Auditing Final

Which of the following controls would most likely reduce the risk of diversion of customer receipts by a client's employees? 1) A bank lockbox system. 2) Pre-numbered remittance advices. 3) Monthly bank reconciliations. 4) Daily deposit of cash receipts.

(1) A bank lock box is a post office box controlled by a company's bank at which cash remittances from customers are received. With such a system the bank collects the remittances, immediately credits the cash to the company's bank account, and forwards the remittance advices to the company. Use of a bank lockbox system makes it extremely difficult for employees to divert cash receipts since those cash receipts are sent directly to the post office box controlled by the bank. Answer (2) is incorrect because remittance advices may be prenumbered, but since they come from various customers, they do not have one overall sequence for the client. Answers (3) and (4), bank reconciliations, and daily deposit of cash receipts, are controls, but controls that ordinarily are not as effective as a bank lockbox system.

The document issued by a common carrier acknowledging the receipt of goods and setting forth the provisions of the transportation agreement is the: 1) Bill of lading. 2) Job time shipping. 3) Production order. 4) Production schedule.

(1) A bill of lading acknowledges the receipt of goods and sets forth provisions of the transportation agreement.

As part of their audit, auditors obtain a representation letter from their client. Which of the following is not a valid purpose of such a letter? 1) To increase the efficiency of the audit by eliminating the need for other audit procedures. 2) To remind the client's management of its primary responsibility for the financial statements. 3) To document in the audit working papers the client's responses to certain verbal inquiries made by the auditors during the engagement. 4) To provide evidence in those areas dependent upon management's future intentions.

(1) A client letter of representations may never be used as a substitute for other appropriate auditing procedures.

In an audit of a sole proprietorship, a common difficulty is lack of: 1) Segregation of personal net worth and business capital. 2) Availability of the owner. 3) Agreement as to the distribution between retained earnings and owners' capital. 4) Proper measures of dividends.

(1) A common difficulty for a sole proprietorship is segregating personal and business assets and personal net worth. For example, credit cards and cash accounts may be used for both personal and business use, thus complicating the accounting process.

Which of the following ordinarily involves the addition of an emphasis-of-matter paragraph to an audit report? 1) A consistency modification. 2) An adverse opinion. 3) A qualified opinion. 4) Part of the audit has been performed by component auditors.

(1) A consistency modification results in an emphasis-of-matter paragraph. Qualified and adverse opinions include a basis for modification paragraph. When a report refers to component auditors no additional paragraph is added.

In which of the following situations would a public accounting firm have violated the AICPA Code of Professional Conduct in determining its fee? 1) A fee is based on whether or not the public accounting firm's audit report leads to the approval of the client's application for bank financing. 2) A fee is to be established at a later date by the Bankruptcy Court. 3) A fee is based upon the nature of the engagement rather than upon the actual time spent on the engagement. 4) A fee is based on the fee charged by the client's former auditors.

(1) A fee for audit clients which is dependent upon the results achieved by the CPA's efforts is a contingent fee and is prohibited for audit clients by the Contingent Fees Rule.

Which of the following statements is NOT typical of property, plant, and equipment as compared to most current asset accounts? 1) A property, plant, and equipment cutoff error near year-end has a more significant effect on net income. 2) Relatively few transactions occur in property, plant, and equipment during the year. 3) The assets involved with property, plant, and equipment ordinarily have relatively longer lives. 4) Property, plant, and equipment accounts typically have a higher dollar value.

(1) A property, plant and equipment cutoff error has less of an effect, not more, on net income. This is because the only effect on income is the small amount of depreciation involved.

Which of the following is not prohibited by the AICPA Code of Professional Conduct? 1) Advertising in newspapers. 2) Payment of commission to obtain an audit client. 3) Acceptance of a contingent fee for a review of financial statements. 4) Engaging in discriminatory employment practices.

(1) Advertising in newspapers is an acceptable practice. The other three replies are all prohibited by the Code of Professional Conduct.

An audit provides reasonable assurance of detecting material: Fraudulent Financial Reporting/Misappropriation of Assets 1) Yes/Yes 2) Yes/No 3) No/Yes 4) No/No

(1) An audit provides reasonable assurance of detecting misstatements due to fraud, regardless of whether due to fraudulent financial reporting or misappropriation of assets.

A public accounting firm would LEAST likely be considered in violation of the AICPA independence rules in which of the following instances? 1) A partner's checking account, which is fully insured by the Federal Deposit Insurance Corporation, is held at a financial institution for which the public accounting firm performs attest services. 2) A manager of the firm donates services as vice president of a charitable organization that is an audit client of the firm. 3) An attest client owes the firm fees for this and last year's annual engagements. 4) A covered member's dependent son owns stock in an attest client.

(1) An auditor's independence would not be considered to be impaired with respect to a financial institution in which the auditor maintains a checking account which is fully insured.

The general group of the 10 PCAOB Auditing Standards requires that: 1) The auditors maintain an independent mental attitude. 2) The audit be conducted in conformity with generally accepted accounting principles. 3) Assistants, if any, be properly supervised. 4) The auditors obtain an understanding of internal control.

(1) An independent mental attitude on the part of the auditor is required by the second general standard of the PCAOB. Answers (3) and (4) relate to the standards of field work. Answer (2) confuses generally accepted accounting principles with generally accepted auditing standards.

Which of the following is not included in an integrated audit report on the financial statements of a public company? 1) The report states that the audit was performed in accordance with AICPA standards. 2) The report indicates that the financial statements are the responsibility of management. 3) The report indicates that the auditors have also audited the effectiveness of the company's internal control. 4) The report is signed in the name of the CPA firm.

(1) An integrated audit report on the financial statements of a public company states that the audit was performed in accordance with Public Company Accounting Oversight Board standards, not AICPA standards.

The auditor's analytical procedures will be facilitated if the client: 1) Uses a standard cost system that produces variance reports. 2) Segregates obsolete inventory before the physical inventory count. 3) Corrects material weaknesses in internal control before the beginning of the audit. 4) Reduces inventory balances to the lower of cost or market.

(1) Analytical procedures will be facilitated when a client uses a standard cost system that produces variance reports. Such reports will allow the auditors to identify significant deviations from expected values.

An auditor usually obtains evidence of stockholders' equity transactions by reviewing the entity's: 1) Minutes of board of directors meetings. 2) Transfer agent's records. 3) Canceled stock certificates. 4) Treasury stock certificate book.

(1) Answer (1) is correct because the board of directors will, in general, authorize changes in stockholders' equity.

An auditor most likely would inspect loan agreements under which an entity's inventories are pledged to support management's financial statement assertion of: 1) Presentation and disclosure. 2) Valuation or allocation. 3) Existence or occurrence. 4) Completeness.

(1) Answer (1) is correct because the presentation and disclosure assertion deals with whether particular components of the financial statements—such as loan agreement covenants—are properly classified, described, and disclosed. The other assertions are less directly related.

The auditors would be most likely to find unrecorded long-term liabilities by analyzing: 1) Interest payments. 2) Discounts on long-term liabilities. 3) Premiums on long-term liabilities. 4) Recorded long-term liability accounts.

(1) Auditors will test the relationship between interest payments and recorded long term liabilities. When interest payments seem too high, it may be due to the existence of unrecorded liabilities. Also, the process of performing procedures to determine who interest is paid to may reveal unrecorded debt.

Ordinarily, the most significant assertion relating to accounts payable is: 1) Completeness. 2) Existence. 3) Presentation. 4) Valuation.

(1) Because an understatement of liabilities overstates income, auditors are ordinarily most concerned with the completeness assertion for payables. Note, however, that in circumstances in which a client may be motivated to understate income (e.g., to minimize taxes), existence becomes a bigger concern.

A primary objective of procedures performed to obtain an understanding of internal control is to provide the auditors with: 1) Knowledge necessary to determine the nature, timing, and extent of further audit procedures. 2) Audit evidence to use in reducing detection risk. 3) A basis for modifying tests of controls. 4) An evaluation of the consistency of application of management policies.

(1) Because the auditors' purposes are for considering internal control are to obtain the necessary knowledge to (a) assess the risks of material misstatement, and (b) to determine the nature, timing, and extent of the tests to be performed, answer (1) is correct.

What best describes the purpose of the auditors' consideration of internal control in a financial statement audit for a nonpublic company? 1) To determine the nature, timing, and extent of audit testing. 2) To make recommendations to the client regarding improvements in internal control. 3) To train new auditors on accounting and control systems. 4) To identify opportunities for fraud within the client's operations.

(1) Because the auditors' purposes for considering internal control are to (a) plan the audit and (b) to determine the nature, timing, and extent of the tests to be performed, answer (1) is correct.

Audit of which of the following accounts is most likely to reveal evidence relating to recorded retirements of equipment? 1) Accumulated depreciation. 2) Cost of goods sold. 3) Purchase returns and allowances. 4) Purchase discounts.

(1) Because the proper recording of a retirement requires elimination of the accumulated depreciation related to the retired equipment, review of this account is most likely to provide evidence about a recorded retirement. .

The search for unrecorded liabilities for a public company includes procedures usually performed through the: 1) Day the audit report is issued. 2) End of the client's year. 3) Date of the auditors' report. 4) Date the report is filed with the SEC.

(3) The search for unrecorded liabilities should be completed as of the last day possible—ordinarily near the date of the audit report.

Where an independent stock transfer agent is not employed and the corporation issues its own stocks and maintains stock records, canceled stock certificates should: 1) Be defaced to prevent re-issuance and attached to their corresponding stubs. 2) Not be defaced but segregated from other stock certificates and retained in a canceled certificates file. 3) Be destroyed to prevent fraudulent re-issuance. 4) Be defaced and sent to the secretary of state.

(1) Canceled stock certificates should be defaced and attached to corresponding stubs as is done with voided checks. The objective of the control is to prevent re-issuance.

All corporate capital stock transactions should ultimately be traced to the: 1) Minutes of the board of directors. 2) Cash receipts journal. 3) Cash disbursements journal. 4) Numbered stock certificates.

(1) Capital stock transactions should all be approved by the client's board of directors. Answer (2) is incorrect because there will be no cash receipt for stock repurchase transactions. Answers (c) and (d) are incorrect because cash disbursements will not be recorded and numbered stock certificates will not be on hand after stock sales.

Under common law, the CPAs who were negligent may mitigate some damages to a client by proving: 1) Contributory negligence. 2) The CPAs' fee was not material. 3) The CPAs were not competent to accept the engagement. 4) The CPAs' negligence was caused by the fact that they had too much work.

(1) Contributory negligence, negligence on the part of the plaintiff, may be used as a defense and the court may limit or bar recovery by a plaintiff whose own negligence contributed to the loss.

Treetop Corporation acquired a building and arranged mortgage financing during the year. Verification of the related mortgage acquisition costs would be least likely to include an examination of the related: 1) Deed. 2) Canceled checks. 3) Closing statement. 4) Interest expense.

(1) Deed.

Which of the following should be included as part of inventory costs of a manufacturing company? Direct Labor--Raw Materials--Factory Overhead 1) Yes, yes, yes. 2) Yes, no, no. 3) No, yes, no. 4) No, no, no.

(1) Direct labor, raw materials, and factory overhead are all included in inventory costs of a manufacturing company.

For effective internal control, the accounts payable department should compare the information on each vendor's invoice with the: 1) Receiving report and the purchase order. 2) Receiving report and the voucher. 3) Vendor's packing slip and the purchase order. 4) Vendor's packing slip and the voucher.

(1) Each vendor's invoice should be compared with the receiving report (to determine that it was received) and the purchase order (to determine that it was ordered). Answer (2) is incomplete because of the omission of the purchase order. Answers (3) and (4) are incorrect because the receiving report, prepared by the company itself, provides better evidence of what has been received than the vendor's packing slip.

In testing plant and equipment balances, an auditor may select recorded additions in the analysis of plant and equipment and inspect the actual asset(s) involved. Which management assertion is this procedure most directly related to? 1) Existence. 2) Completeness. 3) Rights. 4) Valuation.

(1) Existence

The auditors suspect that a client's cashier is misappropriating cash receipts for personal use by lapping customer checks received in the mail. In attempting to uncover this embezzlement scheme, the auditors most likely would compare the: 1) Details of bank deposit slips with details of credits to customer accounts. 2) Daily cash summaries with the sums of the cash receipts journal entries. 3) Individual bank deposit slips with the details of the monthly bank statements. 4) Dates uncollectible accounts are authorized to be written off with the dates the write-offs are actually recorded.

(1) Lapping will result in a delay in the recording of specific remittance credits in the financial records, but the checks will be deposited in the bank as they are received. Therefore, a comparison of the checks deposited to the credits to customer accounts will likely uncover the scheme.

To have an adequate basis to issue a management report on internal control under Section 404(a) of the Sarbanes-Oxley Act, management must do all of the following, except: 1) Establish internal control with no material weakness. 2) Accept responsibility for the effectiveness of internal control. 3) Evaluate the effectiveness of internal control using suitable control criteria. 4) Support the evaluation with sufficient evidence.

(1) Management may issue a report on internal control regardless of whether the system has a material weakness.

McPherson Corp. does not make an annual physical count of year-end inventories, but instead makes weekly test counts on the basis of a statistical plan. During the year, Sara Mullins, CPA, observes such counts as she deems necessary and is able to satisfy herself as to the reliability of the client's procedures. In reporting on the results of her examination, Mullins: 1) Can issue an unqualified opinion without disclosing that she did not observe year-end inventories. 2) Should comment in the scope paragraph as to her inability to observe year-end inventories, but can nevertheless issue an unqualified opinion. 3) Is required, if the inventories are material, to disclaim an opinion on the financial statements taken as a whole. 4) Should, if the inventories are material, qualify her opinion.

(1) Mullins may issue an unqualified opinion as long as she is satisfied that the client's procedures are adequate to provide a reliable inventory balance.

When a primary risk related to an audit is possible overstated inventory, the assertion most directly related is: 1) Existence. 2) Completeness. 3) Clarity. 4) Presentation.

(1) Of the choices, existence is most directly related to overstated inventory because inclusion of inventory items that do not exist in inventory totals results in an overstated inventory.

There is a presumption that auditors will confirm accounts receivable unless the auditors' assessment of the risk of material misstatement is low. 1) And accounts receivable are immaterial, or the use of confirmations would be ineffective. 2) And accounts receivable are composed of large accounts. 3) And the effectiveness of confirmations is absolutely determined. 4) Or accounts receivable are from extremely reputable customers.

(1) Receivables should be confirmed unless the combined assessment of inherent risk and controls risk is at the low level, receivables are immaterial, or the existence of circumstances in which the use of confirmations would be ineffective.

In an audit report on combined financial statements, reference to the fact that a portion of the audit was performed by a component auditor is: 1) Not to be construed as a qualification, but rather as a division of responsibility between the two CPA firms. 2) Not in accordance with generally accepted auditing standards. 3) A qualification that lessens the collective responsibility of both CPA firms. 4) An example of a dual opinion requiring the signatures of both auditors.

(1) Reference to the work of a component auditor is not, in itself, a qualification of the group audit report. This reference does not lessen the auditors' collective responsibility. Rather, it merely divides this responsibility among two or more CPA firms.

When perpetual inventory records are maintained in quantities and in dollars, and internal control over inventory is weak, the auditor would probably: 1) Want the client to schedule the physical inventory count at the end of the year. 2) Insist that the client perform physical counts of inventory items several times during the year. 3) Increase the extent of tests for unrecorded liabilities at the end of the year. 4) Have to disclaim an opinion on the income statement for that year.

(1) Since the internal control is described as being weak, the CPAs will generally insist upon a physical count at year-end.

The most significant result of the Continental Vending case was that it: 1) Created a more general awareness of the possibility of auditor criminal prosecution. 2) Extended the auditor's responsibility to all information included in registration statements. 3) Defined the CPA's responsibilities for unaudited financial statements. 4) Established a precedent for auditors being held liable to third parties under common law for ordinary negligence.

(1) The Continental Vending case was a landmark in establishing auditors' potential criminal liability under the Securities Exchange Act of 1934. The case involved audited financial statements, was brought under statutory law, and did not involve registration statements (which are covered by the Securities Act of 1933).

The organization established by Congress to narrow the options in cost accounting that are available under generally accepted accounting principles is the: 1) Cost Accounting Standards Board. 2) Financial Accounting Standards Board. 3) Public Company Accounting Oversight Board. 4) Securities and Exchange Commission.

(1) The Cost Accounting Standards Board was established by Congress to narrow the options in cost accounting that are available under generally accepted accounting principles.

Which of the following cases reaffirmed the principles in the Ultramares case? 1) Credit Alliance Corp. v. Arthur Andersen & Co. 2) Rosenblum v. Adler. 3) Ernst & Ernst v. Hochfelder. 4) Escott v. BarChris Construction Corporation.

(1) The Credit Alliance Corp. v. Arthur Andersen & Co. case reaffirmed the principles in the Ultramares case by clarifying the conditions necessary for parties to be considered third-party beneficiaries.

The audit of intangible assets typically involves Vouching the Cost of Assets-Testing Allocation Methods 1) Yes, yes. 2) Yes, no. 3) No, yes. 4) No, no.

(1) The audit of intangible assets typically involves both vouching the cost of assts and testing the allocation of that cost.

Which of the following is not a function of audit working papers? 1) Assist management in illustrating that the financial statements are in accordance with generally accepted accounting principles. 2) Assist audit team members responsible for supervision in reviewing the work. 3) Assist auditors in planning future engagements. 4) Assist peer reviewers and inspectors in performing their roles.

(1) The audit working papers are not prepared to assist management in illustrating that the financial statements are in accordance with generally accepted accounting principles. The other three replies are functions of audit working papers.

The auditors who wish to draw reader attention to a financial statement note disclosure on significant transactions with related parties should disclose this fact in: 1) An emphasis-of-matter paragraph to the auditors' report. 2) A footnote to the financial statements. 3) The body of the financial statements. 4) The "summary of significant accounting policies" section of the financial statements.

(1) The auditor communicates through the auditors' report and therefore only answer (1) is correct. Note that the client will include a discussion of the related party transactions in a note to the financial statements.

Cooper, CPA, is auditing the financial statements of a small rural municipality. The receivable balances represent residents' delinquent real estate taxes. Internal control at the municipality is weak. To determine the existence of the accounts receivable balances at the balance sheet date, Cooper would most likely: 1) Send positive confirmation requests. 2) Send negative confirmation requests. 3) Examine evidence of subsequent cash receipts. 4) Inspect the internal records, such as copies of the tax invoices that were mailed to the residents.

(1) The auditor would send positive confirmations rather than negative confirmations because the fact that the balances are delinquent may indicate that amounts are in dispute. Examining subsequent cash receipts, answer (3), is unlikely to be effective since many of the accounts will not have been collected. Inspection of internal records, answer (4), is likely to result in less credibility evidential matter than confirming the accounts.

An audit of the balance in the accounts payable account is ordinarily not designed to: 1) Detect accounts payable that are substantially past due. 2) Verify that accounts payable were properly authorized. 3) Ascertain the reasonableness of recorded liabilities. 4) Determine that all existing liabilities at the balance sheet date have been recorded.

(1) The auditors do not have as an objective the determination of whether accounts payable are past due.

An auditor is most likely to trace treasury stock purchase transactions to the: 1) Numbered stock certificates on hand. 2) Articles of incorporation. 3) Year's interest expense. 4) Minutes of the audit committee.

(1) The auditors should trace treasury stock purchase transactions to the certificates on hand. If the certificates are not on hand, they should be confirmed directly with the custodian. The articles of incorporation, answer (2), will not provide information on the details of specific stock issuances and treasury stock transactions. There is no interest on the treasury stock, and accordingly, answer (3) doesn't relate directly to treasury stock. Finally, it is far more likely that the overall board of directors, not the audit committee, will approve treasury stock transactions. Therefore, answer (4) is not correct.

In an audit, the valuation of year-end accounts payable is most likely addressed by: 1) Confirmation. 2) Examination of cash disbursements immediately prior to year-end. 3) Examination of cash disbursements immediately subsequent to year-end. 4) Analytical procedures applied to vouchers payable at year-end.

(1) The best procedure to determine valuation of payables is confirmation. Examination of cash disbursements in the subsequent period is more directed towards completeness of payables. Analytical procedures may be useful but would not be as effective as confirmation with respect to the valuation assertion.

Which of the following has primary responsibility for the fairness of the representations made in financial statements? 1) Client's management. 2) Independent auditor. 3) Audit committee. 4) AICPA

(1) The client's management is primarily responsible for representations contained in the financial statements. The independent auditors are responsible for performing their audit in accordance with generally accepted auditing standards.

Which of the following is implied when a CPA signs the preparer's declaration on a federal income tax return? 1) The return is not misleading based on all information of which the CPA has knowledge. 2) The return is prepared in accordance with generally accepted accounting principles. 3) the CPA has audited the return. 4) The CPA maintained an impartial mental attitude while preparing the return.

(1) The declaration requires the preparer to acknowledge that the return is "true, correct, and complete...based on all information of which the preparer has any knowledge."

To determine that all sales have been recorded, the auditors would select a sample of transactions from the: 1) Shipping documents file. 2) Sales journal. 3) Accounts receivable subsidiary ledger. 4) Remittance advices.

(1) The goal is to determine the population to be sampled from to determine that all sales have been recorded; therefore, the sample should be taken from a population of source documents, here the shipping documents file. None of the other three answers represent source documents that may be sampled from to determine that all sales have been recorded.

Reconciliation of the bank account should not be performed by an individual who also: 1) Processes cash disbursements. 2) Has custody of securities. 3) Prepares the cash budget. 4) Reviews inventory reports.

(1) The individual who reconciles the bank account should not be involved in the processing of cash receipts or disbursements. Therefore, answer (1) is correct. All of the other functions are compatible with reconciliation responsibilities.

When a CPA decides that the work performed by internal auditors may have an effect on the nature, timing, and extent of the CPA's procedures, the CPA should consider the competence and objectivity of the internal auditors. Relative to objectivity, the CPA should: 1) Consider the organizational level to which the internal auditors report the results of their work. 2) Review the internal auditors' work. 3) Consider the qualifications of the internal audit staff. 4) Review the training program in effect for the internal audit staff.

(1) The internal auditors' objectivity refers to their relative independence from the organizational units they have been evaluating. This may best be determined by considering the organizational level to which the internal auditors report. The other answers address the issues of the internal auditors' competence, not objectivity.

Hall Company had large amounts of funds to invest on a temporary basis. The board of directors decided to purchase securities and derivatives and assigned the future purchase and sale decisions to a responsible financial executive. The best person or persons to make periodic reviews of the investment activity would be: 1) An investment committee of the board of directors. 2) The chief operating officer. 3) The corporate controller. 4) The treasurer.

(1) The investment committee of the board of directors is not involved in the routine of making buy and sell decisions and can therefore review the transactions objectively. On the other hand, the chief operating officer, the controller, and the treasurer may be closely associated on a daily basis with the financial executive responsible for the investment decisions.

The most important benefit of having an annual audit by a public accounting firm is to: 1) Provide assurance to investors and other outsiders that the financial statements are reliable. 2) Enable officers and directors to avoid personal responsibility for any misstatements in the financial statements. 3) Meet the requirements of government agencies. 4) Provide assurance that illegal acts, if any exist, will be brought to light.

(1) The most important benefit of having an annual audit by a public accounting firm is to provide assurance to investors and other outsiders that the financial statements are dependable. The expansion of the securities markets has tremendously increased the need for verification of financial statements performed by competent, independent persons. Answer (2) is incorrect because management cannot avoid responsibility for the financial statements by retaining independent auditors. Answer (3) gives no recognition to the fact that many nonpublic corporations and other business entities have no obligation to file audited financial statements with governmental agencies. It also disregards the fact that large corporations which secure capital from the general public would continue to provide audited statements even though there were no such requirements by governmental agencies. Answer (4) is unacceptable because it implies that an audit is designed to detect illegal acts without regard to type or size.

Instead of taking a physical inventory count on the balance-sheet date, the client may take physical counts prior to the year-end if internal control is adequate and: 1) Well-kept records of perpetual inventory are maintained. 2) Inventory is slow-moving. 3) Computer error reports are generated for missing pre-numbered inventory tickets. 4) Obsolete inventory items are segregated and excluded.

(1) The professional standards allow auditors to use physical counts prior to year-end when a client has well-kept perpetual (computerized or non-computerized) inventory records.

When auditing the statement of cash flows, which of the following would an auditor not expect to be a source of receipts and payments? 1) Capitalization. 2) Financing. 3) Investing. 4) Operations.

(1) The three sections of a statement of cash flows relate to operations, financing, and investing. Capitalization is not one of the sections.

The aggregated misstatement in the financial statements is made up of: Known Misstatements --- Projected Misstatements --- Other Misstatements. 1) Yes, yes, yes. 2) Yes, yes, no. 3) No, yes, no. 4) No, yes, yes.

(1) The total likely misstatements composed of (a) known misstatements, (b) projected misstatements and (c) other misstatements.

Which of the following procedures would the auditors most likely perform to test controls relating to management's assertion about the completeness of cash receipts for cash sales at a retail outlet? 1) Observe the consistency of the employees' use of cash registers and tapes. 2) Inquire about employees' access to recorded buy un-deposited cash. 3) Trace deposits in the cash receipts journal to the cash balance in the general ledger. 4) Compare the cash balance in the general ledger with the bank confirmation request.

(1) The use of cash registers and tapes helps assure that all sales of a retail store are recorded. Answer (2) is incorrect because the cash has already been recorded. Answer (3) is incorrect because the procedure only deals with recorded deposits and, therefore, the completeness assertion is not addressed as directly as in answer (1). Answer (4) is incorrect because one would not expect the cash balance in the general ledger to agree with the bank confirmation request due to items in transit and checks outstanding.

In the continuing audit of a manufacturing company of medium size, which of the following areas would you expect to require the least amount of audit time? 1) Owners' equity. 2) Revenue. 3) Assets. 4) Liabilities.

(1) Transactions in the owners' equity accounts are very few in comparison with the volume of entries in the other three groups. Consequently, the audit time required for owners' equity is usually much smaller than for revenue, assets, or liabilities.

An auditor concluded that no excessive costs for an idle plant were charged to inventory. This conclusion is most likely related to presentation and disclosure and: 1) Valuation. 2) Completeness. 3) Existence. 4) Rights.

(1) Valuation.

An auditor most likely would make inquiries of production and sales personnel concerning possible obsolete inventory to address: 1) Valuation. 2) Rights. 3) Existence. 4) Presentation.

(1) Valuation.

Identify the control that is most likely to prevent the concealment of a cash shortage resulting from the improper write-off of a trade account receivable: 1) Write-offs must be approved by a responsible official after review of credit department recommendations and supporting evidence. 2) Write-offs must be approved by the accounts receivable department. 3) Write-offs must be authorized by the shipping department. 4) Write-offs must be supported by an aging schedule showing that only receivables overdue by several months have been written off.

(1) Write-offs of receivables should be approved by a responsible officer after a review of the account by the credit department. Answer (2) is incorrect because accounts receivable, a recordkeeping function, should not authorize such entries. Answer (3) is incorrect because other procedures (e.g., a review of shipping documents) may be used to determine that the goods were received and because the shipping department would have no other information on whether the receivable is likely to be collectible. Answer (4) is incorrect because the account need not be overdue by several months as a "current" receivable may become worthless due to, for example, a bankruptcy.

In providing non attest services to an attest client, a CPA is allowed to perform which of the following functions? 1) Maintaining custody of the client's securities. 2) Training client employees. 3) Supervising client employees. 4) Acting as the third approver of large client expenditures.

(2) A CPA may help train client employees for an attest client. The Code of Professional Conduct prohibits maintaining custody of client assets, supervising client employees, and authorizing transactions.

If a CPA performs an audit recklessly, the CPA will be liable to third parties who were unknown and not foreseeable to the CPA for: 1) Strict liability for all damages incurred. 2) Gross negligence. 3) Either ordinary or gross negligence. 4) Breach of contract.

(2) A CPA will be liable to third parties who were unknown and not foreseeable for gross negligence. It should be pointed out that if the third party had been "foreseeable," liability might be established for ordinary negligence under a court following the Rosenblum v. Adler decision.

Which of the following is an example of a compliance audit? 1) An audit of financial statements. 2) An audit of a company's policies and procedures for adhering to environmental laws and regulations. 3) An audit of a company's internal control over financial reporting. 4) An audit of the efficiency and effectiveness of a company's legal department.

(2) A compliance audit measures the compliance of an organization with established criteria such as laws and regulations. Answer (2) is correct because it addresses policies and procedures on environmental laws and regulations.

Management of Warren Company has decided to respond to a particular risk by hedging the risk with futures contracts. This is an example of: 1) Avoidance. 2) Acceptance. 3) Reduction. 4) Sharing.

(2) A confirmation is designed to obtain evidence from a third-party. It is not used to document internal control.

A possible loss, stemming from past events that will be resolved as to existence and amounts, is referred to as a(n): 1) Analytical process. 2) Loss contingency. 3) Probable loss. 4) Unasserted claim.

(2) A loss contingency is a possible loss stemming from past events that will be resolved in the future.

A transfer agent and a registrar are most likely to provide the auditor with evidence on: 1) Restrictions on the payment of accounts payable. 2) Shares issued and outstanding. 3) Preferred stock liquidation value. 4) Transfers occurring between management and related parties.

(2) A registrar and transfer agent keep information on the shares issued, outstanding, and the owners of that stock.

Which of the following statements best describes why auditors investigate related party transactions? 1) Related party transactions generally are illegal acts. 2) The substance of related party transactions may differ from their form. 3) All related party transactions must be eliminated as a step in preparing consolidated financial statements. 4) Related party transactions are a form of management fraud.

(2) According to the definition of "related parties," one party may be able to influence the other to the extent that the two parties do not pursue their own separate interests in conducting transactions. Thus, a risk exists that the substance of related party transactions may differ from their form.

When confirming accounts payable, the approach is most likely to be one of: 1) Selecting the accounts with the largest balances at year-end, plus a sample of other accounts. 2) Selecting the accounts of companies with whom the client has previously done the most business, plus a sample of other accounts. 3) Selecting a random sample of accounts payable at year-end. 4) Confirming all accounts.

(2) Accounts payable confirmations are ordinarily sent to suppliers with whom the client has done the most business. This is because the largest potential for an understatement may exist due to the client having established high levels of credit. A sample of other accounts will ordinarily also be selected.

An audit report for a public client indicates that the audit was performed in accordance with: 1) Generally accepted auditing standards (United States). 2) Standards of the Public Company Accounting Oversight Board (United States). 3) Generally accepted accounting principles (United States). 4) Generally accepted accounting principles (Public Company Accounting Oversight Board).

(2) An audit report of a public client indicates that the audit was performed in accordance with standards of the Public Company Accounting Oversight Board (United States).

Analytical procedures are most likely to detect: 1) Weaknesses of a material nature in internal control. 2) Unusual transactions. 3) Noncompliance with prescribed control activities. 4) Improper separation of accounting and other financial duties.

(2) Analytical procedures are effective in isolating unusual transactions because such transactions may represent a change in a relationship being investigated. Analytical procedures are not typically considered to be tests of internal control, although in certain circumstances they might reveal errors caused by weaknesses in the internal control.

Which of the following is not among the criteria that ordinarily exist for revenue to be recognized? 1) Collectibility is reasonably assured. 2) Delivery has occurred or is scheduled to occur in the near future. 3) Persuasive evidence of an arrangement exists. 4) The seller's price to the buyer is fixed or determinable.

(2) Answer (2) is not among the criteria because of the portion of the answer that states "scheduled to occur in the near future." Ordinarily delivery must have occurred. Answers (2), (3) and (4) all describe circumstances required to recognize revenue.

Tests of controls do not address: 1) How controls were applied. 2) How controls were originated. 3) The consistency with which controls were applied. 4) By what means the controls were applied.

(2) Auditors are not in general concerned with how controls originated.

Which of the following procedures is least likely to be completed before the balance sheet date? 1) Confirmation of receivables. 2) Search for unrecorded liabilities. 3) Observation of inventory. 4) Review of internal accounting control over cash disbursements.

(2) Because a significant portion of the search for unrecorded liabilities deals with transactions recorded after year-end, it is least likely to be completed before the balance sheet date.

Which assertion relating to sales is most directly addressed when the auditors compare a sample of shipping documents to related sales invoices? 1) Existence or occurrence. 2) Completeness. 3) Rights and obligations. 4) Presentation and disclosure.

(2) Comparing shipping documents to related sales invoices addresses the completeness assertion relating to sales. More specifically, it addresses whether all items that have been shipped have been recorded as sales.

The best way to verify the amounts of dividend revenue received during the year is: 1) Recomputation. 2) Verification by reference to dividend record books. 3) Confirmation with dividend-paying companies. 4) Examination of cash disbursements records.

(2) Comparing the recorded amount of dividend revenue with dividend record books (published by investment advisory services) provides evidence of the amount of dividend revenue that should have been received during the year. It is virtually impossible to confirm the receipt of dividends with the company paying those dividends.

During the inventory count an auditor selects items and determines that the proper description and quantity were recorded by the client. This procedure is most closely related to: 1) Rights. 2) Completeness. 3) Existence. 4) Valuation.

(2) Completeness.

Which of the following would be least likely to be considered an objective of internal control? 1) Checking the accuracy and reliability of accounting data. 2) Detecting management fraud. 3) Encouraging adherence to managerial policies. 4) Safeguarding assets.

(2) Detecting management fraud is generally not considered to be an objective of internal control. In fact, one of the inherent limitations of internal control is that it is subject to override by management. All of the other answers represent valid objectives of internal control.

Which of the following does the FASB consider a source of non authoritative guidance for use when there is no authoritative guidance available? 1) The FASB Codification. 2) FASB Concepts Statements. 3) SEC Rules. 4) SEC Interpretative Releases.

(2) FASB Concepts Statements are considered nonauthoritative guidance. The other replies all represent authoritative guidance.

Financial statement audits performed under PCAOB requirements are designed to provide which type(s) of assurance with respect to the detection of material misstatements due to errors or fraud? Reasonable Absolute 1) Yes Yes 2) Yes No 3) No Yes 4) No No

(2) Financial statement audits provide reasonable, not absolute assurance.

Which of the following best describes what is meant by the term "fraud risk factor"? 1) Factors that, when present, indicate that risk exists. 2) Factors often observed in circumstances where frauds have occurred. 3) Factors that, when present, require modification of planned audit procedures. 4) Weaknesses in internal control identified during an audit.

(2) Fraud risk factors are factors that have been observed in circumstances in which fraud has occurred. The fraud risk factors were identified by researchers and practitioners through analyses of many past frauds. Yet, none of the factors was always present in the various individual cases included in the analyses. Answer (1) is incorrect because in any particular circumstance, the existence of a fraud risk factor may or may not indicate that in that circumstance the risk of fraud is high. Answer (3) is incorrect because the existence of a fraud risk factor may not require modification of planned audit procedures (e.g., the audit plan may already have audit procedures that consider the factor). Answer (4) is incorrect because a fraud risk factor may or may not be a significant deficiency.

To strengthen internal control over the custody of heavy mobile equipment, the client would most likely institute a policy requiring a periodic: 1) Increase in insurance coverage. 2) Inspection of equipment and reconciliation with accounting records. 3) Verification of liens, pledges, and collateralizations. 4) Accounting for work orders.

(2) Inspection of equipment and the reconciliation of the equipment with accounting records will strengthen internal control over custody of the equipment.

Effective internal control in a small company that has an insufficient number of employees to permit proper separation of responsibilities can be improved by: 1) Employment of temporary personnel to aid in the separation of duties. 2) Direct participation by the owner in key record keeping and control activities of the business. 3) Engaging a CPA to perform monthly write-up work. 4) Delegation of full, clear-cut responsibility for a separate major transaction cycle to each employee.

(2) Involvement of the owner in key control functions should be a major step toward preventing material errors or defalcations. Answer (1) would not be cost-effective. Answer (3) would provide some measure of control, but not as much as would daily participation by the owner. If it were feasible to hire additional employees, it would be cheaper to hire permanent employees rather than temporary. The need for internal control is permanent. Answer (4) would weaken, not strengthen internal control.

The audit procedure of confirmation is least appropriate with respect to: 1) The trustee of an issue of bonds payable. 2) Holders of common stock. 3) Holders of notes receivable. 4) Holders of notes payable.

(2) It is not customary to confirm stockholdings by direct communication with individual stockholders. For an actively traded stock, contacting individual stockholders would be very costly and not likely to produce a satisfactory proportion of replies.

Which of the following is most likely to be an overall response to fraud risks identified in an audit? 1) Supervise members of the audit team less closely and rely more upon judgment. 2) Use less predictable audit procedures. 3) Use only certified public accountants on the engagement. 4) Place increased emphasis on the audit of objective transactions rather than subjective transactions.

(2) Less predictable audit procedures are likely to be used when fraud risks are high. SAS 99 also suggest that the auditors have increased skepticism, assign more skilled staff, and consider further management's selection and application of accounting principles. Answer (1) is incorrect because supervision of members of the audit team will be closer, not less. Answer (3) is incorrect because team members may or may not be CPAs (e.g., a fraud specialist who is not a CPA might be added to the team). Answer (d) is incorrect because subjective, rather than objective transactions may often be emphasized—depending upon the nature of the fraud risks identified.

Which of the following explanations most likely would satisfy an auditor who questions management about significant debits to the accumulated depreciation accounts? 1) The estimated remaining useful lives of plant assets were revised upward. 2) Plant assets were retired during the year. 3) The prior year's depreciation expense was erroneously understated. 4) Overhead allocations were revised at year-end.

(2) Plant assets were retired during the year.

A search for overstated property, plant, and equipment purchases would most likely include: 1) Accounts receivable. 2) Property, plant, and equipment. 3) Purchase discounts. 4) Repairs and maintenance expense.

(2) Property, plant and equipment.

In what section of the audit working papers would a long-term lease agreement be filed? 1) Current working paper file. 2) Permanent working paper file. 3) Lead schedule file. 4) Corroborating documents file.

(2) Relatively unchanging data, such as a long-term lease agreement, is placed in the permanent working paper file.

The 1136 Tenants' case was important because of its emphasis upon the legal liability of the CPA when associated with: 1) A review of annual statements. 2) Unaudited financial statements. 3) An audit resulting in a disclaimer of opinion. 4) Letters for underwriters.

(2) The 1136 Tenants case was a landmark case concerning auditors' liability when they are associated with unaudited financial statements.

The AICPA over time has played an important role in standards setting. Which of the following standards are currently established by the AICPA? 1) Accounting standards applicable to nonpublic companies. 2) Auditing standards applicable to audits of nonpublic companies. 3) Quality control standards applicable to audits of public companies. 4) Standards for reviews of the interim financial information issued by public companies.

(2) The AICPA has authority to establish auditing standard for nonpublic companies. The Financial Accounting Standards board has authority for accounting standards of both public and nonpublic companies. The Public Company Accounting Oversight Board has authority to establish standards for audits and reviews of public companies, and quality controls for firms that audit public companies.

Which of the following is most likely to be a violation of the AICPA rules of conduct by Bill Jones, a sole practitioner with no other employees? 1) Jones performs consulting services for a percentage of the client's savings; these are the only services provided for the client. 2) Jones names his firm Jones and Smith, CPAs. 3) Jones advertises the services he provides in an Internet set of telephone "yellow pages." 4) Jones, without client consent, makes available working papers for purposes of a peer review of his practice.

(2) The Form of Organization and Name Rule requires that a firm practice under a firm name that is misleading. In this situation the name is misleading since it appears that Jones' firm is a partnership.

The Sarbanes-Oxley Act created the Public Company Accounting Oversight Board (PCAOB). Which of the following is not one of the responsibilities of that board? 1) Establish independence standards for auditors of public companies. 2) Review financial reports filed with the SEC. 3) Establish auditing standards for audits of public companies. 4) Sanction registered audit firms.

(2) The PCAOB ordinarily does not review financial reports filed with the Securities and Exchange Commission—although, if they so desire, they may review such reports to accomplish their other responsibilities. The other three replies are all explicit responsibilities of the PCAOB.

Which of the following approaches to auditors' liability is least desirable from the CPA's perspective? 1) The Ultramares approach. 2) The Rosenblum approach. 3) The Restatement of Torts approach. 4) The Foreseen User approach.

(2) The Rosenblum Approach provides more third parties the ability to recover damages from the CPA who has performed an engagement with ordinary negligence, and accordingly, is least desirable from the perspective of the CPA. The Ultramares Approach is most desirable, and the Restatement Approach (also known as the Foreseen User Approach) is between the two extremes.

The auditors' report should be dated as of the date the: 1) Report is delivered to the client. 2) Auditors have accumulated sufficient evidence. 3) Fiscal period under audit ends. 4) Peer review of the working papers is completed.

(2) The audit report should be dated no earlier than when the auditors have accumulated sufficient appropriate evidence. This date is often the last day of fieldwork.

To provide assurance that each voucher is submitted and paid only once, the auditors most likely would examine a sample of paid vouchers and determine whether each voucher is: 1) Supported by a vendor's invoice. 2) Stamped "paid" by the check signer. 3) Pre-numbered and accounted for. 4) Approved for authorized purchases.

(2) The auditors will determine whether each voucher is stamped "paid" by the check signer to avoid a situation in which supporting documents are used a second time to elicit a second payment.

The auditors' program for the examination of long-term debt should include steps that require the: 1) Verification of the existence of the bondholders. 2) Examination of copies of debt agreements. 3) Inspection of the accounts payable subsidiary ledger. 4) Investigation of credits to the bond interest income account.

(2) The auditors' examination of long-term debt always includes an examination of copies of debt agreements to ensure the client is not in violation of the covenants of these agreements. Answer (1) describes a procedure that is not performed. Answers (3) and (4) describe procedures that may be performed but they pertain more directly to other accounts.

Which of the following is the best audit procedure for the discovery of damaged merchandise in a client's ending inventory? 1) Compare the physical quantities of slow-moving items with corresponding quantities in the prior year. 2) Observe merchandise and raw materials during the client's physical inventory taking. 3) Review the management's inventory representations letter for accuracy. 4) Test overall fairness of inventory values by comparing the company's turnover ratio with the industry average.

(2) The best procedure for the discovery of damaged goods is an examination of the condition of the inventory during the auditors' observation of the physical inventory.

A client erroneously recorded a large purchase twice. Which of the following internal control measures would be most likely to detect this error in a timely and efficient manner? 1) Footing the purchases journal. 2) Reconciling vendors' monthly statements with subsidiary payable ledger accounts. 3) Tracing totals from the purchases journal to the ledger accounts. 4) Sending written quarterly confirmation to all vendors.

(2) The most efficient way in which the duplicate recording of a purchase transaction may be detected is by reconciling the related payable accounts with vendors' statements.

In cases of breach of contract, plaintiffs generally have to prove all of the following, except: 1) The CPAs had a duty. 2) The CPAs made a false statement. 3) The client incurred losses related to the CPAs' performance. 4) The CPAs breached their duty.

(2) The plaintiffs need not prove that the CPA made a false statement, it is enough to prove losses and breach of a duty that the CPA had.

The preliminary assessments of control risk are often referred to as: 1) The assessed level of control risk. 2) The planned assessed level of control risk. 3) Control risk. 4) Internal control objectives risk.

(2) The planned assessed level of control risk is determined during planning.

The primary objective of a CPA's observation of a client's physical inventory count is to: 1) Discover whether a client has counted a particular inventory item or group of items. 2) Obtain direct knowledge that the inventory exists and has been properly counted. 3) Provide an appraisal of the quality of the merchandise on hand on the day of the physical count. 4) Allow the auditor to supervise the conduct of the count in order to obtain assurance that inventory quantities are reasonably accurate.

(2) The primary objective of the CPAs' observation of inventories is to provide sufficient competent evidence as to the existence of the inventory and the controls over the inventory-taking process.

Which of the following is an internal control weakness related to factory equipment? 1) Checks issued in payment of purchases of equipment are not signed by the controller. 2) All purchases of factory equipment are required to be made by the department in need of the equipment. 3) Factory equipment replacements are generally made when estimated useful lives, as indicated in depreciation schedules, have expired. 4) Proceeds from sales of fully depreciated equipment are credited to other income.

(2) The purchase of factory equipment should be made by the purchasing department regardless of which unit of the company will use the equipment. The purchasing department has the expertise and the established procedures and documents to insure that all purchases are made in accordance with company policy.

A basic objective of a CPA firm is to provide professional services that conform with professional standards. Reasonable assurance of achieving this basic objective is provided through: 1) Compliance with generally accepted reporting standards. 2) A system of quality control. 3) A system of peer review. 4) Continuing professional education.

(2) The quality control standards were established to provide reasonable assurance that professional services confirm with professional standards. Answer (1) is incomplete since many standards in addition to reporting standards must be followed. Answer (3) is incorrect because a peer review monitors whether a firm's quality control standards are being met. Answer (4) is incorrect because continuing professional education is only one part of a system of quality control.

When the auditors are performing a first-time internal control audit in accordance with the Sarbanes-Oxley Act and PCAOB standards, they should: 1) Modify their report for any significant deficiencies identified. 2) Use a "bottom-up" approach to identify controls to test. 3) Test controls for all significant accounts. 4) Perform a separate assessment of controls over operations.

(3) In an audit of internal control performed under PCAOB standards the auditors must test controls for all significant accounts.

In using the work of a specialist, the auditors referred to the specialist's findings in their report. This would be an appropriate reporting practice if the: 1) Client is not familiar with the professional certification, personal reputation, or particular competence of the specialist. 2) Auditors, as a result of the specialist's findings, give a qualified opinion on the financial statements. 3) Client understands the auditors' corroborative use of the specialist's findings in relation to the representations in the financial statements. 4) Auditors, as a result of the specialist's findings, decide to indicate a division of responsibility with the specialist.

(2) The work of a specialist is only referred to in circumstances in which those findings do not support the representations made by management in the financial statements, thus causing the auditors to modify their report.

In performing a test of controls, the auditors vouch a sample of entries in the purchases journal to the supporting documents. Which assertion would this test of controls most likely test? 1) Completeness. 2) Existence. 3) Valuation. 4) Rights.

(2) Vouching from the purchases journal to the supporting documents provides evidence with respect to the existence assertion for purchases.

A change in accounting principles that the auditors believe is not justified is likely to result in which of the following types of audit opinions? Qualified ---- Unmodified with Emphasis-of-Matter 1) Yes, yes. 2) Yes, no. 3) No, yes. 4) No, no.

(2) When an unjustified change in accounting principles occurs, either a qualified or adverse opinion is appropriate as this represents a departure from generally accepted accounting principles. Accordingly, answer (2) is correct since an adverse opinion, but not a disclaimer of opinion is appropriate.

A likely reason that consideration of client compliance with debt provisions is important to an audit is that violation of such debt provisions may affect the total recorded: 1) Number of debt restrictions. 2) Current liabilities. 3) Long-term assets. 4) Capital stock.

(2) When debt provisions are violated, long term debt often becomes immediately payable, and therefore, a current liability.

Subsequent to the issuance of the auditor's report, the auditor became aware of facts existing at the report date that would have affected the report had the auditor then been aware of such facts. After determining that the information is reliable, the auditor should next: 1) Notify the board of directors that the auditor's report must no longer be associated with the financial statements. 2) Determine whether there are persons relying or likely to rely on the financial statements who would attach importance to the information. 3) Request that management disclose the effects of the newly discovered information by adding a footnote to subsequently issued financial statements. 4) Issue revised pro forma financial statements taking into consideration the newly discovered information.

(2) When the auditor becomes aware of facts existing at the report date that would have affected the report, s/he should next determine whether there are persons relying or likely to rely on the financial statements who would attach importance to the information. If such persons are believed to exist, the next step is to determine the best manner in which to disclose the information.

Which of the following elements is most frequently necessary to hold a CPA liable to a client? 1) Acted with scienter or guilty knowledge. 2) Was not independent of the client. 3) Failed to exercise due care. 4) Did not use engagement letter.

(3) A CPA may be found liable to a client when due care has not been exercised.

Which of the following is most likely to be considered a Type 1 subsequent event? 1) A business combination completed after year-end, but for which negotiations began prior to year-end. 2) A strike subsequent to year-end due to employee complaints about working conditions which originated two years ago. 3) Customer checks deposited prior to year-end, but determined to be uncollectible after year-end. 4) Introduction of a new line of products after year-end for which major research had been completed prior to year-end.

(3) A Type 1 subsequent event relates to a condition that came into effect before year-end; Type 1 subsequent events result in an adjusting journal entry. In this situation, the customer's check may be assumed to have been uncollectible at year-end, and therefore it would be considered to be a Type 1 subsequent event. The other three replies refer to events most ordinarily considered to be Type 2 events—the events came into existence after year-end.

Three conditions generally are present when fraud occurs. Select the one below that is not one of those conditions. 1) Incentive or pressure. 2) Opportunity. 3) Supervisory position. 4) Attitude.

(3) AICPA AU-C 240 (PCAOB 316) outlines the three functions generally necessary for fraud as (1) incentive or pressure, (2) opportunity, and (3) attitude. Being in a supervisory position is not one of those conditions, although it may provide the individual an opportunity to commit fraud.

Which of the following is most likely to be an audit objective in the audit of owners' equity? 1) Establish that recorded owners' equity includes all long-term debt and equity balances. 2) Determine that common stock is valued at current market value. 3) Determine that the presentation and disclosure of owners' equity are appropriate. 4) Determine that the existence of recorded owner's equity is in conformity with equity accounting rule valuations.

(3) An audit objective for owners' equity is to determine that presentation and disclosure is appropriate. Answer (1) is incorrect because owners' equity does not include long-term debt. Answer (2) is incorrect because common stock should not be valued at current market value. Answer (4) is incorrect because the term "equity accounting rule valuations" is of uncertain meaning.

An audit report for a public client indicates that the financial statements were prepared in conformity with: 1) Generally accepted auditing standards (United States). 2) Standards of the Public Company Accounting Oversight Board (United States). 3) Generally accepted accounting principles (United States). 4) Generally accepted accounting principles (Public Company Accounting Oversight Board).

(3) An audit report for a public client indicates that the financial statements are presented in conformity with generally accepted accounting principles (United States). The PCAOB does not issue accounting standards.

Which of the following events occurring on January 5, 20X2, is most likely to result in an adjusting entry to the 20X1 financial statements? 1) A business combination. 2) Early retirement of bonds payable. 3) Settlement of litigation. 4) Plant closure due to a strike.

(3) The settlement of litigation is most likely to result in an adjusting entry (i.e., be a "Type 1 subsequent event) because the cause of the litigation most likely occurred before 20X2.

Which of the following is least likely to result in inclusion of an emphasis-of-matter paragraph in an audit report? 1) The company is a component of a larger business enterprise. 2) An unusually important significant event. 3) A decision not to confirm accounts receivable. 4) A risk or uncertainty.

(3) An emphasis-of-matter paragraph is appropriate when an auditor wishes to emphasize a matter concerning the financial statements, but not a matter concerning the scope of the audit engagement. Accordingly, answer (3) is not a situation in which an emphasis-of-matter paragraph is appropriate since confirming accounts receivable relates to the scope of the audit.

Which of the following is not an advantage of establishing an enterprise risk management system within an organization? 1) Reduces operational surprises. 2) Provides integrated responses to multiple risks. 3) Eliminates all risks. 4) Identifies opportunities.

(3) An enterprise risk management system cannot eliminate all risks.

An effective procedure for identifying unrecorded retirements of equipment is to: 1) Foot related property records. 2) Recalculate depreciation on the related equipment. 3) Select items of equipment in the accounting records and then locate them in the plant. 4) Select items of equipment and then locate them in the accounting records.

(3) An inability to locate assets may reveal to the auditors that unrecorded retirements have occurred.

An auditor may compensate for a weakness in internal control by increasing the extent of: 1) Tests of controls. 2) Detection risk. 3) Substantive tests of details. 4) Inherent risk.

(3) An increase in the substantive procedures will decrease detection risk, and thereby compensate for the increased level of control risk due to a weakness in internal control. Answer (1) is incorrect because if the weakness exists, increasing the extent of tests will only provide more evidence on the weakness—not evidence that compensates for the weakness. Answers (2) and (4) are incorrect because a decrease in detection risk or inherent risk, not an increase, would compensate. Also, in the case of inherent risk, it may not be possible to change the assessment since it is a function of the firm's environment.

In planning and performing an audit, auditors are concerned about risk factors for two distinct types of fraud: fraudulent financial reporting and misappropriation of assets. Which of the following is a risk factor for misappropriation of assets? 1) Generous performance-based compensation systems. 2) Management preoccupation with increased financial performance. 3) An unreliable accounting system. 4) Strained relationships between management and the auditors.

(3) An unreliable accounting system provides an opportunity for an individual to misappropriate assets. The other items create risks of fraudulent financial reporting.

Which of the following is NOT an overall test of the annual provision for depreciation expense? 1) Compare rates used in the current year with those used in prior years. 2) Test computation of depreciation provisions for a representative number of units. 3) Test deductions from accumulated depreciation for assets purchased during the year. 4) Perform analytical procedures.

(3) Assets purchased during the year should not result in deductions from the accumulated depreciation account.

Which of the following is not a primary approach to auditing an accounting estimate? 1) Review and test management's process for developing the estimate. 2) Review subsequent transactions. 3) Confirm the amounts. 4) Develop an independent estimate.

(3) Auditors use three basic approaches for auditing accounting estimates—reviewing management's process, reviewing subsequent transactions, and developing an independent estimate. Confirmation is not a basic approach for auditing most accounting estimates.

The auditors who physically examine securities should insist that a client representative be present in order to: 1) Detect fraudulent securities. 2) Lend authority to the auditors' directives. 3) Acknowledge the receipt of securities returned. 4) Coordinate the return of securities to the proper locations.

(3) Because of the liquidity of many securities, the auditor should insist that a client representative be present in order to acknowledge the receipt of securities returned. In the event of subsequent "disappearance" of a security the auditor will not be a suspect.

Which of the following best describes the relationship between assurance services and attest services? 1) While attest services involve financial data, assurance services involve non financial data. 2) While attest services require objectivity, assurance services do not require objectivity. 3) Both attest and assurance services require independence. 4) Attest and assurance services are different terms referring to the same types of services.

(3) Both sets of standards require independence.

The AICPA Code of Professional Conduct states that a CPA shall not disclose any confidential information obtained in the course of a professional engagement except with the consent of the client. This rule may preclude a CPA from responding to an inquiry made by: 1) An investigative body of a state CPA society. 2) The trail board of the AICPA. 3) A CPA-shareholder of the client corporation. 4) An AICPA quality review body.

(3) CPAs in public practice are prohibited from disclosing confidential information without the consent of the client, except in certain specified circumstances. Answers (1), (2), and (4) are three of the circumstances in which disclosure of information is permitted.

Of the following, which is the least reliable type of audit evidence? 1) Confirmations mailed by outsiders to the auditors. 2) Correspondence between the auditors and suppliers. 3) Copies of sales invoices inspected by the auditors. 4) Canceled checks returned in the year-end bank statement directly to the client.

(3) Copies of sales invoices represent internally generated evidence, which is considered least reliable. Confirmations mailed by outsiders and correspondence between the auditor and suppliers represent more reliable externally generated evidence. Canceled checks, although internally generated, are considered reliable because they bear the endorsement of the payee and a perforation or stamp indicating payment by the bank.

An auditor selects items from the client's inventory listing and identifies the items in the warehouse. This procedure is most likely related to: 1) Rights. 2) Completeness. 3) Existence. 4) Valuation.

(3) Existence.

The receiving department is least likely to be responsible for the: 1) Determination of quantities of goods received. 2) Detection of damaged or defective merchandise. 3) Preparation of a shipping document. 4) Transmittal of goods received to the store's department.

(3) The shipping department, not the receiving department, is responsible for preparation of a shipping document.

Which of the following is least likely to be among the auditors' objectives in the audit of inventories and cost of goods sold? 1) Determine that the valuation of inventories and cost of goods sold is arrived at by appropriate methods. 2) Determine the existence of inventories and the occurrence of transactions affecting cost of goods sold. 3) Establish that the client includes only inventory on hand at year-end in inventory totals. 4) Establish the completeness of inventories.

(3) Inventory need not be on hand at year-end. For example, purchases in transit on which title has passed to the client should also be included.

Which of the following elements underlies the application of generally accepted auditing standards, particularly the standards of fieldwork and reporting? 1) Adequate disclosure. 2) Quality control. 3) Materiality and audit risk. 4) Client acceptance.

(3) Materiality and audit risk underly the application of generally accepted auditing standard in that so many audit decisions are affected by the amount used as a materiality measure and the level of audit risk assumed on the engagement.

In general, internal auditors' independence will be greatest when they report directly to the: 1) Financial vice president. 2) Corporate controller. 3) Audit committee of the board of directors. 4) Chief executive officer.

(3) Normally, the higher in an organization an internal auditor reports, the greater the degree of independence. Accordingly, reporting to the audit committee of the board of directors increases the likelihood that the internal auditor will be able to act independently of those being audited. Answers (1) and (2) may lead to a lesser degree of independence because when an internal auditor reports to the financial vice-president or the controller they cannot objectively review their work. Answer (4) is incorrect because it is generally not practical or effective for the internal auditor to report to stockholders on a timely basis.

For the audit of a continuing nonpublic client, the emphasis of the testing for property accounts is on: 1) All transactions resulting in the ending balance. 2) Tests of controls over disposals. 3) Transactions that occurred during the year. 4) Performing analytical procedures on beginning balances of the accounts.

(3) Ordinarily, the emphasis for testing property accounts is on transactions that occurred during the year because the account turns over so slowly. Note, however, that audits performed under the PCAOB Standard 2 also require consideration of internal control over property, plant and equipment.

Controls over financial reporting are often classified as preventative, detective, or corrective. Which of the following is an example of a detective control? 1) Segregation of duties over cash disbursements. 2) Requiring approval of purchase transactions. 3) Preparing bank reconciliations. 4) Maintaining backup copies of key transactions.

(3) Preparing bank reconciliations will detect a variety of misstatements related to cash and is a detective control in the sense that it does not prevent the misstatement from occurring, but may detect it. Answers (1) and (2) are incorrect because segregating duties and requiring approvals are primarily designed to prevent misstatements. Answer (4) is incorrect because the primary purpose of keeping backup copies of key transactions (or all transactions) is prevent loss of information in the event of an information system failure.

To assure accountability for fixed asset retirements, management should implement an internal control that includes: 1) Continuous analysis of miscellaneous revenue to locate any cash proceeds from the sale of plant assets. 2) Periodic inquiry of plant executives by internal auditors as to whether any plant assets have been retired. 3) Utilization of serially numbered retirement work orders. 4) Periodic observation of plant assets by the internal auditors.

(3) Serially numbered retirement work orders provide a systematic means of assuring that units of plant and equipment are not retired without authorization by management. Retirement work orders also provide the accounting department with the information necessary to record the retirement of equipment in the accounting records. The alternative procedures suggested are not satisfactory. Some retirements of plant asset do not involve cash receipts. The inquiries and observations by internal auditors would come after the fact of asset retirements.

When the matter is properly disclosed in the financial statements, the likely result of substantial doubt about the ability of the client to continue as a going concern is the issuance of which of the following audit opinions? Qualified ----- Unmodified with Emphasis-of-Matter 1) Yes, yes. 2) Yes, no. 3) No, yes. 4) No, no.

(3) Substantial doubt about a client's ability to continue as a going concern results in either an unqualified report with explanatory language or a disclaimer of opinion. Accordingly answer (3) is correct since a qualified report is not appropriate.

Which portion of an audit is least likely to be completed before the balance sheet date? 1) Tests of controls. 2) Issuance of an engagement letter. 3) Substantive procedures. 4) Assessment of control risk.

(3) Substantive procedures substantiate the account balances as of the balance sheet date and therefore cannot be completed prior to that date. The other items pertain to the operation of the system during the year under audit and could be completed in the interim period.

Which AICPA quality control standard would most likely be satisfied when a CPA firm maintains records indicating which partners or employees of the firm were previously employed by the CPA firm's clients? 1) Professional relationship. 2) Engagement performance. 3) Relevant ethical requirements. 4) Monitoring.

(3) Such a quality control policy is designed to assure that personnel assigned to an engagement are independent to perform the work, an ethical requirement.

Which of the following organizations establishes accounting standards for U.S. government agencies? 1) The Financial Accounting Standards Board. 2) The Governmental Accounting Standards Board. 3) The Federal Accounting Standards Advisory Board. 4) The Public Company Accounting Oversight Board.

(3) The Federal Accounting Standards Advisory Board establishes accounting standards for United States governmental agencies. The Governmental Accounting Standards Board establishes accounting standards for state and local government entities.

An auditor accepted an engagement to audit the 20X8 financial statements of EFG Corporation and began the fieldwork on September 30, 20X8. EFG gave the auditor the 20X8 financial statements on January 17, 20X9. The auditor completed the audit on February 10, 20X9, and delivered the report on February 16, 20X9. The client's representation letter normally would be dated: 1) December 31, 20X8. 2) January 17, 20X9. 3) February 10, 20X9. 4) February 16, 20X9.

(3) The representation letter should be dated as of the date the audit was completed.

Bill Adams, CPA, accepted the audit engagement of Kelly Company. During the audit, Adams became aware of his lack of competence required for the engagement. What should Adams do? 1) Disclaim an opinion. 2) Issue an adverse opinion. 3) Suggest that Kelly Company engage another CPA to perform the audit. 4) Rely on the competence of client personnel.

(3) The General Standards Rule prohibits a public accounting firm from accepting an engagement that the firm is not competent to perform. If technical competence problems develop during the engagement, the CPAs should advise the client and withdraw from the engagement.

Which of the following provisions is NOT included in The Institute of Internal Auditors Code of Ethics? 1) Performance of work with honesty, diligence, and responsibility. 2) Prudence in the use and protection of information acquired in the course of their duties. 3) Use of appropriate sampling methods to select areas for audit. 4) Continual improvement in proficiency and effectiveness and the quality of services provided.

(3) The IIA Code of Ethics does not directly address the use of sampling methods.

Audit firms that are subject to inspections by the PCAOB staff include: 1) All audit firms. 2) Audit firms that are registered with the SEC. 3) Audit firms that are registered with the PCAOB. 4) Audit firms that are registered with a state board of accountancy.

(3) The PCAOB staff performs inspections of audit firms that are registered with the PCAOB. In order to perform an audit of a public client an audit firm must be registered.

Under the Securities and Exchange Act of 1934, auditors and other defendants are faced with: 1) Joint liability. 2) Joint and several liability. 3) Proportionate liability. 4) Limited liability.

(3) The Private Securities Litigation Reform Act of 1995 amended the Securities and Exchange Act of 1934 to place limits on the amount of the auditors' liability through establishing proportionate liability.

At the completion of the audit, the auditors are least likely to know: 1) The assessed level of control risk. 2) The planned assessed level of control risk. 3) Actual control risk. 4) The scope of tests of controls.

(3) The auditors never know the exact control risk involved—they always simply have an estimate of it.

Which of the following is the best way for the auditors to determine that every name on a company's payroll is that of a bona fide employee presently on the job? 1) Examine human resources records for accuracy and completeness. 2) Examine employees' names listed on payroll tax returns for agreement with payroll accounting records. 3) Make a surprise observation of the company's regular distribution of paychecks on a test basis. 4) Visit the working areas and verify that employees exist by examining their badge or identification numbers.

(3) The best procedure for the detection of a fictitious employee is a surprise observation of the distribution of paychecks. The fictitious employee's paycheck will ordinarily not be picked up, and further audit procedures performed by the auditors may reveal that this is a fictitious employee.

The auditors can best verify a client's bond sinking fund transactions and year-end balance by: 1) Recomputation of interest expense, interest payable, and authorization of bond discount or premium. 2) Confirmation with individual holders of retired bonds. 3) Confirmation with the bond trustee. 4) Examination and count of the bonds retired during the year.

(3) The bond trustee will be able to provide information on both the sinking fund transactions and the year-end balance.

Which of the following is least likely to be an audit objective for debt? 1) Determine the existence of recorded debt. 2) Establish the completeness of recorded debt. 3) Determine that the client has rights to receive proceeds relating to the redemption of debt. 4) Determine that the valuation of debt is in accordance with generally accepted accounting principles.

(3) The client will not receive proceeds related to redemption of its interest-bearing debt—it will pay off the debt.

To determine that each voucher is submitted and paid only once, when a payment is approved, supporting documents should be canceled by the: 1) Authorized members of the audit committee. 2) Accounting department. 3) Individual who signs the checks. 4) Chief executive officer.

(3) The individual who signs the checks should ordinarily be provided with supporting documents that provide support for the disbursement. That individual should then manually or electronically "cancel" the documents so that the amount isn't paid a second time.

Which of the following is not explicitly included in a standard report for a nonpublic company? 1) The CPA's opinion that the financial statements comply with generally accepted accounting principles. 2) That generally accepted auditing standards were followed during the audit. 3) That internal control of the client was satisfactory. 4) An identification of the financial statements audited.

(3) The internal control of the client is not explicitly mentioned in the unqualified standard report although it is implicit in the reference to generally accepted auditing standards. Answers (1), (2), and (4) are all explicitly set forth in the unqualified standard form of audit report.

To test the existence assertion for recorded receivables, the auditors would select a sample from the: 1) Sales orders file. 2) Customer purchase orders. 3) Accounts receivable subsidiary ledger. 4) Shipping documents (bills of lading) file.

(3) The objective is to determine the population the auditors would sample from to test the existence assertion for recorded receivables. The direction of testing should be from the accounts receivable subsidiary ledger to the available support, such as sales invoices, bills of lading, sales orders, and customers' orders.

The primary objective of tests of details of transactions performed as substantive procedures is to: 1) Comply with generally accepted auditing standards. 2) Attain assurance about the reliability of the accounting system. 3) Detect material misstatements in the financial statements. 4) Evaluate whether management's policies and procedures are operating effectively.

(3) The objective of tests of details of transactions performed as substantive procedures is to detect material misstatements in the financial statements as transactions are tested to determine whether they have been properly recorded.

The auditors are most likely to seek information from the plant manager with respect to the 1) Adequacy of the provision for uncollectible accounts. 2) Appropriateness of physical inventory observation procedures. 3) Existence of obsolete machinery. 4) Deferral of procurement of certain necessary insurance coverage.

(3) The plant manager would be the most appropriate individual for inquiries about the existence of machinery that is no longer useable.

Which statement best expresses the factors that purchasers of securities registered under the Securities Act of 1933 need to prove to recover losses from the auditors? 1) The purchasers of securities must prove ordinary negligence by the auditors and reliance on the audited financial statements. 2) The purchasers of securities must prove that the financial statements were misleading and that they relied on them to purchase the securities. 3) The purchasers of securities must prove that the financial statements were misleading; then, the burden of proof is shifted to the auditors to show that the audit was performed with "due diligence." 4) The purchasers of securities must prove that the financial statements were misleading and the auditors were negligent.

(3) Under the Securities Act of 1933 purchasers of securities who sustain losses need only prove that the financial statements contained in the registration statement were misleading. Then the burden is shifted to the auditors to prove that they performed the audit with "due diligence."

You have been assigned to the year-end audit of a financial institution and are planning the timing of audit procedures relating to cash. You decide that it would be preferable to: 1) Count the cash in advance of the balance sheet date in order to disclose any kiting operations at year-end. 2) Coordinate the count of cash with the cutoff of accounts payable. 3) Coordinate the count of cash with the count of marketable securities and other negotiable assets. 4) Count the cash immediately upon the return of the confirmation letters from the financial institution.

(3) Unless all negotiable assets are verified at one time, an opportunity exists for a dishonest officer or employee to conceal a shortage by transferring it from one asset category to another a step ahead of the auditors. For example, marketable securities could be pledged as collateral for a loan. The cash thus obtained could be included with other cash being counted by the auditors. After the cash count, the cash derived from the securities could be removed and used to redeem the pledged securities which would then be available for counting by the auditors. Of course, this type of manipulation could hardly be carried on unless there were weaknesses in internal control. Answer (1) is incorrect because counting cash in advance of the balance sheet date does not relate to kiting. Answer (2) is not persuasive because accounts payable can not be substituted for cash as can negotiable assets. Answer (4) is not correct because there is no particular significance to the amount of cash on hand on the day the bank confirmation letters happen to be returned.

What type or types of audit opinion are appropriate when financial statements are materially and pervasively misstated? Qualified ----- Adverse 1) Yes, yes. 2) Yes, no. 3) No, yes. 4) No, no.

(3) When a misstatement is pervasive, an adverse opinion is appropriate.

A material departure from generally accepted accounting principles will result in auditor consideration of: 1) Whether to issue an adverse opinion rather than a disclaimer of opinion. 2) Whether to issue a disclaimer of opinion rather than a qualified opinion. 3) Whether to issue an adverse opinion rather than a qualified opinion. 4) Nothing, because none of these opinions is applicable to this type of exception.

(3) When the auditors take exception to the application of accounting principles in the client's financial statements, they will issue either a qualified or adverse opinion, depending on whether the misstatement is considered pervasive.

Which of the following is least likely to be a test of controls? 1) Inquiries of client personnel. 2) Inspection of documents. 3) Observation of confirmations. 4) Re-performance of controls.

(3) While tests of controls involve, inquiry, inspection, observation and re-performance, "observation of confirmations" doesn't have a clear meaning.

A CPA issued an unqualified opinion on the financial statements of a company that sold common stock in a public offering subject to the Securities Act of 1933. Based on a misstatement in the financial statements, the CPA is being sued by an investor who purchased shares of this public offering. Which of the following represents a viable defense? 1) The investor has not proved fraud or negligence by the CPA. 2) The investor did not actually rely upon the false statement. 3) The CPA detected the false statement after the audit date. 4) The false statement is immaterial in the overall context of the financial statements.

(4) A CPA may avoid liability under the 1933 Act by proving that their negligence was not the proximate cause of the plaintiff's loss. Accordingly, a finding that the false statement is immaterial would in all circumstances represent a viable defense.

Which of the following business characteristics is not indicative of high inherent risk? 1) Operating results that are highly sensitive to economic factors. 2) Large likely misstatements detected in prior audits. 3) Substantial turnover of management. 4) A large amount of assets.

(4) A large amount of assets by itself is not indicative of high inherent risk. Operating results highly sensitive to economic factors, large past misstatements, and turnover of management all represent characteristics that may indicate high inherent risk.

Which of the following is not a covered member for an attest engagement under Rule 101 of the AICPA Code of Professional Conduct? 1) An individual assigned to the attest engagement. 2) A partner in the office of the partner in charge of the attest engagement. 3) A manager who is in charge of providing tax services to the attest client. 4) A partner in the national office of the firm that performs marketing services.

(4) A partner in the national office of the firm that performs marketing services is not considered a covered member as it is unlikely that this partner will be in a position to influence the attest engagement. Individuals assigned to the attest engagement, all partners in the office, and a manager who provides tax services to the client are all included as covered members.

A primary purpose of the audit working papers is to: 1) Aid the auditors by providing a list of required procedures. 2) Provide a point of reference for future audit engagements. 3) Support the underlying concepts included in the preparation of the basic financial statements. 4) Support the auditors' opinion.

(4) A primary purpose of audit working papers is to provide documented evidence that the auditors had a firm basis for their report.

Which of the following would most likely be detected by an auditor's review of the client's sales cutoff? 1) Excessive goods returned for credit. 2) Unrecorded sales discounts. 3) Lapping of year-end accounts receivable. 4) Inflated sales for the year.

(4) Detecting overstated sales is a primary reason the auditors' review of a client's sales cutoff. For example, shipments made in the first part of January may be improperly included in the December sales total.

Which of the following is most likely to be an example of fraudulent financial reporting relating to sales? 1) Inaccurate billing due to a lack of controls. 2) Lapping of accounts receivable. 3) Misbilling a client due to a data input error. 4) Recording sales when the customer is likely to return the goods.

(4) A sale either shouldn't be recorded or a proper allowance for returns should be established when a customer is likely to return the goods. Thus, simply recording the sale is an example of fraudulent financial reporting when the customer is likely to record the goods. Answers (1) and (3) are examples of errors, while answer (2) is an example of misappropriation of assets.

Which of the following questions would an auditor most likely include on an internal control questionnaire for notes payable? 1) Are assets that collateralize notes payable critically needed for the entity's continued existence? 2) Are two or more authorized signatures required on checks that repay notes payable? 3) Are the proceeds from notes payable used for the purchase of noncurrent assets? 4) Are direct borrowings on notes payable authorized by the board of directors?

(4) Answer (4) is correct because companies frequently require that direct borrowings on notes payable be authorized by the board of directors; accordingly, auditors will determine whether proper policy has been followed.

Which of the following would provide the most assurance concerning the valuation of accounts receivable? 1) Trace amounts in the accounts receivable subsidiary ledger to details on shipping documents. 2) Compare receivable turnover ratios to industry statistics for reasonableness. 3) Inquire about receivables pledged under loan agreements. 4) Assess the allowance for uncollectible accounts for reasonableness.

(4) Answer (4) is correct because receivables are valued at net realizable value, and assessing the allowance for uncollectible accounts for reasonableness will help the auditor determine the proper amount. Answer (1) is incorrect because the limited information in the accounts receivable ledger will not make possible tracing details to the shipping documents—also, the shipping documents may not even capture the total sales price that is included in the accounts receivable ledger. Answer (2) is incorrect because while comparing turnover ratios may provide some information on the collectibility of receivables, it is very imprecise. Answer (3) is incorrect because it relates to presentation and disclosure more directly than valuation.

The primary responsibility of a bank acting as registrar of capital stock is to: 1) Ascertain that dividends declared do not exceed the statutory amount allowable in the state of incorporation. 2) Account for stock certificates by comparing the total shares outstanding to the total in the shareholders' subsidiary ledger. 3) Act as an independent third party between the board of directors and outside investors concerning mergers, acquisitions, and the sale of treasury stock. 4) Verify that stock is issued in accordance with the authorization of the board of directors and the articles of incorporation.

(4) Answer (4) is correct because the primary responsibility of the stock registrar is to prevent any over issuance of stock, and thereby verify that the stock is issued properly.

The least likely approach in auditing management's estimate relating to an accrued liability is to: 1) Independently develop an estimate of the amount to compare to management's estimate. 2) Review and test management's process of developing the estimate. 3) Review subsequent events or transactions bearing on the estimate. 4) Send confirmations relating to the estimate.

(4) Auditors audit estimates through (1) independently developing an estimate, (2) reviewing management's process, and (3) reviewing subsequent events. There often is no one to send a confirmation related to the estimate.

Which of the following non attest services may be performed by the auditors of a public company? 1) Internal audit outsourcing. 2) Tax planning for all company officers. 3) Bookkeeping services. 4) Preparation of the company's tax return.

(4) Auditors may currently prepare the company's tax return. The Sarbanes-Oxley Act as implemented by the PCAOB prohibits internal audit outsourcing, performing tax planning for the company's officers, and performing bookkeeping services.

Auditor confirmation of accounts payable balances at the balance sheet date may be unnecessary because: 1) This is a duplication of cutoff tests. 2) Accounts payable balances at the balance sheet date may not be paid before the audit is completed. 3) Correspondence with the audit client's attorney will reveal all legal action by vendors for nonpayment. 4) There is likely to be other reliable external evidence available to support the balances.

(4) Auditors will usually find in the client's possession externally created evidence such as vendors' invoices and statements that substantiate the accounts payable. No such external evidence is on hand to support accounts receivable.

As one step in testing sales transactions, a CPA traces a random sample of sales journal entries to debits in the accounts receivable subsidiary ledger. This test provides evidence as to whether: 1) Each recorded sale represents a bona fide transaction. 2) All sales have been recorded in the sales journal. 3) All debit entries in the accounts receivable subsidiary ledger are properly supported by sales journal entries. 4) Recorded sales have been properly posted to customer accounts.

(4) Because entries in the sales journal represent recorded sales, tracing entries from it to debits in the accounts receivable ledger provides evidence on whether recorded sales have been properly posted to customer accounts.

Which of the following organizations can revoke the right of an individual to practice as a CPA? 1) The Public Company Accounting Oversight Board. 2) The American Institute of Certified Public Accountants. 3) The Securities and Exchange Commission. 4) The applicable state board of accountancy.

(4) Because the license to practice as a CPA is granted by the state, the applicable state, through its state board of accountancy, has the right to revoke the right of an individual to practice as a CPA. Students are sometimes confused by the fact that while the CPA examination is administered nationally, it is the individual states that award CPA certificates.

Which of the following should the auditors obtain from the predecessor auditors before accepting an audit engagement? 1) Analysis of balance sheet accounts. 2) Analysis of income statement accounts. 3) All matters of continuing accounting significance. 4) Facts that might bear on the integrity of management.

(4) Before accepting an engagement the possible successor should ask questions about the integrity of management, disagreements with management, and the reasons for the change in auditors. All of the other replies are incorrect because they represent information that the successor may wish to obtain after accepting the engagement.

The risk that the auditors will conclude, based on substantive procedures, that a material misstatement does not exist in an account balance when, in fact, such misstatement does exist is referred to as: 1) Business risk. 2) Engagement risk. 3) Control risk. 4) Detection risk.

(4) Detection risk is the risk that the auditor will conclude, based on substantive procedures, that a material misstatement does not exist in an account balance, when, in fact, such misstatement does exist.

Which of the following did not precipitate the passage of the Sarbanes-Oxley Act of 2002 to regulate public accounting firms: 1) Disclosures related to accounting irregularities at Enron and WorldCom. 2) Restatements of financial statements by a number of public companies. 3) Conviction of the accounting firm of Arthur Andersen LLP. 4) Ethical scandals at the AICPA.

(4) Ethical scandals at the AICPA was not one of the causes of the passage of the Sarbanes-Oxley Act of 2002. All of the other responses contributed to passage of the Act.

Which of the following is the best audit procedure for determining the existence of unrecorded liabilities? 1) Examine confirmation requests returned by creditors whose accounts appear on a subsidiary trial balance of accounts payable. 2) Examine unusual relationships between monthly accounts payable balances and recorded purchases. 3) Examine a sample of invoices a few days prior to and subsequent to year-end to ascertain whether they have been properly recorded. 4) Examine selected cash disbursements in the period subsequent to year-end.

(4) Examining selected cash disbursements in the period subsequent to the year-end is the best audit procedure for determining the existence of unrecorded liabilities. All liabilities must eventually be paid, and will therefore be reflected in the accounts when paid if not when incurred. By close study of payments made subsequent to the balance sheet date, the auditors may find items that should have appeared in the balance sheet.

The auditors may conclude that depreciation charges are insufficient by noting: 1) Insured values greatly in excess of book values. 2) Large amounts of fully depreciated assets. 3) Continuous trade-ins of relatively new assets. 4) Excessive recurring losses on assets retired.

(4) Excessive recurring losses on assets retired show that the depreciation expense recognized during the actual useful lives of the assets has been less than the real cost of using the assets.

Which of the following is correct about forensic audits? 1) All audit engagements are forensic in nature. 2) Forensic audits are performed by law firms; they are not performed by CPA firms. 3) Forensic audits are equivalent to compliance audits. 4) Forensic audits are usually performed in situations in which fraud has been found or is suspected.

(4) Forensic audits are usually performed when fraud has been found or is suspected. Answer (1) is incorrect because it overstates the nature of most audits by suggesting that all audits are forensic in nature. Answer (2) is wrong in that CPA firms (or law firms) may perform forensic audits. Answer (3) is incorrect because while compliance audits may find fraud, they are not directed at fraud as are forensic audits.

Government auditing, in addition to including audits of financial statements, often includes audits of efficiency, effectiveness, and: 1) Adequacy. 2) Evaluation. 3) Accuracy. 4) Compliance.

(4) Governmental auditing often extends to audits of efficiency, effectiveness, and compliance (with laws, regulations, etc). The other responses, adequacy, evaluation, and accuracy, are terms not typically used to summarize the scope of governmental auditing.

In order to guard against the misappropriation of company-owned marketable securities, which of the following is the best course of action that can be taken by a company with a large portfolio of marketable securities? 1) Require that one trustworthy and bonded employee be responsible for access to the safekeeping area where the securities are kept. 2) Require that employees who enter and leave the safekeeping area sign and record in a log the exact reason for their access. 3) Require that employees involved in the safekeeping function maintain a subsidiary control ledger for securities on a current basis. 4) Require that the safekeeping function for securities be assigned to a bank or stockbroker that will act as a custodial agent.

(4) Having the securities held in safekeeping by a bank or stockbroker provides strong internal control because they are not available to employees responsible for maintaining the accounting records of the securities. Thus the separation of the custody of securities from the accounting function is complete.

Which of the following accounts should be reviewed by the auditors to gain reasonable assurance that additions to property, plant, and equipment are NOT understated? 1) Depreciation. 2) Accounts Payable. 3) Cash. 4) Repairs.

(4) In recording expenditures on property, plant, and equipment, the logical choice usually is between a revenue expenditure and a capital expenditure. If the outlay is judged to be a revenue expenditure (rightly or wrongly), it will probably be recorded in the Repairs and Maintenance account. If items that should be capitalized are erroneously charged to Repairs and Maintenance, the result will be an understatement of property, plant, and equipment. Consequently, the auditors can gain evidence that additions to property, plant, and equipment are not understated by reviewing the Repairs and Maintenance account. The other alternatives suggested in the question are not plausible. An erroneous debit to cash would be disclosed quickly because of the disagreement between cash receipts and the cash being deposited daily in the bank. A debit to Accounts Payable would lead to protests from creditors. A debit to Depreciation Expense would be a conspicuous error because of the timing of the entry and the lack of a related credit to Accumulated Depreciation.

An entity's ongoing monitoring activities often include: 1) Periodic audits by internal auditors. 2) The audit of the annual financial statements. 3) Approval of cash disbursements. 4) Management review of weekly performance reports.

(4) Management review of weekly performance reports is an ongoing monitoring activity that may detect errors or fraud. Answer (1) is incorrect because while periodic audits by internal audit represent a monitoring activity, they best classified as separate evaluations, and not ongoing monitoring activities. Answer (2) is incorrect because the audit of the annual financial statements is the function of the external auditors. Answer (3) is incorrect because approvals of cash disbursements represent a control activity.

Which of the following should not normally be included in the engagement letter for an audit? 1) A description of the responsibilities of client personnel to provide assistance. 2) An indication of the amount of the audit fee. 3) A description of the limitations of an audit. 4) A listing of the client's branch offices selected for testing.

(4) Management should not be informed about which branches were selected for testing at all or at least not until just before testing is to be done.

The audit committee of a company must be made up of: 1) Representatives from the client's management, investors, suppliers, and customers. 2) The audit partner, the chief financial officer, the legal counsel, and at least one outsider. 3) Representatives of the major equity interests, such as preferred and common stockholders. 4) Members of the board of directors who are not officers or employees.

(4) Members of the audit committee should be independent of management. Therefore, the individuals should be board members who are not employees or officers, and who have not relationship with management that might impair their objectivity.

If the CPAs provided negligent tax advice to a public company, the client would bring suit under: 1) The Securities Act of 1933. 2) The Securities Exchange Act of 1934. 3) The federal income tax law. 4) Common law.

(4) Negligent tax advice would ordinarily result in a suit brought under common law. Note that the client is not covered under the Securities Act of 1933 or the Securities Exchange Act of 1934.

Which of the following is NOT a difference noted when comparing the AICPA audit report to the international audit report? 1) The international audit report may use the phrase "true and fair view." 2) The international audit report may be signed using the personal name of the audit partner, the audit firm, or both. 3) The international audit report requires inclusion of the city of the CPA firm office that performed the audit. 4) The international audit report includes an opinion on internal control.

(4) Neither the AICPA audit report nor the international audit report include an opinion on internal control. The other replies provide actual differences between the two reports.

Rule 202 -- Compliance with Standards requires CPAs to adhere to all of the following applicable standards, except: 1) Statements on standards for Consulting Services. 2) Statements on Auditing Standards. 3) Statements on Standards for Attestation Engagements. 4) Statements on Responsibilities for Assurance Services

(4) No Statements on Responsibilities in Assurance Services exist.

Which of the following is least likely to be considered an inherent risk relating to receivables and revenues? 1) Restrictions places on sales by laws and regulations. 2) Decline in sales due to economic declines. 3) Decline in sales due to product obsolescence. 4) Over-recorded sales due to a lack of control over the sales entry function.

(4) Over-recorded sales due to a lack of control over the sales entry function relates to control risk not inherent risk. The other three replies all relate to inherent risk.

Analysis of which account is least likely to reveal evidence relating to recorded retirement of equipment? 1) Accumulate depreciation. 2) Insurance expense. 3) Property, plant, and equipment. 4) Purchase returns and allowances.

(4) Purchase returns and allowances.

Which of the following is least likely to be considered a substantive procedure relating to payroll? 1) Investigative fluctuations in salaries, wages, and commissions. 2) Test computations of compensation under profit sharing for bonus plans. 3) Test commission earnings. 4) Test whether employee time reports are approved by supervisors.

(4) Testing whether employee time reports are approved by supervisors is an example of a test of a control, not a substantive procedure.

Tests of controls ordinarily are designed to provide evidence of: 1) Balance correctness. 2) Control implementation. 3) Disclosure adequacy. 4) Operating effectiveness.

(4) Tests of controls address operating effectiveness of controls.

Which of these organizations has the responsibility to perform inspections of auditors of public companies? 1) American Institute of Certified Public Accountants. 2) Securities and Exchange Commission. 3) Financial Accounting Standards Board. 4) Public Company Accounting Oversight Board.

(4) The Public Company Accounting Oversight Board was given the authority by the Sarbanes-Oxley Act of 2002 to establish or adopt auditing standards for audits of public companies.

Which of the following is not a financial statement assertion made by management? 1) Existence of recorded assets and liabilities. 2) Completeness of recorded assets and liabilities. 3) Valuation of assets and liabilities. 4) Effectiveness of internal control.

(4) The effectiveness of internal control is not a financial statement assertion made by management.

To gather evidence regarding the balance per bank in a bank reconciliation, the auditors would examine any of the following except: 1) Cutoff bank statement. 2) Year-end bank statement. 3) Bank confirmation. 4) General ledger.

(4) The general ledger will not have information on the balance per bank. The cutoff bank statement, year-end bank statement and bank confirmation will all include information on the balance per bank.

Which of the following procedures is most likely to be included in the final review stage of an audit? 1) Obtain an understanding of internal control. 2) Confirmation of receivables. 3) Observation of inventory. 4) Perform analytical procedures.

(4) The performance of analytical procedures is a required part of the final review stage of an audit and is therefore most likely to be included in that stage of the audit.

As a result of analytical procedures, the independent auditors determine that the gross profit percentage has declined from 30 percent in the preceding year to 20 percent in the current year. The auditors should: 1) Express an opinion that is qualified due to the inability of the client company to continue as a going concern. 2) Evaluate management's performance in causing this decline. 3) Require note disclosure. 4) Consider the possibility of a misstatement in the financial statements.

(4) The purpose of analytical procedures is to locate potential misstatements in the financial statements. The auditors should investigate this significant fluctuation to determine whether it results from a financial statement misstatement.

Which of the following is an example of misappropriation of assets relating to sales? 1) Accidentally recording cash that represents a liability as revenue. 2) Holding the sales journal open to record next year's sales as having occurred in the current year. 3) Intentionally recording cash received from a new debt agreement as revenue. 4) Theft of cash register sales.

(4) Theft of cash register sales is an example of misappropriation of assets. Answer (1) is an example of an error while answers (2) and (3) are examples of fraudulent financial reporting.

Assume that the opinion paragraph of an auditors' report begins as follows: "With the explanation given in Note 6.... the financial statements referred to above present fairly ...." This is: 1) An unmodified opinion. 2) A disclaimer of opinion. 3) An "except for" opinion. 4) An improper type of reporting.

(4) This phrase violates the fourth standard of reporting, because it does not give the reader of the report a clear-cut indication of the auditors' opinion. The phrase appears to modify the standard opinion paragraph, but is not forceful enough to constitute qualifying language.

An auditor most likely would analyze inventory turnover rates to obtain evidence about: 1) Existence. 2) Rights. 3) Presentation. 4) Valuation.

(4) Valuation.

A difference of opinion concerning accounting and auditing matters relative to a particular phase of the audit arises between an assistant auditor and the auditor responsible for the engagement. After appropriate consultation, the assistant auditor asks to be disassociated from the resolution of the matter. The working papers would probably: 1) Remain silent on the matter since it is an internal matter of the auditing firm. 2) Note that the assistant auditor is completely dissociated from responsibility for the auditors' opinion. 3) Document the additional work required, since all disagreements of this type will require expanded substantive procedures. 4) Document the assistant auditor's position and how the difference of opinion was resolved.

(4) When a difference of opinion cannot be resolved, the working papers should be expanded to document the various positions and to describe how the difference of opinion was resolved.

In testing controls over cash disbursements, the auditors most likely would determine that the person who signs the checks also: 1) Reviews the monthly bank reconciliation. 2) Returns the checks to accounts payable. 3) Is denied access to the supporting documents. 4) Is responsible for mailing the checks.

(4) When checks are signed they should not be returned to the accounting department. This control is used so as to avoid a situation in which the accounts payable department fabricates documents, and then collects the checks. Not returning the checks makes it more difficult for this sort of fraud in that the perpetrator must also establish a "safe" address for the check to be mailed to. Answer (1) is incorrect because control is stronger if individuals who are otherwise independent of the cash function prepare and review the monthly bank reconciliation. Answer (2) is incorrect because, as discussed, the checks should not be returned to accounts payable. Answer (3) is incorrect because the individual signing the checks needs access to the supporting documents so he or she can determine whether the expenditure is proper.

Source Documents --> Journals --> Ledgers Tracing from source documents to journals most directly tests: 1) Completeness (understatements). 2) Existence (overstatements).

1) Completeness (understatements)

Source Documents ---> Journals ---> Ledgers The auditors are concerned about source documents that reflect valid transactions that have not been recorded in the journals. Which procedure would be most effective? 1) Trace from source documents to journals. 2) Vouch from journals to source documents. 3) Either (1) or (2)

1) Trace from source documents to journals.

Source Documents --> Journals --> Ledgers Vouching from journals (or ledgers) to source documents most directly tests: 1) Completeness (understatements). 2) Existence (overstatements).

2) Existence (overstatements)

Source Documents --> Journals --> Ledgers The auditors are concerned about transactions that have been recorded for improper amounts. Which procedure would be most effective? 1) Trace from source documents to journals. 2) Vouch from journals to source documents. 3) Either (1) or (2)

3) Either a or b. (if transaction is recorded, testing in either direction will address recording for the proper amount—valuation)

Source Documents --> Journals --> Ledgers The auditors are concerned about transactions that have been recorded in the journals (and subsequently in the ledgers) that are not valid -- that is, a transaction is recorded, but it did not actually occur (e.g., a fraudulent overstatement of sales). Which procedure would be most effective? 1) Trace from source documents to journals. 2) Vouch from journals to source documents. 3) Either (1) or (2)

3) Vouch from journals to source documents.