Auditing Exam 3

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

a) A consistency modification. A consistency modification results in an emphasis-of-matter paragraph. Qualified and adverse opinions include a basis for modification paragraph. When a report refers to component auditors no additional paragraph is added.

The aggregated misstatement in the financial statements is made up of: a) Factual misstatements = Yes; Projected misstatements = Yes; Judgmental misstatements = Yes. b) Factual misstatements = Yes; Projected misstatements = Yes; Judgmental misstatements = No. c) Factual misstatements = No; Projected misstatements = Yes; Judgmental misstatements = No. d) Factual misstatements = No; Projected misstatements = Yes; Judgmental misstatements = Yes.

a) Factual misstatements = Yes; Projected misstatements = Yes; Judgmental misstatements = Yes. The aggregated misstatements composed of (1) factual misstatements, (2) judgmental misstatements and (3) projected misstatements.

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

a) Not to be construed as a qualification, but rather as a division of responsibility between the two CPA firms. Reference to the work of a component auditor is not, in itself, a qualification of the group audit report. This reference does not lessen the auditors' collective responsibility. Rather, it merely divides this responsibility among two or more CPA firms.

Instead of taking a physical inventory count on the balance-sheet date, the client may take physical counts prior to the year-end if internal control is adequate and: a) Well-kept records of perpetual inventory are maintained. b) Inventory is slow-moving. c) Computer error reports are generated for missing prenumbered inventory tickets. d) Obsolete inventory items are segregated and excluded.

a) Well-kept records of perpetual inventory are maintained. The professional standards allow auditors to use physical counts prior to year-end when a client has well-kept perpetual (computerized or non-computerized) inventory records.

The primary objective of a CPA's observation of a client's physical inventory count is to: a) Discover whether a client has counted a particular inventory item or group of items. b) Obtain direct knowledge that the inventory exists and has been properly counted. c) Provide an appraisal of the quality of the merchandise on hand on the day of the physical count. d) Allow the auditor to supervise the conduct of the count in order to obtain assurance that inventory quantities are reasonably accurate.

b) Obtain direct knowledge that the inventory exists and has been properly counted. The primary objective of the CPAs' observation of inventories is to provide sufficient competent evidence as to the existence of the inventory and the controls over the inventory-taking process.

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

b) Qualified = Yes; Unmodified with Emphasis-of-Matter = No. When an unjustified change in accounting principles occurs, either a qualified or adverse opinion is appropriate as this represents a departure from generally accepted accounting principles. An adverse opinion is appropriate, but not a disclaimer of opinion.

A client erroneously recorded a large purchase twice. Which of the following internal control measures would be most likely to detect this error in a timely and efficient manner? a) Footing the purchases journal. b) Reconciling vendors' monthly statements with subsidiary payable ledger accounts. c) Tracing totals from the purchases journal to the ledger accounts. d) Sending written quarterly confirmation to all vendors.

b) Reconciling vendors' monthly statements with subsidiary payable ledger accounts. The most efficient way in which the duplicate recording of a purchase transaction may be detected is by reconciling the related payable accounts with vendors' statements.

Which of the following procedures is least likely to be completed before the balance sheet date? a) Confirmation of receivables. b) Search for unrecorded liabilities. c) Observation of inventory. d) Review of internal accounting control over cash disbursements.

b) Search for unrecorded liabilities. Because a significant portion of the search for unrecorded liabilities deals with transactions recorded after year-end, it is least likely to be completed before the balance sheet date.

When confirming accounts payable, the approach is most likely to be one of: a) Selecting the accounts with the largest balances at year-end, plus a sample of other accounts. b) Selecting the accounts of companies with whom the client has previously done the most business, plus a sample of other accounts. c) Selecting a random sample of accounts payable at year-end. d) Confirming all accounts.

b) Selecting the accounts of companies with whom the client has previously done the most business, plus a sample of other accounts. Accounts payable confirmations are ordinarily sent to suppliers with whom the client has done the most business. This is because the largest potential for an understatement may exist due to the client having established high levels of credit. A sample of other accounts will ordinarily also be selected.

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

b) Standards of the Public Company Accounting Oversight Board (United States). An audit report of a public client indicates that the audit was performed in accordance with standards of the Public Company Accounting Oversight Board (United States).

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

c) A decision not to confirm accounts receivable. An emphasis-of-matter paragraph is appropriate when an auditor wishes to emphasize a matter concerning the financial statements, but not a matter concerning the scope of the audit engagement. An emphasis-of-matter paragraph is not appropriate since confirming accounts receivable relates to the scope of the audit.

Which of the following is most likely to be considered a Type 1 subsequent event? a) A business combination completed after year-end, but for which negotiations began prior to year-end. b) A strike subsequent to year-end due to employee complaints about working conditions that originated two years ago. c) Customer checks deposited prior to year-end but determined to be uncollectible after year-end. d) Introduction of a new line of products after year-end for which major research had been completed prior to year-end.

c) Customer checks deposited prior to year-end but determined to be uncollected after year-end. A Type 1 subsequent event relates to a condition that came into effect before year-end; Type 1 subsequent events result in an adjusting journal entry. In this situation, the customer's check may be assumed to have been uncollectible at year-end, and therefore it would be considered to be a Type 1 subsequent event. The other three replies refer to events most ordinarily considered to be Type 2 events--the events came into existence after year-end.

The least likely approach in auditing management's estimate relating to an accrued liability is to: a) Independently develop an estimate of the amount to compare to management's estimate. b) Review and test management's process of developing the estimate. c) Review subsequent events or transactions bearing on the estimate. d) Send confirmations relating to the estimate.

d) Send confirmations relating to the estimate. Auditors audit estimates through (a) independently developing an estimate, (b) reviewing management's process, and (c) reviewing subsequent events. There often is no one to send a confirmation related to the estimate.

Which of the following is least likely to be considered a substantive procedure relating to payroll? a) Investigate fluctuations in salaries, wages, and commissions. b) Test computations of compensation under profit sharing for bonus plans. c) Test commission earnings. d) Test whether employee time reports are approved by supervisors.

d) Test whether employee time reports are approved by supervisors. Testing whether employee time reports are approved by supervisors is an example of a test of a control, not a substantive procedure.

Auditor confirmation of accounts payable balances at the balance sheet date may be unnecessary because: a) This is a duplication of cutoff tests. b) Accounts payable balances at the balance sheet date may not be paid before the audit is completed. c) Correspondence with the audit client's attorney will reveal all legal action by vendors for nonpayment. d) There is likely to be other reliable external evidence available to support the balances.

d) There is likely to be other reliable external evidence available to support the balances. Auditors will usually find in the client's possession externally created evidence such as vendors' invoices and statements that substantiate the accounts payable. No such external evidence is on hand to support accounts receivable.

In an audit, the valuation of year-end accounts payable is most likely addressed by: a) Confirmation. b) Examination of cash disbursements immediately prior to year-end. c) Examination of cash disbursements immediately subsequent to year-end. d) Analytical procedures applied to vouchers payable at year-end.

a) Confirmation. The best procedure to determine valuation of payables is confirmation. Examination of cash disbursements in the subsequent period is more directed towards completeness of payables. Analytical procedures may be useful but would not be as effective as confirmation with respect to the valuation assertion.

Subsequent to the issuance of the auditor's report, the auditor became aware of facts existing at the report date that would have affected the report had the auditor then been aware of such facts. After determining that the information is reliable, the auditor should next: a) Notify the board of directors that the auditor's report must no longer be associated with the financial statements. b) Determine whether there are persons relying or likely to rely on the financial statements who would attach importance to the information. c) Request that management disclose the effects of the newly discovered information by adding a footnote to subsequently issued financial statements. d) Issue revised pro forma financial statements taking into consideration the newly discovered information.

b) Determine whether there are persons relying or likely to rely on the financial statements who would attach importance to the information. When the auditor becomes aware of facts existing at the report date that would have affected the report, s/he should next determine whether there are persons relying or likely to rely on the financial statements who attach importance to the information. If such persons are believed to exist, the next step is to determine the best manner in which to disclose the information.

As a result of analytical procedures, the independent auditors determine that the gross profit percentage has declined from 30 percent in the preceding year to 20 percent in the current year. The auditors should: a) Express an opinion that is qualified due to the inability of the client company to continue as a going concern. b) Evaluate management's performance in causing this decline. c) Require note disclosure. d) Consider the possibility of a misstatement in the financial statements.

d) Consider the possibility of a misstatement in the financial statements. The purpose of analytical procedures is to locate potential misstatements in the financial statements. The auditors should investigate this significant fluctuation to determine whether it results from a financial statement misstatement.

For effective internal control, the accounts payable department should compare the information on each vendor's invoice with the: a) Receiving report and the purchase order. b) Receiving report and the voucher. c) Vendor's packing slip and the purchase order. d) Vendor's packing slip and the voucher.

a) Receiving report and the purchase order. Each vendor's invoice should be compared with the receiving report (to determine that it was received) and the purchase order (to determine that it was ordered). Answer (b) is incomplete because of the omission of the purchase order. Answers (c) and (d) are incorrect because the receiving report, prepared by the company itself, provides better evidence of what has been received than the vendor's packing slip.

When perpetual inventory records are maintained in quantities and in dollars, and internal control over inventory is weak, the auditor would probably: a) Want the client to schedule the physical inventory count at the end of the year. b) Insist that the client perform physical counts of inventory items several times during the year. c) Increase the extent of test for unrecorded liabilities at the end of the year. d) Have to disclaim an opinion on the income statement for that year.

a) Want the client to schedule the physical inventory count at the end of the year. Since the internal control is described as being weak, the CPAs will generally insist upon a physical count at year-end.

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

b) Auditors have accumulated sufficient appropriate evidence. The audit report should be dated no earlier than when the auditors have accumulated sufficient appropriate evidence. This date is often the last day of fieldwork.

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

d) An improper type of reporting. This phrase does not give the reader of the report a clear-cut indication of the auditors' opinion. The phrase appears to modify the standard opinion paragraph, but is not forceful enough to constitute qualifying language.

The document issued by a common carrier acknowledging the receipt of goods and setting forth the provisions of the transportation agreement is the: a) Bill of lading. b) Job time shipping. c) Production order. d) Production schedule.

a) Bill of lading. A bill of lading acknowledges the receipt of goods and sets forth provisions of the transportation agreement.

The search for unrecorded liabilities for a public company includes procedures usually performed through the: a) Day the audit report is issued. b) End of the client's year. c) Date of the auditors' report. d) Date the report is filed with the SEC.

c) Date of the auditors' report. The search for unrecorded liabilities should be completed as of the last day possible--ordinarily near the date of the audit report.

An auditor accepted an engagement to audit the 20X8 financial statements of EFG Corporation and began the fieldwork on September 30, 20X8. EFG gave the auditor the 20X8 financial statements on January 17, 20X9. The auditor completed the audit on February 10, 20X9, and delivered the report on February 16, 20X9. The client's representation letter normally would be dated: a) December 31, 20X8. b) January 17, 20X9. c) February 10, 20X9. d) February 16, 20X9.

c) February 10, 20X9. The representation letter should be dated as of the date the audit was completed.

In performing a test of controls, the auditors vouch a sample of entries in the purchases journal to the supporting documents. Which assertion would this test of controls most likely test? a) Completeness. b) Existence. c) Valuation. d) Rights.

b) Existence. Vouching from the purchases journal to the supporting documents provides evidence with respect to the existence assertion for purchases.

The receiving department is least likely to be responsible for the: a) Determination of quantities of goods received. b) Detection of damaged or defective merchandise. c) Preparation of a shipping document. d) Transmittal of goods received to the store's department.

c) Preparation of a shipping document. The shipping department, not the receiving department, is responsible for preparation of a shipping document.

The organization established by Congress to narrow the options in cost accounting that are available under generally accepted accounting principles is the: a) Cost Accounting Standards Board. b) Financial Accounting Standards Board. c) Public Company Accounting Oversight Board. d) Securities and Exchange Commission.

a) Cost Accounting Standards Board. The Cost Accounting Standards Board was established by Congress to narrow the options in cost accounting that are available under generally accepted accounting principles.

An audit of the balance in the accounts payable account is ordinarily not designed to: a) Detect accounts payable that are substantially past due. b) Verify that accounts payable were properly authorized. c) Ascertain the reasonableness of recorded liabilities. d) Determine that all existing liabilities at the balance sheet date have been recorded.

a) Detect accounts payable that are substantially past due. The auditors do not have as an objective the determination of whether accounts payable are past due.

Which of the following should be included as a part of inventory costs of a manufacturing company? a) Direct Labor = Yes; Raw Materials = Yes; Factory Overhead = Yes. b) Direct Labor = Yes; Raw Materials = No; Factory Overhead = No. c) Direct Labor = No; Raw Materials = Yes; Factory Overhead = No. d) Direct Labor = No; Raw Materials = No; Factory Overhead = No.

a) Direct Labor = Yes; Raw Materials = Yes; Factory Overhead = Yes. Direct labor, raw materials, and factory overhead are all included in inventory costs of a manufacturing company.

When a primary risk related to an audit is possible overstated inventory, the assertion most directly related is: a) Existence. b) Completeness. c) Clarity. d) Presentation.

a) Existence. Of the choices, existence is most directly related to overstated inventory because inclusion of inventory items that do not exist in inventory totals results in an overstated inventory.

The auditor's analytical procedures will be facilitated if the client: a) Uses a standard cost system that produces variance reports. b) Segregates obsolete inventory before the physical inventory count. c) Corrects material weaknesses in internal control before the beginning of the audit. d) Reduces inventory balances to the lower of cost or market.

a) Uses a standard cost system that produces variance reports. Analytical procedures will be facilitated when a client uses a standard cost system that produces variance reports. Such reports will allow the auditors to identify significant deviations from expected values.

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

c) Generally accepted accounting principles (United States). An audit report for a public client indicates that the financial statements are presented in conformity with generally accepted accounting principles (United States). The PCAOB does not issue accounting standards.

To determine that each voucher is submitted and paid only once, when a payment is approved, supporting documents should be canceled by the: a) Authorized members of the audit committee. b) Accounting department. c) Individual who signs the checks. d) Chief executive officer.

c) Individual who signs the checks. The individual who signs the checks should ordinarily be provided with supporting documents that provide support for the disbursement. That individual should then manually or electronically "cancel" the documents so that the amount isn't paid a second time.

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

c) Qualified = No; Adverse = Yes. When a misstatement is pervasive, an adverse opinion is appropriate.

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

c) Qualified = No; Unmodified with Emphasis-of-Matter = Yes. Substantial doubt about a client's ability to continue as a going concern results in either an unqualified report with explanatory language (or, less frequently, a disclaimer of opinion_. A qualified report is not appropriate.

Which of the following events occurring on January 5, 20X2, is most likely to result in an adjusting entry to the 20X1 financial statements? a) A business combination. b) Early retirement of bonds payable. c) Settlement of litigation. d) Plant closure due to a strike.

c) Settlement of litigation. The settlement of litigation is most likely to result in an adjusting entry (i.e., be a "Type 1 subsequent event) because the cause of the litigation most likely occurred before 20X2.

A material departure from generally accepted accounting principles will result in auditor consideration of: a) Whether to issue an adverse opinion rather than a disclaimer of opinion. b) Whether to issue a disclaimer of opinion rather than a qualified opinion. c) Whether to issue an adverse opinion rather than a qualified opinion. d) Nothing, because non of these opinions is applicable to this type of exception.

c) Whether to issue an adverse opinion rather than a qualified opinion. When the auditors take exception to the application of accounting principles in the client's financial statements, they will issue either a qualified or adverse opinion, depending on whether the misstatement is considered pervasive.

Which of the following procedures is most likely to be included near completion of an audit? a) Obtaining an understanding of internal control. b) Confirmation of receivables. c) Observation of inventory. d) Performing analytical procedures.

d) Performing analytical procedures. The performance of analytical procedures is a required part near completion of the audit and is therefore most likely to be included in that stage of the audit.

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

a) An emphasis-of-matter paragraph to the auditors' report. The auditor communicates through the auditors' report. Note that the client will include a discussion of the related party transactions in a note to the financial statements.

McPherson Corp. does not make an annual physical count of year-end inventories, but instead makes weekly test counts on the basis of a statistical plan. During the year, Sara Mullins, CPA, observes such counts as she deems necessary and is able to satisfy herself as to the reliability of the client's procedures. In reporting on the results of her examination, Mullins: a) Can issue an unqualified opinion without disclosing that she did not observe year-end inventories. b) Should comment in the scope paragraph as to her inability to observe year-end inventories, but can nevertheless issue an unqualified opinion. c) Is required, if the inventories are material, to disclaim an opinion on the financial statements taken as a whole. d) Should, if the inventories are material, qualify her opinion.

a) Can issue an unqualified opinion without disclosing that she did not observe year-end inventories. Mullins may issue an unqualified opinion as long as she satisfied that the client's procedures are adequate to provide a reliable inventory balance.

When auditing the statement of cash flows, which of the following would an auditor not expect to be a source of receipts and payments? a) Capitalization. b) Financing. c) Investing. d) Operations.

a) Capitalization. The three sections of a statement of cash flows relate to operations, financing, and investing. Capitalization is not one of the sections.

Ordinarily, the most significant assertion relating to accounts payable is: a) Completeness. b) Existence. c) Presentation. d) Valuation.

a) Completeness. Because an understatement of liabilities overstates income, auditors are ordinarily most concerned with the completeness assertion for payables. Note, however, that in circumstances in which a client may be motivated to understate income (e.g., to minimize taxes), existence becomes a bigger concern.

A possible loss, stemming from past events that will be resolved as to existence and amounts, is referred to as a(n): a) Analytical process. b) Loss contingency. c) Probable loss. d) Unasserted claim.

b) Loss contingency. A loss contingency is a possible loss stemming from past events that will be resolved in the future.

Which of the following is the best audit procedure for the discovery of damaged merchandise in a client's ending inventory? a) Compare the physical quantities of slow-moving items with corresponding quantities in the prior year. b) Observe merchandise and raw materials during the client's physical inventory taking. c) Review the management's inventory representations letter for accuracy. d) Test overall fairness of inventory values by comparing the company's turnover ratio with the industry average.

b) Observe merchandise and raw materials during the client's physical inventory taking. The best procedure for the discovery of damaged goods is an examination of the condition of the inventory during the auditors' observation of the physical inventory.

Which of the following is least likely to be among the auditors' objectives in the audit of inventories and cost of goods sold? a) Determine that the valuation of inventories and cost of goods sold is arrived at by appropriate methods. b) Determine the existence of inventories and the occurrence of transactions affecting cost of goods sold. c) Establish that the client includes only inventory on hand at year-end in inventory totals. d) Establish the completeness of inventories.

c) Establish that the client includes only inventory on hand at year-end in inventory totals. Inventory need not be on hand at year-end. For example, purchases in transit on which title has passed to the client should also be included.

Which of the following is the best way for the auditors to determine that every name on a company's payroll is that of a bona fide employee presently on the job? a) Examine human resources records for accuracy and completeness. b) Examine employees' names listed on payroll tax returns for agreement with payroll accounting records. c) Make a surprise observation of the company's regular distribution of paychecks on a test basis. d) Visit the working areas and verify that employees exist by examining their badge or identification numbers.

c) Make a surprise observation of the company's regular distribution of paychecks on a test basis. The best procedure for the detection of a fictitious employee is a surprise observation of the distribution of paychecks. The fictitious employee's paycheck will ordinarily not be picked up, and further audit procedures performed by the auditors may reveal that this is a fictitious employee.

Which of the following is the best audit procedure for determining the existence of unrecorded liabilities? a) Examine confirmation requests returned by creditors whose accounts appear on a subsidiary trial balance of accounts payable. b) Examine unusual relationships between monthly accounts payable balances and recorded purchases. c) Examine a sample of invoices a few days prior to and subsequent to year-end to ascertain whether they have been properly recorded. d) Examine selected cash disbursements in the period subsequent to year-end.

d) Examine selected cash disbursements in the period subsequent to year-end. Examining selected cash disbursements in the period subsequent to the year-end is the best audit procedure for determining the existence of unrecorded liabilities. All liabilities must eventually be paid, and will therefore be reflected in the accounts when paid if not when incurred. By close study of payments made subsequent to the balance sheet date, the auditors may find items that should have appeared in the balance sheet.