Chapter 17 Review

If group auditors make no reference to component auditors whose work they have relied on as a part of the basis for their report, the group auditors:

Are assuming responsibility for the work of the component auditors.

Which of the following is not included in PCAOB Form AP?

Audit staff investments in each particular client.

The auditors' report should be dated as of the date the:

Auditors have accumulated sufficient appropriate evidence.

An audit report for a public client indicates that the financial statements were prepared in conformity with:

Generally accepted accounting principles (United States).

e. The scope of the auditors' examination is restricted and the auditor is able effectively to apply other procedures.

(A) An unmodified opinion, standard form. (A) An unmodified opinion, standard form.

j. The company changed the lives of some of its fixed assets—the auditor finds the new lives reasonable.

(A) An unmodified opinion, standard form. (A) An unmodified opinion, standard form.

For each of the following situations indicate the letter(s) that corresponds to the appropriate type of auditors' report, both when the situation is "material" and when it is "material and pervasive." Select answer B only when the professional standards require such a report. b. The financial statements reflect a change from one generally accounting principles to another generally accepted accounting principle. The auditor considers the new principle preferable to the previous one.

(B) An unmodified opinion with an additional paragraph (e.g., emphasis of a matter paragraph). (B) An unmodified opinion with an additional paragraph (e.g., emphasis of a matter paragraph).

c. The auditors wish to emphasize in the report a subsequent event described in the notes to the financial statements.

(B) An unmodified opinion with an additional paragraph (e.g., emphasis of a matter paragraph). (B) An unmodified opinion with an additional paragraph (e.g., emphasis of a matter paragraph).

h. Substantial doubt about the client's ability to continue as a going concern exist. This substantial doubt is properly disclosed in the financial statement notes. The auditor will not issue a disclaimer of opinion.

(B) An unmodified opinion with an additional paragraph (e.g., emphasis of a matter paragraph). (B) An unmodified opinion with an additional paragraph (e.g., emphasis of a matter paragraph).

d. The scope of the auditor's examination is restricted and the auditor is not able to effectively apply other procedures.

(C) A qualified opinion (E) A disclaimer opinion.

f. The financial statements reflect a change from one generally accounting principles to another generally accepted accounting principle. The auditor does not consider the new principle preferable to the previous one.

(C) A qualified opinion. (D) An adverse opinion.

i. Substantial doubt about the client's ability to continue as a going concern exist. This substantial doubt is not properly disclosed in the financial statement notes. The auditor will not issue a disclaimer of opinion.

(C) A qualified opinion. (D) An adverse opinion.

10. A client uses the specific identification method of accounting for valuable items in inventory, and LIFO for less valuable items. The auditor concurs that this is a reasonable practice.

1. Unmodified—standard

16. An auditor was hired after year-end and was unable to observe the counting of the year-end inventory. However, she was able to apply other procedures and determined that ending inventory and related information are properly stated.

1. Unmodified—standard

8. A client changed the method it uses to calculate postemployment benefits from one acceptable method to another. The effect of the change is immaterial this year but is expected to be material in the future.

1. Unmodified—standard

9. A client changed the salvage value of certain assets from 5 percent to 10 percent of original cost. The auditor concurs with the change.

1. Unmodified—standard

13. An auditor reporting on group financial statements decides to take responsibility for the work of a component auditor who audited a 70 percent owned subsidiary and issued an unmodified opinion. The total assets and revenues of the subsidiary are 5 percent and 8 percent, respectively, of the total assets and revenues of the entity being audited.

1. Unmodified—standard.

2. A company has not followed generally accepted accounting principles in the recording of its leases. The amounts involved are immaterial.

1. Unmodified—standard.

12. Due to recurring operating losses and working capital deficiencies, an auditor has substantial doubt about an entity's ability to continue as a going concern for a reasonable period of time. The notes to the financial statements do not adequately disclose the substantial doubt situation, and the auditor believes the omission fundamentally affects the users' understanding of the financial statements.

4. Adverse.

1. A company has not followed generally accepted accounting principles in the recording of its leases.

7. Qualified or adverse.

20. In auditing the long-term investments account of a new client, an auditor finds that a large contingent liability exists that is material to the consolidated company. It is probable that this contingent liability will be resolved with a material loss in the future, and this amount is reasonably estimable as $2,000,000. Although no adjusting entry has been made, the client has provided a note to the financial statements that describes the matter in detail and includes the $2,000,000 estimate in that note.

7. Qualified or adverse.

24. A client's financial statements follow GAAP except that they do not include a note on a significant related party transaction.

7. Qualified or adverse.

3. A company valued its inventory at current replacement cost. Although the auditor believes that the inventory costs do approximate replacement costs, these costs do not approximate any GAAP inventory valuation method.

7. Qualified or adverse.

5. A client changed its depreciation method for production equipment from the straight-line to a units-of-production method based on hours of utilization. The auditor does not concur with the change.

7. Qualified or adverse.

Ray, an independent auditor, was engaged to perform an audit of the financial statements of Zena Incorporated one month after its fiscal year had ended. Although the inventory count was not observed by Ray, the auditors were able to obtain sufficient appropriate audit evidence by applying alternative auditing procedures. Rays audit report will probably contain:

A standard unmodified opinion.

Which of the following is not explicitly included in an audit report for a nonpublic company?

A statement that the auditor believes that the audit provides a reasonable basis for expressing negative assurance.

4. An entity changes its depreciation method for production equipment from straight-line to a units-of-production method based on hours of utilization. The auditor concurs with the change, although it has a material effect on the comparability of the entity's financial statements.

A. Unmodified I. Add an emphasis-of-matter paragraph—after opinion paragraph

2. Due to recurring operating losses and working capital deficiencies, an auditor has substantial doubt about an entity's ability to continue as a going concern for a reasonable period of time. However, the financial statement disclosures concerning these matters are adequate. The auditor has decided not to issue a disclaimer of opinion.

A. Unmodified I. Add an emphasis-of-matter paragraph—after opinion paragraph.

3. A group auditor decides to take responsibility for the work of a component CPA who audited a wholly owned subsidiary of the entity and issued an unmodified opinion. The total assets and revenues of the subsidiary represent 17 percent and 18 percent, respectively, of the total assets and revenues of the entity being audited.

A. Unmodified M. Issue standard report without alteration.

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:

An emphasis-of-matter paragraph to the auditors' report.

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:

An improper type of reporting.

5. An entity discloses certain lease obligations in the notes to the financial statements. The auditor believes that the failure to capitalize these leases is a departure from generally accepted accounting principles and, although the possible effects on the financial statements of the misstatements are material, they could not be pervasive.

B. Qualified J. Add a basis-for-modification paragraph—prior to opinion paragraph

For a particular entity's financial statements to be presented fairly in conformity with generally accepted accounting principles, it is not required that the principles selected:

Be applied on a basis consistent with those followed in the prior year.

g. Inventory is valued at sales prices which the auditors find, although reasonable, different from the lower of cost or market valuation system.

C) A qualified opinion. (D) An adverse opinion.

When an auditor of a nonpublic company has concluded there is substantial doubt about an entity's ability to continue as a going concern for a reasonable period of time beyond the date the financial statements will be released (1/26/X2), the auditor's responsibility includes:

Considering the adequacy of disclosure about the entity's possible inability to continue as a going concern.

5. "As discussed in Note 4 to the financial statements, in 20X5 the entity elected to change the estimated life of a number of its plant assets. We concur with this change."

Delete entire paragraph

4. "and subject to the accounting change described in the Emphasis of Matter paragraph"

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Draves Company owns substantial properties that have appreciated significantly in value since the date of purchase. The properties were appraised and are reported in the balance sheet at the appraised values (which materially exceed costs) with related disclosures. The CPAs believe that the appraised values reported in the balance sheet reasonably estimate the assets' current values.

Either qualified or adverse

Slade Company has material investments in stocks of subsidiary companies. Stocks of the subsidiary companies are actively traded in the market. Management insists that all investments be carried at original costs, and the CPA firm is satisfied that the original costs are accurate. The CPA firm believes that the client will never ultimately realize a substantial portion of the investments because the market value is much lower than the cost; the client has fully disclosed the facts in notes to the financial statements.

Either qualified or adverse

During the audit of Eagle Company, the CPA firm has encountered a significant scope limitation relating to inventory record availability and is unable to obtain sufficient appropriate audit evidence in that area.

Either qualified or disclaimer

1. In auditing the long-term investments account, an auditor is unable to obtain audited financial statements for an investee located in a foreign country. The auditor concludes that sufficient appropriate audit evidence regarding this investment cannot be obtained.

F. Qualified or disclaimer J. Add a basis-for-modification paragraph—prior to opinion paragraph.

When an auditor does not confirm material accounts receivable, but is satisfied by the application of alternative auditing procedures, she normally should:

Issue an unmodified opinion with no reference to this omission

a. The financial statements contain a departure from generally accepted accounting principles.

Material (C) A qualified opinion. Mat and Per - (D) An adverse opinion.

An auditor has been asked to report on the balance sheet of Kane Company but not on the other basic financial statements. The auditor will have access to all information underlying the basic financial statements. Under these circumstances, the auditor:

May accept the engagement.

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:

Not to be construed as a qualification, but rather as a division of responsibility between the two CPA firms.

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

Option (3) No Yes

When the matter is properly disclosed in the financial statements of a nonpublic company, 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

Option (3) No Yes

A nonpublic company's 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

Option 2) Yes No

London Company has material investments in stocks of subsidiary companies. Stocks of the subsidiary companies are not actively traded in the market, and the CPA firm's engagement does not extend to any subsidiary company. The CPA firm is able to determine that all investments are carried at original cost but has no real idea of market value. Although the difference between cost and market could be material, it could not have a pervasive effect on the overall financial statements

Qualified

An audit report for a public client indicates that the audit was performed in accordance with:

Standards of the Public Company Accounting Oversight Board (United States).

If financial statements contain a pervasively material departure from generally accepted accounting principles, the auditors usually should issue an adverse opinion.

TRUE

The unmodified standard audit report of a nonpublic company does not explicitly state that:

The audit was conducted in accordance with accounting principles generally accepted in the United States of America.

If audited financial statements include a balance sheet and an income statement, but do not include a statement of cash flows:

The auditors should issue a qualified report for the departure from generally accepted accounting principles.

When reporting on comparative financial statements where the financial statements of the prior period have been examined by a predecessor auditor whose report is not presented, the successor auditor should indicate in the report:

The type of opinion expressed by the predecessor auditor.

Bowles Company is engaged in a hazardous trade and has obtained insurance coverage related to the hazard. Although the likelihood is remote, a material portion of the company's assets could be destroyed by a serious accident.

Unmodified—standard report

The term "except for" in an audit report is:

Used in a qualified opinion.

A material departure from generally accepted accounting principles will result in auditor consideration of:

Whether to issue an adverse opinion rather than a qualified opinion.

2. When financial statements contain a material departure from generally accepted accounting principles, the auditors qualify their opinion, or they issue a(n) __________ opinion depending on the materiality of the departure.

adverse

1. All nonpublic company audit reports that are qualified should contain a(n) __________ explaining the details of the qualification.

basis for modification paragraph (or basis for qualified opinion paragraph)

5. If a scope limitation is so severe that a qualified opinion is inappropriate, the auditors should issue a(n) __________.

disclaimer of opinion

3. The auditor's responsibility relating to a GAAS audit is for __________ on the financial statements.

expressing an opinion

4. When a nonpublic client elects to change accounting principles from one acceptable principle to another acceptable principle and the auditors agree the change is desirable, they should issue a report with a(n) __________ opinion.

unmodified

A scope limitation will generally result in a disclaimer of opinion, regardless of whether sufficient appropriate audit evidence is gathered using alternative procedures.

FALSE

When evaluating the results of audit tests, materiality depends solely upon the dollar amount of the item.

FALSE

6. "Adams, Barnes & Co."

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19. In auditing the long-term investments account of a new client, an auditor finds that a large contingent liability exists that is material to the consolidated company. It is probable that this contingent liability will be resolved with a material loss in the future, but the amount is not estimable. Although no adjusting entry has been made, the client has provided a note to the financial statements that describes the matter in detail.

1. Unmodified—standard.

22. A client is issuing two years of comparative financial statements. The first year was audited by another auditor who is being asked to reissue her audit report. (Reply as to the successor auditors' report.)

1. Unmodified—standard.

6. A client changed the depreciable life of certain assets from 10 years to 12 years. The auditor concurs with the change.

1. Unmodified—standard.

21. A client is issuing two years of comparative financial statements. The first year was audited by another auditor who is not being asked to reissue her audit report. (Reply as to the successor auditors' report.)

10. Other

14. An auditor reporting on group financial statements decides not to take responsibility for the work of a component auditor who audited a 70 percent owned subsidiary and issued an unqualified opinion. The total assets and revenues of the subsidiary are 5 percent and 8 percent, respectively, of the total assets and revenues of the entity being audited.

10. Other.

11. Due to recurring operating losses and working capital deficiencies, an auditor has substantial doubt about an entity's ability to continue as a going concern for a reasonable period of time. The notes to the financial statements adequately disclose the situation. The auditor has decided not to issue a disclaimer of opinion.

2. Unmodified with an emphasis-of-matter paragraph.

23. A client's financial statements follow GAAP, but the auditor wishes to emphasize in his audit report a significant related party transaction that is adequately described in the notes to the financial statements.

2. Unmodified with an emphasis-of-matter paragraph.

4. A client changed its depreciation method for production equipment from the straight-line method to the units-of-production method based on hours of utilization. The auditor concurs with the change.

2. Unmodified with an emphasis-of-matter paragraph.

18. An auditor discovered that a client made illegal political payoffs to a candidate for president of the United States. The auditor was unable to determine the amounts associated with the payoffs because of the client's inadequate record-retention policies. Although there is no likelihood that the financial statements are pervasively misstated, they may be materially misstated. The client refuses to disclose the payoffs in a note to the financial statements.

3. Qualified.

7. A client changed the depreciable life of certain assets from 10 years to 12 years. The auditor does not concur with the change. Confined to fixed assets and accumulated depreciation, the misstatements involved are not considered pervasive.

3. Qualified.

15. An auditor was hired after year-end and was unable to observe the counting of the year-end inventory. She is unable to apply other procedures to determine whether ending inventory and related information are properly stated.

8. Qualified or disclaimer.

17. An auditor discovered that a client made illegal political payoffs to a candidate for president of the United States. The auditor was unable to determine the amounts associated with the payoffs because of the client's inadequate record-retention policies. The client has added a note to the financial statements to describe the illegal payments and has stated that the amounts of the payments are not determinable.

8. Qualified or disclaimer.

Which of the following ordinarily involves the addition of an emphasis-of-matter paragraph to an audit report of a nonpublic company?

A consistency modification

Which of the following is least likely to result in inclusion of an additional paragraph being added to an audit report?

A decision not to confirm accounts receivable.

2. "Sam Best, President"

Replace with "Board of Directors of Keystone"

Certified Public Accountant's Report (Callout #1) To Sam Best, President: (Callout #2) We have audited the accompanying financial statements of Keystone Computers & Networks, Inc., which comprise the balance sheet as of December 31, 20X5, and the related statements of income, changes in stockholders' equity, and cash flows for the year then ended, and the related notes to the financial statements. Management's Responsibility for the Financial Statements Management is responsible for the preparation and fair presentation of these financial statements in accordance with accounting principles generally accepted in the United States of America; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of financial statements that are free from material misstatement, whether due to fraud or error. Auditor's Responsibility Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditor's judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity's preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity's internal control. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion. Basis for Qualified Opinion The Company has excluded from property and debt in the accompanying balance sheets certain lease obligations that, in our opinion, should be capitalized in order to conform with accounting principles generally accepted in the United States of America. If these lease obligations were capitalized, property would be increased by $3,500,000, long-term debt by $3,500,000, and retained earnings by $500,000 as of December 31, 20X5. Additionally, net income would be increased by $500,000 and earnings per share would be increased by $1.12 for the year then ended. (Callout #3) Opinion In our opinion, except for the effects of the matter described in the Basis for Qualified Opinion paragraph and subject to the accounting change described in the Emphasis of Matter paragraph, (Callout #4) the financial statements referred to above present fairly, in all material respects, the financial position of Keystone Computers & Networks, Inc., as of December 31, 20X5, and the results of its operations and its cash flows for the year then ended in accordance with accounting principles generally accepted in the United States of America. Emphasis of Matter As discussed in Note 4 to the financial statements, in 20X5 the entity elected to change the estimated life of a number of its plant assets. We concur with this change. (Callout #5) Adams, Barnes & Co. (Callout #6) Phoenix, Arizona February 6, 20X6. (Callout #7) **1. "Certified Public Accountant's Report"

Replace with "Independent Auditor's Report"

7. "February 6, 20X6."

Replace with "January 31, 20X6, except for Note 7, as to which the date is February 2, 20X6."

3. "Basis for Qualified Opinion: The Company has excluded from property and debt in the accompanying balance sheets certain lease obligations that, in our opinion, should be capitalized in order to conform with accounting principles generally accepted in the United States of America. If these lease obligations were capitalized, property would be increased by $3,500,000, long-term debt by $3,500,000, and retained earnings by $500,000 as of December 31, 20X5. Additionally, net income would be increased by $500,000 and earnings per share would be increased by $1.12 for the year then ended."

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