Chapter 14 Auditing

Subsequent events occur after: -the appointment of the auditor -the going concern assumption -the start of the fiscal year -the end of the fiscal year

the end of the fiscal year

The audit firm must retina the audit of a public company client for: -7 years -4 years -5 years -6 years

7 years

Which of the following is an example of a subsequent event? -Legal action that was settled in the last month of the fiscal year -A major customer declaring bankruptcy two months before the client's year-end -A bond issuance after the balance sheet date but prior to issuance of the financial statements -A cybersecurity attack that occurred in the third quarter of the fiscal year

A bond issuance after the balance sheet date but prior to issuance of the financial statements

Management prepared the financial statements of Jewelry Enterprises as of December 31, 2023. The financial statements were issued on March 6, 2024. When is management's evaluation period related to the going concern assumption? -December 31, 2030 -March 6, 2025 -The foreseeable future -December 31, 2024

March 6, 2025

A/An _____ is an audit inquiry sent to a client's external and inhouse legal counsel to obtain information about litigation, assessments, and claims

Legal letter

If management does not have a formal process for evaluating going concern, it could be considered -a basis for a disclaimer of opinion -a scope limitation -a weakness in internal control -a failure to operate as a going concern

a weakness in internal control

At the conclusion of the audit, the wrap-up process involves all of the following except: -determination that all necessary matters have been appropriately considered -revisiting assessments for materiality, control risk, and risk of fraud -sending confirmations to financial institutions -review of proper and complete execution of planned audit procedures

sending confirmations to financial institutions

All of the following statements are included in a management representation letter except: -the auditor's fee for completing the audit -the effects of uncorrected misstatements are immaterial, both individually and in the aggregate, to the financial statements -no subsequent events have occurred that require adjustment to or disclosure in the financial statements -there have been no violations of law or regulations

the auditor's fee for completing the audit

The going concern assumption means: -assets and liabilities are stated at liquidation values -the auditor is concerned whether the entity is going to change locations -the entity is viewed as continuing is business for the foreseeable future with no need for liquidation -the entity is facing difficulties continuing as a viable business entity

the entity is viewed as continuing is business for the foreseeable future with no need for liquidation

Langford Associates recently completed an audit of Happy Time Inc., a publicly traded manufacturer of children's toys. The firm released its audit report for the assignment on June 15, 2022. How long must Langford Associates retain the audit file for the Happy time audit? -until June 15, 2027 -until June 15, 2029 -until December 15, 2022 -until September 15, 2022

until June 15, 2029

Which of the following statements, extracted from a client's lawyer's letter concerning litigation, claims, and assessments, would be most likely to cause the auditor to request clarification? -"We believe that the possible liability to the company is nominal in amount." -"We believe that the action can be settled for less than the damages claimed." -"We believe that the plaintiff's case against the company is without merit." -"We believe that the company will be able to defend this action successfully."

"We believe that the action can be settled for less than the damages claimed." "Without merit" means that it is highly unlikely that a materially unfavorable outcome will occur, which would be easily understood by the auditor.

Which three of the following are items to consider when reviewing working papers? -Work has been performed in accordance with appropriate audit standards -Significant findings or issues have been raised for further considerations or audit testing -Consultations among team members and others within or outside of the audit firm, have taken place, as needed, and the resulting conclusions have been documented -Competitors have changed their business plans

-Work has been performed in accordance with appropriate audit standards -Significant findings or issues have been raised for further considerations or audit testing -Consultations among team members and others within or outside of the audit firm, have taken place, as needed, and the resulting conclusions have been documented

Which of the following describes a Type II event? -A Type II event does not require an adjustment to the financial statements but may require disclosure in the notes to the financial statements -A Type II event does not require an adjustment to the financial statements nor does it require disclosure in the notes to the financial statements -A Type II event requires an adjustment to the financial statements and my require disclosure in the notes to the financial statements -A Type II event requires an adjustment to the financial statements and disclosure in the notes to the financial statements

A Type II event does not require an adjustment to the financial statements but may require disclosure in the notes to the financial statements

The refusal of a client's attorney to provide information requested in an inquiry letter generally is considered -Grounds for an adverse opinion. -A limitation on the scope of the audit. -Reason to withdraw from the engagement. -Equivalent to a significant deficiency.

A limitation on the scope of the audit. The refusal of a client's attorney to provide information requested in an inquiry letter is considered a limitation on the scope of the audit. It would result in a disclaimer or a qualified opinion.

Match the following statements to the appropriate terms A. the client must grant permission for the attorneys to respond. B. The letter is sent about mid-way through the completion of year-end fieldwork C. A legal letter should be sent to all attorneys the client hired during the year for legal services, as well as in-house counsel D. This paragraph identifies the financial statements under audit and states a request to supply information directly to the auditors -Request for information -Date of the letter -The legal letter is prepared on the client's letterhead -Name and address of the attorneys

A. The legal letter is prepared on the client's letterhead B. Date of the letter C. Name and address of attorneys D. Request for information

Sarah Lang was working on the audit of Wainwright Travel for the year ended 12/31/2020. On 1/28/2021, prior to the completion of the audit fieldwork, Wainwright learned that their largest customer filed for bankruptcy. How should this be treated in the financial statements? -A disclosure should be made as of 12/31/2020 -A disclosure should be made as of 12/31/2020 and a journal entry should be booked as of 1/28/2021 -A journal entry should be made as of 1/28/2021 -An adjustment to the financial statements should be made as of 12/31/2020

An adjustment to the financial statements should be made as of 12/31/2020

The date of the management representation letter should coincide with the date of the -Balance sheet. -Latest interim financial information. -Auditor's report. -Latest related party transaction.

Auditor's report. The auditor is concerned with events occurring through the date of the report that might impact the financial statements. Therefore, the management representation letter should be dated with the date of the auditor's report.

The primary source of information to be reported about litigation, claims, and assessments is the -Client's lawyer. -Court records. -Client's management. -Independent auditor.

Client's management. Management is the primary source of information about litigation, claims, and assessments. The information provided by management is corroborated by the client's lawyer.

During the course of an audit, an auditor finds evidence that an officer has entered fraudulent transactions in the financial statements. The fraudulent transactions can be adjusted so the statements are not materially misstated. What should the auditor do? -Report the matters to regulatory authorities. -Consider the fraud a scope limitation and disclaim an opinion. -Communicate the matter to those charged with governance. -Immediately withdraw from the engagement.

Communicate the matter to those charged with governance. Any fraud involving senior management, whether material or not, should be reported to those charged with governance.

Which of the following statements would most likely be included among the written client representations obtained by the auditor? -Compensating balances and other arrangements involving restrictions on cash balances have been disclosed. -Management acknowledges responsibility for illegal actions committed by employees. -Sufficient evidential matter has been made available to permit the issuance of an unqualified opinion. -Management acknowledges that there are no material weaknesses in the internal control.

Compensating balances and other arrangements involving restrictions on cash balances have been disclosed. The client representation letter would not include an acknowledgment by management that there are no weaknesses in internal control. This determination is made by the auditor in planning the audit and deciding which auditing procedures to employ.

Which of the following is not an audit procedure that the independent auditor would perform concerning litigation, claims, and assessments? -Obtain assurance from management that it has disclosed all unasserted claims that the lawyer has advised are probable of assertion and must be disclosed. -Confirm directly with the client's lawyer that all claims have been recorded in the financial statements. -Inquire about and discuss with management the policies and procedures adopted for identifying, evaluating, and accounting for litigation, claims, and assessments. -Obtain from management a description and evaluation of litigation, claims, and assessments existing at the balance sheet date.

Confirm directly with the client's lawyer that all claims have been recorded in the financial statements. The auditor would NOT confirm with the attorney that ALL claims have been recorded in the financial statements. All claims do not require recording and the attorney would not have knowledge of what had been recorded in the financial statements.

Your auditing team is currently auditing a client's sales transactions. The client informs you that a manufacturing error has caused defects that require them to replace the product at no charge. What should your team do? -Consider lowering the materiality level and gathering additional audit evidence -Issue a disclaimer of opinion -Revise their initial assessment of control and fraud risks -Request that management make adjusting entries to correct factual misstatements

Consider lowering the materiality level and gathering additional audit evidence

Where would the following be found? "We are providing this letter in connection with our audit of the consolidated financial statements of Babson Enterprises, Inc. as of December 31, 2022 and for the year then ended for the purpose of expressing an opinion as to whether the consolidated financial statements present fairly, in all material respects, the financial position, results of operations, and cash flows of Babson Enterprises in conformity with accounting principles generally accepted in the United States of America." -management letter -engagement letter -audit report -management representation letter

management representation letter

To which of the following matters would an auditor not apply materiality limits when obtaining specific written representations from management? -Disclosure of compensating balance arrangements involving restrictions on cash balances. -Information concerning related party transactions and related amounts receivable or payable. -The absence of errors and unrecorded transactions in the financial statements. -Fraud involving employees with significant roles in the internal control structure.

Fraud involving employees with significant roles in the internal control structure. Because of the possible effects of fraud on other areas of the audit, materiality limits would not apply to the reporting of fraud involving employees with significant roles in internal control in the written management representations.

Albert Chung, a partner at Robinson Auditing, Inc, recently conducted a refresher workshop on misstatements for the firm's junior auditors. Which of Albert's statements from the workshop should actually be considered helpful to the junior auditors? -Typically, management makes adjustments for immaterial misstatements, but they may decide not to correct some material misstatements -If it is determined that fraud is the cause of misstatements in an account or class of transactions, it does not matter if the misstatements are material or immaterial -When evaluating the effect of uncorrected misstatements, you should only consider qualitative factors -The working papers should include documentation of misstatements accumulated during the audit, but only those that have been corrected

If it is determined that fraud is the cause of misstatements in an account or class of transactions, it does not matter if the misstatements are material or immaterial

Of which of the following matters is a management representation letter required to contain specific representations? -Length of a material contract with a new customer. -Information concerning fraud by the CFO. -Reason for a significant increase in revenue over the prior year. -The competency and objectivity of the internal audit department.

Information concerning fraud by the CFO. A management representation letter routinely includes a statement pointing out that senior management has no knowledge of any fraud or suspected fraud involving management, which includes the CFO.

Key Co. plans to present comparative financial statements for the years ended December 31, 2005, and 2006, respectively. Smith, CPA, audited Key's financial statements for both years and plans to report on the comparative financial statements on May 1, 2007. Key's current management team was not present until January 1, 2006. What period of time should be covered by Key's management representation letter? -January 1, 2005, through December 31, 2006. -January 1, 2005, through May 1, 2007. -January 1, 2006, through December 31, 2006. -January 1, 2006, through May 1, 2007.

January 1, 2005, through May 1, 2007. The management representation letter should address all periods covered by the auditor's report. Key's management representation letter, therefore, should cover the two periods being audited up through the date of the report, i.e., from January 1, 2005, through May 1, 2007. This requirement exists even if management was not present during all periods covered by the auditor's report.

Which of the following is a Type II subsequent event? -Deterioration in financial results after year-end, which may indicate doubt about the ability to continue as a going concern -Bankruptcy of a customer subsequent to year-end, which would be considered when evaluating the adequacy of the allowance for uncollectible accounts -Loss of plant as a result of fire or flood after year-end -An amount received related to an insurance claim that was in the course of negotiation at year-end

Loss of plant as a result of fire or flood after year-end

Where would the following phrase be found? "We confirm that we are responsible for the fair presentation in the consolidated financial statements of financial position, results of operations, and cash flows in conformity with generally accepted accounting principles". -Engagement letter -Management letter -Audit report -Management representation letter

Management Representation letter

Which of the following statements would an auditor most likely require management to indicate in a written representation letter obtained for an audit? -Management acknowledges its responsibilities for the design and implementation of programs and controls to detect fraud. -Management plans to expand into international operations during the next few years. -Management believes the financial statements are accurately stated in accordance with generally accepted auditing standards (GAAS). -Management believes the company is the premier company in its industry regarding service to customers

Management acknowledges its responsibilities for the design and implementation of programs and controls to detect fraud. A management representation letter routinely requires management to take responsibility for the design, implementation, and maintenance of programs and controls to detect fraud.

Which of the following management roles would typically be acknowledged in a management representation letter? Management has the responsibility for the design of controls to detect fraud. Management communicates its views on ethical behavior to its employees. Management's knowledge of fraud is communicated to the audit committee. Management's compensation is contingent upon operating results.

Management has the responsibility for the design of controls to detect fraud. This is a required item in the management representation letter. Management must acknowledge its responsibility for the design and implementation of programs and controls to prevent and detect fraud.

"We have disclosed to you all known instances of noncompliance or suspected noncompliance with laws and regulations whose effects should be considered when preparing financial statements." The foregoing passage most likely is from a(n) -Client engagement letter. -Report on compliance with laws and regulations. -Management representations letter. -Attestation report on an internal control structure.

Management representations letter. The management representation letter commonly includes a statement as to violations or possible violations of laws or regulations whose effects should be considered for disclosure in the financial statements or as a basis for recording a loss contingency.

If management considers a material loss contingency to be probable but an amount cannot be reasonably estimated, the proper accounting treatment is: -accrual in the financial statements only -accrual in the financial statements and note disclosure -not disclosure only -no adjustment or disclosure necessary

not disclosure only

The scope of an audit is not restricted when an attorney's response to an auditor, as a result of a client's letter of audit inquiry, limits the response to -Matters to which the attorney has given substantive attention in the form of legal representation. -An evaluation of the likelihood of an unfavorable outcome of the matters disclosed by the entity. -The attorney's opinion of the entity's historical experience in recent similar litigation. -The probable outcome of asserted claims and pending or threatened litigation.

Matters to which the attorney has given substantive attention in the form of legal representation. A lawyer may appropriately limit the response to matters to which the lawyer has given substantive attention in the form of legal consultation or representation.

CPA Management's responses to inquiries can be corroborated by each of the following, except -Visits to the entity's premises and plant facilities. -Inspection of documents and internal control manuals. -Preparation of the summary of unadjusted differences. -Observation of entity activities and operations.

Preparation of the summary of unadjusted differences. Correct! The purpose of the "summary of unadjusted differences" is to determine whether identified differences between the accounting records and the audit evidence that are not individually material might be material in the aggregate. These items represent differences already identified and are not applicable to supporting management's responses to the auditor's inquiries.

Which of the following procedures would be most likely to assist an auditor in identifying litigation, claims, and assessments? -Inspect checks included with the client's cut-off bank statement. -Obtain a letter of representations from the client's underwriter of securities. -Apply ratio analysis on the current-year's liability accounts. -Read the file of correspondence from taxing authorities.

Read the file of correspondence from taxing authorities. A taxing authority could impose an assessment on an entity related to tax matters. The auditor might then identify the existence of such an assessment by reviewing correspondence between the entity and the taxing authority.

In auditing contingent liabilities, which of the following procedures would an auditor be most likely to perform? -Confirm the details of outstanding purchase orders. -Apply analytical procedures to accounts payable. -Read the minutes of the board of directors' meetings. -Perform tests of controls on the cash disbursement activities.

Read the minutes of the board of directors' meetings. Issues that are significant to the entity (for example, litigation issues that result in contingent liabilities) normally rise to the level of discussion by those charged with governance. The auditor routinely reads the minutes of these meetings to identify issues that have financial reporting implications, including issues related to contingent liabilities.

In the course of auditing Vista Event Planning, Lynn identified the loss of the company's principal customers. During the audit procedure did Lynn locate this information? -Reading minutes of meetings with internal auditors -Review of compliance with terms of loan agreements -Analytical procedures during risk assessment -Review of subsequent events

Review of subsequent events

What is an auditor's primary method to corroborate information on litigation, claims, and assessments? -Examining legal invoices sent by the client's attorney. -Verifying attorney-client privilege through interviews. -Reviewing the response from the client's lawyer to a letter of audit inquiry. -Reviewing the written representation letter obtained from management.

Reviewing the response from the client's lawyer to a letter of audit inquiry. The auditor will often seek to obtain an attorney's letter, as that provides some of the primary evidence supporting litigation, claims, and assessments. Note that the question indicates that the auditor is corroborating information. The auditor first obtains the information from the client. That information is then corroborated by the information obtained from the attorney.

The auditors of Hashtag Communications, Inc. asked management for a written representation that no material subsequent events had occurred that required adjustment to or disclosure in the financial statements. Which statement is most correct regarding this situation? -The auditors may use that evidence as the audit procedure designed to identify subsequent events -The auditors may only use that evidence as the audit procedure designed to identify subsequent events if the client is a private company -That evidence does not relieve auditors of their duty to perform audit procedures designed to identify subsequent events -The auditors may only use that evidence as the audit procedure designed to identify subsequent events if management agrees to it in writing

That evidence does not relieve auditors of their duty to perform audit procedures designed to identify subsequent events

A lawyer's response to an auditor's inquiry concerning litigation, claims, and assessments may be limited to matters that are considered individually or collectively material to the client's financial statements. Which parties should reach an understanding on the limits of materiality for this purpose? -The auditor and the client's management. -The client's audit committee and the lawyer. -The client's management and the lawyer. -The lawyer and the auditor.

The auditor and the client's management. The client's attorney is asked to provide a letter describing and evaluating litigation pending and in process and asserted claims. Immaterial items may be excluded, provided that the entity and the auditor have reached an understanding on the limits of materiality for this purpose. The understanding needs to then be conveyed to the attorney.

During an audit, an auditor discovers a fraudulent expense reimbursement for a low-level manager. The auditor determines that this transaction is inconsequential and several similar transactions would not be material to the financial statements in the aggregate. Which of the following statements best describes the auditor's required response to the discovery? -The auditor should fully investigate other transactions related to this manager to determine if fraud exists. -The auditor should bring the transaction to the attention of an appropriate level of management. -The auditor should report this finding to those charged with governance. -The auditor's responsibility is satisfied by documenting that the single transaction is inconsequential.

The auditor should bring the transaction to the attention of an appropriate level of management. Fraud that has been detected by the auditor and which is immaterial to the financial statements (and which does not involve senior management) should be reported to the appropriate level of management, at least one level above where the fraud is believed to have originated.

Which of the following matters would an auditor most likely include in a management representations letter? -Communications with the audit committee concerning weaknesses in internal control structure. -The completeness and availability of minutes of stockholders' and directors' meetings. -Plans to acquire or merge with other entities in the subsequent year. -Management's acknowledgment of its responsibility for the detection of all employee fraud.

The completeness and availability of minutes of stockholders' and directors' meetings. The management representations letter typically includes a comment along the following lines: "We have provided you with access to all information, of which we are aware that is relevant to the preparation and fair presentation of the financial statements such as records, documentation and other matters, and additional information that you have requested from us for the purpose of the audit." The foregoing passage encompasses the completeness and availability of all minutes of any meetings of stockholders and the board of directors.

During an audit of Manitou Lake Marina, the auditors had a disagreement with management over the recognition of revenue. After some discussion, the disagreement was resolved. How should the auditors handle this situation? -The disagreement should be reported to the SEC -The disagreement does not need to be reported to those charged with governance -The disagreement should not be included in the permanent file -The disagreement should be reported to those charged with governance

The disagreement should be reported to those charged with governance

If a nonissuer refuses to give permission to the auditor to communicate with its external legal counsel, then the auditor should modify which of the following? -The audit plan -The management representation letter -The attorney's letter of inquiry -The opinion in the auditor's report

The opinion in the auditor's report Management's refusal to cooperate with the auditor in obtaining a lawyer's letter would be a scope limitation that would result in a modified opinion.

One purpose of a management representation letter is to reduce -Audit risk to an aggregate level of misstatement that could be considered material. -An auditor's responsibility to detect material misstatements only to the extent that the letter is relied upon. -The possibility of a misunderstanding concerning management's responsibility for the financial statements. -The scope of an auditor's procedures concerning related party transactions and subsequent events.

The possibility of a misunderstanding concerning management's responsibility for the financial statements. A management representation letter is obtained by the auditor to reduce the possibility of a misunderstanding concerning management's responsibility for the financial statements and to document the representations made by management during the course of the audit.

An auditor is reporting on comparative financial statements for three years. Which of the following statements is correct regarding written representations from management? -The representation letter needs to address the prior-year's financial statements not covered in the report. -The representation letter needs to address only the most current year covered in the report. -The representation letter needs to address only the two most recent years covered in the report. -The representation letter needs to address all of the years being covered in the report.

The representation letter needs to address all of the years being covered in the report. As stated in AICPA Professional Standards (AU-C 580.20) "The written representations should be for all financial statements and period(s) referred to in the auditor's report."

Brenda Gonzalez is the senior auditor on a team conducting an audit of a chain of regional hospitals. As she reviews the working paper of her colleagues, what should Brenda consider? -Whether the objectives of the engagement procedures have been achieved -Whether evidence obtained is sufficient and appropriate to support the auditor's planning needs for the future -Whether the work has been performed in accordance with generally accepted accounting principles -Whether the work performed supports the audit fees charged to the client

Whether the objectives of the engagement procedures have been achieved

Disclosure of irregularities to parties other than a client's senior management and its audit committee or board of directors ordinarily is not part of an auditor's responsibility. However, to which of the following outside parties may a duty to disclose irregularities exist? To the SEC when the client reports an auditor change -Yes -Yes -No -Yes To a successor auditor when the successor makes appropriate inquiries -Yes -No -Yes -Yes To a government funding agency from which the client receives financial assistance -No -Yes -Yes -Yes

Yes, Yes, Yes The existence of irregularities (fraud) is considered to be a severe problem in an audit due to potential ramifications for other areas of the audit. As a result, the auditor has a duty to disclose irregularities to the SEC when the client reports an auditor change, to a successor auditor when the successor makes appropriate inquiries, and to a government funding agency from which the client receives financial assistance.

If auditors discover fraud during the audit, it should first be reported to: -an appropriate level of management or those charged with governance -the employee who is committing the fraud -the PCAOB -the SEC

an appropriate level of management or those charged with governance

Sheila Baldus is the CFO of ABC Corp., which has been struggling to collect cash from customers over the past six months. According to FASB ASC 205-40 Presentation of Financial Statements-Going Concern, Sheila must make an assessment of the entity's ability to continue as a going concern for the -foreseeable future -future period of one year beyond the issuance date of the company's financial statements -future period of five years beyond the issuance date of the company's financial statements -future period of six months beyond the issuance date of the company's financial statements

future period of one year beyond the issuance date of the company's financial statements

A ______ is a letter from management to the auditor acknowledging management's responsibility for the preparation of the financial statements and details of any verbal representations made by management during the course of the audit.

management representation letter

For private company client that follows GAAP, auditors must consider the going concern assumption for a reasonable period of time, which is: -one year from the completion of interim audit procedures -one year from the date of the financial statements -one year from the date the financial statements are issued -one year from the completion of fieldwork

one year from the date the financial statements are issued