AICPA Mock Exam

Which of the following characteristics *most likely* would heighten an auditor's concern about the risk of material misstatements arising from fraudulent financial reporting? a. The entity's industry is experiencing declining customer demand. b. Employees who handle cash receipts are *not* bonded. c. Bank reconciliations usually include in-transit deposits. d. Equipment is often sold at a loss before being fully depreciated.

*a. The entity's industry is experiencing declining customer demand.* Choice "a" is correct. In assessing the risk related to material misstatements in an entity's financial statements, the auditor would consider situations that threaten financial stability or profitability, since such situations might provide an incentive to fraudulently misstate the financial statements. Included as one of these characteristics is declining customer demand. Choice "b" is incorrect. Even though the bonding of employees who handle cash is recommended, it is not a significant characteristic in assessing the risk related to material misstatement in an entity's financial statements. Choice "c" is incorrect. Bank reconciliations with in-transit deposits are *not unusual* and would not heighten the auditor's concern about the risk of material misstatement. In-transit deposits can be verified with the bank at a later date. Choice "d" is incorrect. Since depreciation does not adjust an asset to market value, the sale of equipment at a loss before being fully depreciated is *not unusual* and would not heighten an auditor's concern.

In planning an audit, the auditor's knowledge about the design of relevant internal control activities should be used to a. Identify the types of potential misstatements that could occur. b. Assess the operational efficiency of internal control. c. Determine whether controls have been circumvented by collusion. d. Document the assessed level of control risk.

a. Identify the types of potential misstatements that could occur.

A CPA has been requested by a former audit client to reissue the auditor's report for the prior period. Before reissuing the report, the CPA should a. Obtain a letter of representation from the former client's management. b. Make inquiries of the former client's attorney regarding pending litigation. c. Review the former client's records to verify its compliance with debt and loan agreements. d. Consider whether there is substantial doubt about the former client's ability to continue as a going concern.

a. Obtain a letter of representation from the former client's management.

Which of the following events most likely would indicate the existence of related party transactions? a. Insuring the lives of key executives and listing the entity as beneficiary. b. Selling real estate at a price that differs significantly from its appraised value. c. Making a loan with specific scheduled terms for repayment of the funds. d. Granting stock options to key executives at favorable prices.

b. Selling real estate at a price that differs significantly from its appraised value. The following suggest possible related party transactions: (1) exchanging property for similar property in a nonmonetary transaction, (2) borrowing or lending at rates significantly above or below market rates, (3) selling realty at a price materially different from its appraised value, and (4) making loans with no scheduled repayment terms.

Which of the following, discovered during an audit, most likely would raise a question concerning possible illegal acts? a. Related party transactions, although properly disclosed, were pervasive during the year. b. The entity prepared several large checks payable to cash during the year. c. Material internal control weaknesses previously reported to management were not corrected. d. The entity was a campaign contributor to several local political candidates during the year.

b. The entity prepared several large checks payable to cash during the year.

Which of the following fraudulent activities most likely could be perpetrated due to the lack of effective internal controls in the revenue cycle? a. Fictitious transactions may be recorded that cause an understatement of revenues and an overstatement of receivables. b. Claims received from customers for goods returned may be intentionally recorded in other customers' accounts. c. Authorization of credit memos by personnel who receive cash may permit the misappropriation of cash. d. The failure to prepare shipping documents may cause an overstatement of inventory balances.

c. Authorization of credit memos by personnel who receive cash may permit the misappropriation of cash. Likely frauds that can occur in the revenue cycle include shipping goods to nonexistent customers (which are stolen by employees), failing to bill "customers" (these could again be employees) for goods shipped, recording sales without an underlying transaction in order to inflate the sales and accounts receivable figures, creating fictitious credit memos for "returned" goods (a method of stealing cash), and booking sales in periods earlier than they actually occurred (to hike up the sales figures). A client most likely will overstate revenue and accounts receivable in a fraudulent scheme. Only the "authorization of credit memos by personnel who receive cash may permit the misappropriation of cash" is a likely scenario which would benefit either the entity or certain dishonest employees.Intentionally recording claims for goods returned in other customer's accounts is incorrect because recording such claims in the wrong account is likely to be quickly detected when customers who have not received the credit complain.

During an engagement to *review* the financial statements of a *nonissuer*, an accountant becomes aware of several leases that should be capitalized, but are not capitalized. The accountant considers these leases to be material to the financial statements. The accountant decides to modify the standard review report because management will not capitalize the leases. Under these circumstances, the accountant should a. Issue an adverse opinion because of the departure from GAAP. b. Express no assurance of any kind on the entity's financial statements. c. Emphasize that the financial statements are for limited use only. d. Disclose the departure from GAAP in a separate paragraph of the accountant's report.

d. Disclose the departure from GAAP in a separate paragraph of the accountant's report.

If an auditor includes an emphasis-of-matter paragraph to draw users' attention to a matter relevant to the users' understanding of the financial statements of a nonissuer, then the auditor should a. Indicate in the audit report that the emphasis-of-matter paragraph is required by law or regulation. b. Notify the appropriate regulatory authority if the auditor's opinion was modified on the basis of the matter. c. Modify the introductory paragraph to direct the reader to the emphasis-of-matter paragraph. d. Include the paragraph immediately after the opinion paragraph in the audit report.

d. Include the paragraph immediately after the opinion paragraph in the audit report.

An entity prepares its financial statements on its income tax basis. The accompanying notes include a summary of significant accounting policies that discusses the basis of presentation and describes how that basis differs from GAAP. The dollar amount of the effects of the difference between the income tax basis and GAAP a. Is required to be included only in the auditor's report. b. Is required to be included only in the notes to the financial statements. c. Is required to be included both in the notes to the financial statements and the auditor's report. d. Need not be quantified and included in either the notes to the financial statements or the auditor's report.

d. Need not be quantified and included in either the notes to the financial statements or the auditor's report.

Prior to commencing the compilation of financial statements of a nonissuer, an accountant is required to a. Verify that the financial information supplied by the entity agrees with the books of original entry. b. Perform preliminary analytical procedures to identify accounts that may represent specific risks relevant to the engagement. c. Make inquiries of management concerning the entity's procedures used in adjusting and closing the books of account. d. Obtain an understanding of any specialized financial reporting frameworks and practices used in the entity's industry.

d. Obtain an understanding of any specialized financial reporting frameworks and practices used in the entity's industry.