ACC 580 SU 13,15,16,17

Tread Corp., an issuer, accounts for the effect of a material change in an accounting principle prospectively when period-specific adjustments are required for prior periods presented in comparison with the current year. The auditor would choose between expressing a(n) a. Adverse opinion and a qualified opinion. b. Disclaimer of opinion and an unqualified opinion with an explanatory paragraph. c. Unqualified opinion with an explanatory paragraph and an adverse opinion. d. Qualified opinion and a disclaimer of opinion.

a. Adverse opinion and a qualified opinion. The applicable reporting framework defines accounting changes and the treatment for reporting them. When the financial statements contain a material misstatement, for example, because of an inappropriate selection or application of an accounting principle, the auditor should express a qualified or adverse opinion. A misstatement is a difference between the amount, classification, presentation, or disclosure of a reported item and the amount, etc., required for it to be in accordance with the applicable framework. Misstatements also include adjustments needed for amounts, etc., to be presented fairly. Assuming the principle selected was appropriate, the application of the principle was the basis for the misstatement. A change in principle is accounted for retrospectively, not prospectively. Given that the change was material, the misstatement of financial statement amounts required (1) modification of the opinion and (2) a description and quantification of the financial effects of the misstatement.

When a certified public accountant who is not independent is associated with financial statements, (s)he is precluded from expressing an opinion because a. Any auditing procedures (s)he might perform will not be in accordance with generally accepted auditing standards. b. (S)he will be placed in the position of suffering an adverse decision in a possible liability suit. c. (S)he will be in the position of auditing his or her own work. d. The public will be aware of his or her lack of independence and would place little or no faith in the opinion.

a. Any auditing procedures (s)he might perform will not be in accordance with generally accepted auditing standards. An auditor is associated with financial information when (s)he applies procedures that suffice to report in accordance with GAAS. The auditor must be independent of the entity when performing an engagement in accordance with GAAS unless (1) GAAS provide otherwise or (2) the auditor is required by law to accept and report on the engagement. Barring one of the exceptions, an auditor who is not independent must not report under GAAS. Independence means independence in fact and appearance (AU-C 200). This crucially important quality gives credibility to the auditor's opinion. If an auditor does not maintain the appearance of independence, however unbiased (s)he may be in fact, the public will be reluctant to believe that (s)he is unbiased.

What is an auditor's responsibility for required supplementary information (RSI)? a. Apply limited procedures to the information and report its omission or the need for material modifications. b. Audit the RSI in accordance with applicable auditing standards. c. Add an emphasis-of-matter paragraph to the auditor's report before the opinion paragraph. d. Include a disclaimer on the information only if the auditor is unable to apply limited procedures to it.

a. Apply limited procedures to the information and report its omission or the need for material modifications. RSI differs from other information outside the basic statements because the designated accounting standard setter considers it to be an essential part of financial reporting for placing the basic financial statements in context. The auditor at minimum should apply limited procedures and report on the RSI in an other-matter paragraph that follows the opinion paragraph.

The existence of audit risk is recognized by the statement in the auditor's report that the a. Auditor obtains reasonable assurance about whether the financial statements are free of material misstatement. b. Audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. c. Financial statements are presented fairly, in all material respects, in accordance with GAAP. d. Auditor is responsible for expressing an opinion on the financial statements, which are the responsibility of management.

a. Auditor obtains reasonable assurance about whether the financial statements are free of material misstatement. Audit risk is the risk that the auditor expresses an inappropriate audit opinion when the financial statements are materially misstated (AU-C 200). The high, but not absolute, level of assurance that is intended to be obtained by the auditor is described in the report. Reasonable assurance means that audit risk is reduced to an acceptably low level.

A CPA is considered not associated with unaudited financial statements of a public entity when (s)he a. Completed an audit and reported on the financial statements that, without the CPA's consent, were part of a prospectus including unaudited financial statements. b. Performed a review of an issuer's unaudited financial statements that are presented in a quarterly report to the shareholders. c. Assisted in the preparation of the unaudited financial statements for an issuer. d. Received all input data from the client, analyzed it, and returned it to the client for processing by an independent computer service company.

a. Completed an audit and reported on the financial statements that, without the CPA's consent, were part of a prospectus including unaudited financial statements. PCAOB auditing standards apply to engagements involving issuers. Under these standards, a CPA is associated with unaudited financial statements of a public entity when (s)he prepares or assists in preparing them or consents to the use of his or her name with them. If neither condition is met, the CPA is not associated with the unaudited statements in the prospectus (PCAOB AS 3320).

The primary reason an auditor requests letters of inquiry be sent to a client's legal counsel is to provide the auditor with a. Corroboration of the information furnished by management about litigation, claims, and assessments. b. Legal counsel's opinion of the client's historical experiences in recent similar litigation. c. A description and evaluation of litigation, claims, and assessments that existed at the balance sheet date. d. The probable outcome of asserted claims and pending or threatened litigation.

a. Corroboration of the information furnished by management about litigation, claims, and assessments. A letter of inquiry to a client's external legal counsel is the auditor's primary means of corroborating information furnished by management about litigation, claims, and assessments. If in-house legal counsel is primarily responsible for the entity's litigation, claims, and assessments, the auditor should send a similar letter of inquiry to in-house legal counsel. But the letter to in-house legal counsel is not a substitute for direct communication with external legal counsel.

To which of the following matters would an auditor not apply materiality limits when obtaining specific written management representations? a. Fraud involving employees with significant roles in internal control. b. The absence of errors and unrecorded transactions in the financial statements. c. Information concerning related party transactions and related amounts receivable or payable. d. Disclosure of compensating balance arrangements involving restrictions on cash balances.

a. Fraud involving employees with significant roles in internal control. Management's representations may be limited to matters that are considered individually or collectively material if management and the auditor have reached an understanding about materiality for this purpose. Materiality considerations do not apply to certain representations not directly related to amounts in the financial statements, for example, representations about the premise of the audit (i.e., acknowledgment of responsibility for fair presentation, internal control, and auditor access to information and people). Materiality also does not apply to knowledge of fraud or suspected fraud affecting the entity involving (1) management, (2) employees with significant roles in internal control, or (3) others if the fraud could materially affect the statements (AU-C 580).

The auditor's judgment concerning the overall fairness of the presentation of financial position, results of operations, and cash flows is applied within the framework of a. Generally accepted accounting principles. b. The auditor's assessment of the risk of material misstatement. c. Quality control. d. Generally accepted auditing standards, which include the concept of materiality.

a. Generally accepted accounting principles. Reporting standards require the auditor to state whether the audited entity's financial statements are presented in conformity with GAAP. Without an applicable reporting framework, the auditor would have no uniform standard for judging fairness of presentation.

An auditor may issue an unmodified audit report when the a. Group engagement partner assumes responsibility for the work of a component auditor. b. Financial statements are prepared on the cash receipts and disbursements basis of accounting chosen by management. c. Auditor refers to the findings of an auditor's specialist. d. Financial statements are derived from audited financial statements but contain less detail.

a. Group engagement partner assumes responsibility for the work of a component auditor. If the group engagement partner assumes responsibility for the work of the component auditor, the component auditor is not referred to in the report on the group financial statements.

Comparative financial statements include the financial statements of the prior year that were audited by a predecessor auditor whose opinion is not presented. If the predecessor's opinion was qualified, the auditor should a. Indicate the reasons for the qualification in the predecessor auditor's opinion. b. Express an opinion only on the current year's statements and make no reference to the prior year's statements. c. Request the client to reissue the predecessor's report on the prior year's statements. d. Issue an updated comparative audit report indicating the division of responsibility.

a. Indicate the reasons for the qualification in the predecessor auditor's opinion. When the predecessor's report is not presented, the auditor's report should include an additional paragraph titled "other matter" if for a nonissuer or with no title if for an issuer. The statement also includes (1) a statement that the financial statements of the prior period were audited by another auditor, (2) the date of the report, (3) the opinion expressed, (4) the reasons if the opinion was modified, and (5) the nature of any additional paragraphs.

Which of the following procedures will an auditor most likely perform to obtain evidence about the occurrence of subsequent events? a. Inquiring of the entity's legal counsel concerning litigation, claims, and assessments arising after year end. b. Recomputing a sample of large-dollar transactions occurring after year end for arithmetic accuracy. c. Investigating changes in equity occurring after year end. d. Confirming bank accounts established after year end.

a. Inquiring of the entity's legal counsel concerning litigation, claims, and assessments arising after year end. Subsequent events procedures include (1) reading the latest subsequent interim statements, if any; (2) inquiring of management and those charged with governance about the occurrence of subsequent events and various financial and accounting matters; (3) reading the minutes of meetings of owners, management, and those charged with governance; (4) obtaining a letter of representations from management; (5) inquiring of client's legal counsel; and (6) obtaining an understanding of management's procedures for identifying subsequent events.

Under which of the following circumstances would a disclaimer of opinion not be appropriate? a. Management does not provide reasonable justification for a change in accounting principles. b. The client refuses to permit the auditor to confirm certain accounts receivable or apply alternative procedures to verify their balances. c. The auditor is unable to determine the amounts associated with an employee fraud scheme. d. The chief executive officer is unwilling to sign the management representation letter.

a. Management does not provide reasonable justification for a change in accounting principles. If (1) the new principle and the method of accounting for the effect of the change are in accordance with the applicable reporting framework, (2) disclosures are adequate, and (3) the entity has justified that the principle is preferable, the auditor expresses an unmodified (unqualified) opinion. Otherwise, if the change is material, the misstatement results in expression of a qualified or an adverse opinion in the report for the year of change.

A CPA should not normally refer to which one of the following subjects in a comfort letter? a. Management's determination of operating segments. b. The independence of the CPA. c. Changes in financial statement items during a period subsequent to the date and period of the latest financial statements in the registration statement. d. Unaudited financial statements and schedules in the registration statement.

a. Management's determination of operating segments. AU-C 920 lists the permissible content of a comfort letter. In addition to the other answer choices, the letter may address (1) the form of audit statements and schedules in the registration statement, (2) other items in the filing (e.g., pro forma information, MD&A, and capsule information), and (3) the provision of negative assurance. However, management's determination of operating segments is a matter addressed in an audit, an engagement with a broader scope than that for the issuance of a comfort letter.

As a condition of obtaining a loan from First National Bank, Maxim Co. is required to submit an audited balance sheet but not the related statements of income, retained earnings, or cash flows. Maxim would like to engage a CPA to audit only its balance sheet. Under these circumstances, the CPA a. May audit only Maxim's balance sheet if the CPA can audit interrelated items. b. May not audit only Maxim's balance sheet if the amount of the loan is material to the financial statements as a whole. c. May audit only Maxim's balance sheet if the CPA disclaims an opinion on the other financial statements. d. May not audit only Maxim's balance sheet if Maxim is a nonissuer.

a. May audit only Maxim's balance sheet if the CPA can audit interrelated items. The auditor may report on one basic financial statement and not on the others if (1) the auditor complies with all AU-C sections relevant to the audit, (2) the audit is feasible, and (3) the auditor can perform procedures on interrelated items. For example, (1) sales and receivables, (2) inventory and payables, and (3) equipment and depreciation are interrelated.

When an auditor issues to an underwriter a comfort letter containing comments on data that have not been audited, the underwriter most likely will receive a. Negative assurance on capsule information. b. A limited opinion on pro forma financial statements. c. A disclaimer on prospective financial statements. d. Positive assurance on supplementary disclosures.

a. Negative assurance on capsule information. Capsule information is (1) unaudited summarized interim information for periods subsequent to the periods covered by the audited financial statements or (2) unaudited interim financial information in the securities offering. The auditor may provide negative assurance on whether the capsule information is in accordance with the applicable financial reporting framework. The auditor must review the underlying statements in accordance with GAAS, and the capsule information must meet the framework's disclosure requirements.

When the auditor concurs with a change in accounting principle that materially affects the comparability of the comparative financial statements, the auditor should 1. Concur explicitly with the change 2. Express a qualified opinion 3. Refer to the change in an additional paragraph a. No No Yes b. Yes No Yes c. No Yes No d. Yes Yes No

a. No No Yes A material change in accounting principle raises a consistency issue. Thus, a report with a separate paragraph is required if the auditor's evaluation concludes that certain criteria have been met: (1) the new principle and the method of accounting for it are in accordance with the applicable framework, (2) related disclosures are appropriate, and (3) the entity has justified that the principle is preferable. The opinion is modified for a material change in principle only if the criteria are not met. Furthermore, the auditor's concurrence is implied by the inclusion of a descriptive paragraph. This paragraph is included only if the opinion is not modified with regard to the matter.

When reporting on financial statements prepared on the same basis of accounting used for income tax purposes, the auditor should include in the report a paragraph that a. States that the income tax basis of accounting is a basis of accounting other than GAAP. b. Refers to the authoritative pronouncements that explain the income tax basis of accounting being used. c. Emphasizes that the financial statements are not intended to have been audited in accordance with GAAS. d. Justifies the use of the income tax basis of accounting.

a. States that the income tax basis of accounting is a basis of accounting other than GAAP. An auditor may report on financial statements prepared in accordance with a special purpose framework. Except when regulatory-basis statements are intended for general use, an emphasis-of-matter paragraph (titled "Basis of Accounting") should follow the opinion paragraph. It (1) identifies the special purpose framework, (2) refers to the note describing the framework, and (3) states that the framework is not GAAP.

The client's financial reporting includes supplementary financial information outside the basic financial statements but required by the Financial Accounting Standards Board (FASB). Which of the following statements is correct regarding the auditor's responsibility for this supplementary financial information? a. The auditor should perform limited procedures. b. The auditor should read the supplementary financial information. c. The auditor should apply tests of details of transactions. d. The auditor is not required to report omissions.

a. The auditor should perform limited procedures. The limited procedures performed include inquiry and comparing the supplementary information to the financial statements.

Under which of the following circumstances would a disclaimer of opinion not be appropriate? a. The financial statements fail to contain adequate disclosure concerning related party transactions. b. The auditor is unable to determine the amounts associated with fraud committed by the client's management. c. The auditor is engaged after fiscal year-end and is unable to observe physical inventories or apply alternative procedures to verify their balances. d. The client refuses to permit its attorney to furnish information requested in a letter of audit inquiry.

a. The financial statements fail to contain adequate disclosure concerning related party transactions. A disclaimer is inappropriate when the financial statements contain material departures from the applicable financial reporting framework. Inadequacy of the disclosures required by the applicable financial reporting framework is such a departure. Because U.S. GAAP require certain disclosures about related party transactions, the inadequacy of such disclosures is a basis for expressing a qualified or an adverse opinion.

If a nonissuer refuses to give permission to the auditor to communicate with its external legal counsel, then the auditor should modify which of the following? a. The opinion in the auditor's report. b. The audit plan. c. The management representation letter. d. The attorney's letter of inquiry.

a. The opinion in the auditor's report. The opinion in the auditor's report is modified if legal counsel refuses to respond appropriately to the audit letter of inquiry and the auditor cannot obtain sufficient appropriate evidence by performing alternative procedures. Modification also is required if management refuses permission for the auditor to communicate or meet with external legal counsel. Moreover, external legal counsel's refusal to provide (orally or in writing) information requested in a letter of inquiry may be a scope limitation sufficient to preclude an unmodified opinion. However, the need for confidentiality of client communications with legal counsel protects some matters from disclosure even to the auditor.

When an auditor qualifies an opinion on the financial statements of a nonissuer because of a scope limitation, which part(s) of the auditor's report should indicate that the qualification pertains to the possible effects on the financial statements and not to the scope limitation itself? a. The opinion paragraph only. b. The introductory paragraph. c. An emphasis-of-matter paragraph. d. The auditor's responsibility section.

a. The opinion paragraph only. When a qualified opinion results from an inability to obtain sufficient appropriate evidence in an audit of a nonissuer, the auditor describes the matter in the basis for qualified opinion paragraph, not in a note to the statement. The description of the audit scope is the responsibility of the auditor, not management. The opinion paragraph should indicate that the qualification pertains to the possible effects on the financial statements, not to the scope limitation itself. The wording ". . . except for the possible effects of the matter described in the basis for qualified opinion paragraph . . ." is appropriate. The following are the other effects on the auditor's report when the opinion is qualified due to an inability to obtain sufficient appropriate evidence with possible effects that are material but not pervasive: (1) The introductory paragraph is unchanged; (2) the management's responsibility paragraph is unchanged; and (3) the auditor's responsibility section ends with the sentence, "We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our qualified audit opinion."

In an audit of a nonissuer, the auditor's report most likely is addressed to the following: Board of Directors Audited Entity Internal Auditors a. Yes Yes No b. No Yes No c. Yes Yes Yes d. Yes No No

a. Yes Yes No According to AU-C 700, the auditor's report ordinarily is addressed to those for whom the report is prepared. It may be addressed to the entity whose statements are being audited or to those charged with governance (e.g., the board or the audit committee). If the client is an unincorporated entity, the addressee depends on the circumstances, e.g., to the partners or the proprietor.

Under U.S. GAAP, what is considered a "reasonable period" regarding going-concern issues? a. 6 months. b. 1 year. c. 9 months. d. 2 years.

b. 1 year. Under U.S. GAAP, a "reasonable period" regarding going-concern issues is 1 year from the date the statements are issued or are available to be issued.

An auditor's report on financial statements prepared on the cash receipts and disbursements basis of accounting should include all of the following except a. An opinion as to whether the financial statements are fairly presented in conformity with the cash receipts and disbursements basis of accounting. b. A statement that the cash receipts and disbursements basis of accounting is not a special purpose framework. c. A reference to the note to the financial statements that describes the cash receipts and disbursements basis of accounting. d. A statement that the audit was conducted in accordance with auditing standards generally accepted in the U.S.

b. A statement that the cash receipts and disbursements basis of accounting is not a special purpose framework. The basis of accounting (emphasis-of-matter) paragraph should state that the cash basis of accounting is a basis of accounting other than GAAP.

If deemed necessary, the auditor should request that an audit client send a letter of inquiry to those attorneys who have been consulted regarding litigation, claims, or assessments. The primary reason for this request is to provide a. An expert opinion as to whether a loss is possible, probable, or remote. b. Corroborative evidence. c. Information concerning the progress of cases to date. d. An estimate of the dollar amount of the probable loss.

b. Corroborative evidence. AU-C 501 states that a letter of inquiry to the entity's legal counsel is the primary means of corroborating information provided by management about material litigation, claims, or assessments. The auditor should send the letter after it has been prepared by management.

With respect to consistency of financial statements, which of the following should be done by an auditor who has audited a company's financial statements for the current year but not the preceding year? a. Report on the financial statements of the current year without concern for consistency with the prior year. b. Determine whether the current period's accounting policies are consistently applied regarding opening balances. c. Rely on the report of the prior year's auditors if it does not mention consistency. d. Consider the consistent application of principles within the year under audit but not between the current and preceding year.

b. Determine whether the current period's accounting policies are consistently applied regarding opening balances. In an initial engagement, the statements for the prior period either (1) were not audited or (2) were audited by a predecessor auditor. An auditor's objective in an initial engagement is to obtain sufficient appropriate evidence about whether (1) opening balances materially misstate the current statements, (2) accounting policies reflected in opening balances are consistently applied in the current statements, and (3) change in accounting policies are appropriately accounted for and disclosed (AU-C 510).

A group engagement team of a nonissuer should ask a component auditor to communicate whether it complied with a. State licensure requirements applicable to all group locations. b. Ethical requirements relevant to the group audit. c. Generally accepted accounting principles relevant to the group audit. d. Contract billing requirements related to the group audit.

b. Ethical requirements relevant to the group audit. The group engagement team should obtain an understanding of the component auditor's professional competence and compliance with ethical requirements (especially independence). The understanding also addresses (1) the extent of the team's involvement in the component auditor's work, (2) whether (s)he operates under regulatory oversight, and (3) whether the team will be able to obtain information about the consolidation process from the component auditor.

An auditor has previously expressed a qualified opinion on the financial statements of a prior period because of a material misstatement. The prior-period financial statements are restated in the current period to conform with the applicable reporting framework. The auditor's updated report on the prior-period financial statements should a. Be accompanied by the original auditor's report on the prior period. b. Express an unmodified opinion concerning the restated financial statements. c. Qualify the opinion concerning the restated financial statements because of a change in accounting principle. d. Bear the same date as the original auditor's report on the prior period.

b. Express an unmodified opinion concerning the restated financial statements. If an auditor has previously modified the opinion on statements of a prior year because of a material misstatement, and the statements are subsequently restated in conformity with the applicable reporting framework, the auditor's updated report on the prior period's statements should indicate that they have been restated and should express an unmodified opinion.

An emphasis-of-matter paragraph is included in the auditor's report on the financial statements of a nonissuer to draw users' attention to matters a. Not presented or disclosed in the financial statements. b. Fundamental to users' understanding of the financial statements. c. Relevant to users' understanding of the auditor's responsibilities. d. Relevant to users' understanding of the auditor's report.

b. Fundamental to users' understanding of the financial statements. An emphasis-of-matter paragraph in the auditor's report draws users' attention to a matter appropriately presented or disclosed that is fundamental to their understanding of the financial statements.

Which of the following procedures would an auditor most likely perform in obtaining evidence about subsequent events? a. Reperform the tests of controls that indicated significant deficiencies in the operation of internal control. b. Inquire of management whether new shares have been issued since the year end. c. Recompute depreciation charges for plant assets sold for substantial gains since the year end. d. Examine a sample of transactions that occurred since the year end to verify the effectiveness of computer controls.

b. Inquire of management whether new shares have been issued since the year end. The auditor should perform procedures with respect to material events or transactions that occur after the balance sheet date but prior to the date of the auditor's report. Procedures that should be performed include inquiring of management and those charged with governance about whether (1) increases in capital or issuances of debt have occurred, e.g., an issue of new shares or bonds, or (2) an agreement about a merger or liquidation has been made (AU-C 560).

Which of the following procedures will an auditor most likely perform to obtain evidence about the occurrence of subsequent events? a. Comparing the financial statements being reported on with those of the prior period. b. Inquiring as to whether any unusual adjustments were made after year end. c. Investigating personnel changes in the accounting department occurring after year end. d. Confirming a sample of material accounts receivable established after year end.

b. Inquiring as to whether any unusual adjustments were made after year end. Subsequent events procedures include inquiring of management as to whether (1) subsequent events occurred that might affect the statements; (2) new commitments, borrowings, or guarantees were made; (3) sales or acquisitions of assets occurred or were planned; (4) capital increased or debt was issued; (5) developments regarding contingencies occurred; (6) any events occurred (a) casting doubt on the appropriateness of accounting policies or (b) that are relevant to the measurement of estimates or the recovery of assets; (7) any unusual accounting adjustments were made or considered; and (8) changes occurred in the current status of items that were accounted for on the basis of preliminary or inconclusive data.

Which of the following procedures should an auditor perform concerning litigation, claims, and assessments? a. Confirm directly with the client's legal counsel that all litigation, claims, and assessments have been properly recorded in the financial statements. b. Obtain a list from management that discloses all unasserted claims that it considers to be probable of assertion. c. Inspect legal documents in the possession of the client's legal counsel that are relevant to pending litigation and unasserted claims and assessments. d. Discuss with the client's legal counsel its philosophy of defending litigation, claims, and assessments that have a high probability of being resolved unfavorably.

b. Obtain a list from management that discloses all unasserted claims that it considers to be probable of assertion. The auditor should obtain evidence about the possible loss from litigation, claims, and assessments. One procedure is to obtain a list from management describing and evaluating unasserted claims and assessments that (1) are probable of assertion and (2) have at least a reasonable possibility of an unfavorable outcome, with respect to which legal counsel has performed substantive legal services for the entity (AU-C 501).

Which of the following procedures should an auditor ordinarily perform regarding subsequent events? a. Communicate material weaknesses in internal control to the client's audit committee. b. Read the latest subsequent interim financial statements. c. Send second requests to the client's customers who failed to respond to initial accounts receivable confirmation requests. d. Review the cutoff bank statements for several months after the year end.

b. Read the latest subsequent interim financial statements. Subsequent events procedures include (1) reading the latest subsequent interim statements, if any; (2) inquiring of management and those charged with governance about the occurrence of subsequent events and various financial and accounting matters; (3) reading the minutes of meetings of owners, management, and those charged with governance; (4) obtaining a letter of representations from management; (5) inquiring of client's legal counsel; and (6) obtaining an understanding of management's procedures for identifying subsequent events.

An auditor who conducts an audit in accordance with generally accepted auditing standards and concludes that the financial statements are fairly presented in accordance with a special purpose framework, such as the cash basis of accounting, should issue a a. Review report. b. Report expressing an opinion. c. Report disclaiming an opinion. d. Report expressing a qualified opinion.

b. Report expressing an opinion. An auditor's judgment (opinion) about the fair presentation of financial statements is applied within an identifiable framework, which is usually provided by GAAP. However, a special purpose framework (e.g., cash basis) may sometimes be used. An auditor's report is appropriate for reporting on statements prepared using a special purpose framework.

Which of the following situations would result in an adverse opinion? a. The auditor is unable to complete an inventory count because of a warehouse fire that occurred one month after year end. b. The auditor discovers that the client's 20 largest customers have inflated accounts receivable on the books and that the aggregate of these misstatements is material and pervasive to the financial statements. c. The audit partner on the engagement is the sister of the client's CEO. d. The auditor discovers that the client has been depreciating assets in an inappropriate manner, which has caused accumulated depreciation to be immaterially understated on the balance sheet.

b. The auditor discovers that the client's 20 largest customers have inflated accounts receivable on the books and that the aggregate of these misstatements is material and pervasive to the financial statements. The auditor should express an adverse opinion when, having obtained sufficient appropriate audit evidence, (s)he concludes that misstatements, individually or combined, are material and pervasive to the financial statements.

Mead, CPA, had substantial doubt about Tech Co.'s ability to continue as a going concern when reporting on Tech's audited financial statements for the year ended June 30, Year 1. That doubt has been removed in Year 2. What is Mead's reporting responsibility if Tech, a nonissuer, is presenting its financial statements for the year ended June 30, Year 2, on a comparative basis with those of Year 1? a. The emphasis-of-matter paragraph included in the Year 1 auditor's report should be repeated in its entirety. b. The emphasis-of-matter paragraph included in the Year 1 auditor's report should not be repeated. c. A different emphasis-of-matter paragraph describing Mead's reasons for the removal of doubt should be included. d. A different emphasis-of-matter paragraph describing Tech's plans for financial recovery should be included.

b. The emphasis-of-matter paragraph included in the Year 1 auditor's report should not be repeated. The emphasis-of-matter paragraph included in the previous report should not be repeated in subsequent reports if the doubt has been resolved.

Which of the following factors most likely would cause a CPA not to accept a new audit engagement? a. The CPA's lack of understanding of the prospective client's operations and industry. b. The prospective client's unwillingness to permit inquiry of its legal counsel. c. The indications that management has not investigated employees in key positions before hiring them. d. The inability to review the predecessor auditor's working papers.

b. The prospective client's unwillingness to permit inquiry of its legal counsel. Management is responsible for adopting policies and procedures to identify, evaluate, and account for litigation, claims, and assessments. If the client refuses the auditor's request to obtain corroborating information from legal counsel, a scope limitation exists that could result in a disclaimer of an opinion or withdrawal from the audit (AU-C 501).

Park, CPA, was engaged to audit the financial statements of Tech Co., a new client, for the year ended December 31, Year 1. Park obtained sufficient appropriate audit evidence for all of Tech's financial statement items except Tech's opening inventory. Due to inadequate financial records, Park could not verify Tech's January 1, Year 1, inventory balances. Park's opinion on Tech's Year 1 financial statements most likely will be Balance Sheet Income Statement a. Unmodified Adverse b. Unmodified Disclaimer c. Disclaimer Adverse d. Disclaimer Disclaimer

b. Unmodified Disclaimer The auditor may report on one basic financial statement and not on the others. Because the balance sheet presents information at a specific moment in time, the auditor should be able to become satisfied regarding the balances presented at year end. However, beginning inventory is included in the determination of the results of operations and cash flows. Thus, the auditor will probably not be able to form an opinion as to the fairness of these statements and should disclaim an opinion on them.

Billie J. King, CPA, was engaged to audit the financial statements of Newton Co. after its fiscal year had ended. King neither observed the inventory count nor confirmed the receivables by direct communication with debtors, but was satisfied concerning both after applying alternative procedures. King's auditor's report most likely contained a(n) a. Disclaimer of opinion. b. Unmodified opinion. c. Qualified opinion. d. Unmodified opinion with an emphasis-of-matter paragraph.

b. Unmodified opinion. Because the auditor is satisfied as to inventory quantities and the amounts of receivables, she obtained sufficient appropriate evidence. Accordingly, the opinion is not modified.

Which of the following is the auditor's primary means of obtaining corroboration of information furnished by management concerning litigation, claims, and assessments? a. A review of contracts, leases, loan agreements, and similar documents. b. A letter of representation supplied by management. c. A letter of audit inquiry to the client's lawyer. d. The minutes of stockholders' and directors' meetings.

c. A letter of audit inquiry to the client's lawyer. Management is responsible for adopting policies and procedures to identify, evaluate, and account for litigation, claims, and assessments (LCA). Accordingly, it is the primary source of information about LCA. The auditor should obtain evidence relevant to (1) circumstances indicating an uncertainty as to possible loss from LCA, (2) the period in which the underlying cause for legal action occurred, (3) the probability of an unfavorable outcome, and (4) the amount or range of potential loss. A letter of inquiry to external legal counsel is the auditor's primary means of obtaining corroboration of the information provided about material LCA by management.

An auditor's report on financial statements prepared in accordance with the income tax basis of accounting should include all of the following except a. A statement that the basis of accounting is other than GAAP. b. Reference to the note to the financial statements that describes the basis of accounting. c. An opinion as to whether the basis of accounting used is appropriate under the circumstances. d. An opinion as to whether the financial statements are presented fairly, in all material respects, in accordance with the basis of accounting used for income tax purposes.

c. An opinion as to whether the basis of accounting used is appropriate under the circumstances. The auditor's report should include paragraphs or sections that (1) describe the financial statements; (2) state management's responsibility for the financial statements; (3) describe the auditor's responsibilities; (4) express an opinion on fair presentation in accordance with the income tax basis; and (5) identify in an emphasis-of-matter paragraph the basis of accounting, state that the basis is other than GAAP, and refer to the note that describes that basis. The auditor's responsibilities include evaluating the appropriateness of the accounting policies used. They do not include expression of an opinion on whether the basis of accounting used is appropriate under the circumstances.

Seripak Corporation, a nonissuer, made a material change in accounting principle with which the auditor concurs. The auditor should express a. An adverse opinion with an emphasis-of-matter paragraph. b. A qualified opinion with an emphasis-of-matter paragraph. c. An unmodified opinion with an emphasis-of-matter paragraph. d. An "except for" opinion without an emphasis-of-matter paragraph.

c. An unmodified opinion with an emphasis-of-matter paragraph. An auditor includes an emphasis-of-matter paragraph in the audit report when a material change in accounting principle has occurred. If (1) the new principle and the method of accounting for the effect of the change are in accordance with the applicable reporting framework, (2) disclosures are adequate, and (3) the entity has justified that the principle is preferable, the opinion is unmodified.

Which of the following conditions or events is most likely to cause an auditor to have substantial doubt about an entity's ability to continue as a going concern? a. Research and development projects are postponed. b. Stock dividends replace annual cash dividends. c. Cash flows from operating activities are negative. d. Significant related party transactions are pervasive.

c. Cash flows from operating activities are negative. The significance of conditions or events depends on circumstances, and some conditions or events may be significant only in conjunction with others. Such conditions and events include negative trends, financial difficulties, internal matters, and external matters. Negative cash flows from operating activities provide evidence of negative trends and financial difficulties.

The Securities and Exchange Commission has authority to a. Deny lack of privity as a defense in third-party actions for gross negligence against the auditors of issuers. b. Require a change of auditors of governmental entities after a given period of years as a means of ensuring independence. c. Determine accounting principles for the purpose of financial reporting by companies offering securities to the public. d. Prescribe specific auditing procedures to detect fraud concerning inventories and accounts receivable of companies engaged in interstate commerce.

c. Determine accounting principles for the purpose of financial reporting by companies offering securities to the public. The SEC has the authority to regulate the form and content of all financial statements, notes, and schedules filed with the SEC and also the financial reports to shareholders if the company is subject to the Securities Exchange Act of 1934. The SEC has stated that financial statements conforming to FASB standards will be presumed to be in accordance with U.S. GAAP. However, the SEC reserves the right to substitute its principles for those of the accounting profession and to require any additional disclosures it deems necessary. The Sarbanes-Oxley Act of 2002 authorized the SEC to recognize as generally accepted any accounting principles established by a standards-setting body that meets the act's criteria.

Delta Life Insurance Co. prepares its financial statements on an accounting basis insurance companies use pursuant to the rules of a state insurance commission. If Wall, CPA, Delta's auditor, discovers that the statements are not suitably titled, Wall should a. Explain in the notes to the financial statements the terminology used. b. Apply to the state insurance commission for an advisory opinion. c. Disclose any reservations in a basis for qualified opinion paragraph and qualify the opinion. d. Issue a special statutory-basis report that clearly disclaims any opinion.

c. Disclose any reservations in a basis for qualified opinion paragraph and qualify the opinion. Terms such as "balance sheet," "statement of income," or other unmodified titles are ordinarily understood to apply to statements presented in accordance with GAAP. Consequently, the auditor of statements prepared under a special purpose framework should consider whether the statements are suitably titled. If (s)he believes they are not, the auditor should disclose his or her reservations in a basis for qualified opinion paragraph (AU-C 800).

The auditor's report refers to the U.S. GAAP-based financial statements, which are customarily considered to include the balance sheet and the statements of a. Income and changes in equity. b. Income and cash flows. c. Income, changes in equity, and cash flows. d. Income, changes in retained earnings, and cash flows.

c. Income, changes in equity, and cash flows. The balance sheet, statement of income, statement of changes in equity, and statement of cash flows are the financial statements upon which the auditor customarily reports. Furthermore, provided that the entity has items of other comprehensive income, U.S. GAAP require that comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements that constitute a full set of financial statements. The format may be (1) one continuous statement consisting of net income and other comprehensive income (OCI) or (2) two separate but consecutive statements. The introductory paragraph identifies the titles of the entity's financial statements. However, the statement of changes in equity and a separate statement of comprehensive income are not separately reported on the opinion paragraph. The reason is that changes in equity and comprehensive income are included in financial position, results of operations, and cash flows.

Which of the following best describes other information in documents containing audited financial statements? a. Required supplementary information. b. Notes to the financial statements. c. Information presented in addition to the audited financial statements, such as a report by management on operations. d. Summary financial statements.

c. Information presented in addition to the audited financial statements, such as a report by management on operations. Other information is financial or nonfinancial information (other than the financial statements and the auditor's report) that is included in a document containing audited statements and the auditor's report (excluding RSI). An example of such a document is an annual report to owners. Examples of other information are (1) a management report on operations, (2) selected quarterly data, and (3) financial summaries (AU-C 720).

Which of the following circumstances requires modification of the auditor's report on a review of interim financial information (IFI)? 1. Substantial Doubt about the Entity's Ability to Continue as a Going Concern 2. Inadequate Disclosure a. No No b. Yes No c. No Yes d. Yes Yes

c. No Yes Modification of the report on a review of IFI is necessary because of departures from the applicable financial reporting framework, including inadequate disclosure. A review of IFI is not intended to identify a going concern issue. But the auditor may become aware of conditions or events indicating a possibility that the entity may not be able to continue as a going concern. In this case, the auditor should inquire of management and consider the adequacy of disclosure. If disclosure is adequate, report modification is not required. Nevertheless, the auditor may include an emphasis-of-matter paragraph.

When an issuer refuses to include in its audited financial statements the segment disclosures that the auditor believes are required, the auditor should express a(n) a. Disclaimer of opinion because of the significant scope limitation. b. Adverse opinion because of a significant uncertainty. c. Qualified opinion because of inadequate disclosure. d. Unmodified opinion with an emphasis-of-matter paragraph.

c. Qualified opinion because of inadequate disclosure. If the statements are materially misstated because of the omission of required information, the auditor should modify the opinion for inadequate disclosure and describe the information omitted. The auditor also should include this information in the report, if practicable. But the auditor is not expected to prepare segment information. (S)he need not assume the position of a preparer of financial information.

Which of the following audit procedures most likely would assist an auditor in identifying conditions and events that may indicate there could be substantial doubt about an entity's ability to continue as a going concern? a. Confirmation of accounts receivable from principal customers. b. Reconciliation of interest expense with debt outstanding. c. Review of compliance with terms of debt agreements. d. Confirmation of bank balances.

c. Review of compliance with terms of debt agreements. Continuing as a going concern is assumed in financial reporting absent significant contrary information. Such information relates to the inability to continue to pay liabilities as they become due. Standard audit procedures that may identify conditions and events indicating a going-concern issue include review of compliance with terms of debt agreements. If an entity is not complying with the terms of a debt agreement, the due date may be accelerated. An obligation to pay the debt early could cause the entity to fail to meet its obligations.

An audit of the financial statements included in Form 10-Q is not required. However, an external auditor's involvement with a Form 10-Q that is being prepared for filing with the SEC most likely consists of a(n) a. Comfort letter that covers stub-period financial data. b. Compilation report on the financial statements included in Form 10-Q. c. Review of the interim financial statements included in Form 10-Q. d. Opinion on internal controls under which the Form 10-Q data were developed.

c. Review of the interim financial statements included in Form 10-Q. Form 10-Q is the quarterly report to the SEC. It must be filed by accelerated filers and large accelerated filers within 40 days of the last day of the first 3 quarters of the year (within 45 days by nonaccelerated filers). It need not contain audited financial statements, but it should be prepared in accordance with GAAP. Moreover, the SEC requires a registrant to obtain a review by its independent auditors of interim financial statements reported on Form 10-Q. The independent accountant who has audited the annual financial statements for the periods for which such data are presented should review the selected quarterly data. A review by an accountant permits an expression of limited assurance that no material modifications need to be made to the statements for them to be in conformity with the applicable financial reporting framework. A review helps satisfy the SEC requirement of adequate and accurate disclosure of material facts.

An auditor concludes prior to the release date of the report that a material inconsistency exists in the other information in an annual report to shareholders. The report contains audited financial statements. If the auditor concludes that the financial statements do not require revision, but management refuses to revise or eliminate the material inconsistency, the auditor may a. Express a qualified opinion after discussing the matter with the client's directors. b. Disclaim an opinion on the financial statements after explaining the material inconsistency in a separate other-matter paragraph. c. Revise the auditor's report to include a separate other-matter paragraph describing the material inconsistency. d. Consider the matter closed because the other information is not in the audited statements.

c. Revise the auditor's report to include a separate other-matter paragraph describing the material inconsistency. If the other information contains a material inconsistency that requires revision, and management refuses to make the revision, the auditor should communicate the matter to those charged with governance. The auditor also should (1) revise the report to include an other-matter paragraph, (2) withhold use of the report, or (3) withdraw from the engagement.

Which of the following titles is suitable for financial statements that are prepared on a cash basis? a. Income statement. b. Statement of cash flows. c. Statement of revenue collected and expenses paid. d. Statement of operations.

c. Statement of revenue collected and expenses paid. Terms such as "balance sheet," "statement of financial position," "statement of operations," "income statement," "statement of cash flows," and similar unmodified titles suggest that the statements were prepared in accordance with GAAP. Appropriate titles for comparable cash basis statements are "statement of assets and liabilities arising from cash transactions" and "statement of revenue collected and expenses paid."

An auditor's report on audited financial statements is inappropriate if it refers to a. An assessment of the entity's accounting policies. b. Management's responsibility for the financial statements. c. The CPA's assessment of sampling risk factors. d. Significant estimates made by management.

c. The CPA's assessment of sampling risk factors. The auditor's report on audited financial statements describes the general nature of an audit. But it does not directly refer to sampling or describe specific procedures.

The auditor's report in an audit of an issuer may be addressed to a. Whom it may concern. b. The chief financial officer. c. The board of directors and shareholders. d. The chief operating officer.

c. The board of directors and shareholders.The PCAOB standards (AS 3101) require the audit report to be addressed to the board of directors and shareholders.

Which of the following events occurring after the date of the report most likely will cause the auditor to make further inquiries about the previously issued financial statements? a.The final resolution of a lawsuit explained in a separate paragraph of the auditor's report. b. A technological development that could affect the entity's future ability to continue as a going concern. c. The discovery of information regarding a contingency that existed before the financial statements were issued. d. The entity's sale of a subsidiary that accounts for 30% of the entity's consolidated sales.

c. The discovery of information regarding a contingency that existed before the financial statements were issued. Facts may be discovered by the auditor after the date of the report that, if known at that date, might have caused the auditor to revise the report. In this case, the auditor should (1) discuss the matter with management and (2) determine whether the statements should be revised and, if so, how management intends to address the matter in the statements (AU-C 560).

An auditor who is engaged to report on whether supplementary information is fairly stated, in all material respects, in relation to the statements as a whole should determine that which of the following conditions are satisfied? a. Internal controls are in place to prevent fraud relating to the supplementary information. b. The financial statements are free from material misstatement. c. The supplementary information is derived directly from the underlying records used to prepare the statements and relates to the same period. d. The auditor had participated in a material way to prepare the supplementary information.

c. The supplementary information is derived directly from the underlying records used to prepare the statements and relates to the same period. The auditor must determine whether the supplementary information is derived directly from the underlying records used to prepare the statements and relates to the same period.

An auditor practicing in the U.S. has been engaged to report on the financial statements of a U.S. entity that have been prepared in accordance with a financial reporting framework generally accepted in another country. The auditor should a. Notify management that the auditor is required to disclaim an opinion on the financial statements. b. Receive a waiver from the auditor's state board of accountancy to perform the engagement. c. Understand the framework. d. Be certified by the appropriate auditing or accountancy board of the other country.

c. Understand the framework. An auditor practicing in the U.S. may report on financial statements prepared in accordance with a financial reporting framework generally accepted in another country. Such a framework is not one adopted by a standards setter designated by the AICPA Council to establish GAAP (e.g., the FASB for U.S. GAAP and the IASB for IFRS). In these circumstances, because of the requirement to understand the entity's selection and application of accounting policies (AU-C 315), the auditor should obtain an understanding of the framework. The auditor's report should identify the country of origin of the accounting standards used to prepare the statements. It also should identify the auditing standards followed in performing the audit.

Unaudited financial statements are presented in comparative form with audited financial statements in a document filed with the Securities and Exchange Commission. In accordance with the PCAOB's Auditing Standards, such statements should be 1. Marked as "Unaudited" 2. Withheld until Audited 3. Referred to in the Auditor's Report a. No Yes No b. No Yes Yes c. Yes No No d. Yes No Yes

c. Yes No No According to the PCAOB's Auditing Standards, when unaudited financial statements are presented in comparative form with audited statements in documents filed with the SEC, such statements should be clearly marked as "unaudited." They should not be referred to in the auditor's report or withheld until audited. NOTE: The source of authoritative guidance is the PCAOB's Auditing Standards, not the clarified SASs published by the AICPA. The PCAOB Standards apply to services for issuers.

An auditor may express a qualified opinion for which of the following reasons? Circumstances Limitations Related to Imposed by the Work Management a. No No b. Yes No c. Yes Yes d. No Yes

c. Yes Yes An auditor may express a qualified opinion due to an inability to obtain sufficient appropriate audit evidence if the possible effects are material but not pervasive. The inability to obtain sufficient audit evidence (also called a scope limitation) may result from (1) circumstances not controlled by the entity, such as destruction or government seizure of accounting records; (2) circumstances related to the nature or timing of the work, such as not being able to (a) observe inventory due to the late appointment of the auditor, (b) obtain an investee's financial information, or (c) determine that controls are ineffective; or (3) limitations imposed by management, such as preventing the auditor from observing inventory or confirming receivables (AU-C 705).

Which of the following statements in an attorney's legal letter requires further investigation? a. "It is our opinion that the possible liability to the company in this proceeding is nominal in amount." b. "We believe that the plaintiff's case against the company is without merit." c. "We are of the opinion that this action will not result in any liability to the company." d. "It is our opinion that the company will be able to assert meritorious defenses to this action."

d. "It is our opinion that the company will be able to assert meritorious defenses to this action." A letter of inquiry to external legal counsel is the auditor's primary means of obtaining corroboration of the information provided about material litigation, claims, and assessments by management. Although the attorney believes a strong defense can be mounted against the action, the attorney has not provided an opinion as to whether the action will lead to a liability; thus, further investigation would be required by the auditor.

For which of the following events would an auditor issue a report that omits any reference to a change in accounting principle or correction of a material misstatement? a. Management's lack of reasonable justification for a material change in accounting principle. b. A change in the method of accounting for inventories. c. A change from an accounting principle that is not in accordance with the applicable reporting framework to one that is. d. A change in the useful life used to calculate the provision for depreciation expense.

d. A change in the useful life used to calculate the provision for depreciation expense. A change in estimate is neither a change in accounting principle nor the correction of a material misstatement in previously issued financial statements. Thus, it requires no modification of the opinion or other recognition in the report. However, an exception is a material change in estimate that is inseparable from a change in principle, e.g., a change in the method of depreciation. The auditor evaluates and reports on this change as a change in principle. Under U.S. GAAP, it is accounted for as a change in estimate.

In connection with a proposal to obtain a new client, an accountant in public practice is asked to prepare a written report on the requirements of an applicable financial reporting framework to a specific transaction. The accountant's report should include a statement that a. The guidance provided is for general use. b. The engagement was performed in accordance with Statements on Standards for Consulting Services. c. Nothing came to the accountant's attention that caused the accountant to believe that the application of the financial reporting framework to the facts is inappropriate. d. Any difference in the facts, circumstances, or assumptions presented may change the report.

d. Any difference in the facts, circumstances, or assumptions presented may change the report. The accountant's report is addressed to the requesting party. The report should contain (1) a description of the engagement and a statement that it was performed in accordance with AU-C 915; (2) a description of the transaction and identification of the entity; (3) a description of the financial reporting framework applied (including its country of origin), the type of report that may be issued, and the reasons for the conclusion; (4) a statement that the responsibility for proper accounting is with the preparers of the financial statements; (5) statements of the facts, circumstances, and assumptions and their sources; (6) a statement that any difference in the facts, etc., may change the report; (7) an alert restricting the use of the report to specified parties; and (8), if the accountant is not independent, a statement of the lack of independence.

Management should address written representations about a firm's annual audit to the a.Shareholders. b. Board of directors. c. Firm's attorneys. d. Auditor.

d. Auditor. The auditor is required to obtain written representations from management. They confirm certain matters or support other evidence and complement other procedures. But they do not provide sufficient appropriate evidence. They also do not affect the nature or effects of other procedures. Written representations should be in a letter addressed to the auditor and dated as of the date of the auditor's report. The auditor should possess this letter before release of the auditor's report. The CEO and CFO usually should sign the letter.

When an auditor concludes there is substantial doubt about a continuing audit client's ability to continue as a going concern for a reasonable period of time, the auditor's responsibility is to a. Report to the client's audit committee that management's accounting estimates may need to be adjusted. b. Reissue the prior year's auditor's report and add a separate paragraph that specifically refers to "substantial doubt" and "going concern." c. Express a qualified or adverse opinion, depending upon materiality, due to the possible effects on the financial statements. d. Consider the adequacy of disclosure about the client's possible inability to continue as a going concern.

d. Consider the adequacy of disclosure about the client's possible inability to continue as a going concern. After considering (1) identified conditions and events in the aggregate that raise going concern issues and (2) management's plans for coping with their adverse effects, the auditor may conclude that a substantial doubt exists about the entity's ability to continue as a going concern for a reasonable period of time. In that case, the auditor should consider the possible effects on the financial statements and the adequacy of disclosure. The auditor also should include an emphasis-of-matter paragraph in the report.

After considering management's plans, an auditor concludes that there is substantial doubt about a client's ability to continue as a going concern for a reasonable period of time. The auditor's responsibility includes a. Indicating to the client's audit committee whether management's plans for dealing with the adverse effects of the financial difficulties can be effectively implemented. b. Issuing a qualified or adverse opinion, depending upon materiality, due to the possible effects on the financial statements. c. Disclaiming an opinion on the financial statements due to the indications of possible financial difficulties. d. Considering the adequacy of disclosure about the client's possible inability to continue as a going concern.

d. Considering the adequacy of disclosure about the client's possible inability to continue as a going concern. The auditor considers (1) identified conditions and events in the aggregate that raise going-concern issues, (2) management's written representations, and (3) management's plans for coping with their adverse effects. The auditor then may conclude that a substantial doubt exists about the entity's ability to continue as a going concern for a reasonable period of time. In that case, the auditor should consider the possible effects on the financial statements and the adequacy of disclosure. The auditor also should include an emphasis-of-matter paragraph in the report.

A statement in a group auditor's report that part of the audit was performed by a component auditor most likely indicates the a. Lack of materiality of the portion of the financial statements audited by the component auditor. b. Group auditor's recognition of the component auditor's competence and independence. c. Different opinions the auditors are expressing on the components of the financial statements that each audited. d. Decision not to assume responsibility for the audit of the component auditor.

d. Decision not to assume responsibility for the audit of the component auditor A reference to a component auditor indicates that the group auditor does not assume responsibility for the audit of the component auditor. It also indicates the source of the audit evidence with respect to the component. The reference is not a qualification of the opinion.

Regarding the outcome of uncertainties that exist at the end of the period, management is responsible for which of the following? a. Hedging against all potential outcomes of uncertainties. b. Disclosing all available information about uncertainties in a financial statement note. c. Attempting to tie up all uncertainties before the financial statements are issued. d. Estimating the effect of future events on the financial statements.

d. Estimating the effect of future events on the financial statements. Conclusive audit evidence about the outcome of uncertainties is not expected to exist at the date of the audit. Accordingly, management is responsible for (1) estimating the effect of future events on the financial statements or (2) determining that a reasonable estimate is not possible and making required disclosures.

The financial statements of KCP America, a U.S. entity, are prepared for inclusion in the consolidated financial statements of its non-U.S. parent. These financial statements are prepared in accordance with a financial reporting framework generally accepted in the parent's country and are for use only in that country. Which is an appropriate report on the financial statements for KCP America's auditor to issue? I. A U.S. form of report (unmodified) II. A U.S. form of report modified to report on the financial reporting framework of the parent's country III. The report form of the parent's country a. II only. b. I, II, and III. c. I only. d. II and III only.

d. II and III only. Financial statements may be prepared in accordance with a financial reporting framework generally accepted in another country. In these circumstances, if the statements are prepared for use only outside the U.S., the auditor may use either a U.S. form of report modified to report on the financial reporting framework of the other country or, if appropriate, the report form of the other country. An unmodified U.S. form of report is inappropriate because of the departures from GAAP contained in statements prepared in accordance with a financial reporting framework generally accepted in the other country.

After considering an entity's negative trends and financial difficulties, an auditor has substantial doubt about the entity's ability to continue as a going concern. The auditor's considerations relating to management's plans for dealing with the adverse effects of these conditions most likely would include management's plans to a. Reduce existing lines of credit. b. Purchase assets formerly leased. c. Increase current dividend distributions. d. Increase ownership equity.

d. Increase ownership equity. Once an auditor identifies conditions and events indicating that a substantial doubt exists about an entity's ability to continue as a going concern, (s)he should consider management's plans to mitigate their adverse effects. Increasing equity is likely to be a mitigating factor (AU-C 570). Thus, the auditor should consider the feasibility of such a plan, including arrangements to raise capital, and any arrangements to reduce dividends or to accelerate cash receipts from investors or affiliates.

After issuing an auditor's report, an auditor has no obligation to make continuing inquiries about audited financial statements unless a. A final resolution is made of a contingent liability that had been disclosed in the financial statements. b. Information about a material transaction that occurred just after the auditor's report was issued is deemed to be reliable. c. An event occurs just after the auditor's report was issued that affects the entity's ability to continue as a going concern. d. Information that existed at the report date and may affect the report comes to the auditor's attention.

d. Information that existed at the report date and may affect the report comes to the auditor's attention. Although the auditor may need to extend subsequent events procedures when issuers make filings under the Securities Act of 1933 (AU-C 925, Filings with the U.S. Securities and Exchange Commission Under the Securities Act of 1933), (s)he ordinarily need not apply any procedures after the date of the report. However, facts may be discovered by the auditor after the report release date that, if known at that date, might have caused the auditor to revise the report. In this case, the auditor should (1) discuss the matter with management and (2) determine whether the statements should be revised and, if so, how management intends to address the matter in the statements (AU-C 560).

An auditor is engaged to report on the financial statements of a nonissuer. An emphasis-of-matter paragraph included in the report a. Is described as an explanatory paragraph by the AICPA. b. Refers to matters not disclosed in the financial statements. c. Is never required. d. Is included after the opinion paragraph.

d. Is included after the opinion paragraph. An emphasis-of-matter paragraph draws users' attention to a matter appropriately presented or disclosed that is fundamental to their understanding of the financial statements. An auditor who includes an emphasis-of-matter paragraph in the report should (1) include it immediately after the opinion paragraph, (2) use the heading Emphasis of Matter or another appropriate heading, (3) clearly refer to the matter being emphasized and state where relevant disclosures that fully describe the matter can be found, and (4) indicate that the opinion is not modified with respect to the matter.

An annual shareholders' report includes audited financial statements and contains a management report asserting that the financial statements are the responsibility of management. Is it permissible for the auditor's report to refer to the management report? a. No, because the auditor has no responsibility to read the other information in a document containing audited financial statements. b. Yes, provided the reference is included in a separate explanatory paragraph of the auditor's report. c. Yes, provided the auditor reads the management report and discovers no material misrepresentation of fact. d. No, because the reference may lead to the belief that the auditor is providing assurances about management's representations.

d. No, because the reference may lead to the belief that the auditor is providing assurances about management's representations. According to AU-C 700, such a reference in the auditor's report may lead users to the erroneous belief that the auditor is giving assurances about management's representations in the separate statement in the annual report.

When an audit firm includes a report on compliance with aspects of contractual agreements in the auditor's report on the nonissuer's financial statements, in which paragraph of the audit report should the report on compliance be included? a. Emphasis-of-matter paragraph. b. Opinion paragraph. c. Auditor's responsibility paragraph. d. Other-matter paragraph.

d. Other-matter paragraph. When the report on compliance with aspects of contractual agreements is included in the auditor's report, the report should include an other-matter paragraph. This paragraph refers to a matter not presented or disclosed in the statements that is relevant to understanding (1) the audit, (2) the auditor's responsibilities, or (3) the auditor's report.

If a material change in estimate is inseparable from a change in accounting principle, this event should be evaluated by the auditor as a change in a. Estimate, and the auditor should not recognize the change in the report. b. Principle, and the auditor should not recognize the change in the report. c. Estimate, and the auditor should report on consistency. d. Principle, and the auditor should report on consistency.

d. Principle, and the auditor should report on consistency. When a material change in estimate is inseparable from a change in accounting principle, the FASB requires the change to be accounted for prospectively as a change in estimate, not retrospectively as a change in principle. However, an auditor should evaluate and report on the change as a change in principle. This type of change requires recognition in the auditor's report as to consistency. An example is a change in a method of depreciation of an asset to reflect a change in benefits or in their pattern of consumption (AU-C 708).

If an issuer releases financial statements that purport to present its financial position and results of operations but omits the statement of cash flows, the auditor ordinarily will express a(n) a. Disclaimer of opinion. b. Review report. c. Unmodified opinion with a separate emphasis-of-matter paragraph. d. Qualified opinion.

d. Qualified opinion. An entity that reports financial position and results of operations should provide a statement of cash flows. Thus, the omission of the cash flow statement is normally a basis for modifying the opinion. If the statements fail to disclose required information, the auditor should provide the information in the report, if practicable. However, the auditor is not required to prepare a basic financial statement. Accordingly, (s)he should qualify the opinion and explain the reason in a basis for qualified opinion paragraph.

When a nonissuer entity changes its method of accounting for income taxes, which has a material effect on comparability, the auditor should refer to the change in an emphasis-of-matter paragraph added to the auditor's report. This paragraph should describe the change and a. Describe the cumulative effect of the change on all periods prior to those presented. b. Explain why the change is justified under the applicable reporting framework. c. State the auditor's explicit concurrence with or opposition to the change. d. Refer to the financial statement note that discusses the change in detail.

d. Refer to the financial statement note that discusses the change in detail. When a change in accounting principle has a material effect on comparability, the auditor should add an emphasis-of-matter paragraph after the opinion paragraph that (1) uses the heading "Emphasis of Matter," (2) describes the change in principle, (3) refers to the entity's disclosure, and (4) indicates that the opinion is not modified with regard to the matter emphasized.

Grauer, Inc., accounts for its investment in Salvemini Corporation using the equity method. Grauer's investment in Salvemini equals 45% of the total assets of Grauer. The two entities are not audited by the same CPA. For Grauer's auditor to express an unmodified opinion regarding the value of Grauer's investment in Salvemini and the income derived from it, Grauer's auditor a. Should review the audit documentation of Salvemini's auditor. b. Needs to obtain only Salvemini's audited financial statements. c. Needs to obtain only Salvemini's unaudited financial statements. d. Should obtain Salvemini's audited financial statements and make inquiries about the professional reputation and independence of Salvemini's auditor.

d. Should obtain Salvemini's audited financial statements and make inquiries about the professional reputation and independence of Salvemini's auditor. With respect to investments valued based on the investee's financial results (e.g., the equity method), the auditor who uses another auditor's report to report on the entity's equity and share of earnings or losses is in the position of a group auditor. But whether or not the group auditor wishes to refer to the work of the other auditor, (s)he should obtain an understanding of the professional competence and independence of the other auditor. Furthermore, the auditor may not express an unmodified opinion when a long-term investment is material unless (s)he has obtained sufficient appropriate evidence about the investment. The inability to obtain audited statements of a long-term investee is a common scope limitation that precludes an unmodified opinion.

Which of the following occurs when an adverse opinion is expressed on the financial statements? a. Misstatements are found to be material and the effects are not found to be pervasive. b. The management's responsibility paragraph changes. c. The introductory paragraph changes. d. The auditor's responsibility section changes.

d. The auditor's responsibility section changes The auditor's responsibility section is changed to state, "We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our adverse audit opinion."

Adequate disclosure means that sufficient information is presented so that financial statements are not misleading. The decisions about adequate disclosure should reflect the needs of a. All readers of the financial statements. b. Governmental regulatory agencies. c. Experts in accounting and finance. d. Users with a reasonable knowledge of business.

d. Users with a reasonable knowledge of business. The auditor considers the needs of users of the financial statements. However, it is reasonable for the auditor to assume that users (1) have reasonable knowledge of business and accounting, (2) are willing to study financial information with reasonable diligence, (3) understand the materiality limits of audited statements, (4) recognize that many amounts in the statements are based on estimates and judgments, and (5) make reasonable decisions based on the statements.