Audit Ch 17

Which of the following ordinarily involves the addition of an emphasis-of-matter paragraph to an audit report? a. A consistency modification. b. An adverse opinion. c. A qualified opinion. d. Part of the audit has been performed by component auditors.

a. A consistency modification.

The auditors who wish to draw reader attention to a financial statement note disclosure on significant transactions with related parties should disclose this fact in: a. An emphasis-of-matter paragraph to the auditors' report. b. A footnote to the financial statements. c. The body of the financial statements. d. The "summary of significant accounting policies" section of the financial statements.

a. An emphasis-of-matter paragraph to the auditors' report

The auditors' report should be dated as of the date the: a. Report is delivered to the client. b. Auditors have accumulated sufficient evidence. c. Fiscal period under audit ends. d. Peer review of the working papers is completed.

b. Auditors have accumulated sufficient evidence.

An audit report for a public client indicates that the audit was performed in accordance with: a. Generally accepted auditing standards (United States). b. Standards of the Public Company Accounting Oversight Board (United States). c. Generally accepted accounting principles (United States). d. Generally accepted accounting principles (Public Company Accounting Oversight Board).

b. Standards of the Public Company Accounting Oversight Board (United States).

Which of the following is least likely to result in inclusion of an emphasis-of-matter paragraph in an audit report? a. The company is a component of a larger business enterprise. b. An unusually important significant event. c. A decision not to confirm accounts receivable. d. A risk or uncertainty.

c. A decision not to confirm accounts receivable.

An audit report for a public client indicates that the financial statements were prepared in conformity with: a. Generally accepted auditing standards (United States). b. Standards of the Public Company Accounting Oversight Board (United States). c. Generally accepted accounting principles (United States). d. Generally accepted accounting principles (Public Company Accounting Oversight Board).

c. Generally accepted accounting principles (United States).

A change in accounting principles that the auditors believe is not justified is likely to result in which of the following types of audit opinions? Qualified Unmodified with Emphasis-of-Matter a. Yes Yes b. Yes No c. No Yes d. No No

c. No Yes

What type or types of audit opinion are appropriate when financial statements are materially and pervasively misstated? Qualified Adverse a. Yes Yes b. Yes No c. No Yes d. No No

c. No Yes

When the matter is properly disclosed in the financial statements, the likely result of substantial doubt about the ability of the client to continue as a going concern is the issuance of which of the following audit opinions? Qualified Unmodified with Emphasis-of-Matter a. Yes Yes b. Yes No c. No Yes d. No No

c. No Yes

A material departure from generally accepted accounting principles will result in auditor consideration of: a. Whether to issue an adverse opinion rather than a disclaimer of opinion. b. Whether to issue a disclaimer of opinion rather than a qualified opinion. c. Whether to issue an adverse opinion rather than a qualified opinion. d. Nothing, because none of these opinions is applicable to this type of exception.

c. Whether to issue an adverse opinion rather than a qualified opinion.

Assume that the opinion paragraph of an auditors' report begins as follows: "With the explanation given in Note 6, . . . the financial statements referred to above present fairly. . ." This is: a. An unmodified opinion. b. A disclaimer of opinion. c. An "except for" opinion. d. An improper type of reporting.

d. An improper type of reporting.

For each of the following brief scenarios, assume that you are reporting on a client's financial statements. Select the type(s) of opinion (per below) possible for the scenario. In addition: • Unless stated otherwise, assume the matter involved is material. If the problem doesn't tell you whether a misstatement pervasively misstates the financial statements or doesn't list a characteristic that indicates pervasiveness, two reports may be possible (i.e., replies 6 to 9). • Do not read more into the circumstances than what is presented. • Do not consider an auditor discretionary circumstance for modification of the audit report unless the situation explicitly suggests that the auditor wishes to emphasize a particular matter. Types of Opinion 1. Unmodified—standard. 2. Unmodified with an emphasis-of-matter paragraph. 3. Qualified. 4. Adverse. 5. Disclaimer. 6. Unmodified with an emphasis-of-matter paragraph or disclaimer. 7. Qualified or adverse. 8. Qualified or disclaimer. 9. Adverse or disclaimer. 10. Other. * Note that this simulation has more parts than one would expect in a particular CPA exam simulation. We present it to provide examples of many types of reporting situations in one problem. Types of opinion may be used once, more than once, or not at all.

1. 7 A company has not followed generally accepted accounting principles in the recording of its leases 2. 1 A company has not followed generally accepted accounting principles in the recording of its leases. The amounts involved are immaterial 3. 7 A company valued its inventory at current replacement cost. Although the auditor believes that the inventory costs do approximate replacement costs, these costs do not approximate any GAAP inventory valuation method 4. 2 A client changed its depreciation method for production equipment from the straight-line method to the units-of-production method based on hours of utilization. The auditor concurs with the change. 5. 7 A client changed its depreciation method for production equipment from the straight-line method to the units-of-production method based on hours of utilization. The auditor does not concur with the change. 6. 1 A client changed the depreciation life of certain assets from 10 years to 12 years. The auditor concurs with the change 7. 3 A client changed the depreciation life of certain assets from 10 years to 12 years. The auditor does not concur with the change. Confined to fixed assets and accumulated depreciation, the misstatements involved are not considered pervasive 8. 1 A client changed from the method it uses to calculate post employment benefits from one acceptable method to another. The effect of the change is immaterial this year, but is expected to be material in the future 9. 1 A client changed the salvage value of certain assets from 5 percent to 10 percent of original costs. The auditor concurs with the change 10. 1 A client uses the specific identification method of accounting for valuable items in inventory, and LIFO for less valuable items. The auditors concurs that this is a reasonable practice 11. 6 Due to recurring operating lossees and working capital deficiencies, and auditor has substantial doubt about an entity's ability to continue as a going concern for a reasonable period of time. The notes to the financial statements adequately disclose the situation. 12. 4 Due to recurring operation losses and working capital deficiencies, and auditor has substantial doubt about an entitiy's ability to continue as a going concern for a reasonable period of time. The notes to the financial statements do not adequately disclose the substantial doubt situation, and th auditor believes the omission fundamentally affects the users' understanding of the financial statements 13. 1 An auditor reporting on group financial statemnts decides to take responsibility for the work of a component auditor who audited a 70 percent owned subsidiary and issued an unmodified opinion. The total assets and revenues of the subsidiary are 5 percent and 8 percent, respectively, of the total assets and revenues of the entity being audited. 14. 10 An auditor reporting on group financial statements decides not to take responsibility for the work of a component auditor who audited a 70 percent ownerd subsidiary and issued an unqualified opinion. The total assets and revenues of the subsidiary are 5 percent and 8 percent, respectively, of the total assets and revenues of the entity being audited 15. 8 An auditor was hired after year-end and was unable to observe the counting of the year-end inventory. She is unable to apply other procedures to determine whether ending inventory and related information are properly stated. 16. 1 An auditor was hired after year-end and was unable to observe the counting of the year-end inventory. However, she was able to apply other procedures and determined that ending inventory and related information was properly stated. 17. 8 An auditor discovered that a client made illegal polital payoffs to a candidate for president of the United States. The auditor was unable to determine the amounts associated with the payoffs because of the client's inadequate record-retention policies. The client has added anote to the financial statements to describe the illegal payments and has stated that the amounts of the payments are not determinable. 18. 3 An auditor discovered that a client made illegal polital payoffs to a candidate for president of the United States. The auditor was unable to determine the amounts associated with the payoffs because of the client's inadequate record-retention policies Although there is no likelihood that the financial statemetns are prevasively misstated, they may be materially misstated. The client refuses to disclose the payoffs in a note to the financial statements. 19. 1 In auditing the long-term investments account of a new client, and auditor finds that a large contingent liability exists that is material to the consolidated company. It is probable that this contingent liability will be resolved with a material loss in the future, but the amount is not estimatble. Although no adjusting entry has been made, the client has provided a note to the financial statements that describes that matter in detail. 20. 7 In auditing the long-term investments account of a new client, and auditor finds that a large contingent liability exists that is material to the consolidated company. It is probable that this contingent liability will be resolved with a material loss in the future, and this amount is reasonably estimable as $2,000,000. Although no adjusting entry has been made the client has provided a note to the financial statemenst that describes the matter in detail and includes $2,000,000 estimate in that note. 21. 10 A client is issuing two years of comparative financial statements. The first year was audited by another auditor who is not being asked to reissue her audit report. (reply as to the successor auditors' report.) 22. 1 A client is issuing two years of comparative financial statements. The first year was audited by another auditor who is being asked to reissue her audit report. (reply as to the successor auditors' report.) 23. 2 A client's financial statements follow GAAP, but the auditor wishes to emphasize in his audit report a significant related party transaction that is adequately described in the notes to the financial statements. 24. 7 A client's financial statements follow GAAP except that they do not include a note on a significant related party transaction

tems 1 through 5 present various independent factual situations an auditor might encounter in conducting an audit. For each situation, assume: • The auditor is independent. • The auditor previously expressed an unmodified opinion on the prior year's financial statements. • Only single-year (not comparative) statements are presented for the current year. • The conditions for an unmodified opinion exist unless contradicted in the factual situations. • The conditions stated in the factual situations are material. • No report modifications are to be made except in response to the factual situation. List A represents the types of opinions the auditor ordinarily would issue and List B represents the report modifications (if any) that would be necessary. Select as the best answer for each situation (items 1 through 5) the type of opinion and alterations, if any, the auditor would normally select. Replies may be selected once, more than once, or not at all. List A: Types of Opinions A. Unmodified B. Qualified C. Adverse D. Disclaimer E. Qualified or adverse F. Qualified or disclaimer G. Disclaimer or adverse List B: Report Alteration H. Add an emphasis-of-matter paragraph—prior to opinion paragraph. I. Add an emphasis-of-matter paragraph—after opinion paragraph. J. Add a basis for modification paragraph—prior to opinion paragraph. K. Add a basis for modification paragraph—after opinion paragraph. L. Modifications other than addition of a paragraph. M. Issue standard report without alteration. 1. In auditing the long-term investments account, an auditor is unable to obtain audited financial statements for an investee located in a foreign country. The auditor concludes that sufficient appropriate audit evidence regarding this investment cannot be obtained. 2. Due to recurring operating losses and working capital deficiencies, and auditor has substantial doubt about an entity's ability to continue as a going concern for a reasonable period of time. However, the financial statement disclosures concerning these matters are adequate. The auditor has decided not to issue a disclaimer of opinion. 3. A group auditor decides to take responsibility for the owrk of a component CPA, who audited wholly owned subsidiary represent 17 percent and 18 percent, respectively, of the total assets and revenues of the entity being audited. 4. An entity changes its depreciation method for production equipment from straight-line to a units-of-production method based on hours of utilizaion. The auditor concurs with the change, although it has a material effect on the comparability of the entity's financial statements 5. An entity discloses certain lease obligations in the notes to the financial statements. The auditor believes that the failure to capitalize theese leases is a departure from generally accepted accounting principles and, although the possible effects on the financial statements of the misstatements is material, they could not be pervasive.

1. In auditing the long-term investments account, an auditor is unable to obtain audited financial statements for an investee located in a foreign country. The auditor concludes that sufficient appropriate audit evidence regarding this investment cannot be obtained. **F. Qualified or disclaimer; ** J. Add a basis for modification paragraph—prior to opinion paragraph. 2. Due to recurring operating losses and working capital deficiencies, and auditor has substantial doubt about an entity's ability to continue as a going concern for a reasonable period of time. However, the financial statement disclosures concerning these matters are adequate. The auditor has decided not to issue a disclaimer of opinion. ** A. Unmodified; ** I. Add an emphasis-of-matter paragraph—after opinion paragraph. 3. A group auditor decides to take responsibility for the owrk of a component CPA, who audited wholly owned subsidiary represent 17 percent and 18 percent, respectively, of the total assets and revenues of the entity being audited. **A. Unmodified; **M. Issue standard report without alteration. 4. An entity changes its depreciation method for production equipment from straight-line to a units-of-production method based on hours of utilizaion. The auditor concurs with the change, although it has a material effect on the comparability of the entity's financial statements ** A. Unmodified; ** I. Add an emphasis-of-matter paragraph -after opinion paragraph 5. An entity discloses certain lease obligations in the notes to the financial statements. The auditor believes that the failure to capitalize these leases is a departure from generally accepted accounting principles and, although the possible effects on the financial statements of the misstatements is material, they could not be pervasive. ** B. Qualified; ** J. Add a basis for modification paragraph—prior to opinion paragraph.

For each of the following brief scenarios, assume that you are reporting on a client's financial statements. Reply as to the type(s) of opinion possible for the scenario. In addition: • Unless stated otherwise, assume the matter involved is material. • If the problem does not state that a misstatement (or possible misstatement) is pervasive, assume that it may or may not be pervasive (thus, the appropriate reply may include two possible reports). • Do not read more into the circumstance than what is presented. Do not consider an auditor discretionary circumstance for modification of the audit report unless the situation explicitly suggests that the auditors wish to emphasize a particular matter. Report Types may be used once, more than once, or not at all. a. Bowles company is engaged in hazardous trade and has obtained insurance coverage related to the hazard. Although the likelihood is remote, a material portion of the company's assets could be destroyed by a serious accident. b. Draves Company owns substantial properties that have appreciated significantly in value since the date of purchase. The properties were appraised and we reported in the balance sheet of the appraisal value (which materially exceed costs) with related disclosures. The CPAs believe that the appraised values reported in the balance sheet reasonably estimate the assets' current values c. During the audit of Eagle Company, the CPA firm has encountered a significant scope limitation relating to inventory record availability and is unable to obtain sufficient appropriate audit evidence in that area. d. London Company has material investments in stocks of subsidiary companies. Stocks of the subsidiary companyies are not actively traded in the market, and the CPA firm's engagment does not extend to any subsidiary company. The CPA firm is able to determine that all investments are carried at original costs, but has no real idea of market value. Although the difference between cost and market could be material, it could not have pervasive effect on the overall financial statements e. Slade Company has material investments in stocks of subsidiary companies. Stocks of the subsidiary companies are actively traded in the market. Management insists that all investments be carried at original costs, and the CPA firm is satisfied that the original costs are accurate. The CPA firm believes that the client will never ultimately realize a substantial portion of the investments because the market value is much lower than the cost; the client has fully disclosed the facts in notes to the financial statements.

a. Bowles company is engaged in hazardous trade and has obtained insurance coverage related to the hazard. Although the likelihood is remote, a material portion of the company's assets could be destroyed by a serious accident. ** Unmodified standard report b. Draves Company owns substantial properties that have appreciated significantly in value since the date of purchase. The properties were appraised and we reported in the balance sheet of the appraisal value (which materially exceed costs) with related disclosures. The CPAs believe that the appraised values reported in the balance sheet reasonably estimate the assets' current values ** Either qualified or adverse c. During the audit of Eagle Company, the CPA firm has encountered a significant scope limitation relating to inventory record availability and is unable to obtain sufficient appropriate audit evidence in that area. ** Either qualified or disclaimer d. London Company has material investments in stocks of subsidiary companies. Stocks of the subsidiary companyies are not actively traded in the market, and the CPA firm's engagment does not extend to any subsidiary company. The CPA firm is able to determine that all investments are carried at original costs, but has no real idea of market value. Although the difference between cost and market could be material, it could not have pervasive effect on the overall financial statements ** Qualified e. Slade Company has material investments in stocks of subsidiary companies. Stocks of the subsidiary companies are actively traded in the market. Management insists that all investments be carried at original costs, and the CPA firm is satisfied that the original costs are accurate. The CPA firm believes that the client will never ultimately realize a substantial portion of the investments because the market value is much lower than the cost; the client has fully disclosed the facts in notes to the financial statements. ** Either qualified or adverse

In an audit report on combined financial statements, reference to the fact that a portion of the audit was performed by a component auditor is: a. Not to be construed as a qualification, but rather as a division of responsibility between the two CPA firms. b. Not in accordance with generally accepted auditing standards. c. A qualification that lessens the collective responsibility of both CPA firms. d. An example of a dual opinion requiring the signatures of both auditors.

a. Not to be construed as a qualification, but rather as a division of responsibility between the two CPA firms.