Still Wrong Part 2 6/7/24 Flashcards
Jacob, senior accountant at NEP CPA Firm, is auditing the Year 2 financial statements for Top Firmware Corp., a nonissuer, and he is currently in the planning stage. Top Firmware Corp. sales historically occur evenly throughout the year. Jacob expects a low likelihood of uncorrected and undetected misstatements.
NEP CPA Firm’s materiality guidelines are as follows:
Overall financial statement materiality should be based on either total assets or gross annualized revenue, whichever is larger, and should be calculated by taking the appropriate benchmark and multiplying it by either 1.5 percent if the benchmark is assets, or 1 percent if the benchmark is gross revenue.
Performance materiality is calculated by multiplying the overall materiality by either 80 percent (for low likelihood of uncorrected and undetected misstatements) or 60 percent (for high likelihood of uncorrected and undetected misstatements).
Selected interim financial information from Top Firmware Corp.:
For the period 01/01/Year 2–06/30/Year 2:
Revenue
$2,100,000
Gross profit
$600,000
As of 06/30/Year 2:
Total assets
$2,000,000
Stockholders’ equity
$1,250,000
Based on the information above, what is the overall financial statement materiality?
A. $42,000 B. $60,000 C. $30,000 D. $21,000
Choice “A” is correct.
Overall materiality
=
Applicable benchmark × Applicable percentage
Overall materiality
=
$4,200,000 (annualized revenue = $2,100,000 × 2) × 0.01
Overall materiality
=
$42,000
Choice “B” is incorrect. This calculation incorrectly doubles assets to calculate materiality.
Note: In situations in which assets are used as the benchmark for a materiality calculation, the “as of” amount should be used.
Choice “C” is incorrect. This calculation uses assets as the benchmark. This is incorrect because NEP CPA Firm guidelines require the benchmark to be based on the larger of total assets or gross annualized revenue.
Choice “D” is incorrect. This calculation uses interim revenue as the benchmark when the annualized interim revenue should be used.
Which of the following errors most likely would be detected by analyzing financial totals?
A. A missing digit in an invoice number in a batch of daily sales. B. A purchase order mistakenly entered into two different batches. C. A transposition error on one employee's paycheck on a weekly payroll run. D. Malfeasance resulting from a receivable clerk's pocketing of a customer's payment and altering of the related records.
Choice “C” is correct. A manual total will be calculated for each transaction file and compared to a computer-generated batch control total. Any financial discrepancies (such as an error on an employee paycheck) will be identified and resolved as part of this process.
Choice “A” is incorrect. Analyzing financial totals would not capture missing digits on invoice numbers.
Choice “B” is incorrect. A company should have other controls in place to prevent this, as a financial total is only designed to ensure that what is in the purchase order itself is appropriately reconciled to the computer-generated control total.
Choice “D” is incorrect. A company should have other controls in place to ensure that all payments received are accounted for appropriately, as controls would not necessarily catch this activity.
Which of the following statements indicates that the auditor has gained a sufficient understanding of a client’s controls related to the sales order process?
A. The auditor compared sales orders processed with processing clerk head count for three years and noted that processed orders significantly declined while clerk head count remained the same. B. In a statistically valid sample of 100 sales transactions, the auditor found five undiscovered exceptions and concluded that the system was weak. C. The auditor noted in a narrative that the documentation for the sales order system showed the printing of a shipment-exception report listing non-invoiced shipments. D. The auditor interviewed the company's supervisor of sales clerks and reviewed six shipment-exception reports that were randomly selected and that showed significant unrecorded balances.
Choice “C” is correct. This statement shows that the auditor has gained a sufficient understanding of a client’s internal controls related to the sales order process. A narrative is one way an auditor can describe his or her understanding of internal control.
Choice “A” is incorrect. This statement does not provide information about controls related to the sales order process. The statement provides information about efficiency of the sales order process because it evaluates how many orders were processed as compared with clerk head count.
Choice “B” is incorrect. This statement relates to the actual testing of the control rather than obtaining an understanding of the control because the auditor performed a “statistically valid sample” and concluded on the sample.
Choice “D” is incorrect. This statement is referring to substantive testing (aka dollar balance testing) because the auditor noticed significant unrecorded balances.
Which of the following is not true about accounting estimates?
A. An accounting estimate is an approximation of an account pending the outcome of a future event. B. Accounting estimates measure the effects of past transactions or events that cannot be determined in a timely cost-effective manner. C. An accounting estimate is an approximation of past events that can be determined on a timely cost-effective basis. D. Accounting estimates are monetary values within the financial statements for which there is an inherent lack of precision.
Choice “C” is correct. An accounting estimate pertains to determining the approximation of past events that cannot be determined on a timely, cost-effective basis. If the effect of a past event can be determined on a timely, cost-effective basis, there would be no reason to make an estimate.
Choices “B”, “D”, and “A” are incorrect. Accounting estimates may:
B.Measure the effects of past transactions that cannot be determined in a timely cost-effective manner.
D. Have an inherent lack of precision.
A. Be used to approximate an account pending the outcome of a future event (e.g., uncollectible accounts receivable).
An auditor most likely would issue a disclaimer of opinion because of:
A. Management's refusal to furnish written representations. B. A material departure from generally accepted accounting principles. C. The omission of the statement of cash flows. D. Inadequate disclosure of material information.
Choice “A” is correct. Management’s refusal to furnish written representations is a significant client imposed restriction on the scope of an audit, ordinarily warranting a disclaimer of opinion.
Choice “B” is incorrect. A departure from GAAP would result in either a qualified or adverse opinion, depending on materiality.
Choice “C” is incorrect. A qualified report would be appropriate when a “statement of cash flows” is omitted and the scope of the audit is not restricted.
Choice “D” is incorrect. Inadequate disclosure would result in a qualified or adverse opinion.
Question
Which of the following conditions necessitates a larger sample size?
A. A low level of tolerable misstatement. B. A low frequency of misstatement. C. A low assessed level of control risk. D. A high level of detection risk.
Choice “A” is correct. The sample size used by the auditor has an inverse relationship with the tolerable misstatement. As the tolerable misstatement decreases, the sample size must increase.
Choice “B” is incorrect. A low frequency of misstatement indicates that the risk of material misstatement is low and therefore a larger sample size would not be necessary when analyzing the overall audit risk.
Choice “C” is incorrect. A low assessed level of control risk indicates that the risk of material misstatement is low and therefore a larger sample size would not be necessary when analyzing the overall audit risk.
Choice “D” is incorrect. A high level of detection risk indicates that the risk of material misstatement is low and therefore a larger sample size would not be necessary when analyzing the overall audit risk.
An auditor compares annual revenues and expenses with similar amounts from the prior year and investigates all changes exceeding 10%. This procedure most likely could indicate that:
A. Fourth quarter payroll taxes were properly accrued and recorded, but were not paid until early in the subsequent year. B. Unrealized gains from increases in the value of available-for-sale securities were recorded in the income account for trading securities. C. The annual provision for uncollectible accounts expense was inadequate because of worsening economic conditions. D. Notice of an increase in property tax rates was received by management, but was not recorded until early in the subsequent year.
Choice “B” is correct. Unrealized gains on available-for-sale securities should properly be recorded in other comprehensive income. If such gains were erroneously recorded in the income account for trading securities, this might be discovered through comparison of the current year and prior year revenues and expenses (assuming the error occurred only in the current year, and not in the prior year).
Choice “A” is incorrect. If payroll taxes were properly accrued and recorded, there is unlikely to be a significant change in revenues and expenses for the current year as compared to the prior year. Payables would not be part of the comparison of revenues and expenses.
Choice “C” is incorrect. In times of worsening economic conditions, one would expect the annual provision for uncollectible accounts to increase. Since this answer option indicates that the provision was inadequate, it would appear that the client did not increase the provision appropriately. Investigating changes in revenues and expenses would not be likely to identify this error, since failing to increase the provision would likely result in there being little change between the two years.
Choice “D” is incorrect. An increase in property tax rates should cause a corresponding increase in accrued property tax expense; however, the question indicates that the appropriate increase was not recorded in the current year. Investigating changes in revenues and expenses would not be likely to identify this error, since failing to increase the expense would likely result in there being little change between the two years.
Davis, CPA, accepted an engagement to audit the financial statements of Tech Resources, a nonissuer. Before the completion of the audit, Tech requested Davis to change the engagement to a compilation of financial statements. Before Davis agrees to change the engagement, Davis is required to consider the:
Additional audit effort necessary to complete the audit / Reason given for Tech’s request
A.
No No
B. Yes No C. No Yes D. Yes Yes
Which financial statement assertion is violated when an expense occurring in one year is not recorded until the following year?
A. Occurrence B. Completeness C. Classification D. Accuracy
Choice “B” is correct. Expenses for the current year are not complete if an expense occurring in one year is not recorded until the following year.
Choice “A” is incorrect. Occurrence relates to recording only events that have occurred during the given year.
Choice “C” is incorrect. Classification relates to recording in the proper accounts.
Choice “D” is incorrect. Accuracy relates to recording at an appropriate amount.
When an auditor of a nonissuer qualifies an opinion because of the inability to confirm accounts receivable by direct communication with debtors, the wording of the qualified opinion paragraph of the auditor’s report should indicate that the qualification pertains to the:
A. Possible effects on the financial statements. B. Limitation on the auditor's scope. C. Lack of sufficient appropriate audit evidence. D. Departure from generally accepted auditing standards.
Choice “A” is correct. When an auditor of a nonissuer qualifies his or her opinion because of a scope limitation, such as the inability to confirm accounts receivable, the wording in the opinion paragraph should indicate that the qualification pertains to the possible effects on the financial statements and not to the scope limitation itself.
Choice “B” is incorrect. The Qualified Opinion section of the auditor’s report would not refer to the scope limitation directly, but would include “except for” language related to the opinion.
Choice “C” is incorrect. The lack of sufficient appropriate audit evidence would not be referenced in the Qualified Opinion section of the report.
Choice “D” is incorrect. A departure from generally accepted auditing standards would not have taken place when the auditor appropriately issued a qualified opinion. Additionally, such language would not be contained in the Qualified Opinion section of the auditor’s report.
As part of the information and communication component of the Integrated Framework, a company must:
A. Deploy policies and procedures in a timely manner. B. Identify and assess the effect of entity changes on internal controls. C. Ensure that external auditors are aware of significant internal control issues. D. Communicate internal control deficiencies to responsible parties who have the ability to correct them.
Choice “C” is correct. Communication with external auditors is a significant part of the information and communication component of the Integrated Framework.
Choice “A” is incorrect. The deployment of policies and procedures relates to the (existing) control activities component.
Choice “B” is incorrect. The identification and assessment of the effect of changes on internal controls is a part of the risk assessment component.
Choice “D” is incorrect. The communication of internal control deficiencies is part of the monitoring component.
Gem, CPA, is the auditor of the financial statements of Simple Inc. Simple Inc uses Arrow LLC, a third-party service provider, to house Simple’s lease information and generate lease-related journal entries on its behalf. In performing the audit planning for the engagement, which of the following reports related to Arrow LLC would be most useful to Gem as a form of audit evidence in reducing the assessed risk of material misstatement?
A. SOC 1® Type 2 report B. SOC 2® Type 2 report C. SOC 1® Type 1 report D. SOC 2® Type 1 report
Choice “A” is correct. The SOC 1® Type 2 report provides a user auditor with assurance about the design, implementation, and operating effectiveness of a service organization’s internal controls and therefore may provide evidence that would allow a reduction in the assessed level of control risk for areas of the entity’s accounting affected by the service organization.
Choice “B” is incorrect. The SOC 2® Type 2 report provides assurance over the design, implementation, and operating effectiveness of controls in place at a service organization related to security, availability, processing integrity, confidentiality, and privacy. As it is not specifically related to the internal control over financial reporting (SOC 1®), it is not as useful to the user auditor when assessing risk of material misstatement.
Choice “C” is incorrect. The SOC 1® Type 1 report provides a user auditor with assurance about the design and implementation of internal controls at a service organization but does not include the testing of operating effectiveness. It may aid the user auditor in obtaining an understanding of controls but cannot be used as a basis for reducing assessed risk.
Choice “D” is incorrect. The SOC 2® Type 1 report provides assurance over the design and implementation of controls in place at a service organization related to security, availability, processing integrity, confidentiality, and privacy. As it is not specifically related to the internal control over financial reporting (SOC 1®), it is not as useful to the user auditor when assessing risk of material misstatement.
When an accountant is engaged to prepare financial statements, each of the following requirements applies, except:
A. The accountant should include a statement on each page of the financial statements indicating that no assurance is provided. B. The engagement documentation should include the engagement letter and a copy of the prepared financial statements. C. The agreed-upon terms of the engagement should include identification of the applicable financial framework to be used. D. The accountant should verify the completeness of information provided by management for the financial statements.
Choice “D” is correct. For a preparation engagement, management takes responsibility for the completeness of information. Accountants are not required, but may, make inquiries to verify the completeness of the information provided by the client.
Choice “A” is incorrect. Each page of the financial statements should include an indication that no assurance is provided in a preparation engagement.
Choice “B” is incorrect. Documentation in a preparation engagement should include the engagement letter, a copy of the financial statements prepared by the accountant, and any significant issues or findings.
Choice “C” is incorrect. The accountant should include a description of the financial reporting framework on the face of the financial statements or in a note to the financial statements in a preparation engagement.
In an examination of an entity’s compliance with specified requirements, a practitioner is expected to perform all of the following except:
A. Prepare reports and required documentation. B. Obtain oral representations from management regarding compliance with the specified requirements. C. Determine if supplementary audit requirements exist. D. Perform a risk assessment and design responses to such assessment.
Choice “B” is correct. Representations from management regarding compliance with specified requirements must be in writing. Oral representations are not sufficient.
Choice “A” is incorrect. The practitioner will prepare reports and all required documentation in an examination of an entity’s compliance with specified requirements.
Choice “C” is incorrect. The practitioner must determine if supplementary audit requirements exist in an examination of an entity’s compliance with specified requirements.
Choice “D” is incorrect. The practitioner must perform a risk assessment and design responses to such risks in an examination of an entity’s compliance with specified requirements.
Which of the following is not a procedure the auditor would use in evaluating the reasonableness of an accounting estimate?
A. Use subsequent events to determine whether the estimate was reasonable. B. Confirm via the management representation letter that management has disclosed all significant estimates. C. Develop an independent estimate and compare it to management's estimate. D. Determine how management developed their estimate and test the procedures they used.
Choice “B” is correct. While the auditor might obtain such a representation from management, confirmation that all significant estimates have been disclosed would not be enough to substantiate the reasonableness of the estimates.
Choices “D”, “A”, and “C” are incorrect. In evaluating the reasonableness of an estimate, the auditor may perform one or a combination of the following procedures: Review and test management’s procedures, develop an independent estimate for comparative purposes, or review subsequent events and transactions (occurring prior to the completion of fieldwork) for corroborative purposes.
