on significant deficiencies and material weakness.
The timetable set by management to complete our audit was unreasonable considering the failure of the company’s personnel to complete schedules on a timely basis and delays in providing necessary information.
Auditor’s communication to those charged with governance (other than with respect to significant deficiencies and material weakness).
Several employees have disabled the antivirus detection software on their PCs because the software slows the processing of data and occasionally rings false alarms. The company should obtain antivirus software that runs continuously at all system entry points and that cannot be disabled by unauthorized personnel.
Auditor’s communications on significant deficiencies and material weakness.
In connection with an audit of our financial statements, please furnish to our auditors a description and evaluation of any pending or probable litigation against our company of which you are aware.
Audit inquiry letter to legal counsel.
The company has no plans or intentions that may materially affect the carrying value or classification of assets and liabilities.
Management representation letter.
In planning the sampling application, was appropriate consideration given to the relationship of the sample to the assertion and to planning materiality?
Partner’s engagement review notes.
In which of the following situations would an auditor ordinarily issue an unqualified/unmodified financial statement audit opinion with no explanatory (or emphasis-of-matter/other-matter) paragraph?
The auditor decides to refer to the report of another auditor as a basis, in part, for the auditor’s opinion.
A public entity changed from the straight-line method to the declining balance method of depreciation for all newly acquired assets. This change has no material effect on the current year’s financial statements but is reasonably certain to have a substantial effect in later years. The client’s financial statements contain no material misstatements and the auditor concurs with this change. If the change is disclosed in the notes to the financial statements, the auditor should issue a report with a(n)
Unqualified opinion.
An auditor includes a separate paragraph in an otherwise unmodified financial statement audit report to emphasize that the entity being reported upon had significant transactions with related parties. The inclusion of this separate paragraph
Is appropriate and would not negate the unmodified opinion.
Eagle Company, a public company, had a computer failure and lost part of its financial data. As a result, the auditor was unable to obtain sufficient audit evidence relating to Eagle’s inventory account. Assuming the inventory account is at least material, the auditor would most likely choose either
A qualified opinion or a disclaimer of opinion
Tech Company has disclosed an uncertainty due to pending litigation. The auditor’s decision to issue a qualified opinion on Tech’s financial statements would most likely result from
Lack of sufficient evidence.
In which of the following circumstances would an auditor usually choose between issuing a qualified opinion or an adverse opinion on a client’s financial statements?
Departure from generally accepted accounting principles.
King, CPA, was engaged to audit the financial statements of Chang Company, a private company, after its fiscal year had ended. King neither observed the inventory count nor confirmed the receivables by direct communication with debtors but was satisfied that both were fairly stated after applying appropriate alternative procedures. King’s financial statement audit report most likely contained a(n)
Unmodified opinion.
Comparative financial statements for a public company include the prior year’s statements, which were audited by a predecessor auditor. The predecessor’s report is not presented along with the comparative financial statements. If the predecessor’s report was unqualified, the successor should
Indicate in the auditor’s report that the predecessor auditor expressed an unqualified opinion.
When reporting on comparative financial statements for a private company, which of the following circumstances should ordinarily cause the auditor to change the previously issued opinion on the prior ear’s financial statements?
A departure from GAAP caused an adverse opinion on the prior year’s financial statements, and those statements have been properly restated.
Which of the following best describes the auditor’s responsibility for “other information” included in the annual report to stockholders that contains financial statements and the auditor’s report?
The auditor has no obligation to corroborate the “other information” but should read the “other information” to determine whether it is materially inconsistent with the financial statements.
When reporting on the financial statements prepared on the basis of accounting used for income tax purposes, the auditor should include in the report that a paragraph that
States that the income tax basis of accounting is a basis of accounting other than GAAP.
When the auditor is asked to express an opinion on an entity’s rent and royalty revenues, but he may
Accept the engagement provided the auditor’s opinion is expressed in a special report.
Barefield Corporation, a wholly owned subsidiary of Sandy Inc., is audited by another CPA firm. As the auditor of Sandy Inc., you have assured yourself of the other CPA firm’s independence and professional reputation. However, you are unwilling to take complete responsibility for its audit work.
Unqualified – modified wording
The management of Bonner Corporation has decided to exclude the statement of cash flows from its financial statements because it believes that its bankers do not find the statement to be very useful.
Qualified
You are auditing Diverse Carbon, a manufacturer of nerve gas for the military, for the year ended September 30. On September 1, one of its manufacturing plants caught fire, releasing nerve gas into the surrounding area. Two thousand people were killed and numerous others paralyzed. The company’s legal counsel indicates that the company is liable and that the amount of the liability can be reasonably estimated, but the company refuses to disclose this information in the financial statements.
Adverse
During your audit of Cuccia Coal Company, the controller, Tracy Tricks, refuses to allow you to confirm accounts receivable because she is concerned about complaints from her customers. You are unable to satisfy yourself about accounts receivable by other audit procedures and you are concerned about Tracy’s true motives.
Disclaimer or qualified
On January 31, Asare Toy Manufacturing hired your firm to audit the company’s financial statements for the prior year. You were unable to observe the client’s inventory on December 31. However, you were able to satisfy yourself about the inventory balance using other auditing procedures.
Unqualified
Gelato Bros., Inc., leases its manufacturing facility from a partnership controlled by the chief executive officer and major shareholder of Gelato. Your review of the lease indicates that the rental terms are in excess of rental terms for similar buildings in the area. The company refuses to disclose this related-party transaction in the footnotes.
Qualified
Johnstone Manufacturing Company has used the double-declining balance method to depreciate its machinery. During the current year, management switched to the straight-line method because it felt that it better represented the utilization of the assets. You concur with its decision. All information is adequately disclosed in the financial statements.
Unqualified - extra explanatory paragraph
Thibodeau Mines, Inc., uses LIFO for valuing inventories held in the United States and a non-GAAP method for inventories produced and held in its foreign operations.
Unqualified
Walker Computers is suing your client, Super Software, for royalties over patent infringement. Super Software’s outside legal counsel assures you that Walker’s case is completely without merit.
Unqualified
In previous years, your client, Merc International, has consolidated its Panamanian subsidiary. Because of restrictions on repatriation of earnings placed on foreign-owned corporations in Panama, Merc International has decided to account for the subsidiary on the equity basis in the current year. You concur with the change.
Unqualified – extra explanatory paragraph
In prior years, Worcester Wool Mills has used current market prices to value its inventory of raw wool. During the current year, Worcester changed to FIFO for valuing raw wool.
Unqualified – extra explanatory paragraph, qualified for previous years
Upon review of recent history of the lives of its specialized automobiles, Gas Leak Technology justifiably changed the service lives for depreciation purposes on its autos from 5 years to 3 years. This change resulted in a material amount of additional depreciation expense.
Unqualified
During the audit of Brannon Bakery Equipment, you found that a material amount of inventory had been excluded from the company’s financial statements. After discussing this problem with management, you become convinced that it was an unintentional oversight. Management appropriately corrected the error prior to your finalization of fieldwork.
Unqualified
Jay Rich, CPA, holds 10% of the stock in Rothenburg Construction Company. The board of directors of Rothenburg asks Rich to conduct its audit Rich completes the audit and determines that the financial statements present fairly in accordance with GAAP.
Disclaimer
Ramamoorthi Savings and Loan’s financial condition has been deteriorating for the last 5 years. Most of its problems result from loans made to real estate developers in Saint Johns County. Your review of the loan portfolio indicates that there should be a major increase in the loan-loss reserve. Based on your calculations, the proposed write-down of the loans will put Ramamoorthi into violation of the state’s capital requirements. The client refuses to make the adjustment or to disclose the possible going concern issue in the notes to the financial statements.
Adverse
Period after the balance sheet date but on or before the audit report date
Subsequent Period
Additional evidence in determining the valuation of an account as of the balance sheet date (Type 1) - DR/CR entries
Adjustments
Examples - bankruptcy of an account receivable customer
Ex - settlement of a law suit
Disclosures - Type 2 - additional information that should be disclosed, but it is not information that affects an account balance at 12/31/12
Footnotes
Ex - issuance of stock
Ex - flood to a major plant
3 Types of Subsequent Periods
- Adjustments
- Footnotes
- No disclosures
Audit Procedures
- Talking to client
- Obtain information from client’s legal counsel
- Read the latest minutes - Board of directors
- Read latest available “interim” (monthly) financial statements
- Local and national news
- Review accounts payable file
AU 561 Requires
- Determine if information is reliable and whether the facts existed as of the date of the report
- No - do nothing
- Yes - would the auditors’ report been affected if the information had been known?
- Are persons/entities currently relying on the statements?
- Advise client to make disclosures
If client refuses to disclose…
- Notify each member of the board of directors
- Notify client that the audit report can no longer be associated with the 2012 financial statements
- Notify the regulatory agencies
- Notify each person known by the auditor that the financial statements are in error
Duel Dating
Auditor becomes aware of an event after 2/15 but before the report is released
Extra paragraph dated 2/18 of specific event
Legal Letter
Auditor is trying to corroborate the information furnished by management regarding claims, litigation, and assessments
- Time
- Probable
- Reasonably estimated (possible)
- Remote
Management Representation Letter
- On client stationary
- Signed by the CEO and CFO
- Required by GAAS
- Not signed - scope limitation - qualified opinion
Management Letter
- On CPA’s stationary
- Recommendations
- -IT system
- -Purchasing discounts
- Comments on internal controls
Communication with board of directors and audit committee
- significant events or adjustments the entity’s financial statements
- management disagreements
- reportable conditions
Unqualified
Standard report, clean opinion
Format of Unqualified Report
Title Addressee Introductory Paragraph Scope Paragraph Opinion Paragraph Explanatory Paragraph Name of Auditor Date
Unqualified, modified wording
reference report of another auditor
Unqualified, extra explanatory paragraph
ex - substantial doubt about an entity’s going concern (liquidation value)
ex - change accounting principles (LIFO to FIFO) - lack consistency
ex - departure from GAAP but auditors agree with departure
ex - emphasis of a matter
Disclaimer
- lack of knowledge - overwhelming
- lack of independence
Qualified
Overall okay, but something is not correct
Scope of limitation - not overwhelming
Omit cash flow statement
Adverse
Not in accordance with GAAP
Form and practice and name
proprietorship, professional corporation, LLP (limited liability partnership)
Name must not be misleading
Commissions, referrals, contingency fees
None relates to audit
*No fees given or received
Advertising
CPA can advertise as long as it is not false or deceptive
Confidential client information
need permission from the client to disclose information
Exceptions:
- Subpoena
- peer reviews - sponsored by AICPA or state society
- subsequent discovery of fats
Independence
All partners must be independent of the client
All staff members in the office must be independent
Sarbanes-Oxley
Sarbanes-Oxley
- Partner rotation every 5 years
- CFO, chief accountant cannot be hired from the CPA firm - 1 year lag
- Cannot do consulting work for the audit client
Which of the following statements best explains why public accounting, as a profession, promulgates ethical standards and establishes means for ensuring their observance?
Ethical standards are established so that users of accounting services know what to expect and accounting professionals know what behaviors are acceptable, and so that discipline can be applied when necessary.
All of the following nonaudit services are identified by the SEC as generally impairing an auditor’s independence except
Some specific tax services
Under the SEC’s rules regarding independence, which of the following must a client disclose?
Fees for the external audit, audit-related fees, tax fees, and fees for other nonaudit services performed by the audit firm.
The AICPA Code of Professional Conduct contains both general ethical principles that are aspirational in character and also a
Set of specific, mandatory rules describing minimum levels of conduct a CPA must maintain.
In which of the following situations would a CPA’s independence be considered impaired according to the Code of Professional Conduct?
- The CPA has a car loan from a bank that is an audit client. The loan was made under the same terms available to all customers.
- The CPA has a direct financial interest in an audit client, but the interest is maintained in a blind trust.
- The CPA owns a commercial building and leases it to an audit client. The rental income is material to the CPA.
2 and 3.
A client company has not paid its 2011 audit fees. According to the AICPA Code of Professional Conduct, for the auditor to be considered independent with respect to the 2012 audit, the 2011 audit fees must be paid before the
2012 report is issued.
Which of the following legal situations would be considered to impair the auditor’s independence?
Actual litigation by the auditor against the present management, alleging management fraud or deceit.
A violation of the profession’s ethical standards is least likely to occur when a CPA
Purchases another CPA’s accounting practice and bases the price on a percentage of the fees accruing from clients over a three-year period.
Rick, an independent CPA, must make an ethical judgment related to the audit of a client. If he primarily focuses on whether his decision might yield advantages for some ta the expense of others, he is using
A justice-based perspective
During the audit of Moon Co., the auditor disagrees with management’s estimation of collectible accounts receivable. The possible misstatement amount is material. Which of the statements below should weigh more heavily for the auditor in this instance?
Requiring an adjustment to the allowance for doubtful accounts would give stockholders access to fair and adequate information.
Without the consent of the client, a CPA should not disclose confidential client information contained in working papers to a(n)
CPA firm that has been engaged to audit a former client.
One of a CPA firm’s basic objectives is to provide professional services that conform with professional standards. Reasonable assurance of achieving this basic objective is provided through
A system of quality control.
In connection with the element of engagement performance, a CPA firm’s system of quality control should ordinarily include procedures covering all of the following except
Performance evaluation.
A partner’s dependent part is a 5% limited partner in a firm client. Does the parent’s direct financial interest in the client impair the firm’s independence?
yes, the situation violates the rule
A partner assigned to a firm’s New York office is married to the president of a client for which the firm’s Connecticut office performs audit services. If the partner does not perform services out of or for the Connecticut office, cannot exercise significant influence over the engagement, and has no involvement with the engagement, such as consulting on accounting or auditing issues, is the firm’s independence impaired?
no, the situation does not violate the rule
A CPA’s father acquired a 10% interest in his son’s audit client. The investment is material to the father’s net worth. If the son is aware of his father’s investment and the CPA participates in the audit engagement, is the firm’s independence impaired?
yes, the situation violates the rule
An audit partner has a brother who owns a 60% interest in an audit client, which is material to the brother’s net worth. If the partner participates in the audit engagement, but does not know about his brother’s investment, is the firm’s independence impaired?
yes, the situation violates the rule
Compilation
a. Minimal assurance
b. Write-up work (bookkeeping)
c. For a private company only
d. CPA could lack independence and still perform compilation services
e. CPA compilation report
Minimal assurance
CPA must understand the client’s business and read the financial statements for reasonableness
CPA compilation report
Paragraph 1 - describes that a compilation has been performed
Paragraph 2 - explains what a compilation is and states that no opinion is given on the statements
Paragraph 3 - indicates that management has excluded disclosures (footnotes)
Paragraph 4 - lack independence
Review Services
a. Moderate level of assurance
b. Non-public companies - non-issuer
c. CPA must be independent
d. Reponsibilities
i. Inquiries
- recording transactions
- whether GAAP is being followed
- reading the board of directors minutes
ii. analytical tests - must follow up on unusual items
e. CPA review report
i. state they have done a review
ii. describe a review
iii. need a conclusion
Integrity
establishes trust and thus provides the basis for reliance on their judgment
Objectivity
internal auditors exhibit the highest level of professional objectivity in gathering, evaluating, and communicating information about the activity or process being examined. Internal auditors make a balanced assessment of all the relevant circumstances and are not unduly influenced by their own interests or by others in forming judgments
Confidentiality
internal auditors respect the value and ownership of information they receive and do not disclose information without appropriate authority unless there is a legal or professional obligation to do so.
Competency
Internal auditors apply the knowledge, skills, and experience needed in the performance of internal auditing services
An assurance report on information can provide assurance about the information’s
All of the above (reliability, relevance, timeliness)
Which of the following professional services would be considered an attest engagement?
An engagement to report on compliance with statutory requirements
An accountant may accept an engagement to apply agreed-upon procedures to prospective financial statements, provided that
Distribution of the report is restricted to the specified users
Which of the following statements concerning prospective financial statements is correct?
Any type of prospective financial statement would normally be appropriate for limited use.
When compiling the financial statements of a nonpublic entity, an accountant should
Understand the accounting principles and practices of the entity’s industry.
Which of the following statements is correct concerning both an engagement to compile and an engagement to review a nonpublic entity’s financial statements?
The accountant is not required to obtain an understanding of internal control
The standard report issued by an accountant after reviewing the financial statements of a nonpublic entity states that
The accountant is not aware of any material modifications that should be made to the financial statements
Financial statements of a nonpublic entity that have been reviewed by an accountant should be accompanied by a report stating that
The scope of the inquiry and the analytical procedures performed by the accountant have not been restricted
The general accreditation granted by the Institute of Internal Auditors is known as the
CIA
Which of the following is NOT one of the general areas of the IIA’s International Standards for the Professional Practice of Internal Auditing?
Ethical standards
The four principles of the IIA Code of Ethics are
Confidentiality, competency, objectivity, and integrity
