Audit Exam 2 Chapter Practice
t/f: the auditors ordinarily should confirm AR
correct
t/f: a combination of positive and negative request forms must be used if receivables are significant
incorrect
Do I need to count all items in the inventory?
no The auditor may sample items.
An auditor most likely would make inquiries of production and sales personnel concerning possible obsolete inventory to address: -valuation -rights -existence -presentation
valuation
The best way to verify the amounts of dividend revenue received during the year is: -recomputation -verification by reference to dividend record books -confirmation with dividend-paying companies -examination of cash disbursements records
verification by reference to dividend record books Comparing the recorded amount of dividend revenue with dividend record books (published by investment advisory services) provides evidence of the amount of dividend revenue that should have been received during the year. It is virtually impossible to confirm the receipt of dividends with the company paying those dividends.
"We also owe for two more invoices for purchases we made around year-end; I'm not sure of the exact date"
verify whether the additional invoices noted on the confirmation reply pertain to the year under audit or the subsequent year
Identify the control that is most likely to prevent the concealment of a cash shortage resulting from the improper write-off of a trade account receivable: -write-offs must be approved by a responsible official after review of credit department recommendations and supporting evidence -WOs must be approved by the accounts receivable department -WOs must be authorized by the shipping department -WOs must be supported by an aging schedule showing that only receivables overdue by several months have been written off
write-offs must be approved by a responsible official after review of credit department recommendations and supporting evidence Write-offs of receivables should be approved by a responsible officer after a review of the account by the credit department. Answer (Write-offs must be approved by the accounts receivable department.) is incorrect because accounts receivable, a recordkeeping function, should not authorize such entries. Answer (Write-offs must be authorized by the shipping department.) is incorrect because other procedures (e.g., a review of shipping documents) may be used to determine that the goods were received and because the shipping department would have no other information on whether the receivable is likely to be collectible. Answer (Write-offs must be supported by an aging schedule showing that only receivables overdue by several months have been written off.) is incorrect because the account need not be overdue by several months as a "current" receivable may become worthless due to, for example, a bankruptcy.
Is it safe to assume that any inventory items present as "consigned in" should not be included in the client's inventory?
yes Inventory "consigned in" is owned by the company that supplied the goods.
Is it correct that, because Jilco Inc. manufactures a product, direct labor and overhead ordinarily become a part of inventory costs?
yes Raw materials are also included.
"We mailed the check for this on December 31"
examine shipping documents and/or subsequent cash receipts
go over question 19
(1) DATA ANALYTICS Tests that may be performed include for EXCESS QUANTITIES OF INVENTORIES (only two required): Identify and review items that have a quantity on hand (file 1) that exceeds one-sixth of the sales for the year, 60 day's sales (file 3). Identify and review items that have a ratio of average cost to average sales price greater than 85 percent (less than a 15 percent margin) (files 1,2, and 3). Calculate inventory turnover ratios (files 1 and 3). (2) DATA ANALYTICS Tests that may be performed include UNUSUAL TRANSACTIONS (only two required): Identify and review items purchased from a vendor other than the preferred vendor (files 1 and 2). Identify and review items purchased from related parties. Comparing related party names (file 4) with purchases (file 2) and sales (file 3) throughout the year may identify related party transactions. Note, however, that this will only be effective when individual related party names are identical (or possibly similar) to vendor or customer name. Identify purchases of items (file 2) for which there have been no sales during the year (file 3). Identify transactions with sales prices X % (say, 40-50%) below average sales prices of that item during the year (file 3).
To test the existence assertion for recorded receivables, the auditors would select a sample from the: -sales orders file -customer purchase orders -AR sub ledger -shipping documents (bills of lading) file
AR sub ledger The objective is to determine the population the auditors would sample from to test the existence assertion for recorded receivables. The direction of testing should be from the accounts receivable subsidiary ledger to the available support, such as sales invoices, bills of lading, sales orders, and customers' orders.
The auditors should confirm accounts receivable unless the auditors' assessment of the risk of material misstatement is low: -And accounts receivable are immaterial, or the use of confirmations would be ineffective. -And accounts receivable are composed of large accounts. -And the effectiveness of confirmations is absolutely determined. -Or accounts receivable are from extremely reputable customers.
And accounts receivable are immaterial, or the use of confirmations would be ineffective. Receivables should be confirmed unless the combined assessment of inherent risk and controls risk is at the low level, receivables are immaterial, or the existence of circumstances in which the use of confirmations would be ineffective.
Which of the following would provide the most assurance concerning the valuation of accounts receivable? -Trace amounts in the accounts receivable subsidiary ledger to details on shipping documents. -Compare receivable turnover ratios to industry statistics for reasonableness. -Inquire about receivables pledged under loan agreements. -Assess the allowance for uncollectible accounts for reasonableness.
Assess the allowance for uncollectible accounts for reasonableness. Answer (Assess the allowance for uncollectible accounts for reasonableness.) is correct because receivables are valued at net realizable value, and assessing the allowance for uncollectible accounts for reasonableness will help the auditor determine the proper amount. Answer (Trace amounts in the accounts receivable subsidiary ledger to details on shipping documents.) is incorrect because the limited information in the accounts receivable ledger will not make possible tracing details to the shipping documents—also, the shipping documents may not even capture the total sales price that is included in the accounts receivable ledger. Answer (Compare receivable turnover ratios to industry statistics for reasonableness.) is incorrect because while comparing turnover ratios may provide some information on the collectibility of receivables, it is very imprecise. Answer (Inquire about receivables pledged under loan agreements.) is incorrect because it relates to presentation and disclosure more directly than valuation.
The document issued by a common carrier acknowledging the receipt of goods and setting forth the provisions of the transportation agreement is the: -bill of lading -job time shipping -production order -production schedule
Bill of lading. A bill of lading acknowledges the receipt of goods and sets forth provisions of the transportation agreement.
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: -Can issue an unqualified opinion without disclosing that she did not observe year-end inventories. -Should comment in the scope paragraph as to her inability to observe year-end inventories, but can nevertheless issue an unqualified opinion. -is required, if the inventories are material, to disclaim an opinion on the financial statements taken as a whole. -Should, if the inventories are material, qualify her opinion.
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 is satisfied that the client's procedures are adequate to provide a reliable inventory balance.
Lakeside Company has retained you to conduct an audit so that it will be able to support its application for a bank loan with audited financial statements. The president of Lakeside states that you will have unlimited access to all records of the company and may carry out any audit procedures you consider necessary, except that you are not to communicate with customers. The president feels that contacts with customers might lead them to believe that Lakeside is in financial difficulty. Under these circumstances, will it be possible for you to issue the auditors' standard unqualified audit report? Explain.
Confirmation of accounts receivable by direct communication with debtors is usually essential to the issuance of an unqualified audit report. Confirmation of receivables is a presumed procedure, and failure to perform such a procedure when issuing an unqualified report requires justification in the working papers. The auditors must generally disclaim an opinion on the client's financial statements when they have been forbidden by the client to confirm receivables.
Walter Conn, CPA, is engaged to audit the financial statements of Bingo Wholesaling for the year ended December 31, 20X0. Conn obtained and documented an understanding of the client and its environment, including internal control over the business processes relating to accounts receivable. He assessed the risks of material misstatement for all of the assertions about accounts receivable at a moderate level. Conn requested and obtained from Bingo an aged accounts receivable schedule listing the total amount owed by each customer as of December 31, 20X0. Required: What additional substantive audit procedures should Conn consider applying in auditing the accounts receivable?
Conn should consider applying the following additional substantive audit procedures: (1) Test the accuracy of the aged accounts receivable schedule. (2) Confirm receivables. (3) Review the year-end cutoff of sales transactions. (4) Perform analytical procedures. (5) Review significant year-end sales contracts for unusual terms. (6) Evaluate the propriety of the client's accounting methods for receivables. (7) Determine the adequacy of the client's allowance for uncollectible accounts. (8) Ascertain whether any receivables have been pledged. (9) Investigate any transactions with or receivables from related parties. (10) Evaluate the business purpose of significant and unusual sales transactions. (11) Evaluate financial statement presentation and disclosure.
The organization established by Congress to narrow the options in cost accounting that are available under generally accepted accounting principles is the: -Cost Accounting Standards Board. -Financial Accounting Standards Board. -Public Company Accounting Oversight Board. -Securities and Exchange Commission.
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.
Which of the following cases reaffirmed the principles in the Ultramares case? -Credit Alliance Corp. v. Arthur Andersen -Rosenblum v. Adler -Ernst & Ernst v. Hockfelder -Escott v. BarChris Construction Corp
Credit Alliance Corp. v. Arthur Andersen The Credit Alliance Corp. v. Arthur Andersen & Co. case reaffirmed the principles in the Ultramares case by clarifying the conditions necessary for parties to be considered third-party beneficiaries.
Under SEC rules, which of the following is not among the criteria that ordinarily exist for revenue to be recognized? -Collectibility is reasonably assured. -Delivery has occurred or is scheduled to occur in the near future. -Persuasive evidence of an arrangement exists. -The seller's price to the buyer is fixed or determinable.
Delivery has occurred or is scheduled to occur in the near future. Answer (Delivery has occurred or is scheduled to occur in the near future.) is not among the SEC criteria because of the portion of the answer that states "scheduled to occur in the near future." Ordinarily delivery must have occurred. Answers (Collectibility is reasonably assured.), (Persuasive evidence of an arrangement exists.) and (The seller's price to the buyer is fixed or determinable.) all describe circumstances required to recognize revenue.
Which of the following should be included as a part of inventory costs of a manufacturing company?
Direct labor, raw materials, and factor overhead are all included in inventory costs of a manufacturing company.
Which of the following is least likely to be among the auditors' objectives in the audit of inventories and cost of goods sold? -Determine that the valuation of inventories and cost of goods sold is arrived at by appropriate methods. -Determine the existence of inventories and the occurrence of transactions affecting cost of goods sold. -Establish that the client includes only inventory on hand at year-end in inventory totals -Establish the completeness of inventories.
Establish that the client includes only inventory on hand at year-end in inventory totals
Which of the following is least likely to be among the auditors' objectives in the audit of inventories and cost of goods sold? -Determine that the valuation of inventories and cost of goods sold is arrived at by appropriate methods. -Determine the existence of inventories and the occurrence of transactions affecting cost of goods sold. -Establish that the client includes only inventory on hand at year-end in inventory totals. -Establish the completeness of inventories.
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.
The receiving department is least likely to be responsible for the: -Determination of quantities of goods received. -Detection of damaged or defective merchandise. -Preparation of a shipping document. -Transmittal of goods received to the store's department.
Preparation of a shipping document. The shipping department, not the receiving department, is responsible for preparation of a shipping document.
GO OVER QUESTION 13 FOR CHAPTER 10
GO OVER QUESTION 13 FOR CHAPTER 10
Which of the following is the best audit procedure for the discovery of damaged merchandise in a client's ending inventory? -Compare the physical quantities of slow-moving items with corresponding quantities in the prior year. -Observe merchandise and raw materials during the client's physical inventory taking. -Review the management's inventory representations letter for accuracy. -Test overall fairness of inventory values by comparing the company's turnover ratio with the industry average.
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.
The primary objective of a CPA's observation of a client's physical inventory count is to: -Discover whether a client has counted a particular inventory item or group of items. -Obtain direct knowledge that the inventory exists and has been properly counted. -Provide an appraisal of the quality of the merchandise on hand on the day of the physical count. -Allow the auditor to supervise the conduct of the count in order to obtain assurance that inventory quantities are reasonably accurate.
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.
Which of the following approaches to auditors' liability is least desirable from the CPA's perspective? -Ultramares -Rosenblum -Restatement of Torts -Foreseen User
Rosemblum
a federal securities statue covering registration statements for securities to be sold to the public
Securities Act of 1933
During the audit of Solar Technologies, Inc., the auditors sent confirmation requests to customers whose accounts had been written off as uncollectible during the year under audit. An executive of Solar protested, saying, "You people should be verifying that the receivables on the books are collectible. We know the ones we wrote off are no good." b. Does the Solar executive's statement suggest some misunderstanding of audit objectives? Explain.
The Solar executive appears to believe the auditors are solely concerned with the valuation or collectibility of accounts and notes receivable. In fact, the confirmation process is primarily intended to establish that the receivables are valid and that the customers (or makers of notes) exist. Other audit procedures are followed to determine proper valuation.
"When auditors are verifying a client's bank reconciliation, they are particularly concerned with the possibility that the list of outstanding checks may include a nonexistent or fictitious check, and they also are concerned with the possibility of omission from the reconciliation of a deposit in transit." Criticize the above quotation and revise it into an accurate statement.
The quoted statement is not accurate. In their work on cash, auditors are primarily concerned with the risk of an overstatement of the cash balance. The listing of a non-existent or fictitious check on the outstanding list would have the effect of understating the client's cash position, because too large an amount for outstanding checks would be deducted from the balance per bank, resulting in understatement of the adjusted balance. The other element of the quoted statement relating to the auditors' concern over the possible omission of a deposit in transit is also in error. To omit a deposit in transit would cause an understatement of the year-end cash balance. If the quoted statement were revised into acceptable form, it would read along the following lines: "When auditors are verifying a client's bank reconciliation, they are particularly concerned with the possibility that an outstanding check may be omitted or that a non-existent deposit in transit may be included."
Which of the following is an example of misappropriation of assets relating to sales? -Accidentally recording cash that represents a liability as revenue. -Holding the sales journal open to record next year's sales as having occurred in the current year. -Intentionally recording cash received from a new debt agreement as revenue. -Theft of cash register sales.
Theft of cash register sales. Theft of cash register sales is an example of misappropriation of assets. Answer (Accidentally recording cash that represents a liability as revenue.) is an example of an error while answers (Holding the sales journal open to record next year's sales as having occurred in the current year.) and (Intentionally recording cash received from a new debt agreement as revenue.) are examples of fraudulent financial reporting.
performing duties with such recklessness that persons believing the duties to have completed carefully are being misled. the person performing the duties does not have knowledge of the misrepresentations within the FS
constructive fraud/gross negligence
The auditor's analytical procedures will be facilitated if the client: -Uses a standard cost system that produces variance reports. -Segregates obsolete inventory before the physical inventory count. -Corrects material weaknesses in internal control before the beginning of the audit. -Reduces inventory balances to the lower of cost or market.
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.
When perpetual inventory records are maintained in quantities and in dollars, and internal control over inventory is weak, the auditor would probably: -Want the client to schedule the physical inventory count at the end of the year. -insist that the client perform physical counts of inventory items several times during the year. -Increase the extent of tests for unrecorded liabilities at the end of the year. -Have to disclaim an opinion on the income statement for that year.
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.
When a primary risk related to an audit is possible overstated inventory, the assertion most directly related is: -existence -completeness -clarity -presentation
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.
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: -Well-kept records of perpetual inventory are maintained -Inventory is slow-moving. -Computer error reports are generated for missing prenumbered inventory tickets. -Obsolete inventory items are segregated and excluded.
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.
During the audit of Solar Technologies, Inc., the auditors sent confirmation requests to customers whose accounts had been written off as uncollectible during the year under audit. An executive of Solar protested, saying, "You people should be verifying that the receivables on the books are collectible. We know the ones we wrote off are no good." a. What purpose, if any, is served by this audit procedure?
When confirmation requests are mailed to debtors whose accounts were written off as uncollectible, the auditors' purposes are to determine that the receivables were genuine when they were first recorded in the accounts and to determine that the accounts were not collected and the proceeds stolen. In some fraud cases, fictitious accounts receivable have been created to cover up a shortage. Eventually these fictitious receivables must be disposed of; one method is to write off the fictitious accounts as uncollectible. In other cases, valid accounts receivable have been collected, but written off as uncollectible by the employee who has procured the funds.
Which of the following controls would most likely reduce the risk of diversion of customer receipts by a client's employees? -a bank lockbox system -prenumbered remittance advices -monthly bank reconciliations -daily deposit of cash receipts
a bank lockbox system A bank lockbox is a post office box controlled by a company's bank at which cash remittances from customers are received. With such a system the bank collects the remittances, immediately credits the cash to the company's bank account, and forwards the remittance advices to the company. Use of a bank lockbox system makes it extremely difficult for employees to divert cash receipts since those cash receipts are sent directly to the post office box controlled by the bank. Answer (Prenumbered remittance advices.) is incorrect because remittance advices may be prenumbered, but since they come from various customers, they do not have one overall sequence for the client. Answers (Monthly bank reconciliations.) and (Daily deposit of cash receipts.), are incorrect because bank reconciliations, and daily deposit of cash receipts, are controls, but controls that ordinarily are not as effective at preventing the diversion of customer receipts.
The auditors' primary objective in selecting a sample of items from an audit population is to obtain: -a random sample -a stratified sample -a representative sample -a large sample
a representative sample A sample that is representative of the audit population must be obtained. The sample is "representative" in the sense that it allows the auditor to project sample results to the overall population. The sample may, but need not be random, stratified, or large.
Hale Nelson, CPA, is engaged to audit the financial statements of Hollis Manufacturing, Inc. Hollis engages in very complex sales agreements that create issues with respect to revenue recognition. As a result, Nelson has identified revenue recognition as an audit area of significant risk that requires special audit consideration. Required: a. Describe the implications of Nelson's identification of revenue recognition as an area of significant risk.
a. When the auditors identify a risk as being significant and requiring special audit consideration, they must: (1) Evaluate the design of the related controls and determine that they have been implemented; (2) Not rely solely on analytical procedures to address the risk; and (3) Not rely on evidence obtained from prior audits regarding the operating effectiveness of the related internal controls.
The auditors who physically examine securities should insist that a client representative be present in order to: -detect fraudulent securities -lend authority to the auditors' directives -acknowledge the receipt of securities returned -coordinate the return of securities to the proper locations
acknowledge the receipt of securities returned Because of the liquidity of many securities, the auditor should insist that a client representative be present in order to acknowledge the receipt of securities returned. In the event of subsequent "disappearance" of a security the auditor will not be a suspect.
Hall Company had large amounts of funds to invest on a temporary basis. The board of directors decided to purchase securities and derivatives and assigned the future purchase and sale decisions to a responsible financial executive. The best person or persons to make periodic reviews of the investment activity would be: -an investment committee of the BOD -the CEO -the corporate controller -the treasurer
an investment committee of the BOD The investment committee of the board of directors is not involved in the routine of making buy and sell decisions and can therefore review the transactions objectively. On the other hand, the chief operating officer, the controller, and the treasurer may be closely associated on a daily basis with the financial executive responsible for the investment decisions.
Item (a) relates to what a plaintiff who purchased securities must prove in a civil liability suit against a CPA. a. The plaintiff security purchaser must prove material misstatements were included in a filed document. -only applies to Sec. 11 of the 1933 Securities Act -only applies to Sec. 10b of the Securities Exchange Act -applies to both act -applies to neither
applies to both acts Section 11 of the Securities Act of 1933 imposes liability on auditors for misstatements or omissions of a material fact in certified financial statements or other information provided in registration statements. Similarly, under Section 10(b), Rule 10b-5 of the Securities Exchange Act of 1934, the plaintiff must prove there was a material misstatement or omission in information released by the company, such as audited financial statements.
Item (b) relates to what a plaintiff who purchased securities must prove in a civil liability suit against a CPA. b. The plaintiff security purchaser must prove a monetary loss occurred. -only applies to Sec. 11 of the 1933 Securities Act -only applies to Sec. 10b of the Securities Exchange Act -applies to both act -applies to neither
applies to both acts Under both Section 11 of the 1933 Act and Section 10(b) of the 1934 Act, the plaintiff must allege or prove that s/he incurred monetary damages.
Item (d) relates to what a plaintiff who purchased securities must prove in a civil liability suit against a CPA. d. The plaintiff security purchaser must prove privity with the CPA. -only applies to Sec. 11 of the 1933 Securities Act -only applies to Sec. 10b of the Securities Exchange Act -applies to both act -applies to neither
applies to neither The plaintiff does not have to prove that s/he was in privity with the CPA under either section
Item (c) relates to what a plaintiff who purchased securities must prove in a civil liability suit against a CPA. c. The plaintiff security purchaser must prove lack of due diligence by the CPA. -only applies to Sec. 11 of the 1933 Securities Act -only applies to Sec. 10b of the Securities Exchange Act -applies to both act -applies to neither
applies to neither of the acts Under Section 11 of the 1933 Act, the burden of proof is shifted to the defendant, accountant. The accountant may then defend himself or herself by establishing due diligence—the security purchaser need not prove a lack of due diligence by the CPA. The plaintiff does not have to show lack of due diligence by the CPA Under Section 10, the plaintiff must prove scienter.
Which of the following sampling techniques is typically used for tests of controls? -mean-per-unit sampling -difference sampling -attribute sampling -probability-proportional-to-size sampling
attribute sampling Attribute sampling is used for test of controls since it is a plan that enables auditors to estimate the rate of deviation in a population.
Hale Nelson, CPA, is engaged to audit the financial statements of Hollis Manufacturing, Inc. Hollis engages in very complex sales agreements that create issues with respect to revenue recognition. As a result, Nelson has identified revenue recognition as an audit area of significant risk that requires special audit consideration. b. Describe how Nelson might decide to react to the significant risk related to revenue recognition.
b. Examples of ways that Nelson may react to this particular risk include: (1) Confirm the terms of sales contracts with selected customers. (2) Examine a larger sample of sales contracts. (3) Make expanded inquiries of sales personnel regarding the terms of contracts.
Which of the following statistical sampling techniques is least desirable for use by the auditors? -random number table selection -block selection -systematic selection -random number generator selection
block selection Block sampling is least desirable. It consists of all items during a selected time period, numerical sequence, or alphabetical sequence. Due to the relatively large number of blocks needed to form a reasonable audit conclusion, block sampling cannot generally be relied upon to efficiently produce a representative sample.
failure of one or both parties to a contract to perform in accordance with the contract's provisions
breach of contract
unwritten law that has developed through court decisions; it represents judicial interpretation of a society's concept of fairness
common law
If the CPAs provided negligent tax advice to a public company, the client would bring suit under: -The Securities Act of 1933 -The Securities Exchange Act of 1934 -federal income tax law -common law
common law Negligent tax advice would ordinarily result in a suit brought under common law. Note that the client is not covered under the Securities Act of 1933 or the Securities Exchange Act of 1934.
During the inventory count an auditor selects items and determines that the proper description and quantity were recorded by the client. This procedure is most closely related to: -rights -completeness -existence -valuation
completeness
Which assertion relating to sales is most directly addressed when the auditors compare a sample of shipping documents to related sales invoices? -existence or occurrence -completeness -rights and obligations -presentation and disclosure
completeness Comparing shipping documents to related sales invoices addresses the completeness assertion relating to sales. More specifically, it addresses whether all items that have been shipped have been recorded as sales.
which of the following is an element of sampling risk? -choosing an audit procedure that is inconsistent with the audit objective -concluding that no MM exists in a MM population based on taking a sample that includes no misstatement -failing to detect an error on a doc that has been inspected by an auditor -failing to perform audit procedures that are required by the sampling plan
concluding that no MM exists in a MM population based on taking a sample that includes no misstatement The other choices are elements of nonsampling risk.
Under common law, the CPAs who were negligent may mitigate some damages to a client by proving: -contributory negligence -the CPAs' fee was not material -the CPAs were not competent to accept the engagement -the CPAs' negligence was caused by the fact that they had too much work
contributory negligence (PLAINTIFF'S NEGLIGENCE, NOT THE AUDITORS') Contributory negligence, negligence on the part of the plaintiff, may be used as a defense and the court may limit or bar recovery by a plaintiff whose own negligence contributed to the loss.
You have been assigned to the year-end audit of a financial institution and are planning the timing of audit procedures relating to cash. You decide that it would be preferable to: -count the cash in advance of the BS date in order to disclose any kiting operations at YE -coordinate the count of cash with the cutoff of AP -coordinate the count of cash with the count of marketable securities and other negotiable assets -count the cash immediately upon the return of the confirmation letters from the financial institution
coordinate the count of cash with the count of marketable securities and other negotiable assets Unless all negotiable assets are verified at one time, an opportunity exists for a dishonest officer or employee to conceal a shortage by transferring it from one asset category to another a step ahead of the auditors. For example, marketable securities could be pledged as collateral for a loan. The cash thus obtained could be included with other cash being counted by the auditors Answer (Count the cash in advance of the balance sheet date in order to disclose any kiting operations at year-end.) is incorrect because counting cash in advance of the balance sheet date does not relate to kiting. Answer (Coordinate the count of cash with the cutoff of accounts payable.) is not persuasive because accounts payable can not be substituted for cash as can negotiable assets. Answer (Count the cash immediately upon the return of the confirmation letters from the financial institution.) is not correct because there is no particular significance to the amount of cash on hand on the day the bank confirmation letters happen to be returned.
t/f: auditors may ignore individually immaterial accounts when confirming AR
correct
t/f: confirmations address existence more than they address completeness
correct
t/f: second requests are ordinarily sent for positive form confirmation request when the first request is not returned
correct
t/f: the confirmation requests should be mailed to respondents by the CPAs
correct
The most significant result of the Continental Vending case was that it: -created a more general awareness of the possibility of auditor criminal prosecution -extended the auditor's responsibility to all info included in the reg. statement -defined the cpa's responsibilities for unaudited FS -established a precedent for auditors being held liable to third parties under common law for ordinary negligence
created a more general awareness of the possibility of auditor criminal prosecution The Continental Vending case was a landmark in establishing auditors' potential criminal liability under the Securities Exchange Act of 1934. The case involved audited financial statements, was brought under statutory law, and did not involve registration statements (which are covered by the Securities Act of 1933).
The auditors suspect that a client's cashier is misappropriating cash receipts for personal use by lapping customer checks received in the mail. In attempting to uncover this embezzlement scheme, the auditors most likely would compare the: -details of bank deposit slips with details of credits to customer accounts -daily cash summaries with the sums of the cash receipts JEs -individual bank deposit slips with the details of the monthly bank statements -dates uncollectible accounts are authorized to be written off with the dates the WOs are actually recorded
details of bank deposit slips with details of credits to customer accounts Lapping will result in a delay in the recording of specific remittance credits in the financial records, but the checks will be deposited in the bank as they are received. Therefore, a comparison of the checks deposited to the credits to customer accounts will likely uncover the scheme.
In assessing sampling risk, the risk of incorrect rejection and the risk of assessing control risk too high relate to the: -efficiency of the audit -effectiveness of the audit -selection of the sample -audit QCs
efficiency of the audit (vice versa is effectiveness) The risk of incorrect rejection and assessing control risk too high relate to the efficiency of the audit since the related errors result in additional, unneeded, audit procedures. The risks of incorrect acceptance and assessing control risk too low relate to audit effectiveness.
"While that's what we owe, we didn't owe it on Dec. 31 because we didn't receive the goods until Jan. 2 of year 2"
examine shipping docs and/or subsequent cash receipts
You received no reply to a positive confirmation request to Blake Co. Subsequently you recalled that Blake Co. has a policy of not responding to confirmation--in writing or orally
examine shipping docs and/or subsequent cash receipts
"We returned those goods on December 2" You have been able to determine that the goods were received by the client on Dec. 29, but not recorded until January 2
exception; propose an adjustment
An auditor selects items from the client's inventory listing and identifies the items in the warehouse. This procedure is most likely related to: -rights -completeness -existence -valuation
existence
Which of the following elements is most frequently necessary to hold a CPA liable to a client? -acted with scienter or guilty knowledge -was not independent of the client -failed to exercise due care -did not use an engagement letter
failed to exercise due care a CPA may be found liable to a client when due care has not been exercised
misrepresentation by a person of a material fact, known by that person to be untrue or made with reckless indifference as to whether the fact is true, with intent to deceive and with the result that another party is injured
fraud
To gather evidence regarding the balance per bank in a bank reconciliation, the auditors would examine any of the following except: -cutoff bank statement -EOY bank statement -bank confirmation -general ledger
general ledger The general ledger will not have information on the balance per bank. The cutoff bank statement, year-end bank statement and bank confirmation will all include information on the balance per bank.
If a CPA performs an audit recklessly, the CPA will be liable to third parties who were unknown and not foreseeable to the CPA for: -strict liability for all damages incurred -gross negligence -either ordinary or gross -breach of contract
gross negligence
t/f: AR are ordinarily confirmed on a standard form developed by the AICPA and the Financial Executives Institute
incorrect
t/f: auditors should always confirm the total balances of accounts rather than individual portions (e.g., if the balance is made up of three sales, all three should be confirmed)
incorrect
t/f: confirmation of AR is a generally accepted auditing standard
incorrect
t/f: the best way to evaluate the results of the confirmation process is to compare the total misstatements identified to the account's tolerable misstatements amount
incorrect
Which of the following would most likely be detected by an auditor's review of the client's sales cutoff? -excessive goods returned for credit -unrecorded sales discounts -lapping of YE AR -inflated sales for the year
inflated sales for the year Detecting overstated sales is a primary reason the auditors' review of a client's sales cutoff. For example, shipments made in the first part of January may be improperly included in the December sales total.
In testing controls over cash disbursements, the auditors most likely would determine that the person who signs checks also: -reviews the monthly bank reconciliations -returns the checks to accounts payable -is denied access to the supporting documents -is responsible for mailing the checks
is responsible for mailing the checks When checks are signed they should not be returned to the accounting department. This control is used so as to avoid a situation in which the accounts payable department fabricates documents, and then collects the checks. Not returning the checks makes it more difficult for this sort of fraud in that the perpetrator must also establish a "safe" address for the check to be mailed to. Answer (Reviews the monthly bank reconciliation.) is incorrect because control is stronger if individuals who are otherwise independent of the cash function prepare and review the monthly bank reconciliation. Answer (Returns the checks to accounts payable.) is incorrect because, as discussed, the checks should not be returned to accounts payable. Answer (Is denied access to the supporting documents.) is incorrect because the individual signing the checks needs access to the supporting documents so he or she can determine whether the expenditure is proper.
Assume that in a particular audit the CPAs were negligent but not grossly negligent. Indicate whether they would be "liable" or "not liable" for the following loss proximately caused by their negligence and determine that liability under the various theories discussed and followed by different states: a. Loss sustained by client; suit brought under common law. -liable -not liable
liable
Assume that in a particular audit the CPAs were negligent but not grossly negligent. Indicate whether they would be "liable" or "not liable" for the following loss proximately caused by their negligence and determine that liability under the various theories discussed and followed by different states: c. Loss sustained by a bank known to the auditors to be relying on the financial statements for a loan; suit brought in a state court that adheres to the Credit Alliance v. Arthur Andersen precedent. -liable -not liable
liable
Assume that in a particular audit the CPAs were negligent but not grossly negligent. Indicate whether they would be "liable" or "not liable" for the following loss proximately caused by their negligence and determine that liability under the various theories discussed and followed by different states: d. Losses to stockholders purchasing shares at a public offering; suit brought under the Securities Act of 1933. -liable -not liable
liable
Assume that in a particular audit the CPAs were negligent but not grossly negligent. Indicate whether they would be "liable" or "not liable" for the following loss proximately caused by their negligence and determine that liability under the various theories discussed and followed by different states: e. Loss sustained by a bank named as a third-party beneficiary in the engagement letter; suit brought under common law. -liable -not liable
liable
Assume that in a particular audit the CPAs were negligent but not grossly negligent. Indicate whether they would be "liable" or "not liable" for the following loss proximately caused by their negligence and determine that liability under the various theories discussed and followed by different states: f. Loss sustained by a lender not in privity of contract; suit brought in a state court that adheres to the Rosenblum v. Adler precedent. -liable -not liable
liable
violation of a legal duty to exercise a degree of care than an ordinarily prudent person would exercise under similar circumstances
negligence
Must I document all my test counts in the working papers?
no Although enough counts must be recorded to allow a reviewer to in essence determine whether a proper count has been taken, not every count need be recorded.
Am I correct that our observation of the counting of the inventory primarily addresses the existence of inventory, and not the completeness of the count?
no Both existence and completeness are addressed.
Should Jilco's inventory be valued at the lower of standard cost or market?
no Inventory should be valued at the lower of cost or market, not standard cost.
When I take test counts of items, does this eliminate the need for Jilco Inc. personnel to count those items?
no Jilco Inc. must perform the count.
Jilco Inc. has inventory at many locations. Do we need to be present for the count at all locations?
no Ordinarily, locations may be sampled.
At the completion of the count, should I leave Jilco Inc. personnel with a copy of all my inventory test counts to help assure inventory accuracy?
no The client should not know every test count taken, thus reducing the possibility of manipulation of items not counted.
"We are very satisfied with Jelco and plan to purchase from them in the future"
not an exception; no further audit work is necessary
you received no reply to a negative confirmation request to Adams Co.
not an exception; no further audit work is necessary
Assume that in a particular audit the CPAs were negligent but not grossly negligent. Indicate whether they would be "liable" or "not liable" for the following loss proximately caused by their negligence and determine that liability under the various theories discussed and followed by different states: b. Loss sustained by trade creditor, not in privity of contract; suit brought in a state court that adheres to the Ultramares v. Touche Co. precedent. -liable -not liable
not liable
Assume that in a particular audit the CPAs were negligent but not grossly negligent. Indicate whether they would be "liable" or "not liable" for the following loss proximately caused by their negligence and determine that liability under the various theories discussed and followed by different states: g. Losses sustained by stockholders; suit brought under Sections 18(a) and 10(b) of the Securities Exchange Act of 1934. -liable -not liable
not liable 1934: plaintiff must prove... loss misleading reliance scienter (section 10) [section 18 is auditors must prove "good faith"]
Which of the following procedures would the auditors most likely perform to test controls relating to management's assertion about the completeness of cash receipts for cash sales at a retail outlet? -observe the consistency of the employees' use of cash registers and tapes -inquire about employees' access to recorded but undeposited cash -trace deposits in the cash receipts journal to the cash balance in the general ledger -compare the cash balance in the general ledger with the bank confirmation request
observe the consistency of the employees' use of cash registers and taps The use of cash registers and tapes helps assure that all sales of a retail store are recorded. Answer (Inquire about employees' access to recorded but undeposited cash.) is incorrect because the cash has already been recorded. Answer (Trace deposits in the cash receipts journal to the cash balance in the general ledger.) is incorrect because the procedure only deals with recorded deposits and, therefore, the completeness assertion is not addressed as directly as in answer (Observe the consistency of the employees' use of cash registers and tapes.). Answer (Compare the cash balance in the general ledger with the bank confirmation request.) is incorrect because one would not expect the cash balance in the general ledger to agree with the bank confirmation request due to items in transit and checks outstanding.
Item (f) relates to what a plaintiff who purchased securities must prove in a civil liability suit against a CPA. f. The plaintiff security purchaser must prove the CPA had scienter. -only applies to Sec. 11 of the 1933 Securities Act -only applies to Sec. 10b of the Securities Exchange Act -applies to both act -applies to neither
only applies to Sec. 10b of the Securities Exchange Act The plaintiff does have to prove that the CPA had scienter under Section 10(b) of the 1934 Act. Scienter is not needed under the 1933 Act.
Item (e) relates to what a plaintiff who purchased securities must prove in a civil liability suit against a CPA. e. The plaintiff security purchaser must prove reliance on the document. -only applies to Sec. 11 of the 1933 Securities Act -only applies to Sec. 10b of the Securities Exchange Act -applies to both act -applies to neither
only applies to Section 10(b) of the Securities Exchange Act Under Section 10(b), the plaintiff must prove justifiable reliance on the financial information. This is not true under Section 11 in which the plaintiff need prove only that material misstatements were included in a filed document and monetary loss occurred.
Which of the following is least likely to be considered an inherent risk relating to receivables and revenues? -restrictions placed on sales by laws and regulations -decline in sales due to economic declines -decline in sales due to product obsolescence -over-recorded sales due to a lack of control over the sales entry function
over-recorded sales due to a lack of control over the sales entry function Over-recorded sales due to a lack of control over the sales entry function relates to control risk not inherent risk. The other three replies all relate to inherent risk.
Reconciliation of the bank account should not be performed by an individual who also: -processes cash disbursements -has custody of securities -prepares the cash budget -reviews inventory reports
processes cash disbursements The individual who reconciles the bank account should not be involved in the processing of cash receipts or disbursements. Therefore, answer (Processes cash disbursements.) is correct. All of the other functions are compatible with reconciliation responsibilities.
a method of allocating damages to each group that is liable according to that group's pro-rata share of any damages recovered by the plaintiff
proportionate liability
Under the Securities and Exchange Act of 1934, auditors and other defendants are generally faced with: -joint liability -joint and several liability -proportionate liability -limited liability
proportionate liability The Private Securities Litigation Reform Act of 1995 amended the Securities and Exchange Act of 1934 to place limits on the amount of the auditors' liability through establishing proportionate liability.
damage to another is directly attributable to a wrongdoer's act. this issue may be raised as a defense in the litigation--that is, the defense may argue that some other factor caused the loss
proximate cause
Which of the following is most likely to be an example of fraudulent financial reporting relating to sales? -inaccurate billing due to a lack of controls -lapping of AR -misbilling a client due to a data input error -recording sales when the customer is likely to return the goods
recording sales when the customer is likely to return the goods A sale either shouldn't be recorded or a proper allowance for returns should be established when a customer is likely to return the goods. Thus, simply recording the sale is an example of fraudulent financial reporting when the customer is likely to return the goods. Answers (Inaccurate billing due to a lack of controls.) and (Misbilling a client due to a data input error.) are examples of errors, while answer (Lapping of accounts receivable.) is an example of misappropriation of assets.
In order to guard against the misappropriation of company-owned marketable securities, which of the following is the best course of action that can be taken by a company with a large portfolio of marketable securities? -require that one trustworthy and bonded employee be responsible for access to the safekeeping area where securities are kept -require that employees who enter and leave the safekeeping area sign and record in a log the exact reason for their access -require that employees involved in the safekeeping function maintain a subsidiary control ledger for securities on a current basis -require that the safekeeping function for securities be assigned to a bank or stockbroker that will act as a custodial agent
require that the safekeeping function for securities be assigned to a bank or stockbroker that will act as a custodial agent Having the securities held in safekeeping by a bank or stockbroker provides strong internal control because they are not available to employees responsible for maintaining the accounting records of the securities. Thus the separation of the custody of securities from the accounting function is complete.
intent to deceive, manipulate, or defraud. this concept is used in the 1934 Securities Exchange Act to establish auditor liability
scienter
Cooper, CPA, is auditing the financial statements of a small rural municipality. The receivable balances represent residents' delinquent real estate taxes. Internal control at the municipality is weak. To determine the existence of the accounts receivable balances at the balance sheet date, Cooper would most likely: -send positive confirmation requests -send negative confirmation requests -examine evidence of subsequent cash receipts -inspect the internal records, such as copies of the tax invoices that were mailed to the residents
send positive confirmation requests The auditor would send positive confirmations rather than negative confirmations because the fact that the balances are delinquent may indicate that amounts are in dispute. Examining subsequent cash receipts, answer (Examine evidence of subsequent cash receipts.), is unlikely to be effective since many of the accounts will not have been collected. Inspection of internal records, answer (Inspect the internal records, such as copies of the tax invoices that were mailed to the residents.), is likely to result in less credibility evidential matter than confirming the accounts.
To determine that all sales have been recorded, the auditors would select a sample of transactions from the: -shipping documents file -sales journal -AR sub ledger -remittance advices
shipping documents file The goal is to determine the population to be sampled from to determine that all sales have been recorded; therefore, the sample should be taken from a population of source documents, here the shipping documents file. None of the other three answers represent source documents that may be sampled from to determine that all sales have been recorded.
To provide assurance that each voucher is submitted and paid only once, the auditors most likely would examine a sample of paid vouchers and determine whether each voucher is: -supported by a vendor's invoice -stamped "paid" by the check signer -prenumbered and accounted for -approved for authorized purchases
stamped "paid" by the check signer The auditors will determine whether each voucher is stamped "paid" by the check signer to avoid a situation in which supporting documents are used a second time to elicit a second payment.
written law created by state or federal legislative bodies
statutory law
In cases of breach of contract, plaintiffs generally have to prove all of the following, except: -the CPAs had a duty -the CPAs made a false statement -the client incurred losses related to the CPAs' performance -the CPAs breached their duty
the CPAs made a false statement (must prove the other 3 + proximate cause/causation)
Discovery sampling is particularly effective when: -there are a large # of errors in the population -the auditors are looking for critical deviations that are not expected to be frequent in number -the auditors know where deviations are likely to occur -the population is large in size
the auditors are looking for critical deviations that are not expected to be frequent in number Discovery sampling is a modified case of attributes sampling. Its purpose is to detect at least one deviation, with a predetermined risk of assessing control risk too low, if the deviation rate in the population is greater than the specified tolerable deviation rate. It is effectively used when auditors are looking for critical deviations that are not expected to be frequent in number.
In which of the following circumstances is it least likely that tests of controls will be performed? -the expected deviation rate exceeds the tolerable deviation rate -the planned assessed level of control risk is at a level slightly below the max -the risk of assessing control risk too low is less than the expected deviation rate -the tolerable deviation rate exceeds the risk of assessing control risk too low
the expected deviation rate exceeds the tolerable deviation rate When the expected deviation rate exceeds the tolerable deviation rate it is unlikely that tests of controls will be performed. This is because in such a situation testing is only likely to reveal to the auditors that the system is not operating effectively as they expected.
A CPA issued an unqualified opinion on the financial statements of a company that sold common stock in a public offering subject to the Securities Act of 1933. Based on a misstatement in the financial statements, the CPA is being sued by an investor who purchased shares of this public offering. Which of the following represents a viable defense? -the investor has NOT proved fraud or negligence by the CPA -the investor did NOT actually rely upon the false statement -the CPA detected the false statement after the audit date -the false statement is IMMATERIAL in the overall context of the FS
the false statement is IMMATERIAL in the overall context of the FS A CPA may avoid liability under the 1933 Act by proving that their negligence was not the proximate cause of the plaintiff's loss. Accordingly, a finding that the false statement is immaterial would in all circumstances represent a viable defense.
Which statement best expresses the factors that purchasers of securities registered under the Securities Act of 1933 need to prove to recover losses from the auditors? -the purchasers of securities must prove ordinary negligence by the auditors and reliance on the audited financial statement -the purchasers of securities must prove that the FS were misleading and that they relied on them to purchase the securities -the purchasers of securities must prove that the FS were misleading; then, the burden of proof is shifted to the auditors to show that the audit was performed with "due diligence" -the purchasers of securities must prove that the FS were misleading and the auditors are negligent
the purchasers of securities must prove that the FS were misleading; then, the burden of proof is shifted to the auditors to show that the audit was performed with "due diligence"
Which of the following is accurate regarding tolerable misstatement? -tolerable misstatement is directly related to materiality -tolerable misstatement cannot be determined until the sample results are evaluated -tolerable misstatement does not affect sample size -tolerable misstatement is a measure of reliability of the sample
tolerable misstatement is directly related to materiality Tolerable misstatement is directly related to materiality. That is, as the measure of materiality increases, the tolerable misstatement allocated to the various accounts is increased. Tolerable misstatement is materiality at the account balance level.
The 1136 Tenants' case was important because of its emphasis upon the legal liability of the CPA when associated with: -a review of annual statements -unaudited FS -an audit resulting in a disclaimer of opinion -letters for underwriters
unaudited FS The 1136 Tenants case was a landmark case concerning auditors' liability when they are associated with unaudited financial statements 1136 lessons: 1) adhere to the AICPA code of professional conduct 2)engagement letters are essential 3) be alert for, and follow up with, unusual items 4) report should be clear and concise in SAS and SSARS language
An auditor concluded that no excessive costs for an idle plant were charged to inventory. This conclusion is most likely related to presentation and disclosure and: -valuation -completeness -existence -rights
valuation
An auditor most likely would analyze inventory turnover rates to obtain evidence about: -existence -rights -presentation -valuation
valuation
With strong internal control, may Jilco Inc.'s inventory count be performed during the year rather than at year-end?
yes Strong internal control may create a situation in which the count may be taken prior to year end and updated as necessary.