Auditing Theory 11

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11/25/13 Glimpse of a CPA's mind: August 2010

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This blog is based on International Financial Reporting Standards, American Institute of Certified Public Accountants,

Conceptual Framework of Accounting, andAuditing Assurance & Standards Council, Standards on Review

Engagements, International Standards on Auditing, as well as the Corporate Code of Good Governance.

Glimpse of a CPA's mind

Hello. A warmest greetings to you my fellows!! I have created a blog exclusively for all aspiring CPA's (Certified Public Accountants) to be. This blog is

composed of all the fields of the accountancy profession offered in the Philippines, just the same with other countries where they adapted the currently

applicable Financial Reporting Standards as well as Auditing Standards.

All the questions were have to been updated in accordance with the dynamic changes in the accounting standards just to cope with the changing needs of

the FS users.

Most of the blogs were modified based on the Philippine CPA board examinations, American CPA board examinations, Certified General Accountants of

Canada, National Institute of Accounting Technician of Australia and United Kingdom.

So enjoy reading my blog and don't forget to leave a comment. Try to read and answer all the given questions and continue using this site as your tool to

success. Hoping that you will become a CPA like me too!! Just keep on practicing your skills and make it permanent.

That's all folks, thank you and GOD bless!!

I wil l also include some CPA Board examinations especially made for my beloved classmates, fellow Accounting Bachelor takers, and CPA professors. This

includes, test banks and text banks for accounting, taxation, management advisory and auditing courses.

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Thursday, August 26, 2010

Audit Theory CPA Board

1. The third standard of fieldwork states that sufficient competent evidential matter may, in part,

be obtained through inspection, observation, inquiries, and confirmations, to afford a reasonable

basis for an opinion regarding the financial statements under examination. The evidential matter

required by this standard may, in part, be obtained through

a) Analytical procedures.

b) Auditor working papers.

c) Review of the internal control.

d) Proper planning of the audit engagement.

Answer A is correct. The requirement is to determine which of the listed answers is included in the

third fieldwork standard that specifies the need to obtain sufficient competent evidential matter

during an audit. Evidential matter required by the third fieldwork standard is obtained through two

general classes of auditing procedures: (1) tests of details of transactions and balances and (2)analytical procedures applied to financial information.

Answer B is incorrect because working papers are used to summarize and document the results of

application of audit procedures and not to assist the auditor in obtaining evidence.

Answer C is incorrect because information on internal control pertains to the second fieldwork

standard which is on internal control.

Answer D is incorrect because planning itself does not obtain evidence.

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b) Calculate an independent expectation of the estimate.

c) Confirm the estimate with independent parties.

d) Review subsequent events or transactions occurring prior to completion of fieldwork.

Answer A is incorrect because this is one of the approaches the auditor may use.

Answer B is incorrect because this is one of the approaches the auditor may use.

Answer C is correct. Confirmation of most estimates (e.g., warranty liabilities) i s not an appropriate

approach for evaluating the reasonableness of the estimate.

Answer D is incorrect because this is one of the approaches the auditor may use.

5. Of the following, which is the least persuasive type of audit evidence?

a) Documents mailed by outsider to the auditor.

b) Corresponding between auditor and vendors.

c) Copies of sales invoices inspected by the auditor.

d) Computations made by the auditor.

Answer A is incorrect because externally generated documents received directly by the auditor are

considered more reliable evidence than internally generated evidence.

Answer B is incorrect because information obtained directly by the auditor from a third party source

is considered more reliable than internally generated evidence.

Answer C is correct because copies of sales invoices represent internally generated evidence, which

is considered less reliable than externally generated evidence received directly by the auditor.

Answer D is incorrect because computations made by the auditor represent direct personal

knowledge, which is considered more persuasive than internally generated evidence.

6. Which of the following is the least persuasive documentation in support of an auditors opinion?

a) Schedules of details of physical inventory counts conducted by the client.

b) Notation of inferences drawn from rations and trends.

c) Notation of appraisers conclusions documented in the auditors working papers.

d) Lists of negative confirmation requests for which no response was received by the auditor.

Answer A is correct because schedules of details of physical inventory counts conducted by the client

is least persuasive because it is developed solely within the entity.

Answer B is incorrect because inferences drawn by the auditor from selfcomputed ratios and trends

are more persuasive than those from solely the client's data.


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Answer C is incorrect because an independent third party's conclusions are considered more

persuasive than those generated by the client's internal sources.

Answer D is incorrect because no reply to a negative confirmation from an independent third party is

considered to be support for the accuracy of the accounts receivable and is more persuasive than

internally developed data.

7. Failure to detect material peso errors in the financial statements is a risk which the auditor

primarily mitigates by

a) Performing substantive tests.

b) Performing tests of controls.

c) Evaluating internal control.

d) Obtaining a client representation letter.

Answer A is correct because substantive tests are used to control the risk of incorrect acceptance of

a population which is materially in error. The auditor faces two separate risks. The first risk is that

material misstatements may occur in the accounting process, and the second risk is that material

misstatements that have occurred will not be detected in the auditor's examination. The auditorrelies on internal control to reduce the first risk and substantive tests to reduce the second risk.

Answer B is incorrect because tests of controls relate more directly to the risk of assessing control

risk too high or too low rather than the risk of failing to detect material peso errors.

Answer C is incorrect because the auditor relies on internal control to reduce the risk of

misstatement occurring, not to detect a misstatement which has already occurred.

Answer D is incorrect because obtaining a client representation letter will not in any way mitigate

the risk of failure to detect material misstatements. Representation letters confirm the oralrepresentations which have been made by management to the auditor but are not substitutes for any

other audit procedures.

8. Before applying substantive tests to the details of asset accounts at an interim date, an auditor

should assess

a) Control risk at below the maximum level.

b) Inherent risk at the maximum level.

c) The difficulty in controlling the incremental audit risk.

d) Materiality for the accounts tested as insignificant.

Answer A is incorrect because while control risk will generally be assessed at below the maximum

level in such circumstances, this is not required.

Answer B is incorrect because while inherent risk may be at the maximum level, the situation in

which it is not is more likely, since a lower level of risk is more likely to lead to interim testing.

Answer C is correct because AU 313 requires that an auditor assess the difficulty in controlling the

incremental audit risk. In addition, the auditor should consider the cost of the substantive tests that

are necessary to appropriately examine the remaining period.


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Answer D is incorrect because the accounts tested need not be insignificant.

9. An auditors decision either to apply analytical procedures as substantive tests or to perform tests

of transactions and account balances usually is determined by the

a) Availability of data aggregated at a high level.

b) Relative effectiveness and efficiency of the tests.

c) Timing tests performed after the balance sheet date.

d) Auditors famil iarity with industry trends.

Answer A is incorrect because data aggregated at a high level often obscures relationships used by

analytical procedures.

Answer B is correct because the decision on the appropriate mix of substantive tests is based on the

auditor's judgment on the expected effectiveness and efficiency of the available procedures.

Answer C is incorrect because timing of tests performed after the balance sheet date does nottypically affect the decision on whether to apply analytical procedures as substantive tests or to

perform tests of transactions and account balances.

Answer D is incorrect because familiarity with industry trends is only one factor involved in using

analytical procedures and it does not adequately describe the basis for making this decision.

10. As a result of analytical procedures, the independent auditor determines that the gross profit

percentage has declined from 30% in the preceding year to 20% in the current year. The auditor

should

a) Include an explanatory paragraph in the audit report due to the inability of the client company to

continue as a going concern.

b) Evaluate managements performance in causing this decline.

c) Require footnote disclosure.

d) Consider the possibility of a misstatement in the financial statements.

Answer A is incorrect because a decline in the gross profit percentage would not, by itself, require

that an explanatory paragraph be added to an unqualified report. The firm may still be in a

profitable position and, thus, would not be a candidate for going concern problems.

Answer B is incorrect because the scope of a financial statement audit is not to explicitly evaluate

management's performance.

Answer C is incorrect because a footnote may not be necessary and because it is not the role of an

auditor to require a footnote; the financial statements are the representations of management.

Answer D is correct because a significant fluctuation in the gross profit percentage might be

indicative of a misstatement. Therefore, the auditor must consider the possibility of a misstatement

in the financial statements.

11. Which of the following factors would least influence an auditors consideration of the reliabil ity

of data for purposes of analytical procedures?


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a) Whether the data were processed in a computerized system or in manual accounting system.

b) Whether sources within the entity were independent of those who are responsible for the amount

being audited.

c) Whether the data were subjected to audit testing in the current or prior year.

d) Whether the data were obtained from independent sources outside the entity from sources within

the entity.

Answer A is correct because whether the data were processed in a computerized system or in a

manual accounting system will not in and of itself influence reliabilityeither type of system may

provide reliable (or unreliable) information.

Answer B is incorrect because whether sources within the entity were independent of those who are

responsible for the amount being audited does influence the auditor's consideration of the reliabili ty

of data for purposes of achieving audit objectives.

Answer C is incorrect. It i s a factor which influences the auditor's consideration of the reliability of

data for purposes of achieving audit objectives.

Answer D is incorrect. It is a factor which influences the auditor's consideration of the reliabili ty of

data for purposes of achieving audit objectives.

12. Which of the following is the most reliable analytical procedure to verify the yearend financial

statement balances of a wholesale business?

a) Verify depreciation expense by multiplying the depreciable asset balances by one divided by the

depreciation rate.

b) Verify commission expense by multiplying sales revenue by the companys standard commission

rate.

c) Verify interest expense, which includes imputed interest, by multiplying longterm debt balances

by the yearend prevailing interest rate.

d) Verify IT tax liabi lity by multiplying total payroll costs by the IT contribution rate in effect during

the year.

Answer A is incorrect because depreciation expense would not be determined this way. Therefore,

this is not an analytical procedure.

Answer B is correct because if the firm has a standard commission rate, the commission expense

would be directly related to the sales revenue. Therefore, this would be a reliable analytical

procedure.

Answer C is incorrect because the interest expense, including imputed interest, may not be directly

related to the yearend prevailing interest rate. Thus, interest expense could not be verified in this

manner.

Answer D is incorrect because the IT tax liability would not be directly related to total payroll costs.

Thus, this would not be a reliable analytical procedure.

13. Which of the following statements concerning analytical procedures is correct?

a) Analytical procedures may be omitted entirely for some financial statement audits.

b) Analytical procedures used in planning the audit should not use nonfinancial information.

c) Analytical procedures usually are in effective and efficient for test of controls.


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d) Analytical procedures alone may provide the appropriate level of assurance for some assertions.

Answer A is incorrect because the performance of analytical procedures is required during the

planning and overall review stages of audits.

Answer B is incorrect because analytical procedures used in planning the audit may use nonfinancial

information (e.g., number of employees, square footage of selling space).

Answer C is incorrect because analytical procedures are not used to test controls.

Answer D is correct. The requirement is to identify the correct statement about analytical

procedures. Analytical procedures may in certain circumstances provide the appropriate level of

assurance for some assertions.

14. Which of the following is a basic tool used by the auditor to control the audit work and review

the progress of the audit?

a) Time and expense summary.

b) Engagement letter.

c) Progress flowchart.

d) Audit program.

Answer A is incorrect because the time and expense summary accumulates data concerning hours

worked and expenses charged but does not control the audit work.

Answer B is incorrect because the engagement letter provides documentation of the understandingsbetween the auditor and client at the onset of the engagement.

Answer C is incorrect because a progress flowchart is not a legitimate term.

Answer D is correct because the audit program aids in instructing assistants in the work and includes

audit procedures to accomplish the objectives of the examination. Thus, it allows the auditor to

control the audit work and to review the progress of the audit.

15. Which of the following elements ultimately determines the specific auditing procedures that are

necessary in the circumstances to afford a reasonable basis for an opinion?

a) Auditor judgment.

b) Materiality.

c) Relative risk.

d) Reasonable assurance.

Answer A is correct because the measure of the validity of evidence for audit purposes is based upon

the judgment of the auditor. This audit judgment is used to estimate levels of materiality (Answer

B), and relative risk (Answer C).


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Answer B is incorrect because estimating levels of materiality is only one aspect of audit judgment

used to determine necessary auditing procedures.

Answer C is incorrect because evaluating relative risk is only one aspect of audit judgment used to

determine necessary auditing procedures.

Answer D is incorrect because reasonable assurance is the general concept which states that the cost

of internal control should not exceed the expected benefit.

16. Which of the following analyses appearing in a predecessors working papers is the successor

auditor least likely to be interested in reviewing?

a) Analysis of noncurrent balance sheet accounts.

b) Analysis of current balance sheet accounts.

c) Analysis of contingencies.

d) Analysis of income statement accounts.

Answer A is incorrect because the successor auditor will normally review working papers of

continuing accounting significance. The noncurrent balance sheet accounts would be of continuing

significance and should be reviewed.

Answer B is incorrect because the successor auditor will normally review working papers relating to

matters of continuing accounting significance. The current balance sheet accounts are of continuing

significance and should be reviewed.

Answer C is incorrect because the successor auditor will normally review working papers relating to

matters of continuing accounting significance. Contingencies are of continuing significance and

should be reviewed.

Answer D is correct because the successor will normally review working papers of continuing

accounting significance. Prior income statement accounts are less l ikely to have continuing

significance than are balance sheet accounts and contingencies.

17. Which of the following circumstances would most likely cause an auditor to suspect that

material fraud exists in a clients financial statements?

a) Property and equipment are usually sold at a loss before being fully depreciated.

b) Significant fewer responses to confirmation requests are received than expected.

c) Monthly bank reconciliation usually includes several intransit items.

d) Clerical errors are listed on a computergenerated exception report.

Answer A is incorrect because selling property and equipment at a loss before it is fully depreciated

may simply reveal inadequate depreciation policies, as contrasted to material irregularities.

Answer B is correct because receiving significantly fewer responses to confirmation requests than

were expected is considered a circumstance that should cause the auditor to consider whether

material misstatements exist.


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Answer C is incorrect because for many clients the existence of intransit items is expected and

proper.

Answer D is incorrect because the computergenerated report provides assurance to the auditor that

internal controls are in place, since it provides a means of detecting errors. The existence of good

controls decreases the probability of misstated financials.

18. Which of the following conditions would not normally cause the auditor to question whether

material errors or fraud exist?

a) Bookkeeping errors are listed on an computergenerated exception report.

b) Differences exist between control accounts and supporting subsidiary records.

c) Transactions are not supported by proper documentation.

d) Differences are disclosed by confirmations.

Answer A is correct since the existence of a computergenerated exception report indicates that the

firm is controlling and correcting errors.

Answer B is incorrect because differences between control accounts and subsidiary records indicate

that one or both of the records are incorrect.

Answer C is incorrect since lack of proper documentation might indicate either an error or fraud.

Answer D is incorrect because differences on confirmation replies are often indicative of errors

and/or fraud.

19. On receiving the bank cutoff statement, the auditor should trace

a) Deposits in transit on the yearend bank reconciliation to deposits in the cash receipts journal.

b) Checks dated prior to yearend to the outstanding checks listed on the yearend bank

reconciliation.

c) Deposits listed on the cutoff statement to deposits in the cash receipts journal.

d) Checks dated subsequently to yearend to the outstanding checks listed on the yearend bank

reconciliation.

Answer A is incorrect because comparing deposits in transit on the bank reconciliation with deposits

in the cash receipts journal is a procedure which is not directly related to the bank cutoff

statement.

Answer B is correct because comparing checks returned with the cutoff statement which was dated

prior to yearend with the list of outstanding checks on the bank reconciliation will provide evidence

as to the completeness of the listing of outstanding checks on the bank reconciliation. This step

facilitates a search for unrecorded liabilities.

Answer C is incorrect because only deposits for several days prior to and subsequent to yearend are

compared.

Answer D is incorrect because checks dated subsequent to yearend would not be listed on the year

end bank reconciliation.


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20. An auditor who is engaged to examine the financial statements of a business enterprise will

request a cutoff bank statement primarily in order to

a) Verify the cash balance reported on the bank confirmation inquiry form.

b) Verify reconciling items on the clients bank reconciliation.

c) Detect lapping.

d) Detect kiting.

Answer A is incorrect because verifying the cash balance reported on the bank confirmation is a

secondary objective.

Answer B is correct since a cutoff bank statement will include canceled checks and deposit slips for

the period immediately following yearend. The auditor i s, therefore, able to test whether the

reconciling items at yearend have been handled properly.

Answer C is incorrect because a cutoff bank statement, by itself, will provide limited assistance in

detecting lapping. Lapping is an embezzlement scheme in which cash collections from customers are

stolen and is detected by the use of confirmations and analytical procedures.

Answer D is incorrect because a cutoff bank statement, by itself, wi ll provide limited assistance in

detecting k iting. Kiting is the overstatement of cash by recording a deposit without a corresponding

withdrawal at yearend and is best detected through the use of a bank transfer schedule.

21. A sales cutoff test of bill ings complements the verification of

a) Sales returns.

b) Cash.

c) Account receivable.

d) Sales allowance.

Answer A is incorrect because sales returns on cutoff sales will typically occur subsequent to the

cutoff period.

Answer B is incorrect because the cash for cutoff sales will not be received until some time after

billing.

Answer C is correct because the primary purpose of a sales cutoff test is to obtain reasonable

assurance that sales and accounts receivable are recorded in the accounting period during which

title has passed.

Answer D is incorrect because sales allowances on cutoff sales will occur subsequent to the cutoff

period.

22. An auditor is testing sales transactions. One step is to trace a sample of debit entries from the

accounts receivable subsidiary ledger back to the supporting sales invoices. What would the auditor

intend to establish by this step?


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a) Sales invoices represent bona fide sales.

b) All sales have been recorded.

c) All sales invoices have been properly posted to customer accounts.

d) Debit entries in the accounts receivable subsidiary ledger are properly supported by sales invoices.

Answer A is incorrect because the auditor would trace sales invoices to supporting bills of lading in

order to conclude that sales invoices represent bona fide sales.

Answer B is incorrect because the auditor would trace bills of lading to entries in the subsidiary

ledger in order to conclude that all sales have been properly recorded.

Answer C is incorrect because the auditor will trace sales invoices to the subsidiary ledger in order

to conclude that sales invoices have been properly posted to customer accounts.

Answer D is correct because the auditor would appropriately conclude that entries in the accounts

receivable subsidiary ledger are properly supported by sales invoices.

23. When auditing a public warehouse, which of the fol lowing i s the most important audit procedure

with respect to disclosing unrecorded liabilities?

a) Confirmation of negotiable receipts with holders.

b) Review of outstanding receipts.

c) Inspection of receiving and issuing procedures.

d) Observation of inventory.

Answer A is incorrect because confirmation of negotiable instruments may be impractical due to a

problem of identifying the holder of the negotiable receipt.

Answer B is incorrect because a review of outstanding receipts cannot be made because the auditor

has no knowledge of who may hold "unrecorded" receipts.

Answer C is correct because inspection of receiving and issuing procedures will permit the auditor to

thoroughly evaluate the internal control over the custodial responsibilities of the warehouse

employee. If the custodial responsibilities are not properly discharged, there may be significant

unrecorded liabilities.

Answer D is incorrect because an observation of inventory will only determine what is on hand. The

amount of inventories on hand must be coupled with a review of outstanding warehouse receipts to

determine any unrecorded liabilities.

24. Which of the following statements best describes the phrase Philippine Standard on Auditing?

a) They identify the policies and procedures for the conduct of the audit.

b) They define the nature and extent of the auditors responsibilities.

c) They provide guidance to the auditor with respect to planning the audit and writing the audit

report.

d) They set forth a measure of the quality of the performance of audit procedures.


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Answer A is incorrect because Philippine Standard on Auditing (PSA) give only limited guidance as to

specific policies and procedures for the conduct of the audit.

Answer B is incorrect because Philippine Standard on Auditing (PSA) g ives only limited guidance as to

the nature and extent of the auditor's responsibilities.

Answer C is incorrect because it only relates to the standard concerned with planning the audit and

writing the audit report and not to the other standards.

Answer D is correct because Philippine Standards on Auditing (PSA) deal with measures of the quality

of the performance of audit procedures. Auditing standards relate not only to the auditor's

professional qualities but also to the judgment exercised by the auditor in the performance of the

audit.

25. Which of the following publications does not qualify as a source of generally accepted

accounting principles?

a) Accounting interpretations issued by the FASB.

b) PSA Concepts Statements.

c) PICPA Practice Bulletins.

d) Statements of Financial Standards issued by the FASB

Answer A is incorrect because interpretations issued by the FASB are considered as sources of PAS.

Answer B is correct because the PAS has not issued concepts statements. The concepts statements

issued by the FASB are considered "other accounting literatures" and are not sources of generally

accepted accounting principles of the Philippines.

Answer C is incorrect because Practice Bulletins are considered as sources of PAS

Answer D is incorrect because FASB statements are considered sources of PAS

26. Which of the following statements best describes the auditors responsibility regarding the

detection of material errors and fraud?

a) The auditor is responsible for the fai lure to detect material errors and fraud only when such

failure results from the nonapplication of generally accepted accounting principles.

b) Auditing procedures may or may not need to be extended if the auditors analysis indicates the

existence of fraud risk factors.

c) The auditor is responsible for the failure to detect material errors and fraud only when the

auditor fails to confirm receivables or observed inventories.

d) Extended auditing procedures are required to detect unrecorded transactions even if there is no

evidence that material errors and fraud may exist.

Answer A is incorrect. The auditor should design the audit to provide reasonable assurance of

detecting errors and fraud that is material to the financial statements. This responsibility for

detection is not limited to circumstances arising from the nonapplication of generally accepted

accounting principles.


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Answer B is correct. When fraud risk factors exist, the auditor should consider whether already

designed procedures adequately consider the existence of fraud. When they do not, audit procedures

must be extended.

Answer C is incorrect. The auditor may be held responsible for failures to detect misstatements due

to errors and fraud because of inadequate planning, performance or judgment. Not confirming

receivables or not observing inventories are only two of the many possible situations in which the

auditor may be held responsible for a failure to detect associated errors and fraud.

Answer D is incorrect. The extended auditing procedures are necessary when normal procedures

indicate evidence that misstatements due to errors and fraud may exist, not when there is no such

evidence.

27. Which of the following is not a procedure performed primarily for the purpose of expressing an

opinion on the financial statements, but may bring possible illegal acts to the auditors attention?

a) Consideration of internal control.

b) Review of policies concerning effectiveness of management decision making policies.

c) Test of transactions.

d) Test of balances.

Answer A is incorrect because the consideration of internal control is performed to lead to the

expression of an opinion on the financial statements.

Answer B is correct because the review of effectiveness of decision making policies is not a

procedure when expressing an opinion on the financial statements. External auditors are primarily

concerned with internal controls that affect recording, processing, summarizing, and reporting

financial data.

Answer C is incorrect because tests of transactions (substantive tests) are performed for the purpose

of expressing an opinion on the financial statements.

Answer D is incorrect because tests of balances (substantive tests) are performed for the purpose of

expressing an opinion on the financial statements.

28. An auditor of a manufacturer would most likely question whether that client has committed

illegal acts if the client has

a) Been forced to discontinue operations in a foreign country.

b) Been an annual donor to a local political candidate.

c) Failed to correct material weakness in internal control that were reported after the priors audit.

d) Disclosed several subsequent events involving foreign operations in the notes to the financial

statements.

Answer A is correct because being forced to discontinue operations in a foreign country is consistent

with the existence of an illegal act, although other conditions may have forced such discontinuance.

Answer B is incorrect because such political contributions made by companies are generally not

illegal.


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Answer C is incorrect because failure to correct a material weakness is not necessarily indicative of

violation of a law (e.g., the Foreign Corrupt Practices Act).

Answer D is incorrect because disclosure of subsequent events, whether involving foreign operations

or other information, is a normal acceptable disclosure which need not directly relate to illegal

acts.

29. Hawkins requested permission to communicate with the predecessor auditor and review certain

portions of the predecessor auditors working papers. The prospective clients refusal to permit this

will bear directly on Hawkins decision concerning the

a) Adequacy of the preplanned audit program.

b) Abili ty to establish consistency in application of accounting principles between years.

c) Apparent scope limitation.

d) Integrity of management.

Answer A is incorrect since such a program will not exist before the prospective client is accepted.

Answer B is incorrect because the availability of prior year financial statements and accountingrecords normally provides sufficient evidence concerning consistency.

Answer C is incorrect since the potential successor has not yet accepted the prospective client.

Answer D is correct since obtaining evidence relative to the integrity of management is one of the

objectives to be accomplished during such a review.

30. The concept of materiality would be least important to an auditor when considering the

a) Effects of a direct financial interest in the client upon the CPAs independence.

b) Decision whether to use positive confirmations of accounts receivable.

c) Adequacy of disclosure of a clients illegal act.

d) Discovery of weakness in a clients internal control structure.

Answer A is correct because the auditor may not have any direct financial interest in a client,

regardless of materiality.

Answer B is incorrect because auditors generally consider the size (materiality) of account balances

when choosing between the use of positive or negative confirmation.

Answer C is incorrect because materiality is considered when evaluating the adequacy of disclosures

of illegal acts.

Answer D is incorrect because the materiality of internal control weaknesses should be considered by

the auditor.

31. While obtaining an understanding of a clients risk assessment policies, an auditor ordinarily

considers how management

a) Identifies risks.


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b) Eliminates significant risks.

c) Assesses the likelihood of occurrence of subsequent events.

d) Relate risk assessment to compliance with marketing objectives.

Answer A is correct. An auditor should obtain sufficient knowledge of the entity's risk assessment

process to understand how management considers risks relevant to financial reporting objectives and

decide about actions to address those risks; that knowledge might include understanding of how

management identifies risks, estimates their significance, and assesses the likelihood of their

occurrence, and relates them to financial reporting.

Answer B is incorrect. Refer to the correct answer explanation.

Answer C is incorrect. Refer to the correct answer explanation.

Answer D is incorrect. Refer to the correct answer explanation.

32. Effective internal control requires organizational independence of departments. Organizational

independence would be impaired in which of the following situations?

a) The internal auditors report to the audit committee of the board of directors.

b) The controller reports to the vice president of production.

c) The payroll accounting department reports to the chief accountant.

d) The cashier reports to the treasurer.

Answer A is incorrect because internal auditors typically report to the audit committee of the board

of directors.

Answer B is correct. The requirement is to determine a situation causing the impairment of

organizational independence. The controller, who is in charge of accounting, should be independent

of the production function. Since the accounting function reports on the production function, there

would be a conflict of interest if the controller reported to the vice president of production.

Answer C is incorrect because the payroll department should report to the chief accountant, as the

chief accountant has responsibility for the payroll accounting function.

Answer D is incorrect because cashiers typically account and report to the treasurer because the

treasurer has responsibility for cash custodianship.

33. An auditor would most likely be concerned with controls that provide reasonable assurance

about the

a) Efficiency of managements decisionmaking process.

b) Appropriate prices the entity should charge for its products.

c) Methods of assigning production tasks to employees.

d) Entitys ability to process and summarize financial data.

Answer A is incorrect. While important to the company, this item ordinarily does not relate to a

financial statement audit.


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Answer B is incorrect. While important to the company, this item ordinarily does not relate to a


Answer C is incorrect. While important to the company, this item ordinarily does not relate to a


Answer D is correct. The controls relevant to an audit pertain to the entity's ability to record,

process, summarize, and report financial data consistent with the assertions embodied in the

financial statements.

34. Which of the following controls would an auditor be least likely to review?

a) Segregation of the assethandling and recordkeeping functions.

b) Company policy regarding credit and collection efforts.

c) Cost records classified by date of product introduction.

d) Authorization of addition to plant and equipment.

Answer A is incorrect because the segregation of asset custody (handling) from recordkeeping and

authorization functions is essential.

Answer B is incorrect because an auditor will be concerned with credit and collection efforts in

testing the adequacy of the allowance for doubtful accounts.

Answer C is correct because an auditor is usually not concerned with the date a product was

introduced.

Answer D is incorrect because additions to plant and equipment are major expenditures which need

to be properly controlled.

35. The auditor would be least likely to be concerned about internal control as it relates to

a) Land and buildings.

b) Common stock.

c) Shareholder meeting.

d) Minutes of board of directors meetings

Answer A is incorrect because the auditor would be concerned with the internal control of land and

buildings which may involve a substantial portion of the client's assets.

Answer B is incorrect because the auditor would be concerned with the internal control related to

common stock which may involve a substantial portion of the client's equity.

Answer C is correct because a client's internal control will not relate directly to shareholder

meetings. CPAs wi ll often attend the shareholder meetings and be aware of what has transpired,

but important matters at such meetings are generally publicly available.


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Answer D is incorrect because the minutes of the meetings of the board of directors must be

received by the auditor in complete form so that the auditor may be aware of matters of

significance.

36. Which of the following would not typically be a control relied upon during an audit?

a) Use of the doubleentry system.

b) An internal audit staff.

c) Competent personnel.

d) A comparisonshopping staff.

Answer A is incorrect because use of the doubleentry system is an internal control which aids in

more accurate recording of transactions.

Answer B is incorrect because the presence of an internal audit staff is an internal control. An

internal audit staff strengthens internal control by determining if controls are functioning

effectively.

Answer C is incorrect because competent personnel relate to internal control. Competent personnel

would strengthen internal control because they would be less likely to commit errors in performing

their duties.

Answer D is correct because a comparisonshopping staff is not generally relevant to recording,

processing, summarizing, and reporting financial data.

37. One important reason why a CPA, during the course of an audit engagement, prepares internal

control flowcharts is to

a) Reduce the need for inquiries of client personnel concerning the operations of internal control.

b) Depict the organizational structure and document flow in a single chart for review and reference

purposes.

c) Assemble the internal control findings into a comprehensible format suitable for analysis.

d) Prepare documentation that would be useful in the event of a future consulting engagement.

Answer A is incorrect because flowcharts are prepared as part of the consideration of internal

control. The need for inquiries of client personnel would not necessarily be reduced due to the

preparation of the flowchart.

Answer B is incorrect because the entire organizational structure and document flow of a large

company usually cannot be depicted in a single flowchart.

Answer C is correct because flowcharts are prepared as part of the consideration of internal control.

The use of structure flowcharts assembles the internal control findings into a comprehensible

format.

Answer D is incorrect because flowcharts are prepared as part of the consideration of internal

control. The flowchart is not prepared for the primary reason of obtaining documentation useful for

a future consulting engagement.


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38. When preparing a record of a clients internal control, the independent auditor sometimes uses

a flowchart, which can best be described as a

a) Pictorial presentation of the flow of instruction in a clients internal computer system.

b) Diagram which clearly indicates an organizations internal reporting structure.

c) Graphic illustration of the flow of operations which is used to replace the auditors internal

control questionnaire.

d) Symbolic representation of a system or series of sequential processes.

Answer A is incorrect because it refers to processing within the computer rather than the entire

internal control structure.

Answer B is incorrect because it deals with reporting structure rather than with internal controls.

Answer C is incorrect because an internal control flowchart depicts the organization and

recordkeeping system rather than a flow of operations.

Answer D is correct because the flowchart prepared during the consideration of internal control is a

symbolic representation of a system of sequential processes. It can be used in lieu of the internalcontrol questionnaire which has the same purpose (i.e., to prepare a record of prescribed internal

control).

39. In connection with the consideration of internal control during an examination of financial

statements, the independent auditor

a) Must perform tests of controls for all important controls.

b) Must issue a written communication on reportable conditions, including situations in which none

have been identified.

c) Must flowchart major client transaction cycles.

d) Must perform tests of controls to assess control risk at a level lower than the maximum.

Answer A is incorrect. Refer to the correct answer explanation.



Answer D is correct. When the auditor assesses control risk at below the maximum level, the auditor

believes that specific controls are likely to prevent or detect material misstatements relevant to

specific assertions. The auditor must then perform tests of controls to evaluate the effectiveness of

such controls.

40. The auditor should perform tests of controls on

a) Those controls that the auditor plans to use to support an assessment of control risk below the

maximum.

b) Those controls in which reportable condition were identified.

c) Those controls that have a material effect upon the financial statement balances.

d) A random sample of the controls that were reviewed.


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Answer A is correct because tests of controls are only performed on controls that the auditor plans to

rely upon as a basis for assessing control risk below the maximum. Performance of tests of controls

on these controls may reduce the scope of substantive tests needed.

Answer B is incorrect because the auditor is unlikely to test controls in which reportable conditions

exist since they cannot be relied upon.

Answer C is incorrect because even though some controls have a material effect upon financial

statement balances, they may not be relied upon if substantive testing may be more efficient.

Answer D is incorrect because the decision of whether or not to perform tests of controls is

determined by employing professional judgment based upon the results of assessing control risk, not

by a random sample.

41. Which of the following is ordinarily considered a test of a control?

a) Send confirmation letters to banks.

b) Count and list cash on hand.

c) Examine signatures on checks.

d) Test the clerical accuracy of inventory listings as of the balance sheet date.

Answer A is incorrect because sending confirmation letters to banks helps substantiate the existence

of cash at year end. Therefore, this is a substantive rather than a test of a control.

Answer B is incorrect because a cash count is a test of transactions and balances which is a

substantive test rather than a test of a control.

Answer C is correct because tests of controls are directed toward the effectiveness of the design or

operation of controls. In this case the control procedure is to determine that only authorized persons

sign checks.

Answer D is incorrect because testing the clerical accuracy of inventory listings as of the balance

sheet date is primarily a substantive test to determine whether inventory listings are accurately

compiled.

42. Which of the following would be least likely to suggest to an auditor that the clients

management may have overridden internal control?

a) There are numerous delays in preparing timely internal financial reports.

b) Management does not correct control weakness that it knows about.

c) Differences are always disclosed on a computer exception report.

d) There have been two new controllers this year.

Answer A is incorrect because delays in the preparation of financial reports may suggest that

inappropriate entries are being made by the client's management.

Answer B is incorrect because the auditor must question why management would choose not to


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eliminate internal control weaknesses. The failure of management to correct weaknesses would be

a definite indication that management may have overridden internal control.

Answer C is correct because differences are expected to be disclosed on a computer exception

report; disclosing these differences is the primary purpose of the report. Thus, this would not

indicate that there are problems in the client's internal control.

Answer D is incorrect because a high turnover of controllers (the position normally responsible for

the recordkeeping function) may be indicative of a management override of internal control.

43. Which of the following controls will most likely prevent the concealment of a cash shortage

resulting from the improper writeoff of a trade account receivable?

a) Writeoffs must be approved by a responsible officer after review of credit department

recommendations and supporting evidence.

b) Writeoffs must be supported by an aging schedule showing that only receivables overdue several

months have been written off.

c) Writeoffs must be approved by the cashier who is in a position to know if the receivables have, in

fact, been collected.

d) Writeoffs must be authorized by company field sales employees who are in a position to

determine the financial standing of the customers.

Answer A is correct because if accounts receivable writeoffs must be approved by an officer on the

basis of credit department recommendations including supporting evidence, there is very little

likelihood of improper writeoffs to conceal cash shortages.

Answer B is incorrect because receivable overdue by several months is not a basis for writeoff;

uncollectibility is.

Answer C is incorrect because the cashier could conceal cash shortages by approving the writeoffs

of accounts receivable.

Answer D is incorrect because sales employees could accept payments from customers and then

authorize the accounts to be written off.

44. Which of the following would be the best protection for a company that wishes to prevent the

lapping of trade accounts receivable?

a) Segregated duties so that the bookkeeper in charge of the general ledger has no access to

incoming mail.

b) Segregated duties so that no employee has access to both checks from customers and currently

from daily cash receipts.

c) Have customers send payments directly to the companys depositary bank.

d) Request that customers payment checks be made payable to the company and addressed to the

treasurer.

Answer A is incorrect because lapping involves incorrect entries in the accounts receivable subsidiary

ledger, not the general ledger.

Answer B is incorrect because lapping occurs by misappropriating mail receipts (checks). Lapping

does not necessarily involve abstraction directly from currency.


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Answer C is correct because lapping of trade accounts receivable involves an abstraction of funds

and subsequent delay in crediting receipts to accounts receivable. If customers send payments

directly to a depository bank, there is no opportunity for abstraction of funds or subsequent

misapplication.

Answer D is incorrect because requiring that customer's checks be addressed to the treasurer will not

reduce the risk of lapping significantly compared to having the checks directly deposited.

45. Which of the following is not a basic rule for achieving strong internal control over cash?

a) Separate the cash handling and recordkeeping functions.

b) Decentralized the receiving of cash as much as possible.

c) Deposit each days cash receipts by the end of the day.

d) Have bank reconciliations performed by employees independent with respect to handling cash.

Answer A is incorrect because separation of cash handling and recordkeeping is a proper segregation

of the recordkeeping function from the custodial function.

Answer B is correct because decentralization of cash receipts generally would not increase internalcontrol; in fact, the additional points of cash receipt may well be more difficult to control.

Answer C is incorrect because the daily deposit of cash receipts helps to deter irregularities and

theft.

Answer D is incorrect because separating the reconciliation from the handling of cash is a proper

segregation of the recordkeeping function from the custodial function.

46. In order to safeguard the assets through proper internal control, accounts receivable that are

written off are transferred to a(n)

a) Separate ledger.

b) Attorney for evidence in collection proceedings.

c) Tax deductions files.

d) Credit manager since customers may seek to reestablish credit by paying.

Answer A is correct. Once accounts receivable are written off they should be controlled for possible

future collection. Accordingly, they should be recorded to maintain accountability in a separate

ledger. If they were simply written off and forgotten, there would be no means of maintaining

accountability over these contingent assets.

Answer B is incorrect because accounts transferred to an attorney for collection would not be

written off (i.e., if they were bad debts, there would be no basis for collection proceedings).

Answer C is incorrect because the requirement is for proper internal control over the receivables

rather than information to prepare tax returns.

Answer D is incorrect because credit managers should not have control over accounts that have been

written off because there is not sufficient separation of functional responsibilities.


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47. Jackson, the purchasing agent of Judd Hardware Wholesalers, has a relative who owns a retail

hardware store. Jackson arranged for hardware to be delivered by manufacturers to the retail store

on a COD basis thereby enabling his relative to buy at Judds wholesale prices. Jackson was probably

able to accomplish this because of Judds poor internal control over

a) Purchase orders.

b) Purchase requisitions.

c) Cash receipts.

d) Perpetual inventory records.

Answer A is correct because proper control over purchases would require that ordered goods only be

shipped to authorized locations; proper control would also determine that all ordered goods had

been received by the firm. If purchase orders are issued by Judd and the purchases are never

received, there is an internal control condition over the purchase orders. All purchase orders should

be accounted for (prenumbered) and followed up to assure receipt of orders that are issued.

Answer B is incorrect because purchase requisitions are internal documents which are prepared by

user departments and sent to the purchasing department for action.

Answer C is incorrect because the failure to detect purchase orders that were not received hasnothing to do with cash receipts.

Answer D is incorrect because perpetual inventory records cannot be relied upon to detect the

nonreceipt of purchase orders (i.e., perpetual inventory records are only activated once the goods

are received).

48. To avoid potential errors and f raud a welldesigned internal control in the accounts payable area

should include a separation of which of the following functions?

a) Cash disbursement and invoice verification.

b) Invoice verification and merchandise ordering.

c) Physical handling of merchandise received and preparation of receiving reports.

d) Check signing and cancellation pf payment documentation.

Answer A is correct. The requirements concern internal control in the accounts payable area. The

accounts payable function normally includes invoice verification. The important separation should be

between authorization of payment and actual cash disbursements. Thus the accounts payable area

(including invoice verification) should be separated from cash custodianship and disbursement.

Answer B is incorrect because the accounts payable area does not usually include the purchasing

department.

Answer C is incorrect because those receiving merchandise usually prepare the receiving report

(e.g., on the loading dock).

Answer D is incorrect because the person signing checks should cancel the supporting documentation

as checks are signed.

49. Propex Corporation uses a voucher register and does not record invoices in a subsidiary ledger.

Propex will probably benefit most from the additional cost of maintaining an accounts payable

subsidiary ledger if


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a) There are usually invoices in an unmatched invoice file.

b) Vendors request for confirmation of receivable often go unanswered for several months until

paid invoices can be reviewed.

c) Partial payments to vendors are continuously made in the ordinary course fo business.

d) It is difficult to reconcile vendors monthly statements.

Answer A is incorrect because the function of an unmatched invoice file is to hold off paying invoices

until the receiving report and purchase order are received. There would be invoices in an unmatched

invoice file even with the accounts payable subsidiary ledger.

Answer B is incorrect because maintaining an accounts payable subsidiary ledger for the purpose of

confirming vendor's confirmation requests would not benefit the company.

Answer C is correct because when partial payments are continuously made to vendors, an accounts

payable subsidiary ledger would be very beneficial to the corporation. The subsidiary ledger would

be used to keep track of the amounts still outstanding after partial payments. Otherwise, the partial

payments would have to be written on the voucher register in order to keep track of the amount still

due.

Answer D is incorrect because although an accounts payable subsidiary ledger would aid in this type

of a reconciliation, the corporation would benefit more from a subsidiary ledger if partial payments

to vendors are continuously made.

50. Which of the following is an effective control that encourages receiving department personnel to

count and inspect all merchandise received?

a) Quantities ordered are excluded from the receiving department copy of the purchase order.

b) Vouchers are prepared by accounts payable department personnel only after they match item

count on the receiving report with the purchase order.

c) Receiving department personnel are expected to match and reconcile the receiving report withthe purchase order.

d) Internal auditors periodically examine, on a surprise basis, the receiving department copies of

receiving reports.

Answer A is correct. The requirement is to identify the control used to encourage receiving

department personnel to count and inspect all merchandise received. If the quantities ordered are

not known to the receiving department personnel, they will have to count and inspect the incoming

merchandise without prejudice. In other words, they will not count to an expected number.

Answer B is incorrect because it does not relate to the requirement (i.e., counting and inspecting).

Answer C is incorrect because receiving department personnel should only count and inspect and not

perform reconciliations.

Answer D is incorrect because an examination of the receiving report will not indicate whether

counts were made by receiving department personnel. It will only indicate that numbers were

recorded by receiving department personnel.

51. Ordinarily in an attest examination report a CPA may report on


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Managements written assertion Subject matter

A Yes Yes

B Yes No

C No Yes

D No No

Answer A is correct because in most circumstances, a CPA may report upon either the written

assertion or on the subject matter to which the written assertion relates.




52. In which of the following ways may suitable criteria appropriately be made available?

Publicly available Included with subject matter Included in CPAs report

A Yes Yes Yes

B Yes Yes No

C Yes No No

D No Yes Yes

Answer A is correct because suitable criteria should be available in one or more of the following

ways: (1) publicly, (2) included with the subject matter or in the assertion, (3) included in the CPA's

report, (4) well understood by most users (e.g., the distance between A and B is twenty feet) or (5)

available only to specified parties.




53. Which of the following is least likely to include a reference to the use of a specialist?

a) Unqualified opinion.

b) Adverse opinion.

c) Except for qualified opinion.

d) Subject to qualified opinion.


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Answer A is correct because when issuing an unqualified opinion, the auditor should not refer to the

work or findings of the specialist. When an auditor decides to modify the audit opinion as a result of

the report or findings of the specialist, reference to and identification of the specialist may be made

in the auditor's report if the auditor believes such reference will facili tate understanding.




54. For an entitys financial statements to be presented fairly in conformity with generally accepted

accounting principles, the principles selected should

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

b) Be approved by the Auditing Standard Board or the appropriate industry subcommittee.

c) Reflect transactions in a manner that presents the financial statements within a range of

acceptance limits.

d) Match the principles used by most other entities within the entitys particular industry.

Answer A is incorrect because a change in accounting principle may be acceptable and appropriate.

Answer B is incorrect because the Auditing Standards Board generally does not issue accounting

principles.

Answer C is correct. The requirement is to determine an implication of financial statements being

presented fairly in conformity with generally accepted accounting principles. The principles selected

should reflect transactions in a manner that presents the financial statements within a range ofacceptable l imits.

Answer D is incorrect because the exact principles followed need not be used by most other entities

within the entity's particular industry.

55. Which of the following representations does an auditor make explicitly and which implicitly

when issuing an unqualified opinion?

Conformity with GAAP Adequacy of disclosure

A Explicitly Explicitly

B Implicitly Implicitly

C Implicitly Explicitly

D Explicitly Implicitly




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Answer D is correct. The requirement is to determine whether representations on "conformity with

GAAP" and on "adequacy of disclosure" are made explicitly or implicitly in an unqualified audit

report. The first standard of reporting requires an explicit statement on conformance with GAAP.

However, the third reporting standard results in implicit representations on disclosure since it states

that informative disclosures are to be considered adequate, unless otherwise stated.

56. Jojo, an independent auditor, was engaged to perform an examination of the financial

statements of ThreeR Incorporated 1 month after its fiscal year had ended. Although the inventory

count was not observed by Jojo, and accounts receivable were not confirmed by direct

communication with creditors, Jojo was able to gain satisfaction by applying alternative auditing

procedures. Jojos auditors report will probably contain

a) An except for qualification.

b) An unqualified opinion and an explanatory paragraph.

c) Either qualified opinion or a disclaimer of opinion.

d) A standard unqualified opinion.

Answer A is incorrect because a qualified opinion is not needed since the auditor was able to gain

satisfaction by applying alternative auditing procedures.

Answer B is incorrect because an explanatory paragraph would not be required since the auditor was

able to gain satisfaction by applying alternative auditing procedures.

Answer C is incorrect because the auditor was able to gain satisfaction by applying alternative

auditing procedures. No qualification or disclaimer of opinion is required when the alternative

procedures allow the auditor to acquire sufficient evidence regarding the inventory and accounts

receivable accounts.

Answer D is correct because, although the auditor was not able to observe the inventory count or

confirm accounts receivable, the auditor was able to gain satisfaction through the use of alternative

procedures. In these circumstances, an unqualified opinion may be issued.

57. A lawyer limits a response concerning a l itigated claim because the lawyer is unable to

determine the likelihood of an unfavorable outcome. Which type of opinion should the auditor

express if the litigation is adequately disclosed and the range of potential loss is material in relation

to the clients financial statements considered as a whole?

a) Adverse.

b) Unaudited.

c) Qualified.

d) Unqualified.

Answer A is incorrect because adverse opinions are used when an auditor knows that the statements

are misleading.

Answer B is incorrect because "unaudited" is not a type of audit opinion.



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Answer D is correct because if the contingency has been adequately disclosed by the client, the

auditor would issue an unqualified opinion.

58. When an auditor submits a document containing audited financial statements to a client, the

auditor has a responsibility to report on

a) Only the basic financial statements included in the document.

b) The basic financial statements and only the additional information required to be presented in

accordance with provision of Financial Accounting Standards Board.

c) All of the information included in the document.

d) Only the portion of the document which was audited.



Answer C is correct because the professional standards require that when an auditor submits a

document containing audited financial statements to his/her client or to others, s/he has a

responsibility to report on all the information included in the document. Note that while all

information is to be reported on, it need not all be audited (some of it may be "unaudited").


59. The auditors judgment concerning the overall fairness of the presentation of financial position,

results of operations, and statement of cash flows is applied within the framework of

a) Quality control.

b) Generally accepted auditing standards which include the concept of materiality.

c) The auditors consideration of the auditor companys internal control.

d) Generally accepted accounting principles.

Answer A is incorrect because quality control relates to the policies and procedures established by a

CPA firm to provide reasonable assurance that GAAS are being complied with on all audit

engagements.

Answer B is incorrect because GAAS relate to the conduct of audit engagements rather than the

framework within which the fairness of financial statement presentation is measured (GAAP).

Answer C is incorrect because the auditor's consideration of internal control, while important, is not

as directly related to the overall fairness of f inancial statement presentation as is the framework of

GAAP.

Answer D is correct because the auditor's judgment concerning the fairness of financial statements

should be applied within the framework of generally accepted accounting principles.

60. The first standard of reporting requires that, the report shall state whether the financial

statements are presented in accordance with generally accepted accounting principles. This should


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be construed to require

a) A statement of fact by the auditor.

b) An opinion by the auditor.

c) An implied measure of fairness.

d) An objective measure of compliance.


Answer B is correct because the first standard of reporting is construed to require an opinion as to

whether the financial statements are presented in conformity with GAAP.



61. The fourth reporting standard requires the auditors report to either contain an expression ofopinion regarding the financial statements, taken as a whole, or an assertion to the effect that an

opinion cannot be expressed. The objective of the fourth standard is to prevent

a) The CPA from reporting on one basic financial statement and not the others.

b) The CPA from expressing different opinions on each of the basic financial statements.

c) Misinterpretations regarding the degree of responsibility the auditor i s assuming.

d) Management from reducing its final responsibility for the basic financial statements.

Answer A is incorrect because the auditor may report on one basic statement and not the other

statements (which is not a scope limitation) as long as the auditor has access to information

underlying all the statements.

Answer B is incorrect because the auditor may express an unqualified opinion on one of the

statements and express a qualified, adverse, or disclaimer on another if circumstances call for this

treatment.

Answer C is correct because the objective of the fourth standard of reporting (requiring an

expression of opinion on the financial statements as a whole) is to prevent misinterpretation of the

degree of responsibility the auditor is assuming when the auditor is associated with financial

statements.

Answer D is incorrect because the fourth standard is not directly related to management's

responsibility for the financial statements.

62. An investor is reading the financial statements of the Stankey Corporation and observes that the

statements are accompanied by an auditors unqualified report. From this the investor may conclude

that

a) Any disputes over significant accounting issues have been settled to the auditors satisfaction.

b) The auditor i s satisfied that Stankey is financially sound.

c) The auditor has ascertained that Stankeys financial statements have been prepared accurately.

d) Informative disclosures in the financial statements but not necessarily in Stankeys footnotes are


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to be regarded as reasonably adequate.

Answer A is correct because an unqualified audit report indicates that disputes over significant

accounting issues have been settled to the auditor's satisfaction. If any such disputes have not been

settled, the auditor must render an opinion other than unqualified.

Answer B is incorrect because the objective of an audit is not to conclude that the client is

financially sound. Rather, the auditor renders an opinion on the fairness of the financial statement

presentation in accordance with GAAP.

Answer C is incorrect because there is no assertion as to accuracy by the independent auditor.

Rather, the auditor renders an opinion on the fairness of the financial statement presentation in

accordance with GAAP.

Answer D is incorrect because the footnotes are regarded as an integral part of the financial

statements and must contain adequate informative disclosures.

63. Negative assurance is not permissible in

a) Letters required by security underwriters for data pertinent to SEC registration statements.

b) Reports relating to the results of agreed upon procedures to one or more specified elements,

accounts, or i tems of a financial statement.

c) Reports based upon a review engagement.

d) Reports based upon an audit of the interim financial statements of a closely held business entity.

Answer A is incorrect because letters required by security underwriters may include negative

assurance.

Answer B is incorrect because negative assurance is allowed for specified elements.

Answer C is incorrect because the review report issued includes negative assurance with respect to

the financial statements.

Answer D is correct because, when an audit is performed, negative assurance is not to be provided,

regardless of whether the financial statements are for a fiscal or interim period.

64. Jovy, CPA, examined the 2005 financial statements of PPSI. and issued an unqualified opinion on

March 10, 2006. On April 2, 2006, Jovy became aware of a 2005 transaction that may materially

affect the 2005 financial statements. This transaction would have been investigated had it come to

Jovys attention during the course of the examination. Jovy should

a) Take no action because an auditor is not responsible for events subsequent to the issuance of the

auditors report.

b) Contact PPSIs management and request their cooperation in investigating the matter.

c) Request that PPSIs management disclose the possible effects of the newly discovered transaction

by adding an unaudited footnote to the 2005 financial statements.

d) Contact all parties who might relies upon the financial statements and advise them that the

financial statements are misleading.

Answer A is incorrect because the auditor must take action and is responsible for the subsequent


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discovery of facts existing at the date of the auditor's report.

Answer B is correct. The requirement is to determine an accountant's responsibility when s/he has

become aware of a material transaction which may materially affect financial statements on which

s/he has already reported. The first step is to contact the firm's management and request

cooperation in investigation of the matter.

Answer C is incorrect because the "possible effects" of this newly discovered transaction should be

investigated further to determine whether the financials may need revision in lieu of footnote

disclosure.

Answer D is impractical because it is impossible to contact all parties who might rely upon the

financial statements.

65. A major customer of an audit client suffers a fire just prior to completion of yearend fieldwork.

The audit client believes that this event could have a significant direct effect on the f inancial

statements. The auditor should

a) Advise management to disclose the event in notes to the financial statements.

b) Disclose the event in the auditors report.

c) Withhold submission of the auditors report until the extent of the direct effect on the financial

statements is known.

d) Advise management to adjust the financial statements.

Answer A is correct because conditions which come into existence after yearend which may have a

significant direct effect on the financial statements should be disclosed in the notes to the financial

statements.

Answer B is incorrect because the auditor may or may not decide to disclose the event in the

auditor's report. If the subsequent event has a material impact on the entity, the auditor may wish

to include in the report an explanatory paragraph which directs the reader's attention to the event.However, this type of subsequent event is only occasionally disclosed in the auditor's report.

Answer C is incorrect because the exact total effect on the financial statements need not always be

known. The auditor cannot wait until the effect is known because this would delay the issuance of

the report.

Answer D is incorrect because only conditions coming into existence prior to yearend result in

financial statement adjustments.

66. When a contingency is resolved immediately subsequent to the issuance of a report which was

qualified with respect to the contingency, the auditor should

a) Insist that the client revised financial statements.

b) Inform the audit committee that the report cannot be relied upon.

c) Take no action regarding the event.

d) Inform the appropriate authorities that the report cannot be relied upon.

Answer A is incorrect because resolution of a contingency after the issuance of the report is not

subsequent discovery of facts existing at the date of the auditor's report. Since the contingency was

disclosed in the financial statements and audit report, the statements were not misleading at the

time of issuance and do not have to be revised.


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Answer C is correct because when a contingency is resolved immediately subsequent to the issuance

of a report which was qualified with respect to the contingency, the auditor is not required to take

any action regarding the event. Resolution of the contingency after the issuance of the report is not

subsequent discovery of facts existing at the date of the auditor's report. Because the contingency

did result in a qualified report, the auditor was aware of the facts existing at the date of the

auditor's report. Also, the auditor's responsibility for continuing inquiry is precluded by AU 561.


67. Under which of the following circumstances may audited financial statements contain a note

disclosing a subsequent event which is labeled unaudited?

a) When the subsequent event does not require adjustment of the financial statements.

b) When the event occurs after completion of fieldwork and before issuance of the auditors report.

c) When audit procedures with respect to the subsequent event were not performed by the auditor.

d) When the event occurs between the date of the auditors original report and the date of thereissuance of the report.


Answer B is incorrect because if the auditor is aware of a subsequent event that has occurred after

the completion of fieldwork but before issuance of the report which should be disclosed, the auditor

may either dual date the report or date the report as of the date of the subsequent event and

extend the procedures for review of subsequent events to that date. The auditor may not label the

note unaudited.


Answer D is correct because when the subsequent event occurs between the date of the original

report and the date of the reissuance of the report, the event may be labeled unaudited.

68. Subsequent events affecting the realization of assets ordinarily wil l require adjustment of the

financial statements under examination because such events typically represent

a) The culmination of conditions that existed at the balance sheet date.

b) The final estimates of losses relating to casualties occurring in the subsequent events period.

c) The discovery of new conditions occurring in the subsequent events period.

d) The preliminary estimate of losses to new events that occurred subsequent to the balance sheet.

Answer A is correct because subsequent events affecting the realization of assets ordinarily will

require adjustment of the financial statements because such events typically represent the

culmination of conditions that existed at the balance sheet date.

Answer B is incorrect because a loss related to a casualty that occurred in the subsequent events

period would not result in adjustment of the financial statements.


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Answer C is incorrect because the discovery of new conditions occurring in the subsequent events

period would not result in adjustment of the financial statements.


69. Which of the following material events oc

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