Multiple Choice A3 & A4
times interest earned
(earnings before interest and taxes) / interest expense the client's ability to cover interest charges
which of the following circumstances considered individually would be an indication of substantial doubt about an entity's ability to continue as a going concern?
1. the company is unable to pay quarterly dividends to shareholders that were previously declared 2. the company defaults on loan covenants related to its long term financing arrangement
T/F: statistical sampling is required by GAAS
FALSE: either statistical or non statistical sampling methods are accepted under GAAS
T/F: statistical sampling eliminates subjectivity in evaluating sampling results
FALSE: statistical sampling does not eliminate subjectivity in evaluating sample results. for example, the auditor must still use judgment to evaluate the appropriateness of audit evidence, determine whether a given situation constitutes a deviation, etc
T/F: statistical sampling should not be used when there is a significant amount of population variability
FALSE: statistical sampling may be used when there is a significant amount of population variability, although the auditor may choose to stratify the population in such cases. population variability may also affect the determination of sample size
T/F: statistical sampling will always result in a smaller sample size than non statistical sampling
FALSE: while statistical sampling methods can aid the auditor in findings the smallest sample size that achieves the desired level of risk, there is no guarantee that statistical sampling will result in a smaller sample size than non statistical sampling
an entity has obtained a new auditor, Gem, CPA to perform the audit of their current year FS. as a result of the fat that the predecessor auditor included a going concern section in the prior year report:
Gem, CPA need not include the prior year going concern section in the current year audit report unless based upon the current year assessment there is still substantial doubt about the entity's ability to continue as a going concern for a reasonable period of time
return on equity
Net Income/ Average Total Equity the return earned by the client's shareholders
T/F: statistical sampling requires the use of mathematical formulas and/or tables
TRUE: statistical sampling involves the use of mathematical formulas and/or tables to determine the sample size that achieves an acceptable level of risk, to evaluate results, etc
T/F: statistical sampling allows a greater quantification of risk and reliability than does non statistical sampling
TRUE: with statistical sampling, auditors specify the sampling risk they are willing to accept and then calculate the sample size that provides that degree of reliability. non statistical methods use qualitative rather than quantitative judgments of risk and reliability
which of the following provides the best evidence supporting the existence of marketable securities included in the client's financial statements?
a custodial statement received and held by the client
Bell, CPA is auditing BPJ Inc, a manufacturing company. Legal Team, LLC is the external council for BPJ Inc and represents them on any major legal dispute throughout the year. Bell CPA's audit procedures should include:
a letter prepared by BPJ Inc and sent to Legal Team LLC regarding confirmation of information disclosed to Bell, CPA with respect to legal matters in which Legal Team LLC was directly engaged
GEMM, CPA is auditing the 12/31/X1 FS of Diamond LLC. GEMM determined that sufficient, appropriate audit evidence was obtained as of 2/27/X2 and issued the audit report on the same day. a management representation letter was obtained from Diamond LLC as of the report date. which of the following circumstances would be considered a recognized subsequent event in the 12/31/X1 financial statements?
a material legal settlement was reached on 1/15/X2 related to litigation that occurred on 11/11/X1
Raupp, CPA uncovered an instance of fraud when performing their tests of controls over the check disbursement process at Bernard Inc. After assessing the impact of the fraud scheme, the client determined that only an immaterial amount of cash was misappropriated during the scheme and that only the company's CFO was involved. based on the circumstances, Raupp should consider the finding:
a material weakness
which of the following would be a result of management refusing to provide a representation letter to the auditor at the conclusion of the audit?
a scope limitation which generally results in a disclaimer of opinion or withdrawal from the engagement
to test for completeness, preform what?
a search for unrecorded liabilities
a client acquired 25% of its outstanding capital stock after YE but prior to the date of the auditor's report. the auditor should :
advise management to disclose the acquisition in the notes to the FS
which of the following is LEAST likely to be a reasonable explanation for an increase in accounts receivable turnover?
allowance of a new grace period for customer payments
which of the following items are NOT required to be documented about uncorrected misstatements?
an explanation as to the auditor's reasons for not booking the adjusting journal entries for the uncorrected misstatements
what provides sufficient detail to provide evidence that the client's valuation of contingencies is reasonable?
attorneys response
an audit program for the examination of retained earnings account should include a step that requires verification of the:
authorization for both cash and stock dividends
which of the following is true about confirmations?
blank confirmations provide greater assurance but. lower response rates than nonblank confirmations
how should confirmation responses received electronically be verified?
by calling the sender and the sender is also requested to mail the original confirmation directly to the auditor
an auditor searching for unrecorded payables most likely would:
compare subsequent bank statements with the accounts payable listing
which financial statement assertion is violated when an expense occurring in one year is NOT recorded until the following year?
completeness the answer is NOT occurrence because that means they show it in the financial statements but did not actually occur
which of the following is LEAST likely to be evidence that auditor examines to determine whether controls are operating effectively?
confirmations of accounts receivable because confirmation is a substantive procedure
which of the following procedures would NOT provide an auditor evidence regarding a client's actual or potential litigation, claims and assessments?
confirming key details of pending litigation with the opposing party
when obtaining proof of authorization by the BOD for new company investments, the auditor is evaluating which of the following?
controls around segregation of duties
to measure how efficiently an entity employs its resources, an auditor calculates inventory turnover by dividing average inventory into:
cost of goods sold
which of the following controls most likely would assure that all billed sales are correctly posted to the accounts receivable ledger?
daily sales summaries are compared to daily postings to the accounts receivable ledger
decrease the population variability
decrease in sample size - population variability is DIRECTLY related to sample size so a decrease in population variability causes sample size to decrease
decrease both the expected misstatement and the assessed risk of material misstatement
decrease in sample size - since both the expected misstatement and the assessed risk of material misstatement vary DIRECTLY with sample size, a decrease in these 2 parameters will result in a decrease in sample size
decrease the assessed risk of material misstatement
decrease in sample size - the assessed risk of material misstatement is DIRECTLY related to sample size so a decrease in the assessed level of risk results in a smaller sample size
increase the tolerable misstatement
decrease in sample size - tolerable misstatement is INVERSELY related to sample zine so an increase in tolerable misstatement results in a decrease in sample size
in assessing sampling risk, the risk of incorrect rejection and the risk of assessing control risk is too high relate to the:
efficiency of the audit
which of the following is a substantive procedure?
examining open vouchers as part of the search for unrecorded liabilities
an auditor analyzes repair and maintenance accounts primarily to obtain evidence in support of the audit assertion that all:
expenditures for property and equipment have not been charged to expense
asset turnover
how effectively the client makes use of its assets
inventory turnover
how quickly the client's inventory is sold during the year
significant deficiencies are control deficiencies that come to an auditor's attention that are:
important enough to merit attention by those charged with governance
increase the population variability
increase in sample size - population variability is DIRECTLY related to sample size so an increase in population variability causes sample size to increase
reduce both the tolerable misstatement and the expected misstatement
indeterminate effect on sample size - a reduction in tolerable misstatement causes an INCREASE in sample size, whereas a reduction in expected misstatement causes a DECREASE in sample size
which of the following is NOT a substantive procedure used when testing accounts receivable?
inspect the client's files related to management's' reviews of customer credit records to ensure each customer was investigated - this is a test of control
Calibro, CPA, believes that there is substantial doubt about the ability of Canto Company, a nonissuer, to continue as a going concern and the concern has not been alleviated based on management's plans. This matter is appropriately disclosed in Canto's financial statements. Calibro should
issue an unmodified opinion and add a separate section with the heading "substantial doubt about the entity's ability to continue as a going concern" describing the situation
which of the following is used to measure a firm's short-term ability to pay maturing obligations?
liquidity ratios
Davis, CPA, believes there is substantial doubt about the ability of Hill Co. to continue as a going concern for a reasonable period of time. In evaluating Hill's plans for dealing with the adverse effects of future conditions and events, Davis most likely will consider, as a mitigating factor, Hill's plans to
negotiate reductions in required dividends being paid on preferred stock
change from blank confirmation forms to confirmations that state the balance
no effect on sample size - changing the form of the A/R confirmations have no effect sample size
increase the population to include another category of payables
no effect on sample size - the # of items in the population has virtually no effect on sample size unless the population is very small (NOTE: on the CPA exam, if the question does not clearly indicate an unusually small population assume population size does NO effect on sample size)
during which phase of the audit are analytical procedures required to be used?
planning and final review phase
which of the following controls would most likely detect a kiting scheme>
prepare a bank transfer schedule
an advantage of using statistical over non statistical sampling methods in tests of controls is that the statistical methods:
provide an objective basis for quantitatively evaluating sample risk
an auditor is likely using attributes sampling when he or she selects a sample of:
purchase orders and examines them for indication of proper approval
in auditing payroll function of a client, an auditor would LEAST likely:
request specific management representations related to payroll
an auditor who uses statistical sampling for attributes in testing internal controls should reduce the planned reliance on a prescribed control when the:
sample rate of deviation plus the allowance for sampling risk exceeds the tolerable rate
Tracing shipping documents to sales invoices provides evidence that
shipments to customers were properly invoiced
a number of factors influence the sample size for a substantive set of details of an account balance. all other factors being equal, which of the following would lead to a larger sample size?
smaller measure of tolerable misstatement
what provides evidence of completeness and existence for cash?
standard bank confirmation is signed and dated, with no exceptions noted
calculate interest income as a percentage of average investment in bonds
substantive test
compare CY actual sales to the CY forecasted sales
substantive test
confirm accounts receivable
substantive test
examine subsequent cash collections
substantive test
perform sales cutoff test
substantive test
recalculate interest expense for reasonableness
substantive test
trace the auditor's test counts of inventory into the client's inventory schedule
substantive test
the risk of incorrect acceptance relates to?
substantive tests and affects audit effectiveness
inquire regarding access controls to the client's computer systems
test of controls
inspect checks for restrictive endorsement prior to deposit
test of controls
observe the use of time clocks and time cards
test of controls
verify that voucher packages indicate agreement of purchase order, receiving report, and invoice
test of controls
which limitation on response from an attorney in response to auditor's inquiry may result in a qualified opinion?
the attorneys refusal to respond when the attorney has given substantial attention to the matter
which of the following is most likely to be an indication of a material weakness in a client's internal control environment?
the auditor determines that the financial statements for the previous 2 years must be restated to correct a material misstatement
an auditor issues a report dated 2/12/year 2 on FS for the year ended 12/31/year 1. what best describes the auditor's responsibility for an event occurring on 2/1/year 2 and an event occurring on 3/1/year 2?
the auditor has an active responsibility to investigate the 2/1/year 2 event and must also consider the effect of the 3/1/year 2 event if it comes to his/her attention
which of the following circumstances most likely would cause an auditor to suspect that there are material misstatements in an entity's financial statements?
the auditor identifies an inappropriate valuation method that is widely applied by the entity
Blue, CPA is auditing the inventory of Crayon Factory Inc. During the auditor's review of the client's policy on periodic inventory counts, the auditor noted the following as an incorrect inventory count procedure:
the auditor must count the physical inventory in full at least once annually - NOT the auditor's responsibility but the client's - the auditor's responsibility is to observe the inventory count
which of the following procedures should not be performed by an auditor when auditing accounts payable and purchase transactions?
the auditor should test the adequacy of the allowance for uncollectible accounts
return on assets
the client's efficiency in using its resources
quick ratio
the client's immediate short term liquidity
profit margin
the client's profit rate
which limitation on response from an attorney in response to auditor's inquiry may result in a disclaimer of opinion?
the client's refusal to permit inquiry of the attorney
current ratio
the client's short term liquidity
accounts receivable turnover
the client's success in collecting outstanding receivables
an auditor notices that interest expense stayed approximately the same as the PY even though the debt outstanding significantly increased from the PY. the client only invests in debt that has a fixed interest rate. which of the following best explains the reason for the above explanation?
the company acquired a new loan for construction of a building that began during the year under audit - qualifies for capitalization which is why interest expense stayed the same
when assessing the operating effectiveness of internal controls, an auditor should obtain evidence regarding which of the following?
the consistency and timing of the control application
debt to equity ratio
the degree of protection afforded to the client's creditors in the case of insolvency
a control deficiency exists in a client's internal control environment when:
the design or operation of a control does nor allow employees to prevent or detect and correct misstatements on a timely basis
The client does not need to disclose the case because
the documents indicate that the probability of an unfavorable outcome is remote - remote losses do NOT have to be disclosed in order to meet minimum GAAP disclosure requirements
under which of the following circumstances would an auditor of a non-issuer issue an unmodified option and have the option of including an emphasis of matter paragraph related to substantial doubt about the entity's ability to continue as a going concern?
the going concern basis of accounting is appropriate, substantial doubt about the entity's ability to continue as a going concern has been alleviated, and related disclosures are adequate
which of the following statements is generally correct about audit evidence?
the more effective the internal control structure, the more assurance it provides about the reliability of the accounting data and financial statements
which best describes an appropriate division of responsibilities in the expenditure cycle?
the purchasing department creates a purchase order based on an approved requisition, while the accounts payable department approves the corresponding invoice for payment
according to U.S GAAS, the date of the management representation letter should be:
the same as the date of the auditor's report
if it is a process,
then test of controls
an auditor has selected a sample of vouchers to test whether they are appropriately canceled after payment. the auditor's tolerable rate is 5% and the auditor determines a 3% deviation rate based on the sample. which of the following is an appropriate conclusion?
there is not enough information given to draw a conclusion - the auditor needs to add an allowance for sampling risk to the 3% sample deviation rate to determine the upper deviation rate - it is the upper deviation rate that would be then compared to the tolerable rate of 5% in forming a conclusion
which of the following best describes the purpose of an auditor's external inquiry sent to the client's attorney?
to corroborate information provided by management with respect to litigation, claims and assessments
which of the following best describes the primary purpose of an auditor performing audit procedures and gathering evidence related to potential litigation, claims and assessments of the clients?
to determine if management has adequately accounted for and recorded any amounts that are considered probable and reasonably estimable and to verify that amounts that are probable and not reasonably estimable or that are reasonably possible are adequately disclosed
which of the following best describes the primary purpose of management representation letter obtained during an audit?
to ensure management accepts its responsibility for the assertions in the FS and to document the client's representations and responses to inquiries related to various audit areas
after multiple attempts, an auditor is unable to obtain a response for several positive requests for year end accounts receivable confirmations. an appropriate alternative procedures to verify the existence of accounts receivable is:
to examine the applicable sales order, shipping document and subsequent cash receipts
In auditing a manufacturing entity, which of the following procedures would an auditor least likely perform to determine whether slow-moving, defective, and obsolete items included in inventory are properly identified? A. Test the computation of standard overhead rates. B. Tour the manufacturing plant or production facility. C. Compare inventory balances to anticipated sales volume. D. Review inventory experience and trends.
tour the manufacturing plant or production facility
which audit procedure would most likely provide evidence of completeness?
tracing forward from source documents to journal entries or financial statements
when auditing expenditures, the proper segregation of duties would involve all of the following departments except:
warehouse and shipping
which of the following statements would management NOT include in a management letter?
we provide absolute assurance that the FS are free from material misstatement and presented fairly in accordance with U.S. GAAP
