Study Unit 16: questions

Question 1

The accuracy of information included in notes that accompany the audited financial statements of a company whose shares are traded on a stock exchange is the primary responsibility of the

Answer 1

Company’s management

The notes are considered part of the basic financial statements. Because management has the primary responsibility for the financial statements, it also has the primary responsibility for the accuracy of information included in notes.

Question 2

Eagle Company’s financial statements contain a departure from generally accepted accounting principles because, due to unusual circumstances, the statements would otherwise be misleading. The auditor should express an opinion that is

Answer 2

unmodified and describe the departure in an other-matter paragraph.

Question 3

What are the financial statement that the auditor customarily reports on?

Answer 3

The balance sheet, statement of income, statement of changes in equity, and statement of cash flows are the financial statements upon which the auditor customarily reports.

Question 4

What does adequate disclosure mean?

Answer 4

Means that sufficient information is presented so that financial statements are not misleading.

Question 5

The auditor considers the needs of users of the financial statements. However, it is reasonable for the auditor to assume that users:

Answer 5

(1) have reasonable knowledge of business and accounting,
(2) are willing to study financial information with reasonable diligence,
(3) understand the materiality limits of audited statements,
(4) recognize that many amounts in the statements are based on estimates and judgments, and
(5) make reasonable decisions based on the statements.

Question 6

The auditor’s judgment concerning the overall fairness of the presentation of financial position, results of operations, and cash flows is applied within the framework of

Answer 6

Generally accepted accounting principles.

Reporting standards require the auditor to state whether the audited entity’s financial statements are presented in conformity with GAAP. Without an applicable reporting framework, the auditor would have no uniform standard for judging fairness of presentation.

Question 7

When a certified public accountant who is not independent is associated with financial statements, (s)he is precluded from expressing an opinion because

Answer 7

Any auditing procedures (s)he might perform will not be in accordance with generally accepted auditing standards.

Question 8

For a particular entity’s financial statements to be presented fairly, it is not required that

Answer 8

Accounting policies be applied on a basis consistent with those followed in the prior year.

A lack of consistency does not preclude fair presentation in accordance with the applicable reporting framework. For example, if the entity voluntarily changes from one accounting principle in accordance with the framework to another and the auditor concurs with the change, an emphasis-of-matter paragraph is required to be included in the auditor’s report. But the financial statements will be in accordance with the framework.

Question 9

If financial statements are to meet the requirements of adequate disclosure,

Answer 9

All information believed by the auditor to be essential to the fair presentation of the financial statements must be disclosed, no matter how confidential management believes the data to be.

In considering the adequacy of disclosure, the auditor necessarily uses confidential client information. Otherwise, forming an opinion on the statements would be difficult. To the extent required by GAAP or an other appropriate financial reporting framework, such information must be disclosed. But beyond these requirements, the auditor who discloses confidential information without specific consent violates the Code of Professional Conduct.

Question 10

The financial statements include a separate statement of changes in equity. This statement should

Answer 10

Be identified in the introductory paragraph of the report but need not be reported on separately in the opinion paragraph.

The balance sheet, statement of income, statement of changes in equity, and statement of cash flows are the financial statements upon which the auditor customarily reports. The introductory paragraph identifies the titles of the entity’s financial statements. However, the statement of changes in equity and a separate statement of comprehensive income are not separately reported on the opinion paragraph. The reason is that changes in equity and comprehensive income are included in financial position, results of operations, and cash flows.

Question 11

A major purpose of the auditor’s report on financial statements is to

Answer 11

Clarify for the public the nature of the auditor’s responsibility and performance.

One of the highest priorities of the AICPA has been to reduce the gap between the nature of the auditor’s responsibility and performance and the public’s perception of the audit function. The auditor’s report issued in accordance with auditing standards clarifies the role of the auditor with the intention of diminishing the gap.

Question 12

When financial statements audited by the independent auditor contain notes that are captioned “unaudited” or “not covered by the auditor’s report,” the auditor

Answer 12

May refer to these notes in the auditor’s report.

If information included in the basic statements is (1) not required by the applicable reporting framework, (2) not necessary for fair presentation, and (3) clearly differentiated from the statements, the information may be identified as “unaudited” or “not covered by the auditor’s report” (AU-C 700). If the auditor wishes to draw attention to such a matter that is appropriately presented or disclosed, (s)he may include an emphasis-of-matter paragraph in the auditor’s report (AU-C 705). If (1) the information constitutes other information, (2) the information is materially inconsistent with the audited statements, and (3) management has not revised the information after a request by the auditor, the auditor should (1) include an other-matter paragraph in the report, (2) withhold the report, or (3) withdraw from the engagement. If the information contains a material misstatement of fact that management refuses to correct, the auditor should take further appropriate action (AU-C 720).

Question 13

The evaluation of fairness in determining the appropriate opinion to express should include consideration of the qualitative aspects of the entity’s accounting practices, including whether

A.Indicators of possible bias exist in management’s judgments.

B.The accounting principles used are the most conservative available.

C.Management and those charged with governance agree with all the standards used in the reporting process.

D.The auditor and management agree with all the standards used in the reporting process

Answer 13

Indicators of possible bias exist in management’s judgments.

Answer (A) is correct.
The auditor should be aware of the potential for management bias. For example, management’s judgments may indicate a lack of neutrality that results in selective correction of identified misstatements and bias in making accounting estimates.

Question 14

Which is explicitly and which is implicitly expressed in the unmodified opinion: Conformity with the applicable fiancial reporting Framework/Adequacy of Disclosure

Answer 14

Conformity with the applicable financial reporting framework is explicitly expressed and adequacy of disclosure if implicitly expressed. Adequacy of disclosure is implied if the report does not mention disclosure.

Question 15

Which of the following statements is a basic element of the auditor’s report for a nonissuer?

A.The procedures used depend on the auditor’s judgment.

B.The financial statements are consistent with those of the prior period.

C.The auditor evaluated management decisions.

D.The disclosures provide reasonable assurance that the financial statements are free of material misstatement.

Answer 15

The procedures used depend on the auditor’s judgment.

Answer (A) is correct.
The auditor’s responsibility section states, “The procedures selected depend on the auditor’s judgment . . .”

Question 16

Without affecting the CPA’s willingness to express an unmodified opinion on the client’s U.S.-GAAP-based financial statements, corporate management may refuse a request to

Answer 16

Change its basis of accounting for inventories from FIFO to LIFO because, in the opinion of the CPA, the FIFO method fails to give adequate recognition to the extraordinary increases in prices of merchandise acquired and held by the company.

FIFO (first-in, first-out) and LIFO (last-in, first-out) are both methods of accounting for inventories that are generally accepted in the U.S. LIFO has the advantage during periods of inflation of matching current costs with current revenues. An independent auditor who has requested a change from FIFO to LIFO is likely to express an unmodified opinion even if management refuses to do so because the financial statements would still conform with U.S. GAAP.

Question 17

The existence of audit risk is recognized by the statement in the auditor’s report that the auditor

Answer 17

Obtains reasonable assurance about whether the financial statements are free of material misstatement.

The existence of audit risk is recognized by the statement in the auditor’s report that the auditor obtained reasonable assurance about whether the financial statements are free of material misstatement. Audit risk is the risk that the auditor expresses an inappropriate audit opinion when the financial statements are materially misstated. Audit risk exists because the assurance is not absolute. Reasonable assurance is obtained when the auditor has obtained sufficient appropriate evidence to reduce audit risk to an acceptably low level (AU-C 200).

Question 18

The auditor’s report most likely is addressed to the following:

Answer 18

Board of Directors/Audited Entity.

Question 19

A former client requests a predecessor auditor to reissue an audit report on a prior period’s financial statements. The financial statements are not restated and the report is not revised. What date(s) should the predecessor auditor use in the reissued report?

Answer 19

The date of the prior-period report.

Use of the original date in a predecessor auditor’s reissued report removes any implication that records, transactions, or events after such date have been audited or reviewed. However, the predecessor auditor should perform the following procedures to determine whether the report is still appropriate: (1) read the statements of the subsequent period, (2) compare the prior statements with the current statements, and (3) obtain written representations from management and the successor auditor about information obtained or events that occurred subsequent to the original date of the report (also see AU-C 925 regarding filings under the Securities Act of 1933).

Question 20

An auditor’s decision concerning whether to dual date the audit report is based upon the auditor’s willingness to

Answer 20

Extend auditing procedures.

When a subsequent event disclosed in the financial statements occurs after the date of the auditor’s report but before the release of the auditor’s report, the auditor may use dual dating. (S)he may date the report as of the original report date except for the matters affected by the subsequent event, which would be assigned the appropriate later date. In that case, the auditor’s responsibility for events after the original report date would be limited to the specific event. If the auditor is willing to accept responsibility to the later date and accordingly extends subsequent events procedures to that date, the auditor may choose the later date as the date for the entire report.

Question 21

The report should be dated no earlier than the date on which the auditor has:

Answer 21

The report should be dated no earlier than the date on which the auditor has obtained sufficient appropriate audit evidence.

Question 22

Under which of the following circumstances may audited financial statements contain a note that is labeled “unaudited,” disclosing an event occurring after the balance sheet date?

Answer 22

When the event occurs after the date of the auditor’s original report.

To prevent the financial statements from being misleading, management may disclose an event that arose after the date of the auditor’s report. If the event is included in a separate note labeled as unaudited [e.g., a note captioned as “Event (Unaudited) Subsequent to the Date of the Independent Auditor’s Report”], the auditor need not perform any procedures on the note. Moreover, the auditor’s report should have the same date as the original report (AU-C 560).

Question 23

The date of the audit report is important because

Answer 23

The auditor cannot date the report earlier than the date on which sufficient appropriate evidence to support the opinion has been obtained.

The auditor cannot date the report until sufficient appropriate evidence has been obtained. This date informs users that the auditor has considered the effects of events and transactions occurring up to that date of which the auditor became aware.

Question 24

In what circumstance would an auditor usually choose between expressing a qualified opinion or disclaiming an opinion?

Answer 24

Inability to obtain sufficient appropriate audit evidence.

Scope limitations may require a qualification of the opinion or a disclaimer. The choice depends on whether the possible effects of undetected misstatements are material and pervasive.

Question 25

Kapok Corporation is a substantial user of computer equipment and has used an outside service bureau to process data in years past. During the current year, Kapok adopted the policy of leasing all hardware and expects to continue this arrangement in the future. This change in policy is adequately disclosed in notes to Kapok’s financial statements, but uncertainty prohibits either Kapok or its auditor from assessing the impact of this change upon future operations. The audit report should include

Answer 25

An unmodified opinion.

In the absence of a material misstatement, for example, because of inadequate disclosure or a scope limitation, an uncertainty does not require modification of the opinion.

Question 26

The financial statements fail to disclose info that is required by the applicalbe reporting framework: what opinion/s can be issued?

Answer 26

Choose between expressing a qualified opinion and an adverse opinion.

Misstatements, including inadequate disclosures, may result in either a qualified or an adverse opinion. The auditor should exercise judgment about materiality by considering such factors as (1) benchmarks for dollar amounts, (2) significance to the statements and the entity, and (3) pervasiveness. If the misstatement is not pervasive, the auditor should express a qualified opinion.

Question 27

An auditor’s opinion reads as follows: “In our opinion, except for the above-mentioned limitation on the scope of our audit…” This is an example of an

Answer 27

Unacceptable reporting practice.

Answer (A) is correct.
When an opinion is qualified because of a scope limitation, the opinion paragraph should indicate that the qualification pertains to the possible effects on the statements of undetected misstatements (AU-C 705). The language given in the question bases the qualification on the restriction itself and is unacceptable.

Question 28

An auditor may reasonably express a “subject to” qualified opinion for

• Lack of Consistency
• Departure from an Applicable Financial Reporting Framework

A. Yes No
B. No No
C. Yes Yes
D. No Yes

Answer 28

Answer (B) is correct.
The phrase “subject to” should not be used in any report. It is not clear or forceful enough (AU-C 705).

Question 29

When the financial statements contain a misstatement, the effect of which is material but not pervasive, the auditor should

Answer 29

Qualify the opinion and include a basis for qualified opinion paragraph that describes the matter resulting in the qualification.

Question 30

An auditor who is unable to form an opinion on a new client’s opening inventory balances may express an unmodified opinion on the current year’s

Answer 30

Balance sheet only.

Answer (C) is correct.
An inability to obtain sufficient appropriate audit evidence related to beginning inventory may prevent the auditor from expressing an unmodified opinion on some of the financial statements. Opening inventories enter into the determination of net income and cash flows. Thus, the auditor may disclaim an opinion on results of operations and cash flows. However, the balance sheet reports only the ending inventory balances. Thus, the auditor may express an unmodified opinion on the balance sheet.

Question 31

Zag Co. presents financial position and results of operations but not the related statement of cash flows. Zag would like to engage Brown, CPA, to audit its financial statements without the statement of cash flows, although Brown’s access to all of the information underlying the basic financial statements will not be limited. Under these circumstances, Brown most likely would

Answer 31

Explain to Zag that the omission requires a qualification of the auditor’s opinion.

Answer (C) is correct.
An entity that reports financial position and results of operations should provide a statement of cash flows. Thus, the omission of the cash flow statement is normally a basis for modifying the opinion. If the statements fail to disclose required information, the auditor should provide the information in the report, if practicable. However, the auditor is not required to prepare a basic financial statement. Accordingly, (s)he should qualify the opinion and explain the reason in a basis for qualified opinion paragraph.

Question 32

When management will not permit inquiry of outside legal counsel, the audit report will ordinarily contain a(n)

Answer 32

Disclaimer of opinion.

Answer (D) is correct.
The auditor may be unable to determine the legality of certain acts or the amounts associated with them because of an inability to gather sufficient appropriate audit evidence. For example, management may not permit inquiry of external legal counsel. In these circumstances, the scope limitation requires a qualified opinion or a disclaimer. However, if (1) the auditor cannot obtain sufficient appropriate evidence because of a management-imposed limitation, and (2) the possible effects of undetected misstatements are material and pervasive, the auditor should disclaim an opinion or withdraw from the engagement.

Question 33

An auditor’s report included an additional paragraph disclosing that there is a difference of opinion between the auditor and the client for which the auditor believed an adjustment to the financial statements should be made. The opinion paragraph of the auditor’s report most likely expressed

Answer 33

A qualified opinion.

Answer (B) is correct.
The most likely reason for including a separate paragraph disclosing a difference of opinion with the client is that the selection or application of an accounting principle is not in accordance with the applicable reporting framework. Such a disagreement is described in a basis for qualified opinion or basis for adverse opinion paragraph, depending upon the pervasiveness of the material misstatement.

Question 34

What report modifications do you have to do to an adverse opinion?

Answer 34

The opinion should state that, because of the significance of the matter(s) described in the basis for adverse opinion paragraph, the financial statements are not presented fairly in accordance with the framework. The following are other effects on the auditor’s report when an adverse opinion is expressed: (1) The introductory paragraph is unchanged; (2) the management’s responsibility paragraph is unchanged; and (3) the auditor’s responsibility section is changed to state, “We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our adverse audit opinion.”

Question 35

When an independent CPA is associated with the financial statements of an issuer but has not audited or reviewed such statements, the appropriate form of report to be issued must include a(n)

Answer 35

Disclaimer of opinion.

Answer (B) is correct.
PCAOB auditing standards apply to engagements involving issuers. Under these standards, when an accountant is associated with the financial statements of an issuer but has not audited or reviewed such statements, the report should disclaim an opinion on them (PCAOB Interim Auditing Standards).

Question 36

If an issuer releases financial statements that purport to present its financial position and results of operations but omits the statement of cash flows, the auditor ordinarily will express a(n)

Answer 36

Qualified opinion.

Answer (D) is correct.
An entity that reports financial position and results of operations should provide a statement of cash flows. Thus, the omission of the cash flow statement is normally a basis for modifying the opinion. If the statements fail to disclose required information, the auditor should provide the information in the report, if practicable. However, the auditor is not required to prepare a basic financial statement. Accordingly, (s)he should qualify the opinion and explain the reason in a basis for qualified opinion paragraph.

Question 37

Green, CPA, is aware that Green’s name is to be included in the interim report of National Company, a publicly held entity. National’s quarterly financial statements are contained in the interim report. Green has not audited or reviewed these interim financial statements. Green should request that

Green’s name not be included in the communication.

The financial statements be marked as unaudited, with a notation that no opinion is expressed on them.

Answer 37

Either I or II.

Answer (D) is correct.
The accountant may become aware that his or her name is to be included in a client-prepared written communication of an issuer containing financial statements that have not been audited or reviewed. Under PCAOB standards, which apply to engagements involving issuers, (s)he should request either that (1) his or her name not be included in the communication or (2) the financial statements be marked as unaudited, with a notation included to the effect that (s)he does not express an opinion on them.

Question 38

If an accountant concludes that unaudited financial statements of an issuer on which the accountant is disclaiming an opinion also lack adequate disclosure, the accountant should suggest appropriate revision. If the client does not accept the accountant’s suggestion, the accountant should

Answer 38

Describe the appropriate revision to the financial statements in the accountant’s disclaimer of opinion.

Answer (B) is correct.
PCAOB auditing standards apply to engagements involving issuers. Under these standards, inadequate disclosure is a departure from U.S. GAAP. When an accountant who is associated with the unaudited statements of an issuer suggests revision because of such a departure and the client declines to provide the necessary disclosures, the disclaimer should be modified to describe the departure. The description should refer specifically to the nature of the departure and, if practicable, state the effects on the financial statements or include the necessary information for adequate disclosure (PCAOB Interim Auditing Standards).