Audit Exam 1
Greenbloom Garden Centers is a small, privately held corporation that has two stores in Orlando, Florida. The Greenbloom family owns 100 percent of the company's stock, and family members manage the operations. Sales at the company's stores have been growing rapidly, and there appears to be a market for the company's sales concept— providing bulk garden equipment and supplies at low prices. The controller prepares the company's financial statements, which are not audited. The company has no debt but is considering expanding to other cities in Florida. Such expansion may require long-term borrowings and is likely to reduce the family's day-to-day involvement in all of the company's operations. The family does not intend to sell stock in the company. Required: Discuss the factors that may make an audit necessary and potentially valuable for the company. Be sure to consider the concept of information risk.
1. They may require long-term financing for its expansion from banks or insurance companies > limits information risk to the lender since there is information asymmetry 2. as the family loses control over day to day operations, an audit will provide additional monitoring activity for the family
what are the four categories of Principles Underlying an Audit Conducted in Accordance with GAAP
1. purpose and premise of an audit 2. responsibilities (professional skepticism/judgment) 3. performance 4. reporting
A violation of the profession's ethical standards is least likely to occur when a CPA a. Purchases another CPA's accounting practice and bases the price on a percentage of the fees accruing from entities over a three-year period. b. Receives a percentage of the amounts invested by the CPA's audit entities in a tax shelter with the entities' knowledge and approval. c. Has a public accounting practice and is president and sole stockholder of a corporation that engages in data processing services for the public. The CPA often refers his attest entities to the data processing company. d. Forms an association—not a legally binding partnership—with two other sole practitioners and calls the association Adams, Betts & Associates, CPAs.
A
An auditor includes a separate paragraph in an otherwise unmodified financial statement audit report to emphasize that the entity being reported upon had significant transactions with related parties. The inclusion of this separate paragraph a. Is appropriate and would not negate the unmodified opinion. b. Is considered an "except for" qualification of the opinion. c. Violates auditing standards if this information is already disclosed in footnotes to the financial statements. d. Necessitates a revision of the opinion paragraph to include the phrase "with the foregoing explanation."
A
Eagle Company, a public company, had a computer failure and lost part of its financial data. As a result, the auditor was unable to obtain sufficient audit evidence relating to Eagle's inventory account. Assuming the inventory account is at least material, the auditor would most likely choose either a. A qualified opinion or a disclaimer of opinion. b. A qualified opinion or an adverse opinion. c. An unqualified opinion with no explanatory paragraph or an unqualified opinion with an explanatory paragraph. d. A qualified opinion with no explanatory paragraph or a qualified opinion with an explanatory paragraph.
A
Tech Company has appropriately disclosed an uncertainty due to pending litigation. However, the auditor was unable to satisfy herself that all pending litigation had been identified. The auditor's decision to issue a qualified opinion on Tech's financial statements would most likely result from a. A lack of sufficient evidence. b. An inability to estimate the amount of loss. c. The entity's lack of experience with such litigation. d. A lack of insurance coverage for possible losses from such litigation.
A
The Public Company Accounting Oversight Board a. Is a quasi-governmental organization that has legal authority to set auditing standards for audits of public companies. b. Is a quasi-governmental organization that has legal authority to set accounting standards for public companies. c. Is a quasi-governmental organization that has a policy to ignore public comment and input in the process of setting auditing standards. d. Is a quasi-governmental organization that is independent of the SEC in setting auditing standards.
A
Which of the following best describes the relationship between business objectives, strategies, processes, controls, and transactions? a. To achieve its objectives, a business formulates strategies and implements processes, which are carried out through business transactions. The entity's information and internal control systems must be designed to ensure that the transactions are properly executed, captured, and processed. b. To achieve its strategies, a business formulates objectives and implements processes, which are carried out through the entity's information and internal control systems. Transactions are conducted to ensure that the processes are properly executed, captured, and processed. c. To achieve its objectives, a business formulates strategies to implement its transactions, which are carried out through business processes. The entity's information and internal control systems must be designed to ensure that the processes are properly executed, captured, and processed. d. To achieve its business processes, a business formulates objectives, which are carried out through the entity's strategies. The entity's information and internal control systems must be designed to ensure that the entity's strategies are properly executed, captured, and processed.
A
Which of the following is the most important reason for an auditor to gain an understanding of an audit client's system of internal control over financial reporting? a. Understanding a client's system of internal control can help the auditor assess risk and identify areas where financial statement misstatements might be more likely. b. Understanding a client's system of internal control can help the auditor make valuable recommendations to management at the end of the engagement. c. Understanding a client's system of internal control can help the auditor sell consulting services to the client. d. Understanding a client's system of internal control is not a required part of the audit process.
A
Each of the following situations involves a possible violation of the Independence Rule of the AICPA's Code of Professional Conduct. Indicate whether each situation violates the Code. If it violates the Code, explain why. a. Julia Roberto, a sole practitioner, has provided extensive advisory services for her audit entity, Leather Ltd. She has interpreted financial statements, provided forecasts and other analyses, counseled on potential expansion plans, and counseled on banking relationships but has not made any management decisions. Leather is a privately held entity.
A CPA may provide such advisory services to an audit client and not impair independence because the member's role is advisory in nature and because the client is a privately held entity (see Section 1.295).
what is professional skepticism?
Attitude that includes a questioning mind and a critical assessment of the appropriateness and sufficiency of audit evidence. (questioning mindset, suspension of judgment, search for knowledge, interpersonal understanding, autonomy, self esteem)
A client has used an inappropriate method of accounting for its pension liability on the balance sheet. The resulting misstatement is material, but the auditor does not consider its effect to be pervasive. The auditor is unable to convince the client to alter its accounting treatment. The rest of the financial statements are fairly stated in the auditor's opinion. Which kind of audit report should the auditor issue under these circumstances? a. Standard unqualified opinion. b. Qualified opinion due to departure from GAAP. c. Adverse opinion. d. No opinion at all.
B
An independent audit adds value to the communication of financial information because the audit a. Confirms the exact accuracy of management's financial representations. b. Lends credibility to the financial statements. c. Guarantees that financial data are fairly presented. d. Assures the readers of financial statements that any fraudulent activity has been corrected.
B
During the audit of Moon Co., the auditor disagrees with management's estimation of collectible accounts receivable. The possible misstatement amount is material. Which of the statements below should weigh most heavily for the auditor in this instance? a. Moon management has the right to make company estimates. b. Requiring an adjustment to the allowance for doubtful accounts would give stockholders access to fair and adequate information. c. There is a small but reasonable chance that accounts receivable as stated by Moon Co. might turn out to be fully collectible. d. The interests of Moon Co., the auditor, and the public should be weighed equally in the decision.
B
In which of the following situations would an auditor ordinarily issue an unqualified/ unmodified financial statement audit opinion with no explanatory (or emphasis-of matter/other-matter) paragraph? a. The auditor wishes to emphasize that the entity had significant related-party transactions. b. The auditor decides not to refer to the report of another auditor as a basis, in part, for the auditor's opinion. c. The entity issues financial statements that present financial position and results of operations but omits the statement of cash flows. d. The auditor has substantial doubt about the entity's ability to continue as a going concern, but the circumstances are fully disclosed in the financial statements.
B
Which of the following best describes the reason why an independent auditor is often retained to report on financial statements? a. Management fraud may exist, and it is more likely to be detected by independent auditors than by internal auditors. b. Different interests may exist between the entity preparing the statements and the persons using the statements, and thus outside assurance is needed to enhance the credibility of the statements. c. A misstatement of account balances may exist, and all misstatements are generally corrected as a result of the independent auditor's work. d. An entity may have a poorly designed internal control system.
B
Which of the following is not a part of the role of internal auditors? a. Assisting the external auditors. b. Providing reports on the reliability of financial statements to investors and creditors. c. Consulting activities. d. Operational audits.
B
Without the consent of the entity, a CPA should not disclose confidential entity information contained in working papers to a(n) a. Authorized quality control review board. b. Successor CPA firm that has been engaged to audit the former audit entity. c. Federal court that has issued a valid subpoena. d. Disciplinary body created under state statute.
B
For each of the following independent situations, indicate the type of financial statement audit report that you would issue and briefly explain your reasoning. Assume that each item is at least material. d. During your audit of Cuccia Coal Company, the controller, Tracy Tricks, refuses to allow you to confirm accounts receivable because she is concerned about complaints from her customers. You are unable to satisfy yourself about accounts receivable by other audit procedures and you are concerned about Tracy's true motives.
Because the client wouldn't allow the confirmations to be sent, the appropriate response would generally be either a qualified opinion or a disclaimer of opinion for a scope limitation imposed by the client's management, depending on the materiality of accounts receivable. However, even if accounts receivable isn't highly material, if the auditor suspects fraud by upper management, the scope limitation would merit a disclaimer.
For what primary purpose does the auditor obtain an understanding of the entity and its environment? a. To determine the audit fee. b. To decide which facts about the entity to include in the audit report. c. To plan the audit and determine the nature, timing, and extent of audit procedures to be performed. d. To limit audit risk to an appropriately high level.
C
Rick, an independent CPA, must make an ethical judgment related to the audit of an entity. If he primarily focuses on whether his decision might yield unfair advantages for some at the expense of others, he is using a. A utilitarian perspective. b. A rights-based approach. c. A justice-based perspective. d. Rule-based AICPA guidelines.
C
Which of the following best describes relationships among auditing, attest, and assurance services? a. Attest is a type of auditing service. b. Auditing and attest services represent two distinctly different types of services— there is no overlap. c. Auditing is a type of assurance service. d. Assurance is a type of attest service.
C
Which of the following best describes the general character of the section of the "Principles Underlying an Audit of Financial Statements," titled "Performance"? a. Description of the competence, independence, and professional care of persons performing the audit. b. Criteria for the content of the auditor's report on financial statements and related footnote disclosures. c. Criteria for audit planning and evidence gathering. d. The need to maintain an independence of mental attitude in all matters relating to the audit.
C
Which of the following is correct regarding the types of audits over which the ASB and the PCAOB, respectively, have standard-setting authority in the United States? ASB, PCAOB : a. Nonpublic company audits, Nonpublic company audits b. Public company audits, Public company audits c. Nonpublic company audits, Public company audits d. Public company audits, Nonpublic company audits
C
Which of the following statements best describes the role of materiality in a financial statement audit? a. Materiality refers to the "material" from which audit evidence is developed. b. The higher the level at which the auditor assesses materiality, the greater the amount of evidence the auditor must gather. c. The lower the level at which the auditor assesses materiality, the greater the amount of evidence the auditor must gather. d. The level of materiality has no bearing on the amount of evidence the auditor must gather.
C
Which of the following statements best explains why public accounting, as a profession, promulgates ethical standards and establishes means for ensuring their observance? a. Vigorous enforcement of an established code of ethics is the best way to prevent unscrupulous acts. b. Ethical standards that emphasize excellence in performance over material rewards establish individual reputations for competence and character. c. Ethical standards are established so that users of accounting services know what to expect and accounting professionals know what behaviors are acceptable, and so that discipline can be applied when necessary.
C
Which of the following statements relating to attest and assurance services is not correct? a. Independence is an important attribute of assurance service providers. b. Assurance services can be performed to improve the quality or context of information for decision makers. c. Financial statement auditing is a form of attest service but it is not an assurance service. d. In performing an attest service, the CPA determines the correspondence of the subject matter (or an assertion about the subject matter) against criteria that are suitable and available to users.
C
Preliminary engagement activities include a. Understanding the client and the client's industry. b. Determining audit engagement team requirements. c. Ensuring the independence of the audit team and audit firm. d. All of the above.
D
The auditing standards that are used to guide the conduct of the audit are : a. Implicitly referred to in the critical audit matters section of the auditor's standard report. b. Explicitly referred to in the critical audit matters section of the auditor's standard report. c. Implicitly referred to in the basis for opinion section of the auditor's standard report. d. Explicitly referred to in the basis for opinion section of the auditor's standard report. e. Implicitly referred to in the opinion section of the auditor's standard report. f. Explicitly referred to in the opinion section of the auditor's standard report.
D
Which of the following statements best describes what is meant by an unqualified audit opinion? a. Issuance of an unqualified auditor's report indicates that in the auditor's opinion the client's financial statements are not fairly enough presented in accordance with agreed-upon criteria to qualify for a clean opinion. b. Issuance of an unqualified auditor's report indicates that the auditor is not qualified to express an opinion that the client's financial statements are fairly presented in accordance with agreed-upon criteria. c. Issuance of an unqualified auditor's report indicates that the auditor is expressing different opinions on each of the basic financial statements regarding whether the client's financial statements are fairly presented in accordance with agreedupon criteria. d. Issuance of a standard unqualified auditor's report indicates that in the auditor's opinion the client's financial statements are fairly presented in accordance
D
A "covered member" is a CPA who qualifies for participation in the AICPA's professional liability insurance program.
F
Compilation and bookkeeping services are examples of attest services that CPAs can provide to clients. (t/f)
F
PCAOB auditing standards must be followed on all financial statement audits performed in the U.S. (T/F)
F
Both the AICPA Code of Professional Conduct and the SEC's independence rules restrict the types of nonaudit services that can be provided to attest entities. However, some key differences between these two sets of rules exist. Under the AICPA's independence rules, auditors may generally provide appraisal, valuation, or actuarialservices to nonpublic attest entities, while the SEC independence rules generally prohibit the provision of these professional services to public audit entities.
F - "The [AICPA] Code [of Professional Conduct] indicates that CPAs may not perform appraisal, valuation, or actuarial services if the results of those services will have a material affect on the entity's financial statements and the service involves considerable subjectivity." "The SEC specifies nine categories of nonaudit services that...are considered to impair independence if provided to a public company audit entity...[including]...[a]ppraisal or valuation services..., [and] [a]ctuarial services..."
If the financial statements contain a material departure from GAAP that is so pervasive that the financial statements overall do not present fairly the financial position and results of operations, then the auditor should issue a qualified audit report. (t/f)
F - adverse opinion when the financial statements do not present fairly due to a GAAP departure that materially and pervasively affects the financial statements overall."
scope limitation results from an inability to obtain sufficientappropriate evidence about some component of the financial statements. If the scope limitation is imposed by the client, and its effect is so pervasive as to preclude the auditor from forming an opinion regarding the fairness of the financial statements overall, then the auditor should issue an adverse audit report. (t/f)
False- "Auditing standards suggest that when restrictions imposed by the client significantly limit the scope of the engagement, the auditor should consider disclaiming an opinionon the financial statements."
Each of the following situations involves a possible violation by a member in industry 19-6, 19-7 of the AICPA's Code of Professional Conduct. For each situation, indicate whether it violates the Code. If it violates the Code, indicate which rule is violated and explain why. d. Brian Thorough, CPA, is currently employed as controller of Trans-Louisiana Oil Company. He has discovered that Trans-Louisiana has been illegally paying state environmental employees so that they will not charge Trans-Louisiana with dumping highly toxic chemicals into the bayous. The related environmental fines and clean-up liabilities would be highly material to the financial statements. Thorough discloses this information to the state attorney general.
No. Section 2.400 states that if a member in industry concludes that the financial statements or records could be materially misstated and do not comply with professional standards, the member should consider whether any responsibility exists to communicate the problem to third parties, such as regulators. However, the CPA should consult his attorney prior to any disclosure.
For each of the following independent situations, indicate the type of financial statement audit report that you would issue and briefly explain your reasoning. Assume that each item is at least material. g. Johnstone Manufacturing Company has used the double-declining balance method to depreciate its machinery. During the current year, management switched to the straight-line method because it felt that it better represented the utilization of the assets. You concur with its decision. All information is adequately disclosed in the financial statements.
Recall that the instructions to the problem indicate the assumption that all matters listed are at least material. Since the change in accounting principle is properly accounted for, the auditor should issue an unqualified audit report with an explanatory paragraph for a lack of consistency in the application of GAAP.
Each of the following situations involves a possible violation of the Independence Rule of the AICPA's Code of Professional Conduct. Indicate whether each situation violates the Code. If it violates the Code, explain why. Jimmy Saad, a sole practitioner, audited Dallas Conduit, Inc.'s financial statements for the year ended June 30 and was issued stock by the entity as payment of the audit fee. Saad disposed of the stock before commencing fieldwork planning for the audit of the next year's June 30 financial statements.
Saad's independence is impaired by his acceptance of payment for the audit fee in stock of the audited entity. Independence is impaired if a member has a direct financial interest in a client during the period of the professional engagement or at the time of expressing an opinion. The period of professional engagement starts when the member begins to perform professional services requiring independence and ends with the client's or member's notification of that relationship's termination (see section 1.240).
Each of the following situations involves a possible violation of the Independence Rule of the AICPA's Code of Professional Conduct. Indicate whether each situation violates the Code. If it violates the Code, explain why. Zeker & Associates audits a condominium association in which the parents of a member of the firm own a unit and reside. The unit is material to the parents' net worth, and the member participates in the engagement.
Section 1.270 of the Code indicates that an auditor's independence would be considered impaired if a close relative (e.g., a parent) has a material financial interest in an enterprise of which the auditor is participating in the engagement and has knowledge of the financial interest.
19-31 Perez, CPA, has been asked by a nonpublic company, for which Perez provides audit services, to perform a nonrecurring engagement involving implementation of an IT information and control system. The entity requests that, in setting up the new system and during the period prior to conversion to the new system, Perez ∙ Counsel on potential expansion of business activity plans. ∙ Search for and interview new personnel. ∙ Hire new personnel. ∙ Train personnel. In addition, the entity requests that, during the three months subsequent to the conversion, Perez ∙ Supervise the operation of the new system. ∙ Monitor entity-prepared source documents and make changes in basic IT-generated data as Perez may deem necessary without the concurrence of the entity. Perez responds that he may perform some of the services requested but not all of them. Required: Which of these services may Perez perform, and which of them may Perez not perform? (AICPA, adapted)
Services that Perez may perform: -Counsel on potential expansion plans. -Search for and interview new personnel. -Train personnel. Services that Perez may not perform: - Hire new personnel. -Supervise the operation of the system. -Monitor client-prepared source documents and make changes in basic IT-generated data without the concurrence of the client.
For each of the following independent situations, indicate the type of financial statement audit report that you would issue and briefly explain your reasoning. Assume that each item is at least material. e. On January 31, Asare Toy Manufacturing hired your firm to audit the company's financial statements for the prior year. You were unable to observe the client's inventory on December 31. However, you were able to satisfy yourself about the inventory balance using other auditing procedures.
Since the auditor is satisfied about the inventory balance using alternative audit procedures, a standard unqualified audit report can be issued. The alternative audit procedures would normally include a physical count subsequent to year end and reconciliation to the balance at the end of the reporting period.
(t/f) In order to become a licensed Certified Public Accountant (CPA), an individual must pass all four parts of the Uniform CPA Examination, including Auditing and Attestation (AUD), Financial Accounting and Reporting (FAR), Regulation (REG), and Business Environment and Concepts (BEC).
T
After the client acceptance/continuance decision is made but prior to planning the audit, the auditor completes preliminary engagement activities. Preliminary engagement activities generally include(1)assembling an engagement team with appropriate levels of experience and expertise, (2) ensuring the independence of the audit team and the audit firm with respect to the audit client,(3)and establishing the terms of the agreement to provide audit services in a signed engagement letter.
T
Auditing standards promulgated by the ASB are called Statements on Auditing Standards (SAS), and are reorganized by topic in what is called the AU (or AU-C) codification. (t/f)
T
Auditors perform three general types of audit tests: (1) Risk assessment procedures; (2) Tests of controls; (3) Substantive procedures. While tests of controls provide indirect evidence, substantive procedures provide direct evidence regarding the presence of material misstatements in classes of transactions, account balances, or disclosures in the financial statements.
T
For purposes of evaluating the potential impairment of an auditor's independence, financial relationships between the auditor and the auditor's audit client can be classified as either direct or indirect. Effective control of the financial interest (e.g., investment) by the auditoris the distinguishing characteristic between a direct financial interest and an indirect financial interest. While an indirect financial interest is considered to impair an auditor's independence with respect to his/her audit clientonly if such financial interest is considered material to the auditor's net worth, anydirect financial interest in his/her audit client would impair independence, regardless of materiality.
T
Overall materiality(also referred to as planning materiality) is the maximum amount by which the auditor believes the financial statements could be misstated and still not affect the decisions of financial statement users. The determination of overall materiality is a matter of professional judgment, however, in practice, auditors typically begin the process by applying a given percentage to a quantitative benchmark (i.e., summary measure of financial performance orfinancialhealth) from the financial statements. The benchmark used for this purpose should be (1) important tofinancial statement users and (2) relatively stable across accounting periods.
T
The AICPA Code of Professional Conduct contains a rule that prohibits CPAs from committing discreditable acts, or in other words, acts that may affect the profession's reputation.Interpretations of this rule identify specific acts that would be "discreditable," including failure to file a tax return or pay a tax liability, discrimination and harassment in employment practices, and solicitation or disclosure of CPA Examination questions and answers.
T
There are three primary situations in which an auditor may be unable to express an unqualified opinion: (1) there is a scope limitation; (2) the financial statements contain a departure from GAAP; (3) the auditor is not independent with respect to the audited entity. (t/f)
T
When considering whether to accept a prospective audit client, auditing standards require the successor auditor to make certain inquiries of the predecessor auditor. The predecessor auditor must obtain the audit client's consent prior to responding to the successor auditor's inquiries. Among other things, the successor auditor's inquiries to the predecessor auditor should include the following: (1) the predecessor auditor's understanding ofthe reasons for an auditor change; (2) information that might bear on the integrity of management; (3) any disagreements with management regarding accounting policies and/or auditing procedures.
T
the AICPA Code of Professional Conduct is organized into a preface, which is applicable to all CPAs, followed by three Parts. Part 1 applies to CPAs who provide assurance and conduct audits on which third-party stakeholders will rely. Part 2 applies to CPAs working in business who do not issue assurance reports on which the public will rely. Part 3 applies to CPAs who are neither functioning as an auditor nor in business. (t/f)
T
Under the Sarbanes-Oxley Act of 2002, the PCAOB is given authority for standard setting, inspections, investigations, and enforcement for public company audits.(T/F)
T - post enron
For each of the following independent situations, indicate the reason for and the type of financial statement audit report that you would issue. Assume that each item is at least material. f. Jay Rich, CPA, holds 10 percent of the stock in Rothenburg Construction Company. The board of directors of Rothenburg asks Rich to conduct its audit. Rich completes the audit and determines that the financial statements present fairly in accordance with generally accepted accounting principles.
The CPA is not independent of the company but the how the lack of independence should be handled depends on whether Rothenburg is a public company. Under PCAOB standards the auditor should issue a disclaimer for a lack of independence, and the auditor is not allowed to disclose the reasons for the auditor's lack of independence. Under ASB standards (for non-public entities), the auditor will not issue a report unless required to do so by law or regulation, but similar to PCAOB standards, if issued, the report should disclaim an opinion due to lack of independence. However, under ASB standards, the auditor may choose to disclose the reasons for the lack of independence, but if the auditor so chooses, all relevant reasons for the lack of independence must be included.
Each of the following situations involves a possible violation of the Independence Rule of the AICPA's Code of Professional Conduct. Indicate whether each situation violates the Code. If it violates the Code, explain why. b. Steve Rackwill, CPA, has been asked by his audit entity, Petry Plumbing Supply, to help implement a new control system. Rackwill will arrange interviews for Petry's hiring of new personnel and instruct and oversee the training of current entity personnel. Petry Plumbing is a privately held company. Petry will make all hiring decisions and supervise employees once they are trained.
The CPA's independence is not impaired under these circumstances provided the client makes all significant management decisions related to the hiring of new personnel and the implementation of the system. The auditor must also limit his or her supervisory activities to initial instruction and training of personnel and should avoid direct supervision of the actual operation of the system or related activities that would constitute undue involvement in or identification with management functions. The auditor would be prohibited from providing these services for a public company audit client
For each of the following independent situations, indicate the type of financial statement audit report that you would issue and briefly explain your reasoning. Assume that each item is at least material. b. The management of Bonner Corporation has decided to exclude the statement of cash flows from its financial statements because it believes that its bankers do not find the statement to be very useful.
The auditor should issue a qualified audit report because management has not complied with GAAP. The auditor is not required to prepare the statement of cash flows for disclosure in the audit report.
For each of the following independent situations, indicate the reason for and the type of financial statement audit report that you would issue. Assume that each item is at least material. e. During the audit of Brannon Bakery Equipment, you found that a material amount of inventory had been excluded from the company's financial statements. After discussing this problem with management, you become convinced that it was an unintentional oversight. Management appropriately corrected the error prior to your finalization of field work.
The auditor should issue a standard unmodified audit report because the client corrected the mistake before issuing the financial statements.
For each of the following independent situations, indicate the reason for and the type of financial statement audit report that you would issue. Assume that each item is at least material. b. Walker Computers is suing your client, Super Software, for royalties over patent infringement. Super Software's outside legal counsel assures you, and you agree, that Walker's case is completely without merit. Super Software does not disclose any contingency relating to the case.
The auditor should issue a standard unmodified audit report. As long as this uncertainty is properly disclosed or accounted for in accordance with GAAP, the auditor need not modify the audit report. In this case, a negative outcome for this uncertainty appears to be remote. Therefore, the client is not required to disclose the uncertainty in the financial statements.
For each of the following independent situations, indicate the reason for and the type of financial statement audit report that you would issue. Assume that each item is at least material. a. Thibodeau Mines, Inc., uses LIFO for valuing inventories held in the United States and FIFO for inventories produced and held in its foreign operations.
The auditor should issue a standard unmodified audit report. It is acceptable for an entity to use different inventory methods in different international regions. Many countries do not allow LIFO, and it can be costly for the entity to maintain inventory records using both valuation methods.
For each of the following independent situations, indicate the type of financial statement audit report that you would issue and briefly explain your reasoning. Assume that each item is at least material. a. Barefield Corporation, a wholly owned subsidiary of Sandy, Inc., is audited by another CPA firm. As the auditor of Sandy, Inc., you have assured yourself of the other CPA firm's independence and professional reputation. However, you are unwilling to take complete responsibility for its audit work.
The auditor would issue an unqualified audit report with modified wording for the reliance on the other auditors. In this case, the principal auditor does not intend to take responsibility for the other auditor's work.
The following auditor's report was drafted by a staff accountant of Nathan and Matthew, CPAs, at the completion of the audit of the comparative financial statements of Monterey for the years ended December 31, 2018 and 2017. The report was submitted to the engagement partner, who reviewed matters thoroughly and properly concluded that an unmodified opinion should be expressed. The draft of the report prepared by an inexperienced staff auditor is as follows: Auditor's Report We have audited the accompanying financial statements of Monterey, which comprise the statements of assets, liabilities, and capital as of December 31, 2018, and the related statement of revenue and expenses for the year then ended, and the related notes to the financial statements. We conducted our audit in accordance with standards established by the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditor's judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. An audit also includes evaluating the appropriateness of accounting policies used as well as evaluating the overall presentation of the financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion. Opinion In our opinion, the financial statements referred to above present fairly, in all material respects, the assets, liabilities, and owners' equity of Monterey as of December 31, 2018, and its revenue and expenses for the year then ended in conformity with generally accepted accounting principles applied on a consistent basis. Critical Audit Matters There were no critical audit matters. Nathan and Matthew, CPAs April 3, 2019 Required: Identify the errors and omissions in the auditor's report as drafted by the staff auditor. (AICPA, adapted)
The report should be divided by the main categories: Opinion on the Financial Statements Basis of Opinion Critical Audit Matters Report title & Address: "Independent" is omitted from the title of the auditors' report. Report should be addressed to the shareholders and board of directors. Opinion on Financial Statements paragraph: The opinion paragraph references owners' equity while the opening paragraph references the statement of "capital." Basis of Opinion paragraph: The auditor's responsibility to express an opinion on the financial statements is omitted. There is no mention that the auditor considers internal control in making risk assessments and in designing appropriate audit procedures. Reference to assessing "significant estimates made by management" is omitted. Critical Audit Matters paragraph: No deficiencies Signature: CPA firm's name must be signed Must disclose the number of years that the firm has served as the client's auditor.
Define audit risk
The risk that the auditor may unknowingly fail to appropriately modify the opinion on financial statements that are materially misstated
For each of the following independent situations, indicate the type of financial statement audit report that you would issue and briefly explain your reasoning. Assume that each item is at least material. c. You are auditing Diverse Carbon, a manufacturer of nerve gas for the military, for the year ended September 30. On September 1, one of its manufacturing plants caught fire, releasing nerve gas into the surrounding area. Two thousand people were killed and numerous others paralyzed. The company's legal counsel indicates that the company is liable and that the amount of the liability can be reasonably estimated, but the company refuses to disclose this information in the financial statements.
This approach is not in accordance with GAAP because such contingencies must be disclosed in the notes to the financial statements if the amount of the contingency can be reasonably estimated and the loss is probable. A departure from GAAP such as this one requires either a qualified or an adverse opinion, depending on the materiality of the item in question. In this case the potential settlement is likely to be very large given the proportions of the tragedy in terms of human loss and suffering. In addition, the tragedy may well threaten the company's ability to be involved in similar projects in the future and perhaps its own survival. Thus, an adverse opinion is very likely the most appropriate response.
For each of the following independent situations, indicate the reason for and the type of financial statement audit report that you would issue. Assume that each item is at least material. d. Upon review of the recent history of the lives of its specialized service trucks, Gas Leak Technology justifiably changed the service lives for depreciation purposes on its trucks from five years to three years. This change resulted in a material amount of additional depreciation expense.
This is a change in accounting estimate. Such a change does not affect consistency in the application of accounting principles, and the auditor should thus issue a standard unmodified audit report.
Each of the following situations involves a possible violation by a member in industry 19-6, 19-7 of the AICPA's Code of Professional Conduct. For each situation, indicate whether it violates the Code. If it violates the Code, indicate which rule is violated and explain why. c. Janet Jett, CPA, formerly worked for Delta Disk Drive, Inc. She is currently interviewing for a new position with Maxiscribe, Inc., another manufacturer of disk drives. Jett has agreed to provide confidential information about Delta's trade secrets if she is hired by Maxiscribe.
Yes. If a member in industry uses confidential information obtained from an employer for his or her personal benefit, disclosure of the information is considered an act discreditable to the profession in violation of section 2.400 of the Code.
Each of the following situations involves a possible violation by a member in industry 19-6, 19-7 of the AICPA's Code of Professional Conduct. For each situation, indicate whether it violates the Code. If it violates the Code, indicate which rule is violated and explain why. a. Jack Jackson is a CPA and controller of Acme Trucking Company. Acme's external auditors have asked Jackson to sign the management representation letter. Jackson has signed the management representation letter, even though he knows that full disclosures have not been made to Acme's external auditors
Yes. Signing such a letter would be a known misrepresentation of fact in violation of section 2.130 of the Code.
Each of the following situations involves a possible violation by a member in industry 19-6, 19-7 of the AICPA's Code of Professional Conduct. For each situation, indicate whether it violates the Code. If it violates the Code, indicate which rule is violated and explain why. b. Mary McDermott, CPA, is employed in the internal audit department of the United Fund of America. The United Fund raises money from individuals and distributes it to other organizations. McDermott has also provided external audit services for Children's Charities, an organization that receives funds from United Fund.
Yes. This would be a violation of section 2.110 of the Code because McDermott's employer is the source of the revenues for the entities being audited.
Each of the following situations involves a possible violation by a member in industry of the AICPA's Code of Professional Conduct. For each situation, indicate whether it violates the Code. If it violates the Code, indicate which rule is violated and explain why. e. Jill Burnett, CPA, was hired by Cooper Corporation to supervise its accounting department in preparing financial statements and presenting them to senior management. Due to considerable time incurred on other financial activities, Burnett was unable to supervise the accounting staff adequately. It is later discovered that Cooper's financial statements contain false and misleading information due to errors made by Burnett's staff.
Yes. Under 2.400, a member who, through his or her negligence, makes or permits another to make false and misleading entries in the financial statements has committed an act discreditable to the profession.
In connection with the element of engagement performance, a CPA firm's system of quality control should ordinarily include procedures covering all of the following except a. Performance evaluation. b. Consistent, high-quality engagement performance. c. Supervision responsibilities. d. Review responsibilities.
a
One of a CPA firm's basic objectives is to provide professional services that conform with professional standards. Reasonable assurance of achieving this basic objective is provided through a. A system of quality control. b. A system of peer review. c. Continuing professional education. d. Compliance with generally accepted reporting standards.
a
Operational auditing is oriented primarily toward a. Efficiency and future improvements to accomplish the goals of management. b. The accuracy of data reflected in management's financial records. c. Verification that an entity's financial statements are fairly presented. d. Past protection provided by existing internal control. Messier Jr, William.
a
You were recently hired by the CPA firm of Honson & Hansen. Within two weeks, you were sent to the first-year staff training course. The instructor asks you to prepare answers for the following questions: a. How is audit evidence defined? b. How does audit evidence relate to assertions and to the audit report? C. What characteristics of evidence should an auditor be concerned with when searching for and evaluating audit evidence?
a. Evidence that assists the auditor in evaluating financial statement assertions, consists of the underlying accounting data and any additional information available to the auditor, whether originating from the client or externally. b. audit evidence helps determine whether management assertions are met c. relevance and reliability
For each of the following descriptions, indicate which type of audit (financial statement audit, audit of internal control, compliance audit, operational audit, or forensic audit) best characterizes the nature of the audit being conducted. Also indicate which type of auditor (external auditor, internal auditor, government auditor, or forensic auditor) is likely to perform the audit engagement. a. Evaluate the policies and procedures of the Food and Drug Administration in terms of bringing new drugs to market. b. Determine the fair presentation of Ajax Chemical's balance sheet, income statement, and statement of cash flows. c. Review the payment procedures of the accounts payable department for a large manufacturer. d. Examine the financial records of a division of a corporation to determine if any accounting irregularities have occurred. e. Evaluate the feasibility of forecasted rental income for a planned low-income public housing project. f. Evaluate a company's computer services department in terms of the efficient and effective use of corporate resources. g. Audit the partnership tax return of a real estate development company. h. Investigate the possibility of payroll fraud in a labor union pension fund.
a. operational, government b. financial statement, external c. compliance/operational/internal control, internal or external d. forensic/financial, external/internal/forensic e. operational, governmental/internal/external f. operational, internal/external g. compliance, government h. forensic/compliance, forensic/external/gogovernment
The questions that follow are based on the Independence Rule of the AICPA Code of Professional Conduct as it relates to independence and family relationships. Check yes if the situation violates the rule, no if it does not. a. A partner's dependent parent is a 5 percent limited partner in an entity audited by the partner's firm. Does the parent's direct financial interest in the entity impair the firm's independence? b. A partner assigned to a firm's New York office is married to the president of an entity for which the firm's Connecticut office performs audit services. If the partner does not perform services out of or for the Connecticut office, cannot exercise significant influence over the engagement, and has no involvement with the engagement, such as consulting on accounting or auditing issues, is the firm's independence impaired? c. A CPA's father acquired a 10 percent interest in a company that the CPA audits. The investment is material to the father's net worth. If the son is aware of his father's investment and the CPA participates in the audit engagement, is the firm's independence impaired? d. An audit partner has a brother who owns a 60 percent interest in an entity for which the partner provides attest services. The interest is material to the brother's net worth. If the partner participates in the audit engagement, but does not know about his brother's investment because the investment is held by a corporation that obscures the brother's investment, is the firm's independence impaired?
a. yes b. no c. yes d. no
Comparative financial statements for a public company include the prior year's financial statements, which were audited by a predecessor auditor. The predecessor's report is not presented along with the comparative financial statements. If the predecessor's report was unqualified, the successor should a. Express an opinion on the current year's statements alone and make no reference to the prior year's statements. b. Indicate in the auditor's report that the predecessor auditor expressed an unqualified opinion. c. Obtain a letter of representations from the predecessor concerning any matters that might affect the successor's opinion. d. Disclaim an opinion.
b
In which of the following situations would a CPA's independence be considered impaired according to the Code of Professional Conduct? 1. The CPA has a car loan from a bank that is an audit entity. The loan was made under the same terms available to all customers. 2. The CPA has a direct financial interest in an audit entity, but the investment is maintained in a blind trust. 3. The CPA owns a commercial building and leases it to an audit entity. The rental income is material to the CPA. a. 1 and 2. b. 2 and 3. c. 1 and 3. d. 1, 2, and 3.
b
The AICPA Code of Professional Conduct contains both general ethical principles that are aspirational in character and a a. List of violations that would cause the automatic suspension of a CPA's license. b. Set of specific, mandatory rules describing minimum levels of conduct a CPA must maintain. c. Description of a CPA's procedures for responding to an inquiry from a trial board. d. Complete list of all the different kinds of crimes that would be considered as acts discreditable to the profession.
b
When reporting on comparative financial statements, which of the following circumstances should ordinarily cause the auditor to change the previously issued opinion on the prior year's financial statements? a. The prior year's financial statements are restated following the purchase of another company in the current year. b. A departure from generally accepted accounting principles caused an adverse opinion on the prior year's financial statements, and those prior year statements have been properly restated. c. A change in accounting principle causes the auditor to make a consistency modification in the current year's audit report. d. A scope limitation caused a qualified opinion on the prior year's financial statements, but the current year's opinion is properly unqualified.
b
Which of the following best describes the auditor's responsibility for "other information" included in the annual report to stockholders that contains financial statements and the auditor's report? a. The auditor has no obligation to read the "other information." b. The auditor has no obligation to corroborate the "other information" but should read the "other information" to determine whether it is materially consistent with the financial statements. c. The auditor should extend the examination to the extent necessary to verify the "other information." d. The auditor must modify the auditor's report to state that the other information "is unaudited" or "is not covered by the auditor's report."
b
A public entity changed from the straight-line method to the declining balance method of depreciation for all newly acquired assets. This change has no material effect on the current year's financial statements but is reasonably certain to have a substantial effect in later years. The client's financial statements contain no material misstatements and the auditor concurs that this change is justified. If the change is disclosed in the notes to the financial statements, the auditor should issue a report with a(n) a. "Except for," qualified opinion. b. Adverse opinion. c. Unqualified opinion. d. Consistency modification.
c
An audited company has not paid its 2018 audit fees. According to the AICPA Code of Professional Conduct, for the auditor to be considered independent with respect to the 2019 audit, the 2018 audit fees must be paid before the a. 2018 report is issued. b. 2019 fieldwork is started. c. 2019 report is issued. d. 2020 fieldwork is started.
c
In which of the following circumstances would an auditor usually choose between issuing a qualified opinion or a disclaimer of opinion on a client's financial statements? a. Departure from generally accepted accounting principles. b. Inadequate disclosure of accounting policies. c. Inability of the auditor to obtain sufficient appropriate evidence. d. Unreasonable justification for a change in accounting principle.
c
King, CPA, was engaged to audit the financial statements of Chang Company, a private company, after its fiscal year had ended. King neither observed the inventory count nor confirmed the receivables by direct communication with debtors but was satisfied that both were fairly stated after applying appropriate alternative procedures. King's financial statement audit report most likely contained a(n) a. Qualified opinion. b. Disclaimer of opinion. c. Unmodified opinion. d. Unmodified opinion with an emphasis-of-matter paragraph.
c
Under the SEC's rules regarding independence, which of the following must an entity disclose? a. Only fees for the external audit. b. Only fees for internal and external audit services provided by the audit firm. c. Fees for the external audit, audit-related fees, tax fees, and fees for other nonaudit services performed by the audit firm. d. Only fees for systems implementation and design and nonaudit services performed by the audit firm.
c
When an auditor is asked to express an opinion on an entity's rent and royalty revenues, he or she may a. Not accept the engagement because to do so would be tantamount to agreeing to issue a piecemeal opinion. b. Not accept the engagement unless also engaged to audit the full financial statements of the entity. c. Accept the engagement, provided the auditor's opinion is expressed in a special report that clearly states that only these specific accounts were audited. d. Accept the engagement, provided distribution of the auditor's report is limited to the entity's management.
c
When reporting on financial statements prepared on the basis of accounting used for income tax purposes, the auditor should include in the report a paragraph that a. Emphasizes that the financial statements have not been examined in accordance with generally accepted auditing standards. b. Refers to a tutorial that explains the income tax basis of accounting. c. States that the income tax basis of accounting is a basis of accounting other than generally accepted accounting principles. d. Justifies the use of the income tax basis of accounting.
c
Which of the following legal situations would be considered to impair the auditor's independence? a. An expressed intention by the present management to commence litigation against the auditor, alleging deficiencies in audit work for the entity, although the auditor considers that there is only a remote possibility that such a claim will be filed. b. Actual litigation by the auditor against the entity for an amount not material to the auditor or to the financial statements of the entity arising out of disputes as to billings for management advisory services. c. Actual litigation by the auditor against the present management, alleging management fraud or deceit. d. Actual litigation by the entity against the auditor for an amount not material to the auditor or to the financial statements of the entity arising out of a dispute as to billings for tax services.
c
Which of the following statements best describes management's and the external auditor's respective levels of responsibility for a public company's financial statements? a. Management and the external auditor share equal responsibility for the fairness of the entity's financial statements in accordance with GAAP. b. Neither management nor the external auditor has significant responsibility for the fairness of the entity's financial statements in accordance with GAAP. c. Management has the primary responsibility to ensure that the company's financial statements are prepared in accordance with GAAP, and the auditor provides reasonable assurance that the statements are free of material misstatement. d. Management has the primary responsibility to ensure that the company's financial statements are prepared in accordance with GAAP, and the auditor provides a guarantee that the statements are free of material misstatement.
c
Desirable characteristics of a house inspector (auditor)
competent, objective, honest, skeptical, responsible, liable
All of the following nonaudit services are identified by the SEC as generally impairing an auditor's independence with respect to an audited entity except a. Information systems design and implementation. b. Human resource services. c. Management functions. d. Some specific tax services. e. All of the above are seen by the SEC as impairing independence.
d
Which of the following best places the events of the last decade in proper sequence? a. Sarbanes-Oxley Act, increased consulting services to auditees, Enron and other scandals, prohibition of most consulting work for auditees, establishment of PCAOB. b. Increased consulting services to auditees, Sarbanes-Oxley Act, Enron and other scandals, prohibition of most consulting work for auditees, establishment of PCAOB. c. Enron and other scandals, Sarbanes-Oxley Act, increased consulting services to auditees, prohibition of most consulting work for auditees, establishment of PCAOB. d. Increased consulting services to auditees, Enron and other scandals, SarbanesOxley Act, prohibition of most consulting work for auditees, establishment of PCAOB.
d
Which of the following would be considered a nonattest assurance service engagement? I. Expressing an opinion about the reliability of an entity's financial statements. II. Reporting that a company's sustainability metrics are complete and accurate. a. I only. c. Both I and II. b. II only. d. Neither I nor II.
d
Each of the following situations involves a possible violation of the Independence Rule of the AICPA's Code of Professional Conduct. Indicate whether each situation violates the Code. If it violates the Code, explain why. Kraemeer & Kraemeer recently won the audit of Garvin Clothiers, a large manufacturer of women's clothing. Jock Kraemeer had a substantial investment in Garvin prior to bidding on the engagement. In anticipation of winning the engagement, Kraemeer placed his shares of Garvin stock in a blind trust.
he independence of the auditor, according to section 1.245 of the Code, would be considered impaired whether or not the financial interest is placed in a blind trust.
For each of the following independent situations, indicate the reason for and the type of financial statement audit report that you would issue. Assume that each item is at least material. g. Ramamoorthi Savings and Loan's financial condition has been deteriorating for the last five years. Most of its problems result from loans made to real estate developers in Saint Johns County. Your review of the loan portfolio indicates that there should be a major increase in the loan-loss reserve. Based on your calculations, the proposed writedown of the loans will put Ramamoorthi into violation of the state's capital requirements. The client refuses to make the adjustment or to disclose the possible going concern issue in the notes to the financial statements.
if the client refuses to make the adjustment to the loan-loss reserve, the auditor should issue a qualified or adverse opinion because the financial statements will not be in accordance with GAAP. The auditor may also have substantial doubt about the entity's ability to continue as a going concern, which could result in the addition of an emphasis-of-matter paragraph to the audit opinion to disclose the going concern issues. If the auditor concludes that there is a going concern problem and the client refuses to disclose the issue in the notes to the financial statements, the auditor's opinion will be adverse
Each of the following situations involves a possible violation of the Independence Rule of the AICPA's Code of Professional Conduct. Indicate whether each situation violates the Code. If it violates the Code, explain why. Dip-It Paint Corporation requires an audit for the current year. However, Dip-It has not paid Allen & Allen the fees due for tax-related services performed two years ago. Dip-It issued Allen & Allen a note for the unpaid fees, and Allen & Allen proceeded with the audit services.
independence is impaired under section 1.230 of the Code because the note is a prohibited loan from the member to the client.
For each of the following independent situations, indicate the type of financial statement audit report that you would issue and briefly explain your reasoning. Assume that each item is at least material. f. Gelato Bros., Inc., leases its manufacturing facility from a partnership controlled by the chief executive officer and major shareholder of Gelato. Your review of the lease indicates that the rental terms are in excess of rental terms for similar buildings in the area. The company refuses to disclose this related-party transaction in the footnotes.
since the client fails to disclose the related-party transaction, the auditor should issue a qualified or adverse audit report depending on the materiality of the matter. The client's failure to disclose the related parties means that the financial statements do not comply with GAAP.
For each of the following independent situations, indicate the reason for and the type of financial statement audit report that you would issue. Assume that each item is at least material. c. In prior years, Worcester Wool Mills has used current market prices to value its inventory of raw wool. During the current year, Worcester changed to FIFO for valuing raw wool.
this is a correction of an error in principle because the use of replacement cost to value inventory is not in accordance with GAAP. The auditor should modify the standard unmodified report by adding an emphasis-of-matter paragraph describing the change from replacement cost to FIFO for valuing inventory.
desirable characteristics of a house inspection service (audit)
timely, reasonably priced, systematic and reliable, complete, effective, informative
AS 3101, the newest audit reporting standard issued by the PCAOB, represents the first major change to the basic form and content of the audit report in over 70 years. (t/f)
true
Annual reports often contain other information in addition to audited financial statements and the audit report. Although the audit report does not provide assurance regarding the fairness of other information contained in an annual report, the auditor irresponsible to read this other information and determine if such is consistent with the information in the audited financial statements. (t/f)
true
