Advanced Auditing Exam 1 Review

Select the appropriate case to which each is most closely related. Auditors may be liable to third parties for ordinary negligence if these parties should be foreseen by auditors as relying on the financial statements.

Fleet National Bank v. Gloucester Co.

Which of the following philosophical theories places emphasis on following rules, rather than on the consequences of the decision?

Imperative principle.

Which of the following is not a restriction placed on audit partners by Sarbanes-Oxley?

Engagement partners must review nonaudit work to ensure that independence has not been compromised.

The first significant case under Section 11 of the Securities Act of 1933 charging auditors with not conducting a reasonable investigation was

Escott v. BarChris Construction Corp.

Which of the following defines the imperative principle of ethics?

Ethics are a function of moral rules and principles.

Select the appropriate case to which each is most closely related. Third parties cannot rely on reviewed financial statements to the same extent as they can on audited financial statements.

Iselin v. Landau

CPA Krogstad is the executive in charge of the Omaha office of the audit firm. He is responsible for the practice in all areas of audit, tax, and consulting, but he does not serve as a field audit partner or a reviewer. CPA Ward is the partner in charge of the Dodger, Inc. audit (an SEC filing). The audit firm's independence is impaired if:

Krogstad owns Dodger common stock.

Which of the following is the best defense auditors can assert in a suit for common law fraud based on their unqualified opinion on materially misstated financial statements?

Lack of scienter.

While conducting an audit, Larson Associates, CPAs, failed to detect material misstatements included in its client's financial statements. Larson's unqualified opinion was included with the financial statements in a registration statement and prospectus for a public offering of securities made by the client. Larson knew that its opinion and the financial statements would be used for this purpose. Which of the following statements is correct with regard to a suit against Larson and the client by a purchaser of the securities under Section 11 of the Securities Act of 1933?

Larson will not be liable if it had reasonable grounds to believe the financial statements were accurate.

Which of the following is not addressed in an SOC 1 Type 1 report?

Operating effectiveness of the service organization's internal controls.

The Securities Act of 1933

regulates the initial issuance of securities.

Which of the following represents the level of assurance provided in a compilation engagement on a non-issuer's financial statements?

No opinion or assurance on the fairness of the financial statements.

Which of the following is true according to Government Independence Standards?

Nonaudit services are allowed providing the audit organization does not perform management functions, make management decisions, or audit its own work.

Which of the following procedures should an accountant perform during an engagement to review the financial statements of a non-issuer?

Obtain a representation letter from members of management.

Which of the following procedures would not be performed in a review of financial statements of a non-issuer?

Obtain an attorney's letter regarding litigation and unasserted claims.

Which of the following is true for audits of governmental entities under Government Independence Standards?

Personnel who provide nonaudit services are prohibited from planning, conducting, or reviewing audit work related to the nonaudit service.

A preparation engagement might include all of the following except:

Preparation of financial statements solely for submission to a taxing authority.

When bringing suit against auditors under Section 10(b) of the Securities Exchange Act of 1934, plaintiffs must allege and prove:

auditors were aware of material misstatements in the financial statements.

The party in an attestation engagement who provides an assertion with respect to information is the:

Responsible party.

Paula performed the audit of the financial statements of Abdul Company (a nonpublic entity currently not subject to filing requirements under the Securities Act of 1933 or Securities Exchange Act of 1934). Abdul Company is currently considering several alternatives for raising capital, including seeking financing from area banks or an initial public offering of its securities. Which of the following parties would have the lowest likelihood of successfully bringing suit for ordinary negligence against Paula?

Simon Whitaker, a private investor who is considering acquiring Abdul Company.

According to Sarbanes-Oxley, accountants performing an audit or review must maintain all engagement documentation for a period of

7 years.

What agency has the ultimate authority in defining independence for public companies?

The SEC

To prevail in an action brought under common law, the plaintiff must show all of the following except:

auditors knew the financial statements contained a material misstatement.

In a compilation engagement, the accountant:

does not express an opinion.

A responsible party for information to subject to an attestation engagement would not include:

the independent accountant.

Which of the following statements included in the advertising of a CPA firm is permissible according to the Advertising and Other Forms of Solicitation Rule.

"We audit the five largest manufacturing companies in the state."

For each situation (1-5), identify the most applicable AICPA rule of conduct and whether there is a violation or no violation of the rule (A-F). One or more letters may not be used. A.Independence Rule; no violation B.Independence Rule; violation C.Confidential Client Information Rule; no violation D.Confidential Client Information Rule; violation E.Fees and Other Types of Remuneration Rule; no violation F.Fees and Other Types of Remuneration Rule; violation 1.Jackson, CPA, and one of his audit clients are considering investing in a business together. Jackson would own 25% of the business and the client would own 50%. Jackson's investment in the business is material to his net worth. 2.Feller, CPA, is the corporate controller for Robert Corporation. Feller believes his employer may have committed an illegal act. After discussing the matter with his attorney, Feller decides to disclose the matter to the appropriate authorities. 3.Brock, CPA, is an owner in the firm Louis and Brock, CPAs. Brock's husband is on the board of directors of Midland Corporation, an audit client of Louis and Brock. Brock does not participate on the audit engagement. 4.Ruth, CPA, owns a building and leases a portion of the space to an audit client. The income from the lease is not material to Ruth. 5.Maris, CPA, performs investment advisory services for an audit client and receives an annual fee based on a percentage of the value of the client's investment portfolio at the end of each year. 6.Brandon Frisby, CPA, found out that his client, Uptonogood, Inc., had failed to properly account for several leases. Frisby informed Uptonogood's management that he must issue a qualified audit report and disclose the lease problem in the report. Uptonogood's management indicated that such a disclosure would constitute a disclosure of confidential information. Nevertheless, Frisby rendered the qualified audit report, including an explanatory paragraph about the inadequate lease accounting. 7.Priscilla Hudson, CPA, a partner in Hudson and Danhoffer, CPAs, holds the position of honorary director for the Friends of the Symphony Orchestra, a firm audit client. 8.The wife of Gerald Skoch, CPA, is the controller of Fine Corporation. Skoch is an audit partner for Barnes and Bucknell, CPAs, in their Long Island office. The Long Island office of Barnes and Bucknell audits Fine Corporation, but Skoch is not part of the audit team and provides no other services to Fine Corporation. 9.Johnny Beacon, CPA, is the auditor of Novak Wholesale, Inc. Beacon received a 10% commission from Computer Systems, Inc. for hardware sold to Novak Wholesale, Inc. The sale was made based on Beacon's recommendation to Novak Wholesale that the company needed a new accounting information system. Beacon disclosed the commission to Novak's management. Beacon also performs an annual audit for Novak. 10. Cecilia Hart, CPA, provides tax services to Myers Company. Hart received a 10% commission from Computer Systems, Inc. for hardware sold to Myers Company. The sale was made based on Hart's recommendation to Myers Company that the company needed a new accounting information system. Hart disclosed the commission to Myers' management.

1. B 2. C 3. B 4. A 5. F 6. C 7. A 8. B 9. F 10. E

An engagement in which accountants perform procedures delineated by the entity is referred to as a(n):

Agreed-upon procedures engagement.

Which of the following is required for a CPA firm to designate itself as "Members of the American Institute of Certified Public Accountants" on its letterhead?

All owners must be members.

According to Sarbanes-Oxley, the audit committee must pre-approve all audit and non-audit services. This can be done

Case-by-case basis: Yes; Through established policies: Yes; Delegating the responsibility: No

Which of the following statements about the Securities Act of 1933 is not true?

The plaintiff must prove they read and relied upon the financial statements.

Which of the following philosophical principles in ethics places emphasis on the consequences of action, rather than on following the rules?

Utilitarianism principle.

Maralee has been approached by J. Fox Entertainment to perform an audit of her theatre company. Maralee has never audited a theatre company before. Maralee can

accept the engagement if she can obtain the required knowledge before the end of the engagement.

The procedures used in a review engagement are:

analytical procedures, inquiry, and obtaining a management representation letter.

Third-party plaintiffs bringing action under common law need not prove

breach of contract.

The SEC requires companies to disclose fees paid to independent public accounting firms for audit and consulting services in the belief that:

client directors and financial statement users should consider all aspects related to auditors' independence, and information about fees is important.

The accountant's standard report for a compilation engagement would not include a statement that:

compilation service consists primarily of inquiries of company personnel and analytical procedures applied to financial data.

Failure to provide any level care in fulfilling a duty owed to another party, including reckless disregard for the truth, is called

constructive fraud.

Auditors should not be liable to any party if they perform services that met the standards of:

due care.

Compiled financial statements for a non-issuer should be accompanied by a report stating that:

the accountant does not express an opinion or any other form of assurance on the financial statements.

An audit client hires a member of the audit engagement team to be its new controller. Sarbanes-Oxley rules require that:

the client must find a new audit firm.

Typical defenses for auditors in common law actions include all of the following, except

the plaintiff was foreseen.

Foreseeable third parties are best described as

those third parties whose decisions normally rely on audited financial statements and opinions on those financial statements.

Which of the following would not need to be demonstrated by third parties bringing suit against auditors for losses sustained under the Securities Act of 1933?

Auditors were aware of the materially misstated financial statements.

Which of the following is not true if auditors are requested to express an opinion on the fairness of a non-issuers' balance sheet?

The auditors' procedures will be limited only to those related to the balance sheet.

During a review engagement, which of the following is not a required inquiry of management?

The changes made to internal controls during the period under review.

Mays bought McCovey Corp. common stock in an offering registered under the Securities Act of 1933. Hart & Co., CPAs, gave an unqualified opinion on McCovey's financial statements that were included in the registration statement filed with the Securities and Exchange Commission. Mays sued Hart under the provisions of the 1933 act that deal with omission of facts required to be in the registration statement. Mays must prove that:

The financial statements contained a material misstatement.

Which of the following is not part of the definition of proportionate liability adopted by the Private Securities Litigation Reform Act?

The full amount of damages may be recovered from any defendants involved in the action.

Lancaster & Co., CPAs, is auditing the financial statements of Cooper Corporation. During the course of the audit, Cooper Corporation sent the following memo to the engagement partner:We have requested $1 million worth of products from Ladd Corporation with credit terms of net 30 days. Ladd has requested audited financial statements for its credit decision. We notified Ladd that our annual audit was in process and we would provide the audited financial statements to them as soon as they were completed.Which of the following statements is true with regards to this memo?

The memo may move Ladd Corporation closer to a primary beneficiary and reposition them as third party with a standing to sue, depending on the jurisdiction of any future lawsuits.

Which of the following factors would not influence third parties' abilities to bring suit against auditors for ordinary negligence under common law?

The nature of activity by auditors that resulted in their failure to exercise appropriate levels of professional care.

Which of the following is not a difference in the report on an agreed-upon procedures engagement compared to an auditors' report on an audit conducted under generally accepted auditing standards?

The report indicates the engagement was conducted in conformity with generally accepted auditing standards.

Which of the following indicates the minimum required scope in an agreed-upon procedures engagement:

There is no minimum required scope in an agreed-upon procedures engagement.

What is the primary reason that the auditor of a user organization would request a report from a service organization?

To determine the design and/or operating effectiveness of internal controls.

Select the appropriate case to which each is most closely related. Concluded that auditors could be liable to third parties who were not in privity with them.

Ultramares Corp. v. Touche.

Select the appropriate case to which each is most closely related. Conviction of auditors for willingly conspiring to defraud in an engagement related to pro forma financial statement.

United States v. Benjamin

While conducting an audit of a public entity, Wallace failed to identify material misstatements in its client's financial statements. Investors then sued Wallace in connection with this audit. Which of the following would not need to be demonstrated in order for the shareholders to successfully bring suit against Wallace under Section 10(b)-5 of the Securities Act of 1934?

Wallace was in privity with the shareholders.

What is the appropriate name for an assurance service provided by a CPA regarding a client's commercial Internet site with reference to the principles of privacy, security, processing integrity, availability, and confidentiality?

WebTrust.

Engagements to express an opinion on an account, element, or item of a financial statements:

Would limit the opinion expressed to the specific account, element, or item that serves as the focus of the engagement.

To be successful in a civil action under Section 11 of the Securities Act of 1933 against auditors for liability for a materially misstated registration statement, the plaintiff must prove which of the following?

Auditors' intent to deceive: No; Plaintiff's reliance on the registration statement: No

When providing limited assurance that the reviewed financial statements of a non-issuer require no material modifications to be in accordance with generally accepted accounting principles, the accountant should:

understand the accounting principles of the industry in which the entity operates.

The AICPA Council has designated the following bodies to pronounce accounting principles under the Accounting Principles Rule except the

Auditing Procedures Board.

Which of the following is not a condition that must be met for an attestation engagement related to compliance:

Auditors must also conduct an audit engagement on the client's financial statements.

Which of the following statements is true concerning auditors' responsibilities during the audit?

Auditors must exercise the level of care, skill, and judgment expected of a reasonably prudent auditor under the circumstances.

Which of the following would not be an appropriate reporting option for financial statements prepared using a special purpose framework?

A disclaimer of opinion because of the failure of the entity to use generally accepted accounting principles.

Violet, CPA, audits Big Bank, a local financial institution. Which of the following would most likely impair Violet's independence with regard to Big Bank?

A home loan with the value of the house exceeding the mortgage balance.

According to the ethical standards of the profession, which of the following acts is generally prohibited?

Accepting a commission for recommending a product to an audit client.

At a minimum, the auditor of an issuer that has material transactions processed by a service organization would have to request which of the following from the service organization?

An SOC 1 Type 2 report.

Which of the following best describes an engagement to report on a non-issuer's internal control over financial reporting?

An attestation engagement to examine and report on management's written assertions about the effectiveness of its internal control over financial reporting.

Which of the following engagements is not conducted under Statements on Standards for Accounting and Review Services?

An engagement to perform agreed-upon procedures to historical financial statements.

Which of the following statements would normally be included in a report on financial statements prepared using a special purpose framework?

An indication that the audit was conducted in accordance with generally accepted auditing standards.

Which of the following would not be included in an SOC 1 Type 2 report?

An indication that the service auditors' engagement was conducted in accordance with generally accepted auditing standards.

In a report on compliance with contractual agreements conducted in conjunction with an audit of the financial statements, the auditors' report would include all of the following except:

An opinion on the entity's compliance with contractual agreements.

Beckler & Associates, CPAs, examined and issued an unqualified opinion on the financial statements of Queen Co. The financial statements contained misstatements that resulted in a material overstatement of Queen's net worth. Queen provided the audited financial statements to Mac Bank in connection with a loan made by Mac to Queen. Beckler knew that the financial statements would be provided to Mac. Queen defaulted on the loan. Mac sued Beckler to recover for its losses associated with Queen's default. Which of the following must Mac prove in order to recover? I. Beckler did not conduct the audit with the appropriate level of professional care. II. Mac relied on the financial statements.

Both I and II.

Select the appropriate case to which each is most closely related. The court applied the restatement of torts doctrine to identify the plaintiff as a primary beneficiary.

Credit Alliance v. Arthur Andersen

Select the appropriate case to which each is most closely related. Established a three point test for auditor liability, including that auditors demonstrate some action to acknowledge the existence of the third party and the third party's intent to rely on the opinion and financial statements.

Credit Alliance v. Arthur Andersen.

In an engagement to audit financial statements prepared using a special purpose framework, the audit team would conduct all of the following procedures except:

The audit team would perform all of the above procedures.

According to the profession's ethical standards, an auditor would be considered independent in which of the following instances?

The auditor's checking account that is fully insured by a federal agency is held at a client financial institution.

Which of the following parties is most likely to recover against auditors for losses resulting from acts of ordinary negligence?

The auditors' client.

Which of the following is not a key element of the definition of ethics?

Definitive conclusions

If an entity prepares financial statements that omit footnote disclosures required by generally accepted accounting principles, the accountants' compilation report should:

Disclaim an opinion or assurance on the financial statements and reference the omitted disclosures.

The accountant's report in an agreed-upon procedures engagement:

Disclaims an opinion or conclusion on the matter subject to the engagement.

Which of the following claims concerning the quality of auditors' work would least likely result in civil liability for damages?

Failure to investigate possible fraud when other entities in the industry have experienced frauds.

Julie and Lisa are sisters. Julie is a CPA auditing the company where Lisa works. Julie's independence is impaired if

Lisa is the controller.

Which of the following is the responsibility of the Professional Ethics Executive Committee?

Make and enforce all the rules of conduct for CPAs who are AICPA members.

For which type of prospective financial information can an accountant conduct an examination engagement? Financial forecast Financial projection A. Yes Yes B. Yes No C. No Yes D. No No

Option A

When auditors report on compliance with contractual agreements in conjunction with an audit of the financial statements conducted under generally accepted auditing standards, which of the following is a reporting option with respect to compliance? Combined report Separate report A.Yes Yes B.Yes No C.No Yes D.No No

Option A

Which type of entit(ies) may prepare financial statements using a special purpose framework. Issuers Non-issuers A.Yes Yes B.Yes No C.No Yes D.No No

Option C

Which of the following forms of organization would NOT be allowed under the Form of Organization and Name Rule of the Professional Code of Conduct?

Partnership; 40 percent of partners are CPAs.

Which of the following is required in a preparation engagement?

Preparing an engagement letter prior to accepting the engagement.

How does the Securities Act of 1933, which imposes civil liability on auditors for misrepresentations or omissions of material facts in a registration statement, expand auditors' liability to purchasers of securities beyond that of common law?

Privity with purchasers is not a necessary element of proof.

Which of the following is not a principle of Trust Service engagements?

Proficiency in preparing transactions.

Which of the following is NOT one of the AICPA Principles of Professional Conduct?

Reliability

Under the liability provisions of Section 11 of the Securities Act of 1933, auditors may be liable to any purchaser of securities for certifying materially misstated financial statements that are included in the registration statement. Under Section 11, which of the following must be proven by a purchaser of the security?

Reliance on financial statements: No; Fraud by auditors: No

Select the appropriate case to which each is most closely related. Was the first United States case involving a suit against auditors.

Smith v. London Assurance Corp.

Select the appropriate case to which each is most closely related. Concluded that reckless misstatements, even if not deliberate, are the basis for liability to third parties.

State Street Trust v. Ernst.

Engagements related to prospective financial information are conducted under:

Statements on Standards for Attestation Engagements.

In which of the following circumstances would a CPA who audits XZ Corporation lack independence?

The CPA and XZ's president each own 25 percent of FOB Corporation, a closely held company.

Based on Sarbanes-Oxley, who is ultimately responsible for the independence of the external auditor?

The audit committee.

Perry Pinkney, CPA, is one of the general partners in a partnership, which in turn invested 70 percent of its assets in the common stock of Pinkney's audit client (Darby Corporation). According to the AICPA Code of Professional Conduct, Pinkney is considered to have

a direct financial interest in Darby.

Many individuals are apprehensive about using the Internet to purchase items. This apprehension mainly arises from users' concerns about:

a lack of security for information transmitted over the Internet.

According to the Accounting Principles Rule requires the auditor to adhere to official pronouncements except when

adherence to a pronouncement would be misleading.

Shelly's Bank has loaned money to Pete's Auto Supply. The loan is collateralized by inventory. The loan also requires a CPA to observe the count of the inventory and trace sampled items to the vendor invoices in order to determine the value of inventory is not misstated. This service would be:

an attestation engagement.

While conducting an audit, Larson Associates, CPAs, failed to detect material misstatements included in its client's financial statements. Larson's unqualified opinion was included with the financial statements in a registration statement and prospectus for a public offering of securities made by the client. Larson knew that its opinion and the financial statements would be used for this purpose. In a suit by a purchaser against Larson, Larson's best defense would be that the

audit was conducted in accordance with generally accepted auditing standards.

An audit failure occurs when

auditors fail to conduct the examination in accordance with generally accepted auditing standards, which results in the failure to identify material misstatements in the financial statements.

A client has omitted a significant disclosure from the financial statements. The auditor has asked the client to include the information, but the client refuses and claims the information is confidential. The position of the CPA should be that the information

cannot be considered confidential if it is necessary to the completeness of the financial statements.

Hamell Corporation is making a presentation to a prospective investor. The presentation includes a projection showing that the company's sales will be between $25,000,000 and $27,000,000 within the next three years. Hamell believes the information will be better received if its CPA provides an attestation report on the financial projection. In order to provide such a report the CPA must do all of the following except:

confirm expected sales with customers.

Delta Life Insurance Co. prepares its financial statements on an accounting basis insurance companies use pursuant to the rules of a state insurance commission. Wall, CPA, is Delta's auditor. If Wall discovers that the statements are not suitably titled, Wall should:

disclose any reservations in an explanatory paragraph and qualify the opinion.

Attestation engagements include:

examinations, reviews, and agreed-upon procedures.

The restatement of torts is a general legal doctrine that extends liability for ordinary negligence to

foreseen third parties.

The SEC Rule 10b-5 deals with

fraud in the purchase or sale of securities.

An interpretation of the Independence Rule allows members to

have loans from a client that are collateralized by cash deposits held by the client.

Under the liability provisions of Section 11 of the Securities Act of 1933, auditors may be liable to any purchaser of a security for certifying materially misstated financial statements that are included in the registration statement. Under Section 11, auditors usually will not be liable to the purchaser

if auditors can demonstrate due diligence.

A report on sustainability, as defined by the AICPA, might include all of the following except:

internal control over financial reporting.

In a common law action against auditors, lack of privity is a viable defense if the plaintiff

is the client's creditor who sues auditors for ordinary negligence.

Lauren hires Humphrey, a CPA, to audit her financial statements. The engagement letter includes a statement acknowledging that audited financial statements are needed for a filing with a regulatory body. Humphrey completes the audit and issues an unqualified opinion. Based on the audited financial statements, Key Largo Bank approves a loan to Lauren. Four months later, Lauren files for bankruptcy. Key Largo Bank would most likely sue Humphrey claiming:

it was a foreseeable party.

Lauren hires Humphrey, a CPA, to provide an audit of her financial statements. The engagement letter includes a statement acknowledging that audited financial statements will be provided to financial institutions for a loan, but does not name any financial institutions. Humphrey completes the audit and issues an unqualified opinion. Based on the audited financial statements, Key Largo Bank approves the loan to Lauren. Four months later, Lauren files for bankruptcy. Key Largo Bank would most likely sue Humphrey claiming:

it was a foreseen party.

In a compilation engagement:

managers or owners may choose to omit all the footnote disclosures.

In an agreed-upon procedures engagement, an accountant:

may restrict the use of the report to specified users.

An interpretation of the Acts Discreditable Rule would not include

membership in an activist political party.

When a company uses a service organization to prepare its payroll, the company's auditors:

need to understand the internal controls over the transaction regardless of the location of the control.

If an audit is performed for the benefit of a specific person or organization, that person or organization is known as a(n)

primary beneficiary.

An auditors' report on financial statements prepared in conformity with the cash basis of accounting should include an emphasis-of-matter paragraph that:

refers to the note to the financial statements that describes the special purpose framework.

ABC Company prepares financial statements showing the last two years, years X and Y. (Year X is the year prior to year Y.) The auditor performed an audit of year X and a review of year Y. The auditor may:

report on the year Y review and reissue the year X audit report.

Auditors can gain sufficient understanding of the internal controls at a service organization by:

reviewing a report on internal controls provided by the service organization's auditors.

Special purpose frameworks include all of the following except:

statements that conform to accounting principles that are generally accepted.