TEST BANK for Auditing and Assurance Services, 8th Edition, Timothy Louwers, Penelope Bagley, Allen by StudyGuide

CHAPTER 1 MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) The audit objective that all transactions and accounts that should be presented in the financial statements are in fact included is related to which of the PCAOB assertions? A) Existence. B) Rights and obligations. C) Completeness. D) Valuation.

2) Cutoff tests designed to detect purchases made before the end of the year that have been recorded in the subsequent year provide assurance about management's assertion of: A) presentation and disclosure. B) completeness. C) rights and obligations. D) existence.

3) During an audit of an entity's stockholders' equity accounts, the auditor determines whether there are restrictions on retained earnings resulting from loans, agreements, or state law. This audit procedure most likely is intended to verify management's assertion of: A) existence or occurrence. B) completeness. C) valuation or allocation. D) presentation and disclosure.

4) The confirmation of an account payable balance selected from the general ledger provides primary evidence regarding which management assertion?

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A) Completeness. B) Valuation. C) Allocation. D) Existence.

5) What type of evidence would provide the highest level of assurance in an attestation engagement? A) Evidence secured solely from within the entity. B) Evidence obtained from independent sources. C) Evidence obtained indirectly. D) Evidence obtained from multiple internal inquiries.

6) Which of the following management assertions is an auditor most likely testing if the audit objective states that all inventory on hand is reflected in the ending inventory balance? A) The entity has rights to the inventory. B) Inventory is properly valued. C) Inventory is properly presented in the financial statements. D) Inventory is complete.

7) An auditor traces the serial numbers on equipment to a nonissuer's sub-ledger. Which of the following management assertions is supported by this test? A) Valuation and allocation. B) Completeness. C) Rights and obligations. D) Presentation and disclosure.

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8) An auditor has substantial doubt about the entity's ability to continue as a going concern for a reasonable period of time because of negative cash flows and working capital deficiencies. Under these circumstances, the auditor would be most concerned about the: A) control environment factors that affect the organizational structure. B) correlation of detection risk and inherent risk. C) effectiveness of the entity's internal control activities. D) possible effects on the entity's financial statements.

9) Which of the following types of audit evidence provides the least assurance of reliability? A) Receivable confirmations received from the client's customers. B) Prenumbered receiving reports completed by the client's employees. C) Prior months' bank statements obtained from the client. D) Municipal property tax bills prepared in the client's name.

10) Which of the following is a management assertion regarding account balances at the period end? A) Transactions and events that have been recorded have occurred and pertain to the entity. B) Transactions and events have been recorded in the proper accounts. C) The entity holds or controls the rights to assets, and liabilities are obligations of the entity. D) Amounts and other data related to the transactions and events have been recorded appropriately.

11) A practitioner is engaged to express an opinion on management's assertion that the square footage of a warehouse offered for sale is 150,000 square feet. The practitioner should refer to which of the following sources for professional guidance?

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A) Statement of Auditing Standards. B) Statements on Standards for Attestation Engagements. C) Statements on Standards for Accounting and Review Services. D) Statements on Standards for Consulting Services.

12) In auditing the long-term debt account, an auditor's procedures most likely would focus primarily on management's assertion of: A) existence. B) completeness. C) allocation. D) rights and obligations.

13) An auditor selected items for test counts from the client's warehouse during the physical inventory observation. The auditor then traced these test counts into the detailed inventory listing that ultimately agreed to the financial statements. This procedure most likely provided evidence concerning management's assertion of: A) completeness. B) valuation. C) presentation and disclosure. D) existence. E) rights and obligations.

14) An auditor selected items from the client's detailed inventory listing (that agreed to the financial statements). During the physical inventory observation, the auditor then found each item selected and counted the number of units on hand. Assuming that the amount on hand was the same as the amount in the client's detailed inventory listing, this procedure most likely would provide evidence concerning management's assertion of:

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A) completeness. B) valuation. C) presentation and disclosure. D) existence. E) rights and obligations.

15) According to PCAOB Auditing Standard No. 2201 ( AS 2201), the auditor should identify significant accounts and disclosures and their relevant assertions. Which of the following financial statement assertions is not explicitly identified in AS 2201? A) Completeness. B) Valuation or allocation. C) Accuracy. D) Existence or occurrence. E) All of these are assertions identified in AS 2201.

16) When testing the completeness assertion for a liability account, an auditor ordinarily works from the: A) financial statements to the potentially unrecorded items. B) potentially unrecorded items to the financial statements. C) accounting records to the supporting evidence. D) trial balance to the subsidiary ledger.

17) If an auditor is performing procedures related to the information that is contained in the client's pension footnote, he/she is most likely to obtain evidence concerning management's assertion about: A) rights and obligations. B) existence. C) valuation. D) presentation and disclosure.

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18) Which of the following questions would be inappropriate for an auditor to ask a client when exhibiting an appropriate level of professional skepticism while completing an audit procedure related to the internal control system? A) What can go wrong in this process? B) Which of your employees is a fraudster? C) What else is important to know about this process? D) What happens when a key employee goes on vacation?

19) To be proficient as an auditor, a person must first be able to accomplish which of these tasks in a decision-making process? A) Identify audit evidence relevant to the verification of assertions management makes in its unaudited financial statements and notes. B) Formulate evidence-gathering procedures (audit plan) designed to obtain sufficient, competent evidence about assertions management makes in financial statements and notes. C) Recognize the financial assertions made in management's financial statements and footnotes. D) Evaluate the evidence produced by the performance of procedures and decide whether management's assertions conform to generally accepted accounting principles and reality.

20) Which of the following is an underlying condition that in part creates the demand by users for reliable information? A) Economic transactions that are numerous and complex. B) Decisions that are time-sensitive. C) Users separated from accounting records by distance and time. D) Financial decisions that are important to investors and users. E) All of the these choices are correct.

21) Which of the following is not included in the American Accounting Association (AAA) definition of auditing? Version 1

A) Potential conflict of interest. B) Systematic process. C) Assertions about economic actions. D) Established criteria.

22) What is the term used to identify the risk that the client's financial statements may be materially false and misleading? A) Business risk. B) Information risk. C) Client risk. D) Risk assessment.

23) Which of the following is not a recommendation usually made following the completion of an operational audit? A) Economic and efficient use of resources. B) Effective achievement of business objectives. C) Attesting to the fairness of the financial statements. D) Compliance with company policies.

24) In order to be considered as external auditors with respect to government agencies, GAO auditors must be: A) organizationally independent. B) empowered as the accounting and auditing agency by the U.S. Congress. C) funded by the federal government. D) guided by standards similar to GAAS.

25)

Which of the following is the essential purpose of the audit function?

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A) Detection of fraud. B) Examination of individual transactions to certify as to their validity. C) Determination of whether the client's financial statement assertions are fairly stated. D) Assurance of the consistent application of correct accounting procedures.

26) The audit objective that all the transactions and accounts presented in the financial statements represent real assets, liabilities, revenues, and expenses is related most closely to which of the PCAOB assertions? A) Existence or occurrence. B) Rights and obligations. C) Completeness. D) Presentation and disclosure.

27) The audit objective that all transactions are recorded in the proper period is related most closely to which of the Audit Standards Board (ASB) transaction assertions? A) Occurrence. B) Completeness. C) Cutoff. D) Accuracy.

28) The audit objective that all transactions are recorded in the proper account is related most closely to which one of the ASB transaction assertions? A) Occurrence. B) Completeness. C) Accuracy. D) Classification.

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29) The audit objective that all balances include items owned by the client is related most closely to which one of the ASB balance assertions? A) Existence. B) Rights and obligations. C) Completeness. D) Valuation.

30) The audit objective that all balances include all items that should be recorded in that account is related most closely to which one of the ASB balance assertions? A) Existence. B) Rights and obligations. C) Completeness. D) Valuation.

31) The audit objective that footnotes in the financial statements should be clear and expressed such that the information is easily conveyed to the readers of the financial statements is related most closely with which of the ASB presentation and disclosure assertions? A) Occurrence. B) Rights and obligations. C) Comprehensibility. D) Understandability.

32) The engineering department at Omni Company built a piece of equipment in the company's own shop for use in the company's operations. The auditor reviewed all work orders that were capitalized as part of the equipment costs. Which of the following is the ASB transaction assertion most closely related to the auditor's testing?

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A) Occurrence. B) Completeness. C) Accuracy. D) Classification.

33) The engineering department at Omni Company built a piece of equipment in the company's own shop for use in the company's operations. When looking at the ending balance for the fixed asset account the auditor examined all work orders, purchased materials, labor cost reports, and applied overhead that were capitalized as part of the equipment costs. Which of the following is the ASB balance assertion most closely related to the auditor's testing? A) Existence. B) Completeness. C) Rights and obligations. D) Valuation.

34) Which of the following best describes the primary role and responsibility of independent external auditor? A) Produce a company's annual financial statements and notes. B) Express an opinion on the fairness of a company's annual financial statements and footnotes. C) Provide business consulting advice to audit clients. D) Obtain an understanding of the client's internal control structure and give management a report about control problems and deficiencies.

35) Which of the following best describes the main reason independent auditors report on management's financial statements?

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A) Management fraud may exist and it is likely to be detected by independent auditors. B) The management that prepares the statements and the persons who use the statements may have conflicting interests. C) Misstated account balances may be corrected as the result of the independent audit work. D) The management that prepares the statements may have a poorly designed system of internal control.

36) The auditor's judgment concerning the overall fairness of the presentation of financial position, results of operations, and cash flows is applied within the framework of: A) quality control. B) generally accepted auditing standards, which include the concept of materiality. C) the auditor's evaluation of the audited company's internal control. D) the applicable financial reporting framework (i.e., GAAP in the United States).

37)

Assurance services involve all of the following, except: A) relevance as well as the reliability of information. B) nonfinancial information as well as traditional financial statements. C) providing absolute rather than reasonable assurance. D) electronic databases as well as printed reports.

38) Because of the risk of material misstatement, an audit of financial statements in accordance with generally accepted auditing standards should be planned and performed with an attitude of: A) objective judgment. B) independent integrity. C) professional skepticism. D) impartial conservatism.

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39)

Which of the following best describes assurance services?

A) Independent professional services that report on the client's financial statements. B) Independent professional services that improve the quality of information for decision makers. C) Independent professional services that report on specific written management assertions. D) Independent professional services that improve the operations of the client.

40) Which of the following is not a PCAOB assertion about inventory related to presentation and disclosure? A) Inventory is properly classified as a current asset on the balance sheet. B) Inventory is properly stated at its cost on the balance sheet. C) Major inventory categories and their valuation bases are adequately disclosed in notes. D) All of these are PCAOB presentation and disclosure assertions about inventory.

41) Which of the following is not an ASB assertion about inventory related to presentation and disclosure? A) Inventory is properly classified as a current asset on the balance sheet. B) Inventory is properly stated at cost on the balance sheet. C) Major inventory categories and their valuation bases are adequately disclosed in notes. D) All of these are ASB presentation and disclosure assertions about inventory.

42)

In performing an attestation engagement, a CPA typically:

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A) supplies litigation support services. B) assesses control risk at a low level. C) expresses a conclusion on an assertion about some type of subject matter. D) provides management consulting advice.

43)

An attestation engagement is one in which a CPA is engaged to:

A) issue, or does issue, a report on subject matter or an assertion about the subject matter that is the responsibility of another party. B) provide tax advice or prepare a tax return based on financial information the CPA has not audited or reviewed. C) testify as an expert witness in accounting, auditing or tax matters, given certain stipulated facts. D) assemble prospective financial statements based on the assumptions of the entity's management without expressing any assurance.

44) The underlying conditions that create demand by users for reliable information include all of the following, except: A) transactions are numerous and complex. B) users lack professional skepticism. C) users are separated from accounting records by distance and time. D) financial decisions are important to investors and users. E) decisions are time-sensitive.

45) Cutoff tests designed to detect credit sales made before the end of the year that have been recorded in the subsequent year provide assurance about the PCAOB assertion of: A) presentation. B) completeness. C) rights. D) existence.

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46) Inquiries of warehouse personnel concerning possible obsolete or slow moving inventory items provide assurance about the PCAOB assertion of: A) completeness. B) existence. C) presentation. D) valuation. E) rights and obligations.

47) Inquiries of warehouse personnel concerning possible obsolete or slow moving inventory items provide assurance about the ASB balance assertion of: A) completeness. B) existence. C) presentation. D) valuation. E) rights and obligations.

48) The probability that the information circulated by a company will be false or misleading is referred to as: A) business risk. B) information risk. C) assurance risk. D) audit risk.

49) The Sarbanes-Oxley Act of 2002 requires that the key company officials certify the financial statements. Certification means that the company CEO and CFO must sign a statement indicating:

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A) they have read the financial statements. B) they are not aware of any false or misleading statements (or any key omitted disclosures). C) they believe that the financial statements present an accurate picture of the company's financial condition. D) All of the these choices are correct.

50) The process of a CPA obtaining a certificate and license in a state other than the state in which the CPA's certificate was originally obtained is referred to as: A) substantial equivalency. B) quid pro quo. C) relicensing. D) re-examination.

51)

The risk an entity will fail to meet its objectives is referred to as: A) business risk. B) information risk. C) assurance risk. D) audit risk.

52)

The four basic requirements for becoming a CPA in most states are:

A) education, the CPA Examination, experience, and substantial equivalency. B) the CPA Examination, experience, continuing professional education, and a state certificate. C) continuing professional education, the CPA Examination, experience, and an AICPA certificate. D) education, the CPA Examination, experience, and a state certificate.

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53) The study of business operations for the purpose of making recommendations about the efficient use of resources, effective achievement of business objectives, and compliance with company policies is referred to as A) environmental auditing. B) financial auditing. C) compliance auditing. D) operational auditing.

54) The accounting, auditing, and investigating agency of the U.S. Congress, headed by the U.S. Comptroller General, is known as A) the Federal Bureau of Investigation (FBI). B) the U.S. General Accountability Office (GAO). C) the Internal Revenue Service (IRS). D) the United States Legislative Auditors (USLA).

ESSAY. Write your answer in the space provided or on a separate sheet of paper. 55) What are the differences between the American Accounting Association and AICPA definitions and objectives of auditing?

56)

What is operational auditing and by whom is it performed?

57)

What is information risk? What is business risk?

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58)

What are the four basic requirements for becoming a CPA?

59)

Define assurance, attestation, and auditing in the context of "lending credibility."

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Answer Key Test name: Chap 01_8e_Test Bank 1) C 2) B 3) D 4) D 5) B 6) D 7) B 8) D 9) B 10) C 11) B 12) B 13) A 14) D 15) C 16) B 17) D 18) B 19) C 20) E 21) A 22) B 23) C 24) A 25) C 26) A Version 1

27) C 28) D 29) B 30) C 31) D 32) D 33) D 34) B 35) B 36) D 37) C 38) C 39) B 40) B 41) D 42) C 43) A 44) B 45) B 46) D 47) D 48) B 49) D 50) A 51) A 52) D 53) D 54) B

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55) The AAA definition is broad and general enough to encompass independent, internal, and governmental auditing. The AICPA has not defined auditing but its statement on objectives of financial audits restricts auditing to independent CPA's audit of the traditional financial statements and their footnotes. The AICPA SAS also offers guides to report on internal control, letters to underwriters, and special reports. 56) Operational auditing is the evaluation of business operations for various purposes. Operational auditing includes: (1) testing for compliance with laws and regulations and company policies and procedures, (2) evaluating the effectiveness of operations in achieving goals and objectives, and (3) evaluating the efficiency and economy of operations. Operational audits are normally performed by internal auditors. However, operational audits also may be conducted by independent CPA firms as part of their management advisory services. 57) Information risk is the risk that financial statements will be materially false or misleading. Business risk is the risk an entity will fail to meet its objectives. 58) Education, the CPA Examination, experience, and a state certificate. 59) Assurance is the "lending of credibility" to information. Attestation is the "lending of credibility" to assertions made by a third party. Auditing is the "lending of credibility" to financial statements.

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CHAPTER 1: PROBLEM MATERIAL ESSAY. Write your answer in the space provided or on a separate sheet of paper. 1) Which of the PCAOB assertions (A-E) are best verified by the following audit procedures (1-4)? A.Existence or occurrence B.Rights and obligations C.Valuation or allocation D.Completeness E.Presentation and disclosure

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1. Confirming inventory held on consignment by the client with independent third party. 2. Consulting the Wall Street Journal for year-end prices of securities held by the client. 3. Physically examine all major property and equipment additions. 4. Review the aged trial balance for significant past due accounts.

2) ABC Company had a major sale to XYZ Company. This sale accounted for 20% of the revenue of ABC Company. The auditors performed the audit procedures listed 1-3. For each audit procedure select the ASB transaction assertion that is most likely being tested. A.Occurrence B.Completeness C.Cutoff D.Accuracy E.Classification

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___ 1. The auditor reviewed the shipping documents to check the date that product was shipped to XYZ Company. ___ 2. The auditor reviewed the shipping documents to ensure that all product included in the sales revenue to XYZ had been shipped. ___ 3. The auditor reviewed the invoice sent to XYZ Company to ensure that XYZ had been properly billed.

3) Auditors are auditing the warehouse of Huge Lots Corporation. The auditors performed the audit procedures listed 1-5. For each audit procedure select the ASB balance assertion that is most likely being tested. A.Existence B.Rights and obligations C.Completeness D.Accuracy E.Valuation

___ 1. The auditors walked through the warehouse looking for obsolete inventory. ___ 2. The auditors compared invoices received from suppliers with the cost of inventory listed in the inventory accounts. ___ 3. The auditors reviewed purchase orders to determine if any inventory was on consignment. ___ 4. The auditors reviewed vendor invoices to determine if freight costs, taxes, tariffs or other costs had been included in inventory costs. ___ 5. The auditors selected items from the inventory and reviewed inventory records to ensure these items were included in those records.

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Answer Key Test name: Chap 01_8e_Test Bank_Problem Material 1) 1. B, 2. C, 3. A, 4. C 2) 1. C, 2. B, 3. D 3) 1. E, 2. D, 3. B, 4. E, 5. C

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CHAPTER 2 MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) Control risk is A) the probability that a material misstatement could not be prevented or detected by the entity's internal control policies and procedures. B) the probability that a material misstatement could occur and not be detected by auditors' procedures. C) the risk that auditors will not be able to complete the audit on a timely basis. D) the risk that auditors will not properly control the staff on the audit engagement.

2) The responsibilities principle under generally accepted auditing standards does not include which of the following? A) Competence and capabilities. B) Independent attitude. C) Due care. D) Planning and supervision.

3) Which of the following types of auditors' reports does not require additional information to support the opinion? A) Unmodified opinion. B) Adverse opinion. C) Qualified opinion. D) Disclaimer of opinion.

4) Which of the following is an element of a system of quality control that should be considered by a public accounting firm in establishing its quality control policies and procedures?

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A) Lending credibility to a client's financial statements. B) Using statistical sampling techniques. C) Acceptance and continuance of client relationships and specific engagements. D) Membership in the Center for Public Company Audit Firms.

Which of the following presumptions does not relate to the reliability of audit evidence?

A) The more effective the client's internal control, the more assurance it provides about the accounting data and financial statements. B) The auditors' opinion, to be economically useful, is formed within reasonable time and based on evidence obtained at a reasonable cost. C) Evidence obtained from independent sources outside the entity is more reliable than evidence secured solely within the entity. D) The independent auditors' direct personal knowledge, obtained through observation and inspection, is of higher quality than information obtained indirectly.

An important role of the Public Company Accounting Oversight Board is to oversee the A) issuance of statements by the Financial Accounting Standards Board. B) preparation and grading of the Uniform CPA Examination. C) peer review of member firms of the Private Companies Practice Section. D) regulation of firms that audit issuers.

Audit evidence is usually considered sufficient when

A) it is reliable. B) there is enough quantity to afford a reasonable basis for an opinion on financial statements. C) it has the qualities of being relevant, objective, and free from unknown bias. D) it has been obtained through random selection methods.

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Which of the following is not considered a type of audit evidence? A) The entity's trial balance. B) Auditors' calculations. C) Physical observation. D) Verbal statements made by client personnel.

9) An audit of the financial statements of Camden Corporation is being conducted by external auditors. The external auditors are expected to: A) certify the correctness of Camden's financial statements. B) make a complete examination of Camden's records and verify all of Camden's transactions. C) give an opinion on the fair presentation of Camden's financial statements in conformity with the applicable financial reporting framework (e.g., GAAP, IFRS). D) give an opinion on the attractiveness of Camden for investment purposes and critique the wisdom and legality of its business decisions.

10)

Auditors try to achieve independence in appearance in order to: A) maintain public confidence in the profession. B) become independent in fact. C) comply with the responsibilities principle. D) maintain an unbiased mental attitude.

11) The preparation of an audit plan prior to the beginning of field work is appropriately considered documentation of A) planning. B) supervision. C) information evaluation. D) quality assurance.

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12)

Which of the following procedures would provide the most reliable audit evidence? A) Inquiries of the client's accounting staff held in private. B) Inspection of pre-numbered client shipping documents. C) Inspection of bank statements obtained directly from the client's financial institution. D) Analytical procedures performed by auditors on the client's trial balance.

13) Which of the following would most likely be a violation of the independence requirement found in the responsibilities principle under generally accepted auditing standards? A) An auditor on the engagement has a distant relative who is employed by a vendor that does a significant amount of business with clients. B) The client's Chief Executive Officer graduated from the same university as the partner in charge of the accounting firm. C) An auditor on the engagement owns a financial interest in the stock of the client. D) The client provides financial support to a number of charitable causes that also receive support from the accounting firm.

14) A vendor's invoice received and held by the client would be considered what type of evidence? A) External. B) Internal. C) External-internal. D) Written representation.

15) Which of the following statements is generally correct about the appropriateness of audit evidence?

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A) Auditors' direct personal knowledge, obtained through observation and inspection, is of higher quality than information obtained indirectly from independent outside sources. B) To be reliable, audit evidence must be either valid or relevant, but need not be both. C) Client accounting data alone may be considered sufficient appropriate audit evidence to issue an unmodified opinion on client financial statements. D) Appropriateness of audit evidence refers to the amount of corroborative evidence to be obtained.

16) The standard auditors' report refers to standards of the PCAOB and GAAP in which section(s)? A) Standards of the PCAOB: Basis for Opinion; GAAP: Opinion on the Financial Statements. B) Standards of the PCAOB: Opinion on the Financial Statements; GAAP: Opinion on the Financial Statements and Basis for Opinion. C) Standards of the PCAOB: Opinion on the Financial Statements and Basis for Opinion; GAAP: Opinion on the Financial Statements. D) Standards of the PCAOB: Opinion on the Financial Statements; GAAP: Opinion on the Financial Statements.

17) Which of the following is not included in the auditors' standard report representing an unmodified opinion? A) A brief indication of the responsibility of auditors and management for the financial statements. B) An indication that all appropriate disclosures have been made and included in the financial statements. C) An indication that the audit was conducted in accordance with standards established by the PCAOB. D) The auditors' opinion on the fairness of the financial statements.

18)

Internal evidence

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A) is obtained directly from third parties independent of the client. B) originates outside of the client's system but has been received and processed by the client. C) consists of documents that are produced, used, and stored within the client's information system. D) consists of representations made by the client's officers, directors, owners, and employees.

19)

Which of the following presumptions is correct about the reliability of audit evidence?

A) Information obtained indirectly from outside sources is the most reliable form of audit evidence. B) To be reliable, audit evidence should be convincing rather than persuasive. C) Reliability of audit evidence refers to the amount of corroborative evidence obtained. D) An effective system of internal control provides more assurance about the reliability of audit evidence.

20)

The auditors' responsibility to express an opinion on the financial statements is

A) implicitly represented in the auditors' standard report. B) explicitly represented in the Opinion on the Financial Statements section of the auditors' standard report. C) explicitly represented in the Basis for Opinion section of the auditors' standard report. D) explicitly represented in the Critical Audit Matters section of the auditors' standard report.

21) Which of the following is not a concept from the performance principle under generally accepted auditing standards?

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A) The auditor must plan the work and properly supervise any assistants. B) The auditor must express an opinion in accordance with the auditor's findings. C) The auditor must obtain sufficient appropriate evidence about whether material misstatements exist. D) The auditor must determine and apply an appropriate materiality level throughout the audit.

22) Under generally accepted auditing standards, which of the following relates to the responsibilities principle? A) The initial planning of the audit engagement. B) The confirmation of accounts receivable. C) The completion of an internal control questionnaire. D) Maintaining professional skepticism and exercising professional judgment.

23) Which of the following represent audit quality guides that remain stable over time and are applicable for all audits? A) Auditing procedures. B) Auditing standards. C) Due care. D) System of quality control.

24) Which of the following situations would most likely be in conflict with the responsibilities principle?

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A) Auditors perform the engagement with the performance level expected of prudent auditors, but not expert auditors. B) Auditors obtain expertise in their client's industry as they are conducting the audit examination. C) Auditors are directly involved with a client manager in a strategic decision-making capacity. D) Auditors fail to document their assessment of control risk following their study of internal control.

25) Which of the following statements is not true with respect to the evidence that would be gathered when assessments of control risk are high? A) Auditors would be required to rely on external (rather than internal) forms of evidence. B) Auditors would be required to perform procedures at interim periods, rather than at year end. C) Auditors would be required to confirm a larger number of customer accounts receivable balances. D) Auditors would be required to obtain more evidence through direct personal observation.

26)

As it relates to audit evidence, appropriateness refers to the A) originality of evidence gathered. B) quality of evidence gathered. C) quantity of evidence gathered. D) timeliness of evidence gathered.

27) Which of the following information would not be included in the auditors' standard report?

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A) The names of the financial statements audited. B) A description of the nature of an audit. C) An indication that all necessary disclosures have been presented. D) An opinion on the entity's financial statements.

28)

The primary purpose of the auditors' study of internal control for a non-issuer is: A) to provide constructive suggestions to the client for improving its internal control. B) to report on internal control as required by Auditing Standard No. 5. C) to identify and detect fraud and irregularities perpetrated by client personnel. D) to determine the nature, timing, and extent of further audit procedures.

29) Which reporting options do auditors have if the client's financial statements are not presented according to the applicable financial framework (e.g., GAAP, IFRS)? A) Unmodified opinion or disclaimer of opinion. B) Qualified opinion or disclaimer of opinion. C) Unmodified opinion or adverse opinion. D) Qualified opinion or adverse opinion.

30)

Which of the following statements is true with respect to the quality of audit evidence?

A) Quality is related to the relevance of evidence, but not the reliability of evidence. B) Evidence is considered of higher quality when gathered prior to year-end than following year-end. C) Evidence obtained under environments of stronger internal control is of higher quality than evidence obtained under environments of weaker internal control. D) In evaluating quality, sufficiency of evidence is of greater importance than appropriateness of evidence.

31)

Which of the following concepts is least related to the risk of material misstatement?

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A) Control risk. B) Detection risk. C) Inherent risk. D) Materiality.

32) Which of the following statements describes an appropriate relationship with respect to the reliability of audit evidence? A) Receiving confirmation from third parties as to the existence of securities is more reliable than the auditors' personal inspection of those securities. B) Verbal inquiries received from the client regarding sales made to customers are more reliable than sales invoices prepared by the client for its customers. C) A bank confirmation received directly by the auditor is more reliable than a bank confirmation initially received by the client and forwarded to the auditor. D) Evidence drawn from a document prepared by the client is more reliable than evidence drawn from a document prepared by an external party that is forwarded to the auditor by the client.

33) A periodic review of an audit firm's system of quality control by the PCAOB is referred to as a(n): A) inspection. B) peer review. C) principles review. D) quality review.

34)

The performance principle would include all of the following except:

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A) the auditors' determination of materiality levels. B) the auditors' evaluation of independence with respect to their clients. C) the auditors' evaluation of the risk of material misstatement. D) the auditors' determination of the nature, timing, and extent of further audit procedures.

35)

Which of the following is most closely associated with the responsibilities principle? A) Due care. B) Planning. C) Qualified audit opinion. D) Risk of material misstatement.

36) Which of the following statements is not true with respect to the responsibility for establishing generally accepted auditing standards? A) The PCAOB issues auditing standards for the audit of issuers, subject to SEC approval. B) Standards issued by the Auditing Standards Board after 2003 apply to the audits of both issuers and non-issuers. C) The Auditing Standards Board currently issues auditing standards for the audit of non-issuers. D) Prior to the Sarbanes-Oxley Act, the Auditing Standards Board issued auditing standards for the audits of both issuers and non-issuers.

37)

Which of the following would normally be considered earliest in the audit examination? A) Determination of materiality levels for use during the audit. B) Consideration of the ability of the entity's internal control to prevent or detect errors. C) Preparation of a written audit plan. D) Evaluation of the type of audit opinion to be issued, based on the auditor's findings.

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38) The state of mind that characterizes the auditors' appropriate questioning and critical assessment of audit evidence is referred to as: A) due care. B) independence in appearance. C) professional judgment. D) professional skepticism.

39)

Which of the following is least related to the concept of independence in appearance?

A) The auditors' objectivity and ability to act impartially toward the client. B) The perceptions of individuals who rely on the financial statements and auditors' opinion on the financial statements. C) The ownership of a financial interest in a client by the auditor. D) The employment of the auditor's family member in an important position with the client.

40) The concept of _____ recognizes that a GAAS audit may fail to detect all material misstatements. A) absolute assurance B) due care C) reasonable assurance D) risk of material misstatement

41)

Generally accepted auditing standards are

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A) specific actions performed by auditors during an examination. B) standards that guide the conduct of an audit examination. C) legal requirements auditors must observe during the audits of issuers. D) standards used by entities in deciding whether to engage or retain the services of auditors.

42) Which of the following could serve as a source of professional guidance in the audit of an issuer? Auditing Standards Issued by the PCAOB Yes Yes No No

A. B. C. D.

Statements on Auditing Issued by the ASB No Yes Yes No

A) Option A B) Option B C) Option C D) Option D

43) Which of the following is not true with respect to the responsibilities for establishing generally accepted auditing standards? A) Auditing standards for both issuers and non-issuers must be formally approved by the Securities and Exchange Commission. B) Interpretive publications are issued by the AICPA to provide guidance on the application of generally accepted auditing standards in specific circumstances. C) The PCAOB is the body with formal authority for the creation of auditing standards for the audits of issuers. D) If specific guidance is not provided by PCAOB Auditing Standards, auditors may refer to Statements on Auditing Standards that have not been amended or superseded.

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44)

Which of the following is not related to the responsibilities principle?

A) Continuing professional education to ensure that professionals' knowledge keeps pace with changes in the accounting and auditing profession. B) Firm-wide policies to evaluate the financial and professional relationships of its professionals. C) Specific auditing procedures designed to determine the effectiveness of the entity's internal control over financial reporting. D) The auditors' use of professional judgment throughout the examination.

45) A level of performance that would be exercised by reasonable auditors in similar circumstances is referred to as A) due care. B) independence. C) professional judgment. D) professional skepticism.

46) During which stages of an audit examination are auditors required to exhibit the appropriate use of professional judgment? Gathering Evidence

Drawing Conclusions

Yes Yes No No

No Yes Yes No

A. B. C. D.

A) Option A B) Option B C) Option C D) Option D

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47)

Which of the following is not true with respect to the concept of reasonable assurance?

A) Reasonable assurance allows for mistakes and misinterpretations by the audit team throughout the examination. B) The nature of many audit procedures is such that they cannot always be relied upon to detect misstatements. C) Audit teams should evaluate all transactions and components of an account balance or class of transactions. D) Auditors should control the overall risk in an audit to an acceptably low level.

48)

A. B. C. D.

Which of the following factors influences the risk of material misstatement? Susceptibility of the Account Balance to Misstatement Yes Yes No No

Nature, Timing, and Extent of Further Audit Procedures No Yes Yes No

A) Option A B) Option B C) Option C D) Option D

49)

Which of the following is not true with respect to the auditors' report for an issuer?

A) The report title should contain the word "independent." B) The report provides a detailed listing of major auditing procedures performed during the examination. C) The opinion assesses the financial statements against an applicable financial reporting framework. D) The report specifically identifies the financial statements and years examined by the auditor.

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50) Which of the following section(s) references the requirement of auditors to be independent? A) Opinion on the Financial Statements section. B) Basis for Opinion section. C) Critical Audit Matters section. D) Opinion on the Financial Statements section and Basis for Opinion section.

51)

Which of the following is true with respect to the PCAOB inspection process?

A) All firms performing audits of issuers are inspected every year. B) PCAOB inspections are conducted by partners of other CPA firms. C) PCAOB inspection teams review a sample of audit engagements conducted by the firm as well as the firm's system of quality control. D) Deficiencies from sample audit engagements reviewed by the inspection team and deficiencies in the firm's system of quality control are publicly disclosed on the PCAOB's website.

52)

Which of the following would be evaluated during the PCAOB inspection process?

A. B. C. D.

Firm's system of quality control Yes Yes No No

Financial viability of the firm No Yes Yes No

A) Option A B) Option B C) Option C D) Option D

53) The Public Company Accounting Oversight Board was established by which of the following? Version 1

A) The Financial Accounting Standards Board. B) The American Institute of Certified Public Accountants. C) The Sarbanes-Oxley Act of 2002. D) The International Accounting Standards Board.

54) Which of the following types of audit evidence provides the least assurance of reliability? A) Receivable confirmations received from the client’s customers. B) Prenumbered receiving reports completed by the client's employees. C) Prior months' bank statements obtained from the client. D) Municipal property tax bills prepared in the client's name.

55) A CPA firm would provide itself reasonable assurance of meeting its responsibility to offer professional services that conform with professional standards by A) establishing an understanding with each client concerning individual responsibilities in a signed engagement letter. B) assessing the risk that errors and fraud may cause the financial statements to contain material misstatements. C) developing specific audit objectives to support management's assertions that are embodied in the financial statements. D) maintaining a comprehensive system of quality control that is suitably designed in relation to its organizational structure.

56) Which of the following courses of action is most appropriate if an auditor concludes that there is a high risk of material misstatement? A) Use smaller, rather than larger, sample sizes. B) Perform substantive tests as of an interim date. C) Select more effective substantive tests. D) Increase tests of controls.

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57) Which of the following actions should a CPA firm take to comply with the AICPA's quality control standards? A) Establish procedures that comply with the standards of the Sarbanes-Oxley Act. B) Use attributes sampling techniques in testing internal controls. C) Consider inherent risk and control risk before determining detection risk. D) Establish policies to ensure that the audit work meets applicable professional standards.

58)

Which of the following is a definition of control risk?

A) The risk that a material misstatement will not be prevented or detected on a timely basis by the client's internal controls B) The risk that the auditor will not detect a material misstatement C) The risk that the auditor's assessment of internal controls will be at less than the maximum level D) The susceptibility of material misstatement assuming there are no related internal control policies or procedures

59) Prior to, or in conjunction with, the information-gathering procedures for an audit, audit team members should discuss the potential for material misstatement due to fraud. Which of the following best characterizes the mind-set that the audit team should maintain during this discussion? A) Presumptive B) Judgmental C) Criticizing D) Questioning

60)

An independent auditor must have which of the following?

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A) A pre-existing and well-informed point of view with respect to the audit B) Technical training that is adequate to meet the requirements of a professional C) A background in many different disciplines D) Experience in taxation that is sufficient to comply with generally accepted auditing standards

61) What type of evidence would provide the highest level of assurance in an attestation engagement? A) Evidence secured solely from within the entity. B) Evidence obtained from independent sources. C) Evidence obtained indirectly. D) Evidence obtained from multiple internal inquiries.

62)

Which of the following is an important consideration during the planning of the audit?

A) Considering the independence of members of the audit team B) Performing some of the audit procedures prior to the end of the year under audit C) Considering the ability and expertise of the audit team with respect to accounting and auditing issues in the client's industry D) Considering the impact of tests of controls on the overall assessment of control risk

63)

The initial development of auditing standards was in response to

A) a scandal involving embezzlement that was not detected during an audit engagement. B) auditors' concerns that all components of the financial statements were not being verified. C) independent inquiries of the public accounting profession made by the SEC. D) requests by companies for greater assurance with respect to the auditors' ability to detect financial statement misstatements.

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64) All of the following statements are true regarding generally accepted auditing standards (GAAS) except: A) departures from auditing standards that impose presumptively mandatory requirements on auditors are not permitted under any circumstances. B) Auditing Standards issued by the PCAOB serve as an appropriate source of GAAS for the audits of issuers. C) separate auditing standards have been developed for the audits of U.S. governmental entities and foreign entities. D) Interpretive Publications, which are officially considered less authoritative and less binding than auditing standards, are included as part of GAAS.

65) The particular and specialized actions that auditors undertake to obtain evidence in a specific audit engagement are known as A) Auditing Standards. B) audit procedures. C) Interpretive Publications. D) Statements on Auditing Standards.

66) The role of the Public Company Accounting Oversight Board in the standard-setting process is to develop A) Statements on Auditing Standards for the audits of non-issuers. B) Auditing Standards for the audits of issuers. C) Governmental Auditing Standards for the audits of governmental entities. D) International Standards on Auditing for the audits of foreign entities.

67) Pronouncements issued by the Public Company Accounting Oversight Board are subject to formal approval by the

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A) American Institute of Certified Public Accountants. B) Auditing Standards Board. C) International Auditing and Assurance Standards Board. D) Securities and Exchange Commission.

68)

The three fundamental principles underlying GAAS include all of the following, except: A) general principle. B) performance principle. C) reporting principle. D) responsibilities principle.

69) The fundamental principles developed by the Auditing Standards Board are best described as: A) ten basic standards underlying an audit. B) standards that apply only to audits of issuers. C) industry-specific guidance on how audit procedures should be conducted. D) guidelines for the general conduct of audit engagements.

70) The relevant ethical requirements relating to due care, professional skepticism, and professional judgment are responsibilities of the auditor at which stage(s) of the audit? A. B. C. D.

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Risk Assessment

Audit Evidence

Yes Yes No No

No Yes Yes No

A) Option A B) Option B C) Option C D) Option D

71) Which of the following does not directly relate to an auditor's responsibility for having appropriate competence and capabilities to perform the audit? A) Participating in continuing professional education B) Gaining experience through hands-on practice C) Obtaining reliable documentary evidence D) Attending on-the-job training

72)

Which of the following situations would result in the issuance of a disclaimer of opinion?

A) The audit reveals weaknesses in the client's internal control over financial reporting. B) The auditor is discovered to own a financial interest in the entity. C) The audit is performed, with limited exception, in accordance with generally accepted auditing standards. D) The entity's financial statements are not presented in conformity with the applicable financial reporting framework.

73) In a system of quality control, leadership responsibilities for quality within the firm are best characterized by: A) basing personnel performance evaluations on the employees' ability to generate revenues from existing clients or by acquiring new clients. B) management's evaluation of the integrity and business reputation of the client. C) management's clear and consistent demonstration of its own commitment to quality control and high-quality work. D) assigning management responsibilities in such a manner that commercial considerations are the firm's top priority.

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74) The audit failures of both Enron and WorldCom were examples in which the leadership responsibilities for quality work within the accounting firm were overshadowed by fears that losing a key client would A) result in shareholder losses from reduced company profitability. B) require additional audit procedures and increase the fees paid by the companies to the accounting firm. C) negatively influence the results of the firm's inspection. D) negatively impact individual auditors' performance evaluations.

75) Which of the following is an example of the appropriate implementation of a system of quality control? A) The firm requires all documents obtained during the audit to be destroyed immediately following the engagement to ensure the client's information remains confidential. B) The firm's quality control policies have evolved through the performance of audit procedures but are not formally developed or communicated to staff members. C) All firm employees must verbally confirm their compliance with the appropriate independence requirements before being assigned to an engagement. D) The firm uses manuals and standardized forms for audit documentation to help ensure engagement performance objectives and quality standards are met.

76) An internal evaluation of the significant judgments made by the audit team and the conclusions reached in formulating its report for engagements meeting specified criteria is known as a(n): A) engagement quality control review. B) inspection. C) peer review. D) performance control evaluation.

77) Which element of a system of quality control strives to provide the firm with reasonable assurance that its policies and procedures are operating effectively? Version 1

A) Human resources B) Leadership responsibilities for quality within the firm C) Monitoring D) Relevant ethical requirements

78) When a firm decides to withdraw from an engagement, it should document all of the following except: A) significant issues influencing the decision to withdraw from the engagement. B) the basis for any conclusions related to this decision to withdraw from the engagement. C) significant consultations related to the decision to withdraw from the engagement. D) significant effects the decision to withdraw from the engagement could have on the firm.

79) Firm A performs audits of 60 issuers, while firm B performs audits of 120 issuers. How often must each firm undergo a PCAOB inspection? A) Both firm A and firm B will be inspected every other year. B) Firm A will be inspected annually and firm B will be inspected every three years. C) Firm A will be inspected every three years and firm B will be inspected annually. D) Both firm A and firm B will be inspected annually.

80)

PCAOB inspections are conducted by

A) individuals selected by the PCAOB who are not current employees of public accounting firms. B) another public accounting firm selected by the firm being inspected. C) current employees of another public accounting firm selected by the PCAOB. D) the AICPA's Public Oversight Board.

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81) All of the following are examples of procedures a firm can use to monitor its system of quality control except: A) discussions with firm personnel. B) conducting reviews of engagement documentation. C) devoting sufficient resources to developing a system of quality control. D) assessing compliance with independence policies and procedures.

ESSAY. Write your answer in the space provided or on a separate sheet of paper. 82) Alan Fallon was recently promoted to senior accountant. He was put in charge of the Mellow Markets audit because of his experience with other grocery clients. Mellow Markets has a small, but growing, chain of natural food stores. This is the first year Mellow Markets has been audited. Because of their growth, Mellow Markets needs additional capital and intend to use their audited financial statements to secure a loan. Alan has been assigned two inexperienced staff assistants for the audit. Because this is his first engagement as a senior, he intends to bring the job in on budget. To save time, he provided his assistants with a copy of the audit plan for Happy Time Food Stores. He told them that this would make things go more quickly. He also told them that he could not spend much time with them at the client's place of business, because "my time is billed out at such a high rate, we'll go right over budget." However, he did call them once a day from another audit on which he was working. After beginning their work, the assistants told Alan that the audit plan did not always match up with what they found at Mellow Markets. Alan responded, "just cross out whatever is not relevant in the audit plan and don't add anything – it will only make us go over the budget." When Alan came to the client near the end of field work, one assistant was concerned that no inventory observation was done at the out-of-town locations of Mellow Markets (the audit plan had stipulated that inventory should be observed for in-town stores only). Happy Time had only one out-of-town location, while three of Mellow Markets' five stores were in other cities. Alan told the assistant to get inventory sheets from the client for the other stores and added "make sure that the inventory balance in the general ledger agrees with the total for all the inventory sheets." The next day, Alan reviewed all audit documentation and submitted the job for review by the manager. Required: 1. Describe the performance principle of GAAS. 2. Do you believe that the Mellow Markets audit complies with the performance principle? Explain.

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Answer Key Test name: Chap 02_8e_Test Bank 1) A 2) D 3) A 4) C 5) B 6) D 7) B 8) A 9) C 10) A 11) A 12) C 13) C 14) C 15) A 16) C 17) B 18) C 19) D 20) C 21) B 22) D 23) B 24) C 25) B 26) B Version 1

27) C 28) D 29) D 30) C 31) B 32) C 33) A 34) B 35) A 36) B 37) A 38) D 39) A 40) C 41) B 42) B 43) A 44) C 45) A 46) B 47) C 48) A 49) B 50) B 51) C 52) A 53) C 54) B 55) D 56) C Version 1

57) D 58) A 59) D 60) B 61) B 62) B 63) A 64) A 65) B 66) B 67) D 68) A 69) D 70) B 71) C 72) B 73) C 74) D 75) D 76) A 77) C 78) D 79) C 80) A 81) C

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82) According to the performance principle, to obtain reasonable assurance, which is high but not an absolute level of assurance, the auditor: 1.Plans the work and properly supervises any assistants. 2.Determines and applies appropriate materiality level or levels throughout the audit. 3.Identifies and assesses risks of material misstatement, whether due to fraud or error, based on an understanding of the entity and its environment, including the entity's internal control. 4.Obtains sufficient appropriate audit evidence about whether material misstatements exist, through designing and implementing appropriate responses to the assessed risks. The Mellow Markets audit does not comply with the performance principle. With respect to planning, the failure to prepare an appropriate audit plan and lack of time and attention the inexperienced staff received from Alan violate the performance principle. In addition, there is no indication that any steps were taken to either understand the client's business or its internal control. Finally, these deficiencies suggest that the appropriate procedures were not performed to collect sufficient appropriate evidence. Further, the lack of a relevant plan to observe inventory in other cities and Alan's decision to limit inventory procedures to agreeing the inventory sheets and the general ledger inventory balance demonstrates the failure to gather sufficient appropriate evidence and represents an overall violation of the performance principle.

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CHAPTER 2: PROBLEM MATERIAL ESSAY. Write your answer in the space provided or on a separate sheet of paper. 1) For each of the items below, indicate through the appropriate letter the fundamental principle to which the item is most closely related. A.Responsibilities principle B.Performance principle C.Reporting principle

___ ___

___

___ ___

___ ___ ___

___ ___

1. Maintaining professional skepticism. 2. An auditors’ overall conclusion of the fairness of the client’s financial statements. 3. The use of an audit plan to identify audit procedures to be performed during the engagement. 4. Auditors’ assessment of the risk of material misstatement. 5. Accounting firm policies with respect to the level of expected continuing professional education. 6. Expressing an opinion in accordance with the auditor’s findings. 7. Proper supervision of assistants on the audit.c 8. Auditors’ requests to obtain bank statements directly from financial institutions with whom the client does business. 9. An indication that an opinion cannot be expressed. 10. Determining and applying an appropriate materiality level.

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2) For each of the statements below, indicate through the appropriate letter whether it relates to the PCAOB, Auditing Standards Board, both the PCAOB and Auditing Standards Board, or neither the PCAOB nor Auditing Standards Board. A.PCAOB B.Auditing Standards Board C.Both PCAOB and Auditing Standards Board D.Neither PCAOB nor Auditing Standards Board

___ ___ ___ ___ ___

1. Conducts inspections of firms that audit issuers. 2. Pronouncements may be used in the audit of non-issuers. 3. Pronouncements may be used in the audit of issuers. 4. Was created by the Sarbanes Oxley Act of 2002. 5. Involved with the certification and licensure of public accountants. ___ 6. Issues Statements on Auditing Standards. ___ 7. Conducts peer reviews of firms that audit non-issuers. ___ 8. Sanctions individual auditors for violations of generally accepted auditing standards.

3) For each of the items below, indicate through the appropriate letter the element of a system of quality control to which it is most closely related. A.Leadership responsibilities B.Relevant ethical requirements C.Acceptance and continuance of clients D.Human resources E.Engagement performance F.Monitoring

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___ ___

___

___ ___

___

___ ___

1. Reviewing selected administrative and personnel records. 2. Obtaining written confirmations regarding compliance with appropriate independence requirements. 3. Ensuring that financial considerations do not override the quality of work performed. 4. Establishing policies and procedures for resolving differences of opinion within the engagement team. 5. Devoting sufficient resources for developing, communicating, and supporting the firm’s quality control policies and procedures. 6. Evaluating the integrity and business reputation of the client. 7. Identifying circumstances and relationships that create threats to auditor independence. 8. Ensuring the firm’s ability to perform the engagement with an appropriate level of professional competence. 9. Maintaining engagement documentation for an appropriate period of time. 10. Assessing the appropriateness of the firm’s guidance materials and professional aids.

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Answer Key Test name: Chap 02_8e_Test Bank_Problem Material 1) 1. A; 2. C; 3. B; 4. B; 5. A; 6. C; 7. B; 8. B; 9. C; 10. B 2) 1. A; 2. B; 3. C; 4. A; 5. D; 6. B; 7. D; 8. D 3) 1. F; 2. B; 3. A; 4. E; 5. A; 6. C; 7. B; 8. C; 9. E; 10. F

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CHAPTER 3 MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) Which of the following auditor concerns most likely could be so serious that the auditor would conclude that a financial statement audit cannot be conducted? A) The entity has no formal written code of conduct. B) The integrity of entity's management is suspect. C) Procedures requiring separation of duties are subject to management override. D) Management fails to modify prescribed controls for changes in conditions.

Before accepting an engagement to audit a new client, an auditor is required to:

A) make inquiries of the predecessor auditor after obtaining the consent of the prospective client. B) obtain the prospective client's signature to the engagement letter. C) prepare a memorandum setting forth the staffing requirements and documenting the preliminary audit plan. D) discuss the management representation letter with the prospective client's audit committee.

3) Which of the following statements is most accurate regarding sufficient and appropriate documentation? A) Accounting estimates are not considered sufficient and appropriate documentation. B) Sufficient and appropriate documentation should include evidence that the audit working papers have been reviewed. C) If additional evidence is required to document significant findings or issues, the original evidence is not considered sufficient and appropriate and therefore should be deleted from the working papers. D) Audit documentation is the property of the client, and sufficient and appropriate copies should be retained by the auditor for at least five years.

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4) When applying analytical procedures during an audit, which of the following is the best approach for developing expectations?

A) Considering unaudited account balances and ratios to calculate what adjusted balances should be. B) Comparing current-year account balances to balances of one or more comparable periods. C) Considering the pattern of several unusual changes without trying to explain what caused them. D) Comparing client data with client-determined expected results to reduce detailed tests of account balances.

5) Which of the following explanations best describes why an auditor may decide to reduce tests of details for a particular audit objective? A) The audit is being performed soon after the balance sheet date. B) Audit staff are experienced in performing the planned procedures. C) Analytical procedures have revealed no unusual or unexpected results. D) There were many transactions posted to the account during the period.

6) Which of the following steps should an auditor perform first to determine the existence of related parties? A) Examine invoices, contracts, and purchasing orders. B) Request a list of related parties from management. C) Review the company's business structure. D) Review proxy and other materials filed with the SEC.

7) Which of the following is a correct statement regarding the nature and timing of communications between an accounting firm performing an initial audit of an issuer and the issuer's audit committee?

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A) Prior to accepting the engagement, the firm must orally affirm its independence to the audit committee with all members present. B) The firm must address all independence impairment issues on the date of the audit opinion. C) Communications related to independence may occur in any form prior to issuance of the financial statements. D) Prior to accepting the engagement, the firm should describe in writing all relationships that, as of the date of the communication, may reasonably be thought to bear on independence.

Before accepting an engagement to audit a new client, a CPA is required to obtain: A) an assessment of fraud risk factors likely to cause material misstatements. B) an understanding of the prospective client's industry and business. C) the prospective client's signature to a written engagement letter. D) the prospective client's consent to make inquiries of the predecessor, if any.

9) During a financial statement audit an internal auditor may provide direct assistance to the independent CPA in performing. Tests of controls

Substantive Tests

Yes Yes No No

Yes No Yes No

A. B. C. D.

A) Option A B) Option B C) Option C D) Option D

10)

When assessing internal auditors' objectivity, an independent auditor should:

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A) consider the policies that prohibit the internal auditors from auditing areas where they were recently assigned. B) review the internal auditors' reports to determine that their conclusions are consistent with the work performed. C) verify that the internal auditors' assessment of control risk is comparable to the independent auditor's assessment. D) evaluate the quality of the internal auditors' working paper documentation and their recent audit recommendations.

11) Which of the following procedures would a CPA most likely perform in the planning phase of a financial statement audit? A) Make inquiries of the client's lawyer concerning pending litigation. B) Perform cutoff tests of cash receipts and disbursements. C) Compare financial information with nonfinancial operating data. D) Recalculate the prior year's accruals and deferrals.

12)

Which of the following matters does an auditor usually include in the engagement letter? A) Arrangements regarding fees and billing. B) Analytical procedures that the auditor plans to perform. C) Indications of negative cash flows from operating activities. D) Identification of working capital deficiencies.

13) Which of the following factors should an external auditor obtain updated information about when assessing an internal auditor's competence? A) The reporting status of the internal auditor within the organization. B) The educational level and professional experiences of the internal auditor. C) Whether policies prohibit the internal auditor from auditing areas where relatives are employed. D) Whether the board of directors, audit committee, or owner-manager oversees employment decisions related to the internal auditor.

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14) Which of the following would a successor auditor ask the predecessor auditor to provide after accepting an audit engagement? A) Disagreements between the predecessor auditor and management as to significant accounting policies and principles. B) The predecessor auditor's understanding of the reasons for the change of auditors. C) Facts known to the predecessor auditor that might bear on the integrity of management. D) Matters that may facilitate the evaluation of financial reporting consistency between the current and prior years.

15) Which of the following factors most likely would cause an auditor not to accept a new audit engagement? A) An inadequate understanding of the entity's internal controls. B) The close proximity to the end of the entity's fiscal year. C) Concluding that the entity's management probably lacks integrity. D) The inability to perform preliminary analytical procedures before assessing control risk.

16)

The auditor is not required to ask the predecessor auditor about:

A) facts that might bear on the integrity of management. B) disagreements the predecessor may have had with management about accounting principles and audit procedures. C) the fees charged for the previous audit. D) the predecessor's understanding about the reasons for the change of auditors.

17)

Audit documentation does not normally include the: A) specific assertions under audit. B) industry accounting guides. C) record of the procedures performed. D) decisions made in the course of the audit.

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18) C. Hill, CPA, has been retained to audit the financial statements of Monday Co. Monday's predecessor auditor was K. Post, CPA, whom Monday has notified by that its services have been terminated. Under these circumstances, which party should initiate the communications between Hill and Post? A) Hill, the auditor. B) Post, the predecessor auditor. C) Monday's controller or CFO. D) The chair of Monday's board of directors.

19) Which of the following provides the best method of obtaining an understanding of a continuing client's business for planning an audit? A) Performing tests of details of transactions and balances. B) Reviewing prior year audit documentation and the permanent file for the client. C) Reading specialized industry journals. D) Reevaluating the client's internal control environment.

20) The pre-engagement activities of an audit engagement for a public accounting firm do not include: A) evaluating the public accounting firm's independence with regard to the audit engagement. B) obtaining predecessor audit documentation. C) obtaining an engagement letter. D) ensuring that there are sufficient firm resources to complete the engagement on a timely basis.

21) Which of the following procedures would an auditor most likely perform in planning a financial statement audit?

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A) Inquiring of the client's legal counsel concerning pending litigation. B) Comparing the financial statements to anticipated results. C) Examining computer-generated exception reports to verify the effectiveness of internal controls. D) Searching for unauthorized transactions that may aid in detecting unrecorded liabilities.

22)

This year, Blakeney Enterprises engaged a new auditor who must:

A) attempt to communicate with the predecessor auditor before accepting the engagement. B) review the predecessor's audit documentation if the audit is to be in accordance with GAAS. C) seek the SEC's permission to accept the engagement if Blakeney is publicly owned. D) reject the engagement if the change in auditors resulted from a dispute with the predecessor.

23)

An engagement letter is used primarily to: A) ensure a clear contractual understanding of the services to be provided by the CPA. B) express an opinion on the financial statements. C) provide management representations to be included in the audit evidence. D) disclaim liability.

24) The firm of Banta, Brown, and Burgess, CPAs, requires that audit documentation contain the initials of the preparer and the reviewer in the top right-hand corner. This procedure provides evidence of professional concern regarding which generally accepted auditing standard? A) Independence. B) Adequate technical competence and capabilities. C) Adequate planning and supervision. D) Gathering sufficient competent evidence.

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25)

During the initial planning phase of an audit, a CPA most likely would:

A) test specific internal control activities that are likely to prevent fraud. B) evaluate the reasonableness of the client's accounting estimates of inventory obsolescence. C) discuss the timing of the audit procedures with the client's management. D) inquire of the client's attorney as to whether any unrecorded claims are probable of assertion.

26) Prior to beginning the fieldwork on a new audit engagement in which the audit team does not possess expertise in the industry in which the client operates, the audit team should: A) reduce audit risk by lowering the preliminary levels of materiality. B) design special substantive tests to compensate for the lack of industry expertise. C) engage financial experts familiar with the nature of the industry. D) obtain knowledge of matters that relate to the nature of the entity's business.

27)

Which of the following is not a category of audit documentation? A) Temporary files. B) Permanent files. C) Audit administrative files. D) Current documentation files.

28) For which of the following judgments may an independent auditor share responsibility with an entity's internal auditor who is assessed to be both competent and objective? A) Assessment of inherent risk, yes; assessment of control risk, yes. B) Assessment of inherent risk, yes; assessment of control risk, no. C) Assessment of inherent risk, no; assessment of control risk, yes. D) Assessment of inherent risk, no; assessment of control risk, no.

29)

Which of the following is not considered an accounting estimate?

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A) Allowance for loan losses. B) Credit sales. C) Net realizable value of inventory. D) Percentage-of-completion revenue to be recorded.

30)

Which of the following would be a step in an internal control program? A) Obtain an aged trial balance of the accounts receivable. B) Prepare and send confirmations on a sample of customers' accounts receivable. C) Assess the control risk for sales and collections. D) Read sales contracts for evidence of customers' rights of return or price allowance

terms.

31)

The idea of the cycle approach is to group accounts together by: A) specific function. B) financial statement assertion. C) audit objective. D) transactions that affect all accounts in that particular group.

32)

Which of the following is not one of the four major cycles? A) Revenue and cash collection. B) Acquisition and expenditure. C) Cash receipts and disbursements. D) Financing and investing.

33)

Looking at vendors' invoices for particular information is an example of:

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A) physical observation. B) confirmation. C) inspection of documents. D) scanning.

34) An auditor who uses 7 percent of income before taxes as a basis for overall materiality would be basing judgment on: A) absolute size. B) relative size. C) nature of the item. D) cumulative effects.

35) Which of the following is not a way in which auditors use the concept of overall materiality? A) As a guide to planning the audit plan. B) As a guide to the evaluation of evidence. C) As a guide for making decisions about the audit report. D) As a guide for assessing control risk.

36) The auditor looked at a bank statement received and held by the client. What kind of audit procedure would this be considered? A) Recalculation. B) Physical observation. C) Confirmation. D) Examination of documents.

37)

In testing the existence assertion for an asset, an auditor ordinarily works from the:

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A) financial statements to the potentially unrecorded items. B) potentially unrecorded items to the financial statement. C) accounting records to the supporting evidence. D) supporting evidence to the accounting records.

38) In determining whether transactions have been recorded, the direction of the audit testing should start from the: A) general ledger balances. B) adjusted trial balance. C) original source documents. D) general journal entries.

39)

Auditors should design the written audit plan so that:

A) all material transactions will be selected for substantive testing. B) substantive tests prior to the balance sheet date will be minimized. C) the audit procedures selected will achieve specific audit objectives. D) each account balance will be tested under either tests of controls or tests of transactions.

40) In designing written audit plans, an auditor should establish specific audit objectives that relate primarily to the: A) timing of audit procedures. B) cost-benefit of gathering techniques. C) selected audit techniques. D) financial statement assertions.

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41) In considering overall materiality for planning purposes, an auditor believes that misstatements aggregating $10,000 would have a material effect on an entity's income statement but that misstatements would have to aggregate $20,000 to materially affect the balance sheet. Ordinarily, it would be appropriate to design audit procedures that would be expected to detect misstatements aggregating: A) $10,000. B) $15,000. C) $20,000. D) $30,000.

42) The independent auditors' audit design prepared prior to the start of fieldwork is appropriately considered documentation of: A) planning. B) supervision. C) information evaluation. D) quality assurance.

43)

In the preparation of an audit plan, which of the following items is not essential? A) A review of material from prior audits. B) The preparation of a budget identifying the costs of resources needed. C) An understanding of controls established by management. D) Assessment of inherent risk.

44) To satisfy the valuation assertion when auditing an investment in another company that is publicly and actively traded, an auditor most likely would seek to:

A) inspect the stock certificates evidencing the investment. B) examine the audited financial statements of the investee company. C) review the broker's advice or canceled check for the investment's acquisition. D) obtain market quotations from The Wall Street Journal or another independent source.

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45) Cutoff tests designed to detect credit sales made before the end of the year that have been recorded in the subsequent year provide assurance about management's assertion of: A) presentation and disclosure. B) completeness. C) rights and obligations. D) existence.

46) Which of the following audit procedures probably would provide the most reliable evidence concerning the entity's assertion of rights and obligations related to inventories? A) Trace test counts noted during the physical count of inventory to the summarization of quantities. B) Inspect agreements for evidence of inventory held on consignment. C) Select the last few shipping advices used before the physical count and determine whether the shipments were recorded as sales. D) Inspect the open purchase order file for significant commitments to consider for disclosure.

47) During an audit of an entity's stockholders' equity accounts, the auditor determines whether there are restrictions on retained earnings resulting from loans, agreements, or state law. This audit procedure most likely is intended to verify management's assertion: A) existence or occurrence. B) completeness. C) valuation or allocation. D) presentation and disclosure.

48) Which of the following most likely would give the most assurance concerning the valuation assertion of accounts receivable?

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A) Tracing amounts in the subsidiary ledger to details on shipping documents. B) Comparing receivable turnover rates to industry statistics for reasonableness. C) Inquiring about receivables pledged under loan agreements. D) Assessing the allowance for uncollectible accounts for reasonableness.

49) An auditor most likely would inspect additions to the audit client's Property, Plant, and Equipment account to obtain evidence concerning management's assertions about: A) existence or occurrence. B) rights and obligations. C) presentation and disclosure. D) valuation or allocation.

50) Which of the following is a substantive test that an auditor most likely would perform to verify the existence and valuation of recorded accounts payable? A) Investigating the open purchase order file to ascertain that prenumbered purchase orders are used and accounted for. B) Receiving the client's unopened mail for a reasonable period of time after year-end to search for unrecorded vendor's invoices. C) Vouching selected entries in the accounts payable subsidiary ledger to purchase orders and receiving reports. D) Confirming accounts payable balances with known vendors and suppliers who have zero balances at year-end.

51) An auditor most likely would review an entity's periodic accounting for the numerical sequence of shipping documents and invoices to support management's financial statement assertion of: A) rights and obligations. B) completeness. C) presentation and disclosure. D) existence or occurrence.

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52) In auditing accrued liabilities, an auditor's procedures most likely would focus primarily on management's assertion of: A) existence or occurrence. B) completeness. C) presentation and disclosure. D) valuation or allocation.

53) An auditor selected items for test counts from a client's inventory listing before observing the client's physical inventory at the warehouse. The auditor then found the items selected at the warehouse and counted them. This procedure most likely obtained evidence concerning management's assertion of: A) rights and obligations. B) completeness. C) existence or occurrence. D) valuation.

54) An auditor tests an entity's control that matches shipping documents to sales invoices before they are recorded in the financial statements as revenue in support of management's financial statement assertion of: A) valuation or allocation. B) presentation and disclosure. C) existence or occurrence. D) rights and obligations.

55) Which of the following audit procedures would an auditor most likely perform to test controls relating to management's valuation assertion for accounts receivable?

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A) Verify that extensions and footings on the entity's sales invoices and monthly customer statements have been recomputed. B) Inspect the entity's reports of prenumbered shipping documents that have not been recorded in the sales journal. C) Compare the invoiced prices on prenumbered sales invoices to the entity's authorized price list. D) Inquire about the entity's credit-granting policies and test whether credit checks have been consistently applied to new customers.

56) The confirmation of a cash balance provides primary evidence regarding which management assertion? A) Existence. B) Valuation. C) Allocation. D) Completeness.

57) The confirmation of an accounts receivable balance provides primary evidence regarding which management assertion? A) Completeness. B) Valuation. C) Allocation. D) Existence.

58) In testing the completeness assertion for a liability account, an auditor ordinarily works from the: A) financial statements to the potentially unrecorded items. B) potentially unrecorded items to the financial statements. C) accounting records to the supporting evidence. D) trial balance to the subsidiary ledger.

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59) An auditor's purpose in auditing the information contained in the pension footnote most likely is to obtain evidence concerning management's assertion about: A) rights and obligations. B) existence. C) presentation and disclosure. D) valuation.

ESSAY. Write your answer in the space provided or on a separate sheet of paper. 60) Explain the bottom-up approach and the top-down approach to quantifying overall materiality.

61) Do the following regarding auditors' concepts of overall "materiality" considered at the planning stage (i.e., "planning materiality"). a.Define or describe independent auditors' concept of "planning materiality." b.Name (but do not describe or explain) three common relationships or considerations used by auditors when assessing the dollar amount considered to be material.

62)

Identify the two types of audit plans and indicate the purpose of each.

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63) D. Jackson, CPA, audited Washington Company's financial statements for the year ended December 31, 2017. On November 1, 2018, Washington notified Jackson that it was changing auditors and that Jackson's services were being terminated. On November 5, 2018, Washington invited Lincoln, CPA, to make a proposal for an engagement to audit its financial statements for the year ended December 31, 2018. Required: What procedures concerning Jackson should Lincoln perform before accepting the engagement?

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Answer Key Test name: Chap 03_8e_Test Bank 1) B 2) A 3) B 4) B 5) C 6) B 7) D 8) D 9) A 10) A 11) C 12) A 13) B 14) D 15) C 16) C 17) B 18) A 19) B 20) B 21) B 22) A 23) A 24) C 25) C 26) D Version 1

27) A 28) D 29) B 30) C 31) D 32) C 33) C 34) B 35) D 36) D 37) C 38) C 39) C 40) D 41) A 42) A 43) B 44) D 45) B 46) B 47) D 48) D 49) A 50) C 51) B 52) B 53) C 54) C 55) D 56) A Version 1

57) D 58) B 59) C 60) In the bottom-up approach to judging materiality, amounts in each account are judged separately and then combined to determine the overall effect. In the top-down approach to judging materiality, an overall material amount is determined for the financial statements and then allocated to each particular account. 61) a.Planning materiality is the largest amount of uncorrected dollar misstatement the auditors believe could exist in published financial statements without causing them to be considered materially misleading. b.Absolute size, relative size, nature of the item or issue, circumstances, uncertainty, cumulative effects. 62) The two types of audit plans are (1) the internal control program and (2) the substantive audit plan. The internal control program contains the specification of procedures for obtaining an understanding of the entity's business and environment, including its internal control, and for assessing the inherent risk and the control risk related to the financial account balances. The substantive audit plan contains the specification of substantive tests for gathering direct evidence on the assertions about dollar amounts in the account balances.

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63) a.Lincoln should explain to Washington the need to make an inquiry of Jackson and should request permission to do so. b.Lincoln should ask Washington to authorize Jackson to respond fully to Lincoln's inquiries. c.If Washington refuses to permit Jackson to respond or limits Jackson's response, Lincoln should inquire as to the reasons and consider the implications in deciding whether to accept the engagement. d.Lincoln should make specific and reasonable inquiries of Jackson regarding matters Lincoln believes will assist in determining whether to accept the engagement, including specific questions regarding. e.(1) Facts that might bear on the integrity of management. f.(2) Disagreements with management as to accounting principles, audit procedures, or other similarly significant matters. g.(3) Communications Jackson made to management about fraud, illegal acts, or internal control recommendations. h.(4) Jackson's understanding as to the reasons for the change of auditors. i.If Lincoln receives a limited response, Lincoln should consider its implications in deciding whether to accept the engagement.

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CHAPTER 3: PROBLEM MATERIAL ESSAY. Write your answer in the space provided or on a separate sheet of paper. 1) For each of the descriptions 1-6, match the correct word or phrase from A-H. A.Inspections of tangible assets B.Confirmation C.Tracing D.Vouching E.Inquiry F.External-internal evidence G.Audit plan H.Substantive procedures

___ 1. Documentation prepared by independent parties and sent to the client. ___ 2. Proceeding forward through the accounting and control system from the evidence to the financial statements. ___ 3. Audit of details of transactions and balances. ___ 4. Audit procedure that provides compelling evidence of existence. ___ 5. Direct correspondence with independent parties. ___ 6. A list of audit procedures.

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Answer Key Test name: Chap 03_8e_Test Bank_Problem Material 1) 1. F; 2. C; 3. H; 4. A; 5. B; 6. G

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CHAPTER 4 MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) The major emphasis in GAAS related to consideration of fraud in a financial statement audit (AU-C 240) is on: A) employee misappropriation of assets. B) management fraud. C) client fraud on customers. D) employee embezzlement.

Management fraud generally refers to: A) unintentional mistakes. B) noncompliance. C) intentional distortions of financial statements. D) violations of GAAS.

External auditors are responsible:

A) for authenticating documents. B) for reporting immaterial frauds to a level of management at least one level above the people involved. C) for finding all intentional misstatements concealed by collusion. D) for reporting all frauds to outside agencies or parties.

4) Which of the following information that comes to an auditor's attention most likely would raise a question about the occurrence of illegal acts? A) The exchange of property for similar property in a nonmonetary transaction. B) The discovery of unexplained payments made to government employees. C) The presence of several difficult-to-audit transactions affecting expense accounts. D) The failure to develop adequate procedures that detect unauthorized purchases.

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5) Analytical procedures are most appropriate when testing which of the following types of transactions? A) Payroll and benefit liabilities. B) Acquisitions and disposals of fixed assets. C) Operating expense transactions. D) Long-term debt transactions.

6) An auditor's analytical procedures indicate a lower than expected return on an equity method investment. This situation most likely could have been caused by: A) an error in recording amortization of the excess of the investor's cost over the investment's underlying book value. B) the investee's decision to reduce cash dividends declared per share of its common stock. C) an error in recording the unrealized gain from an increase in the fair value of available-for-sale securities in the income account for trading securities. D) a substantial fluctuation in the price of the investee's common stock on a national stock exchange.

7) Prior to, or in conjunction with, the information-gathering procedures for an audit, audit team members should discuss the potential for material misstatement due to fraud. Which of the following best characterizes the mind-set that the audit team should maintain during this discussion? A) Presumptive. B) Judgmental. C) Criticizing. D) Questioning.

8) Which of the following analytical procedures most likely would be used during the planning stage of an audit?

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A) Comparing current-year to prior-year sales volumes. B) Reading the financial statements and notes and considering the adequacy of evidence. C) Comparing the current-year ratio of aggregate salaries paid to the number of employees to the prior-year's ratio. D) Reading the letter from the client's attorney and considering the threat of litigation.

In auditing related party transactions, an auditor ordinarily places primary emphasis on: A) the probability that related party transactions will recur. B) confirming the existence of the related parties. C) verifying the valuation of the related party transactions. D) the adequacy of the disclosure of the related party transactions.

10)

Which of the following would not be considered an analytical procedure?

A) Converting dollar amounts of income statement account balances to percentages of net sales for comparison with industry averages. B) Developing the current year's expected net sales based on the sales trend of similar entities within the same industry. C) Projecting a deviation rate by comparing the results of a statistical sample with the actual population characteristics. D) Estimating the current year's expected expenses based on the prior year's expenses and the current year's budget.

11) While performing an audit of the financial statements of a company for the year ended December 31, year 1, the auditor notes that the company's sales increased substantially in December, year 1, with a corresponding decrease in January, year 2. In assessing the risk of fraudulent financial reporting or misappropriation of assets, what should be the auditor's initial indication about the potential for fraud in sales revenue?

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A) There is a broad indication of misappropriation of assets. B) There is an indication of theft of the entity's assets. C) There is an indication of embezzling receipts. D) There is a broad indication of financial reporting fraud.

12)

Inherent risk and control risk differ from detection risk in which of the following ways?

A) Inherent risk and control risk are calculated by the client. B) Inherent risk and control risk exist independently of the audit. C) Inherent risk and control risk are controlled by the auditor. D) Inherent risk and control risk exist as a result of the auditor's judgment about materiality.

13) While performing interim audit procedures of accounts receivable, numerous unexpected errors are found resulting in a change of risk assessment. Which of the following audit responses would be most appropriate? A) Move detailed analytical procedures from year end to interim. B) Increase the dollar threshold of vouching customer invoices. C) Send negative accounts receivable confirmations instead of positive accounts receivable confirmations. D) Use more experienced audit team members to perform year-end testing.

14) If not already performed during the overall review stage of the audit, the auditor should perform analytical procedures relating to which of the following transaction cycles? A) Payroll. B) Revenue. C) Purchasing. D) Inventory.

15) According to auditing standards, external auditors' responsibilities for indirect noncompliance do not include: Version 1

A) designing audit procedures to detect noncompliance in the absence of specific information brought to the auditors' attention. B) performing audit procedures when specific information indicates that possible noncompliance may have a material indirect effect on financial statements. C) considering the qualitative materiality of known and suspected noncompliance. D) obtaining written management representations concerning the absence of violations of laws and regulations.

16) Certain conditions and circumstances are often present when management fraud occurs. Which of the following is not such a condition or circumstance? A) Unfavorable industry conditions. B) Lack of working capital. C) High liquidity. D) Slow customer collections.

17) Independent auditors who consider fraud in the course of financial statement audits are well-advised to quantify "materiality" in terms of: A) the maximum amount of asset overstatement that might mislead investors in relation to the latest financial statements under audit. B) a maximum percentage of net income overstatement that might mislead investors in relation to the latest financial statements under audit. C) a cumulative amount of misstatement of assets or income over several years past and current that might mislead investors in relation to the latest financial statements under audit. D) controversial accounting measurements that might mislead investors in relation to the latest financial statements under audit.

18)

An auditor assesses the risk of material misstatement because it: A) is relevant to the auditor's understanding of the control environment. B) provides assurance that the auditor's overall materiality levels are appropriate. C) indicates to the auditor where inherent risk may be the greatest. D) affects the level of detection risk that the auditor may accept.

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19) When fraud risk is significant, and management cooperation is unsatisfactory, the auditors will most likely: A) perform extended audit procedures. B) consult with fraud examiners. C) report directly to the Securities and Exchange Commission within one day. D) withdraw from the engagement.

20)

Which of the following statements concerning noncompliance by clients is correct?

A) An auditor's responsibility to detect noncompliance that has a direct and material effect on the financial statements is the same as that for errors and frauds. B) An audit in accordance with generally accepted auditing standards normally includes audit procedures specifically designed to detect noncompliance that has an indirect but material effect on the financial statements. C) An auditor considers noncompliance from the perspective of the reliability of management's representations rather than their relation to audit objectives derived from financial statement assertions. D) An auditor has no responsibility for noncompliance that has an indirect effect on the financial statements.

21) Which of the following statements best describes auditors' responsibility to detect errors and frauds? A) Auditors should design an audit to provide reasonable assurance of detecting errors and frauds that are material to the financial statements. B) Auditors are responsible to detect material errors, but have no responsibility to detect material frauds that are concealed through employee collusion or management override of the internal control structure. C) Auditors have no responsibility to detect errors and frauds unless analytical procedures or tests of transactions identify conditions causing a reasonably prudent auditor to suspect that the financial statements were materially misstated. D) Auditors have no responsibility to detect errors and frauds because an auditor is not an insurer and an audit does not constitute a guarantee.

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22) The probability that an audit team will give an inappropriate opinion on financial statements best describes: A) audit risk. B) inherent risk. C) control risk. D) detection risk.

23)

Inherent risk is the:

A) probability that some accounts are more susceptible to misstatement than others. B) probability that the client's internal control policies and procedures will fail to detect material misstatements. C) probability that material misstatements have occurred in transactions entering the accounting system used to develop financial statements. D) probability that the auditor may not detect material misstatements in the financial statements.

24) If control risk increases, and all other risks in the audit risk model stay constant except the one referred to below, which of the following statements is correct? A) Detection risk will decrease. B) Inherent risk will increase. C) Audit risk will decrease. D) Detection risk will increase.

25) If fictitious credit sales were recorded, and the fictitious accounts receivable were later directly written off as bad debt expense, A) income would be overstated. B) income would be understated. C) income would not be misstated. D) accounts receivable would be understated.

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26)

An audit team uses the assessed risk of material misstatement to:

A) evaluate the effectiveness of the entity's internal control policies and activities. B) identify transactions and account balances where inherent risk is at the maximum. C) indicate whether materiality thresholds for planning and evaluation purposes are sufficiently high. D) determine the acceptable level of detection risk for financial statement assertions.

27)

The risk of material misstatement differs from detection risk in that it: A) arises from the misapplication of audit procedures. B) may be assessed in either quantitative or non-quantitative terms. C) exists independently of the financial statement audit. D) can be changed at the auditor's discretion.

28) The risk that an auditor's procedures will lead to the conclusion that a material misstatement does not exist in an account balance when, in fact, such misstatement actually exists is: A) audit risk. B) inherent risk. C) control risk. D) detection risk.

29) Based on audit evidence gathered and evaluated, an auditor decides to increase the assessed level of control risk from that originally planned. To achieve an overall audit risk level that is substantially the same as the planned audit risk level, the auditor would: A) decrease substantive testing. B) decrease detection risk. C) increase inherent risk. D) increase materiality levels.

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30)

The acceptable level of detection risk is inversely related to the: A) assurance provided by substantive tests. B) risk of misapplying audit procedures. C) preliminary judgment about materiality levels. D) risk of failing to discover material misstatements.

31) The existence of audit risk is recognized by the statement in the auditor's standard report that the: A) auditor is responsible for expressing an opinion on the financial statements, which are the responsibility of management. B) financial statements are presented fairly, in all material respects, in conformity with applicable financial reporting framework. C) audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. D) auditor obtains reasonable assurance about whether the financial statements are free of material misstatement.

32) When determining the inherent risk related to an account balance, an auditor theoretically does not explicitly consider the: A) liquidity of the account. B) degree of management estimation involved in determining the proper account balance. C) related internal control policies and procedures. D) complexity of calculations involved.

33) An auditor who discovers that client employees have committed an illegal act that has a material effect on the client's financial statements most likely would withdraw from the engagement if:

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A) the noncompliance is a violation of generally accepted accounting principles. B) the client does not take the remedial action that the auditor considers necessary. C) the illegal act was committed during a prior year that was not audited. D) the auditor has already assessed control risk at the maximum level.

34) When an auditor becomes aware of possible noncompliance by a client, the auditor should obtain an understanding of the nature of the act to: A) evaluate the effect on the financial statements. B) determine the reliability of management's representations. C) consider whether other similar acts may have occurred. D) recommend remedial actions to the audit committee.

35) Jones, CPA, is auditing the financial statements of XYZ Retailing Inc. What assurance does Jones provide that direct effect noncompliance that is material to XYZ's financial statements, and noncompliance that has a material, but indirect effect on the financial statements will be detected? A) Direct effect noncompliance: Reasonable; Indirect effect noncompliance: None. B) Direct effect noncompliance: Reasonable; Indirect effect noncompliance: Reasonable. C) Direct effect noncompliance: Limited; Indirect effect noncompliance: None. D) Direct effect noncompliance: Limited; Indirect effect noncompliance: Reasonable.

36)

Generally accepted auditing standards states that analytical procedures:

A) should be applied in the planning and final review stages of the audit and as a substantive test during the audit. B) should be applied in the planning and final review stages of the audit and can be used as a substantive test during the audit. C) should be applied in the planning stage and can be applied as a substantive test and in the final review stage. D) should be applied in the final review stage, and can be applied as a substantive test and in the planning stage.

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37)

In the planning stage, analytical procedures are used to: A) identify potential problem areas. B) provide direct evidence about the balances in accounts. C) determine the mathematical correctness of the financial statements. D) perform all of these.

38) Assume that application of analytical procedures revealed significant unexplained differences between recorded amounts and the expectations (estimates) developed by the auditor. If management is unable to provide an acceptable explanation, the auditor should: A) consider the matter a scope limitation. B) perform additional audit procedures to investigate the matter further. C) intensify the audit with the expectation of detecting management fraud. D) withdraw from the engagement.

39) For audits of financial statements made in accordance with generally accepted auditing standards, the use of analytical procedures is required to some extent. A) As a substantive test: Yes; In the final review stage: Yes. B) As a substantive test: Yes; In the final review stage: No. C) As a substantive test: No; In the final review stage: Yes. D) As a substantive test: No; In the final review stage: No.

40) Which of the following would not likely be found in the minutes of the board of directors? A) Amount of dividends declared. B) Approval to pledge assets as security for debts. C) Authorization of officers' salaries. D) Approval of a new desktop computer for the controller.

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41) If an auditor encounters significant risks at the client, the auditor should do all of the following except: A) inform the SEC. B) perform extended procedures. C) include more experienced auditors on the engagement. D) perform tests closer to year end.

42)

Horizontal analysis refers to: A) the trend of income from year to year of persons suspected of fraud. B) changes of financial statement numbers and ratios across several years. C) financial statement amounts expressed each year as a proportion of a base amount. D) the change in a suspect's net worth from the beginning to the end of a period.

43)

Analytical procedures used in planning an audit should focus on: A) reducing the scope of tests of controls and substantive tests. B) providing assurance that potential material misstatements will be identified. C) enhancing the auditor's understanding of the client's business. D) assessing the adequacy of the available evidential matter.

44)

Sources of financial and nonfinancial data do not include: A) financial account information for comparable prior periods. B) nonfinancial information such as physical production statistics. C) company budgets and forecasts. D) Bureau of Labor statistics.

45) The type of financial analysis that expresses balance sheet accounts as percentages of total assets is known as:

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A) horizontal analysis. B) vertical analysis. C) net worth analysis. D) expenditure analysis.

46) Which of the following accounts tends to be most predictable for purposes of analytical procedures? A) Accounts receivable. B) Travel and entertainment expense. C) Interest expense. D) Income taxes payable.

47) Analytical procedures are audit methods of evaluating financial statement accounts by studying and comparing relationships among financial and nonfinancial data. The primary purpose of analytical procedures conducted during the planning stages is to: A) identify the appropriate schedules to be prepared by the client. B) identify the types of errors or frauds that can occur in transactions. C) identify unusual conditions that deserve additional audit effort. D) determine the existence of unrecorded liabilities or overstated assets.

48) Which of the following is not required by AU-C 240, "Consideration of Fraud in a Financial Statement Audit"? A) Conduct a continuing assessment of the risks of material misstatement due to fraud throughout the audit. B) Conduct a discussion by the audit team of the risks of material misstatement due to fraud. C) Conduct the audit with professional skepticism, which includes an attitude that assumes balances are incorrect until verified by the auditor. D) Conduct inquiries of shareholders as to their views about the risks of fraud and their knowledge of any fraud or suspected fraud.

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49) When an auditor increases the planned assessed level of control risk because certain control activities were determined to be ineffective, the auditor would most likely increase the: A) extent of substantive tests of details. B) level of inherent risk. C) extent of tests of controls. D) level of detection risk.

50) What assurance does the auditor provide that errors, frauds, and direct effect noncompliance that are material to the financial statements will be detected? A) Errors: Limited; Frauds: Negative; Direct effect noncompliance: Limited. B) Errors: Limited; Frauds: Limited; Direct effect noncompliance: Reasonable. C) Errors: Reasonable; Frauds: Limited; Direct effect noncompliance: Limited. D) Errors: Reasonable; Frauds: Reasonable; Direct effect noncompliance: Reasonable.

51)

Experience has shown that the many large fraudulent transactions can be found in: A) systematic processing of large volumes of day-to-day ordinary transactions. B) payroll fraudsters' mistakes in using unissued Social Security numbers. C) petty cash embezzlements. D) non-routine, nonsystematic journal entries.

52) Inherent risk and control risk differ from detection risk in that inherent risk and control risk are: A) elements of audit risk whereas detection risk is not. B) changed at the auditor's discretion whereas detection risk is not. C) considered at the individual account-balance level whereas detection risk is not. D) functions of the client and its environment whereas detection risk is not.

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53) The auditor uses the assessed level of risk of material misstatement to determine the acceptable level of detection risk for financial statement assertions. As the acceptable level of detection risk decreases, the auditor may do one or more of the following except change the: A) nature of substantive tests to more effective procedures. B) timing of substantive tests, such as performing them at year-end rather than at an interim date. C) extent of substantive tests, such as using larger sample sizes. D) assurances provided by substantive tests to a lower level.

54) Which of the following is not an acceptable response to fraud risks related to sales that were identified in an audit? A) Exercise professional skepticism when performing sales testing. B) Increase the assessment of control risk for sales. C) Increase the assessment of detection risk for sales. D) Perform additional substantive sales procedures on a surprise basis.

55) If tests of controls induce the auditor to change the assessed level of control risk for Property Plant & Equipment from 50% to 100%, and audit risk (6%) and inherent risk remain constant, the acceptable level of detection risk: A) would most likely change from 10% to 5%. B) would most likely change from 20% to 40%. C) would most likely change from 30% to 15%. D) would be unchanged, because the auditor has control over detection risk. E) cannot be determined because inherent risk is not given.

56)

Managing business risk is the responsibility of: A) the auditors. B) management. C) the SEC. D) the PCAOB.

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57)

Auditors would use the enterprise risk model: A) to reduce the client's business risk. B) to determine detection risk. C) to evaluate management's risk assessment. D) to monitor client risk.

58)

Auditors use brainstorming: A) to heighten the audit team's awareness of fraud potential. B) to heighten management's awareness of fraud potential. C) to determine detection risk. D) to set materiality.

59)

The purpose of an audit strategy is: A) to provide a defense against litigation. B) to gain an understanding of the client. C) to comply with securities law. D) to set the scope, timing, and direction for auditing each relevant assertion.

ESSAY. Write your answer in the space provided or on a separate sheet of paper. 60) What are the independent auditor's responsibilities to detect and report errors and frauds?

61) Can an auditor place complete reliance on internal control to the exclusion of other audit procedures? Explain your answer using the audit risk model.

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62) Post, CPA, accepted an engagement to audit the financial statements of General Co., a new client. General is a publicly held retailing entity that recently replaced its operating management. In the course of applying audit procedures, Post discovered that General's financial statements may be materially misstated due to the existence of fraud. Required: 1. (a) Describe Post's responsibilities on the circumstances described above. 2. (b) Describe Post's responsibilities for reporting on General's financial statements and other communications if Post is precluded from applying necessary procedures in searching for frauds. 3. (c) Describe Post's responsibilities for reporting on General's financial statements and other communications if Post concludes that General's financial statements are materially affected by frauds.

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63) Items 1 through 6 represent an auditor's observed changes in certain financial statement ratios or amounts from the prior year's ratios or amounts. For each observed change, select the most likely explanation or explanations from the list of explanations provided. Answers on the list may be selected once, more than once, or not at all. Auditor's observed changes (considered independent of each other). 1.Inventory turnover increased substantially from the prior year. (Select 3 explanations) 2.Accounts receivable turnover decreased substantially from the prior year. (Select 3 explanations) 3.Allowance for doubtful accounts increased from the prior year, but allowance for doubtful accounts as a percentage of accounts receivable decreased from the prior year. (Select 3 explanations) 4.Long term debt increased from the prior year, but interest expense increased a larger than proportionate amount than long term debt. (Select 1 explanation) 5.Operating income increased from the prior year although the entity was less profitable than in the prior year. (Select 2 explanations) 6.Gross margin percentage was unchanged from the prior year although gross margin increased from the prior year. (Select 1 explanation)

64) Analytical procedures consist of evaluations of financial information made by a study of plausible relationships among both financial and nonfinancial data. They range from simple comparisons to the use of complex models involving many relationships and elements of data. They involve comparisons of recorded amounts, or ratios developed from recorded amounts, to expectations developed by auditors. Required: a.Describe the broad purposes of analytical procedures. b.Identify the sources of information from which an auditor develops expectations.

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65) Analytical procedures are one type of evidence gathering procedure. According to auditing standards, there are five general forms of analytical procedures. Auditing standards also provide examples of five sources of information for analytical procedures. Required: Describe three of the five general forms of analytical procedures. For each form, describe a typical source of the information for the form. For each source, include any questions or concerns an auditor would have about the reliability or relevancy of the source.

66) This question tests your ability to perceive the place(s) where various potential problems may exist and the type of problem (overstatement or understatement) that may exist. It asks that you supply the words or descriptions that complete the analysis begun by applying analytical procedures. Required: For each of the items below, identify the account(s) that need(s) to be audited carefully and the reason (i.e., potential overstatement or understatement of _______). a.If the current year accounts receivable are larger than last year but the allowance for doubtful accounts is the same. b.If the current year inventory is larger than last year and the current year gross margin (profit) is larger. c.If current year long-term liabilities are larger than last year and the interest expense is the same. d.If current year fixed assets are larger and current depreciation expense is the same as last year.

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67) Analytical procedures are evaluations of financial information made by a study of plausible relationships among financial and nonfinancial data. Understanding and evaluating such relationships are essential to the audit process. The following financial statements were prepared by ABC Manufacturing Co. for the year ended December 31, 2020. Also presented are various financial statement ratios for Holiday as calculated from the prior year's financial statements. Sales represent net credit sales. The total assets and the receivables and inventory balances at December 31, 2020, were the same as at December 31, 2019.

Receivables

ABC Manufacturing Co. Balance Sheet December 31, 2020 Liabilities and Capital 240,000 Accounts payables 400,000 Notes payable

Inventory

600,000

Assets Cash

Total current assets Plant and equipment–net

$ 1,240,000 760,000

Other current liabilities Total current liabilities Long-term debt

160,000 100,000 140,000

400,000 350,000

Common stock

750,000

Retained earnings

500,000

Total assets

$ 2,000,000

Total liabilities and capital

Sales

ABC Manufacturing Co. Income Statement Year Ended December 31, 2020 $ 3,000,0000

$ 2,000,000

Cost of goods sold Material Labor

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800,000 700,000

Overhead

300,000

Gross margin Selling expenses

1,800,000 $ 1,200,000

General and administrative expenses Operating income

240,000 300,000

Less interest expense Income before taxes

540,000

40,000 $

Less federal income taxes Net income

660,000

620,000 220,000

400,000

Required: Items 1 through 9 below represent financial ratios that the auditor calculated during the prior year's audit. For each ratio, calculate the current year's ratio from the financial statements presented above. Calculations

12/31/2020

12/31/2019

Current ratio

2.5

Quick ratio

1.3

Accounts receivable turnover

5.5

Inventory turnover

2.5

Total asset turnover

1.2

Gross margin percentage

35 %

Net operating margin %

25 %

Times interest earned

Total debt to equity

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10.3 50 %

68)

Why is it important for auditors to understand their clients' business risks?

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Answer Key Test name: Chap 04_8e_Test Bank 1) B 2) C 3) B 4) B 5) C 6) A 7) D 8) A 9) D 10) C 11) D 12) B 13) D 14) B 15) A 16) C 17) C 18) D 19) D 20) A 21) A 22) A 23) C 24) A 25) C 26) D Version 1

27) C 28) D 29) B 30) A 31) D 32) C 33) B 34) A 35) A 36) B 37) A 38) B 39) C 40) D 41) A 42) B 43) C 44) D 45) B 46) C 47) C 48) D 49) A 50) D 51) D 52) D 53) D 54) C 55) C 56) B Version 1

57) C 58) A 59) D 60) Independent auditors have the responsibility to (1) assess the risk that errors and frauds may cause a client's financial statements to be materially misstated, and (2) design the audit to provide reasonable assurance of detecting errors and frauds material to the financial statements. Extended procedures should be performed if evidence indicates that material errors or frauds might exist. 61) An auditor cannot place complete reliance on internal control to the exclusion of other audit procedures. You cannot have a condition where: AR = IR × CR (= 0) × DR = 0

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62) 1. (a) If Post discovers that General's financial statements may be materially misstated due to the existence of frauds, Post should consider the implications for other aspects of the audit and discuss the matter and approach to further investigation with an appropriate level of management that is at least one level above those involved with the frauds. Post should also attempt to obtain sufficient competent evidential matter to determine whether, in fact, material frauds exist and, if so, their effect. Post may suggest that General consult with its legal counsel on matters concerning questions of law. 2. (b) If Post is precluded from applying necessary procedures, Post should disclaim or qualify an opinion on the financial statements and communicate these findings to General's audit committee or its board of directors. Post should also consider resigning from the audit. 3. (c) If Post concludes that General's financial statements are materially affected by frauds, Post should insist that the financial statements be revised and, if they are not, express a qualified or an adverse opinion on the financial statements, disclosing all the substantive reasons for such an opinion. Additionally, Post should adequately inform General's audit committee or its board of directors about the frauds.

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63) A.Items shipped on consignment during the last month of the year were recorded as sales. B.A significant number of credit memos for returned merchandise that were issued during the last month of the year were not recorded. C.Year-end purchases of inventory were overstated by incorrectly including items received in the first month of the subsequent year. D.Year-end purchases of inventory were understated by incorrectly excluding items received before the year-end. E.A larger percentage of sales occurred during the last month of the year, as compared to the prior year. F.A smaller percentage of sales occurred during the last month of the year, as compared to the prior year. G.The same percentage of sales occurred during the last month of the year, as compared to the prior year. H.Sales increased at the same percentage as cost of goods sold, as compared to the prior year. I.Sales increased at a greater percentage than cost of goods sold increased, as compared to the prior year. J.Sales increased at a lower percentage than cost of goods sold increased, as compared to the Prior year. K.Interest expense decreased, as compared to the prior year. L.The effective income tax rate increased, as compared to the prior year. M.The effective income tax rate decreased, as compared to the prior year. N.Short-term borrowing was refinanced on a long-term basis at the same interest rate. O.Short-term borrowing was refinanced on a long-term basis at lower interest rates. P.Short-term borrowing was refinanced on a long-term basis at higher Version 1

interest rates. 1. Inventory turnover increased substantially from the prior year. (Select 3 explanations) 1. (A) Items shipped on consignment during the last month of the year were recorded as sales. 2. (B) A significant number of credit memos for returned merchandise that were issued during the last month of the year were not recorded. 3. (D) Year-end purchases of inventory were understated by incorrectly excluding items received before the year end. 2. Accounts receivable turnover decreased substan-tially from the prior year. (Select 3 explanations) 1. (A) Items shipped on consignment during the last month of the year were recorded as sales. 2. (B) A significant number of credit memos for returned merchandise that were issued during the last month of the year were not recorded. 3. (F) A smaller percentage of sales occurred during the last month of the year, as compared to the prior year. 3. Allowance for doubtful accounts increased from the prior year, but allowance for doubtful accounts as a percentage of accounts receivable decreased from the prior year. (Select 3 explanations) 1. (A) Items shipped on consignment during the last month of the year were recorded as sales. 2. (B) A significant number of credit memos for returned merchandise Version 1

that were issued during the last month of the year were not recorded. 3. (F) A smaller percentage of sales occurred during the last month of the year, as compared to the prior year. 4. Long-term debt increased from the prior year, but interest expense increased a larger-than-proportionate amount than long-term debt. (Select 1 explanation) 1. (P) Short-term borrowing was refinanced on a long-term basis at higher interest rates. 5. Operating income increased from the prior year although the entity was less profitable than in the prior year. (Select 2 explanations) 1. (L) The effective income tax rate increased, as compared to the prior year. 2. (P) Short-term borrowing was refinanced on a long-term basis at higher interest rates. 6. Gross margin percentage was unchanged from the prior year although gross margin increased from the prior year. (Select 1 explanation) 1. (H) Sales increased at the same percentage as cost of goods sold, as compared to the prior year.

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64) a. Analytical procedures are used for these broad purposes: 1.To assist the auditor in planning the nature, timing, and extent of other audit procedures. 2.As a substantive test to obtain evidential matter about particular assertions related to account balances or classes of transactions. 3.As an overall review of the financial information in the final review stage of the audit. b. An auditor's expectations are developed from the following sources of information: 1.Financial information for comparable prior periods considering known changes. 2.Anticipated results for example, budgets, forecasts, and extrapolations. 3.Relationships among elements of financial information within the period. 4.Information regarding the industry in which the client operates. 5.Relationships of financial information with relevant nonfinancial information.

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65) The five general forms of analytical procedures (and sources of information): 1.Comparison of current year account balances of one or more comparable periods. 2.Financial account information for comparable prior period(s). 3.Comparison of the current year account balances to anticipated results found in the company's budgets and forecasts. 4.Evaluation of the relationships of current year account balances to other current year balances and conformity with predictable patterns based on the company's experience. (Financial relationships among accounts in the current period.) 5.Comparison of current year account balances and financial relationships (e.g., ratios) with similar information for the industry in which the company operates. (Industry statistics.) Study of the relationships of current year account balances with relevant nonfinancial information (e.g., physical production statistics). Considerations about relevance and reliability of sources of information: (Note to instructor: These considerations are not explicitly discussed in the chapter with regard to analytical procedures. Additional considerations are possible.) 1.Has the financial information from prior period(s) been audited? 2.Are company budgets or forecasts generally accurate? What processes does the client go through to develop these? 3.Are the industry statistics from a reliable source? Are the industry statistics specific enough to the client or the particular segment or division of the client being examined? 4.Has the nonfinancial information been audited? Have the controls over the production of the nonfinancial information been tested?

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66) a.The collectability of accounts receivable is of concern. The allowance for doubtful accounts may be understated. The bad debt expense may be understated. b.The existence of the inventory account is of concern. Inventory may be overstated. Cost of goods sold may be understated. c.The amount of accrued interest is of concern. Interest expense may be understated. Less likely, long-term liabilities could be overstated. d.Depreciation expense and accumulated depreciation may be understated. It may also be possible that fixed assets are overstated. 67) Ratio 1. Current ratio

2. Quick ratio

3. Accounts receivable turnover

12/31/2020

12/31/2019

Current assets/Current liabilities 1,240,000/400,000

3.1

2.5

(Current asset − Inventory)/Current 640,000/400,000

1.6

1.3

7.5

5.5

3.0

2.5

1.5

1.2

40 %

35 %

Sales/A/R

3,000,000/400,000 4. Inventory turnover

COGS/Inventory 1,800,000/600,000

5. Total asset turnover

Net sales/Net assets 3,000,000/2,000,000

6. Gross margin percentage

Gross margin/Sales 1,200,000/3,000,000

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7. Net operating margin %

Operating income / sales 660,000/3,000,000

8. Times interest earned

9. Total debt to equity %

(Operating income)/Interest expense 660,000/40,000

22 %

16.5

25 %

10.3

Total debt/Equity 750,000/1,250,000

60 %

50 %

68) Auditing standards recognize that most business risks are eventually reflected in the financial statements. So audit teams now devote a significant amount of their engagement planning to their clients' business risks. Firms believe they must learn more about their clients' business strategies and processes to understand whether the financial statements are fairly presented.

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CHAPTER 4: PROBLEM MATERIAL ESSAY. Write your answer in the space provided or on a separate sheet of paper. 1) The audit risk model includes the four risks listed below. Match the type of risk with the related definition. A.Detection risk B.Control risk C.Inherent risk D.Audit risk

___ 1. The probability that an auditor will give an inappropriate opinion on financial statements. ___ 2. The probability that audit procedures will fail to produce evidence of material misstatements. ___ 3. The probability that the client's internal control policies and procedures will fail to detect material misstatements if they have entered the accounting system. ___ 4. The probability that material misstatements have occurred in transactions entering the accounting system.

2) For each of the following statements, match the term it best describes or typifies. A.Management fraud B.Embezzlement or defalcation C.White-collar crime D.Larceny E.Errors

___ 1. An employee in a supermarket takes home bags of fresh fruit each day without paying for them.

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___ 2. A type of fraud involving employees or nonemployees wrongfully taking money or property entrusted to their care. ___ 3. Misdeeds done by people who steal with a pencil or computer. ___ 4. The controller changed the journal entry for estimating bad debt expense to a smaller number to hide the poor results from extending credit to high risk customers. This made income materially higher than it otherwise would have been. ___ 5. A bookkeeper inadvertently recorded depreciation by transposing numbers in a journal entry.

3) For each of the descriptions in Column A, match the correct word or words from Column B. A.Analytical procedures B.Year-end audit work C.Audit trail D.Horizontal analysis E.Vertical analysis F.Interim audit work

___ 1. Refers to changes across two or more years ___ 2. A wide range of evidence-gathering activity that occurs before year-end ___ 3. Chain of evidence found at an audit client ___ 4. Procedures performed that rely on relationships among account balances and/or relevant non-financial data 5. Financial statement amounts expressed as proportions of a base

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Answer Key Test name: Chap 04_8e_Test Bank_Problem Material 1) 1.B; 2.C; 3.D; 4.A 2) 1.D; 2.B; 3.C; 4.A; 5.E 3) 1.D; 2.F; 3.C; 4.A; 5.E

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CHAPTER 5 MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) An audit team's responsibility would not include: A) designing client's internal controls. B) documentation of understanding of a client's internal controls. C) communicating internal control deficiencies. D) assessing the effectiveness of a client's internal controls.

The appropriate separation of duties does not include: A) authorization to execute transactions. B) recording of transactions. C) custody of assets involved in transactions. D) data preparation.

3) A set of characteristics that helps to define a seriousness about employees' attitudes about the control activities in a company is referred to as: A) management assertions. B) the control environment. C) control risk assessment. D) functional responsibilities.

4) When an auditor plans to rely on controls that have changed since they were last tested, which of the following courses of action would be most appropriate?

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A) Test the operating effectiveness of such controls in the current audit. B) Document that reliance and proceed with the original audit strategy. C) Inquire of management as to the effectiveness of the controls. D) Report the reliance in the report on internal controls.

5) An auditor is concerned about a policy of management override as a limitation of internal control. Which of the following tests would best assess the validity of the auditor's concern? A) Matching purchase orders to accounts payable. B) Verifying that approved spending limits are not exceeded. C) Tracing sales orders to the revenue account. D) Reviewing minutes of board meeting.

6) Which of the following activities performed by a department supervisor most likely would help in the prevention or detection of a payroll fraud? A) Distributing paychecks directly to department store employees. B) Setting the pay rate for departmental employees. C) Hiring employees and authorizing them to be added to payroll. D) Approving a summary of hours each employee worked during the pay period.

7) Which of the following outcomes is a likely benefit of information technology used for internal control? A) Processing of unusual or nonrecurring transactions. B) Enhanced timeliness of information. C) Potential loss of data. D) Recording of unauthorized transactions.

Which of the following procedures is considered a test of controls?

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A) An auditor reviews the entity's check register for unrecorded liabilities. B) An auditor evaluates whether a general journal entry was recorded at the proper amount. C) An auditor interviews and observes appropriate personnel to determine segregation of duties. D) An auditor reviews the audit workpapers to ensure proper sign-off.

9) Which of the following factors is most likely to affect the extent of the documentation of the auditor's understanding of a client's system of internal controls? A) The industry and the business and regulatory environments in which the client operates. B) The degree to which information technology is used in the accounting function. C) The relationship between management, the board of directors, and external stakeholders. D) The degree to which the auditor intends to use internal audit personnel to perform substantive tests.

10) Which of the following payroll control activities would most effectively ensure that payment is made only for work performed? A) Require all employees to record arrival and departure by using the time clock. B) Have a payroll clerk recalculate all time cards. C) Require all employees to sign their time cards. D) Require employees to have their direct supervisors approve their time cards.

11) Each of the following types of controls is considered to be an entity-level control, except those:

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A) relating to the control environment. B) pertaining to the company's risk assessment process. C) regarding the company's annual stockholder meeting. D) addressing policies over significant risk management practices.

12)

Which of the following is not a component of internal controls? A) Control environment. B) Control activities. C) Inherent risk. D) Monitoring.

13)

Which of the following is a definition of control risk?

A) The risk that a material misstatement will not be prevented or detected on a timely basis by the client's internal controls. B) The risk that the auditor will not detect a material misstatement. C) The risk that the auditor's assessment of internal controls will be at less than the maximum level. D) The susceptibility of material misstatement assuming there are no related internal controls, policies, or procedures.

14) Which of the following should an auditor do when control risk is assessed at the maximum level? A) Perform fewer substantive tests of details. B) Perform more tests of controls. C) Document the assessment. D) Document the control structure more extensively.

15)

Which of the following statements is correct regarding internal control?

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A) A well-designed internal control environment ensures the achievement of an entity's control objectives. B) An inherent limitation to internal control is the fact that controls can be circumvented by management override. C) A well-designed and operated internal control environment should detect collusion perpetrated by two people. D) Internal control is a necessary business function and should be designed and operated to detect all errors and fraud.

16) Which of the following is the best way to compensate for the lack of adequate segregation of duties in a small organization? A) Disclosing lack of segregation of duties to the external auditors during the annual review. B) Replacing personnel every three or four years. C) Requiring accountants to pass a yearly background check. D) Allowing for greater management oversight of incompatible activities.

17) Obtaining an understanding of an internal control involves evaluating the design of the control and determining whether the control has been: A) authorized. B) implemented. C) tested. D) monitored.

18) Which of the following statements best describes why an auditor would use only substantive procedures to evaluate specific relevant assertions and risks?

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A) The relevant internal control components are not well documented. B) The internal auditor already has tested the relevant controls and found them effective. C) Testing the operating effectiveness of the relevant controls would not be efficient. D) The cost of substantive procedures will exceed the cost of testing the relevant controls.

19) An auditor is evaluating a client's internal controls. Which of the following situations would be the most difficult internal control issue for an auditor to detect? A) The accounting staff neglects the control, due to increased transactions to be processed. B) The technology department writes a program that does not properly implement the control, due to a lack of understanding. C) Two employees, who work in different departments, are circumventing an internal control. D) Someone erroneously disables edit checks in a software program designed to identify control exceptions.

20)

Which of the following is a factor in the control environment? A) Segregation of duties. B) Information processing. C) Performance reviews. D) Management's philosophy and operating style.

21) Control activities intended to ensure that transactions are recorded in the right period are designed to achieve the ASB assertion of: A) occurrence. B) accuracy. C) valuation or allocation. D) cutoff.

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22) Sound internal control can be described as separating all of the following duties and responsibilities except for: A) transaction authorization. B) recordkeeping. C) custody of, or direct access to, assets. D) hiring of employees.

23) After obtaining an understanding of the entity's internal control and assessing control risk, an auditor of a non-public company decided not to perform additional tests of controls. The auditor most likely concluded that the: A) additional evidence to support a further reduction in control risk was not cost beneficial. B) assessed level of inherent risk exceeded the assessed level of control risk. C) internal control structure was properly designed and justifiably may be relied on. D) evidence obtainable through tests of controls would not support an increased level of control risk.

24) Regardless of the assessed level of control risk, an auditor of a non-public company would perform some: A) tests of controls to determine the effectiveness of internal control policies. B) analytical procedures to verify the design of internal control activities. C) substantive tests to restrict detection risk for significant transaction classes. D) dual purpose tests to evaluate both the risk of monetary misstatement and preliminary control risk.

25) The "obtaining an understanding" work phase (Phase 1) of internal control evaluation would not give auditors an overall acquaintance with the client's:

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A) control environment. B) information and communication system. C) control activity effectiveness. D) monitoring activities.

26)

Which of the following is an information technology general control? A) Check digit. B) Run-to-run totals. C) Distribution of computerized output. D) Separation of duties in the IT department.

27) Control strengths and weaknesses should be documented in audit documentation, sometimes called: A) questionnaires, narratives, and flowcharts. B) bridge working papers. C) communications of significant deficiencies. D) internal control letters.

28)

The internal control in small business is highly dependent on the: A) separation of functional responsibilities. B) complexity of the client's internal controls. C) owner-manager's competence, as well as his/her ethics and integrity. D) bonding of employees.

29)

Which of the following is not an input control activity?

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A) Reasonableness tests. B) Record counts. C) Financial totals. D) Hash totals.

30) A sales clerk enters a customer's six-number customer account. The computer program uses the first five numbers to calculate a sixth number. This resulting number is then compared to the sixth number entered by the sales clerk. This is an example of a: A) valid character test. B) missing data test. C) reasonableness test. D) check digit.

31) Which of the following is the least important audit reason for the auditor's obtaining an understanding of a company's internal control? A) To serve as a basis for constructive suggestions. B) To plan subsequent substantive tests. C) To identify types of possible misstatements that may occur. D) To consider factors that may affect the risk of material misstatement.

32)

Tracing bills of lading to sales invoices provides evidence that: A) shipments to customers were invoiced. B) shipments to customers were recorded as sales. C) recorded sales were shipped. D) invoiced sales were recorded as sales.

33) Which of the following client internal control activities is not usually performed in the treasurer's department? Version 1

A) Verifying the accuracy of checks and vouchers. B) Controlling the mailing of checks to vendors. C) Approving vendors' invoices for payment. D) Canceling payment vouchers when paid.

34) Which of the following audit procedures most likely would provide an auditor with the most assurance about the effectiveness of the operation of an entity's internal control? A) Confirmation with outside parties. B) Inquiry of client personnel. C) Successful re-performance of the control activity. D) Observation of client personnel.

35) When obtaining an understanding of an entity's internal control in a financial statement audit at a non-public company, an auditor is not obligated to: A) determine whether the control activities have been placed in operation. B) perform procedures to understand the design of the internal control system. C) document the understanding of the company's internal control system. D) search for significant deficiencies in the operation of the internal control system.

36) After obtaining an understanding of a client's financial reporting control activities, the auditor would next: A) test the client's control activities. B) assess the final control risk. C) document the understanding obtained. D) plan the remainder of the audit work.

37)

If auditors assess control risk at the maximum level, they will tend to:

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A) perform a great deal of additional tests of controls. B) perform a great deal of substantive testing during the audit. C) perform substantive tests at an interim date. D) perform more audit procedures using internal evidence.

38) The ultimate purpose of assessing control risk is to contribute to the auditor's evaluation of the: A) factors that raise doubts about the auditability of the financial statements. B) operating effectiveness of internal control policies and procedures. C) risk that material misstatements exist in the financial statements. D) possibility that the nature and extent of substantive tests may be reduced.

39) When the audit team increases the planned assessed level of control risk because certain control activities were determined to be ineffective, the audit team would most likely increase the: A) extent of substantive tests of details. B) level of inherent risk. C) extent of tests of controls. D) level of detection risk.

40) In computer systems, the information technology general controls (ITGC) would not include: A) processing control activities. B) separation of various computer system functions. C) appropriate documentation of the data processing system. D) control over physical access to computer hardware.

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41) When auditing financial statements of a private company, the minimum work an auditor must perform in connection with a company's internal control is best described by which of the following statements? A) Perform exhaustive tests of accounting controls and evaluate the company's control system effectiveness. B) Determine whether the company's control policies are designed well enough to prevent material misstatements. C) Prepare auditing working papers that document the auditor's understanding of the company's internal control. D) Design procedures to search for significant deficiencies in the actual operation of the company's internal control.

42)

Which of the following would most likely be classified as a material weakness?

A) Absence of appropriate separation of duties. B) Absence of appropriate reviews and approvals of transactions. C) Evidence of failure of control activities. D) Ineffective oversight of the financial reporting process by the company's audit committee.

43)

Each member of a company’s audit committee must be: A) financially literate. B) a financial expert. C) involved in the entity’s day to day management. D) independent of the entity’s board of directors.

44) Generally accepted auditing standards (GAAS) give auditors considerable discretion to decide the amount of work required to satisfy auditing standards guiding internal control evaluation and related audit planning. Which of the descriptions below best expresses the minimum amount of work permitted by GAAS for nonpublic companies?

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A) Do not obtain an understanding of client environment, accounting, or control activities. Do not document the decision to assess control risk at maximum. Perform 100% substantive audit on all financial statement transactions and balances. B) Obtain an understanding of client environment, accounting, and control activities. Document the decision to assess control risk at maximum. Perform an extensive but not 100% substantive audit on financial statement transactions and balances. C) Obtain an understanding of client environment, accounting, and control activities, and perform detail tests of controls. Document the decision to assess control risk below the maximum. Perform restricted substantive audit on financial statement transactions and balances, considering the control risk assessment. D) Obtain an understanding of client environment, accounting, and control activities, and perform detail tests of controls. Document the decision to assess control risk at zero. Perform no substantive audit on financial statement transactions and balances, since zero control risk means that no errors or fraud can reach the accounts.

45) Proper separation of duties reduces the opportunities to allow persons to be in positions to both: A) journalize entries and prepare financial statements. B) record cash receipts and cash disbursements. C) establish internal controls and authorize transactions. D) perpetrate a fraud and then conceal it in the books.

46) In an audit of financial statements, an auditor's primary consideration regarding an internal control policy or activity is whether the policy or activity: A) reflects management's philosophy and operating style. B) affects management's financial statement assertions. C) provides adequate safeguards over access to assets. D) enhances management's decision making processes.

47) Which of the following is a step in an auditor's decision to assess control risk at below the maximum?

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A) Apply analytical procedures to both financial data and nonfinancial information to detect conditions that may indicate weak controls. B) Perform tests of details of transactions and account balances to identify potential errors and fraud. C) Identify specific internal control policies and activities that are likely to detect or prevent material misstatements. D) Document that the additional audit effort to perform tests of controls exceeds the potential reduction in substantive testing.

48) Which of the following is not an objective of internal controls over financial reporting as defined by the Sarbanes-Oxley Act? A) Policies and procedures that pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the registrant. B) Policies and procedures that provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and receipts and expenditures of the registrant are being made only in accordance with authorizations of management and directors of the registrant. C) Policies and procedures that provide reasonable assurance regarding the compliance with applicable laws and regulations. D) Policies and procedures that provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the registrant's assets that could have a material effect on the financial statements.

49) Which of the following most likely would not be considered an inherent limitation of the potential effectiveness of an entity's internal controls? A) Incompatible duties. B) Management override. C) Mistakes in judgment. D) Collusion among employees.

50)

As part of understanding the internal control, an auditor is not required to:

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A) consider factors that affect the risk of material misstatement. B) ascertain whether internal control policies and activities have been placed in operation. C) identify the types of potential misstatements that can occur. D) obtain knowledge about the operating effectiveness of the client's internal control activities.

51) The primary objective of procedures performed to obtain an understanding of the entity's internal control is to provide an auditor with: A) knowledge necessary for audit planning. B) evidential matter to use in assessing inherent risk. C) a basis for modifying tests of controls. D) an evaluation of the consistency of application of management's policies.

52) The overall attitude and awareness of an entity's board of directors concerning the importance of the client's internal control usually is reflected in its: A) computer-based control activities. B) system of separation of duties. C) control environment. D) safeguards over access to assets.

53) After obtaining an understanding of internal controls and assessing control risk on the audit of a non-public company, an auditor decided to perform tests of controls. The auditor most likely decided that:

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A) it would be efficient to perform tests of controls that would result in a reduction in planned substantive tests. B) additional evidence to support a further reduction in control risk is not available. C) an increase in the assessed level of control risk is justified for certain financial statement assertions. D) there were many internal control weaknesses that could allow errors to enter the accounting system.

54) In an audit of financial statements of a non-public company in accordance with generally accepted auditing standards, an auditor is required to: A) document the auditor's understanding of the entity's internal control. B) search for significant deficiencies in the operation of the internal controls. C) perform tests of controls to evaluate the effectiveness of the entity's accounting system. D) determine whether control activities are operating effectively to prevent or detect material misstatements.

55) In testing control activities, an auditor ordinarily selects from a variety of techniques, including: A) inquiry and analytical procedures. B) reperformance and observation. C) comparison and confirmation. D) inspection and verification.

56)

Assessing control risk at below the maximum level most likely would involve:

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A) performing more extensive substantive tests with larger sample sizes than originally planned. B) reducing inherent risk for most of the assertions relevant to significant account balances. C) changing the timing of substantive tests by omitting interim-date testing and performing the tests at year end. D) identifying specific internal control activities that are relevant to specific financial statement assertions.

57) A report on internal control effectiveness by the management team of public companies is required by: A) the Sarbanes-Oxley Act of 2002. B) the PCAOB. C) the AICPA. D) the auditors.

58)

Management's report on internal controls must include each of the following except:

A) a statement that management is responsible for establishing and maintaining adequate internal control over financial reporting. B) a statement identifying the framework management uses to evaluate the effectiveness of the company's internal control. C) a statement providing management's assessment of the effectiveness of the company's internal control. D) a statement providing management's evaluation of the company's control environment.

59) Which of the following areas can external auditors rely on internal auditors' work in auditing internal controls?

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A) Evaluation of the auditing environment. B) Testing of low risk internal control activities. C) All testing of the operating effectiveness of internal control activities. D) As providing the principle evidence for the external auditors' opinion.

ESSAY. Write your answer in the space provided or on a separate sheet of paper. 60) What is the difference between an internal control's design effectiveness and its operating effectiveness?

61)

List several elements of a company's control environment.

62)

List and explain briefly the phases of an internal control evaluation.

63) What are some of the problems in establishing an internal control system in small business?

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64) Explain the different opinions that auditors can issue for an entity's internal control over financial reporting.

65) Auditors are required to obtain a sufficient understanding of an entity's internal control. This understanding is required by the performance principle of GAAS. Required: A.What are some of the goals (purposes) for conducting an evaluation of an entity's internal control? B.What is the impact on substantive testing procedures if the auditor assesses control risk at the "maximum" level? What is the impact on substantive testing procedures if the auditor assesses control risk below the "maximum" level? C.Should auditors always try to obtain enough evidence to assess control risk below the "maximum" level? Explain.

66) What are the six steps auditors of public companies should use to audit internal control over financial reporting (ICOFR)?

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67)

What constitutes a material weakness?

68)

What is the difference between a significant deficiency and a material weakness?

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Answer Key Test name: Chap 05_8e_Test Bank 1) A 2) D 3) B 4) A 5) B 6) D 7) B 8) C 9) B 10) D 11) C 12) C 13) A 14) C 15) B 16) D 17) B 18) C 19) C 20) D 21) D 22) D 23) A 24) C 25) C 26) D Version 1

27) B 28) C 29) A 30) D 31) A 32) A 33) C 34) C 35) D 36) C 37) B 38) C 39) A 40) A 41) C 42) D 43) A 44) B 45) D 46) B 47) C 48) C 49) A 50) D 51) A 52) C 53) A 54) A 55) B 56) D Version 1

57) A 58) D 59) B 60) Design effectiveness determines whether the controls over financial reporting, if operating effectively, would be expected to prevent or detect errors or fraud that could result in a material financial misstatement. Operating effectiveness is whether the control is operating as designed and whether the person performing the control possesses the necessary authority and qualifications to perform the control effectively. 61) Some of the elements of a control environment include: * Management's philosophy and operating style. * Company organization structure. * Functioning of the board of directors, particularly its audit committee. * Methods of assigning authority and responsibility. * Management's monitoring methods, including internal auditing. * Personnel policies and practices. * External influences.

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62) Phase 1: Understanding and document the client's internal control structure. This phase includes a general knowledge of the control environment, including the identification of entity level controls. In addition, the auditor should gain an understanding of the flow of transactions through the accounting system and document this understanding using a questionnaire, narrative descriptions and perhaps flowcharts. Phase 2: Assessing the control risk on a preliminary basis. At this point of the process, the strengths and weaknesses of the system are analyzed and should be documented in a bridge work paper. A preliminary assessment of internal controls is completed. At this point, a decision is made as to which controls are going tested and a required degree of compliance is determined. Phase 3: Performing tests of controls audit procedures and reassess control risk. When the audit team determines that a specific control activity could have a significant effect in reducing control risk to a low level for a specific assertion, they perform test of that control activity to obtain specific audit evidence about the effectiveness of the design or operation of that control activity. At this point, the actual degree of compliance is compared with the required degree of compliance. The audit team then must determine the final assessment of control risk and then determine whether any changes to the substantive testing plan must be made.

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63) Internal control problems in small business would include: A.Separation of functional responsibilities would be difficult because of the small number of employees. B.The owner manager has to assume a greater role to oversee and supervise authorization, recordkeeping, and custodial functions. C.The owner manager must be diligent, competent, and have a high degree of integrity. 64) Auditors can issue the following opinions for an audit of an entity's internal control over financial reporting: ● Unqualified. No material weaknesses exist. ● Disclaimer. The audit team cannot perform all of the procedures considered necessary and therefore cannot issue an opinion. ● Adverse opinion. One or more material weaknesses exist.

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65) A.The audit team has two primary reasons for conducting an evaluation of an entity's internal control. First, Sarbanes-Oxley requires an audit of the effectiveness of internal control that is an integrated part of the financial statement audit for publicly traded companies. The second reason for evaluating an entity's internal control is to comply with the performance principle of GAAS: To assess the risk of material misstatement to give the auditors a basis for planning the audit and determining the nature, timing, and extent of audit procedures for the substantive audit plan. The audit team assesses control risk. B.If auditors assess control risk as "maximum" or 100 percent (i.e., poor control), they will tend to perform a great deal of substantive procedures with large sample sizes (extent), at or near the entity's fiscal year end (timing), using procedures designed to obtain high-quality external evidence (nature). On the other hand, if auditors assess control risk as "low," usually around 10 to 20 percent (i.e., effective control), they can perform fewer substantive procedures with smaller sample sizes (extent), at an interim date before the entity's fiscal year end (timing), using a mixture of procedures designed to obtain high-quality external evidence and lower-quality internal evidence (nature). Of course, auditors may assess control risk between "low" and "maximum" (e.g., "moderate," "high," or "slightly below maximum") and adjust the substantive procedures accordingly. C.No. here may be occasions when the audit team chooses to test everything substantively rather than relying on internal controls to reduce substantive testing. For example, for fixed assets, there are usually a small number of very material transactions. Testing controls would not be efficient if the audit team is going to examine every transaction anyway.

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66) 1.Planning the engagement 2.Using a top-down approach to gain an understanding 3.Testing controls 4.Evaluating control deficiencies 5.Wrapping up: forming an opinion on the effectiveness of internal control over financial reporting 6.Reporting on internal control 67) A material weakness in internal control is defined as a deficiency, or combination of deficiencies, that results in a reasonable possibility that a material misstatement would not be prevented or detected on a timely basis. The following circumstances should be regarded as strong indicators that a material weakness exists: ● Restatement of previously issued financial statements to reflect the correction of a misstatement. ● Evidence of material misstatements (caught by the audit team) that were not prevented or detected by the client's internal controls. ● Ineffective oversight of the financial reporting process by the entity's audit committee. ● Indication of fraud (either material or immaterial) by senior management. 68) The difference between a significant deficiency and a material weakness is the (1) likelihood and (2) materiality that a potential (or actual) misstatement would not be detected on a timely basis.

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CHAPTER 5: PROBLEM MATERIAL ESSAY. Write your answer in the space provided or on a separate sheet of paper. 1) Below are several of the ASB management assertions. A.Occurrence B.Completeness C.Rights and obligations D.Allocation or valuation E.Classification F.Existence G.Cutoff H.Accuracy I.Understandability For each of the following control activities, identify the management assertion that best applies by placing the correct letter in the blank space below.

___ 1. Match shipping documents with sales invoices before a sale is recorded. ___ 2. Balance total of individual customers' receivables with the control account. ___ 3. Sales manager approves taking discounts. ___ 4. Computer check for billing the quantity shipped, list price, and total. ___ 5. Account for numerical sequence of pre-numbered shipping documents.

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Answer Key Test name: Chap 05_8e_Test Bank_Problem Material 1) 1. A, 2. E, 3. D, 4. H, 5. B

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CHAPTER 6 MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) When auditing financial statements and finding indications of a possible misappropriation of assets, independent auditors should: A) investigate fully to determine the total amount of the misappropriation. B) determine which accounts are affected and the amount by which they are overstated or understated. C) determine the methods by which the misappropriation was carried out. D) identify a person(s) who are likely responsible for the misappropriation and obtain evidence about some other fraud indications in their work. E) all of the these choices are correct.

2) When an employee embezzles company funds from an electric utility company for the purpose of paying expenses of an anti-nuclear protest organization, the fraudster's motive is said to be: A) psychotic. B) egocentric. C) ideological. D) economic.

3) Which of the following management policies would increase the probability of fraud in a company? A) Diversifying authority throughout divisions and subsidiaries in the organization. B) Measuring performance and awarding bonuses based on short-term operating results. C) Giving employees performance feedback that considers positive and constructive praise along with critical and negative observations on their work. D) Establishing work teams that share responsibilities, performance, and bonuses based on collective efforts.

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4) An auditor has identified the controller's review of the bank reconciliation as a control to test. In connection with this test, the auditor interviews the controller to understand the specific data reviewed on the reconciliation. In addition, the auditor verifies that the bank reconciliation is properly prepared by the accountant and reviewed by the controller as evidenced by their respective sign-offs. Which of the following types of audit procedures do these actions illustrate? A) Observation and inspection of records. B) Confirmation and reperformance. C) Inquiry and inspection of records. D) Analytical procedures and reperformance.

Each of the following is a type of known misstatement,

except:

A) an inaccuracy in processing data. B) the misapplication of accounting principles. C) differences between management and the auditor's judgment regarding estimates. D) a difference between the classification of a reported financial statement element and the classification according to generally accepted accounting principles.

6) Which of the following situations most likely represents the highest risk of a misstatement arising from misappropriation of assets? A) A large number of bearer bonds on hand. B) A large number of inventory items with low sales prices. C) A large number of transactions processed in a short period of time. D) A large number of fixed assets with easily identifiable serial numbers.

7) A company employs three accounts payable clerks and one treasurer. Their responsibilities are as follows:

Employee Clerk 1 Clerk 2

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Reviews Review vendor invoices for proper signature approval. Enters vendor invoice into the accounting system and verifies payment terms. 2

Clerk 3 Treasurer

Posts entered vendor invoices to accounts payable ledger for payment and mails checks. Review the vendor invoices and signs each check.

Which of the following would indicate a weakness in the company's internal controls? A) Clerk 1 opens all of the incoming mail. B) Clerk 2 reconciles the accounts payable ledger with the general ledger monthly. C) Clerk 3 mails the checks and remittances after they have been signed. D) The treasurer uses a stamp for signing checks.

8) An auditor is considering whether the omission of the confirmation of investments impairs the auditor's ability to support a previously expressed unmodified opinion. The auditor need not perform this omitted procedure if: A) the results of alternative procedures that were performed compensate for the omission. B) the auditor's assessed level of detection risk is low. C) the omission is documented in a communication with the audit committee. D) no individual investment is material to the financial statements taken as a whole.

9) Which of the following is not considered one of the three factors increasing the probability of fraud? A) Motive. B) Lack of training. C) Opportunity. D) Rationalization.

10) Which of the following is ordinarily considered an "extended procedure" during the independent audit of financial statements?

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A) Send positive confirmations on recorded customer accounts receivable balances. B) Perform physical observation and test count during the client's inventory taking. C) Measure the time lag between the date of recording cash receipts in the books to the date of deposit credit in the bank. D) Conduct interviews with the client's sales billing personnel to learn about sales recording control activities.

11) If the amount of a check is altered by an employee after it has cleared the bank, the change can be detected by: A) comparing the amount written on the check face to the amount written in the cash disbursements journal. B) comparing the magnetic imprint of the amount paid to the amount written on the check face. C) examining the endorsement on the back of the check. D) comparing the check number on the face of the check to the check number in the cash disbursements journal.

12) Which of the following would be consistent with an employee taking cash receipts from customers on account? A) The total of the accounts receivable subsidiary ledger balances is less than the accounts receivable control account. B) The total of the accounts receivable subsidiary ledger balances is greater than the accounts receivable control account. C) Total cash receipts from customers for the month are less than credit sales for the month. D) Total cash receipts from customers for the month are greater than credit sales for the month.

13)

An audit plan of substantive procedures for cash would not include:

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A) request a cutoff bank statement be mailed to the client. B) request client to prepare bank reconciliations. C) prepare a schedule of interbank transfers for a period of ten business days before and after year-end date. D) obtain a written client representation concerning compensating balance agreements.

14)

In the audit of cash the auditor obtains a bank cutoff statement primarily to:

A) identify old outstanding checks that the client may exclude from the year-end bank reconciliation in order to misappropriate cash. B) obtain sufficient information to reconcile the client's bank account as of year-end. C) obtain direct confirmation of the client's bank balances as of year-end. D) test the propriety of items appearing on the client's year-end bank reconciliation.

15) Auditors ordinarily send an electronic confirmation request to all banks with which the client has done business during the year under audit, regardless of the year-end balances. A purpose of this procedure is to: A) provide the data necessary to prepare a proof of cash. B) request that a cutoff bank statement and related checks be sent to the auditor. C) detect questionable bank activities that may otherwise not be discovered. D) seek information about contingent liabilities and security agreements.

16) To gather evidence regarding the bank's balance in a bank reconciliation, an auditor would examine all of the following except the: A) cutoff bank statement. B) general ledger. C) bank confirmation. D) year-end bank statement.

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17) An entity with a large volume of customer remittances by mail could most likely reduce the risk of employee misappropriation of cash by using: A) employee fidelity bonds. B) independently prepared mailroom prelists. C) daily check summaries. D) a bank lockbox system.

18)

Which of the following sets of information does an auditor usually confirm on one form? A) Accounts payable and purchase commitments. B) Cash in bank and collateral for loans. C) Inventory on consignment and contingent liabilities. D) Accounts receivable and accrued interest receivable.

19) An unrecorded check issued during the last week of the year would most likely be discovered by the auditor when the: A) check register for the last month is reviewed. B) cutoff bank statement is reconciled. C) bank confirmation is reviewed. D) search for unrecorded liabilities is performed.

20) An auditor wishes to perform tests of controls on a client's cash disbursements procedures. If the control activities leave no audit trail of documentary evidence, the auditor most likely will test the activities by: A) confirmation and observation. B) observation and inquiry. C) analytical procedures and confirmation. D) inquiry and analytical procedures.

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21) To provide assurance that each voucher is submitted and paid only once, an auditor most likely would examine a sample of paid vouchers and determine whether each voucher is: A) supported by a vendor's invoice. B) stamped "paid" by the check signer. C) prenumbered and accounted for. D) approved for authorized purchases.

22) In order for auditors to be able to recognize potential fraud, they must be aware of the basic characteristics of fraud. Which of the following is not a characteristic of fraud? A) Intentional deception. B) Taking unfair or dishonest advantage of other people. C) Perpetration for the benefit or detriment of the organization. D) Negligence on the part of executive management.

23) An auditor who discovers that client employees have committed an illegal act that has a material effect on the client's financial statements most likely would withdraw from the engagement if: A) the illegal act is a violation of generally accepted accounting principles. B) the client does not take the remedial action that the auditor considers necessary. C) the illegal act was committed during a prior year that was not audited. D) the auditor has already assessed control risk at the maximum level.

24) An auditor would least likely initiate a discussion with a client's audit committee concerning:

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A) the methods used to account for significant unusual transactions. B) the maximum dollar amount of misstatements that could exist without causing the financial statements to be materially misstated. C) indications of fraud and illegal acts committed by a corporate officer that were discovered by the auditor. D) disagreements with management as to accounting principles that were resolved during the current year's audit.

25) Which of the following statements is correct with respect to the elements of the "fraud triangle"? A) Motive is a cause that pressures people into action. B) Opportunity refers to a situation that allows someone with motive to carry out fraud. C) A lack of integrity describes a person who does not stick to the social or organizational ethical code. D) Fraud is most common when these three factors exist together. E) All of these statements are correct.

26) Narbona, CPA, is reviewing controls over cash received through a bank night depository. Which controls would she find most important? A) Responsibilities are rotated for processing night depository receipts among employees of the various departments. B) Dual control (joint custody) is established over the contents of the night depository box from the time of removal until initial recording is completed. C) Vacations are required for all employees engaged in night depository activities. D) All deposit tickets related to night deposits are numbered.

27) Your client is in the process of acquiring another company. You have been requested to verify that cash for the company being acquired is properly stated. The audit technique that will yield the most persuasive evidence is:

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A) examination of the company's escrow account. B) interview with the company's treasurer and cash manager. C) preparation and review of standard bank confirmation inquiries. D) analytical computations comparing current cash in the bank with previous accounting periods.

28)

A proof of cash: A) is required by GAAS. B) can be used to test the transactions process. C) is most helpful when control risk for cash is low. D) always detects lapping.

29) When counting cash on hand the auditor must exercise simultaneous control over all cash and other negotiable assets to prevent: A) theft. B) irregular endorsement. C) replacement or substitution of stolen assets. D) deposits in transit.

30) As payments are received, one mailroom employee is assigned the responsibility of prelisting receipts and preparing the deposit slip prior to forwarding the receipts, deposit slip, and remittance advices to accounts receivable for posting. Accounts receivable personnel re-foot the deposit slip, stamp a restrictive endorsement on the back of each check, and then forward the receipts and deposit slip to the treasury department. Evaluate the internal control of the described process. Which of the following is a reasonable assessment of internal control in this process?

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A) Adequate internal control. B) Inadequate internal control because mailroom employees should not have access to cash. C) Inadequate internal control because treasury employees should prepare the deposit slip. D) Inadequate internal control because of a lack of separation of duties.

31) Which of the following should be performed by the persons opening the mail and recording payments? A) Restrictive endorsement on all checks. B) Entering of payment information into customer accounts. C) The preparation of the deposit slip and the delivery of the checks to the bank. D) The segregation of all payments made on accounts listed as past due.

32) At the end of each business day, Safe Company sends its bank a listing of all checks written during the day including the check number, payee, and amount. When a check is sent to the bank for payment the bank compares the payee and the amount with the listing provided by Safe Company. This system is called: A) PayChex. B) Pay-As-You-Go. C) Positive Pay. D) Pay Master.

33) The mail which includes payments should be opened by two people. This control is called: A) separation of duties. B) joint custody. C) anti-collusion. D) lapping.

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34) Most fraud investigators utilize the fraud triangle theory. A new theory called the fraud diamond has been proposed. Which of the following is an element of the fraud diamond and is not an element of the fraud triangle? A) Motive. B) Opportunity. C) Capability. D) Liquidity.

ESSAY. Write your answer in the space provided or on a separate sheet of paper. 35) When you examine canceled checks returned in the bank statement by a client's bank, how could you tell whether the amount on the check had been skillfully raised (increased, say, from $75.00 to $7,500 in the amount box, and altered in the written line from "Seventy-five dollars" to "Seventy-five hundred dollars") after the check was cleared by the bank? (An employee might do this to "support" a $7,500 cash disbursement journal entry.)

36) After checks are signed for vendor invoices, why should vouchers be marked "paid" or otherwise mutilated?

37)

List, and briefly describe, the three factors that increase the probability of fraud.

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38) What kind of error or fraud could happen if the inventory warehouse manager also had responsibility for making the physical inventory count and reconciling discrepancies to the perpetual inventory records?

39)

Describe how a lockbox works and indicate the advantages of such a system.

40) Ed's wife Diane owns a printing business in town. Ed works in the accounts payable department of Jiffy Abs Vitamin Company. Diane prints invoices for work supposedly done for Jiffy Abs (no actual work was performed) and Ed places in the invoice in the approved for payment invoice pile. Jiffy Abs pays these invoices and sends Diane a check. 1.Name two internal controls that might prevent or detect these fraudulent payments. 2.Name two audit procedures that might detect this fraud.

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41) Micro Chip Corporation (MCC) has a special PO Box for customer payments. Jane is responsible for: ● going to the post office every day, ● emptying the post office box, ● opening the mail, ● making a prelist, ● sending the remittance advices to accounts receivable, and ● sending the checks to the cashier's office. Jane has opening a business account at her bank for Master Cleaning Company (MCC). Several of Micro Chips checks are made out with only the initials MCC. Jane selects certain checks made out only with the initials MCC and deposits them in her business account. She would destroy the remittance advice. 1.Name two controls that would prevent or detect this fraud. 2.Name two audit procedures that might detect this fraud.

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Answer Key Test name: Chap 06_8e_Test Bank 1) E 2) C 3) B 4) C 5) C 6) A 7) C 8) A 9) B 10) C 11) B 12) A 13) A 14) D 15) D 16) B 17) D 18) B 19) B 20) B 21) B 22) D 23) B 24) B 25) E 26) B Version 1

27) C 28) B 29) C 30) D 31) A 32) C 33) B 34) C 35) The bank imprints the check with the amount paid by the bank (magnetic print in the lower right corner). It will be 00007500, meaning $75.00. 36) To show they have been processed so they cannot be paid again. 37) Motive, opportunity, and lack of integrity are the three factors that increase the probability of fraud. Motive is a cause that pressures people into action. Economic motives are common in business fraud. Opportunity refers to a situation that allows someone with motive to carry out fraud. An example would be a lack or lapse of a specific control or controls in an organization. A lack of integrity describes a person who does not stick to the social or organizational ethical code. They may rationalize their actions to defend such a lack of integrity. Fraud is most common when these three factors exist together. 38) The inventory manager could 1.Commit an inadvertent error of miscounting and adjust the error into the accounts and inventory records. 2.Steal inventory and adjust the inventory records permanently to cover up the theft.

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39) A lockbox is a post office box under the control of the bank. The bank will send employees to retrieve checks from the box and deposit them in the company's account. The bank will provide a listing of deposits and the remittance advises to the company. The bank may also provide images of the checks (if the company is willing to pay for these additional services). There are two main advantages to this system: 1.Checks are retrieved by the bank and never enter the company. Therefore the risk that checks will be misplaced or end up in the hands of the wrong individuals is eliminated. Separation of duties also becomes easier since the custody of the asset is no longer a possible for record keepers or authorizers. 2.The money is placed immediately into the bank allowing for immediate access to the use of the funds or interest on the funds. 40) 1.Controls include: ● Voucher package that includes a receiving report ● An approved vendor list and the requirement that the vendor be on the approved vendor list ● The inclusion of an expense account for the charging of all material. Each department gets a report of all expenses each month for review. 2.Procedures include: ● Review of voucher packages to ensure goods were received ● Review of voucher packages to ensure vendors are on the approved vendor list ● Analytical procedures to identify increases in expenditures for specific types of products (printing services) ● Analytical procedures to identify increases in expenditures to specific vendors. Version 1

41) Controls include: 1.A separate person could empty the PO Box, record how many envelops were in the box and deliver the unopened mail to Jane. Jane would be required to account for each envelop. ● The mail could be picked up under joint custody ● The mail could be opened under joint custody ● Surveillance equipment could be used to monitor the opening and recording of payments ● Since customer complaints would be made because payments would not be credited to their account, and independent and vigorous complaint resolution process would be a good control ● Mailing of statements each month to customers with balances or activity in their account ● Follow up communication on customer accounts that are past due by someone independent of accounts receivable 2.Procedures would include: ● Observe the opening of the mail and the recording of cash ● Review of customer complaints for patterns and appropriate follow up by company personnel ● From a sample of customer complaints, ask customers to send a copy of their payment (front and back) and review check for endorsement and bank account ● Review of the aging of accounts receivable schedule (accounts where payments were diverted would begin to have past due balances) ● Confirm account balances with customers ● Review responses to follow up communications on customer past due accounts.

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CHAPTER 6: PROBLEM MATERIAL ESSAY. Write your answer in the space provided or on a separate sheet of paper. 1) Auditors are auditing the cash receipts for Great Wall Corporation. For each audit procedure performed (numbered 1 - 5 below) select the control objective being tested by placing the correct letter in the blank. A. Existence B. Completeness C. Authorization D. Accuracy E. Classification F. Accounting and posting G. Proper period

_______

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For a sample of recorded cash receipts, the auditors compared the date of receipt to the recording date. The auditors traced a sample of daily cash reports to the cash receipts journal. The auditors vouched a sample of recorded cash receipts to the deposits in the bank statement. The auditors recalculate the cash listed on the daily deposit for a sample of recorded cash receipts. The auditors traced a sample of recorded cash receipts to postings in the correct customers' accounts.

Answer Key Test name: Chap 06_8e_Test Bank_Problem Material 1) 1. G, 2. B, 3. A, 4. D, 5. F

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CHAPTER 7 MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) To be recognized, revenues must also be realized or realizable and: A) foreseeable. B) collected. C) earned. D) shipped.

The SEC requires all of the following for revenue to be recognized except: A) cash is collected. B) persuasive evidence of an arrangement exists. C) delivery has occurred or services have been rendered. D) the seller's price to the buyer is fixed or determinable.

"Bill and hold" refers to an arrangement where: A) sales are recorded but are not shipped. B) sales are shipped but are not recorded. C) sales are billed but not collected. D) inventory is held but not billed.

Custody of inventory is transferred to the shipping area upon authorization of: A) the customer order. B) the shipping order. C) the invoice. D) the purchase order.

The document that generates recording of a sale is the:

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A) customer order. B) shipping order. C) invoice. D) purchase order.

6) The sum of customers' unpaid balances that is compared to the general ledger balance comes from: A) a total of sales invoices. B) a total of shipping orders. C) the sales journal. D) the accounts receivable trial balance.

7) The file that contains sales transactions that were initiated in the system but are not yet completed is the: A) credit check file. B) sales detail. C) inventory master. D) pending order master.

8) is:

The assertion that auditors will probably emphasize in the revenue and collection cycle

A) occurrence. B) completeness. C) accuracy. D) classification.

A small business owner can best offset the lack of separation of duties by:

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A) creating an internal audit department. B) installing the latest computer equipment and software. C) being actively involved in the accounting process. D) relying on the external auditor to detect errors.

10)

Accountants should be under orders to record sales and accounts receivable when: A) the customer's order is received. B) all supporting documentation of shipping is in order. C) the item has been paid for. D) the terms are agreed upon.

11) Which of the following is an example of a control activity that satisfies the accuracy control objective for sales invoices? A) Recorded sales in the sales journal are supported by invoices. B) Invoices, shipping documents, and sales orders are prenumbered and the numerical sequence is checked. C) Sales are recorded in the proper account. D) Invoice quantities are compared to shipment and customer order quantities.

12) Scanning sales invoices for missing numbers in the sequence would be an activity intended to satisfy what assertion? A) Completeness. B) Accuracy. C) Occurrence. D) Classification.

13) Vouching debits from a sample selection of customers' accounts receivable records to supporting sales invoices is an audit procedure designed to obtain evidence about the assertion of:

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A) occurrence. B) completeness. C) classification. D) accuracy.

14) Alpha Brewery Corporation recorded sales through January 4, 2021, dating them December 31, 2020. This situation is an example of a violation of which of the following assertions? A) Existence or occurrence. B) Completeness. C) Classification. D) Accuracy.

15) Confirmations of accounts receivable provide the most evidence for which of the following assertions? A) Existence. B) Valuation or allocation. C) Rights and obligations. D) Completeness.

16) The auditor maintains control of the mailing and receipt of confirmations by typically performing all of the following except:

A) preparing the confirmation letters. B) mailing the confirmation letters. C) receiving the confirmation letters. D) None of these choices are correct.

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17) If the auditor obtains sufficient appropriate evidence on the client's accounts receivable balance by alternative procedures because it is impractical to confirm accounts receivable, the auditor's opinion should be unqualified and could be expected to: A) disclose the fact that alternative procedures were used due to client-imposed scope limitation. B) disclose in the opinion paragraph that confirmation of accounts receivable was impracticable. C) avoid mentioning the alternative procedures. D) include an explanatory paragraph that discloses the performance of alternative procedures.

18) Which of the following is not a valid reason for an auditor deciding not to send accounts receivable confirmations? A) The balance is immaterial. B) Confirmations would be ineffective. C) The client requests alternative procedures be performed instead. D) Other procedures provide sufficient competent evidence.

19) When an account receivable is considered uncollectible, the person who generally authorizes the write-off is the client's: A) credit manager. B) treasurer. C) accountant. D) internal auditor.

20) Which of the following audit procedures is the most effective in testing sales for understatement?

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A) Analyze the aged trial balance of recorded accounts receivable. B) Confirm recorded accounts receivable. C) Trace a sample of shipping documents to sales invoices recorded in the sales journal. D) Vouch a sample of recorded sales from the sales journal to shipping documents.

21) To determine whether sales transactions have been recorded in the proper accounting period, the auditor performs cutoff tests. Which of the following best describes the overall approach used when performing cutoff tests? A) Ascertain that management has included in the representation letter a statement that transactions have been accounted for in the proper accounting period. B) Analyze transactions occurring within a few days before and after year-end. C) Confirm year-end transactions with regular customers. D) Examine cash receipts in the subsequent period.

22) The most effective audit procedure for determining the collectability of an account receivable is the: A) review of the subsequent cash collections. B) examination of the related sales invoice(s). C) confirmation of the account. D) review of authorization of credit sales to the customer and the previous history of collections.

23) In determining the adequacy of the allowance for uncollectible accounts, the least valuable evidence would be obtained from: A) an aging schedule of past due accounts that the auditor has tested. B) correspondence with the client's collection agency. C) financial statements of individual customers. D) no reply to negative confirmations.

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24) An auditor confirms a representative number of open accounts receivable as of December 31 and investigates respondents' exceptions and comments. By this procedure, the auditor would be most likely to learn of which of the following? A) One of the cashiers has been covering a personal embezzlement by lapping. B) One of the sales clerks has not been preparing charge slips for credit sales to family and friends. C) One of the IT control clerks has been removing all sales invoices applicable to his account from the data file. D) The credit manager has misappropriated remittances from customers whose accounts have been written off.

25) An auditor should normally perform alternative procedures to substantiate the existence of accounts receivable when: A) no reply to a positive confirmation request is received. B) no reply to a negative confirmation request is received. C) collectability of the receivables is in doubt. D) pledging of the receivables is probable.

26) A customer reply on a positive confirmation says "We dispute the $250 charge. We believe it is excessive." This confirmation: A) provides evidence of existence. B) does not provide evidence of existence because the customer may refuse to pay the $250 charge. C) provides evidence that the account was understated. D) provides evidence that the account should be written off.

27) The primary consideration when planning whether to send confirmations of accounts receivable before the balance sheet date is the:

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A) type of confirmation to be used. B) client's internal control over transactions affecting receivables. C) availability of staff auditors. D) number of customer accounts.

28) In the revenue and collection cycle, the auditor checks the numerical sequence of shipping documents. This procedure is related to which of the following assertions? A) Existence. B) Completeness. C) Rights and obligations. D) Valuation or allocation.

29) The auditor selects a sample of recorded sales invoices and vouches them to shipping documents. This procedure is related to which of the following assertions? A) Occurrence. B) Completeness. C) Accuracy. D) Cutoff.

30) In which of the following circumstances would the use of the negative form of accounts receivable confirmation most likely be justified? A) A substantial number of accounts may be in dispute and the accounts receivable balance arises from sales to a few major customers. B) A substantial number of accounts may be in dispute and the accounts receivable balance arises from sales to many customers with small balances. C) A small number of accounts may be in dispute and the accounts receivable balance arises from sales to a few major customers. D) A small number of accounts may be in dispute and the accounts receivable balance arises from sales to many customers with small balances.

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31) Which of the following controls most likely would help ensure that all credit sales transactions of an entity are recorded? A) The billing department supervisor sends copies of approved sales orders to the credit department for comparison to authorized credit limits and current customer account balances. B) The accounting department supervisor independently reconciles the accounts receivable subsidiary ledger to the accounts receivable control account monthly. C) The accounting department supervisor controls the mailing of monthly statements to customers and investigates any differences reported by customers. D) The billing department supervisor matches prenumbered shipping documents with entries in the sales journal.

32) Which of the following internal control activities most likely would ensure that all billed sales are correctly posted to the accounts receivable ledger? A) Daily sales summaries are compared to daily postings to the accounts receivable ledger. B) Each sales invoice is supported by a prenumbered shipping document. C) The accounts receivable ledger is reconciled daily to the control account in the general ledger. D) Each shipment on credit is supported by a prenumbered sales invoice.

33) In evaluating the adequacy of the allowance for doubtful accounts, an auditor most likely reviews the entity's aging of receivables to support management's financial statement assertion of: A) existence. B) valuation or allocation. C) completeness. D) rights and obligations.

34) Which of the following procedures would an auditor most likely perform for year-end accounts receivable confirmations when the auditor did not receive replies to second requests?

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A) Review the cash receipts journal for the month prior to the year-end. B) Intensify the study of the internal control structure concerning the revenue cycle. C) Increase the assessed level of detection risk for the existence assertion. D) Inspect the shipping records documenting the merchandise sold to the debtors.

35) Which of the following most likely would be detected by an auditor's review of a client's sales cutoff? A) Shipments lacking sales invoices and shipping documents. B) Excessive write-offs of accounts receivable. C) Unrecorded sales at year-end. D) Lapping of year-end accounts receivable.

36)

Tracing shipping documents to prenumbered sales invoices provides evidence that: A) no duplicate shipments or billings occurred. B) shipments to customers were properly invoiced. C) all goods ordered by customers were accounted for. D) all prenumbered sales invoices were accounted for.

37) Which of the following statements is correct concerning the use of negative confirmation requests? A) Unreturned negative confirmation requests rarely provide significant explicit evidence. B) Negative confirmation requests are effective when detection risk is low. C) Unreturned negative confirmation requests indicate that alternative procedures are necessary. D) Negative confirmation requests are effective when understatements of account balances are suspected.

38) The confirmation of customers' accounts receivable rarely provides reliable evidence about the completeness assertion because: Version 1

A) many customers merely sign and return the confirmation without verifying its details. B) recipients usually respond only if they disagree with the information on the request. C) customers may not be inclined to report understatement errors in their accounts. D) auditors typically select many accounts with low recorded balances to be confirmed.

39) Negative confirmation of accounts receivable is less effective than positive confirmation of accounts receivable because: A) a majority of recipients usually lacks the willingness to respond objectively. B) some recipients may report incorrect balances that require extensive follow up. C) the auditor cannot infer that all nonrespondents have verified their account information. D) negative confirmations do not produce evidential matter that is statistically quantifiable.

40) Elm Tree Inc. has a December 31 year end. On October 15, the auditor evaluated and tested Elm Tree's internal control procedures over the sales recording process and finds the controls to be effective. At a minimum, the auditor's year-end procedures for testing internal control procedures must include: A) confirmations of year-end accounts that were examined on October 15. B) tests the client's internal control procedures from October 15 through the year end. C) tests of compliance with internal control for a random sample of transactions throughout the audit period. D) a comparison of the responses to the auditor's internal control questionnaire with a detailed flowchart of control procedures at year end.

41)

Revenues are normally considered to have been earned when:

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A) all possibility of return has expired. B) the company has substantially accomplished what it must to be entitled to the benefits. C) the cash is collected. D) goods have been shipped.

42)

Sales are normally recorded on the date of the: A) customer purchase order. B) bill of lading. C) sales invoice. D) payment check.

43) When auditing the revenue and collection cycle, auditors normally select balances to confirm from the: A) sales journal. B) accounts receivable listing. C) general ledger. D) cash receipts listing.

44)

Which of the following accounts is not normally part of the revenue and collection cycle? A) Sales. B) Accounts Receivable. C) Cash. D) Purchases Returns and Allowances.

45) The control activity "credit sales approved by credit department" is directed toward which transaction assertion?

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A) Occurrence. B) Completeness. C) Accuracy. D) Cutoff.

46) Which of the following would be the best protection for a company that wishes to prevent the "lapping" of trade accounts receivable? A) Separate duties so that the bookkeeper in charge of the general ledger has no access to incoming mail. B) Separate duties so that no employee has access to both checks from customers and currency from daily cash receipts. C) Have customers send payments directly to the company's depository bank. D) Request that customer's payment checks be made payable to the company and addressed to the treasurer.

47) Which of the following internal control activities will most likely prevent the concealment of a cash shortage by improperly writing off a trade account receivable? A) Write-offs must be approved by a responsible officer after review of credit department recommendations and supporting evidence. B) Write-offs must be supported by an aging schedule showing that only receivables overdue several months have been written off. C) Write-offs must be approved by the cashier who is in a position to know if the receivables have, in fact, been collected. D) Write-offs must be authorized by company field sales employees who are in a position to determine the financial standing of the customers.

48) Auditors sometimes use comparisons of ratios as audit evidence. An unexplained decrease in the ratio of gross profit to sales may suggest which of the following possibilities?

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A) Unrecorded purchases. B) Unrecorded sales. C) Merchandise purchases being charged to selling and general expense. D) Fictitious sales.

49) An audit team is auditing sales transactions. One step is to vouch a sample of debit entries from the accounts receivable subsidiary ledger back to the supporting sales invoices. The purpose of this audit procedure is to establish that: 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) entries in the accounts receivable subsidiary ledger were properly invoiced.

50) An auditor noted that client sales had increased 10 percent for the year. At the same time, cost of goods sold as a percentage of sales had decreased from 45 percent to 40 percent and yearend accounts receivable had increased by 8 percent. The auditor is most likely concerned about: A) unrecorded costs. B) improper credit approvals. C) improper sales cut-off. D) fictitious sales.

51) An auditor noted that client sales had increased 10 percent for the year. At the same time, cost of goods sold as a percentage of sales had decreased from 45 percent to 40 percent and yearend accounts receivable had increased by 8 percent. The auditor interviewed the sales manager who stated that the increase in sales without a corresponding increase in cost of goods sold was due to a price increase enacted by the company during the year. How would the auditor best test the sales manager's representation?

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A) Perform additional inquiries with sales personnel. B) Obtain copies of all price lists in use during the year and vouch the prices to sales invoices. C) Send confirmations asking customers about unit prices paid for product. D) Vouch vender invoices to payments made after year-end.

52) To conceal defalcations involving receivables, a dishonest bookkeeper might charge which of the following accounts? A) Miscellaneous income. B) Petty cash. C) Miscellaneous expense. D) Sales returns.

53) Which of the following responses to an accounts receivable confirmation at December 31 would cause an audit team the most concern? A) "This amount was paid on December 30th." B) "We received this shipment on January 2nd." C) "These goods were returned for credit on November 15th." D) "The balance does not reflect our sales discount for paying by January 5th."

54) A client has a separate sales group for its largest "preferred" customers. This is a select group of customers that normally make purchases in excess of $250,000 and often have accounts receivable balances in excess of $1 million. Which of the following audit procedures would the auditor most likely perform? A) Prepare a schedule of purchases and payments for these customers. B) Send out negative confirmations on a large sample of these customers. C) Inquire of the sales manager regarding the accounts receivable terms. D) Send out positive confirmations on a large sample of these customers.

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55) Audit documentation often includes a client-prepared, aged trial balance of accounts receivable as of the balance sheet date. The audit team uses this aging primarily to: A) evaluate internal control over credit sales. B) test the accuracy of recorded charge sales. C) estimate credit losses. D) verify the existence of the recorded receivables.

56) Which of the following might be detected by auditors' cutoff review and examination of sales journal entries for several days prior to the balance sheet date? A) Lapping year-end accounts receivable. B) Inflating sales for the year. C) Kiting bank balances. D) Misappropriating merchandise.

57) Confirmation of individual accounts receivable balances directly with debtors will, of itself, normally provide the strongest evidence concerning the: A) collectability of the balances confirmed. B) ownership of the balances confirmed. C) existence of the balances confirmed. D) internal control over balances confirmed.

58) Which of the following is the best reason for prenumbering in sequence such documents as sales orders, shipping documents, and sales invoices? A) Enables company personnel to determine the accuracy of each document. B) Enables personnel to determine the proper period for recording of sales revenue and receivables. C) Enables personnel to check the numerical sequence for missing documents and unrecorded transactions. D) Enables personnel to determine the validity of recorded transactions.

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59) When a sample of customer accounts receivable is selected for vouching debits, auditors will vouch them to: A) sales invoices with shipping documents. B) records of accounts receivable write-offs. C) cash remittance lists and bank deposit slips. D) credit files and reports.

60)

In the audit of accounts receivable, the most important emphasis should be on the: A) completeness assertion. B) existence assertion. C) rights and obligations assertion. D) presentation and disclosure assertion.

61) When accounts receivable are confirmed at an interim date, auditors need not be concerned with: A) obtaining a summary of receivables transactions from the interim date to the yearend date. B) obtaining a year-end trial balance of receivables, comparing it to the interim trial balance, and obtaining evidence and explanations for large variations. C) sending negative confirmations to all the customers as of the year-end date. D) considering the necessity for some additional confirmations as of the balance sheet date if balances have increased materially.

62) The negative request form of accounts receivable confirmation is useful particularly when the: Assessed Level of Risk of Number of Material Small Misstatement Relating to Balances Is Receivables Is A. Low Many B. Low

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Few

Proper Consideration by the Recipient Is

Likely Unlikely

C. High

Few

Likely

D. High

Many

Likely

A) Option A B) Option B C) Option C D) Option D

63) When an audit team traces a sample of shipping documents to the related sales invoice copies, they are trying to find relevant evidence that: A) shipments to customers were invoiced. B) shipments to customers were recorded as sales. C) recorded sales were shipped. D) invoiced sales were shipped.

64)

Write-offs of doubtful accounts should be approved by: A) the salesperson. B) the credit manager. C) the treasurer. D) the cashier.

65) When an audit team does not receive a response on a positive accounts receivable confirmation, auditors should do all of the following except: A) send a second request. B) do nothing for immaterial balances. C) examine shipping documents. D) examine client correspondence files.

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66) Cash receipts from sales on account have been misappropriated. Which of the following acts would conceal this defalcation and be least likely to be detected by an auditor? A) Understating the sales journal. B) Overstating the accounts receivable control account. C) Overstating the accounts receivable subsidiary ledger. D) Understating the cash receipts journal.

67) Which of the following internal control activities most likely would deter lapping of collections from customers? A) Independent internal verification of dates of entry in the cash receipts journal with dates of daily cash summaries. B) Authorization of write-offs of uncollectible accounts by a supervisor independent of credit approval. C) Separation of duties between receiving cash and posting the accounts receivable ledger. D) Supervisory comparison of the daily cash summary with the sum of the cash receipts journal entries.

68) The financial records of the Movitz Company show that Mr. Dennis owes $4,100 on an account receivable. An independent audit is being carried out and the auditors send a positive confirmation to Mr. Dennis. What is the most likely reason as to why a positive confirmation rather than a negative confirmation was used here? A) Control risk was particularly low for accounts receivable. B) Inherent risk was particularly high for accounts receivable. C) Mr. Dennis's account was not yet due. D) Mr. Dennis's account was not with a related party.

69) In the revenue and collection cycle, the order of the activities in the cycle is best illustrated by:

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A) delivering goods, billing customer, granting credit, and performing collection activities. B) customer ordering, delivering goods, granting credit, and billing customers. C) processing customer orders, granting credit, delivering goods, and billing customers. D) granting credit, billing customers, delivering goods, and processing cash receipts.

70)

Which of the following controls is designed to meet the completeness assertion? A) Prenumbering invoices, shipping documents, and sales orders. B) Sales orders are approved by the credit department prior to shipping goods. C) The sale is to a customer on the approved customer list. D) Sales are dated by the computer to ensure it is included in the proper period.

71) Which of the following questions included in an internal control questionnaire would evaluate the valuation objective of revenues? A) Is customer credit approved before orders are shipped? B) Are sales orders prenumbered? C) Are shipping documents required before a customer invoice is sent? D) Are payments received from the customer deposited in the bank in a timely manner?

72) Favorite Soda Company distributes beverages in the Portland, Oregon area. Which of the following would be the test to determine that shipments made were actual sales? A) Trace bills of lading to the sales journal. B) Vouch entries made in the sales journal to the bills of lading. C) Trace entries in the sales journal to accounts receivable subsidiary ledger. D) Vouch bills of lading to the customer order documents.

73) Smith Manufacturing Company's accounts receivable clerk has a friend who is also Smith's customer. The accounts receivable clerk, on occasion, has issued fictitious credit memorandums to his friend for goods supposedly returned (these returns did not exist). The most effective control for preventing this activity is to: Version 1

A) prenumber and account for all credit memorandums. B) require receiving reports to support all credit memorandums before they are approved. C) have the sales department independent of the accounts-receivable department. D) mail monthly statements to the customer.

74) While performing interim audit procedures of accounts receivable, numerous unexpected errors are found resulting in a change of risk assessment. Which of the following audit responses would be most appropriate? A) Move detailed analytical procedures from year end to interim. B) Increase the dollar threshold of vouching customer invoices. C) Send negative accounts receivable confirmations instead of positive accounts receivable confirmations. D) Use more experienced audit team members to perform year-end testing.

75) In confirming a client's accounts receivable in prior years, an auditor discovered many differences between recorded account balances and confirmation replies. These differences were resolved and were not misstatements. In defining the sampling unit for the current year's audit, the auditor most likely would choose: A) customers with credit balances. B) small account balances. C) individual overdue balances. D) individual invoices.

76) When an auditor decides to confirm accounts receivable balances rather than individual invoices, it most likely would be beneficial to include with the confirmations: A) copies of the client's shipping documents that support the account balances. B) lists of the customers' recent payments that the client has already recorded. C) client-prepared statements of account that show the details of the account balances. D) copies of the customers' purchase orders that support the account balances.

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FILL IN THE BLANK. Write the word or phrase that best completes each statement or answers the question. 77) __________ of accounts receivable records implies the power to alter them directly or enter transactions to alter them.

78) The pending sales orders can be reviewed for evidence of the _______ of recorded _______ and _______.

79) Internal control assessment is important because it governs the _______, _______ and _______ of substantive procedures.

80)

Information about the internal control system can be gathered by completing an _______.

81) Another way to obtain information about the internal control system is to take a single example of a transaction and _______ the process from its initiation to its recording in the accounting records.

82) The actions in tests of controls involve _______, _______, _______, _______ and _______.

83) Dual direction testing involves samples of transactions selected to obtain evidence about control over _______ in one direction and control over _______ in the other direction.

84) A procedure to gather evidence on both account balances and controls is called a _______ procedure.

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85) Assertions related to account balances are _______, _______, _______ _______, _______ and _______.

86) Confirmations provide evidence of _______ and, to a limited extent, _______ of accounts and notes receivable.

87) _______ may be used to access computerized receivable files to select and print confirmations.

88) Two widely used confirmation forms to test accounts receivable are _______ and _______ confirmations.

89) The _______ confirmation form is used when individual balances are _______ or accounts are in _______.

90) Auditing the details of customer payments listed in bank deposits in comparison to details of customer payment postings can detect _______.

ESSAY. Write your answer in the space provided or on a separate sheet of paper. 91) What is dual direction testing?

92) Is the confirmation of cash and accounts receivable required according to auditing standards? Explain.

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93) In tests of controls auditing, auditors need to define "deviations" in advance. Give seven examples of control compliance deviations related to a client's processing of credit sales transactions and the related assertion that was violated.

94) You are the auditor for Wilson Wholesale Products Inc. As part of the audit of accounts receivable, Wilson has provided you an electronic file representing its accounts receivable as of its fiscal year-end. The file includes the customer name, customer address, customer number, sales invoice number, sales invoice date, and amount. Required: Describe three or more substantive audit procedures you might perform using computerassisted audit tools and techniques (CAATs) with this computer file.

95) What procedures should an auditor perform for a positive confirmation that is not returned by the client's customer?

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Answer Key Test name: Chap 07_8e_Test Bank 1) C 2) A 3) A 4) B 5) C 6) D 7) D 8) A 9) C 10) B 11) D 12) A 13) A 14) A 15) A 16) A 17) C 18) C 19) B 20) C 21) B 22) A 23) D 24) A 25) A 26) A Version 1

27) B 28) B 29) A 30) D 31) D 32) A 33) B 34) D 35) C 36) B 37) A 38) C 39) C 40) B 41) B 42) C 43) B 44) D 45) C 46) C 47) A 48) B 49) D 50) D 51) D 52) D 53) C 54) D 55) C 56) B Version 1

57) C 58) C 59) A 60) B 61) C 62) A 63) A 64) C 65) B 66) A 67) C 68) B 69) C 70) A 71) A 72) D 73) B 74) D 75) D 76) C 77) Custody Question also found in study guide 78) [completeness, sales, accounts receivable] Question also found in study guide 79) [nature, timing, extent] Question also found in study guide 80) internal control questionnaire Question also found in study guide

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81) walkthrough Question also found in study guide 82) [vouching, tracing, observing, scanning, recalculating] Question also found in study guide 83) [completeness, occurrence] Question also found in study guide 84) dual purpose Question also found in study guide 85) [existence, completeness, rights, obligations, obligations, allocation] Question also found in study guide 86) [existence, valuation] Question also found in study guide 87) CAATs Question also found in study guide 88) [positive, negative] 89) [positive, large, dispute] Question also found in study guide 90) lapping Question also found in study guide 91) Dual direction testing involves samples selected to obtain evidence about control over completeness in one direction and control over occurrence in the other direction. The completeness direction determines whether all transactions that occurred were recorded. The occurrence direction determines whether recorded transactions actually occurred.

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92) In general, the use of confirmations for cash balances and trade accounts receivable is considered a requirement under auditing standards (SAS 67). However, auditors may decide not to use them if suitable alternative procedures are available and applicable in certain circumstances. Justifications for not using confirmations include (a) receivables are not material, (b) confirmations would not be effective, and (c) analytical procedures and other substantive tests of details procedures would provide sufficient, competent evidence. 93) a.Occurrence. Fictitious sales are recorded. b.Completeness. Shipments to customers are not recorded. c.Accuracy. Customer credit is not approved. d.Accuracy. Sales are recorded in the wrong amount (quantity and/or price is wrong). e.Classification. Sales are recorded in the wrong revenue account. f.Completeness. Some sales are not posted to the customer accounts. g.Cutoff. Sales are recorded for the wrong date. 94) The following substantive tests could be performed with CAATs. a. Compute the total accounts receivable by adding the sales invoice amounts. Compare to general ledger control account total (manual). b. Scan the sales invoice date field for any dates after the year-end. c. Prepare an aged accounts receivable trial balance using the sales invoice date and amount. d. Select and print accounts for confirmation of accounts receivable. e. Scan the sales invoice amount for negative balances. f. Other ________.

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95) Auditors have to perform alternative procedures to ensure existence. These include examining (a) subsequent cash receipts, (b) sales orders, invoices and shipping documents, and (c) correspondence files for past due accounts. Examining subsequent cash receipts is a particularly effective test because a customer's payment of the account is strong evidence that the receivable existed. The cash receipt should be traced to the remittance advice and the deposit into cash.

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CHAPTER 7: PROBLEM MATERIAL ESSAY. Write your answer in the space provided or on a separate sheet of paper. 1) For each of the tests of controls for sales and receivables, indicate the assertion that is supported by placing the correct number in the blank. 1. Accuracy 2. Completeness 3. Occurrence 4. Completeness 5. Accuracy _______

Scan sales invoices for missing numbers in sequence.

_______

Perform arithmetic recalculation of a sample of recorded sales invoices. For a sample of recorded sales, determine whether credit was approved. Trace a sample of credit memos to postings in customers' accounts. Select a sample of customer accounts and vouch debits to sales invoices.

2) The following questions appeared on an internal control questionnaire for sales. Next to each of the questions indicate the related assertion.

Are sales invoice blanks prenumbered?

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Are all credit sales approved by the credit department prior to shipment?

A _______ B _______

C D E F

Are invoice quantities compared to shipped quantities? Are summary journal entries approved before posting?

C _______

Are sales prices and terms based on approved standards? Is access to sales invoice blanks restricted?

E _______

H I

Does the accounting manual contain instructions to date sales invoices on the shipment date?

D _______

F _______ G _______

Are returned sales credits supported by documentation? Are prenumbered bills of lading prepared in the shipping department?

H _______

Are periodic sales data reported directly to general ledger accounting independent of accounts receivable accounting?

J _______

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I _______

Answer Key Test name: Chap 07_8e_Test Bank_Problem Material 1) A. 2, B. 1, C. 1, D. 2, E. 3 2) a. Completeness, b. Accuracy, c. Accuracy, d. Accuracy, e. Accuracy, f. Occurrence, g. Cutoff, h. Occurrence, i. Completeness, j. Accuracy

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CHAPTER 8 MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) When confirming accounts payable, emphasis should be put on what kind of accounts? A) Accounts with small or zero balances from known suppliers. B) All accounts should be equally emphasized. C) Accounts with large balances D) Accounts listed in the accounts payable subsidiary

2) "Recorded vouchers (accounts payable entries) in the voucher register (e.g., purchases journal) supported by completed voucher documentation" is a specific example of which management assertion? A) Classification B) Occurrence C) Completeness D) Cutoff

3) "All purchase orders are supported by requisitions from proper persons" is a specific example of which management assertion? A) Occurrence B) Completeness C) Cutoff D) Classification

Cash disbursements are authorized by

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A) purchase orders. B) invoices. C) receiving reports. D) a complete voucher package.

For the copy of the purchase order that goes to the receiving department, it is best to

A) leave off the description of the goods ordered. B) leave off the quantity of the goods ordered. C) leave off the name of the vendor. D) have the receiving department forward all copies of the purchase order to accounts payable.

Vouchers should be stamped PAID to A) prevent duplicate payment. B) generate a new purchase order. C) indicate posting in the voucher register. D) facilitate preparation of the bank reconciliation.

A voucher package is used to A) document receipt of inventory. B) document completion of services. C) document a purchase contract. D) provide a source document for recording the purchase of a good or service.

8) An auditor traced a sample of purchase orders and the related receiving reports to the purchases journal. The purpose of this substantive audit procedure most likely was to

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A) identify usually large purchases that should be investigated further. B) verify that cash disbursements were for goods actually received. C) determine that purchases were properly recorded. D) test whether payments were for goods actually ordered.

9) The usual source for journal entries posted to the general ledger to record the purchase of inventory is A) sales invoices updated with cost data from the inventory records department. B) purchase invoices updated with cost data from the inventory records department. C) receiving reports updated with cost data from the accounts payable department. D) vouchers payable journal from the accounts payable department.

10)

Which of the following would detect the understatement of a purchase discount? A) Verify the arithmetic accuracy of the purchases journal B) Compare purchase disbursement records and checks with invoice terms C) Compare approved purchase orders to receiving reports D) Verify the receipt of items ordered and invoiced

11) Which of the following situations indicates a potential material weakness in internal control over acquisition and expenditure? A) Purchase orders are not prepared for services acquired directly under authorization of department heads. B) The same person authorizes voucher packages and signs checks. C) Unacceptable goods are not scheduled on receiving reports. D) The same person signs checks and stamps vouchers PAID.

12) Which of the following client control activities is not usually performed in the vouchers payable (accounts payable) department? Version 1

A) Determining the mathematical accuracy of the vendors' invoices B) Writing checks for the treasurer's signature to take advantage of purchase discounts C) Controlling the mailing of the check and remittance advice D) Checking the prices on the vendor's invoice

13) When auditing merchandise inventory at year-end, the auditor performs a purchase cutoff test to obtain evidence that A) all goods purchased before year-end are received before the physical inventory count. B) no goods held on consignment for customers are included in the inventory balance. C) no goods observed during the physical count are pledged or sold. D) all goods owned at year-end are included in the inventory balance.

14)

Auditors may conclude that depreciation charges are too small by noting A) insured values much larger than book values. B) large numbers of fully depreciated assets. C) frequent trade-ins of relatively new assets. D) large and frequent losses on assets retired.

15) The auditor decided to test accounts payable by sending open-ended (blank) confirmations to selected vendors. The auditor's best approach in selecting the vendor accounts to confirm is to A) select vendor accounts with large balances. B) select vendor accounts at random in order to apply a statistical sampling procedure. C) select vendor accounts based on the number of purchases from vendors during the year. D) select vendor accounts that are past due.

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16) What evidence is appropriate to determine whether recorded purchase transactions are valid and the vendors charged the correct prices? A) Purchase requisitions and accounts payable entries B) Receiving reports and purchase orders C) Purchase requisitions and purchases orders D) Purchase orders and bid quotes

17) Purchase cutoff procedures should be designed to produce evidence of whether merchandise is included in the inventory of the client company if the company A) has paid for the merchandise. B) has physical possession of the merchandise. C) holds legal title to the merchandise. D) holds the shipping documents for the merchandise issued in the company's name.

18) Which of the following accounts would most likely be reviewed by the auditor to gain reasonable assurance that additions to the equipment account are not understated? A) Depreciation expense B) Gain on disposal of equipment C) Accounts payable D) Repairs and maintenance expense

19) Which of the following would not be included in the supporting documents for a voucher? A) Purchase order B) Vendor invoice C) Receiving report D) Blank check

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20)

A voucher would typically contain A) a purchase requisition, purchase order, vendor invoice, receiving report, and check

copy. B) a purchase requisition, purchase order, sales invoice, receiving report, and check copy. C) a purchase requisition, sales order, sales invoice, receiving report, and check copy. D) a purchase requisition, sales order, vendor invoice, receiving report, and check copy.

21) When using confirmations to provide evidence about the completeness assertion for accounts payable, the appropriate population most likely would be A) vendors with whom the entity has previously done business. B) amounts recorded in the accounts payable subsidiary ledger. C) payees of checks drawn in the month after the year-end. D) invoices filed in the entity's open invoice file.

22) Which of the following procedures would an auditor most likely perform in searching for unrecorded payables? A) Reconcile receiving reports with related cash payments made just prior to year-end. B) Contrast the ratio of accounts payable to purchases with the prior year's ratio. C) Vouch a sample of creditor balances to supporting invoices, receiving reports, and purchase orders. D) Compare cash payments occurring after the balance sheet date with the accounts payable trial balance.

23) An entity's internal control structure requires for every check request that there be an approved voucher, supported by a prenumbered purchase order and a prenumbered receiving report. To determine whether checks are being issued for unauthorized expenditures, an auditor most likely would select items for testing from the population of all

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A) purchase orders. B) canceled checks. C) receiving reports. D) approved vouchers.

24) An auditor wishes to perform tests of controls on a client's purchasing procedures. If the control activities leave no audit trail of documentary evidence, the auditor most likely will test the procedures by A) confirmation and observation. B) observation and inquiry. C) analytical procedures and confirmation. D) inquiry and analytical procedures.

25) Which of the following audit procedures is best for identifying unrecorded accounts payable? A) Reviewing cash disbursements recorded subsequent to the balance sheet date to determine whether the related payables apply to the prior period. B) Investigating payables recorded just prior to and just subsequent to the balance sheet date to determine whether they are supported by receiving reports C) Examining unusual relationships between monthly accounts payable balances and recorded cash payments D) Reconciling vendors' statements to the file of receiving reports to identify items received just prior to the balance sheet date

26) To provide assurance that each voucher is submitted and paid only once, an auditor most likely would examine a sample of paid vouchers and determine whether each voucher is

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A) supported by a vendor's invoice. B) stamped "paid" by the check signer. C) prenumbered and accounted for. D) approved for authorized purchases.

27) Cutoff tests designed to detect purchases made before the end of the year that have been recorded in the subsequent year most likely would provide assurance about management's assertion of A) valuation or allocation. B) existence or occurrence. C) completeness. D) rights and obligations.

28)

When auditing PP&E, the auditor's approach is generally to A) examine evidence supporting the amounts in the ending balance. B) examine evidence supporting additions during the year. C) follow a reliance strategy, testing internal controls and analytical procedures. D) concentrate on finding unrecorded assets.

29) Which of the following procedures would an auditor most likely perform in searching for unrecorded liabilities? A) Trace a sample of accounts payable entries recorded just before year-end to the unmatched receiving report file. B) Compare a sample of purchase orders issued just after year-end with the year-end accounts payable trial balance. C) Vouch a sample of cash disbursements recorded just after year-end to receiving reports and vendor invoices. D) Scan the cash disbursements entries recorded just before year-end for indications of unusual transactions.

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30) In performing a search for unrecorded retirements of fixed assets, an auditor most likely would A) inspect the property ledger and the insurance and tax records, and then tour the client's facilities. B) tour the client's facilities, and then inspect the property ledger, and the insurance and tax records. C) analyze the repair and maintenance account, and then tour the client's facilities. D) tour the client's facilities, and then analyze the repair and maintenance account.

31) A weakness in internal control over recording retirements of equipment may cause an auditor to A) inspect certain items of equipment in the plant and trace those items to the accounting records. B) review the subsidiary ledger to ascertain whether depreciation was taken on each item of equipment during the year. C) trace additions to the "other assets" account to search for equipment that is still on hand but no longer being used. D) select certain items of equipment from the accounting records and locate them in the plant.

32)

Failure to record a liability generally results in A) an understatement of profit. B) an understatement of current ratio. C) an overstatement of profit. D) an overstatement of assets.

33)

Improperly capitalizing an expense item results in.

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A) understatement of profit in the current year and overstatement in future years. B) understatement of profit in the current year and in future years. C) overstatement of profit in the current year and understatement in future years. D) overstatement of profit in the current year and in future years.

34)

A liability for a long-term purchase contract should generally be recognized when A) the contract is signed. B) the goods are shipped. C) the goods are received. D) the goods are sold to match the cost.

35) Which of the following expense accounts would not normally be tested by listing all debits and examining any significant items? A) Legal Expense B) Miscellaneous Expense C) Repairs and Maintenance D) Payroll Expense.

36)

Which of the following would be an indicator of potential fraud? A) Photocopies of invoices in the voucher file B) Vendor invoices in numerical order C) Vendors with only post office box addresses D) All of these indicate potential fraud.

37)

Which of the following fraud detection steps could not be performed by CAATs?

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A) Look for photocopies in invoice files. B) Look for vendor invoices in numerical order. C) Look for vendor invoices slightly below the approval threshold. D) Look for duplicate vendor numbers.

38) Tracing a sample of time clock cards to payroll registers (journals) is a procedure designed to obtain evidence about the transaction assertion(s) of A) occurrence only. B) occurrence and accuracy only. C) completeness only. D) accuracy only.

39) The permanent reference files (master files) in a personnel and payroll database ordinarily do not include which of the following? A) Deduction table B) Payroll master C) Compensation table D) Employee earning record.

40) Which of the following situations represents an internal control weakness in the payroll department? A) Payroll department personnel are rotated in their duties. B) Paychecks are distributed by the employees' immediate supervisor. C) Payroll records are reconciled with quarterly tax reports. D) The timekeeping function is independent of the payroll department.

41) Which of the following personnel department procedures reduces the risk of payroll fraud and represents an appropriate responsibility for the department? Version 1

A) Distributing paychecks B) Authorizing overtime hours C) Authorizing the addition or deletion of employees from the payroll. D) Collecting and retaining unclaimed paychecks

42) To test the transaction assertion of occurrence in the area of payroll, the auditor most likely would A) select a sample of personnel files and trace the pay rate to union contracts or other rate rights and obligations. B) select a sample of personnel files and trace the pay rate to payroll department files used in payroll preparation. C) select a sample of payroll register entries and recalculate gross pay, deductions, and net pay. D) select a sample of payroll register entries and vouch hours worked to clock time cards.

43) Small Corporation uses a Wages Clearing Account for its payroll disbursements. At the end of February, a reasonably large debit balance remained in this account. The most likely reason for this is that A) more labor cost had been assigned to the expense accounts than had been paid. B) some labor cost had not been properly classified in the expense accounts. C) some employees had not yet cashed their checks. D) not enough cash had been transferred to the bank account.

44)

Which of the following is not a major control risk in the payroll cycle? A) Paying fictitious "employees" B) Overpaying for time or production C) Losing employees to competitors. D) Incorrect accounting for costs or expenses

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45) The sampling unit in a test of controls pertaining to the existence or occurrence of payroll transactions ordinarily is a(an): A) clock card or time ticket. B) employee Form W-2. C) employee personnel record. D) payroll register (journal) entry.

46) The purpose of segregating the duties of hiring personnel and distributing payroll checks is to separate the A) human resources function from the controllership function. B) administrative controls from the internal accounting controls. C) authorization of transactions from the custody of related assets. D) operational responsibility from the recordkeeping responsibility.

47) An auditor most likely would assess control risk at the maximum if the payroll department supervisor is responsible for A) examining authorization forms for new employees. B) comparing payroll registers with original batch transmittal data. C) distribute payroll checks to all employees. D) hiring all subordinate payroll department employees.

48)

An auditor most likely would extend substantive tests of payroll when A) payroll is extensively audited by the state government. B) payroll expense is substantially higher than in the prior year. C) overpayments are discovered in performing tests of controls. D) employees complain to management about too much overtime.

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49) An auditor most likely would perform substantive procedures on payroll transactions and balances when A) cutoff tests indicate a substantial amount of accrued payroll expense. B) the assessed level of control risk relative to payroll transactions is low. C) analytical procedures indicate unusual fluctuations in recurring payroll entries. D) accrued payroll expense consists primarily of unpaid commissions.

50) An auditor vouched data for a sample of employees in a payroll register to approved clock card data to provide assurance that A) payments to employees are computed at authorized rates. B) employees work the number of hours for which they are paid. C) separation of duties exists between the preparation and distribution of the payroll. D) internal controls relating to unclaimed payroll checks are operating effectively.

51) Substantive tests of account balances in the payroll cycle are likely to include the following procedures except A) analytical review procedures. B) recalculation of accruals. C) comparison of accruals to subsequent payments. D) detail vouching of payroll expense entries.

52) Which of the following accounts does not appear in the acquisition and expenditure cycle? A) Cash B) Purchases Returns C) Sales Returns D) Prepaid Insurance

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53) For which of the following accounts would the matching concept be the most appropriate? A) Cost of Goods Sold. B) Research and Development C) Depreciation Expense D) Sales

54)

Which of the following would not overstate current-period net income? A) Capitalizing an expenditure that should be expensed B) Failing to record a liability for an expenditure C) Failing to record a check paying an item in vouchers payable. D) All of these would overstate net income

55) A client's purchasing system ends with the recording of a liability and its eventual payment. Which of the following best describes auditors' primary concern with respect to liabilities resulting from the purchasing system? A) Accounts payable are not materially understated. B) Authority to incur liabilities is restricted to one designated person. C) Acquisition of materials is not made from one vendor or one group of vendors. D) Commitments for all purchases are made only after established competitive bidding procedures are followed.

56) Which of the following is an internal control activity that could prevent a paid disbursement voucher from being presented for payment a second time?

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A) Vouchers should be prepared by individuals who are responsible for signing disbursement checks. B) Disbursement vouchers should be approved by at least two responsible management officials. C) The date on a disbursement voucher should be within a few days of the date the voucher is presented for payment. D) The official who signs the check should compare the check with the voucher and should stamp PAID on the voucher documents.

57) R. Budd, the purchasing agent of Lake Hardware Wholesalers, has a relative who owns a retail hardware store. Budd arranged for hardware to be delivered by manufacturers to the retail store on a cash-on-delivery (COD) basis, thereby enabling his relative to buy at Lake's wholesale prices. Budd was probably able to accomplish this because of Lake's poor internal control over A) purchase requisitions. B) cash receipts. C) perpetual inventory records. D) purchase orders.

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

59) Which of the following procedures is least likely to be performed before the balancesheet date?

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A) Observation of inventory B) Review of internal control over cash disbursements C) Search for unrecorded liabilities. D) Confirmation of receivables

60) To determine whether accounts payable are complete, auditors perform a test to verify that all merchandise received has been recorded. The population for this test consists of all A) vendors' invoices. B) purchase orders. C) receiving reports. D) canceled checks.

61) When verifying debits to the perpetual inventory records of a nonmanufacturing company, auditors would be most interested in examining a sample of purchase A) approvals. B) requisitions. C) invoices. D) orders.

62) A furniture company ordered 84 tables from a supplier. The supplier accidentally sent only 48 tables, but the receiving department at the furniture company accepted the tables. The invoice was eventually received but was for the 84 tables ordered. The furniture company paid the entire amount. Which of the following controls would have been least likely to have prevented this erroneous payment?

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A) The copy of the purchase order sent to the furniture company's receiving department should not have shown an expected quantity. B) Personnel in the furniture company's accounts payable department should compare the receiving report to the purchase invoice before creation of the voucher. C) Personnel in the furniture company's cash disbursements department should compare the check that is prepared to all of the backup documentation. D) Personnel in the furniture company's purchasing department should compare the purchase requisition to the purchase order.

63) L. Curtis, a maintenance supervisor, submitted maintenance invoices from a phony repair company and received the checks at a post office box. This should have been prevented by A) comparison of the company name to the approved vendor list by the check signer. B) recognition of the excess maintenance costs by Curtis's supervisor. C) refusal by the purchasing department to approve the vendor. D) All of the these choices are correct.

64) An audit team would most likely examine the detail support for which of the following charges? A) Payroll expense B) Cost of goods sold C) Supplies expense D) Legal expense.

65) Which of the following accounts would most likely be audited in connection with a related balance sheet account? A) Property Tax Expense. B) Payroll Expense C) Research and Development D) Legal Expense

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66) When auditing liabilities account balances, auditors are most concerned with management' assertion about A) existence. B) rights and obligations. C) completeness. D) valuation and allocation.

67) In a test of controls, auditors may trace receiving reports to vouchers recorded in the voucher register. This is a test for A) occurrence. B) completeness. C) classification. D) cutoff.

68) An audit team most likely would assess control risk at the maximum if the payroll department supervisor is responsible for A) examining authorization forms for new employees. B) comparing payroll registers with original batch transmittal data. C) authorizing payroll rate changes for all employees. D) hiring all subordinate payroll department employees.

69) Which of the following departments most likely would approve changes in pay rates and deductions from employee salaries? A) Personnel B) Treasurer C) Controller D) Payroll

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70) Matthew Corp. has changed from a system of recording time worked on clock cards to a computerized payroll system in which employees record time in and out with magnetic cards. The computerized system automatically updates all payroll records. Because of this change, A) a generalized computer audit plan must be used. B) part of the audit trail is altered. C) the potential for payroll-related fraud is diminished. D) transactions must be processed in batches.

71)

Effective control over the cash payroll function would mandate which of the following?

A) The payroll clerk should fill the envelopes with cash and include a computation of the net wages. B) The paymaster should be retain unclaimed payroll envelopes. C) Each employee should be asked to sign a receipt for wages received. D) A separate checking account for payroll should be maintained.

72) A large retail enterprise has established a policy that requires the paymaster to deliver all unclaimed payroll checks to the internal audit department at the end of each payroll distribution day. This policy was most likely adopted to A) ensure that employees who were absent on a payroll distribution day are not paid for that day. B) prevent the paymaster from cashing checks that are unclaimed for several weeks. C) prevent a bona fide employee's check from being claimed by another employee. D) detect any fictitious employee who may have been placed on the payroll.

73) Auditors ordinarily ascertain whether payroll checks are properly endorsed during the audit of

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A) clock cards. B) the voucher system. C) cash in bank. D) accrued payroll.

74) In determining the effectiveness of an entity's policies and procedures relating to the occurrence assertion for payroll transactions, auditors most likely would inquire about and A) observe the separation of duties concerning personnel responsibilities and payroll disbursement. B) inspect evidence of accounting for prenumbered payroll checks. C) recompute the payroll deductions for employee fringe benefits. D) verify the preparation of the monthly payroll account bank reconciliation.

75) An auditor is planning the testing of the accounts payable balance. The auditor's main concerns should be A) existence and accuracy. B) completeness and cutoff. C) occurrence and cutoff. D) valuation and accuracy.

76)

When goods are received, the receiving clerk should match the goods with the A) purchase order and the requisition form. B) vendor's invoice and the receiving report. C) vendor's shipping document and the purchase order. D) receiving report and the vendor's shipping document.

77) The auditor traces items from the receiving reports to the accounts payable journal in order to satisfy the Version 1

A) existence assertion. B) rights and obligations assertion. C) completeness assertion. D) valuation assertion.

78) A CPA learns that his client has paid a vendor twice for the same shipment; once based upon the original invoice and once based upon the monthly statement sent from the vendor. A control procedure that should have prevented this duplicate payment is A) prenumbering of disbursement vouchers. B) attachment of the receiving report to the disbursement report. C) use of a limit or reasonableness test. D) prenumbering of receiving reports.

79) Which of the following controls should prevent an invoice for the purchase of merchandise from being paid twice? A) The check signer accounts for the numerical sequence of receiving reports used in support of each payment. B) An individual independent of cash operations prepares a bank reconciliation. C) The check signer reviews and cancels the voucher packets. D) Two check signers are required for all checks over a specified amount.

80) Computer controls that might be found in an advanced online acquisition and expenditure system would not include A) all vendor invoices are prenumbered and the numbers accounted for. B) each terminal performs only designated functions. C) an identification number and password are required to enter the nonautomatic purchase orders. D) the check signature is printed using a signature plate that is installed on the computer printer only when checks are printed.

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81)

Specific balance assertions typical of accounts payable would not include A) recorded liabilities are obligations of the entity. B) estimated liabilities are properly valued. C) accounts payable are not pledged as collateral. D) payables are recorded in the proper period.

82) is

The inherent risk that accounts payable may be omitted or otherwise understated typically

A) low. B) high. C) moderate. D) indeterminate.

83) An audit plan for accounts payable would not include which of the following procedures? A) Obtaining a trial balance of recorded accounts payable B) Sending confirmation to accounts with zero balances C) Reviewing cash receipts for the period after year-end. D) Obtaining written client representations about related-party payables and pledges of assets as collateral for liabilities

84) Which of the following would not typically be a specific relevant assertion about fixed asset accounts?

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A) Fixed assets in the accounts exist and are in productive use. B) Net carrying book values in the accounts are reflected at current market values. C) Depreciation has been calculated properly using accepted methods and reasonable estimates of useful life and other factors. D) Fixed assets are properly classified in the balance sheet under appropriate descriptive captions.

85)

The typical functions of the personnel and payroll cycle would not include A) labor relations. B) report of attendance and work performed. C) allocation to cost of goods sold. D) payroll accounting.

86) An internal control questionnaire for payroll processing occurrence assertion would not include which of the following questions? A) Are names of terminated employees reported in writing to the payroll department? B) Is the payroll compared to personnel files periodically? C) Are checks distributed by the employee's immediate supervisor? D) Are all wage rates determined by contract or approved by a personnel officer?.

87) Which of the following functional responsibilities would not typically relate to salaried employees? A) Collecting timekeeping data. B) Supervision C) Personnel or labor relations D) Payroll distribution

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FILL IN THE BLANK. Write the word or phrase that best completes each statement or answers the question. 88) The _______ inspects the goods received for _______ and _______ and then puts them in the hands of other responsible persons.

89) When the _______, _______ and _______ are in hand, the accountants can record the accounts payable.

90) Auditors can compare the _______ file to the _______ to determine whether the company has material unrecorded liabilities on the financial statement date.

91) _______ and _______ can cause "unmatched" invoices and related "unmatched" receiving reports to be unnoticed.

92)

A _______ is a cover sheet containing all supporting documentation for an acquisition.

93)

A list of all purchases might exist only in a _______ file rather than a _______.

94) Assessment of _______ of _______ is important because it governs the nature, timing, and extent of substantive procedures that will be applied in the audit of account balances in the acquisition cycle.

95) Vendor invoices should be compared to _______ and _______ to determine that the vendor is charging the approved price and for quantity received.

96) _______ consist of (1) identification of data population for audit and (2) an expression of the action to be taken to produce relevant audit evidence.

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97) When considering assertions and obtaining evidence about accounts payable, auditors must put emphasis on the _______ assertion.

98) The _______ is a set of procedures designed to yield audit evidence of liabilities that were not recorded in the reporting period.

99) The five functional responsibilities of a payroll cycle are _______, _______, _______, and _______.

100) The _______ has transaction initiation authority to add new employees and delete terminated employees.

101)

A personnel file should establish the reality of a person's _______ and _______.

102)

The _______ is the primary original record for payroll accounting.

ESSAY. Write your answer in the space provided or on a separate sheet of paper. 103) Explain why auditors must put more emphasis on the completeness and obligation assertion when auditing payables and contrast this with the audit of asset accounts.

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104) F. Jack, CPA, is the auditor of Jill Corporation. Jack plans to follow last year's work papers in selecting accounts payable to be confirmed. Confirmations were mailed to 50 of Jill's 200 suppliers. The sample was designed to select accounts with the largest balances. Jack and Jill spent a lot of time reconciling minor differences between the confirmation amounts and the accounts payable trial balance. Required: Do you believe Jack should use the same sample design for accounts payable confirmations this year? If not, what suggestions can you give to improve the design?

105) After checks are signed for vendor invoices, why should vouchers be marked PAID or otherwise mutilated?

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106) This question requires knowledge of specific account balance assertions, general audit procedures, and trade accounts payable. You are assigned to audit the accounts payable of Green Corporation whose business is wholesale and retail trade. The company purchases products from 1,002,000 manufacturers ("vendors") and sells the products to its retail and wholesale customers. The general ledger shows the Accounts Payable control balance as of the balance-sheet date in the amount of $42 million (which is 70 percent of current liabilities, 50 percent of total liabilities, and 35 percent of total liabilities and owners' equity). Green's management accountants post the summary entries from the purchases journal and from the cash disbursements journal each month to the Accounts Payable control account. The accounts payable manager gave you a detailed trial balance that lists all recorded unpaid invoices (recording date, vendor name, vendor invoice number, invoice date, and amount) subtotaled by vendor. Other members of the audit team have already decided to assess control risk at the maximum for the accounts payable work. The engagement manager gave you last year's audit working papers but said the audit plan was missing (!). Thus, the first part of your assignment is to write the audit plan for audit of the Green Corporation trade accounts payable. Required: For each of the balance assertions (existence, completeness, and valuation or and allocation), write two or more specific audit procedures designed to produce evidence related to the accounts payable balance of $42 million. (Hints: [1] For each of the three balance assertions, think about a specific assertion before you write a procedure to gather evidence. [2] Write specific procedures as adaptations of the general audit procedures: recalculation, observation, confirmation, document examination, inquiry, scanning, analytical procedures. [3] Most procedures are two-part statements: "Select a sample of... [identify the population]...and "do something"... [specify an action].)

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107) When performing procedures in a search of unrecorded liabilities, auditors can utilize various sources of evidence/information (e.g., documents, files, management and clerical personnel). Required: List at least five, but not more than seven, sources of evidence/information for the search for unrecorded liabilities. (Do not write procedures. Do not take time to write about particular evidence that can be obtained or reasons for using the sources.)

108) Julie works in accounts payable. Her job is to prepare the voucher package and submit the completed voucher to the treasurer’s office for payment. When the voucher is paid by the Treasurer’s department it is returned to Julie (without the check) for filing. The company receives invoices from Mona’s Office Supply. When Julie receives the voucher package back from the Treasurer, Julie scans the invoice from Mona’s Office Supply and changes the address so that a duplicate payment is sent to a Mail Boxes Etc. store where Julie rents a mail box under the name Mini’s Official Supplies. With the slightly altered invoice (no other changes are made), Julie submits the voucher package a second time. Julie also has a bank account with the name Mini’s Official Supplies. When Julie receives the check for Mona’s Office Supply, Julie deposits it in her Mini’s Official Supplies bank account and then used an ATM card to withdraw the cash. 1. A) Define the internal control weakness that allowed the situation to exist – if any; 2. B) One (and only one) specific internal controls that should be in place to prevent or detect the problem; and 3. C) One (and only one) test of control audit procedure. 4. D) One (and only one) substantive audit procedure that may detect the situation described. No credit will be given for generic controls (e.g. policies and procedures; separation of duties without specifics; discuss with management). Be specific

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Answer Key Test name: Chap 08_8e_Test Bank 1) A 2) B 3) A 4) D 5) B 6) A 7) D 8) C 9) D 10) B 11) B 12) C 13) D 14) D 15) C 16) B 17) C 18) D 19) D 20) A 21) A 22) D 23) B 24) B 25) A 26) B Version 1

27) C 28) B 29) C 30) A 31) D 32) C 33) C 34) C 35) D 36) D 37) A 38) C 39) D 40) B 41) C 42) D 43) B 44) C 45) D 46) C 47) C 48) C 49) C 50) B 51) D 52) C 53) A 54) C 55) A 56) D Version 1

57) D 58) B 59) C 60) C 61) C 62) D 63) C 64) D 65) A 66) C 67) B 68) C 69) A 70) B 71) C 72) D 73) A 74) A 75) B 76) C 77) C 78) B 79) C 80) A 81) C 82) B 83) C 84) B 85) A 86) D Version 1

87) A 88) [receiving department, quantity, quality] Question also found in study guide 89) [purchase order, vendor's invoice, receiving report] Question also found in study guide 90) [unmatched receiving reports, payables listing] Question also found in study guide 91) [System failures, human coding errors] Question also found in study guide 92) voucher Question also found in study guide 93) [computer transaction, purchase journal] Question also found in study guide 94) [risk, material misstatement] Question also found in study guide 95) [purchase orders, receiving reports] Question also found in study guide 96) Test of controls Question also found in study guide 97) completeness Question also found in study guide 98) search for unrecorded liabilities Question also found in study guide 99) [personnel, supervision, timekeeping, record keeping, payroll distribution] Version 1

Question also found in study guide 100) personnel department Question also found in study guide 101) [existence, employment] Question also found in study guide 102) payroll register Question also found in study guide 103) The emphasis on completeness is rightly placed because companies typically are less concerned about timely recording of expenses and liabilities. Generally, they are more concerned with the timely recording of revenues and assets. For asset accounts, the emphasis therefore is on the existence and rights assertions. Ample evidence is usually available to verify that an asset exists. However, less evidence usually exists for unrecorded liabilities. 104) Because of the concern for understatement of liabilities, auditors are more concerned with the completeness and valuation assertions for accounts payable. Auditors emphasize accounts payable that are more likely understated. Therefore, small and zero balances should be included in the sample design. Also, vendors with high activity during the year might be selected. 105) To show they have been processed so they cannot be paid again.

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106) There may be other correct answers to this question Existence a. Select a sample of recorded accounts payable and send confirmations to vendors. b Select a sample of recorded accounts payable and vouch them to vendor statements received after the balance sheet date. c. Other ________ Completeness a. Select a sample of small and zero account payable balances and send confirmations to vendors. b. Select a sample of (or scan) cash disbursements recorded after yearend and determine whether they should have been recorded as accounts payable at year-end. c. List unmatched vendor invoices and determine when the good were received. Review whether the invoices should have been recorded at year-end. d. Scan the open purchase order file for old orders that might have been received. Trace to the purchases journal. e. Study the accounts payable trial balance for indications of untimely recording or omission of vendors' invoices. f. Other ________ Valuation or Allocation a. Interview the accounts payable manager for information about disputed accounts payable. b. Audit the confirmations returned for evidence of disputed balances. c. Obtain written client representations on the payables total. d. Study the attorney's response letter for indication of disputed accounts payable. e. Other _______

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107) Inquiry of client personnel, open purchase order file, unmatched vendor invoices listing, the unmatched receiving reports, and cash disbursements from the accounting period following the balance-sheet date. Other possible sources are vendor statements or confirmations. 108) Students may give any of the following Weakness: There is no mention of the voucher package being marked “Paid” or in some other way be marked so that documents cannot be reused. Control: Have the company mark each document “Paid” so they cannot be reused Control Audit Procedure: ● Observation of treasurer payment procedures ● Inquiry of the treasurer regarding payment procedures ● Inspect paid voucher packages for indication of payment on documents Substantive Audit Procedure: ● Scan cash disbursements journal for duplicate payments ● Perform analytical procedures on office supplies ● Check vendor payment addresses with mailbox stores’ addresses ● Vouch payments to receiving reports and physical supplies

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CHAPTER 8: PROBLEM MATERIAL ESSAY. Write your answer in the space provided or on a separate sheet of paper. 1) The internal control questionnaire for purchases and accounts payable includes the following questions. Next to each of the questions, indicate the letter of the related transaction assertion. A. Occurrence B. Completeness C. Accuracy D. Classification E. Cutoff _______

_______

Are vendor's monthly statements reconciled with individual accounts payable accounts? Are all purchases made only on the basis of approved purchase requisitions? Are vendors' invoices listed immediately upon receipt? Are vendors' invoices matched against purchase orders and receiving reports before a liability is recorded? Is the accounts payable customer ledger balanced periodically with the general ledger control account? Does the accounting manual give instructions to date purchase entries on the date of receipt of goods? Are shipping documents authorized and prepared for goods returned to vendors? Is the accounts payable department notified of goods returned to vendors?

2) The test of controls for purchases, cash disbursements, and accounts payable include the following audit procedures. Next to each of the procedures, indicate the related transaction assertion.

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Test of Controls 1.

2. 3. 4. 5. 6. 7.

Select a sample of receiving reports and trace to inventory record posting of additions. Vouch a sample of receiving reports to related purchase orders. Trace a sample of voucher debits to generaland subsidiary ledger accounts. Scan a sample of vouchers for missing numbers. Select a sample of open accounts payable and vouch to supporting documents of purchase. Trace debits arising from accounts payable transactions for proper account. Test a sample of cash disbursement voucher documents for accurate mathematics.

Transaction Assertion 1. _______

2. _______ 3. _______ 4. _______ 5. _______ 6. _______ 7. _______

3) The test of controls for payroll includes the following audit procedures. Next to each of the procedures, indicate the related management assertion about transactions. Test of Controls 1.

Trace payroll information to management reports and to general ledger account postings.

Obtain control of a periodic payroll and conduct a surprise distribution of paychecks.

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Transaction Assertion 1. _______

2. _______

Select a sample of personnel files and trace pay rate and deduction information to payroll department files.

3. _______

Trace cost accounting labor cost distributions to management reports and postings in general ledger accounts.

4. _______

Select a sample of payroll register entries and recalculate gross pay, deductions, and net pay.

5. _______

Select a sample of cost accounting analyses and vouch to time records.

6. _______

Select a sample of clock time cards and trace to payroll register.

7. _______

Select a sample of personnel files and trace pay rate to union contracts.

8. _______

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Answer Key Test name: Chap 08_8e_Test Bank_Problem Material 1) Answer: 1. C; 2. A; 3. B; 4. A; 5. C; 6. E; 7. A; 8. B 2) 1. completeness; 2. occurrence; 3. accuracy; 4. completeness; 5. occurrence; 6. classification; 7. accuracy Reference: Question also found in study guide 3) 1. classification; 2. occurrence; 3. accuracy; 4. classification; 5. accuracy; 6. occurrence; 7. completeness; 8. accuracy Question also found in study guide.

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CHAPTER 9 MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) A client's physical count of inventories was higher than the inventory quantities shown in the perpetual records. This situation could be the result of the failure to record A) sales. B) sales discounts. C) purchases. D) purchase discounts.

2) The audit procedures used in an observation of the client's physical inventory taking are designed primarily to A) test and observe the client's physical count of inventory. B) verify independently the physical counts obtained by the client. C) assist the client in taking test counts of year-end inventory. D) determine whether inventory contains obsolete goods.

3) Mary Monitor, CPA, noted that ABC Co. received goods prior to year-end that were included in physical inventory but had not been recorded. In this case, which of the following adjustments should be made? A) Debit purchases/credit cost of goods sold. B) Debit cost of goods sold/credit accounts payable. C) Debit inventory/credit accounts payable. D) None.

4) L. Martinez, CPA, was auditing a client, Marvelous Retail Company and selected a sample of inventory items from the perpetual records and vouched additions to receiving reports. This procedure was intended to satisfy which PCAOB assertion?

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A) Rights and obligations. B) Completeness. C) Existence or occurrence. D) Valuation or allocation.

5) An auditor who wished to test for the existence or occurrence of inventory would most likely select a sample of inventory items from the perpetual records and A) trace additions to the general ledger. B) vouch additions to receiving reports. C) vouch additions to sales invoices. D) trace receipts to receiving reports.

6) An auditor selected an inventory item on the warehouse floor, test counted it, and traced the count to the final inventory compilation. The auditor most likely was testing the PCAOB assertion of A) existence. B) valuation. C) completeness. D) rights and obligations.

7) An auditor selected an invoice for a large inventory purchase and vouched the invoice to the receiving report. Which ASB transaction assertion is the auditor most likely testing? A) Occurrence B) Completeness C) Rights and obligations D) Valuation

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8) An auditor selected a product maintained in the finished goods warehouse. The auditor counted the product and compared this amount with the amount in the finished goods perpetual inventory subsidiary account. Which ASB balance assertion is the auditor most likely testing? A) Existence B) Completeness C) Rights and obligations D) Valuation

9) An auditor selected a product recorded in the finished goods perpetual inventory subsidiary account. The auditor went to the warehouse and counted the product and compared this amount with the amount in the finished goods perpetual inventory subsidiary account. Which ASB balance assertion is the auditor most likely testing? A) Existence B) Completeness C) Rights and obligations D) Valuation

10) Periodic or cycle counts of selected inventory items are made at various times during the year rather than during a single inventory count at year-end. Which of the following is necessary if the auditor plans to observe inventories at interim dates? A) Complete recounts by independent teams are performed. B) Perpetual inventory records are maintained. C) Unit cost records are integrated with production accounting records. D) Inventory balances are rarely at low levels.

11) While observing a client's annual physical inventory, an auditor recorded test counts for several items and noticed that certain test counts were higher than the recorded quantities in the client's perpetual records. This situation could be the result of the client's failure to record

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A) purchase discounts. B) purchase returns. C) sales. D) sales returns.

12) To gain assurance that all inventory items in a client's inventory listing schedule are valid, an auditor most likely would trace A) inventory tags noted during the auditor's observation to items in the inventory listing schedule. B) inventory tags noted during the auditor's observation to items listed in receiving reports and vendors' invoices. C) items in the inventory listing schedule to inventory tags and the auditor's recorded count sheets. D) items in receiving reports and vendors' invoices to the inventory listing schedule.

13) Selecting a sample of cost accounting reports for labor and vouching it to time records is a procedure designed to test the ASB transaction assertion of A) occurrence. B) valuation. C) completeness. D) presentation and disclosure.

14) Your client plans to count inventory at several locations on the same day. No location is material in amount, but the total of inventory is quite material. How is an auditor likely to plan to observe?

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A) Observe all counts at all locations by using the required number of auditors. B) Insist the inventory be counted on separate days so the auditor can be present at all locations. C) Work with the client to determine which locations to observe. D) Observe a sample of locations on a surprise basis.

15)

Generally accepted accounting principles (GAAP) require that inventory be recorded at A) the lower of cost or fair market value. B) the lower of cost or net realizable value. C) the higher of cost or net realizable value less a normal profit (floor). D) None of the choices are correct.

16) If overhead is miscalculated so that it is underabsorbed, the result if the error is not corrected will be that A) inventory will be understated and net income will be overstated. B) inventory and net income will be overstated. C) inventory will be overstated and net income will be understated. D) inventory and net income will be understated.

17) Which of the following steps would not normally be included in a program for a physical inventory observation? A) Vouch unit prices to vendors' invoices or other cost records. B) Obtain the client's inventory counting instructions and review them for completeness. C) Inspect the tags used and unused and record the tag numbers used. D) Obtain the numbers of the last five receiving reports and last five shipping documents.

18)

Counting different parts of inventory at different times of the year is called

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A) LIFO inventory. B) inventory cutoff. C) cycle counting. D) just-in-time inventory.

19) A company's cost accountant periodically reconciles job cost sheets to the work-inprocess inventory accounts. This reconciliation is most likely performed to provide assurance that A) recorded production transactions are valid and documented. B) valid production transactions are recorded and none omitted. C) production accounting and posting is complete. D) production transactions are recorded in the proper period.

20) To test the control assertion of completeness in the area of work-in-process inventory, the auditor most likely would A) select a sample of open and closed production cost reports and recalculate all costs entered. B) select a sample of issue slips from the raw materials stores file and trace materialsused reports to production cost reports. C) select a sample of open and closed production cost reports and vouch overhead charges to overhead analysis schedules. D) select a sample of production orders and determine whether the production orders were authorized.

21) An auditor's tests of controls over the issuance of raw materials to production would most likely include

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A) reconciling raw materials and work-in-process perpetual inventory records to general ledger balances. B) inquiring of the custodian about the procedures followed when defective materials are received from vendors. C) observing that raw materials are stored in secure areas and that storeroom security is supervised by a responsible individual. D) examining material requisitions and reperforming client controls designed to process and record issuances.

22) Which of the following is not an acceptable method of determining inventory cost under GAAP? A) FIFO. B) LIFO. C) Average cost. D) All of the choices are acceptable.

23)

Inventory count tags are controlled A) to prevent counting errors. B) to test cutoff. C) to prevent subsequent addition of goods to the inventory. D) for reasons specified in all of the choices.

24) Counting inventory on the warehouse floor and tracing the count to the inventory compilation provides evidence to support which management (PCAOB) assertion? A) Existence or occurrence. B) Completeness. C) Rights and obligations. D) Valuation or allocation.

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25)

Auditors record the last bill of lading used at the time of the inventory count to A) search for unrecorded sales. B) test cutoff. C) verify ownership. D) All of the choices.

26) An auditor most likely would make inquiries of production and sales personnel concerning possible obsolete or slow-moving inventory to support management's financial statement (PCAOB) assertion of A) valuation or allocation. B) rights and obligations. C) existence or occurrence. D) presentation and disclosure.

27) Which of the following methods for determining inventory cost is not allowed by GAAP? A) Average cost. B) FIFO. C) LIFO. D) Standard cost.

28)

Which cycle is not directly linked to the production cycle? A) Acquisition and expenditure cycle. B) Payroll cycle. C) Revenue and collection cycle. D) Finance and investment cycle.

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29) To determine the client's planned amount and timing of production of a product, the auditor will review the A) sales forecast. B) inventory reports. C) production plan. D) purchases journal.

30)

An auditor reviews job cost sheets to test which transaction assertion? A) Occurrence. B) Completeness. C) Accuracy. D) Classification.

31) Which of the following is an internal control weakness for a company whose inventory of supplies consists of a large number of individual items? A) Supplies of relatively little value are expensed when purchased. B) The cycle basis is used for physical counts. C) The warehouse manager is responsible for maintenance of perpetual inventory records. D) Perpetual inventory records are maintained only for items of significant value.

32) To make a year-to-year comparison of inventory turnover most meaningful, the auditor will perform the analysis A) for the company as a whole. B) by division. C) by product. D) All of the choices are correct.

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33) Which of the following procedures would best prevent or detect the theft of valuable items from an inventory that consists of hundreds of different items selling for $1 to $10 and a few items selling for hundreds of dollars? A) Maintain a perpetual inventory of only the more valuable items with frequent periodic verification of the accuracy of the perpetual inventory record. B) Have an independent accounting firm prepare an internal control report on the effectiveness of the controls over inventory. C) Have separate warehouse space for the more valuable items with frequent periodic physical counts and comparison to perpetual inventory records. D) Require a manager's signature for the removal of any inventory item with a value above $50.

34) An auditor will usually trace the details of the test counts made during the observation of physical inventory counts to a final inventory compilation. This audit procedure is undertaken to provide evidence that items physically present and observed by the auditor at the time of the physical inventory count are A) owned by the client. B) not obsolete. C) physically present at the time of the preparation of the final inventory schedule. D) included in the final inventory schedule.

35) A retailer's physical count of inventory was higher than that shown by the perpetual records. Which of the following could explain the difference? A) Inventory items had been counted but the tags placed on the items had not been taken off and added to the inventory accumulation sheets. B) Credit memos for several items returned by customers had not been recorded. C) No journal entry had been made on the retailer's books for several items returned to its suppliers. D) An item purchased FOB shipping point had not arrived at the date of the inventory count and had not been reflected in the perpetual records.

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36) From the auditors' point of view, inventory counts are more acceptable prior to the year end when A) internal control is weak. B) accurate perpetual inventory records are maintained. C) inventory is slow moving. D) significant amounts of inventory are held on a consignment basis.

37) Which of the following internal control activities most likely addresses the completeness assertion for inventory? A) The work-in-process account is periodically reconciled with subsidiary inventory records. B) Employees responsible for custody of finished goods do not perform the receiving function. C) Receiving reports are prenumbered and the numbering sequence is checked periodically. D) There is a separation of duties between the payroll department and inventory accounting personnel.

38)

When auditing inventories, an auditor would least likely verify that A) all inventory owned by the client is on hand at the time of the count. B) the client has used proper inventory pricing. C) the financial statement presentation of inventories is appropriate. D) damaged goods and obsolete items have been properly accounted for.

39) A client maintains perpetual inventory records in quantities and in dollars. If the assessed control risk is high, an auditor would probably

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A) apply gross profit tests to ascertain the reasonableness of the physical counts. B) increase the extent of tests of controls relevant to the inventory cycle. C) request the client to schedule the physical inventory count at the end of the year. D) insist that the client perform physical counts of inventory items several times during the year.

40) An auditor selected items for test counts while observing a client's physical inventory. The auditor then traced the test counts to the client's inventory listing. This procedure most likely obtained evidence concerning management's balance assertion of A) rights and obligations. B) completeness. C) existence. D) accuracy and valuation.

41) Which of the following auditing procedures probably would provide the most reliable evidence concerning the entity's assertion of rights and obligations related to inventories? A) Trace test counts noted during the entity's physical count to the entity's summarization of quantities. B) Inspect agreements to determine whether any inventory is pledged as collateral or subject to any liens. C) Select the last few shipping documents used before the physical count and determine whether the shipments were recorded as sales. D) Inspect the open purchase order file for significant commitments that should be considered for disclosure.

42) An auditor most likely would analyze inventory turnover rates to obtain evidence concerning management's balance assertions about

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A) existence. B) rights and obligations. C) completeness. D) accuracy and valuation.

43) An auditor would vouch inventory on the inventory status report to the vendor's invoice to obtain evidence concerning management's balance assertions about A) existence. B) rights and obligations. C) completeness. D) valuation.

44)

When evaluating inventory controls, an auditor would be least likely to A) inspect documents. B) make inquiries. C) observe procedures. D) consider policy and procedure manuals.

45) When testing a company's cost accounting system, the auditor uses procedures that are primarily designed to determine that A) quantities on hand have been computed based on acceptable cost accounting techniques that reasonably approximate actual quantities on hand. B) physical inventories agree substantially with book inventories. C) the system is in accordance with generally accepted accounting principles and is functioning as planned. D) costs have been properly assigned to finished goods, work-in-process, and cost of goods sold.

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46) The auditor tests the quantity of materials charged to work-in-process by vouching these quantities to A) cost ledgers. B) perpetual inventory records. C) receiving reports. D) material requisitions.

47) Your client counts inventory three months before the end of the fiscal year. Internal controls over inventory are excellent. Which procedure is not necessary for the inventory rollforward? A) Check that shipping documents for the last three months agree with perpetual records. B) Tracing receiving reports for the last three months to perpetual records. C) Compare gross margin percentages for the last three months. D) Request the client to recount inventory at the end of the year.

48) An auditor is examining a nonpublic company's inventory procurement system and has decided to perform tests of controls. Under which of the following conditions should the auditor perform tests of controls? A) Significant weaknesses were found in the company's internal control. B) The auditor hopes to reduce the amount of work to be done in assessing inherent risk. C) The auditor believes that testing the controls could lead to a reduction in overall audit time and cost. D) Tests of controls are always performed when the auditor begins to assess control risk.

49)

The typical functions of the production and conversion includes

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A) cash payments for raw materials purchased. B) inventory planning and control. C) purchase requisitioning and purchase ordering for inventory. D) receiving of inventory shipments from vendors.

50)

When a production plan is complete the production planner needs to determine A) what raw materials need to be ordered. B) labor rates for the jobs are needed to produce the orders. C) which vendors need to supply raw materials. D) what equipment needs to be purchased to meet production quotas.

51)

The production planner determines what inventory is need for future production using A) finished goods inventory status report for the product being produced. B) bill of materials for the product being produced. C) standard costs for the product being produced. D) manpower availability report from human resources.

52) At the beginning of the observation of the inventory count, the auditor records the last bill of lading used by the company to A) test inventory cut-off. B) search for unrecorded sales. C) verify inventory ownership. D) record the inventory valuation of items received.

53)

Which of the following would be considered an analytical procedure?

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A) Testing purchasing, shipping, and receiving cutoff activities. B) Comparing inventory balances to recent sales activities. C) Projecting the deviation rate of a statistical sample to the population. D) Reconciling physical counts to perpetual records and general ledger balances.

54) An auditor's observation procedures for inventory may be performed during or after the end of the period under audit under which of the following conditions? A) When the client maintains periodic inventory records. B) When the auditor finds minimal variations in client records and test counts in prior periods. C) When total inventory has not varied more than 5% in the last five years. D) When well-kept perpetual inventory records are checked by the client periodically by comparisons with physical counts.

55) Vouching a sample of items from the perpetual inventory records to the receiving reports achieves the specific ASB balance assertion of A) completeness. B) occurrence. C) presentation. D) valuation.

56) Which of the following is the assertion with the highest inherent risk in auditing inventory? A) Completeness. B) Rights. C) Existence. D) Properly classification on the balance sheet.

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57) Maple Company has an increase in purchases from specific vendors and an increase in raw materials inventory for the items purchased from these vendors. Sales for the company have not increased and are not forecast to increase. From this information an auditor might suspect A) an increase in obsolete raw material inventory. B) theft of raw material inventory. C) kickbacks from vendors. D) poor security over raw material inventory.

58) Which of the following procedures would be most appropriate for testing the completeness assertion as it applies to inventory? A) Scanning perpetual inventory, production, and purchasing records. B) Examining paid vendor invoices. C) Tracing inventory items from the tag listing back to the physical inventory quantities. D) Performing cutoff procedures for shipping and receiving.

FILL IN THE BLANK. Write the word or phrase that best completes each statement or answers the question. 59) The overall production starts with production planning, which usually is based on a _______.

60)

Production planning interacts with the preparation of _______.

61)

A production order usually includes a _______.

62)

_______ are used by the purchasing department to place orders for materials.

63) The function of _______ refers to comparing the physical count of inventory to the perpetual inventory records. Version 1

64) _______ can be used in connection with knowledge of the shape of management's plans for the year under audit.

65) Production reports of finished units should be signed by the _______ and finished goods inventory custodian and forwarded to _______ .

66) Materials requisitions should be compared in the _______ department with the ________ on the production order.

67) Tracing production cost accumulation forward into the production cost reports in the cost accounting department is a test for _______ .

68) With a sample of open and closed production cost reports, vouching labor cost to ________ is a test for ________ .

69)

A material error or fraud in inventory typically has a _______ on financial statements.

70) Auditors _______ the inventory taking and make _______ , but they seldom _______ the entire inventory.

71) Selecting inventory from locations on the warehouse floor, obtaining a test count, and tracing the count to the final inventory compilation produces evidence for the _______ ASB balance assertion.

72) The physical observation procedures for inventory are principally designed to audit for the balance assertions of _______ , _______ , and _______ .

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73) An inventory trial balance can be used to scan for _______ and as a population for sample selection for the _______ .

74) A sample from the source documents meets the _______ requirement to determine whether transactions were actually recorded in the inventory records.

75) A sample from the perpetual inventory records meets the _______ requirement to determine whether all recorded transactions are supported by reports and documents.

76) Inventory observation may need to be scheduled on the year-end date, making a large number of test counts if the test of controls _______ .

ESSAY. Write your answer in the space provided or on a separate sheet of paper. 77) Explain briefly the two directions of inventory test counts.

78) The cost accounting department at Blue Manufacturing Company receives various types of information at the end of each week. The production floor reports time and production work data directly to the cost accounting department. Also, the payroll department sends labor cost data to the cost accounting department. What is the cost accounting department likely to do with this information? Why?

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79)

Prepare an audit plan for the observation of an inventory count.

80)

Prepare an audit plan for inventory pricing and compilation.

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Answer Key Test name: Chap 09_8e_Test Bank 1) C 2) A 3) C 4) C 5) B 6) C 7) A 8) B 9) A 10) B 11) D 12) C 13) B 14) D 15) D 16) D 17) A 18) C 19) C 20) B 21) D 22) D 23) C 24) B 25) B 26) A Version 1

27) D 28) D 29) C 30) C 31) C 32) C 33) C 34) D 35) B 36) B 37) C 38) A 39) C 40) B 41) B 42) D 43) D 44) D 45) D 46) D 47) D 48) C 49) B 50) A 51) B 52) A 53) B 54) D 55) B 56) C Version 1

57) C 58) D 59) sales forecast Question also found in study guide 60) production orders Question also found in study guide 61) bill of materials Question also found in study guide 62) Material requisitions Question also found in study guide 63) periodic reconciliation Question also found in study guide 64) Forecasts Question also found in study guide 65) [production supervisor, cost accounting] Question also found in study guide 66) [cost accounting, list (bill) of materials] Question also found in study guide 67) completeness Question also found in study guide 68) [labor reports, occurrence] Question also found in study guide 69) pervasive effect Question also found in study guide 70) [observe, test counts, count] Question also found in study guide Version 1

71) completeness Question also found in study guide 72) [existence, completeness, valuation] Question also found in study guide 73) [unusual conditions, physical inventory observation] Question also found in study guide 74) completeness Question also found in study guide 75) occurrence Question also found in study guide 76) reveals weaknesses (assessed high) Question also found in study guide 77) The inventory test counts can run from the A. Basic transaction files to perpetual inventory records (completeness assertion). B. Perpetual inventory records to the detail source documents (existence or occurrence assertion). 78) In this situation, the cost accounting department is receiving data independently for the same labor information. They should reconcile the information from the two sources for quantity (time) and amount (dollars). This reconciliation is performed to make sure that cost accounting is using actual payroll data and that the payroll department is paying only for work performed.

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79) Note that other answers are possible. 1. Obtain client's inventory counting instructions and review for completeness. 2. Tour facility before count looking for out-of-the-way items, obsolete items, and movement of inventory. 3. Observe client personnel counting inventory for compliance with instructions. 4. Test count a selection of items throughout the facility and record a sample of your test counts. Note description, stage of completion, counting unit, and condition. 5. Inspect tags used and unused and record tag numbers used. 6. Select a sample of used tags and trace each to the items on the floor. 7. Obtain the number of the last five receiving reports and last five shipping documents. Record numbers of the next unused items in sequence. 8. Tour facilities to ensure all items have been counted.

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80) Note that other answers are possible. 1.Obtain the client's inventory listing and foot and agree it to the general ledger. 2.Trace test counts from inventory observation to the final inventory compilation. 3.Select a sample of inventory items. Vouch unit prices to vendors' invoices or other cost records. Recalculate the multiplication of units and price. 4.Scan the inventory compilation for items added from sources other than the physical count and items that appear to be large round numbers or systematic fictitious additions. 5.Recalculate the extensions and footings of the final inventory compilation for clerical accuracy. Reconcile the total to the adjusted trial balance. 6.For selected inventory items and categories, determine the replacement cost and the applicability of lower-of-cost-or-market valuation. 7.Determine whether obsolete or damaged goods should be written down. 8.Inquire about obsolete, damaged, slow-moving, and overstocked inventory. 9.Scan the perpetual records for slow-moving items. 10.During the physical observation, be alert to notice damaged or scrap inventory. 11.Compare the listing of obsolete, slow-moving, damaged, or unsalable inventory from last year's audit to the current inventory compilation. 12.At year-end, obtain the numbers of the last shipping and receiving documents for the year. Compare these to the sales, inventory/cost of sales, and accounts payable entries for proper cutoff. Version 1

13.Read bank confirmations, debt agreements, and minutes of the board, and make inquiries about pledge or assignment of inventory to secure debt. 14.Inquire about inventory out on consignment and about inventory on hand that is consigned in from vendors. 15.Confirm or inspect inventories held in public warehouses. 16.Recalculate the amount of intercompany profit to be eliminated in consolidation. 17.Obtain management representations concerning pledging of inventory as collateral, intercompany sales, and other related-party transactions.

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CHAPTER 9: PROBLEM MATERIAL ESSAY. Write your answer in the space provided or on a separate sheet of paper. 1) The tests of controls for inventory records would include the following procedures. A.Existence. B.Rights. C.Completeness. D.Valuation. E.Presentation and disclosure. For each of the procedures, choose the letter of the correct PCAOB assertion(s). Only one letter per procedure should be used.

_______

Trace a sample of sales invoices to perpetual inventory record entry of issue. Select a sample of inventory item from perpetual records and vouch additions to receiving reports. Select a sample of shipping documents and review the accounting summary of the quantities and prices. Trace posting of sample of sales invoices to amounts in general ledger. Review the appropriateness of standard costs to price inventory issues and cost of goods sold.

2) The tests of controls for inventory records would include the following procedures. A. Existence. B. Rights and obligations. C. Completeness. D. Accuracy and valuations. E. Presentation and disclosure. For each of the procedures, choose the letter of the correct ASB balance assertion(s). Only one letter per procedure should be used.

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_______

Test counted inventory and traced the count to the perpetual inventory record.

_______

Selected a sample of inventory items from the perpetual records and vouch additions to receiving reports. Reviewed a sample of vendor invoices for prices paid for inventory.

_______

Review inventory footnote for the financial statements.

_______

Reviewed vendor invoices and purchase orders for terms of the contract.

3) The auditors of Mikel's Shops obtained the following information when performing cutoff testing procedures during their observation of Mikel's physical inventory count at December 31, 2020: Bill of Lading Number

1235

1236

1237

1238

Date

12/31/20

1/2/20

Sales price

$ 12,000

$ 4,500

$ 18,000

$ 16,000

Cost of goods

$ 3,000

$ 12,000

9,000

When comparing the cutoff information to the sales records, the auditors found that all these shipments were recorded as 2020 sales. The goods shipped on bills of lading 1235 and 1236 were not counted in the inventory, but the goods on bill of lading 1237 and 1238 were included. Required: Prepare the appropriate journal entry to correct the cutoff error. (If no entry is required for a transaction/event, select "No journal entry required")

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4) Audit planning requires that the auditor consider possible inventory errors or frauds that might occur that could affect the financial statements. For each of the types of inventory errors listed in the following table, indicate what would be the possible effect in the inventory and cost of sales accounts: overstated, understated, or no effect. Effect on Account Inventory Error

Inventory

Cost of Sale

Unrecorded Receipt of Inventory

_______

December sales recorded in January

_______

December purchase recorded in January

_______

Inventory omitted during physical count

_______

Consigned out inventory omitted during physical count Unrecorded shipment of inventory

_______

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Answer Key Test name: Chap 09_8e_Test Bank_Problem Material 1) 1.C; 2.A; 3.D; 4.C; 5.D 2) 1.C; 2.A; 3.D; 4.E; 5.D 3)

Inventory

$24,000

Sales

$34,000

Cost of goods sold

$24,000

Accounts receivable

$34,000

1. 2. 3. 4. 5. 6.

Inventory

Cost of Sale

Understated No effect Understated Understated Understated Overstated

No effect (a) No effect (d) No effect (a) Overstated (b) Overstated (b) Understated (c)

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a. If book inventory is adjusted to agree with the physical inventory, the effect in inventory would be "no effect" and the cost of goods sold would be "understated."b. The assumption is that the book inventory is adjusted to agree with the physical inventory.c. If book inventory is adjusted to agree with the physical inventory with the adjustment debit going to cost of sales, the result is "no effect" on both accounts.d. Both are "no effect." The cost is transferred from inventory to cost of sales, but the sales and receivables are both understated.

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CHAPTER 10 MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) The typical business activity of the finance and investment cycle would not include A) proposals for cash forecasts, capital budgets, and business expansion. B) analysis of excess cash funds. C) reconciliation of cash. D) sale of stocks, bonds, or notes.

2) Selecting a sample of paid notes and tracing interest to the general ledger account is a test of the PCAOB assertion for: A) accounting. B) valuation or allocation. C) completeness. D) existence or occurrence.

3) The typical assertions related to investments and related accounts would not include the PCAOB assertion that: A) capitalized intangible costs relate to intangibles acquired in exchange transactions. B) amortization is properly calculated. C) research and development costs are properly classified. D) goodwill is valued at market value.

4) The decision of a company to have a transfer agent handle exchanges of shares is related primarily to which of the functional responsibilities? A) Rights and obligations B) Custody C) Record keeping D) Periodic reconciliation

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5) ABC Company has issued a bond that pays 5% interest semiannually to bond holders on record June 30 and December 30. Payments are made on July 15 and January 15. ABC Company has a December 31 fiscal year-end. The auditor vouches the January 15, 2021 payment to the liabilities recorded on the December 31, 2020 balance sheet. Which of the following ASB balance assertions is the auditor testing? A) Existence B) Rights and obligations C) Completeness D) Valuation

6) Auditors count investment securities held by the client primarily to test the ASB balance assertion of: A) existence. B) rights and obligations. C) completeness. D) valuation.

7) Which of the following is not a substantive audit procedure for estimates of management? A) Recalculating the mathematical estimate B) Observing whether estimates are prepared by qualified personnel C) Developing an independent estimate based on alternative assumptions D) Comparing the estimates of management to subsequently discovered facts before the end of fieldwork

8) Which of the following would not be a place in which owners' equity transactions would be documented?

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A) Capital budget B) Minutes of the meetings of the board of directors C) Proxy statements D) Securities offering registration statements

9) If it would be appropriate to confirm capital stock, the auditor would obtain the confirmation from: A) management. B) the board of directors. C) stockholders. D) an independent registrar.

10) In Case 10.4 (No Treasure in This Treasure Planet), Disney overvalued net assets by capitalizing unrecoverable production costs. The lesson for the auditors in this case was to: A) always recalculate the client's figures regardless of how simple they appear. B) maintain professional skepticism when evaluating clients' estimates. C) always look into the background of the client before accepting an engagement. D) none of the above.

11) Which ASB balance assertion is of the most importance to auditors for long-term liabilities? A) Existence B) Completeness C) Rights and obligations D) Valuation

12) "Are interest payments and accruals monitored for due dates and financial statement dates?" is an internal control questionnaire item that is related to the ASB transaction assertion of:

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A) occurrence. B) completeness. C) cutoff. D) accuracy.

13) Which of the following would not be a typical feature of management's control over the production of estimates? A) Accumulation of relevant, sufficient, and reliable data B) Preparation of estimates by qualified personnel C) Review by the independent auditor D) Consideration by management of whether particular accounting estimates are consistent with the company's operational plans

14) Which of the following management assertions for long-term liabilities is related to the ASB balance assertion of completeness? A) All material long-term liabilities are recorded. B) New long-term liabilities and debt extinguishments are properly authorized. C) Terms, conditions, and restrictions relating to noncurrent debt are adequately disclosed. D) Disclosures of maturities for the next five years are accurate and adequate.

15)

The preferred method of determining fair value of transactions is: A) market-based values. B) basing them on reasonable management assumptions. C) external auditor estimates. D) detailed computations by outside experts.

16)

Derivative instruments include:

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A) stocks. B) preferred stocks. C) stock options. D) all the above.

17)

A transfer agent:

A) keeps the stockholder list and, from time to time, determines the shareholders eligible to receive dividends. B) handles the exchange of shares, canceling the shares surrendered by sellers and issuing new certificates. C) records notes and bonds payable. D) makes investment decisions for an entity.

18) In the audit of notes payable, an auditor testing the ASB balance assertion of accuracy and valuation most likely would: A) read directors' and finance committee's minutes for authorization of financing transactions. B) select a sample of paid notes and trace interest expense to the general ledger account. C) select a sample of paid notes and recalculate interest expense for the period under audit. D) select a sample of notes payable and vouch cash receipt to the bank statement.

19) To determine whether facts support management's intent to hold securities to maturity, an auditor might: A) study the entity's cash flow forecasts. B) obtain published market quotations. C) compare fair value of the securities to cost. D) confirm that the securities are held by a broker.

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20) Which of the following controls would be most effective in ensuring that the proper custody of assets in the investing cycle is maintained? A) Direct access to securities in the safety deposit box is limited to only one corporate officer. B) Personnel who post investment transactions to the general ledger are not permitted to update the investment subsidiary ledger. C) The purchase and sale of investments are executed on the specific authorization of the board of directors. D) Independent personnel periodically compare the recorded balances in the investment subsidiary ledger with the contents of the safety deposit box.

21)

In auditing long-term bonds payable, an auditor most likely would: A) perform analytical procedures on the bond premium and discount accounts. B) examine documentation of assets purchased with bond proceeds for liens. C) compare interest expense with the bond payable amount for reasonableness. D) confirm the existence of individual bondholders at year-end.

22) During an audit of an entity's stockholders' equity accounts, the auditor determines whether there are restrictions on retained earnings resulting from loans, agreements, or state law. This audit procedure most likely is intended to verify the ASB presentation and disclosure assertion of: A) occurrence. B) completeness. C) rights and obligations. D) understandability.

23) In auditing intangible assets, an auditor most likely would review or recompute amortization and determine whether the amortization period is reasonable in support of the ASB balance assertion of:

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A) valuation. B) existence. C) completeness. D) rights and obligations.

24) In confirming with an outside agent, such as a financial institution, that the agent is holding investment securities in the client's name, an auditor most likely gathers evidence in support of ASB balance assertion of existence and: A) valuation. B) rights and obligations. C) completeness. D) accuracy.

25)

The focus of controls in the finance and investment cycle is on: A) proper authorizations and competent personnel. B) computer controls over transactions. C) physical security of assets. D) prenumbered documents.

26)

One primary focus of substantive tests in the finance and investment cycle is on: A) reconciliation of detailed listings with general ledger amounts. B) proper cut-off. C) search for unrecorded items. D) gaining an understanding and verifying amounts and calculations.

27)

Compensating controls in the finance and investment cycle:

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A) feature separation of duties by upper management. B) feature involvement of two or more persons handling all important responsibilities. C) include involvement by the external auditor. D) include all the above.

28)

Which of the following is not a relevant aspect of internal controls over estimates? A) External auditor involvement in developing assumptions B) Adequate review by appropriate levels of authority C) Comparison of prior estimates with subsequent results D) All the above are relevant aspects of internal controls over estimates.

29)

Loan covenants: A) describe the collateral of the loan. B) require the borrower to maintain certain financial characteristics. C) describe the lender's responsibilities. D) include all the above.

30)

Related party transactions: A) must be valued as if they were arm's length. B) must be assumed to be valued differently than if they were arm's length. C) must be disclosed in the financial statements. D) must be disclosed in the financial statements and the auditor's report.

31)

Taking a "big bath" in the financial statements refers to: A) overstating income. B) overstating revenues. C) understating income. D) an economic downturn.

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32) Keeping track of securities owners for payment of interest or dividends is usually done by the company's: A) treasurer. B) broker. C) transfer agent. D) registrar.

33)

Records of stock and bond certificates are usually maintained by the company's: A) treasurer. B) chief financial officer. C) transfer agent. D) registrar.

34)

Tests of controls in the finance and investment cycle: A) normally focus on tests of transactions. B) primarily involve observing physical security of assets. C) typically amount to inquiries and observations related to management involvement. D) can significantly reduce the extent of substantive tests.

35)

Documentation of a count of equity securities should include all of the following except: A) interest rate. B) serial numbers. C) number of shares. D) market value.

36)

Which of the following is not an estimate required in the finance and investment cycle?

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A) Actuarial assumptions for pension accruals B) Residual values for leases C) Stated market value of publicly traded stocks D) All the above are estimates.

37)

Appropriate audit inquiries regarding estimates include all of the following except: A) Who prepares the estimates? B) Why are they prepared? C) What data are used? D) When are they prepared?

38)

Which of the following is not an off-balance-sheet item? A) Purchase commitment B) Capitalized lease C) Loan commitment D) Synthetic lease

39) Which of the following approaches is most suitable for auditing the finance and investment cycle? A) Perform extensive tests of controls and limit substantive procedures to analytical procedures. B) Ignore internal controls and perform extensive substantive procedures. C) Gain an understanding of internal controls and perform extensive substantive procedures. D) Ignore internal controls and limit substantive procedures to analytical procedures.

40)

Loan covenants are used for which of the following reasons?

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A) To protect the lender from the borrower substantially weakening the borrower's financial position. B) To protect the borrower from the lender calling the loan early. C) To protect the auditors from false information by the borrower. D) To protect shareholders from management taking on too much debt.

41)

A related party is a person or entity that: A) has a family tie to a management member. B) does business with the company. C) can exert significant influence over or be influenced by the company. D) is a member of the company's management.

42) Jones was engaged to examine the financial statements of Gamma Corporation for the year ended June 30. Having completed an examination of the investment securities, which of the following is the best method of verifying the accuracy of recorded dividend income? A) Tracing recorded dividend income to cash receipts records and validated deposit slips B) Performing analytical procedures and statistical sampling C) Comparing recorded dividends with amounts appearing on federal information Form 1099 D) Comparing recorded dividends with a standard financial reporting service's record of dividends

43) When the client holds a large amount of negotiable securities, auditors need to plan to guard against: A) unauthorized negotiation of the securities before they are counted. B) unrecorded sales of securities after they are counted. C) substitution of securities already counted for other securities that should be on hand but are not. D) substitution of authentic securities with counterfeit securities.

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44) In connection with the audit of an issue of long-term bonds payable, the audit team should: A) determine whether bondholders are persons other than owners, directors, or officers of the company issuing the bond. B) calculate the effective interest rate to see if it is substantially the same as the rates for similar issues. C) decide whether the bond issue was made without violating state or local law. D) ascertain that the client has obtained the opinion of counsel on the legality of the issue.

45) Which of the following is the most important audit consideration when examining the stockholders' equity section of a client's balance sheet? A) Changes in the capital stock account are verified by an independent stock transfer agent. B) Stock dividends and stock splits during the year under audit were approved by the stockholders. C) Stock dividends are capitalized at par or stated value on the dividend declaration date. D) Entries in the capital stock account can be traced to resolutions in the minutes of meetings of the board of directors.

46) If the auditors discover that the carrying amount of a client's investments is overstated because of a loss in value that is other than a temporary decline in market value, they should insist that: A) the approximate market value of the investments be shown in parentheses on the face of the balance sheet. B) the investments be classified as long term for balance-sheet purposes with full disclosure in the footnotes. C) the loss in value be recognized in the financial statements. D) the equity section of the balance sheet separately show a charge equal to the amount of the loss.

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47) The primary reason for preparing a reconciliation between interest-bearing obligations outstanding during the year and interest expense in the financial statements is to: A) evaluate internal control over securities. B) determine the validity of prepaid interest expense. C) ascertain the reasonableness of imputed interest. D) detect unrecorded liabilities.

48) The auditors should insist that a representative of the client be present during the inspection and count of securities to: A) lend authority to the auditors' directives. B) detect forged securities. C) coordinate the return of all securities to proper locations. D) acknowledge the receipt of securities returned.

49) When independent stock transfer agents are not employed and the corporation issues its own stock and maintains stock records, canceled stock certificates should: A) be defaced to prevent reissuance and attached to their corresponding stubs. B) not be defaced but be segregated from other stock certificates and retained in a canceled certificates file. C) be destroyed to prevent fraudulent reissuance. D) be defaced and sent to the secretary of state.

50) When a client company does not maintain its own capital stock records, the auditors should obtain written confirmation from the transfer agent and registrar concerning: A) restrictions on the payment of dividends. B) the number of shares issued and outstanding. C) guarantees of preferred stock liquidation value. D) the number of shares subject to agreements to repurchase.

51)

All corporate capital stock transactions should ultimately be traced to the:

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A) minutes of the meetings of the board of directors. B) cash receipts journal. C) cash disbursements journal. D) numbered stock certificates.

52) An audit plan for the examination of the retained earnings account should include a step that requires verification of the: A) market value used to charge retained earnings to account for a 2-for-1 stock split. B) approval of the adjustment to the beginning balance as a result of a write-down of account receivables. C) authorization for both cash and stock dividends. D) dividends received from investments.

53) When an entity uses a trust company as custodian of its marketable securities, the possibility of concealing fraud most likely would be reduced if the: A) trust company has no direct contact with the entity employees responsible for maintaining investment accounting records. B) securities are registered in the name of the trust company rather than the entity itself. C) interest and dividend checks are mailed directly to an entity employee who is authorized to sell securities. D) the trust company places the securities in a bank safe deposit vault under the custodian's exclusive control.

54)

An audit team would most likely verify the interest earned on bond investments by: A) vouching the receipt and deposit of interest checks. B) confirming the bond interest rate with the issuer of the bonds. C) recomputing the interest earned on the basis of face amount, interest rate, and period

held. D) testing internal controls relevant to cash receipts.

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55) A client has a large and active investment portfolio that is kept in a bank safe deposit box. If the auditors are unable to count securities at the balance-sheet date, they most likely will: A) request the bank to confirm to the auditors the contents of the safe deposit box at the balance-sheet date. B) examine supporting evidence for transactions occurring during the year. C) count the securities at a subsequent date and confirm with the bank whether securities were added or removed since the balance-sheet date. D) request the client to have the bank seal the safe deposit box until the auditors can count the securities at a subsequent date.

56) An audit team testing long-term investments would ordinarily use analytical procedures to ascertain the reasonableness of the: A) existence of unrealized gains or losses. B) completeness of recorded investment income. C) classification as available-for-sale or trading securities. D) valuation of trading securities.

57)

In auditing for unrecorded long-term bonds payable, an audit team most likely will: A) perform analytical procedures on the bond premium and discount accounts. B) examine documentation of assets purchased with bond proceeds for liens. C) compare interest expense with the bond payable amount for reasonableness. D) confirm the existence of individual bondholders at year-end.

58)

An audit plan to examine long-term debt most likely would include steps that require:

A) comparing the carrying amount of held-to-maturity securities with their year-end market values. B) correlating interest expense recorded for the period with outstanding debt. C) verifying the existence of the holders of the debt by direct confirmation. D) inspecting the accounts payable subsidiary ledger for unrecorded long-term debt.

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

60) An audit team's purpose in reviewing the documentation concerning the renewal of a note payable shortly after the balance-sheet date most likely is to obtain evidence concerning management's assertions about: A) existence. B) valuation. C) completeness. D) classification.

61) Which of the following audit procedures would not likely be performed for audits of investments? A) Read board of directors' minutes for authorization of investment strategies. B) Confirm investments with registrar. C) Confirm investments with broker or trustee. D) Compare valuation to published market prices.

62) Which of the following audit procedures would not likely be performed for audits of shareholders' equity? A) Read board of directors' minutes for authorization of equity transactions. B) Confirm outstanding common and preferred stock with stock registrar. C) Compare valuation of stock to published market prices. D) Obtain management representation about number of shares issued and outstanding.

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63) ABC Company has 100 shares of IBM stock that is held as an investment. The stock was purchased three years ago and has been in the client's safe deposit box along with other investment securities. During an inspection of securities held by the client, the auditor noted the 100 shares of IBM stock had a different CUSIP number than the number listed when purchased and the number verified during the previous audit. Which of the following would be the auditor's main concern about this discovery? A) The certificates in the safe deposit box were forgeries. B) There was unauthorized buying and selling of investment securities. C) The securities may be misclassified on the balance sheet. D) The securities were no longer owned by ABC Company.

64) The typical business activity in the financing and investment cycle that requires an accounting entry is: A) short- and long-term forecast. B) meeting with investment bankers. C) proposal to board of directors for investing excess monies. D) investment of excess funds in temporary or long-term securities.

65) If a company keeps investments in a bank safe deposit box, which of the following two people ideally should have access to the safe deposit box? A) A director and the president B) The president and vice president for finance C) A director and vice president for finance D) A director and general ledger accountant

66) Selecting a sample of notes payable transactions and vouching payments to canceled checks is a test of the ASB balance assertion of: A) accuracy. B) completeness. C) existence. D) presentation.

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67) The typical assertion relating to investments and related accounts in a manufacturing company would not include the assertion that: A) all investments are valued at cost. B) investment securities are on hand or held in safekeeping by a trustee. C) investment income has been properly recorded. D) investments are adequately classified and described in the balance sheet, including disclosures.

68) In an audit test of recorded interest expense and accrued interest, the auditor was able to detect that the recorded interest expense was higher than the calculations showed. This may indicate: A) a failure to accrue interest occurred. B) interest payments are in default. C) interest payments were charged to another account. D) interest was paid on an unknown debt or unrecorded liability.

69)

When auditing the market value of an investment, an auditor would be least likely to: A) examine quoted market prices. B) evaluate management's procedure for determining market prices. C) make his or her own determination of market prices. D) confirm market prices with a broker.

70) When a company keeps its own stock records, which of the following procedures is not required? A) Confirm outstanding common stock with stock registrar agent. B) Inspect the stock record stubs for certificate numbers and number of shares. C) Inspect the unissued certificates. D) Obtain written representation about the number of shares issued and outstanding.

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71)

Which of the following is not a typical assertion relating to owners' equity?

A) The number of shares shown as issued is in fact issued. B) The accounting is proper for options, warrants, and other stock issue plans, and related disclosure is adequate. C) All owners' equity transactions have been authorized by the board of directors. D) The valuation of shares issued for noncash consideration is reflected at book value.

72) When auditing the valuation assertion of an equity method investment, which of the following is the auditor most likely to do? A) Inspect stock certificates. B) Obtain audited financial statements of the investee company. C) Obtain the market price of the stock as of year-end. D) Review management's calculations.

73) An agent of a bond issuer who handles the administrative aspects of a loan and ensures that the borrower complies with the terms of the bond indenture is called a: A) registrar. B) transfer agent. C) trustee. D) none of the above.

74) Which of the following would provide the auditor the best evidence of the Rights assertion for bitcoin recorded as an asset by a client? A) Inspection of purchase records maintained by the client. B) Confirmation of the bitcoin from a third party. C) Execution of a small bitcoin transaction from a digital wallet to demonstrate control of the private key. D) Verification of the price of the bitcoin in the Wall Street Journal as of the balance sheet date.

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75) Which of the following is not an approach an auditor may choose when performing substantive procedures to test accounting estimates? A) Test the company’s process used to develop the accounting estimate. B) Confirm the accounting estimate with a reliable third party expert. C) Develop an independent expectation for comparison to the company’s estimate. D) Evaluate audit evidence from events or transactions occurring after the measurement date.

76)

Which of the following would be considered a Level 3 fair value estimate? A) The valuation of goodwill obtained from a purchase transaction. B) The valuation of a building held for over 20 years. C) The valuation of an equity investment traded on the NYSE. D) The valuation of a bond investment with a 10 year maturity and an A+ S&P bond

rating.

FILL IN THE BLANK. Write the word or phrase that best completes each statement or answers the question. 77) A _______ approved by the board of directors constitutes the authorization for capital asset acquisitions and investments.

78) _______ transactions are obligations and commitments that are not required to be recorded.

79) A _______ is a financial institution appointed to record the issuance and ownership of company securities.

80) A _______ handles the exchange of shares, canceling the shares surrendered by sellers and issuing new certificates to buyers.

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81) Records of interest rates and bonds payable are maintained by the _______ and the _______ .

82) Capital stock may be subject to _______ when independent registrars and transfer agents are employed.

83) The responsibility for financing and investment transactions is basically in the hands of _______ .

84) A _______ is a control feature relied upon when a standard internal control procedure is not in place.

85)

An _______ is an approximation of a financial statement element, item, or accoun

86) _______ is responsible for making estimates and should have a _______ and _______ designed to reduce the likelihood of material misstatements in them.

87) When circumstances call for extended procedures, information on outstanding stock may be _______ .

88) The ASB balance assertion of _______ is paramount in the verification of long-term liabilities and determination that all liabilities are recorded.

89)

The confirmation of notes payable to banks may use the _______ confirmation.

90) Investment accounting may be on the _______ method, _______ method, or _______ method. Version 1

91) _______ of securities can prevent the use of company securities as _______ for personal loans.

92) The primary audit concern with the verification of long-term liabilities is that all _______ are recorded and that the _______ is properly paid or _______ .

ESSAY. Write your answer in the space provided or on a separate sheet of paper. 93) What are "off-balance-sheet" financing transactions? Explain and provide two or more examples.

94) What is a compensating control? Describe what type of compensating controls might be implemented in the finance and investment cycle.

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95) According to auditing standards, specific relevant aspects of an internal control system for making estimates include: ● Management communication of the need for proper accounting estimates. ● Accumulation of relevant, sufficient, and reliable data for estimates. ● Preparation of estimates by qualified personnel. ● Adequate review and approval by appropriate levels of authority. ● Comparison of prior estimates with subsequent results to assess the reliability of the estimation outcomes. ● Consideration by management of whether particular accounting estimates are consistent with the company's operational plans. Required: a.How would the auditor test these control activities over the production of estimates? b.What substantive audit procedures would the auditor use to test the accounting estimates?

96) Interest expense related to interest-bearing liabilities could be audited using analytical procedures. Describe how this might be done and how the results would be used.

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97) Red Corporation had a temporary cash squeeze near its balance-sheet date. It needed cash badly for a seasonal dip in sales. However, a loan covenant requiring a certain debt/equity ratio would be violated if any additional money were borrowed. To remedy this, the top two officers of the Corporation set up another corporation, Pink Inc., Red made a large sale of inventory to Pink at cost. Pink used the inventory as collateral for a three-month loan from a local bank. The money from the loan was used to pay Red for the accounts receivable resulting from the "sale." The officers intended to have Red buy back the inventory from Pink at the end of the threemonth period at a price that would allow Pink to pay off the loan plus interest. Required: a.How would this transaction designed by the two officers enable Red to maintain its required debt/equity ratio while obtaining the cash it needed? b.What tests of controls and substantive tests would enable an auditor to detect this scheme?

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98) Mike is the controller at Huskie Supply Company. Huskie Supply has an investment account with DT National Brokerage. Mike is authorized to call the broker and initiate trades on behalf of the company. Mike's son goes to MEU (Most Expensive University) and Mike has a CD with the money for this year's tuition. MEU changed the tuition due date such that the tuition came due 30 days before Mike's CD matured. Mike would lose a large amount of interest if he cashed in the CD early, and a loan from the bank was not possible (Mike is already over extended), and interest on a credit card advance would be 28%. Mike authorized DT National Brokerage to sell one of the company's investments and send the check to his attention at the company. Mike paid the tuition and 30 days later, when the CD came due Mike repurchased the investment with the broker. In fact, the stock had dropped $3 and mike made a profit of $900. 1. A) Define the internal control weakness that allowed the situation to exist - if any; 2. B) One (and only one) specific internal controls that should be in place to prevent or detect the problem; and. 3. C) One (and only one) test of control audit procedure. 4. D) One (and only one) substantive audit procedure that may detect the situation described. Consider each item separately - no credit will be given for generic controls (e.g. policies and procedures; separation of duties (without specifics); discuss with management.)

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Answer Key Test name: Chap 10_8e_Test Bank 1) C 2) C 3) D 4) B 5) C 6) A 7) B 8) A 9) D 10) C 11) B 12) C 13) C 14) A 15) A 16) C 17) B 18) C 19) A 20) D 21) C 22) C 23) A 24) B 25) A 26) A Version 1

27) B 28) A 29) B 30) C 31) C 32) C 33) D 34) C 35) D 36) C 37) B 38) B 39) C 40) A 41) C 42) D 43) C 44) D 45) D 46) C 47) D 48) D 49) A 50) B 51) A 52) C 53) A 54) C 55) D 56) B Version 1

57) C 58) B 59) D 60) D 61) B 62) C 63) B 64) D 65) B 66) C 67) A 68) D 69) C 70) A 71) D 72) B 73) C 74) C 75) B 76) A 77) capital budget Question also found in study guide 78) Off-balance-sheet financing 79) registrar Question also found in study guide 80) transfer agent Question also found in study guide 81) [accounting department, CFO (or controller)] Question also found in study guide Version 1

82) confirmation Question also found in study guide 83) senior management officials Question also found in study guide 84) compensating control Question also found in study guide 85) accounting estimate Question also found in study guide 86) [Client's management, process, controls] Question also found in study guide 87) confirmed directly with the stockholders Question also found in study guide 88) completeness Question also found in study guide 89) standard bank Question also found in study guide 90) [cost, equity, consolidation] Question also found in study guide 91) [Proper custodial control, collateral] Question also found in study guide 92) [liabilities, interest expense, accrued] Question also found in study guide

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93) "Off-balance-sheet" financing transactions exist when companies enter into obligations and commitments that are not required to be recorded in the accounts. Examples are leases, endorsements on discounted notes or on other companies' obligations, letters of credit, guarantees, repurchase or remarketing agreements, commitments to purchase at fixed prices, commitments to sell at fixed prices, and certain kinds of stock options. 94) A compensating control is a control activity that is used when a standard control activity is not in place or is not operating effectively at a company. In the finance and investment cycle, upper-level management is normally involved in making decisions. Therefore, the traditional separation of duties is difficult to employ. In this cycle, a common compensating control would be to have two or more persons involved in each kind of important functional responsibility. If involvement of multiple persons is not specified, then oversight or review can be substituted instead. 95) a. An auditor would primarily use inquiries and observations to test controls over the production of estimates. Such inquires would include determining who prepares estimates, when are they prepared, what data are used, who reviews and approves the estimates, have you compared prior estimates with subsequent actual events? Observations include the study of (1) data documentation, (2) comparisons of prior estimates with subsequent actual experience, and (3) intercompany correspondence concerning estimates and operational plans. b. Beyond tests of controls, substantive audit procedures include recalculating the mathematical estimate, developing an auditor's own independent estimate based on alternative assumptions, and comparing the estimate to subsequently discovered facts to the extent they are known before the end of the fieldwork.

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96) For interest-bearing liabilities, interest expense can normally be recalculated based on information about the liability. The amount of debt, interest rate, and the time the liability is outstanding during the audit period are used to determine whether the interest expense and accrued interest are properly recorded. By comparing the audit results to the recorded amount, the auditor can determine the reasonableness of the recorded amount. If the amounts are equal, the auditor would normally be satisfied that interest is materially correct. If the calculated amount is more or less than the recorded amount, additional audit work would be required. 97) a.By devising this transaction as a sale at cost, the result was to obtain the cash without recording the liability. The cash replaced the inventory on the balance sheet, thus maintaining the same debt/equity ratio. If the proper entry were made, both assets and liabilities would increase, which would also increase the debt/equity ratio. b.For tests of controls, an auditor would inquire about any large or unusual financing transactions. Because this transaction was large, it might also have been detected in test of controls procedures in the revenue and collection cycle. For substantive tests, analytical procedures would detect the large unexpected amount of sales in this typically low period of sales. Inquiry about related-party transactions might also provoke a response about this transaction. Due to the large amount of the transaction, analysis of accounts receivable and subsequent collections may also have brought this transaction to the auditor's attention.

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98) Weakness: Separation of duties - Mike executes transactions and receives the custody of the asset i.e. the check. Control: ● Money should be electronically transferred to the Huskie Supply's cash account. ● Broker account has instructions only to send checks to the cash receipts department. ● Brokerage advices are sent to an individual not involved in investment transactions. Control Audit Procedure: ● Vouch trades to the Board of Directors minutes. ● Reconciliation of monthly brokerage statements by someone independent of investment transactions. Substantive Audit Procedure: ● Trace stock sale proceeds from brokerage accounts to bank statement.

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CHAPTER 10: PROBLEM MATERIAL ESSAY. Write your answer in the space provided or on a separate sheet of paper. 1) For each of the internal control questions for notes payable, indicate by letter the related ASB transaction assertion. Answers may be used more than once. A. Valuation or allocation B. Occurrence C. Completeness D. Rights

_______

Are paid notes canceled, stamped PAID, and filed?

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Are bank due notices compared with records of unpaid liabilities?

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Are notes payable kept by someone who cannot sign notes or checks?

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Is all borrowing authorization by the directors checked to determine whether all notes payable are recorded?

2) XYZ Company has investment securities held by a broker. An auditor is reviewing the last broker's statement for the year. For each of the tests 1-5, select the ASB balance assertion listed in A-D that the auditor is testing. A. Rights and obligations B. Completeness C. Valuation or Accuracy D. Existence

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Verified the name on the account was the company's name.

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Vouched items listed on the statement to the investment account.

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Vouched purchases listed on the statement by authorization by senior management or the board of directors.

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_______

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The auditor has received a letter of confirmation directly from the broker for investments listed on the statement. The auditor compared the price of the securities listed on the broker's statement with the price listed on that day in The Wall Street Journal to the price used to record the investment on the balance sheet.

Answer Key Test name: Chap 10_8e_Test Bank_Problem Material 1) 1. B; 2. A; 3. B; 4. C 2) 1. A; 2. B; 3. D; 4. D; 5. C

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CHAPTER 11 MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) Which of the following events or activities may occur following the audit report release date? A) Interim testing B) Roll-forward work C) Subsequent events D) Subsequently discovered facts

Interim testing normally occurs between the __________ and the __________. A) beginning of the year under audit; audit report release date B) date of the financial statements; audit report release date C) beginning of the year under audit; date of the financial statements D) end of the year under audit; date of the auditors' report

Roll-forward work normally occurs between the __________ and the __________. A) beginning of the year under audit; audit report release date B) date of the financial statements; audit report release date C) beginning of the year under audit; date of the financial statements D) date of interim work; date of the auditors' report

4) For which of the following objectives would auditors be least likely to use analytical procedures near the end of the audit?

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A) Obtaining evidence about assertions related to account balances or classes of transactions B) Evaluating the adequacy of evidence gathered in response to unexpected account balances C) Identifying unusual or unexpected account balances or relationships among account balances that were not previously identified during the audit D) Evaluating the adequacy of evidence gathered in response to unexpected relationships among account balances

5) Which of the following best describes the auditors' responsibility with respect to management's estimates? A) Verifying the mathematical accuracy of management estimates. B) Assessing the likelihood that actual results will be consistent with management's estimates. C) Evaluating the reasonableness of management's estimates. D) Identifying how the failure of the entity to achieve management's estimates will influence users' decisions.

6) Which of the following would not ordinarily be considered when using analytical procedures to verify the overall reasonableness of revenue and expense accounts? A) Current-year recorded (unaudited) balances. B) Expected balances using a statistical analysis or relationships among accounts. C) Internal budgets and reports. D) Prior-year balances.

7) Why should auditors be particularly concerned with "miscellaneous," "other," and "clearing" accounts classified as revenues or expenses?

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A) These accounts are likely to relate to going-concern matters. B) These accounts are often more difficult to audit using normal substantive procedures. C) These accounts may represent attempts of earnings management. D) These accounts are likely to require the assistance of a specialist.

8) Which of the following is the most effective method of identifying potential earnings management attempts? A) Analytical procedures. B) Detailed substantive procedures. C) Inquiry of client management and key financial personnel. D) Scanning accounts for unusual items.

An important method used by auditors to learn of material contingencies is A) examining documents in the client's possession concerning contingencies. B) inquiring and discussing them with management. C) obtaining responses to an attorney letter. D) confirming accounts receivable with the client's customers.

10) Which of the following procedures is not used in auditors' examination of litigation, claims, and assessments? A) Obtaining a description and evaluation of litigation, claims, and assessments from management. B) Examining documentary evidence regarding litigation, claims, and assessments. C) Reading minutes of meetings of stockholders, directors, and appropriate committees. D) Performing analytical procedures.

11) Which of the following is typically not included in the inquiry letter sent to the client's attorneys? Version 1

A) A disclaimer regarding the likelihood of settlement of pending litigation. B) A listing of pending or threatened litigation, claims, or assessments. C) An evaluation of the likelihood of an unfavorable outcome. D) An estimate of the range of potential loss.

12) Which party should request a letter regarding litigation, claims, and assessments from the client's attorney? A) Attorney B) Auditors C) Client D) Securities and Exchange Commission or other regulatory body

13)

To whom should written representations be addressed? A) Auditors B) Board of directors C) Client D) Stockholders

14) Which of the following items would appear in written representations in the audit of a public entity but not a nonpublic entity? A) Statements related to management's responsibility for the entity's financial statements. B) Statements related to management's responsibility for designing internal control to prevent and detect fraud. C) An indication that all subsequent events have been disclosed to the auditors. D) Management's opinion as to the effectiveness of its internal control over financial reporting.

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15)

What is the primary purpose of obtaining written representations?

A) To provide auditors with substantive evidence of important assertions. B) To impress upon management its primary responsibility for the financial statements. C) To allow auditors to communicate important internal control deficiencies to management. D) To allow auditors to communicate important suggestions for improvement to management.

16) If auditors are appointed on January 3, 2020, the date of the financial statements is December 31, 2020, the date of the auditors' report is February 7, 2021, and the audit report release date is March 3, 2021, what is the appropriate date of the written representations? A) January 3, 2020 B) December 31, 2020 C) February 7, 2021 D) March 3, 2021

17) Which of the following reporting options is available if the client refuses to provide auditors with written representations? A) Unmodified or qualified opinion B) Qualified or adverse opinion C) Qualified opinion or disclaimer of opinion D) Disclaimer of opinion or adverse opinion

18)

Why is it the client's decision to record adjustments to the financial statements?

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A) Having auditors adjust the financial statements would impair independence with respect to the client. B) The financial statements are the responsibility of the client's management. C) Auditors often do not have sufficient client-specific expertise to record adjustments to the financial statements. D) The client will ultimately suffer any losses related to misstated financial statements.

19) Which of the following is not a purpose of the review of audit documentation by a supervisor during fieldwork? A) To ensure that all appropriate steps in the audit plan were performed. B) To ensure that referencing among audit documentation is clear. C) To ensure that the explanations included in the audit documentation are understandable. D) To ensure that the overall scope of the audit was appropriate.

20) Before the impact of adjusting entries proposed by auditors are included in the client's financial statements, the adjustments must be approved by the A) client's management. B) audit manager. C) engagement partner. D) engagement quality review partner.

21)

Subsequent events occur between the __________ and the __________. A) date of the financial statements; date of the auditors' report B) date of the auditors' report; audit report release date C) date of the financial statements; audit report release date D) audit report release date; beginning of subsequent year's audit

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22) Which of the following substantive procedures would not ordinarily be used by auditors in evaluating the potential existence of subsequent events? A) Reviewing the latest interim financial statements. B) Performing cut-off testing near year end. C) Inquiring of officers and other client executives. D) Obtaining written representations.

23) Which of the following conditions or set of circumstances would not ordinarily raise questions about the entity's ability to continue as a going concern: A) Violation of debt covenants. B) Failure to meet forecasted earnings per share. C) Legal proceedings that may have a significant negative impact on the entity. D) Negative cash flow from operations for each of the last three years.

24) Which of the following subsequent events would represent an event that provides information about conditions that arose following the date of the financial statements? A) Settlement of long outstanding litigation. B) Collection of a past due accounts receivable. C) Loss of inventory as a result of a flood. D) An additional tax assessment on prior income.

25) The Orange Corporation was audited for the year ended December 31. The audit was completed on January 25; prior to the release of the report, auditors learned of a two-for-one stock split on February 1. If dual dating is used, what are the proper dates for the auditors' reports?

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A) December 31 and January 25 B) January 25 and February 1 C) January 25 and February 15 D) February 1 and February 15

26) Auditors have a responsibility to evaluate whether financial statements properly reflect all known events through the: A) date of the financial statements. B) date of the auditors' report. C) audit report release date. D) subsequent year's date of the financial statements.

27)

Management letters are not a means of

A) reporting recommendations to the client. B) assisting the client in improving its operations. C) satisfying professional requirements to communicate matters related to the client's internal control. D) developing rapport with the client.

28) An engagement quality review by a second partner of the audit documentation and financial statements is performed to ensure that the: A) "to-do lists" are reviewed and cleared. B) audit plan procedures are "signed off." C) tick-mark notations are cleared. D) audit work meets the quality standards of the firm.

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29) Auditors must complete various phases of an audit after the date of the financial statements. The auditors' responsibility for matters affecting the client extends from the date of the financial statements to the A) date of the auditors' report. B) final review of the audit documentation. C) audit report release date. D) delivery of the auditors' reports to the client.

30) Auditors conclude that the omission of a substantive procedure considered necessary at the time of the examination may impair their present ability to support the previously-expressed opinion. Auditors need not try to perform the omitted procedure if A) the risk of adverse publicity or litigation is low. B) some financial statement users are currently relying on the auditors' reports. C) the auditors' opinion was qualified because of a departure from generally accepted accounting principles. D) the results of other procedures that were applied at the time compensated adequately for the omitted procedure by providing sufficient appropriate evidence.

31)

The primary objective of analytical procedures used near the end of an audit is to A) obtain evidence from details tested to corroborate management assertions. B) obtain evidence on the validity of the assessment of control risk. C) assist auditors in evaluating the overall financial statement presentation. D) identify areas that represent specific risks relevant to the audit.

32) In an audit of contingent liabilities, which of the following procedures would be least effective?

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A) Examining customer confirmation replies. B) Reviewing a bank confirmation letter. C) Examining invoices for professional services. D) Reading the minutes of the board of directors meetings.

33)

Near the end of an audit, the application of analytical procedures is A) recommended by auditing standards. B) not mentioned by auditing standards. C) not useful, since detailed substantive procedures have already been performed. D) required by auditing standards.

34) The primary source of information auditors use to obtain information about litigation, claims, and assessments is the A) client's attorney. B) court records. C) client's management. D) independent auditors.

35) Long and Short, CPAs, were auditing Island Corporation for the year ended December 31, 2020. On January 11, 2021, a major customer of Island Corporation declared bankruptcy as the result of an uninsured loss due to a major fire in their warehouse on January 8, 2021. As a result, a material accounts receivable from the customer was determined to be uncollectible. Long and Short, CPAs, would expect the client to

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A) record the loss on uncollectible accounts as a routine transaction in the year 2021. B) treat the loss as a subsequent event and provide a footnote about the loss in the 2020 financial statements. C) treat the loss as a subsequent event and adjust the 2020 financial statements to record the loss on uncollectible accounts. D) file a lawsuit against the customer in hopes of collecting some of the money owed to the client.

36) Small and Tall, CPAs, completed the December 31, 2020 audit of Big Company on February 10, 2021. After the audit report release date, an outstanding lawsuit against Big Company was settled for materially more than recorded in the December 31, 2020 financial statements. The amount recorded in the financial statements represented the best estimate of management and the company's attorneys at the time the audit was completed. Based on this new information, Small and Tall, CPAs should A) determine whether persons are currently relying on the auditors' reports. B) advise the client to make appropriate changes in the financial statements and reissue them. C) notify each member of the board of directors of Big Company. D) take no action since the event took place after the audit report release date.

37) A partner of the accounting firm who has not been involved in the audit performs an engagement quality review of documentation. This review usually focuses on A) the fair presentation of the financial statements in conformity with GAAP. B) irregularities involving the client's management and its employees. C) the materiality of the adjusting entries proposed by the audit staff. D) the communication of internal control deficiencies to the client's audit committee (or those charged with governance).

38) An entity's income statements were misstated due to the recording of journal entries that involved debits and credits to an unusual combination of expense and revenue accounts. Auditors most likely could have detected this irregularity by

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A) tracing a sample of journal entries to the general ledger. B) evaluating the effectiveness of the internal control policies and procedures. C) investigating the reconciliations between controlling accounts and subsidiary records. D) performing analytical procedures designed to disclose differences from expectations.

39) Following the audit report release date, auditors became aware of facts existing at the report date that would have affected the reports had auditors then been aware of such facts. What is the most appropriate initial course of action that auditors should take? A) Determine whether there are persons relying or likely to rely on the financial statements who would attach importance to the information. B) Request that management disclose the newly-discovered information by issuing revised financial statements. C) Issue revised pro forma financial statements taking into consideration the newly discovered information. D) Give public notice that auditors are no longer associated with financial statements.

40)

Analytical procedures performed near the end of an audit generally include

A) considering unusual or unexpected account balances that were not previously identified. B) performing tests of transactions to corroborate management's financial statement assertions. C) gathering evidence concerning account balances that have not changed from the prior year. D) retesting control activities that appeared to be ineffective during the assessment of control risk.

41) Auditors try to identify predictable relationships when using analytical procedures. Relationships involving transactions from which of the following accounts most likely would yield the highest level of evidence?

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A) Accounts receivable B) Interest expense C) Accounts payable D) Travel and entertainment expense

42) On March 15, 2021, Kent, CPA, issued an unqualified opinion on a client's audited financial statements for the year ended December 31, 2020. On May 4, 2021, Kent's internal inspection program disclosed that engagement personnel failed to observe the client's physical inventory. Omission of this procedure impairs Kent's present ability to support the unqualified opinion. If the stockholders are currently relying on the opinion, Kent should first A) advise management to disclose to the stockholders that Kent's unqualified opinion should not be relied on. B) undertake to apply alternative procedures that would provide a satisfactory basis for the opinion. C) reissue the auditors' reports and add an explanatory paragraph describing the departure from generally accepted auditing standards. D) compensate for the omitted procedure by performing tests of controls to reduce audit risk to a sufficiently low level.

43) Which of the following procedures would auditors most likely perform in obtaining evidence about subsequent events? A) Determine that changes in employee pay rates after year end were properly authorized. B) Recompute depreciation charges for plant assets sold after year end. C) Inquire about payroll checks that were recorded before year end but cashed after year end. D) Investigate changes in long-term debt occurring after year end.

44) Which of the following best describes auditors' responsibilities with respect to evaluating the going-concern status of the entity?

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A) Auditors are required to specifically gather evidence with respect to going-concern status and separately report on the entity's ability to continue as a going concern. B) Auditors are required to specifically gather evidence with respect to going-concern status and modify their report on the financial statements if substantial doubts exist. C) Auditors are required to consider evidence obtained during the audit that may provide information with respect to going-concern status and separately report on the entity's ability to continue as a going concern. D) Auditors are required to consider evidence obtained during the audit that may provide information with respect to going-concern status and modify their report on the financial statements if substantial doubts exist.

45) Which of the following is an audit procedure that auditors most likely would perform concerning litigation, claims, and assessments? A) Request the client's attorney to evaluate whether the client's pending litigation claims, and assessments indicate a going concern problem. B) Examine the legal documents in the client's attorney's possession concerning litigation, claims, and assessments to which the attorney has devoted substantive attention. C) Discuss with management its policies and procedures adopted for evaluating and accounting for litigation, claims, and assessments. D) Confirm directly with the client's attorney that all litigation, claims, and assessments have been recorded or disclosed in the financial statements.

46) Which of the following procedures would auditors most likely perform to obtain evidence about the occurrence of subsequent events? A) Confirming a sample of material accounts receivable established after year-end. B) Comparing the financial statements being reported on with those of the prior period. C) Reading minutes of meetings of owners, management, or those charged with governance held after the date of the financial statements. D) Inquiring as to whether any unusual adjustments were made just before year-end.

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47) Which of the following events occurring after the audit report release date most likely would cause auditors to make further inquiries about the previously-issued financial statements? A) An uninsured natural disaster occurs that may affect the entity's ability to continue as a going concern. B) A contingency is resolved that had been disclosed in the audited financial statements. C) New information is discovered concerning undisclosed lease transactions during the period under audit. D) A subsidiary is sold that accounts for 25% of the entity's consolidated net income.

48) What course of action should auditors take if, after evaluating management's plan to mitigate the effect of factors that suggest going-concern uncertainties, they believe that substantial doubt about going concern does not exist? A) Modify their report on the financial statements to describe management's plan to mitigate going-concern uncertainties, the procedures performed by the auditors, and indicate that substantial doubt about going concern does not exist. B) Prepare a separate report that describes management's plan to mitigate going-concern uncertainties, the procedures performed by the auditors, and indicate that substantial doubt about going concern does not exist. C) Require financial statement disclosure of management's plan to mitigate goingconcern uncertainties with no modification to the auditors' report on the financial statements or no separate report on going concern. D) Conclude that substantial doubt about going concern does not exist and not require financial statement disclosure or modification of the auditors' report.

49) If an entity had litigation pending at the date of the financial statements and auditors learn of the outcome of this litigation following the date of their report (but prior to the audit report release date), this is known as a(an): A) omitted procedure. B) prior period adjustment. C) subsequent event. D) subsequently discovered fact.

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50) Assume that Rory is auditing the financial statements of Augusta, Inc. Rory completes his fieldwork on February 25 and his report (along with Augusta's financial statements) is issued on March 1. On March 3, a hurricane destroys a warehouse that contains a significant amount of uninsured inventory. Which of the following best describes Rory's responsibility with respect to the effects of this hurricane on Augusta's financial statements? A) Because the inventory was included in the financial statements audited by Rory, he is required to perform additional procedures and reissue his report on the revised financial statements. B) Because the hurricane occurred after the date of Rory's report, he has no responsibility to perform additional procedures or reissue his report. C) Because the hurricane occurred prior to the next fiscal quarter, Rory is required to perform additional procedures and reissue his report on the revised financial statements. D) Because the hurricane occurred after the release of the financial statements and Rory's report, he has no responsibility to perform additional procedures or reissue his report.

51) If the date of an entity's financial statements is December 31, the date of the auditor's report is February 20, and the audit report release date is February 22, which of the following is considered a subsequent event? A) A significant acquisition that was announced on February 1 and will be finalized on October 1. B) A court settlement on March 3 related to a case that was pending on December 31. C) Losses from the devaluation of a foreign currency that became finalized on February 21. D) The entity's announcement of a major restructuring plan on December 30 that will be implemented during the upcoming year.

52) Which of the following auditing procedures most likely would assist auditors in identifying conditions and events that may indicate substantial doubt about an entity's ability to continue as a going concern?

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A) Inspecting title documents to verify whether any assets are pledged as collateral. B) Confirming with third parties the details of arrangements to maintain financial support. C) Reconciling the client's cash balance with the cut-off bank statement and the bank confirmation. D) Comparing the entity's depreciation and asset capitalization policies to other entities in the industry.

53) Select the appropriate term to which it is most likely related. Each term is associated with only one statement. Audit documentation and financial statements, including footnotes, are reviewed by a partner who did not participate on the audit. A) Written representations. B) Engagement quality review. C) Management letter. D) Interim audit work. E) Communication with individuals charged with governance. F) Attorney letters.

54) Select the appropriate term to which it is most likely related. Each term is associated with only one statement. Based on the facts, known to us, after a full investigation, it is our opinion that no liability will be established against this entity. A) Written representations. B) Engagement quality review. C) Management letter. D) Interim audit work. E) Communication with individuals charged with governance. F) Attorney letters.

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55) Select the appropriate term to which it is most likely related. Each term is associated with only one statement. Audit procedures performed several weeks or months before the date of the financial statements. A) Written representations. B) Engagement quality review. C) Management letter. D) Interim audit work. E) Communication with individuals charged with governance. F) Attorney letters.

56) Select the appropriate term to which it is most likely related. Each term is associated with only one statement. There have been no irregularities involving management or employees who have significant roles in the client's internal control. A) Written representations. B) Engagement quality review. C) Management letter. D) Interim audit work. E) Communication with individuals charged with governance. F) Attorney letters.

57) Select the appropriate term to which it is most likely related. Each term is associated with only one statement. We discussed the following recommendation for streamlining the receiving department document flow with Ms. Phyllis Cook, receiving department supervisor.

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A) Written representations. B) Engagement quality review. C) Management letter. D) Interim audit work. E) Communication with individuals charged with governance. F) Attorney letters.

58) Select the appropriate term to which it is most likely related. Each term is associated with only one statement. Includes statements regarding auditors' judgment of the quality of the client's accounting principles. A) Written representations. B) Engagement quality review. C) Management letter. D) Interim audit work. E) Communication with individuals charged with governance. F) Attorney letters.

59) For each of the communications listed below, select the appropriate time period during which the communication is typically obtained or provided and whether the communication is oral, written, or either oral or written. Engagement letter A) Prior to or at the date of the auditors' report, Written B) Following the date of the auditors' report; Either oral or written C) Prior to the engagement, Written D) Either following the date of the auditors' report or as significant matters are identified, Written

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60) For each of the communications listed below, select the appropriate time period during which the communication is typically obtained or provided and whether the communication is oral, written, or either oral or written. Acceptance letter (signed copy of engagement letter) A) Prior to or at the date of the auditors' report, Written B) Following the date of the auditors' report; Either oral or written C) Prior to the engagement, Written D) Either following the date of the auditors' report or as significant matters are identified, Written

61) For each of the communications listed below, select the appropriate time period during which the communication is typically obtained or provided and whether the communication is oral, written, or either oral or written.

Attorney letter response A) Prior to or at the date of the auditors' report, Written B) Following the date of the auditors' report; Either oral or written C) Prior to the engagement, Written D) Either following the date of the auditors' report or as significant matters are identified, Written

62) For each of the communications listed below, select the appropriate time period during which the communication is typically obtained or provided and whether the communication is oral, written, or either oral or written. Written representations A) Prior to or at the date of the auditors' report, Written B) Following the date of the auditors' report; Either oral or written C) Prior to the engagement, Written D) Either following the date of the auditors' report or as significant matters are identified, Written

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63) For each of the communications listed below, select the appropriate time period during which the communication is typically obtained or provided and whether the communication is oral, written, or either oral or written. Internal control deficiencies A) Prior to or at the date of the auditors' report, Written B) Following the date of the auditors' report; Either oral or written C) Prior to the engagement, Written D) Either following the date of the auditors' report or as significant matters are identified, Written

64) For each of the communications listed below, select the appropriate time period during which the communication is typically obtained or provided and whether the communication is oral, written, or either oral or written. Communications with individuals charged with governance A) Prior to or at the date of the auditors' report, Written B) Following the date of the auditors' report; Either oral or written C) Prior to the engagement, Written D) Either following the date of the auditors' report or as significant matters are identified, Written

65) For each of the communications listed below, select the appropriate time period during which the communication is typically obtained or provided and whether the communication is oral, written, or either oral or written. Management letter A) Prior to or at the date of the auditors' report, Written B) Following the date of the auditors' report; Either oral or written C) Prior to the engagement, Written D) Either following the date of the auditors' report or as significant matters are identified, Written

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ESSAY. Write your answer in the space provided or on a separate sheet of paper. 66) Explain briefly (a) written representations, (b) internal control communications, and (c) management letters. In your answer, include the general content of the communication, the parties involved with the communication, the required form of the communication, and whether the communication is required under generally accepted auditing standards.

67) Explain briefly auditors’ responsibility for subsequently discovered facts existing at the date of the auditors’ reports.

68) Define what is meant by the term “subsequent event”. In addition, identify the two types of subsequent events and indicate how auditors should modify the engagement for the discovery of subsequent events.

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69) You are auditing Green Corporation for the calendar year 2020. Among other items related to the audit, Green Corporation was being sued for personal injury resulting from the malfunction of one of their products. The lawsuit was initiated by Sue Ewe in September, 2020. Management and the company's outside legal counsel estimated the loss from the suit to be approximately $250,000. This amount is accrued and properly disclosed in the footnotes of the financial statements. You have no reason to believe that the estimate is inaccurate. You completed your audit and dated your report March 2, 2021. The financial statements were issued on March 14, 2021. On March 20, 2021, you read in a national business periodical that the jury in the trial awarded Sue Ewe $1.5 million. Required: Discuss the nature of these events and what responsibility, if any, you have regarding the news of March 20, 2021.

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Answer Key Test name: Chap 11_8e_Test Bank 1) D 2) C 3) D 4) A 5) C 6) A 7) C 8) D 9) C 10) D 11) A 12) C 13) A 14) D 15) B 16) C 17) C 18) B 19) D 20) A 21) A 22) B 23) B 24) C 25) B 26) C Version 1

27) C 28) D 29) C 30) D 31) C 32) A 33) D 34) C 35) B 36) D 37) A 38) D 39) A 40) A 41) B 42) B 43) D 44) D 45) C 46) C 47) C 48) D 49) D 50) D 51) A 52) B 53) B 54) F 55) D 56) A Version 1

57) C 58) E 59) C 60) C 61) A 62) A 63) D 64) B 65) B

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66) a. Written representations normally take the form of a letter on the client's letterhead, addressed to auditors, and signed by a responsible officer of the client. The purpose of this letter is to impress upon management its responsibility for the financial statements. The major categories covered by written representations include sections that discuss (1) the entity’s financial statements, (2) information provided to auditors, and (3) internal control over financial reporting (for audits of public entities). This communication is required by generally accepted auditing standards and must be in writing. b. An internal control communication is normally made by auditors to the client or client's audit committee (those charged with governance). It involves the communication of deficiencies in the client's internal control. This communication is required by generally accepted auditing standards and should be made in writing. c. The management letter is sent by auditors to the client after the completion of the audit. The letter can include recommendations for improvement and suggestions for other possible auditors’ services. Management letters are not required by generally accepted auditing standards; while they are typically prepared in writing, the related communication can be made orally.

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67) If auditors become aware of facts that existed at the date of the reports, auditors should require the client to disclose the facts and their impact on the financial statements to persons relying on the financial statements if the following conditions exist: 1.The facts affect the financial statements and auditors’ reports. 2.Persons are continuing to rely on the financial statements and auditors’ reports. If the client refuses to make the appropriate disclosures (as discussed above), auditors should notify each member of the board of directors that they will be notifying regulatory agencies having jurisdiction over the client (such as the Securities and Exchange Commission) as well as other persons who are currently relying on the reports.

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68) A subsequent event is an event that occurs between the date of the financial statements and the date of the auditors’ report that may affect the presentation and disclosure in the client's financial statements. The two types of subsequent events are: 1.Events that provide new information regarding a condition that existed at the date of the financial statements (such as a loss on uncollectible accounts receivable or settlement of litigation for an amount different than estimated). 2.Events that involve a condition that arose after the date of the financial statements, such as a bond sale, capital stock issuance, or loss of plant or inventories as a result of fire or flood. Subsequent events related to conditions that existed at the date of the financial statements require adjustment of reported amounts in the financial statements. In contrast, subsequent events related to conditions that arose following the date of the financial statements will require disclosure in the financial statements. In cases where the events are discovered after the date of the auditors’ report but prior to the audit report release date, auditors would recommend adjustment or disclosure in the financial statements and dual date the reports. If the events are discovered after the audit report release date, auditors should recommend client disclosure of the event to persons relying on the financial statements if (1) the facts affect the financial statements and auditors’ reports, and (2) persons are continuing to rely on the financial statements and auditors’ reports.

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69) The outcome of the lawsuit would ordinarily be considered a subsequent event that provides new information regarding a financial condition that existed at the date of the financial statements. However, auditors have no responsibility with regard to the March 20 outcome because it occurred after the audit report release date. Since the best estimate had been properly recorded and disclosed in the financial statements issued, auditors have no additional responsibility in this situation.

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CHAPTER 11: PROBLEM MATERIAL ESSAY. Write your answer in the space provided or on a separate sheet of paper. 1) Below is a list of events that occur throughout an audit examination. Indicate, using the correct letter, the time period during which these events are most likely to occur. An event may occur in more than one time period. A.Prior to the date of the financial statements. B.Between the date of the financial statements and the date of the auditors' report. C.Between the date of the auditors' report and the audit report release date. D.After the audit report release date.

___ 1. Subsequently discovered facts. ___ 2. Roll-forward work. ___ 3. Attorney letters. ___ 4. Interim testing relating to substantive procedures. ___ 5. Preparation of proposed adjusting journal entries. ___ 6. Dual dating for subsequently discovered facts. ___ 7. Communications with the individuals charged with governance. ___ 8. Written representations. ___ 9. Identification of subsequent events. ___ 10. Interim testing related to tests of controls.

2) Indicate, using the letters C (client), A (auditors), and AT (attorney) which party is responsible for each of the following duties relating to letters of inquiry of attorneys. Each statement is associated with only one party. ___ 1. Respond directly to auditors' initial inquiries regarding litigation, claims, and assessments. ___ 2. Initiate request for attorney letter. ___ 3. Respond to attorney letter.

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___ 4. Provide initial description and evaluation of litigation, claims, and assessments. ___ 5. Request attorney letter. ___ 6. Perform various procedures relating to litigation, claims, and assessments. ___ 7. Identify whether client's views expressed in the attorney letter are appropriate. ___ 8. Party the attorney informs if an unasserted claim must be disclosed.

3) Indicate the type of communication(s) that correspond to each of the following statements. Use the letters A (attorney letter), M (management letter), and WR (written representations). Each statement may be related to more than one type of communication. ___ 1. Discusses management's responsibility for the fairness of the financial statements. ___ 2. Is obtained on the date of the auditors' report. ___ 3. Provides auditors with significant evidence regarding litigation, claims, and assessments. ___ 4. Discusses the absence of fraud activity by the client and its personnel. ___ 5. Is not required by generally accepted auditing standards. ___ 6. Is intended to be returned to auditors as a form of evidence. ___ 7. Is typically prepared following the audit report release date. ___ 8. Is signed by an executive of the client.

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Answer Key Test name: Chap 11_8e_Test Bank_Problem Material 1) 1.C, D, 2. B, 3. B, 4. A, 5. B, 6. C, 7. D (could occur throughout the audit), 8. B, 9. B (auditors would need to act if they became aware of events prior to the audit report release date), 10. A 2) 1. C, 2. A, 3. AT, 4. C, 5. C, 6. A, 7. AT, 8. C 3) 1. WR; 2. WR; 3. A; 4. WR; 5. M; 6. A,WR; 7. M; 8. A, WR

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CHAPTER 12 MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) Which of the following statements is not included in the Auditor's Responsibilities for the Audit of the Financial Statements Section of the standard (unmodified) report? A) "In accordance with accounting principles generally accepted in the United States of America." B) "Our objectives are to obtain reasonable assurance…and to issue an auditor’s report that includes our opinion" C) "…it is not a guarantee that an audit conducted in accordance with GAAS will always detect a material misstatement…" D) "Reasonable assurance is a high level of assurance but is not absolute assurance…"

2) Which of the following situations would not result in auditors adding an emphasis-ofmatter paragraph or section to their report without modifying the remainder of the report? A) Reference to a change in the method of accounting mandated by the issuance of a new accounting standard. B) Reference to a going-concern uncertainty facing the entity. C) Reference to a departure from GAAP that is material, but not pervasive, to the financial statements. D) Reference to an acquisition made by the entity during the most recent fiscal year.

3) Which of the following statements is not included in the Basis for Opinion Section of the standard (unmodified) report on the entity's financial statements? A) "We are required to communicate with those charged with governance…" B) "We are required to be independent of [the client]…" C) "We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion." D) "We conducted our audit in accordance with…(GAAS)"

Auditors are required to reference consistency in their report when there are changes in

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A) accounting estimates. B) the format of the Statement of Cash Flows. C) the classification of financial statement amounts. D) accounting principles.

5) If financial statements contain a material but non-pervasive departure from generally accepted accounting principles, the auditors should render a(n) A) Qualified opinion with reference to departure. B) adverse opinion with scope limitation reference. C) adverse opinion with reference to departure. D) disclaimer of opinion.

6) Which of the following scope limitations would ordinarily be of most concern to the auditors? A) The inability to observe inventories because auditors were appointed following the date of the financial statements. B) Management's refusal to provide auditors with written representations. C) The inability to obtain confirmation of year-end balances from customers because of different billing dates. D) The use of the work of component auditors in the audit of group financial statements.

7) When auditors are engaged to examine an entity's financial statements but decide to issue a disclaimer of opinion because of a scope limitation, the report would not A) identify management's responsibility for the financial statements. B) refer to any scope limitation in the Basis for Opinion Section. C) modify the Auditor’s Responsibilities for the Audit of the Financial Statements Section to identify the basis for the disclaimer. D) indicate that the auditors were engaged to audit the financial statements.

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8) A report that acknowledges reliance on the reports of component auditors is a type of report modification known as a(n) A) qualification. B) division of responsibility. C) expansion of scope. D) scope limitations.

9) "As described in Note 5 to the financial statements, General Express changed its statistical method of computing product warranty expense for the year ended December 31, 20x1…" is an illustration of a A) consistency change requiring a qualified opinion. B) scope limitation. C) departure from generally accepted accounting principles. D) report with a consistency modification.

10) The auditors' report on the entity's financial statements included language disclosing a difference of opinion between the auditors and the entity for which the auditors believed an adjustment to the financial statements should be made. The Opinion Section of the auditors' report should express a(n) A) unmodified opinion. B) qualified opinion citing a departure from generally accepted accounting principles. C) qualified opinion citing a scope limitation and lack of specific evidence. D) disclaimer of opinion.

11)

Auditors will issue an adverse opinion when

A) a severe scope limitation has been imposed by the entity. B) a violation of generally accepted accounting principles is sufficiently material and pervasive that a qualified opinion is not justified. C) a qualified opinion cannot be rendered because the auditors lack independence. D) the entity's ability to continue as a going concern is subject to substantial doubt.

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12)

The issuance of a disclaimer of opinion generally indicates

A) the auditors cannot form an opinion on the fairness of presentation of the financial statements as a whole. B) the auditors have some uncertainties, but these uncertainties are not so material that they cannot form an opinion on the fairness of presentation of the financial statements as a whole. C) the auditors have observed a departure from generally accepted accounting principles but the departure is not of sufficient materiality to justify a qualified opinion. D) the auditors have observed a departure from generally accepted accounting principles that is so material and pervasive that a qualified opinion is not justified.

13) When an entity will not permit inquiry of outside legal counsel, the auditors' report on the entity's financial statements will ordinarily contain a(n) A) disclaimer of opinion. B) qualified opinion referencing a departure from generally accepted accounting principles. C) unmodified opinion with an emphasis-of-matter paragraph. D) adverse opinion.

14) In which of the following circumstances may auditors issue the standard (unmodified) report on the entity's financial statements? A) The entity changed accounting principles having an immaterial effect on the entity's financial position, results of operations, and cash flows. B) The auditors wish to emphasize a matter regarding the financial statements. C) The auditors reference component auditors who examined a subsidiary of group financial statements. D) The auditors have not been able to audit a substantial portion of the balance sheet because of a circumstance-imposed scope limitation.

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15) The auditors conclude that there is a material inconsistency in the "other information" in an annual report to shareholders containing audited financial statements. If the auditors conclude that the financial statements do not require revision, but the entity refuses to revise or eliminate the material inconsistency, the auditors may A) issue a qualified opinion on the entity's financial statements, citing a departure from generally accepted accounting principles. B) consider the matter closed since the other information is not included in the audited financial statements. C) issue an adverse opinion on the entity's financial statements due to inadequate disclosure. D) revise the report on the entity's financial statements to include an additional section describing the material inconsistency.

16) When auditors lack independence, which of the following is true about the report on the entity's financial statements that should be issued? A) The auditors should disclaim an opinion and should state specifically that they are not independent. B) The auditors should disclaim an opinion but not mention that they are not independent. C) The auditors should issue an unmodified opinion with an other-matter paragraph stating that they are not independent. D) The auditors should issue a qualified opinion with an other-matter paragraph stating that they are not independent.

17)

In which of the following circumstances would a qualified opinion not be appropriate?

A) A scope limitation prevents the auditors from completing an important auditing procedure. B) The entity has failed to properly disclose going-concern uncertainties. C) An accounting principle at variance with generally accepted accounting principles is used. D) The auditors lack independence with respect to the audited entity.

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18) Auditors should disclose the substantive reasons for expressing an adverse opinion on the entity's financial statements in A) the Adverse Opinion Section. B) the Basis for Adverse Opinion Section. C) the Auditor’s Responsibilities for the Audit of the Financial Statements Section. D) the footnotes to the financial statements.

19) When auditors qualify their opinion on the entity's financial statements because of inadequate disclosure, the auditors should describe the nature of the omission and modify A) the Qualified Opinion Section only. B) the Basis for Qualified Opinion Section only. C) the Auditor’s Responsibilities for the Audit of the Financial Statements Section only. D) the Qualified Opinion Section and the Basis for Qualified Opinion Section.

20) Restrictions imposed by an entity prohibited the observation of physical inventories, which accounted for 35 percent of total assets. Alternative auditing procedures were not feasible, although the auditors were able to examine satisfactory evidence for all other items in the financial statements. The auditors would most likely express A) a qualified opinion on the entity's financial statements, referring to a departure from generally accepted accounting principles. B) a disclaimer of opinion on the entity's financial statements. C) an unmodified opinion on the entity's financial statements with an other-matter paragraph. D) an unmodified opinion on the entity's financial statements with a modification of the Auditor’s Responsibilities for the Audit of the Financial Statements Section.

21) If management fails to provide adequate justification for a change from one generally accepted accounting principle to another, the auditors should

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A) Modify the Opinion Section and Basis for Opinion Section of the report for lack of conformity with generally accepted accounting principles. B) disclaim an opinion on the entity's financial statements because of uncertainty. C) disclose the matter in an emphasis-of-matter paragraph but not modify the Opinion Section of the report. D) Not modify the report because both principles are generally accepted accounting principles.

22) Charlie Company's comparative financial statements include the financial statements of the prior year that were audited by predecessor auditors whose report on those financial statements is not presented. If the predecessor's report was qualified, the successor auditors should A) indicate in their report the substantive reasons for the qualification issued by the predecessor auditors. B) request the entity to reissue the predecessor's report on the prior years' statements. C) issue an updated comparative report on the entity's financial statements, indicating the involvement of component auditors. D) express an opinion only on the current year's financial statements and make no reference to the prior years' financial statements or opinion.

23) Auditors who are reporting on financial statements that contain a material departure from generally accepted accounting principles should A) express a qualified or adverse opinion. B) not modify the Opinion Section of the report as long as the departure is adequately disclosed in a footnote. C) disclaim an opinion on the financial statements. D) express a qualified opinion or disclaimer of opinion.

24) Which of the following is an example of a material accounting change that requires recognition in an unmodified opinion on the entity's financial statements?

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A) A change in the estimate of useful lives used to depreciate property, plant, and equipment. B) A change in the entity's form of reporting entity. C) Management has changed from one generally accepted accounting principle to another but has not provided reasonable justification. D) A change from an accounting principle that conforms with GAAP to one that does not.

25) Independent auditors must consider whether the entity has the ability to continue as a going concern. If a substantial doubt exists but disclosure is adequate and no other basis exists for modifying the report, the auditors would normally A) disclaim an opinion. B) express an adverse opinion. C) qualify the opinion. D) express an unmodified opinion with an additional section describing the goingconcern uncertainty.

26) Auditors most likely would issue a disclaimer of opinion on the entity's financial statements because of A) inadequate disclosure of material information. B) the omission of the Statement of Cash Flows. C) a material departure from generally accepted accounting principles. D) management's refusal to furnish written representations.

27) When disclaiming an opinion due to a client-imposed scope limitation, auditors should describe the nature of the scope limitation and modify the

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A) Opinion Section. B) Opinion Section and Auditor’s Responsibilities for the Audit of the Financial Statements Section. C) Opinion Section, Basis for Opinion Section, and Auditor’s Responsibilities for the Audit of the Financial Statements Section. D) Basis for Opinion Section and Auditor’s Responsibilities for the Audit of the Financial Statements Section.

28) Under which of the following circumstances would a disclaimer of opinion on the entity's financial statements not be appropriate? A) The financial statements fail to contain adequate disclosure of related-party transactions. B) The entity refuses to permit its attorney to furnish information requested in an attorney letter. C) The auditors are engaged after the date of the financial statements and are unable to observe physical inventories or apply alternative procedures to verify their balances. D) The auditors are unable to determine the amounts associated with illegal acts committed by the entity's management.

29) When audited financial statements are presented in a document containing other information, the auditors should A) perform inquiry and analytical procedures to ascertain whether the other information is reasonable. B) add an emphasis-of-matter paragraph describing the other information to the auditors' report without modifying the opinion on the financial statements. C) perform the appropriate substantive procedures to corroborate the other information. D) read the other information to determine that it is consistent with the audited financial statements.

30) Reference in a group auditors' report to the fact that part of the audit of group financial statements was performed by component auditors most likely would be an indication of

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A) involvement of component auditors in the audit of the group financial statements. B) the portion of the group statements audited by the component auditors not being considered material. C) group auditors' recognition of the component auditors' competence, reputation, and professional certification. D) different opinions the auditors are expressing on the components of the financial statements that each audited.

31) The auditors include an emphasis-of-matter paragraph in an otherwise unmodified report on the entity's financial statements to emphasize that the entity being reported on had significant transactions with related parties. The inclusifis considered a qualification of the opinion.on of this separate paragraph A) is considered a qualification of the opinion. B) violates generally accepted auditing standards if this information is already disclosed in footnotes to the financial statements. C) necessitates a revision of the Opinion Section to include the phrase "with the foregoing explanation." D) is appropriate and would not otherwise affect the unmodified opinion.

32) When there has been a change in accounting principles, but the effect of the change on the comparability of the financial statements is not material, the auditors should A) refer to the change in an emphasis-of-matter paragraph. B) explicitly concur that the change is preferred. C) not refer to consistency in the report. D) refer to the change in the Basis for Opinion Section.

33) When financial statements contain a departure from GAAP, the auditors should explain the unusual circumstances in a separate paragraph and express an opinion that is

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A) unmodified. B) qualified. C) adverse. D) qualified or adverse, depending on the overall materiality and pervasiveness of the GAAP departure.

34) In which of the following circumstances would auditors be most likely to express an adverse opinion? A) The chief executive officer refuses to provide the auditors access to minutes of board of directors' meetings. B) Tests of controls show that the entity's internal control is so ineffective that it cannot be relied upon. C) The financial statements are not in accordance with generally accepted accounting principles regarding the capitalization of leases. D) Information comes to the auditors' attention that raises substantial doubt about the entity's ability to continue as a going concern.

35) In which of the following circumstances would auditors most likely add an emphasis-ofmatter paragraph or additional section to the standard (unmodified) report without modifying the opinion on the entity's financial statements? A) The auditors are asked to report on the balance sheet, but not on the other basic financial statements. B) There is substantial doubt about the entity's ability to continue as a going concern. C) Management's estimates of the effects of future events on the entity's financial condition, results of operations, and cash flows are unreasonable. D) Certain transactions cannot be tested because of management's records retention policy.

A) unmodified opinion. B) unmodified opinion with an emphasis-of-matter paragraph. C) qualified opinion due to a scope limitation. D) qualified opinion due to a departure from generally accepted auditing standards.

37) In which of the following situations would auditors ordinarily choose between expressing a qualified opinion or an adverse opinion on the entity's financial statements? A) The auditors did not observe the entity's physical inventory and are unable to become satisfied as to its balance by other auditing procedures. B) The financial statements fail to disclose information that is required by generally accepted accounting principles. C) The auditors are asked to report only on the entity's balance sheet and not on the other basic financial statements. D) Events disclosed in the financial statements cause the auditors to have substantial doubt about the entity's ability to continue as a going concern.

38) The auditors conclude that an entity's illegal act, which has a material effect on the financial statements, has not been properly accounted for or disclosed. Depending on the overall materiality and pervasiveness of the effect of this illegal act on the financial statements, the auditors should express either a(n) A) adverse opinion or a disclaimer of opinion. B) qualified opinion or an adverse opinion. C) disclaimer of opinion or an unmodified opinion with a separate emphasis-of-matter paragraph. D) unmodified opinion with a separate emphasis-of-matter paragraph or a qualified opinion.

39) Auditors would not normally issue a qualified opinion on the entity's financial statements when

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A) an accounting principle at variance with generally accepted accounting principles is used. B) the auditors lack independence with respect to the audited entity. C) a scope limitation prevents the auditors from completing an important auditing procedure. D) the entity has undertaken a change in accounting principle with which the auditor does not agree.

40) Which of the following phrases would auditors most likely include in their report when expressing a qualified opinion on the entity's financial statements because of inadequate disclosure? A) "Subject to the departure from generally accepted accounting principles, as described below." B) "With the foregoing explanation of these omitted disclosures." C) "Except for the effects of the matter described in the Basis for Qualified Opinion Section of our report" D) "Does not present fairly in all material respects."

41) If the auditors obtains sufficient appropriate evidence on the entity's accounts receivable balance by alternative procedures because it is impracticable to confirm accounts receivable, the opinion on the entity's financial statements should be unmodified and would A) disclose the fact that alternative procedures were used due to client-imposed scope limitation. B) disclose in the Basis for Opinion Section that confirmation of accounts receivable was impracticable. C) not mention the alternative procedures. D) include an other-matter paragraph that discloses the performance of alternative procedures.

42) When reporting on comparative financial statements, auditors ordinarily should modify their previously expressed opinion on the prior years' financial statements if the

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A) prior years' financial statements are restated to conform with generally accepted accounting principles. B) auditors were predecessor auditors who have been requested by a former client to reissue the previous report. C) prior years' opinions were unmodified and the opinion on the current year's financial statements is modified due to a lack of consistency. D) prior years' financial statements are restated following an acquisition in the current year.

43) Which of the following paragraphs or sections of the group auditors' report is modified to identify the extent of component auditor involvement in the audit of group financial statements? A) The Opinion Section.. B) The Basis for Opinion Section. C) The Auditor’s Responsibilities for the Audit of the Financial Statements Section. D) The other-matter paragraph.

44) When component auditors are involved in the audit of group financial statements, the group auditors are required to A) consider the independence and professional reputation of the component auditors in deciding how to utilize their work. B) identify the extent of component auditors' involvement if they choose not to rely on the component auditors' work. C) identify the component auditors by name in their report to appropriate limit their liability for the component auditors' work. D) disclaim an opinion on the portion of the financial statements examined by the component auditors.

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A) Issue a standard (unmodified) report that does not reference any involvement by the component auditors. B) Identify the component auditors by name and present their report along with the group auditors' report. C) Refer to the component auditors' work and disclose the extent of their work in the group auditors' report. D) Disclaim an opinion on the portion of the financial statements examined by the component auditors.

46) Which of the following best describes the auditors' responsibility when financial statements are presented in comparative format? A) The auditors' report must only refer to the current year's financial statements. B) The auditors' report must only refer to the prior years' financial statements if they were audited by the current auditor. C) The auditors' report must only refer to the prior years' financial statements if they were audited by either the current auditors or predecessor auditors. D) The auditors' report must refer to all financial statements presented in comparative form, regardless of whether they have been audited by the current auditors or predecessor auditors.

47) Which of the following situations would require auditors to add an other-matter paragraph to their report on comparative financial statements? A) An unmodified opinion is issued in the current year while a qualified opinion was issued in prior years. B) A qualified opinion is issued in the current year because of a scope limitation; because this limitation was not encountered in prior years, the opinion issued in those years was unmodified. C) The updated opinion issued on prior years' financial statements differs from the opinion originally issued on those financial statements. D) The auditors' unmodified opinion issued on prior years' financial statements is still considered to be appropriate.

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48) Situations in which auditors provide additional copies of a previously issued report or grant entities permission to use a previously issued report in a document containing financial statements after its original date are known as A) additional use reports. B) reissued reports. C) subsequent use reports. D) updated reports.

49) When a predecessor auditor has examined the prior years' financial statements presented in comparative format, the current auditors' report should A) make no reference to the predecessor auditors' report. B) reference the predecessor auditors' report in the Opinion Section, Basis for Opinion Section, and Auditor’s Responsibilities for the Audit of the Financial Statements Section. C) reference the predecessor auditors' report in an other-matter paragraph. D) disclaim an opinion on the prior years' financial statements.

50)

What is the major difference between a reissued report and an updated report?

A) An updated report considers information that has come to the auditors’ attention since the date of the original report, while a reissued report does not consider this information. B) An updated report can be presented along with the entity's financial statements, but a reissued report cannot be presented along with the entity's financial statements. C) An updated report will express a different opinion on the prior years' financial statements that were originally expressed by the auditors, while a reissued report will express the same opinion. D) An updated report will not express an opinion other than an unmodified opinion, while a reissued report can express an unmodified opinion, qualified opinion, adverse opinion, or disclaimer of opinion.

51) On which of the following matters would it not be appropriate for the auditors to report using an other-matter paragraph?

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A) An indication that a predecessor auditor examined prior year’s financial statements presented in comparative form. B) Procedures performed related to supplementary mineral reserve information required by the Financial Accounting Standards Board. C) The consistency of summary financial statements with the audited financial statements from which they were derived. D) An updated opinion on comparative financial statements that differs from the opinion originally issued by the auditors.

52) What is the auditors' responsibility for reporting on other information accompanying financial statements? A) Because this information is not a fundamental part of the financial statements, the auditors have no reporting responsibility with respect to this information. B) Auditors are required to report on the consistency of other information with the audited financial statements. C) Auditors are required to provide reasonable assurance with respect to whether the other information is presented in accordance with generally accepted accounting principles. D) Auditors are required to express an opinion on whether the other information is presented in accordance with generally accepted accounting principles.

53) Which of the following best reflects the auditors' reporting responsibility under generally accepted auditing standards?

A. B. C. D.

Other Information Accompanying the Financial Statements Exception Exception Required Required

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Required Supplementary Information Required Exception Required Exception

A) Option A B) Option B C) Option C D) Option D

54) Which of the following is true with respect to the auditors' report on summary financial statements? A) Auditors can only issue a report on summary financial statements if they have expressed an unmodified opinion on the full financial statements. B) The report will indicate whether the summary financial statements are fairly stated in relation to the full financial statements. C) The report will express limited assurance on whether the summary financial statements are prepared in accordance with AICPA presentation guidelines. D) The report will express an opinion on whether the summary financial statements present the financial condition, results of operations, and cash flows in accordance with generally accepted accounting principles.

55) An auditor who is unable to form an opinion on a new client's opening inventory balances may issue an unmodified opinion on the current year's A) income statement only. B) statement of cash flows only. C) balance sheet only. D) statement of changes in shareholders' equity only.

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A) add an other-matter paragraph to the standard (unmodified) report that justifies the omission. B) refuse to accept the engagement as proposed because of the client-imposed scope limitation. C) explain to Zag that the omission requires a qualification of the auditors' opinion. D) prepare the statement of cash flows as an accommodation to Zag and express an unmodified opinion.

57) A client has capitalizable leases but refuses to capitalize them in the financial statements. Which of the following reporting options does an auditor have if the misstatements have a material and pervasive effect on the financial statements? A) Qualified opinion. B) Unmodified opinion. C) Disclaimer of opinion. D) Adverse opinion.

58) Hart, CPA, is auditing the year 2 financial statements of Kell Co. Previously, Hart audited Kell's year 1 financial statements and expressed a qualified opinion due to a scope limitation. Hart decides to include an other-matter paragraph in the year 2 report because comparative financial statements are being presented for year 2 and year 1. This paragraph should indicate the A) substantive reasons for the prior year's qualification. B) reason that Hart continued to provide audit services, despite the previous scope limitation. C) consistency of application of accounting principles between year 2 and year 1. D) restriction on the distribution of the report.

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A) document in the engagement letter that the group auditors assume no responsibility for the component auditors' work. B) obtain written permission from the component auditors to omit the reference in the group auditors' report. C) contact the component auditors' and review the audit programs and working papers pertaining to the subsidiary. D) add an other-matter paragraph to the group auditors' report indicating that the subsidiary's financial statements are not material to the consolidated financial statements.

60) In which of the following should an auditors' report refer to the lack of consistency when there is a change in accounting principle that is significant? A) The Auditor’s Responsibilities for the Audit of the Financial Statements Section. B) The Opinion Section. C) An emphasis-of-matter paragraph following the Basis for Opinion Section. D) An emphasis-of-matter paragraph preceding the Basis for Opinion Section.

61) An entity's comparative financial statements include the financial statements of the prior year that were audited by a predecessor auditor whose report is not presented. If the predecessor's report was qualified, the successor should A) issue an updated comparative report indicating the involvement of component auditors. B) explain to the client that comparative financial statements may not be presented under these circumstances. C) express an opinion only on the current year's financial statements and make no reference to the prior years' statements. D) indicate the substantive reasons for the qualification in the predecessor auditors' opinion.

62) How do auditors make the following representations when issuing the standard (unmodified) auditors' report? Consistent Application of

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Independence Requirement

Accounting Principles Implicitly Explicitly Implicitly Explicitly

A. B. C. D.

Explicitly Implicitly Explicitly Explicitly

A) Option A B) Option B C) Option C D) Option D

63) An auditor concludes that there is substantial doubt about an entity's ability to continue as a going concern for a reasonable period of time. The entity's financial statements adequately disclose its financial difficulties. Under these circumstances, the auditor's report is required to include an emphasis-of-matter paragraph that specifically uses the phrase(s). "Except for the Effects of Such Adjustments" A. B. C. D.

Yes Yes No No

"Possible Discontinuance of the Entity's Operations" Yes No Yes No

A) Option A B) Option B C) Option C D) Option D

64) After considering management's plans, an auditor concludes that there is substantial doubt about a client's ability to continue as a going concern for a reasonable period of time. The auditor's responsibility includes

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A) disclaiming an opinion on the financial statements due to the indications of possible financial difficulties. B) indicating to the client's audit committee whether management's plans for dealing with the adverse effects of the financial difficulties can be effectively implemented. C) considering the adequacy of disclosure about the client's possible inability to continue as a going concern. D) issuing a qualified or adverse opinion, depending upon materiality, due to the possible effects on the financial statements.

65) When qualifying an opinion because of an insufficiency of audit evidence, an auditor should refer to the situation in the Auditor’s Responsibilities for the Audit of the Financial Statements Section Yes Yes No No

A. B. C. D.

Notes to the Financial Statements Yes No Yes No

A) Option A B) Option B C) Option C D) Option D

66) An auditor may report on summary financial statements that are derived from a complete set of audited financial statements only if the auditor

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A) expresses an unmodified opinion on the audited financial statements from which the summary financial statements are derived. B) indicates whether the information is fairly stated in all material respects in relation to the complete financial statements. C) determines that the summary financial statements include all the disclosures necessary for the complete set of financial statements. D) presents the summary financial statements in comparative form with the prior years' summary financial statements.

67) the

Issuers’ financial statements should be accompanied by all of the following reports except

A) auditors' report on internal control over financial reporting. B) management's report on internal control over financial reporting. C) auditors' report on financial statements and related disclosures. D) management's report on financial statements and related disclosures.

68) When auditors conclude that a material and pervasive departure from GAAP exists in an entity's financial statements, which of the following phrases would most likely be included in their report? A) "Do not present fairly." B) "Except for the effects of the matter described in the Basis for Qualified Opinion Section of our report…" C) "We were engaged to audit the accompanying financial statements." D) "As a result of the departures discussed in the Opinion Section of our report…"

69) Which of the following would not be communicated to users in the auditors' report on an entity's financial statements and related disclosures?

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A) Whether the financial statements are presented in accordance with GAAP, or another applicable financial reporting framework. B) Unusual aspects of the audit examination, such as the involvement of component auditors in the audit of group financial statements. C) Specific details regarding the audit examination, such as the materiality threshold used to identify material misstatements. D) Other matters affecting the client, such as substantial doubt about the entity's ability to continue as a going concern.

70) Management determined it was probable that a pending litigation claim would result in a material loss. The loss was disclosed in the footnotes to the financial statements but was not accrued in the income statement. If the auditors believe an accrual should be made, what type of report should be issued? A) Standard (unmodified) report. B) Unmodified opinion with an emphasis-of-matter paragraph. C) Qualified opinion based on a circumstance-imposed scope limitation. D) Qualified or adverse opinion based on a departure from GAAP.

71) The auditors have determined that there is substantial doubt about an entity's ability to continue as a going concern. When considering the appropriateness of management's disclosures and severity of the uncertainty, all of the following reports could be issued, except A) qualified opinion based on a material and pervasive uncertainty. B) unmodified opinion with an additional section describing the uncertainty. C) adverse opinion based on inadequate disclosure of the uncertainty. D) disclaimer of opinion based on a material and pervasive uncertainty.

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A) Qualified or adverse opinion. B) Disclaimer or adverse opinion. C) Disclaimer of opinion or qualified opinion. D) Unmodified opinion with an other-matter paragraph.

73) When a circumstance-imposed scope limitation has a material but not pervasive effect on the sufficiency of the auditors' evidence, the auditors' report will A) modify the Opinion Section and Basis for Opinion Section. B) modify the Opinion Section and Auditor’s Responsibilities for the Audit of the Financial Statements Section. C) modify the Opinion Section, Basis for Opinion Section, and Auditor’s Responsibilities for the Audit of the Financial Statements Section. D) modify the Opinion Section and Basis for Opinion Section and omit the Auditor’s Responsibilities for the Audit of the Financial Statements Section.

74) Which of the following guidelines should be followed when a disclaimer of opinion is issued? A) The report should identify the financial statements accompanying the disclaimer of opinion. B) The report should be addressed to the client and specific users who originally retained the auditors. C) If the disclaimer is due to a lack of independence, the report should indicate the specific reasons for the auditors not being independent. D) The report should describe any auditing procedures performed prior to issuing the disclaimer.

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A) The report should be modified to include an emphasis-of-matter paragraph describing the pending litigation. B) A disclaimer of opinion should be issued because the auditors' independence is impaired. C) The litigation will not have any impact on the report or auditors' independence unless Holmes & Smith are found guilty. D) A qualified or adverse opinion should be issued depending on the severity of the lawsuit.

76) Holmes, CPA, assisted Williams Corporation in preparing its financial statements and gave Williams permission to use Holmes's name in communications containing these financial statements. If Holmes did not audit the financial statements, what type of opinion should be expressed? A) Unmodified opinion with an other-matter paragraph limiting the level of assurance provided by Holmes. B) Qualified opinion with indicating a circumstance-imposed scope limitation. C) Disclaimer of opinion because Holmes did not audit the financial statements. D) Homes is not required to issue a report or opinion in this situation.

77) Carson, LLP, audited Best Corporation's financial statements for the year ended December 31, Year 1. On February 15, Year 3, Carson gave Best permission to reissue the report previously issued on and dated March 1, Year 2. When is the cutoff date for Carson's responsibility on the reissued report? A) December 31, Year 1. B) March 1, Year 2. C) December 31, Year 2. D) February 15, Year 3.

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A) issue a qualified opinion on the comparative financial statements as a whole. B) issue an unmodified opinion on the Year 1 financial statements and disclaim an opinion on the Year 2 financial statements. C) issue an unmodified opinion on the Year 1 financial statements and a qualified opinion on the Year 2 financial statements. D) reissue the previous opinion on the Year 1 financial statements and withdraw from the engagement.

79) When updating the report on prior years' financial statements presented in comparative form, the auditors' responsibility for the prior years' financial statements is A) limited to the previously issued report date. B) extended to the date of the updated audit report. C) limited to 30 days after the date of the prior years' financial statements. D) extended to the updated report date only if information comes to the auditors' attention requiring modification of the previously expressed opinion.

80) When a previously expressed opinion is updated from qualified to unmodified, the auditors' report on comparative financial statements should A) not modify the previously expressed opinion or refer to factors affecting the opinion on the prior years' financial statements. B) update the opinion expressed on the prior years' financial statements but provide no explanation for the updated opinion. C) not modify the previously expressed opinion but include a reference to the footnote describing the factors affecting the opinion on the prior years' financial statements. D) update the previously expressed opinion and explain the reasons for the change, including a reference to the footnote describing the change.

81) When reporting on financial statements that include only summarized totals of account balances, the auditors' conclusion should state whether the information in the summary financial statements

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A) is complete with respect to disclosures required by the SEC. B) is fairly stated, in all material respects, in accordance with generally accepted accounting principles. C) is consistent, in all material respects, with the prior years' summary financial statements. D) is fairly stated, in all material respects, in relation to the complete financial statements.

82) When other information is presented in a document with audited financial statements, the auditors' report should A) state that the auditor read the other information for inconsistencies and misstatements with the financial statements. B) provide limited assurance as to whether the other information is presented in accordance with generally accepted accounting principles. C) reference the other information only if inconsistencies or material misstatements are identified between this information and the financial statements. D) be expanded to express an opinion that the other information is consistent with the financial statements and not materially misstated.

83) Harris is auditing the financial statements of Cole Corp., an energy company. The FASB requires that these financial statements must be accompanied by supplementary mineral reserve information. If this required information is materially misstated, what type of report should Harris issue? A) Unmodified opinion with an other-matter paragraph disclaiming an opinion on the mineral reserve information. B) Adverse opinion on the financial statements and mineral reserve information due to the misstatement. C) Unmodified opinion on the financial statements with an other-matter paragraph expressing an adverse opinion on the mineral reserve information. D) Qualified opinion on the financial statements and mineral reserve information due to the misstatement.

84)

The standard (unmodified) report issued in the audit of a non-issuer includes a(n)

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A) Responsibilities of Management for the Financial Statements Section providing a general description of an audit conducted in accordance with the applicable auditing standards. B) Opinion Section identifying the responsibility of management and auditors in the financial reporting process. C) Internal Control Section indicating the effectiveness of the entity's internal control over financial reporting. D) Opinion Section providing the auditors' conclusion as to the fair presentation of the financial statements.

ESSAY. Write your answer in the space provided or on a separate sheet of paper. 85) Below are two independent situations. A.Grinner and Greeter, CPAs, were engaged to perform an audit of the financial statements of Happy, Inc. Happy's management would not allow Grinner and Greeter to confirm any of the accounts receivable. All other auditing procedures were performed as considered necessary by Grinner and Greeter and no issues were encountered. However, Grinner and Greeter were unable to satisfy themselves with regard to the balance in accounts receivable. B.Tick and Tie, CPAs, were performing their annual audit of Johnson Manufacturing Company. Johnson is currently being sued for $2,000,000 related to an alleged defective product that they sold to a customer. Johnson's legal counsel has told Tick and Tie that it is probable that Johnson will lose the suit and have to pay the entire $2,000,000. Johnson's management has included information in the footnotes about the lawsuit. However, they have not recorded any loss or liability in the income statement or balance sheet. Required: For each of the independent situations presented above, state what type of opinion should be issued on the company's financial statements. Briefly explain your rationale. Finally, state what modifications, if any, would be required to the standard report.

86) Define a scope limitation and distinguish between client-imposed and circumstanceimposed scope limitations. What reporting options are available to auditors when scope limitations are encountered during the engagement?

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87) Murray & Co., CPAs completed the audit of Classic, Inc., a non-issuer, on March 1, 2018 for a January 31, 2018 fiscal year end. The audit team encountered no significant issues and found no material misstatements. Murray & Co. has audited Classic, Inc. for several years and past audits did not reveal any significant issues or material misstatements. The audit team partner determined that a standard (unmodified) report on Classic, Inc.'s financial statements was appropriate. The auditors’ report, drafted by I.M. Nu, a staff assistant, is provided below. Independent Auditor’s Report To the Board of Directors and Shareholders Classic, Inc. Report on the Audit of the Financial Statements Opinion We have audited the financial statements of Classic Inc., which comprise the balance sheet as of January 31, 2021 and the related statements of changes in shareholders' equity and cash flows for the year then ended, and the related notes to the financial statements. In our opinion, the accompanying financial statements present fairly, the financial position of Classic, Inc. as of January 31, 2021 and the results of its operations and its cash flows for the year then ended. Basis for Opinion We conducted our audit in accordance with generally accepted auditing standards. We are required to be independent of Classic Inc. and to meet our other ethical responsibilities, in accordance with the relevant ethical requirements relating to our audit. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion. Responsibilities of Management 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. In preparing the financial statements, management is required to evaluate whether there are conditions or events, considered in the aggregate, that raise substantial doubt about Classic Inc.’s ability to continue as a going concern for one year following the issuance of the financial statements. Auditor’s Responsibilities for the Audit of the Financial Statements Our objectives are to obtain reasonable assurance about whether the financial statements as a

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whole are free from material misstatement, whether due to fraud or error. Reasonable assurance is a high level of assurance but is not absolute assurance and therefore is not a guarantee that an audit conducted in accordance with GAAS will always detect a material misstatement when it exists. Misstatements are considered material if, individually or in the aggregate, they could reasonably be expected to influence the economic decisions of users made on the basis of these financial statements. In performing an audit in accordance with GAAS, we: [detail omitted; assume all elements of the GAAS audit are appropriately worded] Murray & Co, CPAs January 31, 2021 Required: Identify the deficiencies and errors in the draft report. Do not rewrite the report, but be specific as to what is incorrect or omitted. Organize your answer by paragraph or section.

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Answer Key Test name: Chap 12_8e_Test Bank 1) A 2) C 3) A 4) D 5) A 6) B 7) C 8) B 9) D 10) B 11) B 12) A 13) A 14) A 15) D 16) A 17) D 18) B 19) D 20) B 21) A 22) A 23) A 24) B 25) D 26) D Version 1

27) C 28) A 29) D 30) A 31) D 32) C 33) D 34) C 35) B 36) A 37) B 38) B 39) B 40) C 41) C 42) A 43) A 44) A 45) D 46) D 47) C 48) B 49) C 50) A 51) C 52) B 53) C 54) B 55) C 56) C Version 1

57) D 58) A 59) C 60) C 61) D 62) A 63) D 64) C 65) D 66) B 67) D 68) A 69) C 70) D 71) A 72) C 73) A 74) A 75) B 76) C 77) B 78) C 79) B 80) D 81) D 82) A 83) A 84) D

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85) A. The company has imposed a scope limitation on Grinner and Greeter. Although it is possible to issue a qualified opinion for a less material scope limitation, disclaimers of opinion are more appropriately issued for client-imposed scope limitations than for circumstance-imposed scope limitations. For the disclaimer of opinion: ● The Opinion Section (labeled Disclaimer of Opinion) would be modified to note that the audit team was “engaged” to audit the financial statements, express a disclaimer of opinion, and indicate that the audit team was unable to gather sufficient appropriate evidence. ● The Basis for Opinion Section (labeled Basis for Disclaimer of Opinion) would be modified to identify the scope limitation and delete the standard paragraph indicating that a GAAS audit had been conducted. ● The Auditor’s Responsibilities for the Audit of the Financial Statements Section would be modified to note that the audit team was not able to obtain sufficient appropriate evidence and delete language describing an audit and indicating that the audit provides a reasonable basis for the opinion., B. Because Johnson Manufacturing has not properly recorded a loss and a liability, the financial statements are not in accordance with generally accepted accounting principles. Therefore, depending on the overall materiality and pervasiveness of the misstatement, Tick and Tie should issue either a qualified or adverse opinion. In each case, the report would be modified as follows: ● The Opinion Section (labeled Qualified Opinion or Adverse Version 1

Opinion) would be modified to express the appropriate type of opinion. ● The Basis for Opinion Section (labeled Basis for Qualified Opinion or Basis for Adverse Opinion) would include a description of the departure from GAAP. 86) Scope limitations are situations in which auditors are unable to obtain sufficient appropriate evidence. Circumstance-imposed scope limitations are those limitations that are beyond the auditors’ or client’s control (for example, late appointment of the auditors); client-imposed scope limitations are based on deliberate refusals by the client to provide access to evidence or otherwise limit the auditors’ application of auditing procedures. The auditors’ reporting options are as follows: 1.If alternative procedures are available, a standard (unmodified) report is issued. 2.If the scope limitation is material, but not pervasive, a qualified opinion is issued. 3.If the scope limitation is material and pervasive, a disclaimer of opinion is issued. Because of the nature of a client-imposed scope limitation, a disclaimer of opinion is normally appropriate in these circumstances.

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87) Opinion Section: a.The consolidated statements of income are not included as one of the financial statements audited. b.The phrase "in all material respects" has been omitted. c.The final sentence should conclue with the phrase "in accordance with accounting principles generally accepted in the United States of America" Basis for Opinion Section: a.The first sentence should indicate that the audit was conducted in accordance with "auditing standards generally accepted in the United States of America" and not "generally accepted auditing standards". b.The reference to the Auditor’s Responsibilities for the Audit of the Financial Statements Section is omitted. Responsibilities of Management for the Financial Statements Section: a.The wording related to management's responsibility for the design, implementation, and maintenance of internal control has been omitted. Auditor's Responsibilities for the Audit of the Financial Statements Section: a.In the first sentence, the auditors’ responsibility to issue an audit report is omitted. b.The sentence indicating that the risk of not detecting a material misstatement resulting from fraud is higher than one resulting from error has been omitted. c.The paragraph relating to communications with those charged with governance has been omitted. Other: Version 1

a.The report should be dated as of the audit completion date (March 1, 2021) and not the date of the financial statements (January 31, 2021).

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CHAPTER 12 MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) Which of the following statements is not included in the Basis for Opinion section of the standard report? A) "These financial statements are the responsibility of [the company’s] management." B) "Those standards require that we plan and perform the audit to obtain reasonable assurance…" C) "…it is not a guarantee that an audit conducted in accordance with GAAS will always detect a material misstatement…" D) "We believe that our audit provides a reasonable basis for our opinion"

2) Which of the following situations would not result in auditors adding an explanatory paragraph without modifying the remainder of the report? A) Reference to a change in the method of accounting mandated by the issuance of a new accounting standard. B) Reference to a going-concern uncertainty facing the entity. C) Reference to a departure from GAAP that is material, but not pervasive, to the financial statements. D) Reference to an acquisition made by the entity during the most recent fiscal year.

3) Which of the following statements is not included in the Basis for Opinion section of the standard report on the entity's financial statements? A) "The critical audit matter communicated is a matter arising from the current period audit…" B) "We are a public accounting firm registered with the Public Company Accounting Oversight Board…" C) "Our audit included evaluating the accounting principles used and significant estimates made by management..." D) "We conducted our audit in accordance with the standards of the PCAOB."

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Auditors are required to reference consistency in their report when there are changes in A) accounting estimates. B) the format of the Statement of Cash Flows. C) the classification of financial statement amounts. D) accounting principles.

7) When auditors are engaged to examine an entity's financial statements but decide to issue a disclaimer of opinion because of a scope limitation, the report would not A) identify management's responsibility for the financial statements. B) refer to any scope limitation in the Basis for Opinion Section. C) identify the scope limitation as a critical audit matter. D) indicate that the auditors were engaged to audit the financial statements in the Disclaimer of Opinion on the Financial Statements section.

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10) The auditors' report on the entity's financial statements included language disclosing a difference of opinion between the auditors and the entity for which the auditors believed an adjustment to the financial statements should be made. The Opinion on the Financial Statements section of the auditors' report should express a(n) A) unqualified opinion. B) qualified opinion citing a departure from generally accepted accounting principles. C) qualified opinion citing a scope limitation and lack of specific evidence. D) disclaimer of opinion.

11)

Auditors will issue an adverse opinion when

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12)

The issuance of a disclaimer of opinion generally indicates

13) When an entity will not permit inquiry of outside legal counsel, the auditors' report on the entity's financial statements will ordinarily contain a(n) A) disclaimer of opinion. B) qualified opinion referencing a departure from generally accepted accounting principles. C) unqualified opinion with an explanatory paragraph. D) adverse opinion.

14) In which of the following circumstances may auditors issue the standard report on the entity's financial statements?

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A) The entity changed accounting principles having an immaterial effect on the entity's financial position, results of operations, and cash flows. B) The auditors wish to emphasize a matter regarding the financial statements. C) The auditors reference component auditors who examined a subsidiary of group financial statements. D) The auditors have not been able to audit a substantial portion of the balance sheet because of a circumstance-imposed scope limitation.

16) When auditors lack independence, which of the following is true about the report on the entity's financial statements that should be issued? A) The auditors should disclaim an opinion and should state specifically that they are not independent. B) The auditors should disclaim an opinion but not mention that they are not independent. C) The auditors should issue an unqualified opinion with an explanatory paragraph stating that they are not independent. D) The auditors should issue a qualified opinion with an explanatory paragraph stating that they are not independent.

17)

In which of the following circumstances would a qualified opinion not be appropriate?

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18) Auditors should disclose the substantive reasons for expressing an adverse opinion on the entity's financial statements in A) the Opinion on the Financial Statements section. B) the Basis for Opinion section. C) the Critical Audit Matters section. D) the footnotes to the financial statements.

19) When auditors qualify their opinion on the entity's financial statements because of inadequate disclosure, the auditors should describe the nature of the omission and modify A) the Opinion on the Financial Statements section only. B) the Basis for Opinion section only. C) the Critical Audit Matters section only. D) the Opinion on the Financial Statements section and the Basis for Opinion section.

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A) a qualified opinion on the entity's financial statements, referring to a departure from generally accepted accounting principles. B) a disclaimer of opinion on the entity's financial statements. C) an unqualified opinion on the entity's financial statements with an explanatory paragraph. D) an unqualified opinion on the entity's financial statements with a modification of the Basis for Opinion section.

21) If management fails to provide adequate justification for a change from one generally accepted accounting principle to another, the auditors should A) Modify the Opinion on the Financial Statements section of the report for lack of conformity with generally accepted accounting principles. B) Modify the Opinion on the Financial Statements section and Basis for Opinion section of the report for lack of conformity with generally accepted accounting principles. C) disclose the matter in an explanatory paragraph but not modify the Opinion on the Financial Statements section of the report. D) Not modify the report because both principles are generally accepted accounting principles.

23) Auditors who are reporting on financial statements that contain a material departure from generally accepted accounting principles should Version 1

A) express a qualified or adverse opinion. B) not modify the Opinion on the Financial Statements section of the report as long as the departure is adequately disclosed in a footnote. C) disclaim an opinion on the financial statements. D) express a qualified opinion or disclaimer of opinion.

24) Which of the following is an example of a material accounting change that requires recognition in an unqualified opinion on the entity's financial statements? A) A change in the estimate of useful lives used to depreciate property, plant, and equipment. B) A change in the entity's form of reporting entity. C) Management has changed from one generally accepted accounting principle to another but has not provided reasonable justification. D) A change from an accounting principle that conforms with GAAP to one that does not.

25) Independent auditors must consider whether the entity has the ability to continue as a going concern. If a substantial doubt exists but disclosure is adequate and no other basis exists for modifying the report, the auditors would normally A) disclaim an opinion. B) express an adverse opinion. C) qualify the opinion. D) express an unqualified opinion with an explanatory paragraph describing the goingconcern uncertainty.

26) Auditors most likely would issue a disclaimer of opinion on the entity's financial statements because of

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A) inadequate disclosure of material information. B) the omission of the Statement of Cash Flows. C) a material departure from generally accepted accounting principles. D) management's refusal to furnish written representations.

27) When disclaiming an opinion due to a client-imposed scope limitation, auditors should describe the nature of the scope limitation and modify the A) Disclaimer of Opinion on the Financial Statements section. B) Basis for Disclaimer of Opinion section. C) Disclaimer of Opinion on the Financial Statements section and Basis for Disclaimer of Opinion section. D) Disclaimer of Opinion on the Financial Statements section, Basis for Disclaimer of Opinion section, and explanatory paragraph.

29) When audited financial statements are presented in a document containing other information, the auditors should

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A) perform inquiry and analytical procedures to ascertain whether the other information is reasonable. B) add an explanatory paragraph describing the other information to the auditors' report without modifying the opinion on the financial statements. C) perform the appropriate substantive procedures to corroborate the other information. D) read the other information to determine that it is consistent with the audited financial statements.

30) Reference in a group auditors' report to the fact that part of the audit of group financial statements was performed by component auditors most likely would be an indication of A) involvement of component auditors in the audit of the group financial statements. B) the portion of the group statements audited by the component auditors not being considered material. C) group auditors' recognition of the component auditors' competence, reputation, and professional certification. D) different opinions the auditors are expressing on the components of the financial statements that each audited.

31) The auditors include an explanatory paragraph in an otherwise unqualified report on the entity's financial statements to emphasize that the entity being reported on had significant transactions with related parties. The inclusion of this separate paragraph A) is considered a qualification of the opinion. B) violates generally accepted auditing standards if this information is already disclosed in footnotes to the financial statements. C) necessitates a revision of the Opinion Section to include the phrase "with the foregoing explanation." D) is appropriate and would not otherwise affect the unqualified opinion.

32) When there has been a change in accounting principles, but the effect of the change on the comparability of the financial statements is not material, the auditors should

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A) refer to the change in an explanatory paragraph. B) explicitly concur that the change is preferred. C) not refer to consistency in the report. D) refer to the change in the Basis for Opinion Section.

33) When financial statements contain a departure from GAAP, the auditors should explain the unusual circumstances in a separate paragraph and express an opinion that is A) unqualified. B) qualified. C) adverse. D) qualified or adverse, depending on the overall materiality and pervasiveness of the GAAP departure.

35) In which of the following circumstances would auditors most likely add an explanatory paragraph to the standard report without modifying the opinion on the entity's financial statements?

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A) The auditors are asked to report on the balance sheet, but not on the other basic financial statements. B) There is substantial doubt about the entity's ability to continue as a going concern. C) Management's estimates of the effects of future events on the entity's financial condition, results of operations, and cash flows are unreasonable. D) Certain transactions cannot be tested because of management's records retention policy.

36) Green, CPA, was engaged to audit the financial statements of Essex Co. after its fiscal year had ended. The timing of Green's appointment and the start of fieldwork made confirmation of accounts receivable by direct communication with the customers not feasible. However, Green applied other procedures and was satisfied as to the reasonableness of the account balances. Green's auditors' report most likely contained a(n) A) unqualified opinion. B) unqualified opinion with an explanatory paragraph. C) qualified opinion due to a scope limitation. D) qualified opinion due to a departure from generally accepted auditing standards.

A) adverse opinion or a disclaimer of opinion. B) qualified opinion or an adverse opinion. C) disclaimer of opinion or an unqualified opinion with a separate explanatory paragraph. D) unqualified opinion with a separate explanatory paragraph or a qualified opinion.

39) Auditors would not normally issue a qualified opinion on the entity's financial statements when A) an accounting principle at variance with generally accepted accounting principles is used. B) the auditors lack independence with respect to the audited entity. C) a scope limitation prevents the auditors from completing an important auditing procedure. D) the entity has undertaken a change in accounting principle with which the auditor does not agree.

40) Which of the following phrases would auditors most likely include in their report when expressing a qualified opinion on the entity's financial statements because of inadequate disclosure? A) "Subject to the departure from generally accepted accounting principles, as described below." B) "Except for the effects of [XXX] as discussed in the Basis for Opinion section…” C) "Except for the effects of [XXX] as discussed in the following paragraph…” D) "Does not present fairly in all material respects."

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A) disclose the fact that alternative procedures were used due to client-imposed scope limitation. B) disclose in the Basis for Opinion section that confirmation of accounts receivable was impracticable. C) not mention the alternative procedures. D) include an explanatory paragraph that discloses the performance of alternative procedures.

42) When reporting on comparative financial statements, auditors ordinarily should modify their previously expressed opinion on the prior years' financial statements if the A) prior years' financial statements are restated to conform with generally accepted accounting principles. B) auditors were predecessor auditors who have been requested by a former client to reissue the previous report. C) prior years' opinions were unqualified and the opinion on the current year's financial statements is modified due to a lack of consistency. D) prior years' financial statements are restated following an acquisition in the current year.

43) Which of the following paragraphs or sections of the group auditors' report is modified to identify the extent of component auditor involvement in the audit of group financial statements? A) The Opinion on the Financial Statements section. B) The Basis for Opinion section. C) The Opinion on the Financial Statements section and Basis for Opinion section. D) The explanatory paragraph.

44) When component auditors are involved in the audit of group financial statements, the group auditors are required to

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A) consider the independence and professional reputation of the component auditors in deciding how to utilize their work. B) identify the extent of component auditors' involvement if they choose not to rely on the component auditors' work. C) identify the component auditors by name in their report to appropriate limit their liability for the component auditors' work. D) disclaim an opinion on the portion of the financial statements examined by the component auditors.

45) Which of the following is not an appropriate reporting option when component auditors are involved in the audit of group financial statements, assuming that the component auditors' work did not identify any issues affecting the group auditors' report? A) Issue a standard report that does not reference any involvement by the component auditors. B) Identify the component auditors by name and present their report along with the group auditors' report. C) Refer to the component auditors' work and disclose the extent of their work in the group auditors' report. D) Disclaim an opinion on the portion of the financial statements examined by the component auditors.

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47) Which of the following situations would require auditors to add an explanatory paragraph to their report on comparative financial statements? A) An unqualified opinion is issued in the current year while a qualified opinion was issued in prior years. B) A qualified opinion is issued in the current year because of a scope limitation; because this limitation was not encountered in prior years, the opinion issued in those years was unqualified. C) The updated opinion issued on prior years' financial statements differs from the opinion originally issued on those financial statements. D) The auditors' unqualified opinion issued on prior years' financial statements is still considered to be appropriate.

49) When a predecessor auditor has examined the prior years' financial statements presented in comparative format, the current auditors' report should A) make no reference to the predecessor auditors' report. B) reference the predecessor auditors' report in the Opinion on the Financial Statements section and Basis for Opinion section. C) reference the predecessor auditors' report in an explanatory paragraph. D) disclaim an opinion on the prior years' financial statements.

50)

What is the major difference between a reissued report and an updated report?

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A) An updated report considers information that has come to the auditors’ attention since the date of the original report, while a reissued report does not consider this information. B) An updated report can be presented along with the entity's financial statements, but a reissued report cannot be presented along with the entity's financial statements. C) An updated report will express a different opinion on the prior years' financial statements that were originally expressed by the auditors, while a reissued report will express the same opinion. D) An updated report will not express an opinion other than an unqualified opinion, while a reissued report can express an unqualified opinion, qualified opinion, adverse opinion, or disclaimer of opinion.

51) On which of the following matters would it not be appropriate for the auditors to report using an explanatory paragraph? A) An indication that a predecessor auditor examined prior year’s financial statements presented in comparative form. B) Procedures performed related to supplementary mineral reserve information required by the Financial Accounting Standards Board. C) A departure from GAAP that has a material, but not pervasive, effect on the financial statements. D) An updated opinion on comparative financial statements that differs from the opinion originally issued by the auditors.

52) What is the auditors' responsibility for reporting on other information accompanying financial statements? A) Because this information is not a fundamental part of the financial statements, the auditors have no reporting responsibility with respect to this information. B) Auditors are only required to report on other information if it is inconsistent with information in the audited financial statements. C) Auditors are required to provide reasonable assurance with respect to whether the other information is presented in accordance with generally accepted accounting principles. D) Auditors are required to express an opinion on whether the other information is presented in accordance with generally accepted accounting principles.

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53) Which of the following best reflects the auditors' reporting responsibility under generally accepted auditing standards?

A. B. C. D.

Other Information Accompanying the Financial Statements Exception Exception Required Required

Required Supplementary Information Required Exception Required Exception

A) Option A B) Option B C) Option C D) Option D

54) Which of the following is true with respect to the auditors' report on condensed financial statements? A) Auditors can only issue a report on condensed financial statements if they have expressed an unqualified opinion on the full financial statements. B) The report will indicate whether the condensed financial statements are fairly stated in relation to the full financial statements. C) The report will express limited assurance on whether the condensed financial statements are prepared in accordance with AICPA presentation guidelines. D) The report will express an opinion on whether the condensed financial statements present the financial condition, results of operations, and cash flows in accordance with generally accepted accounting principles.

55) An auditor who is unable to form an opinion on a new client's opening inventory balances may issue an unqualified opinion on the current year's A) income statement only. B) statement of cash flows only. C) balance sheet only. D) statement of shareholders' equity only.

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56) Zag Co. issues financial statements that present financial position and results of operations, but Zag omits the related statement of cash flows. Zag would like to engage Brown, CPA, to audit its financial statements without the statement of cash flows although Brown's access to all of the information underlying the basic financial statements would not be limited. Under the circumstances, Brown most likely would A) add an explanatory paragraph to the standard report that justifies the omission. B) refuse to accept the engagement as proposed because of the client-imposed scope limitation. C) explain to Zag that the omission requires a qualification of the auditors' opinion. D) prepare the statement of cash flows as an accommodation to Zag and express an unqualified opinion.

57) A client has capitalizable leases but refuses to capitalize them in the financial statements. Which of the following reporting options does an auditor have if the misstatements have a material and pervasive effect on the financial statements? A) Qualified opinion. B) Unqualified opinion. C) Disclaimer of opinion. D) Adverse opinion.

58) Hart, CPA, is auditing the year 2 financial statements of Kell Co. Previously, Hart audited Kell's year 1 financial statements and expressed a qualified opinion due to a scope limitation. Hart decides to include an explanatory paragraph in the year 2 report because comparative financial statements are being presented for year 2 and year 1. This paragraph should indicate the A) substantive reasons for the prior year's qualification. B) reason that Hart continued to provide audit services, despite the previous scope limitation. C) consistency of application of accounting principles between year 2 and year 1. D) restriction on the distribution of the report.

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59) The group auditors decide not to refer to the audit of component auditors who audited a subsidiary of the group financial statements. After making inquiries about the component auditors' professional reputation and independence, the group auditor most likely would A) document in the engagement letter that the group auditors assume no responsibility for the component auditors' work. B) obtain written permission from the component auditors to omit the reference in the group auditors' report. C) contact the component auditors' and review the audit programs and working papers pertaining to the subsidiary. D) add an explanatory paragraph to the group auditors' report indicating that the subsidiary's financial statements are not material to the consolidated financial statements.

60) In which of the following should an auditors' report refer to the lack of consistency when there is a change in accounting principle that is significant? A) The Opinion on the Financial Statements section. B) The Basis for Opinion section. C) Both the Opinion on the Financial Statements section and the Basis for Opinion section. D) An explanatory paragraph.

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62) How do auditors make the following representations when issuing the standard auditors' report?

A. B. C. D.

Consistent Application of Accounting Principles Implicitly Explicitly Implicitly Explicitly

Independence Requirement Explicitly Implicitly Explicitly Explicitly

A) Option A B) Option B C) Option C D) Option D

63) An auditor concludes that there is substantial doubt about an entity's ability to continue as a going concern for a reasonable period of time. The entity's financial statements adequately disclose its financial difficulties. Under these circumstances, the auditor's report is required to include an explanatory paragraph that specifically uses the phrase(s).

A. B. C. D.

"Except for the Effects of Such Adjustments" Yes Yes No No

"Possible Discontinuance of the Entity's Operations" Yes No Yes No

A) Option A B) Option B C) Option C D) Option D

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65) When qualifying an opinion because of an insufficiency of audit evidence, an auditor should refer to the situation in the Basis for Opinion Section Yes Yes No No

A. B. C. D.

Notes to the Financial Statements Yes No Yes No

A) Option A B) Option B C) Option C D) Option D

66) An auditor may report on condensed financial statements that are derived from a complete set of audited financial statements only if the auditor A) expresses an unqualified opinion on the audited financial statements from which the condensed financial statements are derived. B) indicates whether the information is fairly stated in all material respects in relation to the complete financial statements. C) determines that the condensed financial statements include all the disclosures necessary for the complete set of financial statements. D) presents the condensed financial statements in comparative form with the prior years' condensed financial statements.

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67) the

Issuers’ financial statements should be accompanied by all of the following reports except

68) When auditors conclude that a material and pervasive departure from GAAP exists in an entity's financial statements, which of the following phrases would most likely be included in their report? A) "Do not present fairly." B) "Except for the effects of the matter described in the Basis for Opinion section of our report…" C) "We were engaged to audit the accompanying financial statements." D) "As a result of the departures discussed in the Opinion on the Financial Statements section of our report…"

69) Which of the following would not be communicated to users in the auditors' report on an entity's financial statements and related disclosures? A) Whether the financial statements are presented in accordance with GAAP, or another applicable financial reporting framework. B) Unusual aspects of the audit examination, such as the involvement of component auditors in the audit of group financial statements. C) Specific details regarding the audit examination, such as the materiality threshold used to identify material misstatements. D) Other matters affecting the client, such as substantial doubt about the entity's ability to continue as a going concern.

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70) Management determined it was probable that a pending litigation claim would result in a material loss. The loss was disclosed in the footnotes to the financial statements but was not accrued in the income statement. If the auditors believe an accrual should be made, what type of report should be issued? A) Standard report. B) Unqualified opinion with an explanatory paragraph. C) Qualified opinion based on a circumstance-imposed scope limitation. D) Qualified or adverse opinion based on a departure from GAAP.

71) The auditors have determined that there is substantial doubt about an entity's ability to continue as a going concern. When considering the appropriateness of management's disclosures and severity of the uncertainty, all of the following reports could be issued, except A) qualified opinion based on a material and pervasive uncertainty. B) unqualified opinion with an additional verbiage describing the uncertainty. C) adverse opinion based on inadequate disclosure of the uncertainty. D) disclaimer of opinion based on a material and pervasive uncertainty.

72) During the year under audit, Forrest Corporation experienced significant losses due to a pervasive fraud scheme. Because of the lack of documentary evidence and inability to perform appropriate auditing procedures, the auditors were unable to determine the total amount of the loss. What type of report should the auditors issue? A) Qualified or adverse opinion. B) Disclaimer or adverse opinion. C) Disclaimer of opinion or qualified opinion. D) Unqualified opinion with an explanatory paragraph.

73) When a circumstance-imposed scope limitation has a material but not pervasive effect on the sufficiency of the auditors' evidence, the auditors' report will

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A) modify the Opinion on the Financial Statements section and Basis for Opinion section. B) modify the Opinion on the Financial Statements section only. C) modify the Basis for Opinion section only. D) modify the Opinion on the Financial Statements section and notes to the financial statements.

74) Which of the following guidelines should be followed when a disclaimer of opinion is issued? A) Because an opinion is not issued, the auditors should not issue a report. B) The report should identify the financial statements accompanying the disclaimer of opinion. C) If the disclaimer is due to a lack of independence, the report should indicate the specific reasons for the auditors not being independent. D) The report should describe any auditing procedures performed prior to issuing the disclaimer.

75) Holmes & Smith, LLP, were engaged to audit the financial statements of Sodolak Reality for the year ended December 31. During the engagement, Sodolak filed a lawsuit against Holmes & Smith, LLP. What effect, if any, will this lawsuit have on the auditors' report? A) The report should be modified to include an explanatory paragraph describing the pending litigation. B) A disclaimer of opinion should be issued because the auditors' independence is impaired. C) The litigation will not have any impact on the report or auditors' independence unless Holmes & Smith are found guilty. D) A qualified or adverse opinion should be issued depending on the severity of the lawsuit.

A) Unqualified opinion with an explanatory paragraph limiting the level of assurance provided by Holmes. B) Qualified opinion with indicating a circumstance-imposed scope limitation. C) Disclaimer of opinion because Holmes did not audit the financial statements. D) Homes is not required to issue a report or opinion in this situation.

78) Harris & Thompson were engaged to audit Smart Corp's comparative financial statements for the years ended December 31, Year 1 and Year 2. The Year 1 financial statements were presented in accordance with generally accepted accounting principles, but the Year 2 financial statements were determined to be materially misstated. As a result, Harris & Thompson should A) issue a qualified opinion on the comparative financial statements as a whole. B) issue an unqualified opinion on the Year 1 financial statements and disclaim an opinion on the Year 2 financial statements. C) issue an unqualified opinion on the Year 1 financial statements and a qualified opinion on the Year 2 financial statements. D) reissue the previous opinion on the Year 1 financial statements and withdraw from the engagement.

79) When updating the report on prior years' financial statements presented in comparative form, the auditors' responsibility for the prior years' financial statements is

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A) limited to the previously issued report date. B) extended to the date of the updated audit report. C) limited to 30 days after the date of the prior years' financial statements. D) extended to the updated report date only if information comes to the auditors' attention requiring modification of the previously expressed opinion.

80) When a previously expressed opinion is updated from qualified to unqualified, the auditors' report on comparative financial statements should A) not modify the previously expressed opinion or refer to factors affecting the opinion on the prior years' financial statements. B) update the opinion expressed on the prior years' financial statements but provide no explanation for the updated opinion. C) not modify the previously expressed opinion but include a reference to the footnote describing the factors affecting the opinion on the prior years' financial statements. D) update the previously expressed opinion and explain the reasons for the change, including a reference to the footnote describing the change.

81) When reporting on financial statements that include only summarized totals of account balances, the auditors' conclusion should state whether the information in the condensed financial statements is A) complete with respect to disclosures required by the SEC. B) fairly stated, in all material respects, in accordance with generally accepted accounting principles. C) consistent, in all material respects, with the prior years' condensed financial statements. D) fairly stated, in all material respects, in relation to the complete financial statements.

82) When other information is presented in a document with audited financial statements, the auditors' report should

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A) state that the auditor read the other information for inconsistencies and misstatements with the financial statements. B) provide limited assurance as to whether the other information is presented in accordance with generally accepted accounting principles. C) reference the other information only if inconsistencies or material misstatements are identified between this information and the financial statements. D) be expanded to express an opinion that the other information is consistent with the financial statements and not materially misstated.

83) Harris is auditing the financial statements of Cole Corp., an energy company. The FASB requires that these financial statements must be accompanied by supplementary mineral reserve information. If this required information is materially misstated, what type of report should Harris issue? A) Unqualified opinion on the financial statements with an explanatory paragraph disclaiming an opinion on the mineral reserve information, but noting the misstatement. B) Adverse opinion on the financial statements and mineral reserve information due to the misstatement. C) Unqualified opinion on the financial statements with an explanatory paragraph expressing a qualified or adverse opinion on the mineral reserve information. D) Qualified opinion on the financial statements and mineral reserve information due to the misstatement.

84)

The standard report issued in the audit of an issuer includes a(n)

A) Responsibilities of Management for the Financial Statements Section providing a general description of an audit conducted in accordance with the applicable auditing standards. B) Opinion on the Financial Statements section identifying the responsibility of management and auditors in the financial reporting process. C) Critical Audit Matters section indicating that an audit was conducted in accordance with PCAOB standards. D) Opinion on the Financial Statements section providing the auditors' conclusion as to the fair presentation of the financial statements.

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ESSAY. Write your answer in the space provided or on a separate sheet of paper. 85) Below are two independent situations. A. Grinner and Greeter, CPAs, were engaged to perform an audit of the financial statements of Happy, Inc. Happy's management would not allow Grinner and Greeter to confirm any of the accounts receivable. All other auditing procedures were performed as considered necessary by Grinner and Greeter and no issues were encountered. However, Grinner and Greeter were unable to satisfy themselves with regard to the balance in accounts receivable. B. Tick and Tie, CPAs, were performing their annual audit of Johnson Manufacturing Company. Johnson is currently being sued for $2,000,000 related to an alleged defective product that they sold to a customer. Johnson's legal counsel has told Tick and Tie that it is probable that Johnson will lose the suit and have to pay the entire $2,000,000. Johnson's management has included information in the footnotes about the lawsuit. However, they have not recorded any loss or liability in the income statement or balance sheet. Required: For each of the independent situations presented above, state what type of opinion should be issued on the company's financial statements. Briefly explain your rationale. Finally, state what modifications, if any, would be required to the standard report.

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87) Murray & Co., CPAs completed the audit of Classic, Inc., an issuer, on March 1, 2021 for a January 31, 2021 fiscal year end. The audit team encountered no significant issues and found no material misstatements. The audit team partner determined that a standard report on Classic, Inc.'s financial statements was appropriate. The auditors' report, drafted by I.M. Nu, a staff assistant, is provided below. (Nu has decided to present separate reports on the financial statements and on internal control over financial reporting). Report of Independent Registered Public Accounting Firm To the Shareholders and Board of Directors Classic, Inc. Opinion on the Financial Statements

We have audited the accompanying balance sheet of Classic Inc. (the Company) as of December 31, 2020 and the related statements of comprehensive income, stockholders' equity, and cash flows for the period ended December 31, 2020, and the related notes (collectively referred to as the "financial statements"). In our opinion, the financial statements present fairly, the financial position of the Company as of December 31, 2020, and the results of its operations and its cash flows for the period ended December 31, 2020. Basis for Opinion

Our responsibility is to express an opinion on the Company’s financial statements based on our audit. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Our audit included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audit also included evaluating the overall presentation of the financial statements. We believe that our audit provides a reasonable basis for our opinion.

Critical Audit Matters

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The critical audit matter communicated is a matter arising from the current period audit of the financial statements that was communicated or required to be communicated to the audit committee. Because we are expressing an unqualified opinion, PCAOB standards do not require communication of critical audit matters in our report.

Murray & Co, CPAs January 31, 2021 Required: Identify the deficiencies and errors in the draft report. Do not rewrite the report, but be specific as to what is incorrect or omitted. Organize your answer by paragraph or section.

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Answer Key Test name: Chap 12_8e_Test Bank_Alternate 1) C 2) C 3) A 4) D 5) A 6) B 7) C 8) B 9) D 10) B 11) B 12) A 13) A 14) A 15) D 16) A 17) D 18) A 19) A 20) B 21) A 22) A 23) A 24) B 25) D 26) D Version 1

27) C 28) A 29) D 30) A 31) D 32) C 33) D 34) C 35) B 36) A 37) B 38) B 39) B 40) C 41) C 42) A 43) C 44) A 45) D 46) D 47) C 48) B 49) C 50) A 51) C 52) B 53) A 54) B 55) C 56) C Version 1

57) D 58) A 59) C 60) D 61) D 62) A 63) D 64) C 65) B 66) B 67) D 68) A 69) C 70) D 71) A 72) C 73) A 74) B 75) B 76) C 77) B 78) C 79) B 80) D 81) D 82) A 83) A 84) D

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85) A.The company has imposed a scope limitation on Grinner and Greeter. Although it is possible to issue a qualified opinion for a less material scope limitation, disclaimers of opinion are more appropriately issued for client-imposed scope limitations. For the disclaimer of opinion: • The Opinion on the Financial Statements section (labeled Disclaimer of Opinion on the Financial Statements) would be modified to note that the audit team was “engaged” to audit the financial statements, indicate that the audit team was unable to gather sufficient appropriate evidence, express a disclaimer of opinion, and identify the scope limitation. • The Basis for Opinion section (labeled Basis for Disclaimer of Opinion) would be modified to delete the sentence describing the responsibility of auditors to express an opinion and delete the standard paragraph indicating that a GAAS audit had been conducted. • The Critical Audit Matters section would not be included. B. Because Johnson Manufacturing has not properly recorded a loss and a liability, the financial statements are not in accordance with generally accepted accounting principles. Therefore, depending on the overall materiality and pervasiveness of the misstatement, Tick and Tie should issue either a qualified or adverse opinion. In each case, the report would be modified as follows: • The Opinion on the Financial Statements section would be modified to express the appropriate type of opinion and include a description of the departure from GAAP. • The Critical Audit Matters section would be deleted (for adverse opinions).

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86) Scope limitations are situations in which auditors are unable to obtain sufficient appropriate evidence. Circumstance-imposed scope limitations are those limitations that are beyond the auditors’ or client’s control (for example, late appointment of the auditors); client-imposed scope limitations are based on deliberate refusals by the client to provide access to evidence or otherwise limit the auditors’ application of auditing procedures. The auditors' reporting options are as follows: 1. If alternative procedures are available, a standard report is issued. 2. If the scope limitation is material, but not pervasive, a qualified opinion is issued. 3. If the scope limitation is material and pervasive, a disclaimer of opinion is issued. Because of the nature of a client-imposed scope limitation, a disclaimer of opinion is normally appropriate in these circumstances.

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87) Opinion on the Financial Statements section: a. The consolidated statement of income is not included as one of the financial statements audited. b. The phrase "in all material respects" has been omitted. c. The final sentence should conclude with the phrase "in conformity with accounting principles generally accepted in the United States of America" d. The paragraph referencing the auditors’ report on internal control over financial reporting, as well as the opinion expressed in that report, has been omitted. Basis for Opinion section: a. The sentence indicating that the financial statements are the responsibility of management has been omitted. b. The sentence indicating the requirement to obtain reasonable assurance has been omitted. c. The phrase related to the requirement to assess the accounting principles used and significant estimates made by management has been omitted. Critical Audit Matters section: a. The description of characteristics of a critical audit matter (accounts that are material to the financial statements and involve challenging, subjective, or complex judgments) have been omitted. b. The language indicating that PCAOB standards do not require communication of critical audit matters is inappropriate. Other: a. The report should be dated as of the audit completion date (March 1, 2021) and not the date of the financial statements (January 31, 2021).

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___ 1. Departure from generally accepted accounting principles that is material but not pervasive. ___ 2. Going-concern uncertainties that may have a material (but not pervasive) effect on the financial statements. ___ 3. Emphasis of a matter, no GAAP departure. ___ 4. Material, but not pervasive, scope limitation. ___ 5. Material and pervasive departure from GAAP.

2) For each of the sentences or phrases below, indicate, by letter, in which section of the standard report on the entity's financial statements the sentence or phrase would appear. A. Opinion on the Financial Statements section B. Basis for Opinion section C. Critical Audit Matters section ___ 1. We conducted our audit in accordance with the standards of the PCAOB. ___ 2. We have audited the accompanying balance sheet of Draper Company… ___ 3. These financial statements are the responsibility of Draper Company’s management. ___ 4. In our opinion, the financial statements present fairly… ___ 5. We believe that our audit provides a reasonable basis for our opinion

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___ 6. The communication of critical audit matters does not alter in any way our opinion on the financial statements…

3) For each of the situations below, indicate, by letter, the type of report most likely to be issued. A. Unqualified opinion, no modification. B. Unqualified opinion, explanatory paragraph for consistency. C. Unqualified opinion, explanatory paragraph for a going-concern uncertainty. D. Qualified opinion. E. Disclaimer of opinion ___ 1. The entity has a lawsuit pending against them. There is significant uncertainty about the outcome of the lawsuit, which could have a significant impact on the viability of the entity. Management has provided adequate disclosure of the lawsuit in the footnotes accompanying the financial statements. ___ 2. The entity has a lawsuit pending against them. It is probable that the entity will lose the suit. Management has accrued the best estimate of the loss and provided adequate disclosure. It is not expected that this lawsuit will have a significant effect on the entity's ability to continue as a going concern. ___ 3. The entity has a lawsuit pending against them. It is probable that the entity will lose the suit. Management has not accrued the best estimate of the loss, but has provided information in the footnotes. It is not expected that this lawsuit will have a significant effect on the entity's ability to continue as a going concern. ___ 4. Based on recent analysis of usage, the entity has changed the useful life of its office equipment from five to four years. This change is reflected in the depreciation amounts computed for the current year. ___ 5. The entity's management has not provided written representations requested by the auditors. The failure to provide these representations is considered to be a significant limitation on the scope of the auditors' work.

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4) Listed below are words and phrases from the auditors' standard report on a non-issuer's financial statements. For each of the words and phrases indicate by letter in which section of the standard report they should appear. A. Opinion on the Financial Statements section B. Basis for Opinion section C. Critical Audit Matters section D. None of the these choices are correct. ___ 1. Audit provides a basis for an opinion. ___ 2. The financial statements present fairly, in all material respects. ___ 3. The risk of not detecting a material misstatement resulting from fraud is higher. ___ 4. Our objectives are to obtain reasonable assurance. ___ 5. Financial statements are in accordance with accounting principles generally accepted in the United States of America. ___ 6. Management responsible to evaluate whether substantial doubt exists about ability to continue as a going concern. ___ 7. Auditor communication of matters to audit committee that involve challenging, subjective, or complex judgments. ___ 8. Conducted our audits in accordance with the PCAOB standards. ___ 9. Auditors are required to be independent with respect to client. ___ 10. Have audited financial statements and internal control over financial reporting.

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5) Shown below are a number of situations that may be encountered during the audit examination. For each, indicate how the auditors' standard report would be modified (each reporting situation may result in more than one modification to the auditors' standard report). A. Modification to Opinion on the Financial Statements section. B. Modification to Basis for Opinion section. C. Modification to (or removal of) Critical Audit Matters section. D. Explanatory paragraph added to report. E. No modifications to the standard report are necessary. ___ 1. Departure from GAAP that does not materially affect the financial statements. ___ 2. Inability of auditors to confirm accounts receivable with customers; while the scope limitation is material, the auditors still believe an opinion may be expressed on the entity's financial statements. ___ 3. Group auditors decide to refer to the work of component auditors in their report. ___ 4. Entity has changed from FIFO to LIFO accounting for inventories. ___ 5. Auditors wish to highlight an event that occurred following the date of the financial statements. ___ 6. Departure from GAAP that has a material, but not pervasive, effect on the financial statements. ___ 7. Group auditors decide to assume full responsibility for the work of component auditors and not refer to component auditors' work in their report. ___ 8. Scope limitation that precludes auditors from expressing an opinion. ___ 9. Auditors would like to disclose potential going-concern uncertainties in their report (these uncertainties have been appropriately disclosed in the entity's financial statements and related disclosures). ___ 10. Departure from GAAP that has a material and pervasive effect on the financial statements.

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Answer Key Test name: Chap 12_8e_Test Bank_Alternate_Problems 1) 1.B; 2.A; 3.A; 4.B; 5.C 2) 1.B, 2.A, 3.B, 4.A, 5.B, 6.C 3) 1. C or E, 2. A, 3. D, 4. A, 5. D or E (most likely, E) 4) 1.B, 2.A, 3.B, 4.B, 5.A, 6.D, 7.C, 8.B, 9.B, 10.A 5) 1. E; 2. A, B; 3. A, B; 4. D; 5. D; 6. A; 7. E; 8. A, B, C; 9. D; 10. A, C

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CHAPTER 12: PROBLEM MATERIAL ESSAY. Write your answer in the space provided or on a separate sheet of paper. 1) In each of the circumstances listed below, indicate, by appropriate letter, which of the following types of opinions should be rendered on the entity's financial statements. A.Unmodified B.Qualified C.Adverse D.Disclaimer ___ 1. Departure from generally accepted accounting principles that is material but not pervasive. ___ 2. Going-concern uncertainties that may have a material (but not pervasive) effect on the financial statements. ___ 3. Emphasis of a matter, no generally accepted accounting principles (GAAP) departure. ___ 4. Material, but not pervasive, scope limitation. ___ 5. Material and pervasive departure from generally accepted accounting principles (GAAP).

2) For each of the sentences or phrases below, indicate, by letter, in which section of the standard (unmodified) report on the entity's financial statements the sentence or phrase would appear. A.Opinion Section B.Basis for Opinion Section C.Responsibilities of Management for the Financial Statements Section D.Auditor’s Responsibilities for the Audit of the Financial Statements Section

___ 1. We conducted our audit in accordance with auditing standards generally accepted in the United States of America generally accepted accounting standards (GAAS). ___ 2. We have audited the financial statements of Draper Company… ___ 3. In preparing the financial statements, management is required

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to evaluate whether there are conditions or events… ___ 4. Reasonable assurance is a high level of assurance but is not absolute assurance… ___ 5. We believe that the audit evidence we have obtained is sufficient and appropriate…

3) For each of the situations below, indicate, by letter, the type of report most likely to be issued. A.Unmodified opinion, no modification. B.Unmodified opinion, emphasis-of-matter paragraph for consistency. C.Unmodified opinion, additional section for a going-concern uncertainty. D.Qualified opinion. E.Disclaimer of opinion.

___ 1. The entity has a lawsuit pending against them. There is significant uncertainty about the outcome of the lawsuit, which could have a highly material impact on the viability of the entity. Management has provided adequate disclosure of the lawsuit in the footnotes accompanying the financial statements. ___ 2. The entity has a lawsuit pending against them. It is probable that the entity will lose the suit. Management has accrued the best estimate of the loss and provided adequate disclosure. It is not expected that this lawsuit will have a significant effect on the entity's ability to continue as a going concern. ___ 3. The entity has a lawsuit pending against them. It is probable that the entity will lose the suit. Management has not accrued the best estimate of the loss, but has provided information in the footnotes. It is not expected that this lawsuit will have a significant effect on the entity's ability to continue as a going concern. ___ 4. Based on recent analysis of usage, the entity has changed the useful life of its office equipment from five to four years. This change is reflected in the depreciation amounts computed for the

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current year. ___ 5. The entity's management has not provided written representations requested by the auditors. The failure to provide these representations is considered to be a significant limitation on the scope of the auditors' work…

4) Listed below are words and phrases from the auditors' standard (unmodified) report on a non-issuer's financial statements. For each of the words and phrases indicate by letter in which section of the standard (unmodified) report they should appear. A.Opinion Section B.Basis for Opinion Section C.Responsibilities of Management for the Financial Statements Section D.Auditor’s Responsibilities for the Audit of the Financial Statements Section

___ 1. Audit provides a basis for an opinion. ___ 2. The financial statements present fairly, in all material respects. ___ 3. The risk of not detecting a material misstatement resulting from fraud is higher. ___ 4. Our objectives are to obtain reasonable assurance. ___ 5. Financial statements are in accordance with accounting principles generally accepted in the United States of America. ___ 6. Management responsible to evaluate whether substantial doubt exists about ability to continue as a going concern. ___ 7. Auditor communication of scope and timing of audit with those charged with governance. ___ 8. Conducted our audits in accordance with the auditing standards generally accepted in the United States of America. ___ 9. Management is responsible for the design, implementation, and maintenance of internal control. ___ 10. We have audited the financial statements.

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5) Shown below are a number of situations that may be encountered during the audit examination. For each, indicate how the auditors’ standard (unmodified) report would be modified (each reporting situation may result in more than one modification to the auditors’ standard (unmodified) report). A.Modification to Opinion Section. B.Modification to Basis for Opinion Section. C.Modification to Responsibilities of Management for the Financial Statements Section. D.Modification to Auditor’s Responsibilities for the Audit of the Financial Statements Section. E.Emphasis-of-matter paragraph, other-matter paragraph, or additional section added to report. F.No modifications to the standard (unmodified) report are necessary ___ 1. Departure from generally accepted accounting principles (GAAP) that does not materially affect the financial statements. ___ 2. Inability of auditors to confirm accounts receivable with customers; while the scope limitation is material, the auditors still believe an opinion may be expressed on the entity's financial statements. ___ 3. Group auditors decide to refer to the work of component auditors in their report. ___ 4. Entity has changed from First-In, First-Out (FIFO) to Last-In, First-Out (LIFO) accounting for inventories. ___ 5. Auditors wish to highlight an event that occurred following the date of the financial statements. ___ 6. Departure from generally accepted accounting principles (GAAP) that has a material, but not pervasive, effect on the financial statements. ___ 7. Group auditors decide to assume full responsibility for the work of component auditors and not refer to component auditors' work in their report. ___ 8. Scope limitation that precludes auditors from expressing an opinion. ___ 9. Auditors would like to disclose potential going-concern uncertainties in their report (these uncertainties have been

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appropriately disclosed in the entity's financial statements and related disclosures). ___ 10. Departure from GAAP that has a material and pervasive effect on the financial statements.

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Answer Key Test name: Chap 12_8e_Test Bank_Problem Material 1) 1.B; 2.A; 3.A; 4.B; 5.C 2) 1.B; 2.A; 3.C; 4.D; 5.B 3) 1. C or E; 2. A; 3. D; 4. A; 5. D or E (most likely, E) 4) 1.B; 2.A; 3.D; 4.D; 5.A; 6.C; 7.D; 8.B; 9.C; 10.A 5) 1. F; 2. A, B; 3. A; 4. E; 5. E; 6. A, B; 7. F; 8. A, B, D; 9. E; 10. A, B

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MODULE A MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) Assurance services are defined as independent professional services that: A) establish criteria for effective measurement of business activity. B) improve the quality of information, or its context, for decision makers. C) attest to the adequacy of controls over business operations. D) develop efficient and effective accounting systems to ensure compliance with accounting standards and policy.

2) Many individuals are apprehensive about using the Internet to purchase items. This apprehension mainly arises from users' concerns about: A) the reliability of computer technology. B) the time delays in Internet purchases. C) a lack of security for information transmitted over the Internet. D) the lack of CPA involvement in Internet company financial information.

The phrase "Trust services" refers to: A) WebTrust and SysTrust Services. B) XBRL and SysTrust Services. C) WebTrust and XBRL Services. D) All AICPA designated assurance services.

Which of the following is not a principle of Trust Service engagements? A) Security from unauthorized use. B) Availability of the system, products, or services. C) Proficiency in preparing transactions. D) Confidentiality of information.

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5) What is the appropriate name for an assurance service provided by a CPA regarding a client's commercial Internet site with reference to the principles of privacy, security, processing integrity, availability, and confidentiality? A) WebTrust. B) SysTrust. C) XBRL. D) WebSecure.

Attestation engagements include:

A) only examinations. B) examinations and assurance services. C) examinations, reviews, and agreed-upon procedures. D) examinations, reviews, compilations, agreed-upon procedures, and assurance services.

7) The accountant's standard report for a compilation engagement would not include a statement that: A) a compilation service has been performed in accordance with Statements on Standards for Accounting and Review Services. B) financial statement information is the representation of the owners of the business. C) compilation service consists primarily of inquiries of company personnel and analytical procedures applied to financial data. D) financial statements have not been audited or reviewed and the accountant does not express an opinion or any other form of assurance.

8) Shelly's Bank has loaned money to Pete's Auto Supply. The loan is collateralized by inventory. The loan also requires a CPA to observe the count of the inventory and trace sampled items to the vendor invoices in order to determine the value of inventory is not misstated. This service would be:

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A) an assurance service engagement. B) an attestation engagement. C) a review engagement. D) a compilation engagement.

Attestation engagements may be more difficult than financial statement audits when:

A) the establishment of suitable measurement criteria is difficult. B) internal controls are difficult to assess. C) management may not understand the underlying assumptions of the attestation. D) the report may be submitted to individuals with insufficient knowledge of the nature of an attestation engagement.

10) A responsible party for information to subject to an attestation engagement would not include: A) the client's controller. B) the independent accountant. C) the client's vice president of marketing. D) a client employee named in a contract or regulation as being responsible for the information.

11) Which of the following procedures would not be performed in a review of financial statements of a non-issuer? A) Inquire about the accounting system and procedures. B) Perform analytical procedures to identify relationships and individual items that appear to be unusual. C) Obtain an attorney's letter regarding litigation and unasserted claims. D) Study the financial statements for indications that they conform to generally accepted accounting principles.

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12) ABC Company prepares financial statements showing the last two years, years X and Y. (Year X is the year prior to year Y.) The auditor performed an audit of year X and a review of year Y. The auditor may: A) report on the year Y review and reissue the year X audit report. B) provide only the report concerning the year Y review. C) reissue the year X audit report with an explanatory paragraph disclosing that only a review was performed on year Y. D) notify the client that prior-year audited financial statements cannot be presented when the current year's statements have not been audited.

13)

In an agreed-upon procedures engagement, an accountant: A) follows all of the fundamental principles of GAAS. B) may restrict the use of the report to specified users. C) expresses limited assurance in the report. D) expresses a qualified audit opinion.

14) Which of the following procedures should an accountant perform during an engagement to review the financial statements of a non-issuer? A) Communicate reportable conditions discovered during the assessment of control risk. B) Obtain a representation letter from members of management. C) Send bank confirmation letters to the entity's financial institutions. D) Examine cash disbursements in the subsequent period for unrecorded liabilities.

15) When an accountant is engaged to compile a non-issuer’s financial statements that omit substantially all disclosures required by GAAP, the accountant should indicate in the compilation report that the financial statements:

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A) might influence users' conclusions about the business, if the disclosures were included. B) are prepared in conformity with a comprehensive basis of accounting other than GAAP. C) are not compiled in accordance with Statements on Standards for Accounting and Review Services. D) are special-purpose financial statements that are not comparable to those of prior periods.

16) An auditors’ report on financial statements prepared in conformity with the cash basis of accounting should include an emphasis-of-matter paragraph that: A) justifies the reasons for departing from generally accepted principles. B) states whether the financial statements are fairly presented in conformity with a special purpose framework. C) refers to the note to the financial statements that describes the special purpose framework. D) explains how the results of operations differ from financial statements prepared in conformity with generally accepted accounting principles.

17) Which of the following best describes an engagement to report on a non-issuer’s internal control over financial reporting? A) An attestation engagement to examine and report on management's written assertions about the effectiveness of its internal control over financial reporting. B) An audit engagement to render an opinion on the entity's internal control over financial reporting. C) An engagement to project and report on the expected benefits of the entity's internal control over financial reporting. D) A consulting engagement to provide constructive advice to the entity on its internal control over financial reporting.

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18) Delta Life Insurance Co. prepares its financial statements on an accounting basis insurance companies use pursuant to the rules of a state insurance commission. Wall, CPA, is Delta's auditor. If Wall discovers that the statements are not suitably titled, Wall should: A) disclose any reservations in an explanatory paragraph and qualify the opinion. B) apply to the state insurance commission for an advisory opinion. C) issue a special statutory basis report that clearly disclaims any opinion. D) explain in the notes to the financial statements the terminology used.

19) When providing limited assurance that the reviewed financial statements of a non-issuer require no material modifications to be in accordance with generally accepted accounting principles, the accountant should: A) assess the risk that a material misstatement could occur in a financial statement assertion. B) confirm with the entity's attorneys that material loss contingencies are disclosed. C) understand the accounting principles of the industry in which the entity operates. D) develop audit plans to determine whether the entity's financial statements are fairly presented.

20) Which of the following procedures is ordinarily performed by an accountant in a compilation engagement of a non-issuer? A) Reading the financial statements to consider whether they are free of obvious mistakes in the application of accounting principles. B) Obtaining written representations from management indicating that the compiled financial statements will not be used to obtain credit. C) Making inquiries of management concerning actions taken at meetings of the stockholders and the board of directors. D) Applying analytical procedures designed to corroborate management's assertions that are embodied in the financial statement components.

21) that:

Compiled financial statements for a non-issuer should be accompanied by a report stating

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A) the scope of the accountant's procedures has not been restricted in testing the financial information that is the representation of management. B) the accountant assessed the accounting principles used and significant estimates made by management. C) the accountant does not express an opinion or any other form of assurance on the financial statements. D) a compilation consists primarily of inquiries of entity personnel and analytical procedures applied to financial data.

22) Hamell Corporation is making a presentation to a prospective investor. The presentation includes a projection showing that the company's sales will be between $25,000,000 and $27,000,000 within the next three years. Hamell believes the information will be better received if its CPA provides an attestation report on the financial projection. In order to provide such a report the CPA must do all of the following except: A) obtain knowledge about the client's business. B) evaluate the assumptions used in preparing the projection. C) confirm expected sales with customers. D) identify key factors affecting the information.

23) Which of the following is not a condition that must be met before an accountant can conduct an attestation engagement? A) Management accepts responsibility for the matter related to the attestation. B) Management has appropriately documented the matter related to the attestation. C) Management's assertion related to the matter of the attestation can be supported by sufficient evidence. D) Management presents a written assertion about the matter related to the attestation.

24)

An accountants’ report includes the phrase "We are not aware". This phrase indicates:

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A) an attestation engagement was not performed. B) management had not established sufficient criteria to allow an opinion to be expressed. C) the accountants are providing limited assurance. D) the accountants are expressing a disclaimer of opinion.

25)

The procedures used in a review engagement are: A) physical examination, reperformance, and obtaining a management representation

letter. B) analytical procedures, reperformance, and obtaining a management representation letter. C) analytical procedures, inquiry, and obtaining a management representation letter. D) physical examination, inquiry, and obtaining a management representation letter.

26)

In a compilation engagement, the accountant: A) provides reasonable assurance that no material misstatements exist. B) provides assurance that no material misstatement came to the auditors attention. C) provides a list of procedures performed and results found. D) does not express an opinion.

27)

In a compilation engagement: A) all appropriate disclosures must be presented. B) managers or owners may choose to omit all the footnote disclosures. C) financial statements must be presented in prescribed forms. D) an auditor provides only limited assurance.

28)

Special purpose frameworks include all of the following except:

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A) statements that conform to a regulatory agency. B) statements prepared on a tax basis. C) statements that conform to accounting principles that are generally accepted. D) statements prepared on a cash basis.

29) Which of the following account titles would not be appropriate for a company that prepared its financial statements using the tax basis of accounting? A) Balance Sheet. B) Statement of Assets, Liabilities, and Owner's Equity. C) Statement of Revenue and Expenses. D) Statement of Change in Partners' Capital Accounts.

30) When a company uses a service organization to prepare its payroll, the company's auditors: A) have no obligation concerning the internal controls at the service organization. B) need to understand the internal controls over the transaction regardless of the location of the control. C) must audit the internal controls at the service organization. D) should include the audit report of the service company's auditors with their auditors' report.

31) Auditors can gain sufficient understanding of the internal controls at a service organization by: A) reviewing the contract with the service organization. B) inquiry with management of the service organization. C) reviewing a report on internal controls provided by the service organization's auditors. D) sending a confirmation concerning internal controls to the service organization's auditors.

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32) During a review engagement, which of the following is not a required inquiry of management? A) The accounting principles and practices used. B) Significant transactions occurring near the end of the reporting period. C) Status of uncorrected misstatements identified in previous engagements. D) The changes made to internal controls during the period under review.

33) During a review engagement, the accountant is required to obtain written representations from management. Which of the following is not one of the required elements of the representation? A) Management's responsibility for the fair presentation of the financial statements. B) Management's belief that it has answered all inquiries fully and truthfully. C) Management has made all adjustments identified during the review. D) Management has disclosed information about subsequent events.

34) At a minimum, the auditor of an issuer that has material transactions processed by a service organization would have to request which of the following from the service organization? A) A description of its internal controls. B) An SOC 1 Type 1 report. C) An SOC 1 Type 2 report. D) An SOC 3 report.

35) A report on sustainability, as defined by the AICPA, might include all of the following except: A) economic viability. B) social responsibility. C) environmental responsibility. D) internal control over financial reporting.

36)

A preparation engagement might include all of the following except:

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A) Preparation of financial statements prior to review by another accountant. B) Preparation of financial statements to be presented alongside an entity’s tax return. C) Preparation of financial statements solely for submission to a taxing authority. D) Preparation of financial statements for presentation alongside a personal financial plan.

37) The party in an attestation engagement who provides an assertion with respect to information is the: A) Asserting party. B) Attesting party. C) Limited party. D) Responsible party.

38)

Which of the following is not an example of an attestation engagement:

A) An audit engagement conducted on historical financial statements. B) A compilation engagement conducted on historical financial statements. C) An examination engagement conducted on a financial forecast. D) An engagement to apply limited procedures identified by the client to historical financial statements.

39) An engagement in which accountants perform procedures delineated by the entity is referred to as a(n): A) Agreed-upon procedures engagement. B) Attestation engagement. C) Evaluation engagement. D) Preparation engagement.

40) Which of the following would not be an appropriate reporting option for financial statements prepared using a special purpose framework?

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A) A qualified opinion because of a departure from the accounting principles of the special purpose framework. B) A disclaimer of opinion because of the failure of the entity to use generally accepted accounting principles. C) An adverse opinion because of a departure from the accounting principles of the special purpose framework. D) A qualified opinion because of a circumstance-imposed scope limitation.

41) Which of the following statements would normally be included in a report on financial statements prepared using a special purpose framework? A) An indication that the auditors examined the balance sheet, statement of operations, and statement of cash flows. B) An opinion on the appropriateness of the special purpose framework. C) A brief summary of differences between the financial results using the special purpose framework and generally accepted auditing standards. D) An indication that the audit was conducted in accordance with generally accepted auditing standards.

42) Which of the following is impacted when a non-issuer prepares financial statements using a special purpose framework? A. B. C. D.

Basis of accounting

Auditing standards

Yes Yes No No

Yes No Yes No

A) Option A B) Option B C) Option C D) Option D

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43) Which type of entit(ies) may prepare financial statements using a special purpose framework. A. B. C. D.

Issuers

Non-issuers

Yes Yes No No

Yes No Yes No

A) Option A B) Option B C) Option C D) Option D

44) In an engagement to audit financial statements prepared using a special purpose framework, the audit team would conduct all of the following procedures except: A) Obtaining an engagement letter. B) Evaluating internal control and assessing control risk. C) Performing substantive tests. D) The audit team would perform all of the above procedures.

45) Which of the following would not be included in the auditors’ report on financial statements prepared using a special purpose framework? A) An identification of the financial statements examined by the auditors. B) An indication that management is responsible for the appropriateness of the special purpose framework. C) A reference to disclosures provided by management relating to the use of the special purpose framework. D) An opinion on the appropriateness of the use of the special purpose framework.

46) Which of the following is not true if auditors are requested to express an opinion on the fairness of a non-issuers’ balance sheet?

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A) The auditors must refuse to accept the engagement if originally engaged to issue an opinion on the complete financial statements and would have expressed an adverse opinion on those financial statements. B) The auditors must conduct the engagement in accordance with generally accepted auditing standards. C) The auditors’ opinion will be limited to the balance sheet and will not reference the remaining financial statements. D) The auditors’ procedures will be limited only to those related to the balance sheet.

47) In which of the following engagements would auditors not be subject to complying with generally accepted auditing standards? A) An examination of a financial forecast. B) An audit of financial statements prepared using the cash basis of accounting. C) An audit of a non-issuer’s statement of cash flows. D) An examination of compliance with contractual agreements conducted in conjunction with an audit of the financial statements.

48) Engagements to express an opinion on an account, element, or item of a financial statements: A) Are not permitted under generally accepted auditing standards. B) Would limit the opinion expressed to the specific account, element, or item that serves as the focus of the engagement. C) May be conducted for either issuers or non-issuers. D) Require auditors to perform some level of procedures related to the complete financial statements.

49) When auditors report on compliance with contractual agreements in conjunction with an audit of the financial statements conducted under generally accepted auditing standards, which of the following is a reporting option with respect to compliance? A. B.

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Combined report

Separate report

Yes Yes

Yes No 14

C. D.

No No

Yes No

A) Option A B) Option B C) Option C D) Option D

50) In a report on compliance with contractual agreements conducted in conjunction with an audit of the financial statements, the auditors’ report would include all of the following except: A) A limitation on the use of the report to identified parties. B) A reference to the audit of the financial statements. C) An indication that the audit was not directed toward identifying instances of noncompliance with contractual agreements. D) An opinion on the entity’s compliance with contractual agreements.

51) Which of the following indicates the minimum required scope in an agreed-upon procedures engagement: A) The accountant must conduct a study and evaluation of internal control. B) The accountant must make specific inquiries of the entity’s management. C) The accountant must perform limited analytical procedures and specific tests of details. D) There is no minimum required scope in an agreed-upon procedures engagement.

52) Which of the following is not a difference in the report on an agreed-upon procedures engagement compared to an auditors’ report on an audit conducted under generally accepted auditing standards?

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A) The report identifies the specified parties and describes the specific procedures performed by the accountant. B) The report specifically notes that an examination was not performed by the accountant and disclaims an opinion. C) The report indicates the engagement was conducted in conformity with generally accepted auditing standards. D) The report provides a summary of findings as a result of performing the agreed-upon procedures.

53)

The accountant’s report in an agreed-upon procedures engagement:

A) Expresses an opinion on the adequacy of procedures performed by the accountant. B) Identifies the minimum required level of procedures for an agreed-upon procedures engagement. C) Disclaims an opinion or conclusion on the matter subject to the engagement. D) Indicates that the accountant(s) are responsible for the scope of the engagement.

54)

The primary difference between a financial forecast and a financial projection is: A) The extent of financial information included in the presentation. B) The level of accountant involvement with the financial information. C) The accounting principles used to generate the financial information. D) The nature of the assumptions used to generate the financial information.

55)

An accountant’s examination report on a financial forecast expresses:

A) An opinion on the presentation of the financial information and the reasonableness of the assumptions. B) An opinion on the presentation of the financial information and limited assurance on the reasonableness of the assumptions. C) Limited assurance on the presentation of the financial information and an opinion on the reasonableness of the assumptions. D) Limited assurance on the presentation of the financial information and the reasonableness of the assumptions.

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56) Financial information that is based on expected future conditions or courses of action is known as a(n): A) Financial forecast. B) Financial presentation. C) Financial projection. D) Pro forma financial information.

57)

Engagements related to prospective financial information are conducted under: A) Generally accepted auditing standards. B) Statements on Auditing Standards. C) Statements on Standards for Accounting and Review Services. D) Statements on Standards for Attestation Engagements.

58) Which of the following would not be included in an accountant’s report on the examination of a financial forecast? A) An indication that the engagement was conducted in accordance with Statements on Standards for Attestation Engagements. B) An indication that differences between forecasted and actual results may occur. C) A limitation on the use of the accountant’s report. D) An indication that the accountant is not responsible to update the report for subsequent events and occurrences.

59) For which type of prospective financial information can an accountant conduct an examination engagement? Financial forecast

Financial projection

Yes

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A) Option A B) Option B C) Option C D) Option D

60) Which of the following is a major difference in the accountant’s report on an examination engagement for a financial forecast and a financial projection? A) The report on a financial projection does not reference Statements on Standards for Attestation Engagements. B) The report on a financial projection identifies the hypothetical assumptions used to prepare the projection. C) The report on a financial projection expresses limited assurance, rather than an opinion, on the presentation of the financial information. D) The report on a financial projection indicates that differences between projected results and actual results may occur, while the report on a forecast does not include such a statement.

61) Which of the following is not a condition that must be met for an attestation engagement related to compliance: A) Management must accept responsibility for compliance. B) Auditors must also conduct an audit engagement on the client’s financial statements. C) Compliance must be capable of evaluation and measurement against reasonable criteria. D) Sufficient evidence must be available to support management’s evaluation of compliance.

62) Which type of attestation engagements may accountants conduct on compliance with contractual agreements?

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Review

Agreed-upon procedures

Yes

A) Option A B) Option B C) Option C D) Option D

63) If broker-dealers file an exemption report from compliance with SEC reporting requirements, accountants may perform a(n): A) Agreed-upon procedures engagement. B) Audit examination. C) Preparation engagement. D) Review engagement.

64) The party conducting an audit examination of a client that utilizes a service organization in processing its transactions is referred to as a(n): A) Component auditor. B) Group auditor. C) Service auditor. D) User auditor.

65) What is the primary reason that the auditor of a user organization would request a report from a service organization?

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A) To verify the appropriate processing of transactions. B) To verify the existence of accounts receivable transactions. C) To assist in forming assessments of inherent risk for material account balances. D) To determine the design and/or operating effectiveness of internal controls.

66) In the audit of an issuer, an SOC 1 Type 2 report (as opposed to an SOC 1 Type 1 report) would normally be obtained because: A) Controls are being implemented at a location physically separate from the issuer. B) The entity is required to file financial statements with the Securities and Exchange Commission. C) The entity has multiple subsidiaries that require audit attention. D) The entity is required to have an auditor’s report on internal control over financial reporting.

67) If auditors wish to gather assurance on the operating effectiveness of controls at a service organization, they would request a(n): A) SOC 1 Type 1 report. B) SOC 1 Type 2 report. C) SOC 2 Type 1 report. D) SOC 2 Type 2 report.

68)

Which of the following is not addressed in an SOC 1 Type 1 report? A) Description of the service organization’s internal controls. B) Design of the service organization’s internal controls. C) Operating effectiveness of the service organization’s internal controls. D) All of these choices are addressed in an SOC 1 Type 1 report.

69)

Which of the following would not be included in an SOC 1 Type 2 report?

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A) The service auditors’ opinion on the operating effectiveness of internal controls. B) A restriction on the use of the report to certain parties. C) An indication that the service auditors’ engagement was conducted in accordance with generally accepted auditing standards. D) A summary of the tests of controls performed by the service auditor.

70) Which of the following represents the level of assurance provided in a compilation engagement on a non-issuer’s financial statements? A) An opinion on the fairness of the financial statements. B) Limited assurance on the fairness of the financial statements. C) A summary of findings resulting from the compilation engagement. D) No opinion or assurance on the fairness of the financial statements.

71) If an entity prepares financial statements that omit footnote disclosures required by generally accepted accounting principles, the accountants’ compilation report should: A) Express an unmodified opinion on the financial statements and reference the omitted disclosures. B) Express a qualified or adverse opinion on the financial statements (depending upon the pervasiveness of the effects of the omitted disclosures) and reference the omitted disclosures. C) Disclaim an opinion or assurance on the financial statements without referencing the omitted disclosures. D) Disclaim an opinion or assurance on the financial statements and reference the omitted disclosures.

72) Which of the following engagements is not conducted under Statements on Standards for Accounting and Review Services? A) A compilation of historical financial statements. B) An engagement to prepare historical financial statements. C) A review of historical financial statements. D) An engagement to perform agreed-upon procedures to historical financial statements.

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73)

Which of the following is required in a preparation engagement?

A) Evaluating the independence of the accountants performing the preparation engagement. B) Preparing an engagement letter prior to accepting the engagement. C) Performing limited inquiries and analytical procedures. D) Issuing a report disclaiming an opinion or any assurance on the financial statements.

74) Which of the following represents a major difference between a compilation engagement and a preparation engagement? A) Accountants are required to be independent in a compilation engagement, but not a preparation engagement. B) Accountants are required to perform substantive procedures in a compilation engagement, but not a preparation engagement. C) Accountants are required to prepare a report in a compilation engagement, but not a preparation engagement. D) Accountants express limited assurance in a compilation engagement, but not a preparation engagement.

ESSAY. Write your answer in the space provided or on a separate sheet of paper. 75) Review engagements on unaudited financial statements consists primarily of conducting inquiries, performing analytical procedures, and obtaining a management representation letter. List the typical procedures accountants would perform on a review engagement.

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76) George Wilson is on the board of directors of a small manufacturing company, Smith Plastics Inc. George holds a CPA certificate and is a member of the AICPA. The president of the company, John Smith, has asked George to prepare financial statements for the company to be submitted to Sixth First Bank as part of a loan request. Mr. Smith tells George that the bank would like a review or an audit, but would settle for a compilation from a CPA. He would like George to do the compilation. Required: Under what conditions, if any, George Wilson would be allowed to prepare a compilation of the financial statements of Smith Plastics Inc.?

77) Donna Prima, CPA, was engaged to review the unaudited financial statements of Rooster Restaurants Inc., a non-issuer. During her review, Donna found that Rooster had not capitalized leases as required by GAAP. The result was so material, that Donna modified the standard review report to state that "the financial statements are not in conformity with GAAP." Required: Is Donna's report in accordance with professional standards? If not, what should she have done under the circumstances? Explain.

78) Public accounting firms have consistently looked for additional services that might increase the profitability of the public accounting firm. To that end, CPAs can provide value to clients with assurance services. Required: A. Describe SysTrust Services and WebTrust Services. B. Why would the public prefer to have a public accounting firm as a provider of these services? C. What are the possible negative consequences for public accounting firms if they provide services outside the realm of traditional accounting services?

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79) Big Ben's Toy (BBT) Company has recently outsourced its payroll operation to Mary's Payroll Service (MPS). MPS receives the changes to the payroll data base (hirings, firings, rate increases, etc.) and the number of hours worked for all hourly employees. MPS calculates the payroll and sends BBT printed payroll checks, a payroll register, and a list of payments to be made to third parties (IRS, insurance, pension plan, etc.). BBT transfers an appropriate amount into its payroll bank account and distributes the checks. Accounts payable uses the list of thirdparty payments to make appropriate payments. You have been hired to perform an audit of BBT Company. During your opening meeting with BBT management you state that your audit plan includes inquiries of Mary's Payroll Service and a review of the report on internal controls at MPS. BBT's management is confused and states that BBT should not have to pay you to review controls at another organization. Prepare a brief explanation to BBT's management as to why it is necessary to review the controls at MPS and the importance of this review to BBT Company.

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Answer Key Test name: Module A Test Bank 1) B 2) C 3) A 4) C 5) A 6) C 7) C 8) B 9) A 10) B 11) C 12) A 13) B 14) B 15) A 16) C 17) A 18) A 19) C 20) A 21) C 22) C 23) B 24) C 25) C 26) D Version 1

27) B 28) C 29) A 30) B 31) C 32) D 33) C 34) C 35) D 36) C 37) D 38) B 39) A 40) B 41) D 42) B 43) C 44) D 45) D 46) D 47) A 48) B 49) A 50) D 51) D 52) C 53) C 54) D 55) A 56) A Version 1

57) D 58) C 59) A 60) B 61) B 62) C 63) D 64) D 65) D 66) D 67) B 68) C 69) C 70) D 71) D 72) D 73) B 74) C

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75) 1.Obtain knowledge of the client's business. 2.Inquire about the accounting system. 3.Inquire about the preparation of the financial statements in accordance with GAAP. 4.Inquire about accounting principles and practices used. 5.Inquire about significant transactions that occurred or were recognized near the end of the reporting period. 6.Inquire of the status of uncorrected misstatements identified during previous engagements. 7.Inquire about questions that have arisen during the engagement. 8.Inquire about subsequent events. 9.Inquire about significant journal entries or adjustments. 10.Inquire about communications with regulatory agencies. 11.Perform analytical procedures to identify relationships and individual items that appear to be unusual. 12.Read the financial statements to determine if they conform to GAAP. 13.Inquire of officers and directors on accounting matters. 14.Perform any procedures considered necessary. 15.Prepare working papers. 16.Obtain a written representation letter. 76) George Wilson is not independent of Smith Plastics since he is a director. However, this does not prevent him from issuing a compilation report if he follows the requirements of AR-C 80. A separate last paragraph of the report should state: "I am not independent with respect to Smith Plastics Inc." The reason for the lack of independence may be disclosed.

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77) Donna's report is not in accordance with Statements for Accounting and Review Services. Review engagements are not audits; therefore no opinion (including the adverse opinion suggested by this language) can be expressed. Donna should have modified the standard review report by adding an explanatory paragraph to describe the known departure from GAAP. This exception would be referred to with the negative assurance provided in the last paragraph of the review report.

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78) A. ● SysTrust Services: An assurance service that reviews a client's information system to provide assurance to business partners concerning the security, privacy, confidentiality of information, system availability and processing integrity. ● WebTrust Services: An assurance service designed to reduce the concerns of Internet users regarding the existence of a company and the reliability of key business information placed on the website. B.The public might prefer to have these services provided by public accounting firms because of their reputation for integrity and objectivity. Often the public is skeptical of advice and recommendations provided by other professionals, such as attorneys and consultants. This skepticism is often founded in the belief that recommendations are based on an economic incentive to sell a product or service that the professional represents. Public accounting firms that perform an assurance service without representing any particular product or service are acting as client advocates and are seen as such by the public. C. The accounting profession needs to be very careful regarding the pursuit of revenues as a primary objective. First, CPAs have always been viewed as specialists in financial and business information and assurance regarding that information. As they begin to branch out into information that might be perceived as outside their expertise, the public may lose confidence in the profession. Second, if the profession pursues revenues without maintaining the traditional values that have been the cornerstone of the profession (i.e., independence and objectivity), the profession's image and public trust may be damaged.

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79) The outsourcing of significant portions of a business does not alleviate the company from its responsibilities for that portion of the business. Auditing standards require the auditor to gain an understanding of internal controls over all material areas of financial reporting, and in almost all cases payroll would be material. In addition, if BBT is an issuer, you would be required to report on internal control over financial reporting, which would include controls operating at MPS. Finally, if there were a failure to meet regulatory requirements, such as improperly calculating the tax liability, the appropriate regulatory body would not take action against the third-party provider, but against the organization responsible for meeting these regulatory requirements.

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MODULE A: PROBLEM MATERIAL ESSAY. Write your answer in the space provided or on a separate sheet of paper. 1) Indicate whether each of the following would be included in an auditors’ report for financial statements prepared using a special purpose framework (responses may be “yes” or “no”). ______ ______ ______ ______ ______ ______

______ ______

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1. A summary of the financial statements examined by the audit team. 2. A statement that management assumes responsibility for the appropriateness of the special purpose framework. 3. An opinion as to the appropriateness of the special purpose framework selected by management. 4. An indication that the audit team conducted the engagement in accordance with generally accepted auditing standards. 5. An opinion as to the fairness of the financial statements based on the special purpose framework. 6. A summary of the significance of differences of financial results prepared using the special purpose framework and generally accepted accounting principles. 7. A limitation on the use of the auditors’ report. 8. A reference to management disclosures of the special purpose framework used to prepare the financial statements. 9. An indication of the financial statement effect(s) of any departures from the special purpose framework. 10. A disclaimer of opinion on the entity’s internal control over financial reporting.

2) For each of the following, indicate the applicable accounting and review service engagements (each item may relate to more than one type of engagement). Use “R” for review engagements, “C” for compilation engagements, “P” for preparation engagements, and “N” for none. ______

1. Accountants obtain engagement letter from client.

______

2. Some level of substantive tests are performed.

______

3. Accountants issue a report related to the engagement.

______

4. Conducted under Statements on Standards for Accounting and Review Services. 5. Accountants required to obtain written representations from client. 6. Accountants required to perform some procedures with respect to internal control over financial reporting. 7. Engagement requires accountants to be independent with respect to the client. 8. Use of accountants’ report is limited to specified users.

______ ______ ______ ______ ______ ______

9. Accountants provide limited assurance with respect to fairness of the financial statements. 10. Accountants obtain knowledge and understanding of client’s financial reporting framework.

3) Indicate whether each of the following statements applies to financial forecasts (FF), financial projections (FP), or neither financial forecasts or projections (N). Each item may relate to more than one type of prospective financial information. ______

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1. Accountants may express an opinion on the presentation and preparation of the prospective financial information.

______

2. Information is available for general use.

______

3. Information is based on the occurrence of one or more hypothetical events. 4. Accountants are required to obtain written representations from the client. 5. Accountants may express an opinion on the reasonableness of the assumptions used to prepare the prospective financial information. 6. Information is based on expected conditions and courses of action. 7. Engagements are conducted under Statements on Standards for Accounting and Review Services. 8. Use of accountants’ report is limited to specified users.

______ ______

______ ______ ______ ______ ______

9. Accountants may provide agreed-upon procedures to prospective financial information. 10. Accountants’ report acknowledges that differences may occur between actual results and prospective financial information.

4) Indicate whether each of the following statements applies to SOC 1 Type 1 (Type 1), SOC 1 Type 2 (Type 2), or neither (N) reports. Each item may relate to more than one report. ______ ______ ______ ______ ______

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1. Report expresses an opinion on the suitability of the design of the internal controls. 2. Would be obtained in the audit of an issuer, rather than a non-issuer. 3. Obtained from a component auditor in the audit of group financial statements. 4. Service auditor required to obtain an understanding of the service organization’s internal controls. 5. Report indicates the service organization management’s responsibility for internal control.

______

6. Service auditor required to perform tests of controls.

______

7. Report expresses an opinion on the fairness of the description of internal controls. 8. Use of report is limited to specified users.

______ ______

______

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9. Report expresses an opinion on the operating effectiveness of internal controls. 10. Report indicates the examination was conducted in accordance with attestation standards established by the AICPA. 11. Report provides limited assurance on the suitability of the design of the internal controls.

Answer Key Test name: Module A_8e_Test Bank_Problem Material 1) 1. Yes, 2. Yes, 3. No, 4. Yes, 5. Yes, 6. No, 7. No, 8. Yes, 9. Yes, 10. Yes 2) 1. R, C, P; 2. R; 3. R, C; 4. R, C, P; 5. R; 6. N; 7. R; 8. N; 9. R; 10. R, C, P 3) 1. FF, FP; 2. FF; 3. FP; 4. FF, FP; 5. FF, FP; 6. FF; 7. N; 8. FP; 9. FF, FP; 10. FF, FP 4) 1. Type 1, Type 2; 2. Type 2; 3. N; 4. Type 1, Type 2; 5. Type 2; 6. Type 1, Type 2; 7. Type 1, Type 2; 8. Type 2; 9. Type 1, Type 2; 10. N

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MODULE B MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) Which of the following is not a key element of the definition of ethics? A) Reflective choice B) Moral principles C) Definitive conclusions D) Consequences of decisions

Which of the following defines the imperative principle of ethics?

A) Ethic decisions cannot be resolved without evaluating all possible outcomes of all choices. B) Ethics are a function of moral rules and principles. C) All ethical decisions will have positive and negative consequences. D) It is essential that decisions be made for the greater good of society.

3) Which of the following philosophical principles in ethics places emphasis on the consequences of action, rather than on following the rules? A) Imperative principle. B) Utilitarianism principle. C) Generalization principle. D) Moral principle.

What agency has the ultimate authority in defining independence for public companies? A) The AICPA B) The SEC C) The Department of Justice D) The U.S. Congress

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5) Which of the following is the responsibility of the Professional Ethics Executive Committee? A) Enforce SEC ethical standards. B) Act as an investigative body of the AICPA when ethical violations are suspected. C) Make and enforce all the rules of conduct for CPAs who are AICPA members. D) Establish minimal ethical standards for financial reporting.

Which of the following is NOT one of the AICPA Principles of Professional Conduct? A) Responsibilities B) Reliability C) Objectivity D) Due care

7) Dara & Co. Audit Hill Corporation. Ellie is the engagement partner on the audit with an office in Buffalo Grove. Which of the following would NOT be considered a covered member? A) Jason, who is a member of the attest engagement team with an office in Elmhurst. B) Adam, who is a tax partner and provided 50 hours of tax service to Hill Company during the year of the audit with an office in Elmhurst. C) Ben, a partner in Dara & Company, with an office in Buffalo Grove. D) Julie, a partner in Dara & Company, with an office in Elmhurst.

Which of the following is NOT included in the Integrity and Objectivity Rule? A) Prudent assessment of facts B) Free of conflict of interests C) Not knowingly misrepresent facts D) Not subordinate judgment to others

9) Based on Sarbanes-Oxley, who is ultimately responsible for the independence of the external auditor?

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A) The CPA firm's engagement partner. B) The CPA firm's quality control partner. C) The client's senior management. D) The audit committee.

10) According to Sarbanes-Oxley, the audit committee must pre-approve all audit and nonaudit services. This can be done A) Case-by-case basis: Yes; Through established policies: No; Delegating the responsibility: Yes B) Case-by-case basis: Yes; Through established policies: Yes; Delegating the responsibility: No C) Case-by-case basis: No; Through established policies: Yes; Delegating the responsibility: No D) Case-by-case basis: No; Through established policies: No; Delegating the responsibility: Yes

11)

Which of the following is not a restriction placed on audit partners by Sarbanes-Oxley?

A) Limits engagement partners to a five-year term as the engagement partner. B) Limits other partners associated with the engagement to a seven-year term. C) Engagement partners must review nonaudit work to ensure that independence has not been compromised. D) Partners that engage in selling services, other than audit, review, and attestation services, to an audit client are not independent with respect to that client.

12)

Which of the following is true according to Government Independence Standards?

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A) Nonaudit services cannot be provided to a government entity that is an attest client. B) Nonaudit services are allowed providing the audit organization does not perform management functions, make management decisions, or audit its own work. C) Nonaudit services are allowed as long as the nature of the service is publicly disclosed including a statement that independence has not been compromised. D) Nonaudit services are allowed if they have been approved by the executive body of the governing organization.

13) Which of the following is true for audits of governmental entities under Government Independence Standards?

A) Personnel who provide nonaudit services are prohibited from planning, conducting, or reviewing audit work related to the nonaudit service. B) The audit organization must never reduce the scope of the audit because of nonaudit services performed. C) The government entity must have established policies to assure the nonaudit services will not affect the audit firm's ability to perform the audit. D) CPAs that perform nonaudit services are prohibited from being a member of the audit team.

14) The General Standards Rule requires a member to comply with standards and interpretations. Which of the following is not a standard covered by this Rule? A) Independence B) Due professional care C) Planning and supervision D) Sufficient relevant data

15) Maralee has been approached by J. Fox Entertainment to perform an audit of her theatre company. Maralee has never audited a theatre company before. Maralee can

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A) not accept the engagement because she does not have the specialized industry knowledge. B) recommend another auditor and receive a fee for the referral. C) accept the engagement if she can obtain the required knowledge before the end of the engagement. D) accept the engagement with the understanding that additional hours will be required for Maralee to learn and understand the nature of the business.

16) An audit client hires a member of the audit engagement team to be its new controller. Sarbanes-Oxley rules require that: A) the new controller sever all relations with the CPA firm, including any retirement funds. B) the new controller not take part in any discussions regarding the retention of the audit form. C) the client must find a new audit firm. D) the client disclose the controller's relationship in the notes to the financial statements.

17) The SEC requires companies to disclose fees paid to independent public accounting firms for audit and consulting services in the belief that: A) such disclosures will end the practice of auditors performing nonaudit services for audit clients. B) financial analysts will attribute far less credibility to financial statements audited by public accounting firms that earn substantial nonaudit fees from audit clients. C) audit firm consulting on client's accounting information processing systems essentially impairs audit independence. D) client directors and financial statement users should consider all aspects related to auditors' independence, and information about fees is important.

18) CPA Krogstad is the executive in charge of the Omaha office of the audit firm. He is responsible for the practice in all areas of audit, tax, and consulting, but he does not serve as a field audit partner or a reviewer. CPA Ward is the partner in charge of the Dodger, Inc. audit (an SEC filing). The audit firm's independence is impaired if:

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A) Krogstad owns Dodger common stock. B) Krogstad's brother owns 10 shares of Dodger common stock. C) Ward's sister-in-law is a sales representative with a territory in California. D) Ward's fellow partner CPA Felix in the Omaha office has a wife who owns Dodger stock through a mutual fund held in her own employer's employee benefit plan.

19) Which of the following philosophical theories places emphasis on following rules, rather than on the consequences of the decision? A) Imperative principle. B) Utilitarianism. C) Generalization principle. D) Virtue ethics.

20) Julie and Lisa are sisters. Julie is a CPA auditing the company where Lisa works. Julie's independence is impaired if A) Lisa owns 25 percent of the company. B) Lisa is the controller. C) Lisa is the marketing manager. D) Independence is impaired in all of the situations listed.

21)

An interpretation of the Independence Rule allows members to A) hold a material indirect interest in a client. B) have loans from a client that are collateralized by cash deposits held by the client. C) have home mortgages with a client even if they are on the engagement. D) be a trustee of a client pension or profit sharing trust.

22) The AICPA Council has designated the following bodies to pronounce accounting principles under the Accounting Principles Rule except the

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A) Financial Accounting Standards Board. B) Auditing Procedures Board. C) Federal Accounting Standards Advisory Board. D) Governmental Accounting Standards Board.

23)

An interpretation of the Acts Discreditable Rule would not include A) membership in an activist political party. B) withholding a client's books until a professional fee is paid. C) failure to follow government audit standards in government audits. D) permitting others to make misleading entries in records.

24) According to the Accounting Principles Rule requires the auditor to adhere to official pronouncements except when A) complying would violate client confidentiality. B) pending legislation may change the reporting requirements of the client. C) adherence to a pronouncement would be misleading. D) it has been established that financial statement users prefer an alternative presentation of information.

25) The Confidential Client Information Rule has been interpreted by the AICPA to explicitly allow a CPA to divulge confidential client information to A) the SEC. B) the U.S. Department of Justice. C) the AICPA Professional Ethics Division. D) the Federal Trade Commission.

26) Perry Pinkney, CPA, is one of the general partners in a partnership, which in turn invested 70 percent of its assets in the common stock of Pinkney's audit client (Darby Corporation). According to the AICPA Code of Professional Conduct, Pinkney is considered to have Version 1

A) an indirect financial interest in Darby. B) a direct financial interest in Darby. C) no financial interest in Darby. D) a partial financial interest in Darby.

27) A client has omitted a significant disclosure from the financial statements. The auditor has asked the client to include the information, but the client refuses and claims the information is confidential. The position of the CPA should be that the information A) cannot be considered confidential if it is necessary to the completeness of the financial statements. B) cannot be considered confidential unless it can be covered by the attorney-client privilege. C) is confidential and will only be disclosed under subpoena or for a regulatory investigation. D) should be discussed with the audit committee to determine if the information should be disclosed.

28) Which of the following philosophical theories places emphasis on the consideration of projecting the consequences of a choice in terms of this question: "What may be the consequences of similar persons making this choice in similar circumstances?" A) Imperative principle. B) Utilitarianism. C) Generalization principle. D) Virtue ethics.

29) Which of the following forms of organization would NOT be allowed under the Form of Organization and Name Rule of the Professional Code of Conduct? A) Limited liability partnership; all partners are CPAs. B) Limited liability partnership; 70 percent of partners are CPAs. C) Limited liability corporation; all shareholders are CPAs. D) Partnership; 40 percent of partners are CPAs.

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30) Red and Green, CPAs, are the external auditors for Blue Corporation, a publicly-held company. Blue Corporation has outsourced its internal audit function to Red and Green. Which of the following statements is true? A) Doing internal audit work does not impair the independence of Red and Green. B) The independence of Red and Green is impaired only if employees of Red and Green act in a management capacity or make management decisions. C) The independence of Red and Green is impaired only if a member of Red and Green's engagement team is hired to manage an accounting function in Blue Corporation. D) Public accounting firms cannot be both the internal and external auditors for publicly-held companies and maintain independence.

31) Violet, CPA, audits Big Bank, a local financial institution. Which of the following would most likely impair Violet's independence with regard to Big Bank? A) A home loan with the value of the house exceeding the mortgage balance. B) A car loan collateralized by the car. C) A personal loan collateralized by cash deposits at Big Bank. D) A Visa credit card issued by Big Bank with a balance of $2,500.

32) According to the profession's ethical standards, an auditor would be considered independent in which of the following instances? A) The auditor is the officially appointed stock transfer agent of a client. B) The auditor's checking account that is fully insured by a federal agency is held at a client financial institution. C) The client owes the auditor fees for more than two years prior to the issuance of the audit report. D) The client is the only tenant in a commercial building owned by the auditor.

33) Which of the following is required for a CPA firm to designate itself as "Members of the American Institute of Certified Public Accountants" on its letterhead?

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A) All owners must be members. B) The owners whose names appear in the firm name must be members. C) At least one of the owners must be a member. D) The firm must be a dues-paying member.

34) In which of the following circumstances would a CPA who audits XZ Corporation lack independence? A) The CPA and XZ's president are both on the board of directors of COD Corporation. B) The CPA and XZ's president each own 25 percent of FOB Corporation, a closely held company. C) The CPA has an automobile loan from XZ, a financial institution. The loan is collateralized by the automobile. D) The CPA reduced XZ's usual audit fee by 40 percent prior to the audit because XZ's financial condition was unfavorable.

35) According to the ethical standards of the profession, which of the following acts is generally prohibited? A) Purchasing a product from a third party and reselling it to a client. B) Writing a financial management newsletter promoted and sold by a publishing company. C) Accepting a commission for recommending a product to an audit client. D) Accepting engagements obtained through the efforts of third parties.

36) According to the ethical standards of the profession, which of the following acts is generally prohibited?

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A) Issuing a modified report explaining a failure to follow a governmental regulatory agency's standards when conducting an attest service for a client. B) Revealing confidential client information during a quality review of a professional practice by a team from the state CPA society. C) Accepting a contingent fee for representing a client in an examination of the client's federal tax return by an IRS agent. D) Retaining client records after an engagement is terminated prior to completion and the client has demanded their return.

37) Which of the following statements included in the advertising of a CPA firm is permissible according to the Advertising and Other Forms of Solicitation Rule. A) "Bob Bullet, CEO of A-One Corp., states that we are the best auditors his company has ever used." B) "We provide the best audit coverage of any firm in the state." C) "We audit the five largest manufacturing companies in the state." D) "We have several tax partners that work closely with Judges and IRS attorneys on high-profile legal issues."

38) To which group can a CPA provide audit documentation without being subpoenaed and without the client's consent? A) The IRS. B) The FASB. C) Another CPA firm performing a peer review. D) Another CPA firm considering the purchase of the auditing firm.

ESSAY. Write your answer in the space provided or on a separate sheet of paper. 39) What are (a) the AICPA Principles of Professional Conduct, (b) Rules of Conduct, and (c) Interpretation of Rules of Conduct?

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40) What is the role of the PCAOB’s Division of Enforcement and Investigation in dealing with independence violations involving accountants engaged to audit public companies?

41) Susan Small, CPA has Medium Corporation as an audit client. Medium has asked Small to create and install a new computerized payroll system. Because Small does not have the appropriate level of expertise, she referred Medium to Compusystems, Inc., a local software consulting company. Small has an arrangement where she is paid ten percent of any fee received by Compusystems from her referrals. Small has disclosed this to her client. Required: The situation above involves a possible violation of the AICPA's Code of Professional Conduct. State the rule in question and explain why or why not there is a violation of the code. You need not refer to the rule number, but should clearly describe the rule in question.

42) Wally Wide is the partner on the audit engagement for First National Bank. Wally was recently promoted to partner. Based on his increase in income, Wally and his family bought a larger home and a new car. First National Bank had the most competitive mortgage rate and auto loan rates so Wally obtained both his mortgage loan and car loan from First National. Wally paid 20% down on the house, received no special rate of interest, and the First National Bank holds the title to the house. Wally traded in his old car and made and additional down payment on the car and financed 60% of the price of the car with the bank. Again, Wally paid the prevailing interest rate and the bank holds the title to the car. Required: The situations above involve possible violations of the AICPA's Code of Professional Conduct. State the rule in question and explain why or why not there is a violation of the code. You need not refer to the rule number, but should clearly describe the rule in question.

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43) Ben Big is a partner in the Cleveland office of the national accounting firm of Price Brickhouse. He owns 1,000 shares of common stock in Public, Inc., an audit client of the firm. This amount is not material to his personal investments. The Public, Inc. audit is done out of the New York office. Ben Big has not informed the firm that he owns the shares because he is not on the audit and it is not done out of the Cleveland office. Required: The situation above involves a possible violation of the AICPA's Code of Professional Conduct. State the rule in question and explain why or why not there is a violation of the code. You need not refer to the rule number, but should clearly describe the rule in question.

44) The Code of Professional Conduct is very important for the auditing profession. The AICPA, State Boards, and other professional organizations spend a great deal of time and effort implementing, and reinforcing the ethical standards, and penalizing those who violate the ethical standards. Required: A. Why is the Code of Conduct important to the profession? B. Many professionals believe that in today's business environment it is more difficult to adhere to the Code of Professional Conduct. Why might this be true?

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Answer Key Test name: Module B Test Bank 1) C 2) B 3) B 4) B 5) C 6) B 7) D 8) A 9) D 10) B 11) C 12) B 13) A 14) A 15) C 16) C 17) D 18) A 19) A 20) B 21) B 22) B 23) A 24) C 25) C 26) B Version 1

27) A 28) C 29) D 30) D 31) A 32) B 33) A 34) B 35) C 36) D 37) C 38) C 39) a. The Principles of Professional Conduct are an expression of the profession's high ideals on ethical conduct. They include essays on responsibilities, the public interest, integrity, objectivity and independence, due care and scope, and nature of services. b. The Rules of Conduct apply to the services performed by members of the AICPA in public and private practice. At present they consist of eleven rules of conduct. c. The Interpretations of Rules of Conduct are detailed explanations of specific rules necessary to help members understand particular applications.

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40) The PCAOB’s Division of Enforcement and Investigations handles disciplinary actions involving accountants (and their firms) who are engaged to audit public companies. The DEI’s role is to identify matters (often from tips) for further investigation, conduct an investigation, and recommend disciplinary proceedings (if considered necessary). Common investigations include violations of the PCAOB’s Auditing Standards, independence violations, and failures to cooperate with inspections/investigations. If violations are found, the DEI makes recommendations for sanctions to the Board. The Board may decide to suspend or permanently bar an accountant from auditing any public companies, suspend or revoke an accounting firm’s registration, appoint a monitor to oversee a firm’s practice, impose monetary penalties, require additional continuing professional education, and/or impose other sanctions permitted under PCAOB rules. 41) The rule in question is the Fees and Other Types of Remuneration Rule. Susan Small has violated this rule because she has accepted a commission from an attestation client. 42) The rule in question is the Independence Rule. Wally Wide has violated this rule in the financing of the house. Under an Independence Rule interpretation, members are no longer allowed to obtain home mortgages. However, because the auto loan is collateralized by the automobile, Wally has not violated the independence rule on the financing of the car. 43) The rule in question is the Independence Rule. Ben Big has not violated this rule because he is not considered a covered member. Partners are only covered members if they are in the office in which the lead attest engagement partner primarily practices in connection with the attest engagement. Only covered members and their immediate families are prohibited from having a direct financial interest in the client.

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44) A. If the profession is to maintain the public trust and the public confidence it must have standards that are visible to the public and the profession must demonstrate an adherence to those standards. Without a set of minimum ethical standards the profession might lose creditability in its opinions provided to financial statements users. B. In today's business environment it may be more difficult to adhere to ethical standards. Many more investment options exist including pension options. It may not always be clear what some of the funds are investing in and the extent of these investments. In addition, as businesses become more complex, integrate more technology, and engage in more global business practices it becomes more difficult for accountants to acquire the knowledge and skills required to me standard of competence. As standards grow in numbers and complexity, the adherence to standards becomes more difficult. Also, as business moves more quickly and corporations attempt to meet market expectations, the pressures placed on auditors to perform audits faster and achieve results in line with management expectations become greater.

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MODULE B: PROBLEM MATERIAL ESSAY. Write your answer in the space provided or on a separate sheet of paper. 1) For each situation (1-5), identify the most applicable AICPA rule of conduct and whether there is a violation or no violation of the rule (A-F). One or more letters may not be used. A.Independence Rule; no violation B.Independence Rule; violation C.Integrity and Objectivity Rule; no violation D.Integrity and Objectivity Rule; violation E.Accounting Principles Rule; no violation F.Accounting Principles Rule; violation

___ 1. Sterling Stevens, CPA, was auditing Global Services Company. Global Services used an accounting principle that was not in conformity with GAAP. Nevertheless, Stevens rendered a standard unqualified audit report. ___ 2. Christina Hall, CPA, provided expert testimony for a plaintiff. The defendant in the case was a client of Hall's. ___ 3. Sam Miller, CPA, owned 100 shares of Johnson Drilling, Inc., his audit client. ___ 4. Dewey Wise, CPA, obtained a loan from an insurance company using the cash value of the insurance policy as collateral. The loan is for less money than the cash value of the policy. ___ 5. Stella Steinbeck, CPA, was auditing Good Services Company. Good Services used an accounting principle that was not in conformity with GAAP. Good Services believed, and Steinbeck concurred, that using a generally accepted method would cause the financial statements to be misleading. Therefore, Steinbeck rendered a standard unqualified audit report.

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2) For each situation (1-5), identify the most applicable AICPA rule of conduct and whether there is a violation or no violation of the rule (A-F). One or more letters may not be used. A.Independence Rule; no violation B.Independence Rule; violation C.Confidential Client Information Rule; no violation D.Confidential Client Information Rule; violation E.Fees and Other Types of Remuneration Rule; no violation F.Fees and Other Types of Remuneration Rule; violation

___ 1. Jackson, CPA, and one of his audit clients are considering investing in a business together. Jackson would own 25% of the business and the client would own 50%. Jackson's investment in the business is material to his net worth. ___ 2. Feller, CPA, is the corporate controller for Robert Corporation. Feller believes his employer may have committed an illegal act. After discussing the matter with his attorney, Feller decides to disclose the matter to the appropriate authorities. ___ 3. Brock, CPA, is an owner in the firm Louis and Brock, CPAs. Brock's husband is on the board of directors of Midland Corporation, an audit client of Louis and Brock. Brock does not participate on the audit engagement. ___ 4. Ruth, CPA, owns a building and leases a portion of the space to an audit client. The income from the lease is not material to Ruth. ___ 5. Maris, CPA, performs investment advisory services for an audit client and receives an annual fee based on a percentage of the value of the client's investment portfolio at the end of each year.

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3) For each situation (1-5), identify the most applicable AICPA rule of conduct and whether there is a violation or no violation of the rule (A-F). One or more letters may not be used. A.Independence Rule; no violation B.Independence Rule; violation C.Confidential Client Information Rule; no violation D.Confidential Client Information Rule; violation E.Fees and Other Types of Remuneration Rule; no violation F.Fees and Other Types of Remuneration Rule; violation

___ 1. Brandon Frisby, CPA, found out that his client, Uptonogood, Inc., had failed to properly account for several leases. Frisby informed Uptonogood's management that he must issue a qualified audit report and disclose the lease problem in the report. Uptonogood's management indicated that such a disclosure would constitute a disclosure of confidential information. Nevertheless, Frisby rendered the qualified audit report, including an explanatory paragraph about the inadequate lease accounting. ___ 2. Priscilla Hudson, CPA, a partner in Hudson and Danhoffer, CPAs, holds the position of honorary director for the Friends of the Symphony Orchestra, a firm audit client. ___ 3. The wife of Gerald Skoch, CPA, is the controller of Fine Corporation. Skoch is an audit partner for Barnes and Bucknell, CPAs, in their Long Island office. The Long Island office of Barnes and Bucknell audits Fine Corporation, but Skoch is not part of the audit team and provides no other services to Fine Corporation. ___ 4. Johnny Beacon, CPA, is the auditor of Novak Wholesale, Inc. Beacon received a 10% commission from Computer Systems, Inc. for hardware sold to Novak Wholesale, Inc. The sale was made based on Beacon's recommendation to Novak Wholesale that the company needed a new accounting information system. Beacon disclosed the commission to Novak's management. Beacon also performs an annual audit for Novak. ___ 5. Cecilia Hart, CPA, provides tax services to Myers Company. Hart received a 10% commission from Computer Systems, Inc. for hardware sold to Myers Company. The sale was made based on Hart's recommendation to Myers Company that the company needed a new accounting information system. Hart disclosed the commission to Myers' management.

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4) For each of the following cases indicate if the action by a member CPA is a violation of the AICPA Code of Professional Conduct and cite the relevant rule. A. Disclosed client information to another CPA firm during the discussion of a merger of the two firms. B. Allow a company to change the way it values inventory to a method that is not GAAP because following GAAP would be misleading. C. Had a new car loan from a bank that is a client when the bank holds the title to the car. D. Based fee on approval of a bank loan dependent upon audited financial statements. E. Did not comply with "Government Auditing Standards on a government audit."

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5) For each of the following cases indicate if the action by a member CPA is a violation of the AICPA Code of Professional Conduct and cite the relevant rule. A. Was a trustee of client's profit-sharing trust. B. Accepted referral fees from local attorneys for nonattest clients with the clients' knowledge. C. Performed audit in accordance with GASB standards. D. Advises client to have an insurance review from a local insurance company in which the CPA has a material financial interest. E. Promoted tax service on local TV station.

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Answer Key Test name: Module B_8e_Test Bank_Problem Material 1) 1.F, 2.C, 3.B, 4.B, 5.E 2) 1.B, 2.C, 3.B, 4.A, 5.F 3) Independence Rule; violation 4) Letter A. B. C. D. E.

Relevant Rule Confidential Client Information Rule Accounting Principles Rule Independence Rule Fees and Other Types of Remuneration Rule Acts Discernable Rule

Violation? (Yes/No) yes No No Yes Yes

E. Acts Discernable Rule Yes 5) Letter A. B. C. D.

Relevant Rule Independence Rule Fees and Other Types of Remuneration Rule Accounting Principles Rule Integrity and Objectivity Rule

Violation? (Yes/No) Yes No No Yes

E. Advertising and Other Forms of Solicitation Rule No

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MODULE C MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) Auditors should not be liable to any party if they perform services that met the standards of: A) ordinary negligence. B) regulatory providence. C) due care. D) good faith.

A principle that may reduce or eliminates auditors' liability to clients is: A) client's constructive negligence. B) client's contributory negligence. C) auditors' ordinary negligence. D) auditors' gross negligence.

3) Elliot Corp. is interested in purchasing Roger Corp. Prior to the purchase Elliot hired Adam & Co. to audit the financial statements of Roger. During the audit, Adam & Co. failed to discover a fraud that resulted in material misstatements in Roger's financial statements. After the acquisition, the fraud was discovered and Elliot Corp. suffered substantial losses. If Elliot sues Adam & Co., Elliot must prove that Adam & Co: A) acted recklessly or with lack of reasonable grounds for belief. B) knew of the instances of fraud. C) failed to exercise the appropriate level of professional care. D) demonstrated gross negligence.

4) Which of the following statements is true concerning auditors' responsibilities during the audit?

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A) Auditors must exercise the level of care, skill, and judgment expected of a reasonably prudent auditor under the circumstances. B) Auditors must plan the audit to gather sufficient competent evidence to guarantee the accuracy of the financial statements. C) Auditors are strictly liable for failures to discover client fraud. D) Auditors are not liable unless they commit gross negligence or intentionally disregard generally accepted auditing standards.

5) Kerry CPA is the auditor for Sammy Corp. During the audit, Kerry discovers a material misstatement in Sammy's financial statements. Sammy's management tells Kerry that if the misstatement is corrected or if Kerry issues an opinion that indicates there is a material misstatement, Sammy Corp. will likely have to declare bankruptcy and thousands of employees will lose their jobs. Which of the following statements is true if the misstatement is not corrected and Kerry issues an unqualified opinion on Sammy's financial statements? A) Kerry is liable only to third parties in privity of contract. B) Kerry is liable only to known users of the financial statements. C) Kerry is likely liable to any person who suffered a loss as a result of the fraud. D) Kerry is likely liable to third parties even if the third parties were aware of the fraud and did not rely on the opinion.

6) Mays bought McCovey Corp. common stock in an offering registered under the Securities Act of 1933. Hart & Co., CPAs, gave an unqualified opinion on McCovey's financial statements that were included in the registration statement filed with the Securities and Exchange Commission. Mays sued Hart under the provisions of the 1933 act that deal with omission of facts required to be in the registration statement. Mays must prove that: A) There was fraudulent activity by Hart. B) The financial statements contained a material misstatement. C) Mays relied on Hart's opinion. D) Mays was in privity with Hart.

7) To prevail in an action brought under common law, the plaintiff must show all of the following except:

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A) he or she was damaged or suffered a loss. B) the financial statements contained a material misstatement. C) auditors knew the financial statements contained a material misstatement. D) he or she relied on the financial statements.

8) Failure to provide any level care in fulfilling a duty owed to another party, including reckless disregard for the truth, is called A) breach of contract. B) ordinary negligence. C) privity. D) constructive fraud.

9) Lauren hires Humphrey, a CPA, to audit her financial statements. The engagement letter includes a statement acknowledging that audited financial statements are required to be filed with a regulatory body by October 1. Humphrey does not complete the audit until October 5. Lauren is late filing the financial statements and is fined $100,000 by the regulatory body. Lauren would most likely sue Humphrey claiming: A) breach of contract. B) ordinary negligence. C) gross negligence. D) constructive fraud.

10) Lauren hires Humphrey, a CPA, to audit her financial statements. The engagement letter includes a statement acknowledging that audited financial statements will be provided to Key Largo Bank for a loan. Humphrey completes the audit and issues an unqualified opinion. Based on the audited financial statements, Key Largo Bank approves the loan to Lauren. Four months later, Lauren files for bankruptcy. Key Largo Bank would most likely sue Humphrey claiming: A) it was in privity of the contract. B) it was a primary beneficiary. C) it was a foreseen party. D) it was a foreseeable party.

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11) Lauren hires Humphrey, a CPA, to provide an audit of her financial statements. The engagement letter includes a statement acknowledging that audited financial statements will be provided to financial institutions for a loan, but does not name any financial institutions. Humphrey completes the audit and issues an unqualified opinion. Based on the audited financial statements, Key Largo Bank approves the loan to Lauren. Four months later, Lauren files for bankruptcy. Key Largo Bank would most likely sue Humphrey claiming: A) it was in privity of the contract. B) it was a primary beneficiary. C) it was a foreseen party. D) it was a foreseeable party.

12) Lauren hires Humphrey, a CPA, to audit her financial statements. The engagement letter includes a statement acknowledging that audited financial statements are needed for a filing with a regulatory body. Humphrey completes the audit and issues an unqualified opinion. Based on the audited financial statements, Key Largo Bank approves a loan to Lauren. Four months later, Lauren files for bankruptcy. Key Largo Bank would most likely sue Humphrey claiming: A) it was in privity of the contract. B) it was a primary beneficiary. C) it was a foreseen party. D) it was a foreseeable party.

13) If an audit is performed for the benefit of a specific person or organization, that person or organization is known as a(n) A) party to the contract. B) primary beneficiary. C) foreseeable third party. D) prime benefactor.

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14) At the request of James Company's management, E.G. audited James Company's financial statements and was aware that James's management intended to deliver the financial statements to its 25 shareholders for the purpose of repurchasing their shares for $50 per share (the investors had originally purchased the shares for $5 per share). The audit was conducted in accordance with generally accepted auditing standards and the financial statements were prepared in accordance with generally accepted accounting principles. Later, the shareholders sued the auditors, claiming that if they fully realized the significance of disclosures about the market value of the assets, they could have received $75 per share from James Company. The shareholders' lawsuit will probably fail because: A) the shareholders did not suffer a loss. B) the shareholders were not primary beneficiaries of the audit engagement and they have no standing to sue. C) the shareholders failed to prove lack of appropriate professional care on the part of auditors. D) the shareholders did not rely properly on the financial statements.

15) Which of the following claims concerning the quality of auditors' work would least likely result in civil liability for damages? A) Gross negligence amounting to constructive fraud. B) Failure to investigate possible fraud when other entities in the industry have experienced frauds. C) Reckless disregard of evidence that the financial statements do not conform to generally accepted accounting principles. D) Issuing an unqualified auditors' opinion when evidence suggests that the financial statements were not prepared according to generally accepted accounting principles.

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16) Lancaster & Co., CPAs, is auditing the financial statements of Cooper Corporation. During the course of the audit, Cooper Corporation sent the following memo to the engagement partner: We have requested $1 million worth of products from Ladd Corporation with credit terms of net 30 days. Ladd has requested audited financial statements for its credit decision. We notified Ladd that our annual audit was in process and we would provide the audited financial statements to them as soon as they were completed. Which of the following statements is true with regards to this memo? A) The memo is an amendment to the engagement letter and makes Ladd Corporation a primary beneficiary of the audited financial statements. B) The memo may move Ladd Corporation closer to a primary beneficiary and reposition them as third party with a standing to sue, depending on the jurisdiction of any future lawsuits. C) The memo is only a courtesy and does not alter the terms of the engagement letter or change the nature of Ladd Corporation's standing to sue. D) The memo is an additional contract placing Ladd in privity of contract.

17) When bringing suit against auditors under Section 10(b) of the Securities Exchange Act of 1934, plaintiffs must allege and prove: A) the financial statements in the offering registration filing contained a material misstatement. B) auditors were aware of material misstatements in the financial statements. C) auditors were guilty of ordinary negligence and failed to discover material misstatements in the financial statements. D) the plaintiffs purchased the specific securities through a public offering and thus have a right to sue.

18) Which of the following parties is most likely to recover against auditors for losses resulting from acts of ordinary negligence?

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A) Third parties that auditors should have foreseen could rely on the client's financial statements. B) The auditors' client. C) Purchasers and sellers of securities under the Securities Exchange Act of 1934. D) Third parties whose reliance on the client's financial statements was reasonably foreseeable.

19)

An audit failure occurs when

A) a client goes bankrupt or has serious financial difficulty. B) auditors fail to conduct the examination in accordance with generally accepted auditing standards, which results in the failure to identify material misstatements in the financial statements. C) auditors cannot collect audit fees owed to them by the client. D) auditors are sued by a third party.

20)

Third-party plaintiffs bringing action under common law need not prove A) they were damaged or suffered an economic loss. B) reliance on the financial statements. C) the financial statements were direct cause of loss. D) breach of contract.

21)

Typical defenses for auditors in common law actions include all of the following, except A) the plaintiff was foreseen. B) the plaintiff contributed to the failure to detect material misstatements. C) the financial statements were not materially misstated. D) the audit was conducted in accordance with generally accepted auditing standards.

22)

The Securities Act of 1933

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A) regulates trading in securities. B) approves and guarantees investments. C) regulates the initial issuance of securities. D) regulates the accounting profession.

23) Which of the following would not need to be demonstrated by third parties bringing suit against auditors for losses sustained under the Securities Act of 1933? A) Auditors were aware of the materially misstated financial statements. B) Third-party purchasers suffered a loss. C) The client's financial statements contained a material misstatement. D) Purchasers would need to demonstrate all of these.

24)

The SEC Rule 10b-5 deals with A) fraud in the purchase or sale of securities. B) penalties for willfully and knowingly violating the Securities Exchange Act of 1934. C) the use of the "due diligence" defense to avoid liability. D) integrated disclosure system for annual reports.

25) The first significant case under Section 11 of the Securities Act of 1933 charging auditors with not conducting a reasonable investigation was A) Rusch Factors v. Levin. B) United States v. Benjamin. C) Escott v. BarChris Construction Corp. D) Ernst & Ernst v. Hochfelder.

26)

Foreseeable third parties are best described as

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A) management of the entity. B) those third parties who have a direct relationship with auditors through previous contract related to the audit engagement. C) those third parties who will rely on the audit and are specifically known by auditors. D) those third parties whose decisions normally rely on audited financial statements and opinions on those financial statements.

27)

Which of the following statements about the Securities Act of 1933 is not true?

A) The plaintiff must prove damages or an economic loss. B) The plaintiff must prove they read and relied upon the financial statements. C) Any purchaser of securities may sue auditors. D) The plaintiff need not prove that the materially misstated financial statements are the direct cause of the loss.

28) The restatement of torts is a general legal doctrine that extends liability for ordinary negligence to A) foreseeable third parties. B) foreseen third parties. C) primary beneficiaries. D) all users of financial statements.

29) Which of the following is not part of the definition of proportionate liability adopted by the Private Securities Litigation Reform Act? A) The total responsibility for loss is divided among all parties responsible for the loss. B) Defendants who knowingly committed a violation of securities laws remain jointly and severally liable. C) The full amount of damages may be recovered from any defendants involved in the action. D) A solvent defendant's liability may be increased by 50 percent if other defendants are insolvent.

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30) Paula performed the audit of the financial statements of Abdul Company (a nonpublic entity currently not subject to filing requirements under the Securities Act of 1933 or Securities Exchange Act of 1934). Abdul Company is currently considering several alternatives for raising capital, including seeking financing from area banks or an initial public offering of its securities. Which of the following parties would have the lowest likelihood of successfully bringing suit for ordinary negligence against Paula? A) Abdul Company. B) Purchasers of Abdul Company's securities in an initial public offering. C) First State Bank, a bank with whom Abdul Company has not previously done business. D) Simon Whitaker, a private investor who is considering acquiring Abdul Company.

31) Which of the following factors would not influence third parties' abilities to bring suit against auditors for ordinary negligence under common law? A) The extent to which the third party relied upon the misstated financial statements and this reliance resulted in their loss. B) The nature of activity by auditors that resulted in their failure to exercise appropriate levels of professional care. C) The relationship between the auditors and third party. D) The jurisdiction in which the action occurred.

32) According to Sarbanes-Oxley, accountants performing an audit or review must maintain all engagement documentation for a period of A) 2 years. B) 3 years. C) 5 years. D) 7 years.

33) true?

Which of the following statements concerning the Ultramares Corp. v. Touche case is not

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A) This case was brought under common law liability. B) This case provided a test to determine whether a third party qualified as a primary beneficiary and could bring suit for ordinary negligence. C) This case established the rights of third parties to bring suits against auditors under common law liability. D) This case concluded that auditors' liability to third parties would be generally limited to gross negligence or fraud.

34)

In a common law action against auditors, lack of privity is a viable defense if the plaintiff A) is the client's creditor who sues auditors for ordinary negligence. B) can prove gross negligence by auditors that amounts to a reckless disregard for the

truth. C) is the auditors' client. D) bases the action upon fraud.

35) Under the liability provisions of Section 11 of the Securities Act of 1933, auditors may be liable to any purchaser of a security for certifying materially misstated financial statements that are included in the registration statement. Under Section 11, auditors usually will not be liable to the purchaser A) if auditors can show contributory negligence on the part of the purchaser. B) if auditors can demonstrate due diligence. C) unless the purchaser can prove privity with auditors. D) unless the purchaser can prove scienter on the part of auditors.

36) Under the liability provisions of Section 11 of the Securities Act of 1933, auditors may be liable to any purchaser of securities for certifying materially misstated financial statements that are included in the registration statement. Under Section 11, which of the following must be proven by a purchaser of the security?

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A) Reliance on financial statements: Yes; Fraud by auditors: Yes B) Reliance on financial statements: Yes; Fraud by auditors: No C) Reliance on financial statements: No; Fraud by auditors: Yes D) Reliance on financial statements: No; Fraud by auditors: No

37) Beckler & Associates, CPAs, examined and issued an unqualified opinion on the financial statements of Queen Co. The financial statements contained misstatements that resulted in a material overstatement of Queen's net worth. Queen provided the audited financial statements to Mac Bank in connection with a loan made by Mac to Queen. Beckler knew that the financial statements would be provided to Mac. Queen defaulted on the loan. Mac sued Beckler to recover for its losses associated with Queen's default. Which of the following must Mac prove in order to recover? 1. Beckler did not conduct the audit with the appropriate level of professional care. 2. Mac relied on the financial statements.

A) I only. B) II only. C) Both I and II. D) Neither I nor II.

38) While conducting an audit, Larson Associates, CPAs, failed to detect material misstatements included in its client's financial statements. Larson's unqualified opinion was included with the financial statements in a registration statement and prospectus for a public offering of securities made by the client. Larson knew that its opinion and the financial statements would be used for this purpose. Which of the following statements is correct with regard to a suit against Larson and the client by a purchaser of the securities under Section 11 of the Securities Act of 1933?

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A) The purchaser must prove that Larson failed to conduct the audit in accordance with generally accepted auditing standards. B) The purchaser must prove that Larson knew of the material misstatements. C) Larson will not be liable if it had reasonable grounds to believe the financial statements were accurate. D) Larson will not be liable if the purchaser did not rely on the financial statements.

39) While conducting an audit, Larson Associates, CPAs, failed to detect material misstatements included in its client's financial statements. Larson's unqualified opinion was included with the financial statements in a registration statement and prospectus for a public offering of securities made by the client. Larson knew that its opinion and the financial statements would be used for this purpose. In a suit by a purchaser against Larson, Larson's best defense would be that the A) audit was conducted in accordance with generally accepted auditing standards. B) client was aware of the misstatements. C) purchaser was not in privity of contract with Larson. D) identity of the purchaser was not known to Larson at the time of the audit.

40) While conducting an audit of a public entity, Wallace failed to identify material misstatements in its client's financial statements. Investors then sued Wallace in connection with this audit. Which of the following would not need to be demonstrated in order for the shareholders to successfully bring suit against Wallace under Section 10(b)-5 of the Securities Act of 1934? A) Wallace was in privity with the shareholders. B) The shareholders relied upon the materially misstated financial statements. C) Wallace acted with gross negligence in his audit. D) The reliance on the materially misstated financial statements caused the shareholders' losses.

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41) Sun Corp. approved a merger plan with Cord Corp. One of the determining factors in approving the merger was the financial statements of Cord that were audited by Frank & Co., CPAs. Sun had engaged Frank to audit Cord's financial statements. While performing the audit, Frank failed to discover certain irregularities that later caused Sun to suffer substantial losses. For Frank to be liable under common law liability, Sun at a minimum must prove that Frank A) knew of the irregularities. B) failed to exercise the appropriate level of professional care. C) demonstrated gross negligence. D) acted with scienter.

42) Which of the following elements, if present, would support a finding of constructive fraud on the part of auditors? A) Gross negligence in conducting the engagement. B) Ordinary negligence in conducting the engagement. C) Failure to perform the engagement in accordance with the terms in the engagement letter. D) Actions that demonstrated scienter.

43) To be successful in a civil action under Section 11 of the Securities Act of 1933 against auditors for liability for a materially misstated registration statement, the plaintiff must prove which of the following? A) Auditors' intent to deceive: Yes; Plaintiff's reliance on the registration statement: Yes B) Auditors' intent to deceive: Yes; Plaintiff's reliance on the registration statement: No C) Auditors' intent to deceive: No; Plaintiff's reliance on the registration statement: Yes D) Auditors' intent to deceive: No; Plaintiff's reliance on the registration statement: No

44) Which of the following is the best defense auditors can assert in a suit for common law fraud based on their unqualified opinion on materially misstated financial statements?

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A) Contributory negligence on the part of the client. B) A disclaimer contained in the engagement letter. C) Lack of privity. D) Lack of scienter.

45) Under the anti-fraud provisions of Section 10(b) of the Securities Exchange Act of 1934, auditors may be liable if they acted A) with ordinary negligence. B) with independence. C) without due diligence. D) without good faith.

46) How does the Securities Act of 1933, which imposes civil liability on auditors for misrepresentations or omissions of material facts in a registration statement, expand auditors' liability to purchasers of securities beyond that of common law? A) Purchasers only have to prove loss caused by reliance on audited financial statements. B) Privity with purchasers is not a necessary element of proof. C) Purchasers have to prove either fraud or gross negligence as a basis for recovery. D) Auditors are held to a standard of care described as professional skepticism.

47) Which of the following is not a reason that the Class Action Fairness Act of 2005 will benefit auditors in class action lawsuits? A) Federal courts provide a higher level of scrutiny for class action lawsuits than state courts. B) Federal courts have more resources at their disposal for managing class action lawsuits. C) State courts may discriminate against defendants from other jurisdictions. D) Verdicts in state courts are normally more appropriate to apply to multiple jurisdictions than verdicts in federal courts.

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48) Under the Securities Act of 1933, which of the following defenses is related to auditors performing a reasonable investigation of the financial statements? A) Causation B) Contributory negligence C) Due diligence D) Prudent auditor

49) Which of the following is not a valid defense for auditors' liability to third parties for ordinary negligence under common law? A) The loss was caused by factors other than the materially misstated financial statements. B) Lack of proper standing (relationship) to bring suit in that jurisdiction. C) Lack of a privity relationship with auditors. D) Third parties did not rely upon the financial statements.

50) Select the appropriatecase to which each is most closely related. Established a three point test for auditor liability, including that auditors demonstrate some action to acknowledge the existence of the third party and the third party's intent to rely on the opinion and financial statements. A) Ernst & Ernst v. Hochfelder. B) Smith v. London Assurance Corp. C) Ultramares Corp. v. Touche. D) Escott v. BarChris Construction Corp. E) 1136 Tenants' Corp. v. Max Rothenberg & Co. F) Credit Alliance v. Arthur Andersen. G) State Street Trust v. Ernst.

51) Select the appropriatecase to which each is most closely related. Was the first United States case involving a suit against auditors.

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A) Ernst & Ernst v. Hochfelder. B) Smith v. London Assurance Corp. C) Ultramares Corp. v. Touche. D) Escott v. BarChris Construction Corp. E) 1136 Tenants' Corp. v. Max Rothenberg & Co. F) Credit Alliance v. Arthur Andersen. G) State Street Trust v. Ernst.

52) Select the appropriatecase to which each is most closely related. Concluded that auditors could be liable to third parties who were not in privity with them. A) Ernst & Ernst v. Hochfelder. B) Smith v. London Assurance Corp. C) Ultramares Corp. v. Touche. D) Escott v. BarChris Construction Corp. E) 1136 Tenants' Corp. v. Max Rothenberg & Co. F) Credit Alliance v. Arthur Andersen. G) State Street Trust v. Ernst.

53) Select the appropriatecase to which each is most closely related. Established precedent for the plaintiff to prove scienter to recover damages under section 10(b) of the Securities Exchange Act of 1934. A) Ernst & Ernst v. Hochfelder. B) Smith v. London Assurance Corp. C) Ultramares Corp. v. Touche. D) Escott v. BarChris Construction Corp. E) 1136 Tenants' Corp. v. Max Rothenberg & Co. F) Credit Alliance v. Arthur Andersen. G) State Street Trust v. Ernst.

54) Select the appropriatecase to which each is most closely related. Concluded that auditors had a duty to inform clients of instances of fraud, even if hired for write-up work.

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55) Select the appropriatecase to which each is most closely related. Concluded that reckless misstatements, even if not deliberate, are the basis for liability to third parties. A) Ernst & Ernst v. Hochfelder. B) Smith v. London Assurance Corp. C) Ultramares Corp. v. Touche. D) Escott v. BarChris Construction Corp. E) 1136 Tenants' Corp. v. Max Rothenberg & Co. F) Credit Alliance v. Arthur Andersen. G) State Street Trust v. Ernst.

56) Select the appropriatecase to which each is most closely related. Found auditors liable for ordinary negligence under the Securities Act of 1933. A) Ernst & Ernst v. Hochfelder. B) Smith v. London Assurance Corp. C) Ultramares Corp. v. Touche. D) Escott v. BarChris Construction Corp. E) 1136 Tenants' Corp. v. Max Rothenberg & Co. F) Credit Alliance v. Arthur Andersen. G) State Street Trust v. Ernst.

57) Select the appropriatecase to which each is most closely related. Auditors are liable to reasonably foreseeable third-party users for ordinary negligence.

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A) United States v. Natelli (National Student Marketing) B) Ernst & Ernst v. Hochfelder C) United States v. Benjamin D) Fleet National Bank v. Gloucester Co. E) Iselin v. Landau F) Credit Alliance v. Arthur Andersen G) Rosenblum, Inc. v. Adler

58) Select the appropriatecase to which each is most closely related. Conviction of auditors for willingly conspiring to defraud in an engagement related to pro forma financial statement. A) United States v. Natelli (National Student Marketing) B) Ernst & Ernst v. Hochfelder C) United States v. Benjamin D) Fleet National Bank v. Gloucester Co. E) Iselin v. Landau F) Credit Alliance v. Arthur Andersen G) Rosenblum, Inc. v. Adler

59) Select the appropriatecase to which each is most closely related. Established precedent for plaintiff's need to allege and prove scienter to impose section 10(b) liability. A) United States v. Natelli (National Student Marketing) B) Ernst & Ernst v. Hochfelder C) United States v. Benjamin D) Fleet National Bank v. Gloucester Co. E) Iselin v. Landau F) Credit Alliance v. Arthur Andersen G) Rosenblum, Inc. v. Adler

60) Select the appropriatecase to which each is most closely related. Third parties cannot rely on reviewed financial statements to the same extent as they can on audited financial statements. Version 1

61) Select the appropriatecase to which each is most closely related. Auditors may be liable to third parties for ordinary negligence if these parties should be foreseen by auditors as relying on the financial statements. A) United States v. Natelli (National Student Marketing) B) Ernst & Ernst v. Hochfelder C) United States v. Benjamin D) Fleet National Bank v. Gloucester Co. E) Iselin v. Landau F) Credit Alliance v. Arthur Andersen G) Rosenblum, Inc. v. Adler

62) Select the appropriatecase to which each is most closely related. The court applied the restatement of torts doctrine to identify the plaintiff as a primary beneficiary. A) United States v. Natelli (National Student Marketing) B) Ernst & Ernst v. Hochfelder C) United States v. Benjamin D) Fleet National Bank v. Gloucester Co. E) Iselin v. Landau F) Credit Alliance v. Arthur Andersen G) Rosenblum, Inc. v. Adler

63) Select the appropriatecase to which each is most closely related. Auditors willfully violated Securities Exchange Act of 1934 by making false and misleading statements in a proxy statement. Version 1

ESSAY. Write your answer in the space provided or on a separate sheet of paper. 64) Distinguish between the “due diligence” and the “causation” defenses available to auditors under section 11 of the Securities Act of 1933.

65)

What are the legal liabilities of auditors under common law?

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66) Sleek Corporation is a public corporation whose stock is traded on a national securities exchange. Sleek hired Garson Associates, CPAs, to audit Sleek’s financial statements. Sleek needed the audit to obtain bank loans and to make a public stock offering so that Sleek could undertake a business expansion program. Before the engagement, Fred Hedge, Sleek’s president, told Garson’s managing partner that the audited financial statements would be submitted to Sleek’s banks to obtain the necessary loans. During the course of the audit, Garson’s managing partner found that Hedge and other Sleek officers had embezzled substantial amounts of money from the corporation. These embezzlements threatened Sleek’s financial stability. When these findings were brought to Hedge’s attention, Hedge promised that the money would be repaid and begged Garson not to disclose the embezzlements. Hedge also told Garson's managing partner that several friends and relatives of Sleek’s officers had been advised about the projected business expansion and proposed stock offering, and had purchased significant amounts of Sleek’s stock based on this information. Garson submitted an unqualified opinion on Sleek’s financial statements, which did not include adjustments for or disclosures of the embezzlements and insider stock transactions. The financial statements and auditors’ opinion were submitted to the banks Sleek normally does business with, including Knox Bank. Knox, relying on the financial statements and the auditors’ report, loaned Sleek $2,000,000. Sleek’s audited financial statements were also included in a registration statement prepared under the provisions of the Securities Act of 1933. The registration statement was filed with the SEC in conjunction with Sleek's public offering of 100,000 shares of its common stock at $100 per share. An SEC investigation of Sleek disclosed the embezzlements and the insider trading. Trading in Sleek’s stock was suspended and Sleek defaulted on the Knox loan. As a result, the following legal actions were taken: ● Knox Bank sued Garson. ● The purchasers of Sleek’s stock offering sued Garson. Required 1. a. Would Knox recover from Garson for fraud? 2. b. Would the purchasers of Sleek’s stock offering recover from Garson 3. 1. Under the liability provisions of section 11 of the Securities Act of 1933? 4. 2. Under the antifraud provisions of section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934?

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67) Briefly explain the concept of proportionate liability. Why is the adoption of proportionate liability important to the accounting profession?

68) Charlie Company is headquartered in Wisconsin. Charlie Company’s auditors are headquartered in Minnesota. Bob lives in Bloomington, Indiana but works in Chicago, Illinois. Based on a tip from his boss, Bob calls his stockbroker (Jim, who offices in Chicago) and instructs him to purchase 1,000 shares of Charlie Company despite never having requested or reviewed Charlie Company’s financial statements. Charlie Company is traded on the New York Stock Exchange and the transaction takes place 15 minutes later on the floor of the exchange. Charlie Company declared bankruptcy three months later and Bob lost his entire investment. Bob sued Charlie Company’s auditors for ordinary negligence. The trial is scheduled for hearing in Madison, Wisconsin. Before the opening of the trial, the attorney for the auditors objects to the trial being held in Wisconsin, since the transaction between Bob and Jim took place in Illinois. The attorney asks that the trial be moved to Illinois. Required: A. Why would the attorney ask for the trial to be moved? B.What defense would you raise if you were the auditors’ attorney?

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Answer Key Test name: Module C Test Bank 1) C 2) B 3) C 4) A 5) C 6) B 7) C 8) D 9) A 10) B 11) C 12) D 13) B 14) C 15) B 16) B 17) B 18) B 19) B 20) D 21) A 22) C 23) A 24) A 25) C 26) D Version 1

27) B 28) B 29) C 30) D 31) B 32) D 33) B 34) A 35) B 36) D 37) C 38) C 39) A 40) A 41) B 42) A 43) D 44) D 45) D 46) B 47) D 48) C 49) C 50) F 51) B 52) C 53) A 54) E 55) G 56) D Version 1

57) G 58) C 59) B 60) E 61) D 62) F 63) A 64) Section 11( b) describes the due diligence defense. If auditors can prove that a reasonable examination was performed, then auditors are not liable for damages. Section 11( e) defines the causation defense. If auditors can prove that the plaintiff’s damages were caused by something other than the materially misstated financial statements, then auditors will not be liable. 65) Legal liabilities of auditors may arise from lawsuits brought on the basis of the law of contracts or as tort actions for failure to exercise the appropriate level of professional care. Breach of contract is a claim that accounting or auditing services were not performed in the manner agreed. Tort actions cover complaints other than breach of contract and normally involve accusations that auditors failed to detect material misstatements. Such actions are normally initiated by users of financial statements.

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66) a. Knox would recover from Garson for fraud. Since Knox suffered a loss because of reliance on materially misstated financial statements, he would need to demonstrate that Garson was aware of the embezzlement and insider transactions. Garson was aware of the embezzlement and insider transactions and, as such, committed fraud. It is important to note that auditors owe all parties responsibility for fraud. b. 1. The purchasers of Sleek’s stock offering would recover from Garson under the liability provisions of section 11 of the Securities Act of 1933. Section 11 of the Act provides that anyone, such as auditors, who submit or contribute to a registration statement or allows material misrepresentations or omissions to appear in a registration statement, is liable to anyone purchasing the security who sustains a loss. Under the facts presented, Garson would not be able to establish a “due diligence” defense for a section 11 action because it knew that the registration statement contained materially misstated financial statements. 2. The purchasers of Sleek’s stock offering would also recover from Garson under the antifraud provisions of section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934. Under Rule 10b-5, Garson’s knowledge that the registration statement included materially misstated financial statements is considered a fraudulent action. Garson’s action was intentional or, at a minimum, a result of gross negligence or recklessness. These purchasers relied on Garson’s opinion on the financial statements and incurred a loss.

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67) Under proportionate liability, a defendant is required to pay a proportionate share of the court’s damage award, depending upon the degree of fault determined by a judge or jury. For example, if a defendant is determined to be 40 percent at fault, they will be required to pay 40 percent of the damages awarded. This is important to the audit profession because under alternative legal concept of “joint and several liability”, auditors could be held liable for all of losses incurred by third parties. This is especially true when the client had declared bankruptcy and was not able to provide any compensation to plaintiffs for damages. 68) A. Third parties have different standing to sue in different jurisdictions. In Wisconsin, Bob may be able to bring suit against auditors for ordinary negligence as a foreseeable party, while in Illinois Bob may have to prove he is a foreseen party or allege gross negligence or fraud on the part of auditors in order to have a right to bring suit. B. The best defense is a lack of causation between the materially misstated financial statements and Bob’s loss. Bob never evaluated the financial statements, but purchased the stock through a tip from his boss. Auditors may also claim that they performed the audit with due care and according to generally accepted auditing standards.

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MODULE D MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) The definition of internal audit includes all of the following except: A) independence and objectivity. B) provision of assurance and consulting activity. C) determination of efficient and effective performance. D) additional value and improved operations.

The reasons for outsourcing an internal audit include: A) more expertise only. B) more expertise and improved control over audit costs. C) improved control over audit costs and improved alignment with company goals. D) All of the answer choices are correct.

3) The primary difference between operational auditing and financial auditing is that in operational auditing, the auditor: A) is concerned only with the audited activity's adherence to company policy and procedures. B) is seeking to help management use resources in the most effective manner possible. C) starts the process with the financial statements of an activity being audited and works backward to the basic processes involved in producing them. D) can use analytical skills and tools that are not necessary in financial auditing.

4) Independence permits internal auditors to render impartial and unbiased judgments. The best way for internal audit departments to achieve independence is through: A) individual knowledge and skills. B) organizational knowledge and skills. C) supervision within the organization. D) organizational status and individual objectivity.

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The proper organizational role of internal auditing is to:

A) assist external auditors in reducing external audit fees. B) perform studies to assist in attaining more efficient operations. C) serve as an investigative arm of senior management and the board of directors. D) serve as an independent, objective assurance and consulting activity that adds value to the organization.

6) During the audit of the quality control area, an auditor identified that a specific product has a 3 percent failure rate when tested. The specification calls for a failure rate of less than 1.8 percent. Product failure might lead to customer injury and in turn lawsuits against the company. The auditor has communicated this to management. Which of the following is not an acceptable response from management with regard to this risk? A) Management is aware of the risk and has decided that it is acceptable. B) Management has decided not to continue manufacturing this product. C) Management has decided to increase the quality control activity to reduce the manufacture of unacceptable product to an acceptably low level. D) Management has decided that the test data are unreliable and has decided not to respond to the audit findings.

7) Having an audit charter is important for internal audit departments. Which of the following items is generally not a reason to have an audit charter? A) It provides a commitment from management to support the internal audit department's activities. B) It defines the skills and competencies required by the internal audit department. C) It defines the department's authority and responsibility. D) It defines the reporting requirements for internal audit departments.

8) Your organization has selected you to develop an internal audit activity. Your approach will most likely be to hire:

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A) internal auditors each of whom possess the skills required to handle all engagements. B) inexperienced personnel and train them the way the organization wants them trained. C) degreed accountants because most internal audit work is accounting related. D) internal auditors who collectively have the knowledge and skills needed to perform the responsibilities of the internal audit activities.

9) The purpose of the internal audit's evaluation of the effectiveness of existing risk management processes is to determine that: A) management has planned and designed the process to provide reasonable assurance of achieving objectives and goals. B) management directs processes to provide reasonable assurance of achieving objectives and goals. C) the organization's objectives and goals will be achieved efficiently and economically. D) the organization's objectives and goals will be achieved in an accurate and timely manner and with minimal use of resources.

10) Senior management has ordered a compliance audit of the organization's employee benefits package. Which of the following do both the chief audit executive and senior management consider a primary engagement objective? A) The level of the organizational contributions is adequate to meet the program's demands. B) Individual programs are operating in accordance with contractual requirements and government regulations. C) Participation levels support continuation of individual programs. D) Benefits payments, when appropriate, are accurate and timely.

11) The Standards for the Professional Practice of Internal Audit of the Institute of Internal Auditors (IIA) is classified in three major categories. Which of the following is not one of these categories?

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A) Attribute standards. B) Performance standards. C) Governance standards. D) Implementation standards.

12) Which of the following is a requirement of the Standards for the Professional Practice of Internal Audit if the Institute of Internal Auditors (IIA) that is not a requirement of an external auditor performing a financial statement audit? A) Due care. B) Internal control evaluation. C) Reporting to the audit committee. D) Performing a follow-up on audit findings.

13) When preparing an audit report, an internal auditor must convince management to take action concerning the report's findings. When reporting on an audit finding, an auditor must include some key elements about that finding in the report. These key elements are: A) condition, criteria, cause, effect, and recommendation. B) condition, criteria, cause, effect, and requirement. C) condition, source, cause, effect, and recommendation. D) location, criteria, cause, effect, and recommendation.

14)

Program audits include determining:

A) the degree to which an entity is acquiring, protecting, and using its resources effectively. B) the effectiveness of an organization's programs, activities, or functions. C) the causes of an organization's inefficiencies or uneconomical practices. D) the entity's compliance with laws and regulations concerning matters of efficiency.

15) The Standards for the Professional Practice of Internal Auditing of the Institute of Internal Auditors (IIA) does not include the broad category of: Version 1

A) proficiency and due care. B) nature of work. C) performance of the engagement. D) quality control.

16)

Which of the following internal audits is generally not a type of government audit? A) Review of compliance with policies, plans, procedures, laws, and regulations. B) Review of the economy and efficiency in the use of resources. C) Review of the means of safeguarding assets. D) Review of the results of programs.

17) The U.S. Government Accountability Office (GAO) standards do not specifically require a written report in financial statement audits for: A) recommendations for actions to improve operations. B) all instances of illegal acts that could result in criminal prosecution. C) compliance with applicable laws and regulations. D) internal control structure and the control risk assessment.

18) The federal law that established uniform requirements for audits of federal assistance provided to state and local governments is called: A) the Single Audit Act of 1984. B) the Uniform Requirements Act of 1992. C) the Sarbanes-Oxley Act or 2002. D) the Audit Reduction Act of 1985.

19)

The definition of administrative control does not include reference to:

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A) operational efficiency. B) accounting errors. C) adherence to managerial policies. D) plan of organization.

20) When dealing with standards, measurements, and comparisons, input measurements are most important for audits of: A) economy. B) efficiency. C) program results. D) financial statements.

21)

Which of the following is not required to become a certified internal auditor (CIA)? A) Hold a college degree. B) Pass a two-day examination. C) Have a full-time position as an internal auditor. D) Meet an experience requirement.

22) When considering the competence of internal auditors, external auditors should obtain evidence about the: A) educational and experience qualifications of the internal auditors. B) organizational status of the internal auditors. C) lines of communication within the entity of the internal auditors. D) the size of the internal audit department.

23) When independent CPAs in public practice take engagements to audit government units or financial assistance recipients, they must follow:

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A) GAAS only. B) GAAS and GAGAS. C) GAGAS only. D) internal auditing standards.

24)

Which of the following statements is true?

A) External auditors must consider the internal audit function as part of obtaining an understanding of a company's internal control structure. B) External auditors must review all work performed by internal auditors. C) External auditors must investigate the competence and objectivity of internal auditors. D) External auditors must share responsibility for the work of internal auditors if it is used for evidence for the financial statement audit.

25) Which of the following is a difference between performing an audit and performing a fraud examination? A) Auditors are not concerned with the nature of a financial misstatement; fraud examiners are concerned with the nature of the misstatement. B) Auditors use analytical procedures, such as trend analysis, to identify risks of misstatements; fraud examiners are not interested in analytical procedures because they must identify specific items that prove the occurrence of fraud. C) Auditors are generally not concerned with small immaterial misstatements; fraud examiners generally do not believe that any fraud is immaterial. D) Auditors are concerned only with financial statement errors; fraud examiners are concerned only with the theft of assets by employees.

26) Fraud examiners have four main objectives in performing an investigation. Which of the following is not one of those objectives?

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A) Determine whether a fraud exists. B) Determine who was involved in the fraud. C) Determine how the fraud occurred. D) Determine the effect on financial statement users.

27) In performing a financial statement audit in accordance with government auditing standards, an auditor is required to report on the entity's compliance with laws and regulations. This report should: A) state that compliance with laws and regulations is the responsibility of the entity's management. B) describe the laws and regulations with which the entity must comply. C) provide an opinion on overall compliance with laws and regulations. D) indicate that the auditor does not possess legal skills and cannot make legal judgments.

28) Which of the following statements is a standard applicable to financial statement audits in accordance with government auditing standards? A) Assess whether the entity has reportable measures of economy and efficiency that are valid and reliable. B) Report on the scope of the auditor's testing of internal controls. C) Briefly describe in the auditor's report the method of statistical sampling used in performing tests of controls and substantive tests. D) Determine the extent to which the entity's programs achieve the desired level of results.

29)

The U.S. Government Accountability Office is an agency of: A) the U.S. Congress. B) the Executive Office of Management and Budget. C) the U.S. Supreme Court. D) the Federal Accounting Standards Board.

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30) The demand for compliance auditing in generally accepted government auditing standards (GAGAS) terms is generated by: A) acts discreditable to the profession. B) financial statement audits performed in accordance with generally accepted auditing standards. C) governmental managers' obligations to follow laws and regulations. D) public reports on government managers' following laws and regulations.

31) After performing work in a compliance attestation engagement and finding that a governmental agency's managers failed to install and perform even the most elementary controls to ensure compliance with laws and regulations and, in fact, committed numerous violations, an auditor most likely would: A) write an adverse report on actual compliance. B) write an unqualified report on actual compliance. C) write a report modified to disclose particular noncompliance events (specific violations of laws and regulations). D) write a disclaimer of opinion related to knowledge of noncompliance.

32) The Single Audit Act of 1984, as amended in 1996 requires an annual audit of all governments, agencies, and nonprofit organizations that: A) receive $500,000 or more federal funds. B) receive $750,000 or more federal funds. C) spend $500,000 or more federal funds. D) spend $750,000 or more federal funds.

33) When auditors report on a financial audit engagement in accordance with generally accepted government auditing standards (GAGAS), the basic report(s) include a:

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A) disclaimer of opinion on financial statements, report on internal control, and report on compliance audit regarding laws and regulations. B) report (opinion) on financial statements, report on internal control, and report on compliance audit regarding laws and regulations. C) report on internal control and report(s) on efficiency and effectiveness of operations. D) report on compliance regarding laws and regulations and report(s) on achievement of program goal(s).

34) Generally accepted government auditing standards (GAGAS) regarding performance reporting standards requires the reports to tell about which of the following? A) Presentation of financial statements in accordance with GAAP and abuse of public money and property. B) Presentation of financial statements in accordance with GAAP and internal control design and strength of operation. C) Abuse of public money and property and management's noteworthy positive accomplishments. D) Abuse of public money and property and internal control design and strength of operation.

35)

In assessing the objectivity of internal auditors, an independent auditor should: A) evaluate the quality control program in effect for the internal auditors. B) examine documentary evidence of the work performed by the internal auditors. C) test a sample of the transactions and balances that the internal auditors examined. D) determine the organizational level to which the internal auditors report.

36)

The work of internal auditors may affect the independent auditor's:

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A) procedures performed in obtaining an understanding of the internal control structure and in assessing the risk of material misstatement only. B) procedures performed in obtaining an understanding of the internal control structure and substantive tests performed in gathering direct evidence only. C) procedures performed in assessing the risk of material misstatement and substantive tests performed in gathering direct evidence only. D) procedures performed in obtaining an understanding of the internal control structure and in assessing the risk of material misstatement and substantive tests performed in gathering direct evidence.

37) When performing a fraud examination, the fraud examiner takes great care to preserve and identify any documents that may indicate fraud, which is called: A) preserving the chain of custody of the evidence. B) establishing evidential procedure. C) marking an evidential exhibit. D) forensic auditing.

38) Which of the following would be considered in determining whether an internal audit department is independent? A) The organizational level of the chief audit officer and the objectivity of the audit staff. B) A requirement for the auditors to report to the audit committee and the composition of the audit committee. C) The organizational status of the audit committee and the individual independence of internal auditors in the department. D) The nature of the audit charter and the objectivity of the audit staff.

39) Which of the following would be considered an independence issue for an internal auditor?

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A) The company decreased every department's budget, including internal audit, by 5%. B) The auditors participated in the employee stock plan and, therefore, owned stock in the company. C) The CAE reports directly to the audit committee. D) The controller had authority to change the audit schedule before being sent to management and the audit committee.

40) Which of the following situations provides the greatest threat to an internal auditor's objectivity? A) An auditor reviews the procedures for a new electronic data interchange (EDI) connection to a major customer before it is implemented. B) A former purchasing assistant performs a review of bidding procedures in the purchasing department four months after being transferred to the internal auditing department. C) An auditor recommends controls and performance measures for inclusion in a new contract with an outside service organization for the processing of payroll and employee benefits. D) A warehouse employee assists an auditor in verifying the physical inventory of small motors.

41) An internal auditor's report should contain five elements for each finding. Which of the following are the correct elements? A) Condition, criteria, cause, effect, recommendation. B) Condition, relevance, cause, effect, recommendation. C) Condition, evidence, cause, effect, recommendation. D) Condition, relevance, evidence, effect, recommendation.

42) A university received a significant grant from the state in which it resides. Which of the following would be of greatest interest to a governmental auditor auditing that grant at the university?

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A) Cash received by the university was deposited in the appropriate account. B) The grant is properly recorded on the university's financial statements. C) Grant money was spent in accordance with the purpose of the grant. D) The person applying for the grant was the person who was utilizing the grant money.

43)

In an audit of a municipality the auditor is most important audit objective is:

A) the municipality is in compliance with laws, regulations, and the municipality's policy and procedures. B) the municipality's internal controls are operating effectively. C) the municipality as sufficient documentation to support all purchases. D) purchases made by the municipality have sufficient encumbrances.

44) Which of the following is mostly concerned with the benefits derived from the expenditure of funds? A) Operational auditing. B) Performance auditing. C) Management auditing. D) Financial statement auditing.

45) A typical objective for internal auditors in the company's sustainability program is for the auditor to: A) determine whether the financial statements fairly present the company's expenditures on regulatory compliance. B) establish funding requirements for sustainability programs. C) assist management in establishing measurements for achieving company objectives. D) report on the company's relative success in attaining sustainability objectives.

46) A governmental auditor assigned to audit the financial statements of the state highway department would not be considered independent if the auditor:

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A) spouse was the CFO of the highway department. B) lived in the state and utilized the highway system on a daily basis. C) performed audits of the state budget that included funding to the highway department. D) reported the audit findings to the transportation committee of the state legislature.

47) Management has instated a new grievance process. When an employee has a grievance a manager, in another department is assigned as an independent mediator to evaluate the employee's complaint. That manager must submit a written report to the Vice President of Human Resources, who must act on the report and discuss the resolution with the employee, the employee's manager, and any other relevant personnel. Management acknowledges that this process will mean that an employee will be paid for several hours of work during the grievance process and several managers will spend time in the process. However, this process will likely reduce employee turnover. This process has been in place for 18 months. Management wants to know what the costs are for the grievance process and if the new process is achieving the stated objective of reducing employee turnover. What type of audit would internal perform? A) Operational audit. B) Governance audit. C) Compliance audit. D) Performance audit.

48) The purpose of the internal audit's evaluation of the effectiveness of existing risk management processes is to determine that: A) management has planned and designed operations to provide reasonable assurance of achieving objectives and goals. B) management's policies and procedures will achieve objectives and goals. C) the organization's objectives and goals are established within risk limits established by the internal audit organization. D) the organization's objectives and goals will be achieved in an accurate and timely manner and with minimal use of resources.

49)

Predication is:

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A) the determination of the method used to enact a fraud. B) evidence used in a court of law in proving fraudulent behavior. C) a reason to believe that a fraud has occurred. D) the amount of restitution that is made to the company when an individual is convicted of a fraud.

50)

In a fraud investigation, the first objective is: A) identify possible motives to commit a fraud. B) inspect documentation for tampering. C) establish who the perpetrators are. D) to determine if a fraud has been committed.

51)

Which of the following would not be an objective of a fraud investigation? A) Determine from the evidence if a fraud has been committed. B) Determine the scope of the fraud. C) Identify internal control weaknesses that allowed the fraud to occur. D) Determine the amount of restitution that should be received from the perpetrators.

52)

Auditors of governmental units would not be presumed to be independent if they are: A) free from sources of personal impairment. B) independent under AICPA Code of Professional Conduct rules. C) auditing the branch of government to which they are assigned. D) elected or appointed and reporting to a legislative body of government.

53)

The services provided by internal auditors do not include:

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A) audits of financial statements for security registration statements. B) review of control systems that ensure compliance with company policies, laws, and regulations. C) review of effectiveness in achieving program results in comparison to pre-established objectives and goals. D) appraisals of the economy and efficiency of operations.

54)

Operational audits do not include determining:

A) whether the entity is acquiring, practicing, and using resources economically and efficiently. B) review of control systems to ensure compliance with company policies. C) the causes of inefficiencies or uneconomical practices. D) whether the department's goals are aligned with the organization's goals.

55)

Program audits do not include determining:

A) the extent to which the desired results or benefits established by the legislature are being achieved. B) the effectiveness of organizations, programs, activities, or functions. C) whether the agency has complied with laws and regulations applicable to the program. D) whether the financial statements of an audited entity fairly present the financial position in accordance with GAAP.

56)

The IIA Performance Standards do not include the standard for: A) managing the internal audit activity. B) nature of work. C) compliance with policies, plans, procedures, laws, and regulations. D) engagement planning.

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57) The GAO Government Auditing Standards requirements for written reports in financial statement audits do not include: A) audit report on financial statements. B) a report of any significant accomplishments and management improvements. C) a report on the auditee's internal control structure and the control risk assessment. D) a report on the auditee's compliance with applicable laws and regulations.

58) In a single audit of federal financial assistance programs, which of the following does the auditor not need to determine and report for each organization? A) An expanded scope audit of economy, efficiency, and program results. B) That the financial statements are presented fairly in accordance with GAAP. C) That an adequate internal control system is in place. D) That the laws and regulations have been complied with.

59) Which of the following auditors is responsible for designing and planning an audit to detect material illegal acts and frauds? A) External auditors. B) Internal auditors. C) Governmental auditors. D) All of the answer choices are correct.

60) Generally, fraud examiners are called when a fraud is already known or suspected. The term that means a reason to believe a fraud has occurred is: A) prediction. B) suspicion. C) predication. D) admonition.

61) Fraud examiners must be concerned with the integrity of the evidence that they find. Preserving the evidence is called: Version 1

A) expert identification. B) chain of custody. C) evidence conservation. D) admissibility of testimony.

62)

The fundamental principle behind Benford’s Law is:

A) Numbers occur in normal distribution about a mean value for account numbers. B) Naturally occurring numbers are not randomly distributed. C) Given a sufficient sample size the population of an account can be accurately approximated. D) Accounts with large balances are more significant to account balances.

63)

Benford’s Law is used to: A) Identify accounts with unusually large balances. B) Identify unusual relationships between different accounts on the financial statements. C) Identify an unusual pattern in the numbers within an account. D) Identify accounts meeting the materiality level of audit.

64) The state Department of Education needs to have audits for various reasons. Select the appropriate type of engagement or practice that would most likely be performed. Answers may be used more than once. To have an opinion regarding the physical condition of several of the older high schools in the state A) Compliance audit B) Attestation engagement C) Operational audit D) Program audit

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65) The state Department of Education needs to have audits for various reasons. Select the appropriate type of engagement or practice that would most likely be performed. Answers may be used more than once. To know if hiring practices in various school districts meet state law A) Compliance audit B) Attestation engagement C) Operational audit D) Program audit

66) The state Department of Education needs to have audits for various reasons. Select the appropriate type of engagement or practice that would most likely be performed. Answers may be used more than once. To know if guidance counselors can adequately handle the number of students assigned to them in an effective manner A) Compliance audit B) Attestation engagement C) Operational audit D) Program audit

67) The state Department of Education needs to have audits for various reasons. Select the appropriate type of engagement or practice that would most likely be performed. Answers may be used more than once. To know if various schools are providing appropriate programs to serve the needs of the students A) Compliance audit B) Attestation engagement C) Operational audit D) Program audit

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68) The state Department of Education needs to have audits for various reasons. Select the appropriate type of engagement or practice that would most likely be performed. Answers may be used more than once. To know if an after school tutoring program has resulted in more high school students continuing with their education in college A) Compliance audit B) Attestation engagement C) Operational audit D) Program audit

SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question. 69) During the audit of a corporation's major division, an auditor interviewed an accounting clerk. The clerk told the auditor that she believes that the division has been capitalizing research and development expenses (GAAP requires that all R&D costs be charged to ordinary expense in the period in which they are incurred). R&D is a significant part of the division's budget. If this information is found to be true, the division may have to expense millions of dollars previously capitalized and significantly reduce its operating profit. The auditor has not performed any testing to determine whether this problem actually exists but has discussed the potential problem with the division controller and you, the director of internal audit. The following day, you received the following e-mail from the company president: The controller of Division B informs me that you have discovered a questionable account classification dealing with research and development expense. I am aware of the issue. You are directed to discontinue any further investigation of this matter until I inform you to proceed. Under the confidentiality standard of your profession, I also direct you not to discuss this matter with other managers, the audit committee, or the outside auditors. As the director of internal audit, write a short memo in response to the president's e-mail. Be sure to explain the position you are taking and why this position is appropriate.

ESSAY. Write your answer in the space provided or on a separate sheet of paper. 70) Explain briefly the purpose and requirements under the Single Audit Act.

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71)

What are the different types of government audits?

72)

What are the different types of internal audits?

73)

How do government auditors achieve objectivity?

74) The standards of the Institute of Internal Auditors (IIA) are grouped under two broad categories. Identify and briefly explain each of the categories. Each category has special standards written for specific types of audits. Identify the two types of special standards for each category.

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Answer Key Test name: Module D Test Bank 1) C 2) B 3) B 4) D 5) D 6) D 7) B 8) D 9) A 10) B 11) C 12) D 13) A 14) B 15) D 16) C 17) A 18) A 19) B 20) D 21) C 22) A 23) B 24) A 25) C 26) B Version 1

27) A 28) B 29) A 30) C 31) A 32) D 33) B 34) C 35) D 36) D 37) A 38) A 39) D 40) B 41) A 42) B 43) A 44) B 45) C 46) A 47) D 48) A 49) C 50) D 51) D 52) C 53) A 54) B 55) D 56) C Version 1

57) B 58) A 59) D 60) C 61) B 62) B 63) C 64) B 65) A 66) C 67) D 68) D 69) Mr. President, I am in receipt of your e-mail requesting that the internal audit department discontinue its audit into Division B's R&D expenses. Although the internal audit department wishes to cooperate with you and the management of Division B whenever possible, in this instance, I cannot comply with your instruction. It is imperative that the internal audit department maintain independence and objectivity in all matters related to our audits. This includes being able to determine the scope of our audit. In addition, it is important that the internal audit department maintain a high standard of integrity to retain the trust of the departments, management, and the audit committee. These elements of internal audit are clearly indicated in the Standards of Professional Practice of the Institute of Internal auditor and, as you are aware, our department adheres to those standards. Our authority to evaluate all areas of the company at our discretion and our responsibilities to follow standards is clearly indicated in the audit charter, which was approved by the Board of Directors.

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70) The purpose of the Single Audit Act was to simplify the reporting requirements for state and local governments that receive federal assistance from several federal agencies. They can now satisfy the reporting requirement by preparing a single audit report for the unit instead of preparing numerous reports by various auditors. In a single audit, auditors must determine and report whether the ● Financial statements are presented in accordance with GAAP. ● Internal control system provides reasonable assurance that the organization is managing federal assistance programs in compliance with applicable laws and regulations. ● Organization has complied with laws and regulations that may have a material effect on its financial statements and on each major federal assistance program. 71) The types of government audits include (1) financial statement audits to determine whether the financial statements are prepared in accordance with GAAP and the entity has complied with laws and regulations. (2) Attestation engagements. (3) Performance audits, which include economy and efficiency audits and program audits. 72) 1.Financial audits. 2.Compliance audits. 3.Operational Audits. 4.Governance Audits. 73) Government auditors achieve objectivity by 1.Finding standards for evaluation, and 2.Using measurement of actual results, so 3.Actual results can be compared to the standards.

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74) The two categories of internal auditing standards are (1) attribute standards that set the characteristics of internal audit departments and the professional that work done in those departments and (2) performance standards that establish requirements when performing an engagement. Within the standards there are specific standards for attestation engagements and for consulting engagements.

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MODULE D: MCQs CHECK ALL THE APPLY. Choose all options that best completes the statement or answers the question. 1) Which of the following characterize the work of fraud examiners? (Select all that apply.) A) Analysis of control weaknesses for determination of acceptable fraud risk. B) Analysis of control strengths as a basis for planning other audit procedures. C) Determination of a materiality amount that represents a significant misstatement of the financial statements. D) Consideration of a materiality amount in cumulative terms—that is, becoming large over a number of years.

MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 2) Which of the following would be considered in determining whether an internal audit department is independent? A) The organizational level of the chief audit officer and the objectivity of the audit staff. B) A requirement for the auditors to report to the audit committee and for the composition of that committee. C) The organizational status of the audit committee and the individual independence of internal auditors in the department. D) The nature of the audit charter and the objectivity of the audit staff.

3) Which of the following would be considered the most significant problem for internal audit if the chief audit executive reports to the controller?

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A) The controller would amend the audit schedule so more audit time was spent on accounting issues. B) The controller may have no training as an internal auditor. C) During times when the budget needs to be cut, internal audit would likely be the first to lose funding. D) The controller can control the scope of audits and censor audit reports before being sent to management and the audit committee.

4) Which of the following is not an internal audit objective designed to add value to a purchasing department? A) A review of the bidding process indicates that a vendor company may be operating under two different names and therefore purchasing is not getting the three independent bids required by policy. B) The purchasing process is causing unnecessary delays in ordering product. C) The purchasing department is not following a new human resource policy requiring a six-month performance review for new employees. D) The director of purchasing is new to the organization and has made several decisions regarding vendor approvals with which the auditor does not agree.

In an internal auditor's report, audit findings would include all of the following except A) The effect of audit finding on the auditee or the company. B) The cause of the audit finding. C) The relevance of the audit finding on the audit. D) The recommendation to correct the audit finding.

6) Governmental auditors' independence and objectivity are enhanced when they report the results of an audit assignment directly to

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A) Managers of the government agency under audit and in which the auditors are employed. B) The audit committee of directors of the agency under audit. C) Political action committees of which they are members. D) The congressional committee that ordered the audit.

7) In all audits of governmental units performed according to GAGAS, the most important work is A) Compliance auditing. B) Obtaining a sufficient understanding of internal control. C) Documentation of the audit. D) Exit interviews with managers in the governmental unit.

8) Which of the following is considered different and more limited in objectives than the others? A) Operational auditing. B) Performance auditing. C) Management auditing. D) Financial statement auditing.

A typical objective of an operational audit is for the auditor to A) Determine whether the financial statements fairly present the company's operations. B) Evaluate the feasibility of attaining the company's operational objectives. C) Make recommendations for achieving company objectives. D) Report on the company's relative success in attaining profit maximization.

10) A governmental auditor assigned to audit the financial statements of the state highway department would not be considered independent if the auditor Version 1

A) Also held a position as a project manager in the highway department. B) Was the state audit official elected in a general statewide election with responsibility to report to the legislature. C) Normally works as a state auditor employed in the department of human services. D) Was appointed by the state governor with responsibility to report to the legislature.

11) Governmental auditing can extend beyond audits of financial statements to include audits of an agency's efficient and economical use of resources and A) Constitutionality of laws and regulations governing the agency. B) Evaluation of the personal managerial skills shown by the agency's leaders. C) Correspondence of the agency's performance with public opinion regarding the social worth of its mission. D) Evaluations concerning the agency's achievements of the goals set by the legislature for the agency's activities.

12) Which of the following best describes how the detailed audit plan of a financial statement auditor compares with the audit client’s comprehensive internal audit plan? A) The comprehensive internal audit plan covers areas that an external auditor would normally not review. B) The comprehensive internal audit plan is more detailed although it covers fewer areas than an external audit would normally cover. C) The comprehensive internal audit plan is substantially identical to the audit plan used by an external auditor because both review substantially identical areas. D) The comprehensive internal audit plan is less detailed and covers fewer areas than an external auditor would normally review.

13) Which of the following is usually not part of an internal audit department’s audit charter?

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A) A commitment from management to ensure the independence of the internal audit department. B) A definition of the scope of the audit department's activities. C) The organizational structure of the internal audit department. D) The reporting requirements of the internal audit department.

14) Which of the following would you not expect to see in an auditor's report(s) on the financial statements of an independent government agency? A) A statement that the audit was conducted in accordance with generally accepted government audit standards. B) A report on the agency's compliance with applicable laws and regulations. C) Commentary by the agency's managers on the audit findings and recommendations. D) A report on the agency's internal controls.

15) The federal Single Audit Act of 1984 as amended in 1996 requires auditors to determine and report several things about state and local governments that receive federal funds. Which of the following is notnormally required to be reported? A) An opinion on the fair presentation of the financial statements in accordance with generally accepted accounting principles. B) A report on the government's internal control related to federal funds. C) The government's performance in meeting goals set in enabling legislation. D) A report on the government's compliance with applicable laws and regulations.

16) The Government Accountability Office (GAO) describes expanded-scope governmental auditing to include all of the following except : A) Financial statement audits. B) Attestation engagements. C) Compliance audits. D) Performance audits.

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17) In government and internal performance auditing, which of the following is the least important consideration when performing the fieldwork? A) Determining the applicable generally accepted government accounting principles pronounced by the GASB. B) Defining problem areas or opportunities for improvement and defining program goals. C) Selecting and performing procedures designed to obtain evidence about operational problems and production output. D) Evaluating evidence in terms of economy, efficiency, and achievement of program goals.

18) Which of the following is the least important consideration for a governmental auditor who needs to be objective when auditing and reporting on an agency's achievement of program goals? A) Measure the actual output results of agency activities. B) Compare the agency's actual output results to quantitative goal standards. C) Perform a comprehensive review of management controls. D) Determine quantitative standards that describe goals the agency was supposed to achieve.

19) Compliance auditing performed under the Single Audit Act of 1984, as amended in 1996, in accordance with GAGAS is necessary for an auditor’s: A) Report on the auditee's internal control, including reportable conditions and material weaknesses. B) Opinion on the auditee's observance, or lack thereof, of applicable laws and regulations. C) Opinion on the auditee's financial statements. D) Report of a supplementary schedule of federal assistance programs and amounts.

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20) When auditing with "fraud awareness," auditors should especially notice and review employee activities under which of these conditions? A) The company always estimates the inventory but never takes a complete physical count. B) The petty cash box is always locked in the desk of the custodian. C) Management has published a company code of ethics and sends frequent communication newsletters about it. D) The board of directors reviews and approves all investment transactions.

21)

The best way to enact a broad fraud prevention program is to

A) Install airtight control systems of checks and supervision. B) Name an ethics officer who is responsible for receiving and acting upon fraud tips. C) Place dedicated hotline telephones on walls around the workplace with direct communication to the company ethics officer. D) Establish a corporate culture conducive to ethical behavior in the workplace.

22)

A reason to believe that a fraud has occurred is called A) Deliberation. B) Forensics. C) Predication. D) Restitution.

23) In a fraud examination, original documents must be protected from damage and tampering to A) Establish motive. B) Develop documentation for employee dismissal. C) Protect the chain of custody. D) Ensure that suspects are unaware of an investigation in progress.

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24)

An environmental audit might include all of following except

A) Determining that proper tracking of waste material is being maintained by the organization. B) Reviewing the liability account established for pending environmental claims against the company. C) Reviewing the environmental history of another company that the internal auditor's organization is interested in purchasing. D) All of the choices are appropriate issues for an environmental audit.

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Answer Key Test name: Module D_8e_MCQ,s 1) [A, D] Fraud examiners “think like crooks” to imagine fraud schemes that get around an organization’s internal control and they think materiality in terms of a cumulative amount. As such, ‘analysis of control weaknesses for determination of acceptable fraud risk’ and ‘Consideration of a materiality amount in cumulative terms—that is, becoming large over a number of years’ are correct. External auditors evaluate control strengths as a basis for planning other audit procedures and need to determine the materiality threshold to find whether significant misstatement exists in the financial statements. Fraud examiners do not. 2) A According to the Professional Standards for the Practice of Internal Audit, auditor independence is determined by the organizational status of the department and the objectivity of the department and individuals practicing internal audit. 3) D The most serious problem in having internal audit report to the controller is that the controller would be able to influence the scope of audits over accounting areas that also report to the controller.In addition, the controller could edit reports from internal audit to amend or exclude items related to the performance of the controller or other departments that report to the controller. 4) C

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The failure to provide a performance review for new employees is a compliance issue.This could result in inefficiencies (if that person was not performing in the job appropriately), but such inefficiencies would likely be known with or without a review. 5) C While having audit findings that are relevant to the audit is clearly a desirable trait, it is not one of the five elements of an audit finding as defined by the Institute of Internal Auditors. 6) D Reporting to Congress (which commissions most GAO reports) is the best answer here because it suggests a higher line of communication outside the audited entity itself. 7) A Auditing for compliance with laws and regulations is required. 8) D Operational, management, and performance auditing are considered synonyms. Their objectives go beyond those for auditing financial statements. 9) C An operational auditing engagement is an engagement to determine the efficiency and effectiveness of an organization in meeting its goals and objective.Recommendations would be directed at helping to achieve those objectives. 10) A A managerial job in the organization being auditing impairs independence in a manner similar to the impairment when an external auditor has a managerial position with an audit client. Version 1

11) D This is “program results” auditing, which is tied to goals set for the agency. 12) A Internal auditing typically is broader in scope and objectives than external audit, which is limited to financial statements. 13) C The organizational structure of the internal audit department is normally not included in the charter. 14) C Commentary by auditee managers is recommended for performance audit reports but not for reports on financial statements. 15) C Performance auditing regarding achievement of program goals is not required by the Single Audit Act. (The Act requires the other reports.) 16) C Compliance audits are not considered part of expanded-scope governmental auditing. 17) A Determining applicable accounting principles is important for financial statement audits but not for performance audits. 18) C The review of management controls is a means of analysis rather than a way to achieve objectivity. 19) B

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Reports on compliance observance of laws and regulations requires compliance tests. 20) A Never taking physical inventory indicates a red flag in the control system. 21) D An ethical corporate culture reduces the likelihood of fraud. 22) C The Association of Certified Fraud Examiners indicates that assignments are initiated only with predication, which means that there is a reason to believe fraud may have occurred. 23) C Protecting documents from damage and tampering establishes a chain of custody that establishes when and where the evidence was obtained and who had access to it.If the chain of custody is compromised, defense attorneys may argue to have the evidence thrown out of court under the grounds that it may have been tampered with or altered. 24) D There are many types of environmental audits including (1) determining that waste material is properly documented, (2) ensuring that sufficient amounts have been accrued for existing environmental liabilities, and (3) ensuring that management is aware of environmental issues connected with the purchases of property or other business operations.

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MODULE D: QUIZ MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) The independence of the internal audit department is greatly enhanced when the department: A) is comprised of qualified individuals. B) reports to an appropriate level in the company and individuals have an impartial and unbiased mental attitude. C) has an approved audit charter. D) is outsourced to a CPA firm or other qualified organization.

2) Of the following: W. Financial audits X. Compliance audits Y. Operational audits Z. Governance audits Which of these is performed by internal auditors? A) W, X, and Y. B) W, Y, and Z. C) X, Y and Z. D) W, X, Y, and Z.

Internal audit standards are divided into three categories. These categories are A) Quality, performance, and ethics. B) Performance, operation and ethics. C) Attribute, operation, and implementation. D) Attribute, performance, and implementation.

4) In an internal audit report the auditor must communicate the audit findings to management. To effectively communicate audit findings, the internal auditor must include in the report all of the following except

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A) The condition that was identified. B) The criteria that renders the condition inappropriate. C) The person responsible for the condition. D) The cause of the condition.

5) An objective and systematic examination of a program against its objective criteria are known as A) Performance audits. B) Compliance audits. C) Operational audit. D) Government audit.

When a government auditor performs a financial audit they must issue

A) An audit report on the use of tax dollars. B) An audit report on the compliance of the entity with grant requirements. C) A report in compliance with the Single Audit Act. D) A report on the financial statements, a report on compliance with laws and regulations, and a report on internal controls.

Once a fraud examiner determines that a fraud exists, the examiner must determine A) If it is material to the financial statements. B) If the fraud should be reported to the audit committee. C) The scope of the fraud. D) The appropriate law enforcement organization to notify.

Most fraud examiners do not believe that fraud can be immaterial because

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A) Most of the fraud may be hidden. B) Fraud which is not address tends to grow. C) Many small frauds can accumulate into considerable money. D) All of the choices are correct.

9) During an audit an auditor notes a large number of voided checks in the cash disbursement account. Which of the following would most likely lead the auditor to suspect this might be a fraud? A) The response by management to the auditor's inquiry about the voided checks is that a new clerk was hired that made many errors in preparing checks. B) The bank reconciliation showed several inter-bank transfers. C) The voided checks could not be located. D) The cashier made deposits to the bank on a daily basis on her way home from the office.

10)

The application of accounting and auditing evidence to a legal problem is called A) Fraud investigation. B) Performance auditing. C) Forensic accounting. D) Judicial support.

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Answer Key Test name: Module D_8e_Quiz 1) C An audit charter approved by senior management and the board of directors provides an essential foundation for building an independent department. 2) D Internal auditors can perform financial, compliance, operational, and governance audits. 3) D Attribute, performance, and implementation are the three major categories of IIA standards. 4) C Identifying the person responsible for the condition is not one of the five elements of a quality audit report. 5) A Performance audits provide an objective and systematic examination of a program against objective criteria. 6) D The GAO standards require financial statement audits include a report on the financial statements, a report on compliance with laws and regulations, and a report on internal controls. 7) C After a fraud is determined to exist, the next step is to determine the scope of the fraud. Version 1

8) D All of the answers are correct. 9) C Companies should keep a copy of voided checks on hand, the absence of the checks should raise suspicions. 10) C Forensic accounting is defined as applying accounting and auditing evidence to legal problems, both civil and criminal.

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MODULE D: PROBLEM MATERIAL FILL IN THE BLANK. Write the word or phrase that best completes each statement or answers the question. 1) __________ auditing refers to the study of business operations for the purpose of making recommendations about __________ and __________ use of resources.

2) Compliance auditing refers to the process of ensuring that a company is operating within __________, __________, and __________.

3) Although internal auditors are associated with their employers in the eyes of the public, they seek __________ and __________ independence.

4) Internal audit findings should always include __________, __________, __________, __________, and __________.

5) GAO performs three types of government audits: __________, __________ and __________ audits.

6) The IIA auditing standards are classified into three major categories: __________, __________, and __________.

7) The __________ is the federal law that established uniform requirements for audits of federal financial assistance provided to __________ and __________ governments.

Government performance audits determine if __________ and __________.

9) The Single Audit Act, as amended in 1996, established an annual audit for all __________ and __________ units that spend $__________ or more of __________ funds. Version 1

10) The Single Audit Act requires the auditor to report on __________ __________, __________, and __________.

11) CPAs in public practice most often are involved in governmental audits as a result of responding to an agency's __________.

12) Internal audit reports are usually considered "__________" until a __________ is performed.

13) Few fraud auditors believe in the concept of an "immaterial fraud" because __________ and __________.

14) Once a fraud is discovered, the focus of the audit changes to an investigation with the primary objective of __________.

15) Fraud examination requires the individual to have expertise in __________ and __________.

16) A fraud examination has four main objectives: (1) determining whether a fraud exists, (2) determining __________, __________, and __________.

17) A person testifying about findings during litigation support, application of accounting principles, or application of auditing standards is called a(n) __________.

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18) Prosecution of fraud perpetrators is advisable because if not prosecuted, they __________, and failure to do so __________.

ESSAY. Write your answer in the space provided or on a separate sheet of paper. 19) Following are five cases (1-5) illustrating different types of audit engagements. In the space provided by each case, indicate the type of audit that would be conducted (H-M), the specific type of auditor who might perform the engagement (P-S), and the auditing standards that would probably apply for the engagement (W-Z). Type of Audit (H) Financial (I) Operational (J) Compliance (K) Performance (L) Governance

Type of Auditor (P) Independent CPA (Q) Internal Auditor (R) GAO Auditor (S) Fraud Examiner

Auditing Standards (W) GAAS (X) GAO (Y) IIA (Z) Association of Cert Fraud Examiners

(M) Attestation

Case 1. A CPA firm's review of the effectiveness of a federally supported unemployment training program. Case 2. An audit of financial statements as part of a registration under the Securities Act of 1933. Case 3. A review of the company's plant security to determine whether it is operating effectively. Case 4. A review of the Human Resource Department's hiring practices. Case 5. A study of how the Department of Defense could reduce costs from a competitive bid program. Letter a.

Type of Audit

Type of Auditor

Auditing Standards

b. c. d.

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20) Following are five cases (1-5) that illustrate different types of audit engagements. In the space provided, indicate the type of audit that would be conducted, the specific auditor who might undertake the engagement, and the auditing standards that would probably apply for the engagement.

Type of Audit Case 1: Case 2:

Case 3:

Case 4:

Case 5:

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Type of Auditors

Auditing Standards

Report on how government agencies could benefit from a shared motor vehicle pool. Review a company's internal control system to determine whether it is consistent with company policy. Review by a CPA firm comparing cost and benefits of a health benefits policy for a federal agency. Determination of the fair presentation of financial statements of a publicly held company. Review of a Department of Education program to determine whether loans were made to qualified minority groups in accordance with the provisions of the program.

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Answer Key Test name: Module D_8e_Test Bank_Problem Material 1) [Operational, efficient, effective] Question also found in study guide. 2) [laws, regulations, company policies] Question also found in study guide. 3) [operational, reporting] Question also found in study guide. 4) [condition, criteria, cause, effect, recommendation] Question also found in study guide. 5) [financial statement, attestation, performance] Question also found in study guide. 6) [attribute standards, performance standards, implementation standards] Question also found in study guide. 7) [Single Audit Act of 1984, state, local] Question also found in study guide. 8) [programs are using resources effectively, desired outcomes are being achieved] Question also found in study guide. 9) [state, local, 750, 000, federal] Question also found in study guide. 10) [financial statements, internal controls, compliance] Question also found in study guide. Version 1

11) request for proposal (RFP) Question also found in study guide. 12) [opened, follow up] Question also found in study guide. 13) [fraud grows, fraud indicates a lack of integrity] Question also found in study guide. 14) building a case against the perpetrator Question also found in study guide. 15) [audit, criminal investigation] Question also found in study guide. 16) [its scope, identifying the perpetrator(s), determining how it occurred] Question also found in study guide. 17) expert witness Question also found in study guide. 18) [will continue to steal, sends a negative message to other employees] Question also found in study guide. 19) Letter a. b. c. d. e.

Type of Audit K H I J M

Type of Auditor P P Q Q R

Auditing Standards W, X W Y Y X

20) Type of Audit

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Type of Auditors

Auditing

Case 1. Operational Case 2. Operational Case 3. Program Case 4. Financial Case 5. Compliance

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Government (GAO) Internal Independent CPA Independent CPA Government (GAO)

Standards GAGAS IIA GAAS & GAGAS GAAS GAGAS

MODULE E MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) Which of the following components of the audit risk model is most closely associated with attributes sampling? A) Audit risk. B) Control risk. C) Detection risk. D) Inherent risk.

The purpose of tests of controls is to determine that: A) internal control policies and procedures are functioning as prescribed. B) the extent of further audit procedures can be reduced. C) errors and irregularities are prevented or detected in a timely manner. D) the auditor has an understanding of internal control.

3) As part of the assessment of control risk, the auditor decided to use audit sampling. After specifying the audit objectives, what would the auditor most likely do next? A) Determine the sample size. B) Select the sample. C) Perform tests of control procedures. D) Define the deviation conditions.

4) For which of the following audit tests would an auditor most likely use attributes sampling? A) Making an independent estimate of the amount of a LIFO inventory. B) Examining invoices in support of the valuation of fixed asset additions. C) Selecting accounts receivable for confirmation of account balances. D) Inspecting employee time cards for proper approval by supervisors.

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The ultimate purpose of control risk assessment is to: A) estimate the overall risk of failing to detect material misstatements. B) decide the nature, timing, and extent of further audit procedures. C) determine the risk of incorrect acceptance. D) determine the probability that errors entered the accounts.

6) If the auditor were interested in ensuring that all sales have been recorded, the population would be defined as: A) entries in the cash receipts journal. B) entries in the general journal. C) remittance advices. D) shipping documents.

7) What is the general order in which the following steps in attributes sampling are performed? 1 = Define the population 2 = Determine the objective of sampling 3 = Determine the sample size 4 = Select the sample A) 1, 2, 3, 4. B) 2, 1, 3, 4. C) 1, 2, 4, 3. D) 2, 1, 4, 3.

8) Which of the following statements is correct concerning statistical sampling in tests of controls?

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A) As the population increases, the sample size should increase proportionally. B) The expected population deviation rate can either be based on prior audits or a small sample of controls examined in the current year. C) There is an inverse relationship between the expected population deviation rate and sample size. D) In determining the tolerable rate of deviation, an auditor considers the desired level of detection risk.

9) Samples to test internal control procedures are intended to provide a basis for an auditor to conclude whether: A) the control procedures are operating effectively. B) the financial statements are materially misstated. C) the risk of incorrect acceptance is too high. D) overall materiality for planning purposes is at a sufficiently low level.

10) In performing tests of controls over authorization of cash disbursements, which of the following statistical sampling methods would be most appropriate? A) Variables. B) Stratified. C) Ratio. D) Attributes.

11) Why is the auditor more concerned with the risk of overreliance than the risk of underreliance? A) The risk of underreliance is not a type of sampling risk. B) The risk of overreliance exposes the auditor to an efficiency loss. C) The risk of overreliance may result in the auditor failing to perform sufficient substantive procedures. D) The risk of overreliance cannot be controlled by the auditor during the sampling process.

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12)

The risk of underreliance is the probability that the evidence in the sample indicates:

A) Low control risk when the actual operating effectiveness of the control does not justify a low control risk assessment. B) Low control risk when the actual operating effectiveness of the control justifies a low control risk assessment. C) High control risk when the actual operating effectiveness of the control would justify a lower control risk assessment. D) High control risk when the actual operating effectiveness of the control would justify a higher control risk assessment.

13) The auditor tested a sample of recorded sales invoices for evidence of credit approval. Based on the results of the sample, the auditor concluded that there was a satisfactory rate of approvals. Unknown to the auditor, credit approvals in the population were not satisfactory. This would be an example of: A) risk of overreliance. B) risk of underreliance. C) risk of incorrect acceptance. D) risk of incorrect rejection.

14)

The risk of underreliance is the risk that the sample selected to test controls:

A) does not support the auditor's planned level of control risk when the true operating effectiveness of the control justifies such an assessment. B) contains misstatements that could be material to the financial statements when aggregated with misstatements in other account balances or transaction classes. C) contains proportionally fewer monetary errors or deviations from prescribed control procedures than exist in the balance or class as a whole. D) does not support the tolerable misstatement for some or all of management's assertions.

15) As a result of tests of controls, an auditor assessed control risk at an inappropriately low level and decreased the effectiveness of substantive procedures. This assessment occurred because the true deviation rate in the population was: Version 1

A) more than the risk of overreliance based on the auditor's sample. B) more than the deviation rate in the auditor's sample. C) less than the risk of overreliance based on the auditor's sample. D) less than the deviation rate in the auditor's sample.

16) An erroneous decision to assess control risk at excessively high levels can have an adverse effect on: A) the efficiency of an audit engagement. B) the effectiveness of an audit engagement. C) the validity of an audit. D) the type of report the auditor decides to render.

17)

Which of the following sampling risks is associated with the use of attributes sampling? A) Risk of underreliance: Yes; Risk of incorrect rejection: Yes B) Risk of underreliance: Yes; Risk of incorrect rejection: No C) Risk of underreliance: No; Risk of incorrect rejection: Yes D) Risk of underreliance: No; Risk of incorrect rejection: No

18) As a result of sampling procedures applied as tests of controls, an auditor incorrectly assesses control risk lower than appropriate. The most likely explanation for this situation is that: A) the deviation rates of both the auditor's sample and the population exceed the tolerable rate of deviation. B) the deviation rates of both the auditor's sample and the population are less than the tolerable rate of deviation. C) the deviation rate in the auditor's sample is less than the tolerable rate of deviation, but the deviation rate in the population exceeds the tolerable rate of deviation. D) the deviation rate in the auditor's sample exceeds the tolerable rate of deviation, but the deviation rate in the population is less than the tolerable rate of deviation.

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19) When the auditor concludes that a control is functioning properly when, in fact, it is not, the auditor has committed the: A) risk of underreliance. B) risk of overreliance. C) risk of incorrect acceptance. D) risk of incorrect rejection.

20) Which of the following would not be an example of nonsampling risk in an attributes sampling application? A) Failure to perform the appropriate type of test of controls procedure. B) Failure to notice a deviation from prescribed control procedures. C) Incorrectly estimating the expected population deviation rate. D) Incorrectly accumulating the number of deviations.

21) Which of the following is not true with regard to the relationship among control risk, the risk of overreliance, and the tolerable rate of deviation? A) Lower levels of control risk result in a higher level of the risk of overreliance. B) Lower levels of the risk of overreliance result in a lower tolerable rate of deviation. C) Lower levels of control risk result in a lower tolerable rate of deviation. D) All of the options are correct.

22)

Which of the following does not have a direct relationship with sample size? A) Expected population deviation rate. B) Population size. C) Risk of overreliance. D) All of these have a direct relationship with sample size.

23) Judgments about the frequency of control deviations that identify a particular control risk level are related to:

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A) sample rate of deviation. B) tolerable rate of deviation. C) upper limit rate of deviation. D) expected population deviation rate.

24) Which of the following is not a judgment or estimate auditors must make when performing attributes sampling? A) Tolerable rate of deviation. B) Expected population deviation rate. C) Sample rate of deviation. D) Risk of overreliance.

25) In order for the auditor to decide to perform tests of controls, which of the following relationships should exist? A) The sampling risk should be less than 5%. B) The tolerable rate of deviation should exceed the expected population deviation rate. C) The expected population deviation rate should exceed the risk of overreliance. D) The expected population deviation rate should exceed the tolerable rate of deviation.

26) In planning a statistical sample for a test of controls, an auditor increased the expected population deviation rate from the rates observed in prior audits because of the results of prior tests of controls and the overall control environment. The auditor most likely would then increase the planned: A) tolerable rate of deviation. B) allowance for sampling risk. C) risk of overreliance. D) sample size.

27)

The sample size for a test of controls varies inversely with:

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A) expected population deviation rate: Yes; tolerable rate of deviation: Yes. B) expected population deviation rate: No; tolerable rate of deviation: No. C) expected population deviation rate: Yes; tolerable rate of deviation: No. D) expected population deviation rate: No; tolerable rate of deviation: Yes.

28) Which of the following statements is correct concerning statistical sampling in tests of controls? A) Deviations from control procedures at a given rate usually result in misstatements at a higher rate. B) As the population size doubles, the sample size should also double. C) The qualitative aspects of deviations are not considered by the auditor. D) There is an inverse relationship between the sample size and the tolerable rate of deviation.

29) In determining the number of documents to select for a test to obtain assurance that all sales returns have been properly authorized, an auditor should consider the tolerable rate of deviation from the control activity. The auditor should also consider: 1. Expected population deviation rate. 2. Allowable risk of underreliance. A) 1 only. B) 2 only. C) Both 1 and 2. D) Either 1 or 2.

30) In the study of internal control, the auditor uses sampling to compare the __________ to the __________. A) error; overall materiality level B) sampling risk; precision C) deviation rate; tolerable rate of deviation D) precision interval; upper limit on misstatement

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31) After examining sample items and classifying items as deviations, the auditor can divide the number of deviations by the sample size and calculate the: A) expected population deviation rate. B) risk of underreliance. C) sample rate of deviation. D) tolerable rate of deviation.

32) An auditor is testing control procedures that are evidenced on an entity's vouchers by matching random numbers with voucher numbers. If a random number matches the number of a voided voucher, that voucher ordinarily should be replaced by another voucher in the random sample if the voucher: A) constitutes a deviation. B) has been properly voided. C) cannot be located. D) represents an immaterial dollar amount.

33) In performing attributes sampling, the auditor will conclude that the control is functioning as intended if the ______ is less than or equal to ______. A) expected population deviation rate; tolerable rate of deviation B) upper limit rate of deviation; tolerable rate of deviation C) tolerable rate of deviation; expected population deviation rate D) tolerable rate of deviation; upper limit rate of deviation

34) If the upper limit rate of deviation exceeds the tolerable rate of deviation, the auditor would most likely: A) accept the account balance as fairly stated. B) reject the account balance as fairly stated. C) increase the planned effectiveness of substantive procedures. D) not increase the planned effectiveness of substantive procedures.

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35) If an auditor calculated an upper limit rate of deviation of 5% when the tolerable rate of deviation was 4%, the auditor would conclude that: A) the population deviation rate is low enough to rely on internal control as planned. B) the population deviation rate may be higher than that necessary to rely on internal control as planned. C) the control risk can be assessed at planned levels. D) the control risk should be assessed at lower levels.

36) If an auditor tested 50 transactions and found two deviations from an important control activity, the auditor could conclude that: A) the tolerable rate is 4%. B) the critical rate of occurrence is 4%. C) the sample rate of deviation is 4%. D) the expected population deviation rate is 4%.

37) The procedures for statistical evaluation of tests of controls with the AICPA Sample Evaluation Tables would not include the following step: A) Identify the population deviation rate. B) Identify the sample size in the left margin. C) Identify the number of actual deviations for the sample size. D) Identify the upper limit rate of deviation given the sample size and number of deviations.

38) To statistically evaluate an attributes sampling application, the auditor would not need to know: A) the acceptable risk of overreliance. B) the actual deviations in the sample. C) the actual population size. D) the upper limit rate of deviation.

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39)

The upper limit rate of deviation in attributes sampling is: A) the actual deviation rate in the population. B) always less than the tolerable rate of deviation. C) always greater than the tolerable rate of deviation. D) a statistical calculation that considers sampling risk.

40) On the basis of attributes sampling, an auditor decided to increase the assessed level of control risk from the level originally planned. To achieve an overall audit risk level that is substantially the same as the original planned level of audit risk, the auditor would: A) increase inherent risk. B) increase overall materiality levels. C) decrease substantive procedures. D) decrease detection risk.

41) Lincoln, CPA, selected a sample of 100 items by dividing the population of 100,000 sales invoices by 100. With a random start, she then selected every 1,000th invoice. This selection process is referred to as: A) unrestricted random selection. B) nonstatistical selection. C) systematic random selection. D) judgmental selection.

42) Mary Todd is auditing White House Furniture. In selecting a sample of purchases, she finds that a purchase order is missing. She should: A) select another purchase to test. B) have the client recreate the purchase order. C) consider the sample item a deviation. D) ask the client if the purchase was authorized.

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43) What is an auditor's evaluation of a statistical sample for attributes when a test of 100 documents results in 4 deviations if the tolerable rate of deviation is 5%, the expected population deviation rate is 3%, and the allowance for sampling risk is 2%? A) Accept the sample results as support for planned reliance on the control because the tolerable rate of deviation less than allowance for sampling risk equals the expected population deviation rate. B) Modify planned reliance on the control because the sample rate of deviation plus the allowance for sampling risk exceeds the tolerable rate of deviation. C) Modify planned reliance on the control because the tolerable rate of deviation plus the allowance for sampling risk exceeds the expected population deviation rate. D) Accept the sample results as support for planned reliance on the control because the sample rate of deviation plus the allowance for sampling risk exceeds the tolerable rate of deviation.

44) An auditor wanted to test credit approval on 10,000 sales invoices processed during the year. The auditor designed a statistical sample that would provide a 1% risk of overreliance (99% confidence) that not more than 7% of the sales invoices lacked approval. The auditor estimated from previous experience that about 2.5% of the sales invoices lacked approval. A sample of 200 invoices was examined and 7 of them were lacking approval. The auditor then determined the upper limit rate of deviation to be 8%. In evaluating this sample, the auditor decided to increase the level of the preliminary assessment of control risk because the: A) tolerable rate of deviation (7%) was less than the upper limit rate of deviation (8%). B) expected population deviation rate (7%) was more than the percentage of errors in the sample (3.5%). C) expected population deviation rate (2.5%) was less than the tolerable rate of deviation. D) upper limit rate of deviation (8%) was more than the percentage of errors in the sample (3.5%).

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45) An auditor wanted to test credit approval on 10,000 sales invoices processed during the year. The auditor designed a statistical sample that would provide a 1% risk of overreliance (99% confidence) that not more than 7% of the sales invoices lacked approval. The auditor estimated from previous experience that about 2.5% of the sales invoices lacked approval. A sample of 200 invoices was examined and 7 of them were lacking approval. The auditor then determined the upper limit rate of deviation to be 8%. The allowance for sampling risk was: A) 5.5%. B) 4.5%. C) 3.5%. D) 1%.

46) As a result of tests of controls, an auditor assessed control risk too low and decreased the effectiveness of her substantive procedures. This assessment occurred because the true deviation rate in the population was: A) less than the risk of overreliance, based on the auditor's sample. B) less than the deviation rate in the auditor's sample. C) greater than the risk of overreliance, based on the auditor's sample. D) greater than the deviation rate in the auditor's sample.

47) An auditor who uses statistical sampling for attributes in testing internal controls should reduce the planned reliance on a prescribed control when the: A) sample rate of deviation plus the allowance for sampling risk equals the tolerable rate of deviation. B) sample rate of deviation is less than the expected rate of deviation used in planning the sample. C) tolerable rate less the allowance for sampling risk exceeds the sample rate of deviation. D) sample rate of deviation plus the allowance for sampling risk exceeds the tolerable rate of deviation.

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48) When an auditor increases the assessed level of control risk because certain control procedures were determined to be ineffective, the auditor would most likely increase the: A) extent of tests of controls. B) level of detection risk. C) extent of substantive tests. D) tolerable rate of deviation.

49) A sampling plan in which an initial sample is selected and the audit team either draws a final conclusion or selects additional items before drawing a final conclusion is called A) attributes sampling. B) discovery sampling. C) sequential sampling. D) statistical sampling.

50) An auditor is examining an important internal control in his audit of ABC Company. Because the account balance affected by this control is highly susceptible to fraud, she will reject the sample if even one deviation is discovered. What type of sampling plan should she use? A) Attributes sampling. B) Discovery sampling. C) Sequential sampling. D) Statistical sampling.

51) The sampling plan for nonstatistical sampling is the same as statistical sampling except for which of the following steps? A) Define the characteristic of interest. B) Define the population. C) Measure the sample items. D) Evaluate the sample results.

52)

Which of the following is not true with respect to the use of nonstatistical sampling?

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A) The use of nonstatistical sampling generally results in a smaller sample size. B) The use of nonstatistical sampling is permissible under generally accepted auditing standards. C) Auditors may use block and haphazard selection methods when using nonstatistical sampling. D) The use of nonstatistical sampling does not permit the auditor to control exposure to the risk of overreliance.

53) Assume that the audit team wishes to determine the extent to which a particular control policy was functioning as intended. Identifying applications of the control throughout the period under audit would be most closely related to which of the following steps in sampling? A) Determining the objective of sampling. B) Defining the characteristic of interest. C) Defining the population. D) Determining the sample size.

54) The maximum rate of deviation that may exist in the operation of a control policy or procedure before the auditors would reduce reliance on internal control is referred to as: A) acceptable rate of deviation. B) control risk. C) tolerable rate of deviation. D) upper limit rate of deviation.

55) Which of the following is the most likely outcome when the upper limit rate of deviation is less than the tolerable rate of deviation? A) The auditor would be exposed to the risk of overreliance. B) The auditor would decide to reduce the planned degree of reliance on internal control. C) The auditor would increase the extent of further audit procedures. D) The auditor would be exposed to a potential efficiency loss.

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56) When examining the client's internal control, what is the relationship of each of the following with sample size? Risk of overreliance

Expected rate of deviation Direct

Direct

Inverse

Direct

A) Option A B) Option B C) Option C D) Option D

57) When considering the results of an attributes sampling application, the auditor compares which of the following two measures? A) Upper limit rate of deviation; sample rate of deviation. B) Tolerable rate of deviation; sample rate of deviation. C) Expected rate of deviation; upper limit rate of deviation. D) Upper limit rate of deviation; tolerable rate of deviation.

58) For which of the following audit tests would an auditor most likely use attributes sampling? A) Inspecting purchase orders for proper approval by supervisors. B) Making an independent estimate of recorded payroll expense. C) Determining that all payables are recorded at year end. D) Selecting accounts receivable for confirmation of account balances.

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59) Assume that the audit team established a tolerable rate of deviation of 5%, an expected population deviation rate of 1%, and desired to control the risk of overreliance to 5%. What is the appropriate sample size in this situation? A) 77 items. B) 93 items. C) 132 items. D) 124 items.

60) Assume that the audit team established a tolerable rate of deviation of 5%, an expected population deviation rate of 1%, and desired to control the risk of overreliance to 10%. What is the appropriate sample size in this situation? A) 77 items. B) 93 items. C) 132 items. D) 124 items.

61)

Why does the risk of overreliance have an inverse relationship with sample size?

A) As the audit team expects fewer deviations from the control policy or procedure, the audit team can appropriately examine fewer items. B) As the audit team is less concerned with making an incorrect conclusion with respect to reliance on the client's internal control, the audit team can appropriately examine fewer items. C) As the level of control risk increases, the audit team is placing less reliance on internal control and can appropriately examine fewer items. D) As the audit team requires greater compliance with the control policy or procedure, the audit team must examine a greater number of items.

62) If the audit team established a tolerable rate of deviation of 5%, an expected population deviation rate of 3%, and desired to control the risk of overreliance to 5%, what sample size would be appropriate in this situation?

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A) 132 items. B) 195 items. C) 258 items. D) 361 items.

63) If the audit team established a tolerable rate of deviation of 3%, an expected population deviation rate of 2%, and desired to control the risk of overreliance to 5%, what sample size would be appropriate in this situation? A) 390 items. B) 568 items. C) 590 items. D) 846 items.

64) The audit team is planning to examine a sample of control policies and procedures. Assume that, based on the intended degree of reliance on internal control, the audit team wishes to control the risk of overreliance to 5%. In addition, based on prior engagements, the audit team anticipates an expected deviation rate of 2%. What would be the impact of reducing the tolerable rate of deviation from 7% to 5% on the sample size? A) Increase sample size by 181 items. B) Decrease sample size by 181 items. C) Increase sample size by 93 items. D) Decrease sample size by 93 items.

65) The audit team is planning to examine a sample of control policies and procedures. Assume that, based on the intended degree of reliance on internal control, the audit team wishes to control the risk of overreliance to 5% and establishes a tolerable deviation rate of 8%. Based on past audits, the audit team would normally estimate the expected population deviation rate at 2%; however, because of improvements in the client's internal control, they now feel that a rate of 1.25% is appropriate. Which of the following is not true with respect to the impact of the reduction in the expected population deviation rate on sample size?

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A) The reduction in the expected population deviation rate would result in a smaller sample size. B) The audit team would likely need to have a reasonable justification for establishing a lower expected population deviation rate. C) The resultant sample size assuming the reduction in the expected population deviation rate would be 77 items. D) The reduction in the expected population deviation rate would result in the audit team examining 19 fewer items.

66) The audit team is planning to examine a sample of control policies and procedures. Assume that, based on the intended degree of reliance on internal control, the audit team wishes to control the risk of overreliance to 5% and, based on past audits, estimates the expected population deviation rate to be 2%. Initially, the audit team was planning for a moderate degree of reliance on internal control and established a tolerable rate of deviation of 7%; however, it is considering increasing its reliance on internal control and reducing the tolerable rate of deviation to 4%. Which of the following is not true with respect to the impact of the reduction in the tolerable rate of deviation on sample size? A) The reduction in the tolerable rate of deviation would result in a smaller sample size. B) The audit team would likely not seek a reduction in the tolerable rate of deviation unless it could obtain a reduction in its substantive testing. C) The resultant sample size assuming the reduction in the tolerable rate of deviation would be 294 items. D) The reduction in the tolerable rate of deviation would result in the audit team examining an additional 206 items.

67) The audit team is planning to examine a sample of control policies and procedures. Assume that the audit team establishes a tolerable rate of deviation of 6% and, based on past audits, estimates the expected population deviation rate to be 2%. Which of the following is not true with respect to the impact of the risk of overreliance on sample size?

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A) The risk of overreliance has an inverse impact on sample size. B) The risk of overreliance should be assessed at higher levels if the audit team wishes to place lower levels of reliance on internal control. C) If the audit team assesses the risk of overreliance at 10%, the resultant sample size would be 88 items. D) If the audit team reduced the risk of overreliance from 10% to 5%, the resultant decrease in the sample size would be 39 items.

68) Which of the following statements is generally correct about the sample size in statistical sampling when testing internal controls? A) As the population size doubles, the sample size should increase by about 67%. B) The sample size is inversely proportional to the expected population deviation rate. C) There is no relationship between the tolerable rate of deviation and the sample size. D) When evaluation very large populations, the population size has little or no effect on the sample size.

69) Which of the following is the audit team's primary objective in selecting an attributes sampling selection method? A) To provide a high probability of selecting at least one item containing a deviation. B) To select a sample that is representative of the population from which it is drawn. C) To select controls applied to larger dollar transactions for examination. D) To select controls applied to transactions that are more likely to contain deviations.

70) Which of the following is true with respect to the use of sequential sampling when used with attributes sampling?

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A) Sequential sampling is normally used when expected deviations occur at a relatively low rate in the population. B) Sequential sampling is normally used when the audit team wishes to place greater reliance on internal control. C) Sequential sampling may provide a more efficient sample size than the use of traditional attributes sampling. D) Sequential sampling will always provide auditors with the smallest final sample size for a given set of sampling parameters.

71) With respect to the use of attributes sampling, in which of the following steps would nonstatistical sampling and statistical sampling differ? Defining the population Evaluating sample results A.

Yes

A) Option A B) Option B C) Option C D) Option D

72) When testing internal controls, which of the following statements is not true with respect to the use of nonstatistical sampling?

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A) Nonstatistical sampling is permitted in the audits of both public and nonpublic entities. B) Nonstatistical sampling does not require the use of random selection techniques. C) When using nonstatistical sampling, auditors are required to quantify the parameters used to determine sample size. D) Auditors are required to use professional judgment in evaluating the sample results in a nonstatistical sampling application.

73) An audit team would be most likely to use attributes sampling in which of the following situations? A) Performing analytical procedures during the planning stages of the audit. B) Evaluating management's integrity during the client acceptance process. C) Determining the effectiveness of the audit committee in evaluating the entity's control environment. D) Examining purchase requisitions for proper authorization.

74) An increase in which of the following would cause the sample size in a test of controls to decrease? A) Expected population deviation rate B) Risk of overreliance C) Risk of underreliance D) Population size

75) The AICPA has developed sample size tables for attributes sampling that specifically incorporate all of the following factors except for the: A) expected population deviation rate. B) risk of overreliance. C) tolerable rate of deviation. D) sample rate of deviation.

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76) When performing attributes sampling, the appropriate AICPA Sample Size Table is initially selected based on the auditors' assessment of the A) risk of overreliance. B) risk of underreliance. C) tolerable rate of deviation. D) expected population deviation rate.

77) To determine the appropriate sample size for an attributes sampling application, Williams, CPA, defined the population to be 25,000 sales invoices. Williams then assessed the risk of overreliance to be 10%, the tolerable rate of deviation to be 4%, and the expected population deviation rate to be 2.5%. Using the AICPA Sample Size Tables, the appropriate sample size would be: A) 9. B) 13. C) 353. D) 513.

78) Carson, CPA, judged that his test of controls of the company's 10,000 sales transactions should be based on a risk of overreliance of 10%, a tolerable rate of deviation of 8%, and an expected population deviation rate of 3.75%. Using the AICPA Sample Size Tables, which of the following modifications would not affect Carson's sample size? A) Decrease in the risk of overreliance from 10% to 5%. B) Increase in the tolerable rate of deviation from 8% to 10%. C) Increase in the expected population deviation rate from 3.75% to 4%. D) Decrease in the tolerable rate of deviation from 8% to 7%.

79)

Which of the following statements is true regarding attributes sampling?

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A) Once the population reaches a certain size, population size has a limited impact on sample size. B) Auditors should use attributes sampling to evaluate controls, regardless of the degree of reliance being placed upon the controls. C) When determining the appropriate sample size, the audit team will specifically control its exposure to both the risk of overreliance and the risk of underreliance. D) Tests of controls should only be applied to transactions occurring at the end of the year under audit because the audit team wants to reach a conclusion about control risk at year end.

80) Williams, CPA, determined that the appropriate sample size for a test of controls related to the completeness of purchase transactions was 148 items. Using the AICPA Sample Size Tables, which of the following represent assessments that could have been made by Williams to determine this sample size? A) 5% risk of overreliance, 4% tolerable rate of deviation, and 1% expected population deviation rate. B) 5% risk of overreliance, 7% tolerable rate of deviation, and 3.25% expected population deviation rate. C) 10% risk of overreliance, 8% tolerable rate of deviation, and 2% expected population deviation rate. D) 10% risk of overreliance, 15% tolerable rate of deviation, and 1.75% expected population deviation rate.

81) While selecting a sample of sales invoices for a test of internal controls, the auditor was unable to locate one invoice and classified this invoice as non-deviation. This is an example of A) sampling risk. B) incorrect acceptance. C) nonsampling risk. D) deviation risk.

82) Which of the following statements is true when selecting a sample of invoices from a population to perform tests of controls?

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A) The audit team should select a few more items than needed to replace any cases in which an invoice is missing or destroyed. B) If the audit team wishes to use statistical sampling, either block or haphazard selection is appropriate. C) Computerized audit techniques can be used to define the population but not to select sample items. D) The audit team's goal in selecting a sample is to increase the likelihood that it is representative of the population.

83) When selecting a sample of items to perform a test of controls, all of the following should be true of a representative sample, except A) the transactions have been processed by the entity throughout the year. B) the transactions should be limited to those processed in a specific geographic area. C) the transactions have been processed by different individuals. D) the transactions represent both large and small dollar amounts.

84)

Nonsampling risk normally occurs during which step of the sampling process? A) Defining the population. B) Selecting sample items. C) Measuring sample items. D) Evaluating sample results.

85) Which of the following statements is correct regarding an audit team's documentation requirements for attributes sampling?

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A) The audit team's conclusions do not need to be documented unless they decide to rely on internal control at planned levels. B) The audit team should document information regarding the number of deviations and sample deviation rate, but not the allowance for sampling risk. C) The audit team's documentation should include information about the control environment, including an assessment of management's integrity. D) The audit team's documentation should include information regarding all steps of the sampling process and implications of the conclusions reached on internal control reliance and substantive procedures.

86)

Which of the following deviations would probably be of most concern to auditors?

A) A deviation resulting from an employee's unintentional error. B) A deviation that represents an isolated and nonrecurring mistake. C) A deviation that represents an employee's careless attention to duties. D) A deviation that has no implications with regard to the effectiveness of other controls.

87) An auditor's determination of a lower level of control risk would most likely be associated with A) larger population sizes for tests of controls. B) larger samples for substantive procedures. C) smaller samples for substantive procedures. D) lower levels of detection risk.

88) Williams, CPA, is using attributes sampling to test controls related to the completeness of purchasing transactions. Williams decided to select all purchase orders from September for testing. This is an example of A) random selection. B) block selection. C) haphazard selection. D) monthly selection.

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89)

Which of the following statements is correct regarding nonstatistical sampling?

A) Nonstatistical sampling must use random selection techniques. B) The sample size when using nonstatistical sampling methods is generally not comparable to that determined using statistical sampling methods. C) Nonstatistical sampling does not use a formal process to mathematically estimate the allowance for sampling risk. D) When using nonstatistical sampling, the audit team is not required to select a sample that is representative of the population.

90) Smith, CPA, is using attributes sampling to test Swimmer Inc.'s internal controls related to the accuracy of sales invoices. Smith defined the population as all 5,000 of Swimmer's sales invoices and determined the appropriate sample size was 200 invoices. What is Smith's sampling interval if systematic random selection is used? A) 20 B) 25 C) 50 D) 250

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Answer Key Test name: Module E Test Bank 1) B 2) A 3) D 4) D 5) B 6) D 7) B 8) B 9) A 10) D 11) C 12) C 13) A 14) A 15) B 16) A 17) B 18) C 19) B 20) C 21) A 22) C 23) B 24) C 25) B 26) D Version 1

27) D 28) D 29) A 30) C 31) C 32) B 33) B 34) C 35) B 36) C 37) A 38) C 39) D 40) D 41) C 42) C 43) B 44) A 45) B 46) D 47) D 48) C 49) C 50) B 51) D 52) A 53) C 54) C 55) A 56) B Version 1

57) D 58) A 59) B 60) A 61) B 62) D 63) D 64) C 65) C 66) A 67) D 68) D 69) B 70) C 71) C 72) C 73) D 74) B 75) D 76) A 77) C 78) C 79) A 80) B 81) C 82) D 83) B 84) C 85) D 86) C Version 1

87) C 88) B 89) C 90) B

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MODULE E: PROBLEM MATERIAL ESSAY. Write your answer in the space provided or on a separate sheet of paper. 1) Indicate how each of the following conditions affect sample size by using the letters I (increase), D (decrease), or N (no effect). For each condition, hold all other factors constant.

___ ___ ___ ___ ___

1. An increase in the expected population deviation rate from 2% to 5%. 2. A decrease in the population from 10,000 controls to 5,000 controls. 3. An increase in the tolerable rate of deviation from 3% to 10%. 4. An increase in the risk of underreliance from 5% to 10%. 5. A decrease in the risk of overreliance from 5% to 1%.

2) Indicate how each of the following conditions affect the upper limit rate of deviation by using the letters I (increase), D (decrease), or N (no effect). For each condition, hold all other factors constant. ___ ___ ___ ___ ___

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1. An increase in the tolerable rate of deviation from 2% to 5%. 2. A decrease in the number of deviations from 5 to 1. 3. An increase in the risk of underreliance from 5% to 10%. 4. A decrease in the risk of overreliance from 10% to 5%. 5. An increase in the sample rate of deviation from 2.3% to 3.5%.

3) Indicate whether each of the following characteristics relate to the risk of overreliance (O), risk of underreliance (U), both (B), or neither (N). ___ ___ ___ ___ ___ ___ ___ ___

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1. Is specifically considered by the auditor in determining sample size and evaluating sample results. 2. Is characterized by the auditor's sample indicating that the control is functioning effectively. 3. Results in the auditor drawing an incorrect conclusion with respect to the population being examined. 4. Is also referred to as the risk of assessing control risk too high. 5. Results in an effectiveness loss to the auditor. 6. Is used to determine the appropriate sample selection method. 7. Is characterized by the population deviation rate being less than the tolerable rate of deviation. 8. Is an example of a sampling risk to which the auditor is exposed when performing tests of controls.

4) Below are situations that illustrate tests of controls performed as a part of an attributes sampling application. Match each description of a situation with the related term. Each term is associated with only one description. A.Expected population deviation rate. B.Risk of overreliance. C.Risk of underreliance. D.Sample rate of deviation. E.Tolerable rate of deviation. F.Upper limit rate of deviation.

___ 1. Based on a random sample, Fitzmaurice, CPA, found that the tolerable rate of deviation was less than the upper limit rate of deviation and assessed control risk at the maximum. Unknown to Fitzmaurice, the true deviation rate in the population was less than the tolerable rate of deviation. ___ 2. Grayson, CPA, calculated the statistical estimate of the population deviation rate as the sum of the sample rate of deviation and allowance for sampling risk. ___ 3. Based on experience with the client and industry, Herbert, CPA, estimated that a 3% deviation rate exists in the client's credit approval of sales invoices this year. ___ 4. Jones, CPA, found four deviations from prescribed control procedures in her sample of 100 sales invoices. ___ 5. Based on a random sample, Kelly, CPA, found that the upper limit rate of deviation was less than the tolerable rate of deviation and assessed control risk as moderate, as originally planned. Unknown to Kelly, the true deviation rate in the population was greater than the tolerable rate of deviation. ___ 6. Alison required the control that all sales invoices were supported by a bona fide shipping document to be functioning very effectively (deviation rate of less than 2%) because of the importance of this control.

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5) Indicate how each of the following conditions affect sample size by using the letters I (increase), D (decrease), or N (no effect). For each condition, hold all other factors constant. ___ 1. Holmes is expecting more deviations in the population from prior years because the client has recently implemented a new transaction processing system. ___ 2. Holmes has been criticized for going over budget in the past so he has decreased the risk of underreliance from 15% to 5%. ___ 3. At the beginning of the period, the client hired a new accounting manager to oversee the implementation of policies and procedures relating to accurate and complete financial reporting. Holmes believes the new manager has helped decrease employee errors. ___ 4. Holmes has decided that the tolerable rate of deviation was set too low initially and should be increased slightly to better reflect the planned level of control risk. ___ 5. Holmes defined the population as all sales invoices found in the client's computerized listing. However, the first list he received did not include sales made during the last two weeks of the period. When an updated list was provided the population (which was already large) increased by 5%. ___ 6. The risk of overreliance has been decreased because Holmes wants to place more reliance on the controls being tested. ___ 7. Due to a change in firm policy, the tolerable rate of deviation has been decreased.

6) In each of the following situations, indicate whether a fixed (F), sequential (S), or discovery (D) attributes sampling plan is being used. ___ 1. The audit team has determined the tolerable rate of deviation to be 5%, the risk of overreliance to be 10%, and the expected

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___

population deviation rate to be zero. 2. Based on the risk of overreliance, expected population deviation rate and tolerable rate of deviation, the audit team examined a sample of 50 items before determining if additional items should be included in the sample. 3. Using the AICPA Sample Size tables, the audit team determined the appropriate sample size and selected the sample items. However, the audit team stopped the examination after a deviation was found. 4. The audit team established the risk of overreliance to be 5%, the tolerable rate of deviation to be 4%, and the expected population deviation rate to be 3%. Using the AICPA Sample Size tables, the audit team decided to sample over 1,000 items. 5. The audit team is performing a sampling application to evaluate the operating effectiveness of an entity's internal controls. The application used could provide a more efficient method of examination, but it is important that the audit team evaluate the sample in the order they were selected.

7) Indicate whether each of the following represents an application of a statistical (S) or nonstatistical (N) sampling application. ___ 1. In order to begin testing the occurrence assertion for Bear's sales invoices, Lion determined the expected population deviation rate to be 1.25%, the tolerable rate of deviation to be 4% and the risk of overreliance to be 5%. ___ 2. Lion determined the tolerable rate of deviation to be low while testing controls concerning loan agreements. The audit team considered the sample size provided by the AICPA tables but decided that more loans needed to be tested to accurately evaluate the population. ___ 3. To test the accuracy of Bear's accounts receivable, Lion ordered the accounts into an aging list and selected the last

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fifty items for examination. ___ 4. A list of pre-numbered purchase orders was used to test the completeness assertion. Lion decided to randomly select items from the list for examination by identifying them from a perusal of files. ___ 5. Lion suspected the existence of fraud in Bear's payroll department. As a result, Lion set the expected population deviation rate at zero and used quantitative measures to ensure that sampling risk was controlled to acceptable levels. ___ 6. Lion used professional judgment to estimate the allowance for sampling risk to determine the likely rate of deviation in the population when testing the cutoff of Bear's sales invoices.

8) In each of the following situations, indicate whether Walters, CPA is using unrestricted random (UR), systematic random (SR), haphazard (H), or block (B) selection. ___ 1. Walters created a list of all sales invoices to verify that they were supported by the appropriate shipping documents. Invoice number 15 was selected first for examination, followed by the invoices numbered 30, 45, 60, 75, 90, and so on until 40 invoices had been selected. ___ 2. To test the occurrence assertion regarding sales invoices, Walters randomly selected invoices from the database storage disk for examination. ___ 3. To ensure proper authorization of payroll functions, Walters selected all transactions during the last 5 days of each pay period to be included in the sample. ___ 4. Sales invoices are commonly stored in a filing cabinet during the 30-day return period before being input in the company's database. To ensure the 30-day return period was not exceeded, Walters decided to pull a few invoices from each drawer until the desired sample size was collected for examination. ___ 5. T&T Company's purchase orders are already pre-numbered and listed in numerical order within the company's database. As a

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result, Walters was able to use one of the firm's computer programs to identify random numbers and match each number with a corresponding purchase order to test the accuracy assertion. ___ 6. Using a random number table, Walters identified a series of 50 numbers and located the corresponding employee identification number to select time cards for examination. ___ 7. Walters used a computer listing of T&T's credit memos, which totaled 2,400 items, to select 4 random starting points for examination. The remaining memos were identified for testing by selecting every 24th item until the sample size reached 100 memos.

9) Using the appropriate sampling tables, identify the missing data for each of the following independent attributes sampling applications. Risk of overreliance Tolerable rate of deviation Expected population deviation rate Sample Size

5% 6% 3% (1)

10% (2) 2% 132

(3) 7% 1% 55

5% 6% (4) 150

10) Based on relationships among these factors, identify the missing data for each of the following independent attributes sampling applications. Sample Size

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100

(3)

200

Number of deviations Sample rate of deviation

(1)

2.5 %

(5)

Upper limit rate of deviation

8.5 %

(4)

12.7 %

Allowance for sampling risk

(2)

7.8 %

(6)

11) Using the appropriate sampling tables, identify the missing data for each of the following independent attributes sampling applications. A

Risk of overreliance

10 %

(6)

Sample Size

(4)

Number of deviations

(1)

10 %

(7)

Sample rate of deviation

Upper limit rate of deviation

(2)

(5)

12.7 %

Allowance for sampling risk

(3)

7.8 %

(8)

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Answer Key Test name: Module E_8e_Test Bank_Problem Material 1) 1. I; 2. N; 3. D; 4. N; 5. I 2) 1. N; 2. D; 3. N; 4. I; 5. I 3) 1. O, 2. O, 3. B, 4. U, 5. O, 6. N, 7. U, 8. B 4) 1) C, 2) F, 3) A, 4) D, 5) B, 6) E 5) 1. I, 2. N, 3. D, 4. D, 5. N, 6. I, 7. I 6) 1. D, 2. S, 3. D, 4. F, 5. S 7) 1. S, 2. N, 3. N, 4. N, 5. S, 6. N 8) 1. SR, 2. H, 3. B, 4. H, 5. UR, 6. UR, 7. SR 9) 1. 195, 2. 5%, 3. 10%, 4. 2.5% 10) 1. 4, 2. 4.5%, 3. 80, 4. 10.3%, 5. 7.5%, 6. 5.2% 11) 1. 3, 2. 12.5%, 3. 7.5%, 4. 50, 5. 17.8%, 6. 5%, 7. 6.25%, 8. 6.45%

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MODULE F MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) Which component of the expanded audit risk model is most closely associated with the risk of incorrect acceptance? A) Analytical procedures risk. B) Risk of material misstatement. C) Nonsampling risk. D) Test of details risk.

2) The sampling method used to examine a population when the auditor wants to estimate a continuous amount (or value) of the population is: A) attributes sampling. B) balance sampling. C) discovery sampling. D) variables sampling.

Which of the following would not be estimated using variables sampling? A) The balance in the client's accounts receivable. B) The extent to which an internal control procedure is not functioning as intended. C) The amount of misstatement in a client's inventory. D) All of these choices would be estimated using variables sampling.

4) Which of the following courses of action would an auditor most likely follow in planning a sample of cash disbursements if the auditor is aware of several unusually large cash disbursements?

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A) Set the tolerable misstatement at a lower level than originally planned. B) Stratify the cash disbursements population so that the unusually large disbursements are selected. C) Increase the sample size to reduce the effect of the unusually large disbursements. D) Continue to draw new samples until all the unusually large disbursements appear in the sample.

The total amount of misstatement identified in a sample is referred to as the: A) projected misstatement. B) tolerable misstatement. C) actual misstatement. D) incremental allowance for sampling risk.

6) Which of the following is not an advantage associated with monetary unit sampling (MUS)? A) MUS methods typically include transactions or components reflecting relatively large dollar amounts. B) MUS methods are more effective in identifying overstatement errors. C) MUS methods provide a conservative (higher) estimate of misstatement in the account balance or class of transactions. D) MUS methods typically result in relatively small sample sizes.

7) The amount at which an item would be recorded assuming no mistakes in judgment or incorrect applications of generally accepted accounting principles were made is the: A) audited value. B) expected misstatement. C) Recorded balance. D) tolerable misstatement.

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8) The auditor's sample would indicate that the client's account balance is fairly stated when the _____ is less than the _____. A) upper limit on misstatements; tolerable misstatement B) actual misstatement; tolerable misstatement C) tolerable misstatement; upper limit on misstatements D) tolerable misstatement; actual misstatement

9) How does monetary unit sampling (MUS) ensure that larger dollar components are selected for examination? A) MUS requires the auditor to identify all items having a balance greater than performance materiality prior to beginning the sample selection process. B) MUS requires the auditor to stratify the sample into larger and smaller dollar components prior to beginning the sample selection process. C) MUS defines the sampling unit as an individual dollar within an account balance or class of transactions. D) MUS selects components having larger balances in the prior audit.

10) Why is the auditor more concerned with controlling the exposure to the risk of incorrect acceptance than with the risk of incorrect rejection? A) Only the risk of incorrect acceptance results in an incorrect decision by the auditor. B) The risk of incorrect rejection is not related to the auditor's substantive procedures. C) The risk of incorrect rejection can be controlled by performing substantive procedures during the interim period. D) The risk of incorrect acceptance may ultimately result in the auditor incorrectly issuing an unmodified opinion on the client's financial statements.

11)

Which of the following is not true with respect to the risk of incorrect acceptance?

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A) This risk provides the auditor with an efficiency loss. B) This risk results in the auditor making an incorrect conclusion about the client's account balance or class of transactions. C) This risk occurs when the sample results suggest that the account balance is fairly stated. D) This risk is controlled by the auditor in determining sample size under monetary unit sampling.

12) Which of the following would not result in a lower level of the risk of incorrect acceptance? A) An increase in the acceptable level of audit risk from 5 percent to 10percent. B) The inability of the auditor to rely on the internal control as planned. C) An increase in the susceptibility of the account balance to misstatement. D) A reduction in the utilization of analytical procedures in the audit examination.

13)

The risk of incorrect acceptance relates to the: A) effectiveness of the audit. B) efficiency of the audit. C) preliminary estimate of materiality. D) allowable risk of tolerable misstatement.

14)

When performing substantive procedures, auditors run the sampling risk(s) of: A) assessing control risk too high or too low. B) incorrect acceptance and incorrect rejection. C) assessing control risk too low only. D) incorrect acceptance only.

15) When the _____ exceeds the _____, the audit team is exposed to the risk of incorrect acceptance.

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A) upper limit on misstatements; tolerable misstatement B) tolerable misstatement; expected misstatement C) tolerable misstatement; upper limit on misstatements D) upper limit on misstatements; expected misstatement

16) Incorrect rejection occurs when the auditor concludes that the account balance is _____ when in fact it is _____. A) material; immaterial B) immaterial; material C) fairly stated; misstated D) misstated; fairly stated

17)

Which of the following is not true with respect to the risk of incorrect acceptance?

A) Incorrect acceptance occurs when the auditor concludes that the account balance is fairly stated. B) The risk of incorrect acceptance has an inverse relationship with sample size. C) The risk of incorrect acceptance exposes the auditor to an efficiency loss D) Incorrect acceptance occurs when the true (but unknown) account balance is materially misstated.

18)

An auditor may decide to increase the risk of incorrect rejection when: A) increased reliability from the sample is desired. B) many differences are expected. C) initial sample results do not support the planned level of control risk. D) the cost and effort of selecting additional items is low.

19)

Which of the following is true with respect to the risk of incorrect acceptance?

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A) The risk of incorrect acceptance is determined in the planning stages of the audit prior to the study of internal control. B) The risk of incorrect acceptance has an inverse relationship with sample size. C) The risk of incorrect acceptance exposes the auditor to an efficiency loss. D) The risk of incorrect acceptance may occur when the true (but unknown) account balance is fairly stated.

20) How does the auditor typically determine the appropriate level of the risk of incorrect rejection when using classical variables sampling? A) Based on prior assessments of audit risk, risk of material misstatement, and analytical procedures risk. B) Based on the recorded amount of the account balance as well as the relationship of the account balance with important financial statement subtotals. C) Based on the findings in prior audits or based on a small sample taken during the current year. D) Based on the anticipated cost of conducting additional substantive procedures.

21) Which of the following is not considered in establishing the sample size in a monetary unit sampling application? A) Expected misstatement. B) Population size. C) Risk of incorrect acceptance. D) All of these choices are considered.

22) All other factors being equal, as the risk of incorrect acceptance and tolerable misstatement increase, the sample size will: A) not be affected. B) increase. C) decrease. D) cannot determine from the information given.

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23)

In a classical variables sampling application, the sample size will be smaller when the: A) risk of incorrect acceptance is lower. B) risk of incorrect rejection is lower. C) tolerable misstatement is lower. D) population variability is lower.

24) Which of the following factors has a direct relationship with sample size in a variables sampling application? A) Tolerable misstatement: Yes; Expected misstatement: Yes B) Tolerable misstatement: No; Expected misstatement: Yes C) Tolerable misstatement: Yes; Expected misstatement: No D) Tolerable misstatement: No; Expected misstatement: No

25) How does the auditor establish the level of tolerable misstatement in a variables sampling application? A) Based on prior assessments of audit risk, risk of material misstatement, and analytical procedures risk. B) Based on the recorded amount of the account balance as well as the relationship of the account balance with important financial statement subtotals. C) Based on the findings in prior audits or based on a small sample taken during the current year. D) Based on the anticipated cost of conducting additional substantive procedures.

26) Which of the following factors is most likely established based on the results of prior audit examinations? A) Expected misstatement. B) Population size. C) Risk of incorrect acceptance. D) Tolerable misstatement.

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27) Which of the following factors that affect sample size can be determined by considering the recorded account balance of the account or class of transactions as well as the relationship between the recorded account balance or class of transactions with important financial statement subtotals? A) Expected misstatement. B) Population size. C) Risk of incorrect acceptance. D) Tolerable misstatement.

28) Which of the following components of the upper limit on misstatements is determined by multiplying the sampling interval by the confidence factor for the acceptable risk of incorrect acceptance? A) Basic allowance for sampling risk. B) Incremental allowance for sampling risk. C) Projected misstatement. D) Sampling interval.

29) A number of factors influence the sample size for a variables sampling application. All other factors held constant, which of the following would lead to a larger sample size? A) A lower assessed level of risk of material misstatement. B) Increased use of analytical procedures to obtain evidence about particular assertions. C) Lower frequency and magnitude of misstatements. D) Lower levels of tolerable misstatement.

30) Which of the following set of conditions would provide the auditor with the smallest sample size under monetary unit sampling (RIA = risk of incorrect acceptance, EM = expected misstatement, TM = tolerable misstatement, PS = population size)?

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A) RIA = 5 percent, EM = $7,500, TM = $15,000, PS = $150,000. B) RIA = 5 percent, EM = $5,000, TM = $10,000, PS = $200,000. C) RIA = 5 percent, EM = $2,000, TM = $10,000, PS = $100,000. D) RIA = 5 percent, EM = $7,500, TM = $15,000, PS = $300,000.

31) Which of the following expresses the relationship between changes in the factors and changes in sample size in variables sampling? A) Tolerable misstatement: Direct; Expected misstatement: Inverse; Risk of incorrect rejection: Direct B) Tolerable misstatement: Inverse; Expected misstatement: Direct; Risk of incorrect rejection: Inverse C) Tolerable misstatement: Inverse; Expected misstatement: Inverse; Risk of incorrect rejection: Inverse D) Tolerable misstatement: Inverse; Expected misstatement: Inverse; Risk of incorrect rejection: Direct

32) Under monetary unit sampling, the sampling interval is determined by dividing the _____ by the _____. A) sample size; population size B) population size; sample size C) tolerable misstatement; population size D) population size; tolerable misstatement

33) Brown, CPA, was using monetary unit sampling to audit an inventory of $3,000,000 that was comprised of 6,000 items. A sample size of 500 was determined and a tolerable misstatement of $20,000 was established. The sampling interval would be: A) $500. B) $5,000. C) $6,000. D) $20,000.

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34) What is the auditor's normal course of action if a "logical unit" is selected twice in monetary unit sampling? A) The auditor should count the logical unit as a single selection and proceed as normal. B) The auditor should count the logical unit as two selections and proceed as normal. C) The auditor should not include the logical unit as a selection, since the dollar amount of this unit is excessively large. D) The auditor should replicate the sample using an alternative random start.

35) Which of the following is found by dividing the amount of misstatement noted in a logical unit by the recorded amount of that logical unit? A) Sample size. B) Sampling interval. C) Projected misstatement. D) Tainting percentage.

36) Which of the following components of the upper limit on misstatements will exist in all monetary unit sampling applications, even in those where no misstatements are found? A) Basic allowance for sampling risk. B) Computed allowance for sampling risk. C) Incremental allowance for sampling risk. D) Projected misstatement.

37) The amount by which a projected misstatement in an account balance or class of transactions differs from an actual misstatement as a result of the sample not being representative of the population would typically arise from: A) a misunderstanding of accounting principles. B) allowance for sampling risk. C) management override of an internal control policy or procedure. D) risk of incorrect acceptance.

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38) If a customer's account was recorded at $45,000, the audited value was $30,000, and the sampling interval was $30,000, the projected misstatement would be: A) $10,000. B) $15,000. C) $20,000. D) $30,000.

39) _____ sampling methods use normal distribution theory and the central limit theorem to provide a range estimate of the account balance or class of transactions or the misstatement in the account balance or class of transactions. A) Attributes B) Classical variables C) Nonstatistical D) Monetary unit

40) In which of the following situations would the auditor be more likely to use monetary unit sampling as opposed to classical variables sampling? A) Larger expected misstatement: Yes; Concern with overstatements: Yes B) Larger expected misstatement: Yes; Concern with overstatements: No C) Larger expected misstatement: No; Concern with overstatements: Yes D) Larger expected misstatement: No; Concern with overstatements: No

41) Samantha, CPA, decided to stratify the population in her statistical sampling plan. Which of the following is the most likely reason she used this approach? A) It eliminates the need for random selection. B) The population is relatively homogenous in terms of the dollar amount of components or transactions. C) It reduces her expected sample size. D) It eliminates the need for calculating the projected misstatement in the account being examined.

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42)

The process of subdividing a population into more homogeneous subgroups is known as: A) classification. B) identification. C) sampling. D) stratification.

43)

What is one of the primary benefits of stratifying a population?

A) Stratifying the population allows different types of audit procedures to be performed on larger and smaller transactions or components. B) Stratifying the population allows the auditor to have a higher likelihood of reaching a favorable conclusion with respect to the client's financial statements. C) Stratifying the population allows the auditor to reduce the necessary sample size. D) Stratifying the population reduces the auditor's exposure to nonsampling risk.

44) Which of the following is considered in determining the sample size in a classical variables sampling application but not in a monetary unit sampling application? A) Standard deviation: Yes; Risk of incorrect acceptance: Yes B) Standard deviation: Yes; Risk of incorrect acceptance: No C) Standard deviation: No; Risk of incorrect acceptance: Yes D) Standard deviation: No; Risk of incorrect acceptance: No

45) In a classical variables sampling application, if the _____ exceeds the maximum difference between the recorded balance and any point within the precision interval, the auditor would decide to _____ the account balance as fairly stated. A) sample estimate; accept B) sample estimate; reject C) tolerable misstatement; accept D) tolerable misstatement; reject

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46) Green, CPA, performed a mean-per-unit sampling plan to examine the inventory balances of ABC Company. Green audited 120 items from a sample and found an audited value of $24,600. The sample had a recorded balance of $30,000. If the entire inventory contained 2,400 items and the total recorded balance of the inventory was $480,000, the estimated account balance using mean per unit estimation is: A) $393,600. B) $474,500. C) $480,000. D) $492,000.

47) Pujols, CPA, performed a nonstatistical sampling plan to examine the inventory balances of Wieserbud Brewing Inc., and estimated the account balance based on the ratio of audited value to recorded balances. He audited 120 items from a sample and found an audited value of $24,600. The sample had a recorded balance of $30,000. If the entire inventory contained 2,400 items and the total recorded balance of the inventory was $480,000, the estimated account balance using nonstatistical methods is: A) $393,600. B) $474,500. C) $480,000. D) $500,000.

48) Jeter, CPA, performed a nonstatistical sampling plan to examine the inventory balances of Big Apple Company and estimated the account balance based on the ratio of audited value to recorded balances. He audited 200 items from a sample and found an audited value of $36,000. The sample had a recorded balance of $40,000. If the entire inventory contained 3,000 items and the total recorded balance of the inventory was $500,000, the estimated account balance using nonstatistical estimation and projecting the error based on number of items examined is: A) $393,600. B) $474,500. C) $450,000. D) $540,000.

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49) Using AICPA monetary unit sampling sample size tables, which of the following combination of factors would result in the largest sample size for accounts receivable with a recorded balance of $5,000,000? A) Tolerable misstatement = $250,000; Expected misstatement = $100,000; Risk of incorrect acceptance = 5%. B) Tolerable misstatement = $250,000; Expected misstatement = $125,000; Risk of incorrect acceptance = 10%. C) Tolerable misstatement = $500,000; Expected misstatement = $250,000; Risk of incorrect acceptance = 5%. D) Tolerable misstatement = $500,000; Expected misstatement = $100,000; Risk of incorrect acceptance = 10%.

50) Summitt, CPA, performed a nonstatistical sampling plan to examine the inventory balances of Hero Inc. Which of the following methods of sample selection are available to her? A) Random and systematic only. B) Block and haphazard only. C) Any method she believes will result in a representative sample. D) Any method where the results can be probabilistically estimated.

51) In which of the following circumstances would the auditor most likely use variables sampling? A) Identifying the susceptibility of the account balance to misstatement. B) Evaluating the operating effectiveness of specific control procedures. C) Evaluating the operating design of specific control procedures. D) Determining whether the client's accounts receivable balance is correctly recorded.

52) Which of the following is the least likely outcome when the upper limit on misstatements exceeds the tolerable misstatement?

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A) The auditor would be exposed to the risk of incorrect rejection. B) The auditor would be exposed to an efficiency loss. C) The auditor would consider expanding the sample to evaluate additional transactions or components of the account balance. D) The auditor would conclude that the account balance is fairly stated.

53)

The upper limit on misstatements is:

A) an adjustment of the sample estimate of misstatement to reflect the desired level of sampling risk. B) an adjustment of the sample deviation rate to reflect the desired level of sampling risk. C) the maximum rate of deviation that could exist before auditors would reduce the reliance on an internal control. D) the maximum misstatement that could exist before auditors would conclude that the account balance is not fairly stated.

54) An auditor discovers that an account balance believed not to be materially misstated based on an audit sample was materially misstated based on the total population of the account balance. This is an example of which of the following types of sampling risks? A) Incorrect rejection. B) Incorrect acceptance. C) Assessing control risk too low. D) Assessing control risk too high.

55) Which of the following would be the most likely situation in which an auditor would use variables sampling?

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A) Comparing the recorded balance in accounts receivable to expected balances or prior-years' balances. B) Selecting customer balances in accounts receivable for confirmation. C) Evaluating sales invoices for evidence of authorization by client personnel. D) Mathematically evaluating the client's provision for the allowance for doubtful accounts.

56)

Which of the following statements is not true regarding variables sampling?

A) Two approaches to variables sampling are monetary unit sampling and classical variables sampling. B) Both statistical and nonstatistical approaches to variables sampling can be used under GAAS. C) The objective of variables sampling is to estimate either the true balance or the extent of misstatement in an account balance or class of transactions. D) Variables sampling is appropriate when the distribution of the population is binary in nature.

57)

When conducting variables sampling, auditors typically examine A) transactions of components of the account balance or class of transactions. B) the balances in an account balance or class of transactions from one or more prior

years. C) the separation of duties among client personnel for transactions related to the account balance or class of transactions. D) minutes from meetings of the client's board of directors.

58) Which of the following selection methods selects individual dollars within an account balance or class of transactions for examination? A) Attribute sampling. B) Classical variables sampling. C) Monetary unit sampling. D) Nonstatistical variables sampling.

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59) Which of the following is not true with respect to the use of monetary unit sampling (MUS)? A) MUS selects individual dollars from an account balance for verification. B) Compared to classical variables sampling, MUS allows the auditors to more effectively control their exposure to sampling risk. C) MUS estimates the extent of misstatement in an account balance or class of transactions. D) MUS provides the auditor with a more conservative estimate of the misstatement than classical variables sampling.

60) Which of the following is considered to be an advantage of monetary unit sampling compared to classical variables sampling? Selection of larger

Ability to identify

components

understatements

Yes

A) Option A B) Option B C) Option C D) Option D

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61) SCA is auditing a client's accounts receivable balance recorded at $10 million using MUS. The following parameters have been established for this account: ● Tolerable misstatement = $500,000 ● Expected misstatement = $100,000 ● Risk of incorrect acceptance = 10 percent Which of the following statements would not be true with respect to the sample size in this situation? A) The correct sample size is 69 customer accounts. B) Decreasing tolerable misstatement from $500,000 to $200,000 (holding all other factors constant) will reduce the sample size by 331 accounts. C) If SCA wishes to reduce its exposure to the risk of incorrect acceptance to 5 percent (holding all other factors constant), sample size will be increased by 24 accounts. D) Increasing expected misstatement to $200,000 (holding all other factors constant) will increase the sample size to 115 customer accounts.

62) MES is auditing a client's accounts receivable balance recorded at $2 million using MUS. The following parameters have been established for this account: ● Tolerable misstatement = $200,000 ● Expected misstatement = $100,000 ● Risk of incorrect acceptance = 5 percent Which of the following statements would not be true with respect to the sample size in this situation? A) The correct sample size is 116 customer accounts. B) Increasing tolerable misstatement from $200,000 to $600,000 (holding all other factors constant) will increase the sample size. C) If MES can accept a risk of incorrect acceptance of 10 percent (holding all other factors constant), sample size will be decreased to 80 accounts. D) Because the size of the population is relatively large, this element does not affect sample size.

63) Which of the following is not a correct relationship between a factor and sample size in a monetary unit sampling application?

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A) Expected misstatement; Inverse. B) Recorded balance of the account; Direct. C) Risk of incorrect acceptance; Inverse. D) Tolerable misstatement; Inverse.

64) Zimmerman is auditing a client's accounts balance recorded at $1 million using monetary unit sampling. After assessing the appropriate parameters, Zimmerman determined an appropriate sample size of 100 items. The following two misstatements were identified as a result of the substantive tests: Recorded Balance

Audited Value

$ 20,000

$ 16,000

5,000

2,500

Assume that Zimmerman's parameters included a tolerable misstatement of $60,000 and a risk of incorrect acceptance of 5 percent. (Confidence factors for a 5 percent risk of incorrect acceptance are shown below): Overstatement Errors 0

Factor 3.00

4.75

6.30

Which of the following is not true with respect to the above? A) The actual misstatement detected by Zimmerman is $6,500. B) The projected misstatement is $7,000. C) The basic allowance for sampling risk is $30,000. D) If the upper limit on misstatements is $46,750, Zimmerman should accept the account balance as fairly stated.

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65) Allister is auditing a client's accounts balance recorded at $500,000 using monetary unit sampling and determined a sample size of 100 items. The following two misstatements were identified as a result of the substantive tests: Recorded Balance

Audited Amount

$ 4,000

$ 1,000

$ 2,000

$ 1,500

Confidence factors for a 5 percent risk of incorrect acceptance are shown below: Overstatement Errors 0

Factor 3.00

4.75

6.30

What is the incremental allowance for sampling risk? A) $3,500 B) $5,000 C) $8,500 D) $15,000

66) Which of the following components of the upper limit on misstatements is affected by misstatements detected during the audit examination? Basic allowance for

Incremental allowance

sampling risk

for sampling risk

Yes

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A) Option A B) Option B C) Option C D) Option D

67) Which of the following components of the upper limit on misstatements is based on the possibility that the sampling interval contains a greater degree of misstatement than the item examined by the auditor? A) Basic allowance for sampling risk. B) Incremental allowance for sampling risk. C) Projected misstatement. D) Risk of incorrect acceptance.

68) Which of the following represents a major difference in the use of monetary unit sampling (MUS) and classical variables sampling? A) MUS is more effective in controlling the auditors' exposure to sampling risk than classical variables sampling. B) MUS considers both the expected misstatement and tolerable misstatement in the determination of sample size, while classical variables sampling only considers the expected misstatement. C) MUS defines the sampling unit as a dollar of an account balance while classical variables sampling defines the sampling unit as a component of an account balance. D) MUS is a nonstatistical sampling method while classical variables sampling is a statistical sampling method.

69) Auditors are evaluating an account with a recorded balance of $500,000 using mean-perunit estimation. This account is comprised of 1,000 individual components. The auditors sampled 100 items and determined a total audited value of $52,500. Using a risk of incorrect acceptance of 10 percent, the auditors determined a precision of $40,000. If the tolerable misstatement is $50,000, which of the following is not true?

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A) The estimated recorded balance of this account is $525,000. B) A 90percent probability exists that the true population value falls between $460,000 and $540,000. C) The auditors would conclude that the account balance is fairly stated. D) The probability that the auditors will incorrectly accept a materially misstated account balance is 10percent.

70) Auditors are evaluating an account with a recorded balance of $600,000 using classical variables sampling. Based on an allowable risk of incorrect acceptance of 5percent, the auditors have determined the following: ● Estimated account balance = $680,000 ● Precision = $20,000 ● Tolerable misstatement = $50,000 Which of the following best describes the auditors' decision and rationale for that decision? A) The auditors would accept the account balance as fairly stated, since the sample estimate falls outside of the precision interval. B) The auditors would conclude that the account balance is not fairly stated, since the sample estimate falls outside of the precision interval. C) The auditors would accept the account balance as fairly stated, since the difference between the lower bound of the precision interval and recorded balance exceeds the tolerable misstatement. D) The auditors would conclude that the account balance is not fairly stated, since the difference between the lower bound of the precision interval and recorded balance exceeds the tolerable misstatement.

71) Auditors are evaluating an account with a recorded balance of $700,000 using classical variables sampling. Based on an allowable risk of incorrect acceptance of 10percent, the auditors have determined the following: ● Estimated account balance = $640,000 ● Precision = $20,000 ● Tolerable misstatement = $50,000 Which of the following best describes the auditors' decision and rationale for that decision?

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A) The auditors would accept the account balance as fairly stated, since the sample estimate falls outside of the precision interval. B) The auditors would conclude that the account balance is not fairly stated, since the sample estimate falls outside of the precision interval. C) The auditors would accept the account balance as fairly stated, since the difference between the upper bound of the precision interval and recorded balance is less than the tolerable misstatement. D) The auditors would conclude that the account balance is not fairly stated, since the difference between the lower bound of the precision interval and recorded balance exceeds the tolerable misstatement.

72) Law, CPA, is using nonstatistical sampling in his examination of Jye Company's accounts receivable. The recorded balance of Jye's accounts receivable was $750,000. Law selected a sample of customer accounts for examination, which were recorded at $50,000. Based on the responses received from accounts receivable confirmations, Law determined an audited value of $45,000 for the accounts receivable. If tolerable misstatement is $60,000, which of the following statements is not true? A) The actual misstatement identified by Law is $5,000. B) The estimated account balance would be $825,000. C) Law would conclude that the account balance is not fairly stated, since the estimated misstatement is greater than the tolerable misstatement. D) Law is not able to provide a quantitative conclusion as to the exposure to the risk of incorrect acceptance.

73) A client's inventory is recorded at $300,000 and is comprised of 1,000 items. If auditors examined a sample of 200 items and found a total misstatement of $20,000 (overstatement), what is the estimated audited value for inventory? A) $20,000 B) $100,000 C) $200,000 D) $400,000

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74) A client's inventory is recorded at $600,000 and is comprised of 1,000 items. The auditors examined a sample of items with a recorded balance of $100,000 and determined an audited value of $90,000. What is the estimated audited value for inventory? A) $90,000 B) $540,000 C) $590,000 D) $666,666

75) As the auditors' assessments of control risk and analytical procedures risk decrease, which of the following statements is true? A) The sample size will not be affected. B) The allowable risk of incorrect acceptance will increase. C) The sample size will increase. D) The allowable risk of incorrect acceptance will decrease.

76) Holding other factors constant in a classical variables sampling application, an increase in which of these factors will cause sample size to increase? A) Risk of incorrect rejection: Yes; Risk of incorrect acceptance: No B) Risk of incorrect rejection: No; Risk of incorrect acceptance: Yes C) Risk of incorrect rejection: Yes; Risk of incorrect acceptance: Yes D) Risk of incorrect rejection: No; Risk of incorrect acceptance: No

77) Which of the following statements is true regarding performance materiality in a monetary unit sampling application? A) Performance materiality replaces the overall level of financial statement materiality. B) Expected misstatement is the application of performance materiality to a particular sampling procedure. C) Performance materiality addresses the risk that the aggregate of individually material misstatements may not cause the financial statements to be materially misstated. D) Performance materiality provides auditors with a conservative measure that considers the presence of undetected misstatements.

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78) As the expected misstatement is large relative to the tolerable misstatement, the audit team would most likely A) increase their degree of reliance on internal controls. B) consider the possibility of an increased level of tolerable misstatement. C) increase the sample size. D) decrease the sample size.

79) In a classical variables sampling application, the auditor determines there is a 95 percent probability that the true (but unknown) value of an entity's accounts receivable is between $45,000 and $55,000. If the estimated population value is $50,000, the precision is A) $10,000. B) $5,000. C) 95 percent. D) 5percent.

80) The audit team is using monetary unit sampling to examine an entity's accounts receivable balance, which is recorded at $500,000. The team has determined the tolerable misstatement to be $25,000, the risk of incorrect acceptance to be 5 percent, and the expected misstatement to be 2 percent. Using the monetary unit sampling sample size table, what is the appropriate sample size? A) 75 B) 162 C) 231 D) 300

81) If an audit team performing a monetary unit sampling application selects a sample using a systematic random selection method, which of the following is true with respect to accounts with a balance greater than the sampling interval?

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A) They have a 100percent probability of being selected. B) They have no probability of being selected. C) They have a greater than 50percent probability of being selected. D) They have a less than 50percent probability of being selected.

82) In a classical variables sampling application, which of the following outcomes would typically not result from stratifying a population? A) A decrease in the population variability. B) A decrease in the expected sample size. C) An increase in the standard deviation. D) A higher likelihood of selecting higher dollar items.

83) the

In classical variables sampling, a measure of the variability of the population is known as

A) sampling average. B) tolerable misstatement. C) standard deviation. D) tainting percentage.

84) Which of the following is not true with respect to the effect of the population standard deviation in a classical variables sampling application? A) The standard deviation can be determined based on experience from prior audits or a small sample taken during the current audit. B) The standard deviation has a direct relationship with sample size. C) When the standard deviation is larger, the audit team is more likely to select a representative sample. D) The standard deviation represents the variability of the population being examined.

85)

Which of the following statements is true regarding classical variables sampling?

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A) A very small dollar account has the same probability of being selected for examination as a very large dollar account. B) The determination of sample size requires auditors to consider a smaller number of factors than are considered under MUS. C) Classical variables sampling should be used when the auditor has greater concerns for overstatement (rather than understatement) errors. D) The sampling unit is defined as each individual dollar in the account under examination.

86) Jones, CPA, used a classical variables sampling application to examine the inventory balance of XYZ Company. The recorded balance of the inventory was $240,000, and Jones determined a tolerable misstatement of $12,000. Jones' sampling procedures resulted in a precision interval of $224,000 to $236,000. As a result, Jones should conclude that the A) inventory balance is fairly stated. B) inventory balance is materially misstated. C) tolerable misstatement should be increased. D) risk of incorrect acceptance is below the desired level.

87) Which of the following does not represent a difference between the use of various approaches to classical variables sampling? A) The use of mean-per-unit estimation typically results in a larger standard deviation than the use of either difference estimation or ratio estimation. B) The use of difference and ratio estimation normally provides smaller sample sizes than the use of mean-per-unit estimation. C) The use of difference and ratio estimation require the auditor to expect a certain number of differences to exist in the population while the use of mean-per-unit estimation does not. D) The use of mean-per-unit estimation requires a reliable measure of recorded balance while the use of difference and ratio estimation do not.

88) Which of the following is not an acceptable course of action the audit team can choose when sample evidence suggests that the account balance is materially misstated?

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A) Increase the tolerable misstatement and examine additional items. B) Increase the sample size and examine additional items. C) Recommend adjustment of the client's account balance. D) All of these choices are acceptable courses of action.

89) Ranger, CPA, used nonstatistical sampling to examine the accounts receivable balances of Cowboy Inc. He audited a sample of 150 items and found an audited value of $5,000 less than the recorded balance of $25,000. The entire account balance contained 2,000 items and had a total recorded value of $350,000. Using nonstatistical methods and assuming that Ranger used the ratio of audited value to recorded value to estimate the account balance, the estimated total account balance is A) $345,000. B) $330,000. C) $295,000. D) $280,000.

90) Romo, CPA, performed nonstatistical sampling to examine the inventory balances of Jones Company. The sample included 125 of the total 1,250 items with a recorded balance of $550,000. Romo determined the expected misstatement to be $25,000 and the tolerable misstatement to be $40,000. The sample had a recorded balance of $54,000 and an audited value of $52,000. What conclusion did Romo draw regarding the account balance? A) Conclude that the account balance is fairly stated, since the estimated misstatement is greater than the expected misstatement. B) Conclude that the account balance is not fairly stated, since the estimated misstatement is greater than the tolerable misstatement C) Conclude that the account balance is not fairly stated, since the estimated misstatement is less than the expected misstatement D) Conclude that the account balance is fairly stated, since the estimated misstatement is less than the tolerable misstatement.

91) In a variables sampling application, which of the following would not ordinarily be documented by the audit team?

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A) A description of the substantive procedures performed on each item selected. B) Information on how the audit team verified the completeness of the identified population. C) The method and parameters used to determine sample size. D) The audit team's rationale for the use of monetary unit sampling as opposed to other sampling techniques.

92) Cruz, CPA, decided to use nonstatistical sampling to examine the accounts payable balances of Maverick Inc. Based on his professional judgment, Cruz judgmentally selected sample invoices from a file, but did so without any intentional bias. The selection method used by Cruz was A) haphazard selection. B) block selection. C) systematic selection. D) random selection.

93) Dawson Company’s inventory was recorded at $2,500,000. Assume that Andre, CPA established a tolerable misstatement of 10% of the recorded balance and, based on previous audits, expected misstatements of 4% in the accounts. If Andre’s desired risk of incorrect acceptance was 5%, which of the following would not be true with respect to the necessary sample size and sampling interval in a monetary unit sampling application? A) The appropriate sample size would be 81 items. B) Holding all other factors constant, a decrease in the expected misstatement to 2% in the accounts would reduce the sample size by 34 items. C) Holding all other factors constant, an increase in the risk of incorrect acceptance to 10% would result in an increase in the sampling interval to $12,239. D) Holding all other factors constant, a reduction in the tolerable misstatement to 8% would increase the sample size by 64 items.

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94) Auditor B is conducting a monetary unit sampling application on C Company’s accounts receivable having a recorded balance of $10,000,000 and established a tolerable misstatement of $500,000, expected misstatement of $100,000, and a risk of incorrect acceptance of 5%. Which of the following independent modifications to these parameters would result in the largest increase in sample size? A) An increase in the expected misstatement to $200,000. B) A reduction in the tolerable misstatement to $400,000. C) An increase to the risk of incorrect acceptance of 10%. D) An increase to the tolerable misstatement to $1,000,000.

95) Cub Company’s inventory was recorded at $1,000,000. Assume that Wrigley, CPA’s desired risk of incorrect acceptance was 5%, which of the following levels of expected misstatement and tolerable misstatement is not associated with the correct sample size? A) Expected misstatement = $10,000, Tolerable misstatement = $100,000, 37 items. B) Expected misstatement = $20,000, Tolerable misstatement = $100,000, 47 items. C) Expected misstatement = $5,000, Tolerable misstatement = $50,000, 74 items. D) Expected misstatement = $10,000, Tolerable misstatement = $50,000, 120 items.

96) Using AICPA monetary unit sample size tables, which of the following combination of factors would result in the smallest sample size for accounts receivable with a recorded balance at $3,000,000? A) Tolerable misstatement = $300,000; Expected misstatement = $120,000; Risk of incorrect acceptance = 5%. B) Tolerable misstatement = $300,000; Expected misstatement = $150,000; Risk of incorrect acceptance = 5%. C) Tolerable misstatement = $150,000; Expected misstatement = $30,000; Risk of incorrect acceptance = 10%. D) Tolerable misstatement = $240,000; Expected misstatement = $120,000; Risk of incorrect acceptance = 10%.

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97) Bruno is using monetary unit sampling to conduct the audit of a client’s accounts receivable with a recorded balance of $10 million. Based on the expected misstatement, tolerable misstatement, and risk of incorrect acceptance, you have determined a sample size of 200 items. After selecting the sample items and confirming the accounts with customers, you have identified the following discrepancies: Account 12

Recorded balance $ 300,000

Audited value $ 150,000

116

20,000

15,000

119

40,000

10,000

A) $35,000 B) $50,000 C) $75,000 D) $200,000

98) RMU is auditing Bauer’s accounts receivable; a review of the audit documentation revealed the following: Tolerable misstatement Actual misstatement Basic allowance for sampling risk Projected misstatement Incremental allowance for sampling risk

$ $ $ $ $

400,000 50,000 100,000 160,000 45,000

What is the upper limit on misstatements? A) $95,000 B) $260,000 C) $305,000 D) $355,000

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99) Barber, CPA is auditing Shop’s inventory, which is recorded at $1 million. Based on the expected misstatement, tolerable misstatement, and risk of incorrect acceptance, Barber determined a monetary unit sampling sample size of 40 items and a sampling interval of $25,000. After performing the appropriate substantive tests for Shop’s inventory, Barber identified the following discrepancies: Item X-11

Recorded balance $ 60,000

Audited value $ 45,000

B-12

$ 10,000

5,000

C-23

$ 20,000

$ 15,000

The following factors are available from monetary unit sampling tables for a 5% risk of incorrect acceptance (the level used by Barber): Overstatement Errors 0

Factor 3.00

4.75

6.30

7.76

Which of the following statements is not true: A) The actual misstatement is $25,000. B) The upper limit on misstatements is $121,563. C) The projected misstatement is $33,750. D) The incremental allowance for sampling risk is $46,563.

100) Burrow, CPA is conducting an audit of Tiger Company’s accounts receivable using monetary unit sampling (MUS). Tiger’s accounts receivable were recorded at $500,000 and, based on Burrow’s expected misstatement, tolerable misstatement, and desired risk of incorrect acceptance, Burrow determined a sample size of 25 items. Burrow’s substantive procedures identified the following misstatements: Account

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Recorded balance

Audited value

TG-22

$ 10,000

MH-44

$ 30,000

$ 20,000

ZZ-66

5,000

8,000

2,500

The following factors are available from MUS tables for a 5% risk of incorrect acceptance (the level used by Barber): Overstatement Errors 0 1 2 3

Factor 3.00 4.75 6.30 7.76

What is Burrow’s incremental allowance for sampling risk? A) $9,700 B) $19,700 C) $24,000 D) $33,700

101) Kramer, CPA is auditing Cosmo’s accounts receivable using monetary unit sampling (MUS), which are recorded at $20 million. Based on the expected misstatement, tolerable misstatement, and risk of incorrect acceptance, Kramer determined a sample size of 50 items and a sampling interval of $400,000. After confirming the accounts with Cosmo’s customers, Kramer identified the following discrepancies: Account E. Benes

Recorded balance $ 110,000

N. Post

240,000

$ 144,000

J. Seinfeld

650,000

$ 400,000

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Audited value $ 99,000

The following factors are available from MUS Sampling Tables for a 10% risk of incorrect acceptance (the level used by Kramer): Overstatement Errors 0 1 2 3

Factor 2.31 3.89 5.33 6.69

Which of the following statements is not true? A) The actual misstatement is $357,000. B) The basic allowance for sampling risk is $924,000. C) The projected misstatement is $353,846. D) The incremental allowance for sampling risk is $110,400.

ESSAY. Write your answer in the space provided or on a separate sheet of paper. 102) Roberts, CPA, decided to use monetary unit sampling in the audit of a client's accounts receivable balance. The recorded amount of the accounts receivable control account totaled $2,000,000 and consisted of approximately 5,000 accounts. Roberts established a tolerable misstatement of $100,000, a risk of incorrect acceptance of 5 percent, and an expected misstatement of $10,000. a. Calculate the sample size. b. Calculate the sampling interval.

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103) You are planning to use monetary unit sampling to evaluate accounts receivable for Violet Company. The accounts receivable account totals $3,000,000. You have assessed a risk of incorrect acceptance of 5 percent, a tolerable misstatement of $120,000, and an expected misstatement of $24,000. a. Calculate the sample size and sampling interval. b. Regardless of your answer to (a), use a sample size of 125 and the related sampling interval and calculate the upper limit on misstatements assuming you found the following differences.

Account

Recorded Balance

102

$ 2,000

235

3,200

Audited Value $

Difference

600

$ 1,400

1,920

1,280

104) You are planning to use monetary unit sampling to evaluate accounts receivable for Rose Company. The accounts receivable account totals $4,000,000. You have assessed a risk of incorrect acceptance of 10 percent, a tolerable misstatement of $200,000, and an expected misstatement of $40,000. a. Calculate the sample size and sampling interval. b. Regardless of your answer to (a), use a sample size of 200 and the related sampling interval to calculate the upper limit on misstatements assuming you found the following differences.

Account

Recorded Balance

Audited Value

Difference

201

$ 12,000

$ 10,800

$ 1,200

532

32,000

24,000

8,000

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105) Rome, CPA, is conducting a classical variables sampling application on a client's accounts receivable recorded at $3,000,000. These receivables are comprised of 5,000 customer accounts. Assume that Rome identified an acceptable level of the risk of incorrect acceptance of 5 percent, determined a sample size of 100, and confirmed the accounts with the client's customers. Rome's substantive procedures indicated that the average audited value was $590 per account. a. Determine the sample estimate of the client's accounts receivable. b. If the standard deviation of sample estimates is $30, calculate the precision. c. Calculate the precision interval.

SECTION BREAK. Answer all the part questions. 106) Bama's accounts receivable were recorded at $600,000. Assume that the auditor determined a sample size of 20 customer accounts and prepared confirmations to be addressed to those customers. One misstatement was determined; an account recorded at $10,000 was confirmed to have a balance of $5,000.

106.1)

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What is the appropriate sampling interval?

A) $60. B) $250. C) $500. D) $30,000.

106.2)

What is the projected misstatement?

A) $5,000. B) $10,000. C) $15,000. D) $30,000.

106.3) Using an incremental confidence factor of 1.58 (corresponding to the risk of incorrect acceptance of 10percent), what is the incremental allowance for sampling risk? A) $5,000. B) $7,900. C) $8,700. D) $23,700.

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Answer Key Test name: Module F Test Bank 1) D 2) D 3) B 4) B 5) C 6) C 7) A 8) A 9) C 10) D 11) A 12) A 13) A 14) B 15) C 16) D 17) C 18) D 19) B 20) D 21) D 22) C 23) D 24) B 25) B 26) A Version 1

27) D 28) A 29) D 30) C 31) B 32) B 33) C 34) B 35) D 36) A 37) B 38) B 39) B 40) C 41) C 42) D 43) C 44) B 45) C 46) D 47) A 48) C 49) A 50) C 51) D 52) D 53) A 54) B 55) B 56) D Version 1

57) A 58) C 59) B 60) A 61) B 62) D 63) A 64) B 65) C 66) C 67) B 68) C 69) B 70) D 71) D 72) B 73) C 74) B 75) B 76) D 77) D 78) C 79) B 80) B 81) A 82) C 83) C 84) C 85) A 86) B Version 1

87) D 88) A 89) D 90) D 91) D 92) A 93) C 94) A 95) D 96) C 97) D 98) C 99) D 100) A 101) C 102) a. Ratio of expected to tolerable misstatement = $10,000 ÷ $100,000 = 0.10 Tolerable misstatement as a percentage of population = $100,000 ÷ $2,000,000 = 5 percent Sample Size from MUS table for risk of incorrect acceptance of 5 percent = 74 b. Sampling interval = $2,000,000 ÷ 74 = $27,027

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103) a. Ratio of expected to tolerable misstatement = $24,000 ÷ $120,000 = 0.20 Tolerable misstatement as a percentage of population = $120,000 ÷ $3,000,000 = 4 percent Sample Size from MUS table for risk of incorrect acceptance of 5 percent = 116 Sampling interval = $3,000,000 ÷ 116 = $25,862 b. NOTE: (b) uses a given sample size of 125 and calculated sampling interval of $24,000 ($3,000,000 ÷ 125 = $24,000) Tainting Percentages Account 102 Account 235

$1,400 ÷ $2,000 = 70 percent $1,280 ÷ $3,200 = 40 percent

Basic Allowance for sampling risk = Sampling Interval× Confidence Factor = $24,000× 3.0 = $72.000 Projected misstatement = Sampling Interval× Tainting percentage Account 102

$ 24,000 ×

0.70 =

$ 16,800

Account 235

$ 24,000 ×

0.40 =

9,600

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$ 26,400

Incremental allowance for sampling risk: Account 102

$ 16,800 ×

(4.75 – 3.00 – 1.00) =

$ 12,600

Account 235

(6.30 – 4.75 – 1.00) =

5,280

9,600 ×

$ 17,880

Upper limit on misstatements

Basic allowance for sampling risk

72,000

Projected misstatement

26,400

Incremental allowance for sampling risk

17,880

Upper limit on misstatements

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$ 116,280

104) a. Ratio of expected to tolerable misstatement = $40,000 ÷ $200,000 = 0.20 Tolerable misstatement as a percentage of population = $200,000 ÷ $4,000,000 = 5 percent Sample Size from MUS table for risk of incorrect acceptance of 10 percent = 69 Sampling interval = $4,000,000 ÷ 69 = $57,971 b. NOTE: (b) uses a given sample size of 200 and calculated sampling interval of $20,000 ($4,000,000 ÷ 200 = $20,000) Tainting Percentages Account 201: $1,200 ÷ $12,000 = 10 percent Account 532: Basic Allowance for sampling risk = Sampling Interval × Confidence Factor = $20,000 × 2.31 = $46,200 Projected misstatement = Sampling Interval × Tainting percentage

Account 201

$ 20,000 ×

Account 532

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8,000 ×

0.10 =

2,000 8,000

$ 10,000

Incremental allowance for sampling risk: Account 201

2,000 ×

(3.89 – 2.31 – 1.00) =

1/160

Upper limit on misstatements Basic allowance for sampling risk

$ 46,200

Projected misstatement

10,000

Incremental allowance for sampling risk

1,160

Upper limit on misstatements

$ 57,360

105) N = number of accounts in population, n = sample size, R(IA) = confidence factor for risk of incorrect acceptance, SD = standard deviation a. Sample estimate

= Average audited value× N = $590 × 5,000 = $2,950,000

b. Precision

= N × R(IA) × (SD ÷ √n) = 5,000 × 1.65 × ($30 ÷ √100) = $24,750

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Precision Interval

= Sample estimate ± Precision = $2,950,000 ± $24,750 = $2,925,250 to $ 2,974,750

106) Section Break 106.1) D 106.2) C 106.3) C

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MODULE F: PROBLEM MATERIAL ESSAY. Write your answer in the space provided or on a separate sheet of paper. 1) Below are some situations in which it would be preferable to use either monetary unit sampling or classical variables sampling. Using the letters M (for monetary unit sampling) or C (for classical variables sampling), identify which sampling method would be most appropriate. ______ ______ ______ ______ ______ ______

______

1. Several sampling units in the population have a zero or negative balance. 2. The auditor would like to examine a smaller number of items. 3. The account balance is susceptible to understatement error. 4. The account balance includes a few logical units with very large dollar balances. 5. The auditor is able to form a reasonable estimate of the variability of the population. 6. The auditor would like to ensure that the sampling method provides a conservative (higher) estimate of misstatement in the account balance. 7. The account balance is susceptible to overstatement error.

2) Indicate how each of the following conditions affect sample size in a monetary unit sampling application by using the letters I (increase), D (decrease), or N (no effect), assuming that all other factors are held constant. ______ ______ ______

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1. An increase in the expected misstatement from $5,000 to $10,000. 2. A decrease in the population size from $1,500,000 to $1,350,000. 3. An increase in the tolerable misstatement from $25,000 to $35,000. 1

______ ______

4. An increase in the risk of incorrect rejection from 5 percent to 10 percent. 5. A decrease in the risk of incorrect acceptance from 5 percent to 1 percent.

3) Indicate whether each of the following factors is considered in determining sample size in monetary unit sampling (M), classical variables sampling (C), both (B), or neither (N). _____ 1. _____ 2. _____ 3. _____ 4. _____ 5. _____ 6. _____ 7.

Population size. Standard deviation. Risk of incorrect acceptance. Expected misstatement. Tolerable misstatement. Risk of incorrect rejection. Tainting percentage.

4) Indicate how each of the following considerations would impact sample size in a classical variables sampling application by using I (increase), D (decrease), or N (no effect). _____ 1. The inventory account balance several unusually large items. Carson had decided to stratify the inventory account balance so that the unusually large items are selected. _____ 2. Carson assigned a higher level of the risk of incorrect rejection initially because he can quickly and inexpensively

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select additional items for examination if needed. _____ 3. Carson increased the expected misstatement due to the change in Furniture Expert's method of processing and recording transactions. _____ 4. Carson conducted a small pilot sample to assess the population's standard deviation. The results indicated that the population was highly variable. _____ 5. The risk of incorrect acceptance has been decreased because the results of Carson's attributes sampling related to inventory transactions indicated control risk should be increased. _____ 6. During the audit, Carson realized his initial determination of the population size only included the first 11 months of year. When he corrected the population to include all 12 months the recorded inventory account balance increased by $100,000 and 55 items.

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Answer Key Test name: Module F_8e_Test Bank_Problem Material 1) 1. C; 2. M; 3. C; 4. M; 5. C; 6. M; 7. M 2) 1. I; 2. D; 3. D; 4. N; 5. I 3) 1. B; 2. C; 3. B; 4. B; 5. B; 6. C; 7. N 4) 1. D; 2. D; 3. I; 4. I; 5. I; 6. I

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MODULE G MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) Audit techniques that take full advantage of big data offer the potential to improve: Audit Efficiency

Audit Effectiveness

Yes

A) Option A B) Option B C) Option C D) Option D

2) What is the primary objective of analytical procedures performed during the planning stages of an audit? A) To identify existing material misstatements B) To identify unusual or unexpected relationships C) To uncover management fraud D) All of these choices are correct.

Which of the following best describes exception testing in internal control testing?

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A) A way of testing a sample of all items in a population to identify violations of a control activity B) A way of testing a sample of all items in a population and projecting the results onto the entire population C) A way of testing all items in a population to identify violations of a control activity D) A way of testing all items in a population to identify design deficiencies in internal controls

4) Which of the following are key issues that the auditor faces when assessing a client’s data? 1.Data Completeness 2.Data format 3.Data Integrity 4.Data Collection 5.Data Accuracy

A) I and V B) I, II, and V C) I, II, III, and V D) I, III, IV, and V

Which aspect of data is not important for data used in Audit Data Analytics (ADA)? A) Reliability B) Relevance C) Completeness D) None of these choices are correct.

6) Which of the following statements is correct regarding the inclusion of client data in audit documentation for an issuer?

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A) Auditors should include client data in audit documentation B) Auditors must include client data in audit documentation C) Auditors must not include client data in audit documentation D) Auditors may include client data in audit documentation

7) When documenting an Audit Data Analytic (ADA), all the following must be included in the audit documentation except: A) The underlying data used to generate graphics or visualization as part of the ADA B) The name of the specific auditor performing the work C) The date the work was finished D) Conclusions reached

8) All of the following procedures are common uses of audit data analytics in risk assessment procedures except: A) Analyzing trends in salary costs B) Assessing the number of days inventory is in stock on an item-by-item basis C) Comparing cash payments made to vendor invoices and discounts in the purchases cycle D) Calculating accounts receivable collection trends by state

Which of the following is a common use of ADA in performing tests of controls? A) The auditor performs an aging of accounts payable B) The auditor conducts trend analysis on inventory turnover C) The auditor performs exception testing for proper approval of purchase transactions D) All of these choices are correct.

10) An auditor is assessing the reliability of data to be used in the audit. The auditor discovers that the data is controlled internally by the accounting department. After learning this information, how should the auditor proceed?

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A) Rely on the data and continue to perform the ADA B) Perform tests of controls over the preparation of the data C) Inquiry of management whether or not the information is reliable D) Not rely on the data and perform an alternative procedure

11)

Which of the following is not important when considering the reliability of client data? A) The source reliability B) Client controls over data preparation C) If the auditor’s information system has been subject to reliability testing D) All of the above are important

12) Which of the following are options the auditor may take if the objectives of the Audit Data Analytic (ADA) test were not achieved? 1.Abandon ADA and perform different procedures 2.Consider a Different ADA

A) I Only B) II Only C) Both I and II D) Neither I nor II

13) Which of the following is not a potential explanation of an outlier identified as a result of an Audit Data Analytic (ADA)? A) The outlier is a duplicate item in the population B) The outlier is a missing item in the population C) The outlier is an item with elevated risk D) All of the above are potential explanations of outliers

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14) Which of the following is true regarding an unusual item identified during an Audit Data Analytic (ADA)? A) The auditor need only address the risk of material misstatement for items identified as unusual B) The auditor must consider whether risk of material misstatement exists in items not identified as unusual C) The auditor must always conduct additional testing on the remaining population of items not identified as unusual D) The auditor is not required to document the results procedures performed on unusual items

15)

Which of the following is true of audit data analytics? A) It is used gain insights and improve audit quality B) It is most appropriate when used on unpredictable relationships C) It is typically performed on a small sample of the population D) All of these choices are correct.

16)

Which of the following is not a reason for data cleansing? A) Fields that should contain dates may have letters B) Data may be too large in volume C) Fields may contain data outside preset acceptable values D) All of the above are reasons for data cleansing

17) The professional standards for audit documentation are quite high. The documentation must contain enough information to allow an experienced auditor to understand the nature, timing, extent, and results of the audit. Which of the following is required for audit documentation for ADA to meet this standard?

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A) Documentation of every matter considered during the analytic B) Documentation of all misstatements identified other than those considered clearly trivial C) All underlying data used D) All of the above are required of audit documentation

18) When performing an Audit Data Analytic (ADA), an auditor must exercise professional skepticism in all of the following situations except: A) When making an assumption while planning the ADA B) When making an assumption while evaluating the results of the ADA C) When documenting rationale for their professional judgement used during the ADA D) When assessing the completeness and accuracy of client data

19)

Which of the following best describes what audit data analytics are? A) Discovering and analyzing patterns in data B) Identifying anomalies in data C) Extracting useful information in data D) All of these choices are correct.

20) Which of the following would not be considered when planning an Audit Data Analytic (ADA)? A) Determine the overall purpose and specific objectives of the ADA B) Determine the relevant financial statement assertions C) Determine the sample of the population to be analyzed D) All of the above would be considered during the planning of an ADA

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21) In order to be considered sufficient, documentation should be prepared so that an experienced auditor, with no prior connection with the engagement can understand 1.The nature, timing, and extent of procedures performed 2.The difficulty of the audit 3.Results of procedures and evidence obtained 4.Conclusions reached and significant judgments made

A) I and III B) III and IV C) I, III, and IV D) I, II, III, and IV

22) Audit Data Analytics (ADA) allow the auditor to test/analyze 100% of the data rather than a sample. What is the benefit of being able to test the entire population of data? Increased Assurance

Increased Reliability

Yes

A) Option A B) Option B C) Option C D) Option D

23) Which of the following is not a step performed during the planning phase when conducting an Audit Data Analytic (ADA)?

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A) Determining the overall purpose of the ADA B) Cleansing the data C) Selecting techniques and tools D) Identifying significant accounts and assertions

24) Which of the following are benefits that distributed ledger technology (DLT) can provide to auditors in the future? 1.Automated Audit Procedures 2.Improved Audit Trails 3.Permanent Record-Keeping

A) I and II B) I and III C) II and III D) I, II, and III

25) After evaluating the results of an Audit Data Analytic (ADA), which notable items should the auditor perform additional procedures on? Missing Items

Duplicate Items

Yes

Items with Elevated Risk Yes

Yes

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A) Option A B) Option B C) Option C D) Option D

26) Through the evaluation of the results of an Audit Data Analytic (ADA), the auditor concludes that the original objectives of the ADA were not reached. What should the auditor do next? A) Issue an adverse opinion B) Adjust the original objective C) Plan and perform alternative procedures D) Issue a disclaimer of opinion

27)

Documentation of an Audit Data Analytic (ADA), should be sufficient enough such that:

A) An experienced auditor, who is familiar with the engagement could understand the conclusions reached and significant judgments made B) An investor looking into the company could understand the conclusions reached and significant judgments made C) An experienced auditor, with no prior connection to the engagement could understand the conclusions reached and significant judgments made D) Both "An investor looking into the company could understand the conclusions reached and significant judgments made" and "An experienced auditor, with no prior connection to the engagement could understand the conclusions reached and significant judgments made" are correct

28)

Data from which of the following sources is most likely to be unreliable? A) Data obtained directly from the client with strong internal controls B) Data obtained from a third-party sent directly to the auditor C) Data obtain through direct personal observation of the auditor D) Data obtained directly from the client with weak internal controls

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29) When accessing and preparing data to be analyzed using an Audit Data Analytic (ADA), it is important to: A) Ensure that all subtotals are present B) Cleanse the data C) Ensure the data is stored in the required standardized format D) All of the choices are correct.

30) Which of the following are true with regard to the relevance and reliability of data used in an Audit Data Analytic (ADA)? 1.The auditor must use all data with a logical connection to the ultimate purpose of the audit procedure 2.The auditor must evaluate internal controls over the preparation of data being used

A) I only B) II only C) Both I and II are true D) Both I and II are false

31) Which of the following statements is true regarding the use of Audit Data Analytics (ADA)? A) The auditor must exercise professional judgment during the ADA, but does not need to act with professional skepticism B) The auditor need not document every professional judgment made C) The standard of documentation sufficiency for an ADA is less than that of other audit procedures D) All misstatements discovered, regardless of materiality, should be included in the audit documentation

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SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question. 32) Please list the steps in the data chain and explain how they are connected. Also explain what the data chain is used for.

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Answer Key Test name: Module G Test Bank 1) D 2) B 3) C 4) C 5) D 6) D 7) A 8) C 9) C 10) B 11) C 12) C 13) D 14) B 15) A 16) B 17) B 18) C 19) D 20) C 21) C 22) D 23) B 24) D 25) C 26) C Version 1

27) C 28) D 29) B 30) B 31) B 32) Data, information, knowledge, and wisdom. “To be useful for decision makers, the data must be thought about within a meaningful context which would allow it to be understood. When considering the data within a context, the data becomes more informative for a decision maker and might be thought about as information at that point. The next step in the data chain for auditors is comparing the information (i.e., data within a meaningful context) to other information in a way that leads to meaningful knowledge. Such a comparison may help the auditors to better assess the risk of material misstatement. The final step in the data chain for auditors is using the knowledge as wisdom for the financial statement audit, otherwise known as sufficient appropriate evidence related to a relevant assertion about a significant account or disclosure.”

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MODULE G: PROBLEM MATERIAL ESSAY. Write your answer in the space provided or on a separate sheet of paper. 1) Please number the steps in the Analytics chain in the proper order (1 = first step. 5 = last step) ___ ___ ___ ___ ___

Modeling Evaluation Understanding Deployment Cleansing

Please match each Audit Data Analytic (ADA) step with its purpose:

a. Plan ADA b. Assess & Prepare Data c. Consider Relevance & Reliability d. Perform ADA e. Evaluate Results

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___ Conduct planned procedures ___ Purpose and objectives of ADA ___ Does evidence achieve the objective of test? ___ Are data complete and accurate? ___ Cleanse data

3) Please assign the appropriate category to each ADA tool listed below. 1.Spreadsheet Tools 2.Generalized Audit Software 3.Data Preparation and Statistical Analysis Tools 4.Visualization Tools

a. b. c. d. e.

Microsoft Excel Tableau Alteryx IDEA Python

___ ___ ___ ___ ___

4) Match the audit procedure type with an appropriate corresponding audit data analytic. A.Risk Assessment Procedure B.Test of Control C.Substantive test of details D.Substantive Analytical Procedure

___ Exception testing on customer credit limit checks ___ Comparing actual cash collections to sales invoices and discounts ___ Assessing accounts receivable collection periods by region ___ Using a predictive model of interest expense

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Answer Key Test name: Module G_8e_Test Bank_Problem Material 1) 3 4 1 5 2

Modeling Evaluation Understanding Deployment Cleansing

2) a. Plan ADA b. Assess & Prepare Data c. Consider Relevance & Reliability d. Perform ADA e. Evaluate Results

D Conduct planned procedures A Purpose and objectives of ADA E Does evidence achieve the objective of test? C Are data complete and accurate? B Cleanse data

3) a. b. c. d. e.

1 4 3 2 3

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B C A D

Exception testing on customer credit limit checks Comparing actual cash collections to sales invoices and discounts Assessing accounts receivable collection periods by region Using a predictive model of interest expense

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MODULE H MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) Which of the following controls most likely would ensure that an organization can reconstruct its financial records? A) Hardware controls are built into the computer by the computer manufacturer. B) Backup files are stored in a location separate from original copies. C) Personnel who are independent of data input perform parallel simulations. D) System flowcharts provide accurate descriptions of computer operations.

2) When audit teams test a computerized processing system, which of the following is true of the test data approach? A) Several transactions of each type must be tested. B) Test data are processed by the client's computer programs under the audit team's control. C) Test data must consist of all possible valid and invalid combinations. D) The computer program used to process test data is different from the program used throughout the year by the client.

3) In end-user computing environments, the processing control procedures would ordinarily not include A) transaction logs. B) control totals. C) comparing input to output. D) online editing and sight verification.

4) Which of the following is not an appropriate statement with regard to computer control activities?

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A) The duties of application programming, computer operation, and control of data files should be separated. B) Computer operators should maintain control of all software programs. C) Specific passwords should be required to access online files. D) Computer programmers should be periodically rotated across different applications.

5) Computer operations controls are typically implemented for files and data used in processing. The major objectives of these controls include each of the following except for A) ensure that appropriate files are used in computerized processing. B) ensure restricted access to the computing environment. C) ensure that files are appropriately secured and protected from loss. D) ensure that files can be reconstructed from earlier versions of information used in processing.

6) Which of the following organizational positions would evaluate the existing system and design new computerized processing systems and documentation? A) Programmer. B) Systems analyst. C) Computer operator. D) Data conversion operator.

7) The effectiveness of general controls is an important consideration for audit teams when assessing control risk on an audit. Which management assertions are primarily affected by general controls? A) Completeness and Accuracy. B) Occurrence and Rights and Obligations. C) Accuracy and Occurrence. D) Completeness and Occurrence.

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The purpose of test data is to determine whether

A) the audit team's test data are consistent with the client's normal transactions. B) controls operate as described in responses to internal control questionnaire items and program flowcharts. C) every possible error is prevented or detected by the client's computer controls. D) all possible combinations of valid data are correctly processed.

Which of the following is an example of a computer operations control? A) Control totals. B) Balancing input to output. C) File backup and retention. D) Transaction logs.

10)

Audit teams would least likely use computer-assisted audit techniques to A) access client data files. B) prepare spreadsheets. C) assess control risk related to computerized processing systems. D) construct and perform parallel simulations.

11) Each of the following automated application controls are designed to ensure that the input of individual transactions and data is accurate except for A) check digits. B) valid sign tests. C) sequence tests. D) limit and reasonableness tests.

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12) Audit teams would most likely introduce test data into a computerized payroll system to test internal controls related to the A) existence of unclaimed payroll checks held by supervisors. B) early cashing of payroll checks by employees. C) discovery of invalid employee identification numbers. D) proper approval of overtime by supervisors.

13) To obtain evidence that controls over access to computer programs are properly functioning, audit teams most likely would A) create checkpoints at periodic intervals after data processing to test for unauthorized use of the system. B) examine the transaction log to discover whether any transactions were lost or entered twice due to a system malfunction. C) enter invalid identification numbers or passwords to ascertain whether the system rejects them. D) vouch a random sample of processed transactions to assure proper authorization.

14)

Tests of controls in an advanced computerized processing system

A) can be performed using only actual transactions because testing simulated transactions does not provide relevant evidence. B) can be performed using actual transactions or simulated transactions. C) is impractical because many procedures within the computerized processing system leave no visible evidence of having been performed. D) is inadvisable because it may distort the evidence in real-time systems.

15) Which of the following is a general control that would most likely assist an organization whose systems analyst resigned during the development of a major project?

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A) Grandfather-father-son file retention. B) Input and output validation routines. C) Systems documentation. D) Check digit verification.

16) Which of the following would most likely be a weakness in the internal control of a client that utilizes portable computing devices rather than a larger computer system? A) Employee collusion possibilities are increased because portable computing devices from one vendor can process the programs of a system from different vendors. B) Computer operators may be able to remove hardware and software components and modify them at an off-site location. C) Programming errors result in all similar transactions being processed incorrectly because those transactions are processed under the same conditions. D) Certain transactions may be automatically initiated by the computerized processing system and management's authorization of these transactions may be implicit in its acceptance of the system design.

17) Which of the following statements are true regarding the use of a systems generated report as audit evidence? A) The auditor should test the accuracy and completeness of the information. B) The auditor should evaluate whether the information is sufficiently precise and detailed for purposes of the audit. C) Both A and B are correct. D) Neither of the above answers are actions the auditors should take for systems generated reports.

18) Which of the following control procedures most likely could prevent computer personnel from modifying programs to bypass computer controls?

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A) Periodic management review of computer utilization reports and systems documentation. B) Separation of duties for computer programming and computer operations. C) Participation of user department personnel in designing and approving new systems. D) Physical security of computer facilities in limiting access to computer equipment.

19) When a real-time computerized processing system is in use, the computer controls can be strengthened by A) providing for the separation of duties between data input and error listing operations. B) using a systems development life cycle for authorization, user involvement, and testing of program modifications. C) preparing batch totals to provide assurance that file updates are made for the entire group of transactions. D) performing a validity check of an identification number before a user can obtain access to the computer files.

20) Which of the following statements best describes the impact on an audit when a client uses computerized processing of transactions? A) The objective of the audit examination focuses on detection of fraud and theft through the computer. B) The type of substantive procedures performed by the audit team change because of the use of computerized processing. C) The effectiveness of computer controls implemented by the client over its computerized processing may need to be evaluated by audit teams. D) Different independence standards are introduced for audit teams when clients utilize computerized processing.

21) Computer controls that are pervasive and apply to all applications of a computerized processing system are referred to as

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A) computer controls. B) environment controls. C) automated application controls. D) general controls.

22)

Which of the following is not an example of a general control?

A) The organization's use of the systems development life cycle when implementing or modifying computerized processing systems. B) The organization's use of check digits to ensure accurate input of transaction data. C) Periodic and preventative maintenance performed on the computer and related equipment. D) The existence of appropriate separation of duties within the computer department.

23) Which of the following is not a control included as part of the systems development life cycle? A) Ensuring that all software acquisition and program development efforts are consistent with the organization's needs and objectives. B) Testing and validating new programs and developing proper implementation plans. C) Requiring that all programming efforts take place under the control of the requesting user department. D) Ensuring that data are converted completely and accurately for use in the new systems.

24) Why is it important that the organization establish systems development and documentation standards?

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A) These standards enable the organization to understand the programming logic underlying recently-developed programs. B) These standards ensure that the program controls and documentation included in recently-developed programs is adequate. C) The absence of these standards would constitute a material weakness in internal control. D) These standards ensure the appropriate separation of duties of computer personnel.

25) Which of the following categories of general controls includes retention and recovery techniques for data and related programs? A) Access to programs and data. B) Computer operations. C) Data file controls. D) Program change controls.

26) Which of the following computer controls would provide the best evidence that unauthorized users are not accessing specific computer programs and files? A) Using passwords requiring access to those programs and files. B) Periodically reviewing and confirming access rights for the organization's users. C) Monitoring actual user activity through a program log and comparing that activity to authorized levels. D) Ensuring that access to programs and files is removed for recently-terminated employees.

27) Which of the following input controls would be least likely to identify the failure of an employee to input a transaction for which documentary evidence has been prepared?

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A) Batch totals. B) Hash totals. C) Missing data tests. D) Sequence tests.

28) Which of the following is not true with respect to the test data approach for evaluating computer controls? A) The test data are created for a separate entity and are run simultaneously with the client's actual data. B) Only one of each type of error transaction needs to be included in the test data. C) The manual results of processing the test data are compared to the results of processing these data through the client's computerized processing system. D) Audit teams consider potential errors and conditions of interest in generating the test data.

29) As part of assessing the risk of material misstatement, the audit team must assess the control risk in the computerized processing system. Initially, the audit team must identify the overall processing scope of the system(s), which would include each of the following considerations except A) the types of transactions that are processed through the system. B) the specific control procedures that have been implemented by the client to prevent or detect misstatements that could occur based on the audit team's analysis. C) the programs and files that are accessed by the system in processing transactions. D) the type of output that is created as a result of processing transactions through the system.

30) Which of the following input controls would not be effective in identifying the erroneous input of numeric fields in a transaction?

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A) Batch totals. B) Hash totals. C) Check digits. D) Record counts.

31)

Which of the following is a category of general controls? A) Detective controls. B) Input controls. C) Processing controls. D) Program change controls.

ESSAY. Write your answer in the space provided or on a separate sheet of paper. 32) At a meeting of the corporate audit committee attended by the general manager of the products division (Smith) and the internal audit manager (Marks), the following dialogue took place between Smith and Jones (chair of the corporate audit committee): Jones: Ms. Marks has suggested that the internal audit department conduct an examination of the computer activities of the products division. Smith: I don't know much about the technicalities of computers, but the division has some of the best computer people in the company. Jones: Do you know whether the internal controls we have implemented are satisfactory? Smith: I suppose they are. No one has complained. What’s so important about controls anyway, as long as the system works? I don’t even know what type of controls we should have for our system. Jones: Ms. Marks, can you explain the objective of computer controls and provide us with some examples? Required: Address Ms. Marks’ response to the following points: a. State the principal objective of achieving control over (1) input, (2) processing, and (3) output. b. Provide examples of (1) input controls, (2) processing controls, and (3) output controls.

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33) Please define what is meant by an information technology dependency. Next, when identifying key internal control activities, how are they generally categorized when determining the extend of information technology dependency?

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Answer Key Test name: Module H Test Bank 1) B 2) B 3) D 4) B 5) B 6) B 7) C 8) B 9) C 10) C 11) C 12) C 13) C 14) B 15) C 16) B 17) C 18) B 19) D 20) C 21) D 22) B 23) C 24) B 25) B 26) C Version 1

27) C 28) A 29) B 30) D 31) D

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32) a. 1. The objective of input controls is to provide reasonable assurance that data received for processing by the computer department have been properly authorized and accurately entered or converted for processing. 2. The objective of processing controls is to provide reasonable assurance that data processing has been performed accurately, without any omission or duplicate processing of transactions. 3. The objective of output controls is to provide reasonable assurance that only authorized persons receive output or have access to files produced by the system. b. 1. Examples of input controls include: ● Data entry and formatting controls ● Authorization and approval controls ● Check digits ● Record counts ● Batch totals ● Hash totals ● Valid character tests ● Valid sign tests ● Missing data tests ● Sequence tests ● Limit and reasonableness tests ● Error correction and resubmission procedures 2. Examples of processing controls include: ● Clients periodically testing and evaluating the processing accuracy of its programs ● Run-to-run totals ● Control total reports ● Error correction and resubmission procedures Version 1

● Limit and reasonableness tests 3. Examples of output controls include: ● Review of output for reasonableness ● Control total reports ● Master file changes ● Controls over output distribution 33) Information technology (IT) dependencies refers to the extent that a key control activity is dependent on the IT system for its effective operation. For each key control activity identified by the auditor, its dependency on the IT system must be carefully determined in order to properly test its operating effectiveness. When identifying IT dependencies, as the key internal control activities are identified and being understood by auditors, they are generally categorized as being: (1) purely manual control activities; (2) manual control activities that rely on a system generated report; or (3) entirely automated controls. The categorization is important because for purely manual controls, there are no IT dependencies to be tested and therefore these controls can be ignored in the IT audit testing plan. However, for manual controls that rely on a system generated report and for control activities that are entirely automated, the proper execution of each key internal control activity is dependent on the IT system (in some way) and therefore must be considered when formulating the IT audit testing plan.

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MODULE H: PROBLEM MATERIAL ESSAY. Write your answer in the space provided or on a separate sheet of paper. 1) Match each of the following categories of general controls (letters A − D) to the description of a computer control (numbers 1 – 8). A category of general controls can be used more than once. A.Program development controls B.Program change controls C.Computer operations controls D.Access to programs and data controls

___ 1. Separating the duties of systems programmers, computer operators, and data librarians. ___ 2. Requiring the use of passwords to access computer programs and files. ___ 3. Using the Systems Development Life Cycle for testing and validation of new programs. ___ 4. Requiring program modifications to be tested and implemented by appropriate personnel. ___ 5. Maintaining backup copies of files at safe, remote locations. ___ 6. Involving users in the design of programs and selection of prepackaged software. ___ 7. Using external labels to identify files and programs. ___ 8. Ensuring that emergency requests are appropriately documented and properly authorized.

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2) Match each of the following input controls (letters A − K) with the description or type of error that might be detected by this control (numbers 1 − 11). Each input control relates to only one description or type of error. A.Authorization and approval controls B.Check digit C.Record count D.Batch totals E.Hash totals F.Valid character tests G.Valid sign tests H.Missing data tests I.Limit and reasonableness tests J.Error correction and resubmission procedures K.Data entry and formatting

___ 1. Data values exceed or fall below some predetermined limit. ___ 2. Comparing number of payroll transactions received for processing with the number of transactions entered into a transaction file. ___ 3. Data fields have the appropriate positive or negative sign. ___ 4. Sum of a data field that has numerical significance (such as the total of hours worked). ___ 5. Ability of data entry personnel to correct data conversion errors in a timely fashion. ___ 6. Computer may automatically generate and authorize transactions. ___ 7. A numerical field appended to another numerical field to ensure accurate input of data. ___ 8. Sum of a data field that has no numerical significance (such as the total of employee numbers). ___ 9. Data fields have the appropriate numeric or alphabetic characters. ___ 10. Data conversion personnel will not fail to enter data in a particular field. ___ 11. Data are inadvertently input in an incorrect field.

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Answer Key Test name: Module H_8e_Test Bank_Problem Material 1) 1. C; 2. D; 3. A; 4. B; 5. C; 6. A; 7. C 8. B 2) 1. I; 2. C; 3. G; 4. D; 5. J; 6. A; 7. B; 8. E; 9. F; 10. H; 11. K

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