aicpa 2005 audit and assurance

Auditing & Attestation Updating Supplement Version 34.2

Copyright © 2005 by Bisk Education, Inc. All rights reserved. of 26

RECENTLY RELEASED AICPA QUESTIONS

In May 2005, the AICPA released several questions labeled as “Year 2005 CPA Exams.” The AUD questions and the related unofficial solutions are reproduced here, along with the exclusive Bisk Education explanations. The AICPA did not state whether these questions were used on an exam. These questions are intended only as a study aid and should not be used to predict the content of future exams. It is extremely unlikely that released questions will appear on future examinations. The five-, six-, or seven-digit alphanumeric identifications associated with these questions were assigned by the AICPA.

Problem 1 MULTIPLE CHOICE QUESTIONS (100 to 125 minutes)

1. If a client will not permit inquiry of outside legal counsel, the auditor’s report ordinarily will contain a(an)a. Adverse opinionb. Disclaimer of opinionc. Unqualified opinion with a separate explanatory

paragraphd. Qualified opinion (R/05, Aud., 0003A, #1, 7796)

2. An auditor is reporting on condensed financial statements for an annual period that are derived from the audited financial statements of a publicly-held entity. The auditor’s opinion should indicate whether the information in the condensed financial statements is fairly stated in all material respectsa. In conformity with accounting principles generally

accepted in the United States of Americab. In relation to the complete financial statementsc. In conformity with an other comprehensive basis

of accountingd. In relation to supplementary filings under federal

security statutes (R/05, Aud., 0038A, #2, 7797)

3. During the initial planning phase of an audit, aCPA most likely woulda. Identify specific internal control activities that are

likely to prevent fraudb. Evaluate the reasonableness of the client’s

accounting estimatesc. Discuss the timing of the audit procedures with

the client’s managementd. Inquire of the client’s attorney as to whether any

unrecorded claims are probable of assertion(R/05, Aud., 0046A, #3, 7798)

4. When an auditor increases the assessed level of control risk because certain control activities were determined to be ineffective, the auditor most likely would increase thea. Level of detection riskb. Extent of tests of details c. Level of inherent riskd. Extent of tests of controls

(R/05, Aud., 0063A, #4, 7799)

5. An independent auditor asked a client’s internal auditor to assist in preparing a standard financial institution confirmation request for a payroll account that had been closed during the year under audit. After the internal auditor prepared the form, the controller signed it and mailed it to the bank. What was the major flaw in this procedure?a. The internal auditor did not sign the form. b. The form was mailed by the controller.c. The form was prepared by the internal auditor.d. The account was closed, so the balance was

zero. (R/05, Aud., 0087A, #5, 7800)

6. Which of the following expressions most likely would be included in a management representation letter?a. No events have occurred subsequent to the bal-

ance sheet date that require adjustment to, or disclosure in, the financial statements.

b. There are no reportable conditions identified during the prior-year’s audit of which the audit committee of the board of directors is unaware.

c. We do not intend to provide any information that may be construed to constitute a waiver of the attorney-client privilege.

d. Certain computer files and other required evidential matter may exist only for a short period of time and only in computer-readable form.

(R/05, Aud., 0088A, #6, 7801)

7. In testing plant and equipment balances, an auditor may inspect new additions listed on the analysis of plant and equipment. This procedure is designed to obtain evidence concerning management’s assertions of

Existence or Presentation occurr e nce and d i sc l osure

a. Yes Yes b. Yes Noc. No Yes d. No No

(R/05, Aud., 0107A, #7, 7802)

8. When performing an engagement to review a nonpublic entity’s financial statements, an accountant most likely woulda. Obtain an understanding of the entity’s internal

controlb. Limit the distribution of the accountant’s reportc. Confirm a sample of significant accounts receiv-

able balancesd. Ask about actions taken at board of directors’

meetings (R/05, Aud., 0110A, #8, 7803)

9. Which of the following procedures would an auditor most likely perform to obtain assurance that slow-moving and obsolete items included in inventories are properly identified?a. Testing shipping and receiving cutoff procedures b. Confirming inventories at locations outside the

entity’s premisesc. Examining an analysis of inventory turnoverd. Tracing inventory observation test counts to per-

petual listings (R/05, Aud., 0126A, #9, 7804)

10. Which of the following procedures should an auditor perform concerning litigation, claims, and assessments?a. Inspect legal documents in the possession of the

client’s lawyer that are relevant to pending litigation and unasserted claims and assessments

b. Discuss with the client’s lawyer its philosophy of defending litigation, claims, and assessments that have a high probability of being resolved unfavorably

c. Confirm directly with the client’s lawyer that all litigation, claims, and assessments have been properly recorded in the financial statements

d. Obtain assurance from management that it has disclosed all unasserted claims that its lawyer has advised are probable of assertion

(R/05, Aud., 0135A, #10, 7805)

11. Which of the following statements describes an auditor’s obligation to identify deficiencies in the design or operation of internal control?a. The auditor should design and apply tests of

controls to discover reportable conditions that could result in material misstatements.

b. The auditor need not search for reportable conditions unless management requests an attestation that "no reportable conditions were noted in the audit."

c. The auditor should search for reportable conditions if the auditor expects to assess control risk at below the maximum.

d. The auditor need not search for reportable conditions but should document and communicate any reportable conditions that are discovered.

(R/05, Aud., 0139A, #11, 7806)

12. Which of the following audit procedures most likely would assist an auditor in identifying conditions and events that may indicate substantial doubt about an entity’s ability to continue as a going concern?a. Reading the minutes of meetings of the stock-

holders and the board of directorsb. Comparing the market value of property to

amounts owed on the propertyc. Reviewing lease agreements to determine

whether leased assets should be capitalizedd. Inspecting title documents to verify whether any

assets are pledged as collateral(R/05, Aud., 0144A, #12, 7807)

13. Which of the following should be the first step in reviewing the financial statements of a nonpublic entity?a. Comparing the financial statements with state-

ments for comparable prior periods and with anticipated results

b. Completing a series of inquiries concerning theentity’s procedures for recording, classifying, and summarizing transactions

c. Obtaining a general understanding of the entity’s organization, its operating characteristics, and its products or services

d. Applying analytical procedures designed to iden-tify relationships and individual items that appear to be unusual (R/05, Aud., 0168A, #13, 7808)

14. Which of the following statements is correct concerning an auditor’s responsibility to report fraud? a. The auditor is required to communicate to the

client’s audit committee all minor fraudulent acts perpetrated by low-level employees, even if theamounts involved are inconsequential.

b. The disclosure of material management fraud to principal stockholders is required when both senior management and the board of directors fail to acknowledge the fraudulent activities.

c. Fraudulent activities involving senior management of which the auditor becomes aware should be reported directly to the SEC.

d. The disclosure of fraudulent activities to parties other than the client’s senior management and its audit committee is not ordinarily part of the auditor’s responsibility.

(R/05, Aud., 0180A, #14, 7809)

15. Which of the following audit techniques ordinarily would provide an auditor with the least assurance about the operating effectiveness of an internal control activity?a. Inquiry of client personnelb. Inspection of documents and reports c. Observation of client personneld. Preparation of system flowcharts

(R/05, Aud., 0192A, #15, 7810)

16. Which of the following procedures most likely could assist an auditor in identifying related party transactions?a. Performing tests of controls concerning the seg-

regation of dutiesb. Evaluating the reasonableness of management’s

accounting estimatesc. Reviewing confirmations of compensating bal-

ance arrangementsd. Scanning the accounting records for recurring

transactions (R/05, Aud., 0204A, #16, 7811)

17. In parallel simulation, actual client data are reprocessed using an auditor software program. An advantage of using parallel simulation, instead of performing tests of controls without a computer, is thata. The test includes all types of transaction errors

and exceptions that may be encountered.b. The client’s computer personnel do not know

when the data are being tested.c. There is no risk of creating potentially material

errors in the client’s data.d. The size of the sample can be greatly expanded

at relatively little additional cost.(R/05, Aud., 0222A, #17, 7812)

18. Analytical procedures performed in the final review stage of an audit generally would includea. Reassessing the factors that assisted the auditor

in deciding on preliminary materiality levels andaudit risk

b. Considering the adequacy of the evidence gathered in response to unexpected balances identified in planning

c. Summarizing uncorrected misstatements specifically identified through tests of details of transactions and balances

d. Calculating projected uncorrected misstatements estimated through audit sampling techniques

(R/05, Aud., 0260A, #18, 7813)

19. An accountant’s standard report on a compilation of a projection should not include a statement thata. There will usually be differences between the

forecasted and actual results.b. The hypothetical assumptions used in the pro-

jection are reasonable in the circumstances.c. The accountant has no responsibility to update

the report for future events and circumstances.d. The compilation of a projection is limited in

scope. (R/05, Aud., 0294A, #19, 7814)

20. To determine whether internal control relative to the revenue cycle of a wholesaling entity is operating effectively in minimizing the failure to prepare sales invoices, an auditor most likely would select a sample of transactions from the population repre- sented by thea. Sales order fileb. Customer order filec. Shipping document filed. Sales invoice file (R/05, Aud., 0362A, #20, 7815)

21. An auditor examining inventory most likely would use variables sampling rather than attributes sampling toa. Identify whether inventory items are properly

pricedb. Estimate whether the dollar amount of inventory

is reasonablec. Discover whether misstatements exist in inven-

tory recordsd. Determine whether discounts for inventory are

properly recorded(R/05, Aud., 0380A, #21, 7816)

22. "In connection with an audit of our financial statements, management has prepared, and furnished to our auditors a description and evaluation of certain contingencies." The foregoing passage most likely is from a(an)a. Audit inquiry letter to legal counsel b. Management representation letterc. Audit committee’s communication to the auditor d. Financial statement footnote disclosure

(R/05, Aud., 0393A, #22, 7817)

23. Which of the following procedures would an auditor most likely perform in obtaining evidence about subsequent events?a. Examine a sample of transactions that occurred

since the year end to verify the effectiveness of computer controls

b. Inquire of management whether there have been significant changes in working capital since the year end

c. Recompute depreciation charges for plant assets sold for substantial gains since the year end

d. Reperform the tests of controls that indicated significant deficiencies in the operation of internalcontrol (R/05, Aud., 0396A, #23, 7818)

24. Which of the following events occurring after the issuance of an auditor’s report most likely would cause the auditor to make further inquiries about the previously issued financial statements?a. A lawsuit is resolved that is explained in a sepa-

rate paragraph of the prior-year’s auditor’s report.

b. New information is discovered concerning undis-closed related party transactions of the prior

year. c. A technological development occurs that affects the entity’s ability to continue as a going

concern.d. The entity sells a subsidiary that accounts for

35% of the entity’s consolidated sales.(R/05, Aud., 0449A, #24, 7819)

25. Which of the following procedures would leastlikely result in the discovery of possible illegal acts?a. Reading the minutes of the board of directors’

meetingsb. Making inquiries of the client’s management c. Performing tests of details of transactionsd. Reviewing an internal control questionnaire

(R/05, Aud., 0470A, #25, 7820)

26. Which of the following procedures would an auditor ordinarily perform first in evaluating the reasonableness of management’s accounting estimates?a. Review transactions occurring prior to the com-

pletion of field work that indicate variations from expectations

b. Compare independent expectations withrecorded estimates to assess management’s process

c. Obtain an understanding of how management developed its estimates

d. Analyze historical data used in developingassumptions to determine whether the process is consistent (R/05, Aud., 0489A, #26, 7821)

27. An accountant had begun to audit the financial statements of a nonpublic entity. Which of the following circumstances most likely would be considered a reasonable basis for agreeing to the entity’s request to change the engagement to a compilation? a. The entity’s management does not provide the

accountant with a signed representation letter.b. The accountant is prohibited from corresponding

with the entity’s legal counsel.c. The entity’s principal creditors no longer require

the entity to furnish audited financial statements.d. The accountant is prevented from examining the

minutes of the board of directors’ meetings. (R/05, Aud., 0587A, #27, 7822)

28. On February 9, Brown, CPA, expressed an unqualified opinion on the financial statements of Web Co. On October 9, during a peer review of Brown’s practice, the reviewer informed Brown that engagement personnel failed to perform a search for subsequent events for the Web engagement. Brown should firsta. Request Web’s permission to perform substan-

tive procedures that would provide a satisfactory basis for the opinion

b. Inquire of Web whether there are persons cur-rently relying, or likely to rely, on the financial statements

c. Take no additional action because subsequent events have no effect on the financial statements that were reported on

d. Assess the importance of the omitted proce-dures to Brown’s present ability to support the opinion (R/05, Aud., 0599A, #28, 7823)

29. An auditor scans a client’s investment records for the period just before and just after the year end to determine that any transfers between categories of investments have been properly recorded. The primary purpose of this procedure is to obtain evidence about management’s financial statement assertions ofa. Rights and obligations, and existence or

occurrenceb. Valuation or allocation, and rights and obligationsc. Existence or occurrence, and presentation and

disclosured. Presentation and disclosure, and valuation or

allocation (R/05, Aud., 0653A, #29, 7824)

30. An accountant has been asked to issue a review report on the balance sheet of a nonpublic entity without reporting on the related statements of income, retained earnings, and cash flows. The accountant may issue the requested review report only ifa. The balance sheet is not to be used to obtain

credit or distributed to the entity’s creditors.b. The balance sheet is part of a comprehensive

personal financial plan developed to assist theentity.

c. There have been no material changes during the year in the entity’s accounting principles.

d. The scope of the accountant’s inquiry and analytical procedures has not been restricted.

(R/05, Aud., 0678A, #30, 7825)

31. Which of the following circumstances most likely would cause an auditor to suspect that there are material misstatements in an entity’s financial statements?a. Senior financial management participates in the

selection of accounting principles and the determination of significant estimates.

b. Supporting accounting records and files that should be readily available are not produced promptly when requested.

c. Related party transactions take place in the ordi- nary course of business with an entity that is audited by another CPA firm.

d. Senior management has an excessive interest in upgrading the entity’s information technology capabilities. (R/05, Aud., 0856A, #31, 7826)

32. A CPA wishes to determine how various publicly-held companies have complied with the disclosure requirements in a Statement of Financial Accounting Standards. Which of the following information sources would the CPA most likely consult for this information?a. AICPA Accounting Trends & Techniquesb. FASB Technical Bulletinsc. AICPA Audit and Accounting Manuald. FASB Statements of Financial Accounting

Concepts (R/05, Aud., 0906A, #32, 7827)

33. The primary purpose of establishing quality control policies and procedures for deciding whether to accept new clients is toa. Minimize the likelihood of association with clients

whose management lacks integrityb. Monitor significant deficiencies in the design and

operation of the client’s internal controlc. Identify noncompliance with aspects of contrac-

tual agreements that affect the financialstatements

d. Provide reasonable assurance that personnel will be adequately trained to fulfill their assigned responsibilities (R/05, Aud., 1107A, #33, 7828)

34. When a CPA reports on audited financial statements prepared on the cash receipts and disbursements basis of accounting, the report shoulda. Explain why this basis of accounting is more

useful for the readers of this entity’s financial statements than GAAP

b. Refer to the note in the financial statements that describes management’s responsibility for the financial statements

c. State that the basis of presentation is a compre-hensive basis of accounting (OCBOA) other thanGAAP

d. Include a separate explanatory paragraph that discusses the justification for, and the CPA’s con- currence with, the departure from GAAP

(R/05, Aud., 1995A, #34, 7829)

35. An auditor’s engagement letter most likely would include a statement regardinga. Management’s responsibility to provide certain

written representations to the auditorb. Conditions under which the auditor may modify

the preliminary judgment about materialityc. Internal control activities that would reduce the

auditor’s assessment of control riskd. Materiality matters that could modify the auditor’s

preliminary assessment of fraud risk(R/05, Aud., 2229A, #35, 7830)

b. Methodology used in applying sampling 42. A client that recently installed a new accountstechniques payable system assigned employees a user identifi-

36. Which of the following procedures represents a weakness in internal controls for payroll?a. The payroll clerk distributes signed payroll

checks. Undistributed checks are returned tothe payroll department.

b. The accounting department wires transfers funds to the payroll bank account. The transfer is based on totals from the payroll department summary.

c. The payroll department prepares checks using a signature plate. The treasurer supervises the process before payroll checks are distributed.

d. The payroll department prepares checks. The chief financial officer signs the payroll checks.

(R/05, Aud., A0035A, #36, 7831)

37. A successor auditor should make specific and reasonable inquiries of the predecessor auditor regarding the predecessor’sa. Understanding of the reasons for the change in

auditors

40. Which of the following activities would most likely be considered an attestation engagement?a. Consulting with management representatives of

a firm to provide adviceb. Issuing a report about a firm’s compliance with

laws and regulationsc. Advocating a client’s position on tax matters that

are being reviewed by the IRSd. Preparing a client’s tax returns

(R/05, Aud., A0157A, #40, 7835)

41. An auditor reviews a client’s accounting policies and procedures when considering which of the following planning matters?a. Method of sampling to be usedb. Preliminary judgments about materiality levels c. Nature of reports to be renderedd. Understanding the client’s operations and

business (R/05, Aud., A0208A, #41, 7836)

c. Opinion on subsequent events that have occurred since the balance sheet date

d. Perception of the competency and reliance on the client’s internal audit function

(R/05, Aud., A0041A, #37, 7832)

38. When an auditor is to conduct an audit of a service organization, what considerations should the auditor make in the planning stages regarding internal controls of the organization?a. The auditor should assess the control risk before

obtaining an understanding of internal controls.b. The auditor should obtain an understanding of

the entity’s internal controls after performing sub-stantive procedures.

c. The auditor should obtain an understanding of the effect of the user organization upon the service organization.

d. The auditor should be engaged to perform agreed-upon procedures.

(R/05, Aud., A0078A, #38, 7833)

39. An auditor’s communication with the audit committee is required to include thea. Basis for the auditor’s preliminary judgment

about materialityb. Justification for the auditor’s selection of

sampling methodsc. Discussion of disagreements with management

about matters that significantly impact the entity’s financial statements

d. Assessment of the quality of the entity’s earnings as compared to the previous year

(R/05, Aud., A0115A, #39, 7834)

cation code (UIC) and a separate password. Each UIC is a person’s name, and the individual’s password is the same as the UIC. Users are not required to change their passwords at initial log-in nor do passwords ever expire. Which of the following statements does not reflect a limitation of the client’s computer- access control?a. Employees can easily guess fellow employees’

passwords.b. Employees are not required to change

passwords.c. Employees can circumvent procedures to segre-

gate duties.d. Employees are not required to take regular

vacations. (R/05, Aud., A0249A, #42, 7837)

43. Which of the following professional services would be considered an attestation engagement?a. Advocating on behalf of a client about trust tax

matters under review by the Internal Revenue Service

b. Providing financial analysis, planning, and capital acquisition services as a part-time, in-house controller

c. Advising management in the selection of a computer system to meet business needs

d. Preparing the income statement and balance sheet for one year in the future based on clientexpectations and predictions

(R/05, Aud., A0297A, #43, 7838)

44. In an environment that is highly automated, an auditor determines that it is not possible to reduce detection risk solely by substantive tests of transactions. Under these circumstances, the auditor most likely woulda. Perform tests of controls to support a lower level

of assessed control riskb. Increase the sample size to reduce sampling risk

and detection riskc. Adjust the materiality level and consider the

effect on inherent riskd. Apply analytical procedures and consider the

effect on control risk(R/05, Aud., A0377A, #44, 7839)

45. An auditor confirmed accounts receivable as of an interim date, and all confirmations were returned and appeared reasonable. Which of the following additional procedures most likely should be performed at year end?a. Send confirmations for all new customer bal-

ances incurred from the interim date to year endb. Resend confirmations for any significant cus-

tomer balances remaining at year endc. Review supporting documents for new large

balances occurring after the interim date, and evaluate any significant changes in balances at year end

d. Review cash collections subsequent to the interim date and the year end

(R/05, Aud., A0417A, #45, 7840)

46. Which of the following types of evidential matter generally is the most competent?a. Inquiries made of managementb. Confirmation of account information c. Analytical proceduresd. Review of prior-year audit procedures

(R/05, Aud., A0428A, #46, 7841)

47. The accounts receivable turnover ratio increased significantly over a two-year period. This trend could indicate thata. The accounts receivable aging has deteriorated. b. The company has eliminated its discount policy. c. The company is more aggressively collecting

customer accounts.d. Customer sales have substantially decreased.

(R/05, Aud., A0440A, #47, 7842)

48. Which of the following events occurring in the year under audit would most likely indicate that internal controls utilized in previous years may be inadequate in the year under audit?a. The entity announced that the internal audit

function would be eliminated after the balance sheet date.

b. The audit committee chairperson unexpectedly resigned during the year under audit.

c. The chief financial officer waived approvals on all checks to one vendor to expedite payment.

d. The frequency of accounts payable check runswas changed from biweekly to weekly.

(R/05, Aud., A0453A, #48, 7843)

49. An accountant is asked to issue a review report on the balance sheet, but not on other related statements. The scope of the inquiry and analytical procedures has not been restricted, but the client failed to provide a representation letter. Which of the following should the accountant issue under these circumstances?a. Review report with a qualification b. Review report with a disclaimerc. Review report and footnote exceptionsd. Compilation report with the client’s consent

(R/05, Aud., C00094A, #49, 7844)

50. Which of the following parties should request inquiry of a client’s lawyer?a. The auditorb. The stockholdersc. Client managementd. The auditor’s attorney

(R/05, Aud., C00608A, #50, 7845)

MULTIPLE CHOICE QUESTION SOLUTIONS

Solution 1

Legend for Cognitive CBT Skills1 Understanding2 Judgment / Application3 Analysis4 Application (APP)

1. (b) AU 508.24 states, “When restrictions that significantly limit the scope of the audit are imposed by the client, ordinarily the auditor should disclaim an opinion on the financial statements.” (Chapter 25-6-2, also see Chapter 29-4-3; CBT Skill:1; CSO: 5.1.1)

2. (b) AU 552.05 states that the auditor’s report on condensed financial statements (CFS) derived from financial statements that s/he has audited should indicate whether the information set forth in the CFS is fairly stated in all material respects in relation to the complete financial statements from which it is derived. Generally, CFS, by definition are not in conformity with GAAP. CFS are not necessarily in conformity with another comprehensive basis of accounting or guidance provided by federal security statutes. Editor’s note: This question is similar to question #22 in Chapter 30 in the 34th edition (6634). (Chapter 30-6-1; CBT Skill: 1; CSO: 5.2.4)

3. (c) During planning, the auditor would discuss the timing of audit procedures that require coordination with the client’s personnel, such as observation of inventory counts or assistance provided by internal auditors. Identification of activities likely to prevent fraud usually occurs during the internal control review stage of the audit. Evaluation of the reasonableness of accounting estimates usually occurs during the evidence-gathering stage of the audit. Inquiry of the client’s attorney usually occurs during the evidence-gathering stage of the audit. (Chapter 21-1-3; CBT Skill: 1; CSO: 1.1.1)

4. (b) As the assessed level of control risk increases, the acceptable level of detection risk decreases. To decrease detection risk, an auditor changes the nature, extent, or timing of tests of details. To decrease detection risk, an auditor increases the extent of test of details. The level of inherent risk doesn’t change, although an auditor may change the assessment of the level of inherent risk. As inherent risk is the susceptibility of an assertion to misstatement, assuming no related internal controls, the assessment of inherent risk level rarely changes due to a change in control risk. Increased testing of controls that the auditor already has

determined to be ineffective provides no benefit. Editor’s note: This question is similar to question #25

in Chapter 23 in the 34th edition (5083). (Chapter23-6-1; CBT Skill: 3; CSO: 2.7.0)

5. (b) Confirmation requests always should be mailed by the auditor and be returned directly to the auditor’s place of business. This is to diminish the possibility that the confirmation request could be altered by the client, either during the mailing process or upon receipt. The internal auditor need not sign the form. It is not inappropriate to get confirmations for closed accounts. The internal auditor may prepare confirmation requests. (Chapter 26-3-1, also Chapter 25-1-5; CBT Skill: 2; CSO: 3.1.3)

6. (a) The last paragraph of the AICPA’s sample representation letter states, “To the best of our knowledge and belief, no events have occurred subsequent to the balance sheet date and through the date of this letter that would require adjustment to, or disclosure in, the aforementioned financial statements.” The auditor, not management, is responsible for reporting reportable conditions to the audit committee. Statements regarding the attorney- client privilege generally are made by attorneys, not the client management. That certain computer files may exist only for a short period of time is more appropriately noted at the beginning of the audit; a management representation letter is dated no earlier than the date of the auditor’s report. (Chap- ter 25-3-4; CBT Skill: 3, 4; CSO: 3.5.0)

7. (b) Confirming that new additions to plant and equipment listings are physically present in the plant obtains evidence concerning existence, but it doesn’t provide evidence that the assets are presented or disclosed in the financial statements, appropriately or otherwise. To obtain evidence that management’s assertion with regard to presentation and disclosure are appropriate generally requires some review of the financial statements. Editor’s note: This question is identical to question #29 in Chapter 26 in the 34th edition (6396). (Chap- ter 26-3-4; CBT Skill: 3; CSO: 3.1.5)

8. (d) In an engagement to review a nonpublic company’s financial statements, a CPA uses inquiry and analytics to provide a basis for express- ing limited assurance that the financial statements to do not contain material deviation from GAAP or OCBOA. Inquiries about actions taken at board of directors’ meetings falls within this scope. A review of a nonpublic company’s financial statements is not intend the CPA to obtain an understanding of internal control, assess control risk, or test account records. A review report is appropriate for general use. Editor’s note: This question is similar to question #56

in Chapter 31 in the 34th edition (2979). (Chap- ter 31-1-3; CBT Skill: 3; CSO: 3.8.0)

9. (c) Inventory turnover ratios measure the speed with which inventory is purchased or made and subsequently sold. Slow-moving and obsolete items have low turnover ratios. Slow-moving and obsolete items are unlikely to be shipped or received. Existence at locations outside the entity’s premises occurs with slow-moving, obsolete, and current items. Slow-moving, obsolete, and current items may all be traced easily to inventory observation test counts to perpetual listings. (Chapter 26-3-3; CBT Skill: 3; CSO: 3.1.4)

10. (d) Management is the primary source of information regarding litigation, claims, and assessments as a basis for the evaluation of the fairness of financial statements. The AICPA’s sample management representation letter states, “There are no…unasserted claims or assessments that our lawyer has advised us are probable of assertion and must be disclosed….” Inspecting legal documents in the lawyer’s possession in a search for pending litigation and unasserted claims and assessments is beyond the scope of most audits. The lawyer’s philosophy is irrelevant to the auditor. The letter of inquiry on litigation, claims, and assessments asks the lawyer to comment on a specified list of pending or threatened litigation, claims, and assessments with which the lawyer has been involved substantially, not to confirm whether the matters are presented fairly in the financial statements. (Chapter 25-6-2, also Chapter 25-3-2; CBT Skill: 3; CSO: 3.2.0)

11. (d) It is not the auditor’s duty to search for reportable conditions unless the client specifically has requested that the auditor be alert to such matters. Because of the potential for misinterpreta- tion of the limited degree of assurance associated with the auditor issuing a written report representing that no reportable conditions were noted during an audit, the auditor should not issue such representations. (Chapter 23-8-3; CBT Skill: 1; CSO: 3.6.0)

12. (a) The minutes of meeting of stockholders and the boards of directors are likely to contain clear indications of doubts about the entity’s ability to continue as a going concern. Comparisons of market value of property and related loans doesn’t focus on the financial condition of the entity as a whole; many assets—such as relationships with customers and suppliers—are very valuable, and yet do not appear on the balance sheet. Lease agreements rarely highlight financial distress. Assets often are pledged as collateral by entities in strong financial condition. (Chapter 29-9-2; CBT Skill: 2; CSO: 4.4.0)

13. (c) Obtaining a general understanding of the entity’s organization its operating characteristics, and its products or services allows the accountant to plan the engagement effectively. The other three answer options can not be finished until this general understanding is obtained. Without a general understanding of the entity, the accountant would not be able to anticipate results. Without a general understanding of the entity, the accountant would not be able to develop appropriate questions about procedures for recording, classifying, and summarizing transactions. Without a general understanding of the entity, the accountant has no basis for determining whether relationships and individual items appear unusual. (Chapter 31-1-3; CBT Skill: 1; CSO: 1.1.2)

14. (d) The auditor must inform the audit committee directly regarding fraud possibly concerning senior management or causing a material misstatement of the financial statements. The auditor may need to disclose information: when legal and regu- latory compliance requirements exist; to a successor auditor; in response to a subpoena; or to a funding agency or other specify agency in accordance with requirements for the audits of entities that receive financial assistance from a governmental agency. Typically, the auditor reports directly to the SEC only when the audit committee fails to do so. (Chap- ter 22-6-5; CBT Skill: 1; CSO: 5.2.1)

15. (d) The CPA examiners generally rec- ognize four types of tests of internal controls to determine the degree of operating effectiveness: inquiries of appropriate entity personnel, inspection of documents and reports, observation of the application of specific internal control policies and procedures, and re-performance of the application of the policy or procedures by the auditor. System flowcharts may document the auditor’s understanding of internal control, but flowchart preparation provides little assurance about the documented activity’s operating effectiveness. (Chapter 23-3-4; CBT Skill: 1; CSO: 2.1.0)

16. (c) Business structure and operating style occasionally are designed deliberately to obscure relationships. Because compensating balance arrangements and nonmonetary transactions obscure the form of transactions, they are suspect. Compensating balance arrangements involve related parties more often than the other answer options. Segregation of duties applies whether the parties to a transaction are related or not. Reasonable and unreasonable accounting estimates both exist with and without related parties present. Entities fre- quently have recurring transactions with independent

entities. Editor’s note: This question is similar to

question #57 in Chapter 25 in the 34th edition (6005). (Chapter 25-8-3; CBT Skill: 2; CSO: 1.10.0)

17. (d) Compared to auditing without a computer, the size of the sample can be greatly expanded at little cost using a computer. Parallel simulation might not include all types of transaction errors and exceptions that may be encountered. Using parallel simulation is no guarantee that the client’s personnel are unaware that the data is being tested. As there is little risk of creating material errors in the client’s data with a non-computer audit procedure, this hardly can be said to be an advantage of parallel simulation using a computer over not using a computer at all. (Chapter 28-6-2; CBT Skill: 3; CSO: 3.1.6)

18. (b) The final review stage of the audit provides an overall review of financial information in light of the audit opinion expressed. A final consideration of the adequacy of evidence is appropriate for this stage. Factors that determined the preliminary materially and audit risk levels would have been reassessed before arriving at final materially and audit risk levels. Summarizing specified uncorrected misstatements and projected uncorrected misstatements estimated through sampling techniques is done before deciding on an audit opinion. (Chap- ter 25-4-2; CBT Skill: 3; CSO: 4.1.0)

19. (b) A report on a compilation of a financial projection must include a statement that a compilation is limited in scope and does not enable the accountant to express an opinion or any other form of assurance of the PFS or the assumptions. As a compilation report should provide no assurance, a statement that that the assumptions used are reasonable is inappropriate. Reports for all types of engagements involving financial projections must include a caveat that the prospective results may not be achieved and a statement that the accountant assumes no responsibility to update the report for events and circumstances occurring after the data of the report. (Chapter 31-7-2; CBT Skill: 1; CSO:5.1.6)

20. (c) For each shipment, there should be a sales invoice. If the auditor selects a sample of transactions from the shipping document file and does not find corresponding sales invoices, the auditor knows the controls are ineffective. For each sales order and customer order, there may or may not be a sales invoice, depending on whether the product was shipped. When testing to see if there is a failure to produce sales invoices, by selecting a sample from the sales invoice file, an auditor would guarantee to get only transactions where this failure did not occur. (Chapter 24-1-4; CBT Skill: 3, 4; CSO:

2.6.0)

21. (b) Generally, variables sampling involves the determining of proper dollar value of the sampled items and makes inferences about the fairness of the amounts reported in the financial statements. Vari- ables sampling typically involves deciding whether the dollar value of an account is reasonable. Gen- erally, attributes sampling involves the determination of the rate of occurrence of some characteristic in a population. Proper prices, the number of misstatements, or proper recording are attributes. (Chapter 27-1-1; CBT Skill: 3, 4; CSO: 3.1.1)

22. (a) The passage is a quote from a sample inquiry letter to legal counsel. It is rare to refer to “our auditors” in a letter to that auditor; it is more likely that a third party is being addressed using this language. Management’s representation letter states that the financial statements are presented fairly in conformity with GAAP and that, “there are no…other liabilities or gain or loss contingencies that are required to be accrued or disclosed….” That information was furnished to auditors generally is inappropriate for footnotes to financial statement. (Chapter 25-6-2; CBT Skill: 3; CSO: 3.3.0)

23. (b) Certain procedures are preformed after the balance sheet date: (1) check for proper cutoff; (2) confirm balances that were unknown until after the balance sheet date; and (3) obtain a management representation letter. Although other procedures are performed if warranted, additional procedures generally include inquiries and reading interim statements and minutes of meetings. Examining internal controls in the next fiscal period and re-computing amounts applicable to the next fiscal period typically are beyond the scope of this work. Editor’s note: This question is similar to question #63 in Chapter 29 in the 34th edition (6003). (Chapter 29-7-2; CBT Skill: 3; CSO: 3.4.0)

24. (b) Management represents that it has informed the auditor of all related parties in its representation letter to the auditor and that it has disclosed all material related party transactions in financial statements by claiming those statements to be in accordance with GAAP. To discover that related party transactions existed at the date of the audit report that the auditor did not know about calls into question either the thoroughness of the audit or management’s integrity. The post-report resolution of a lawsuit properly reported in the financial statements, technological advancements, and subsidiary sales occurring after the date of the auditor’s report generally require no action by the auditor. Editor’s note: This question is similar to question #67 in Chapter29 in the 34th edition (6032). (Chapter 29-7-3; CBT Skill: 3; CSO: 5.3.1)

25. (d) Management and other employees are unlikely to implicate themselves in wrongdoing on an internal control questionnaire that they know is designed expressly for audit purposes. Reading the minutes of the board of directors’ (BOD) meetings, making inquiries of the client’s management, or performing tests of details of transactions is more likely to reveal possible illegal acts. Minutes of the BOD meetings are recorded with considerable BOD scrutiny and over a long period. Close scrutiny makes it difficult to falsify minutes. Also, wrongdoers might not think to falsify minutes sufficiently far enough in advance of possible illegal acts to mask motivations or opportunities for performing illegal acts. Inquiries of the client’s management can target issues raised during those same inquiries. Also, body language, voice tone, and other intangibles noticed during a face-to-face discussion may indicate possible illegal acts to an alert interviewer. Tests of details of transactions may reveal unauthorized or improperly recorded transactions, investigation by a governmental agency, large payments for unspecified service to consultants, excess commissions or agents’ fees, unusually large cash payments, or similar other “red flags.” (Chapter 22-7-1; CBT Skill: 3; CSO: 1.9.0)

26. (c) Of the answer options, the auditor first would learn how management developed its estimates. Then, the auditor would compare the current process to previous estimate development to gain evidence regarding consistency. After evaluating management’s estimate process, the auditor con- siders whether there are factors that the auditor’s estimates failed to take into account. Then, the auditor would be ready to compare management’s and the auditor’s estimates. Reviewing variations from expectations may occur after the period end, when the client finishes its pre-audit financial statements, while the other answer options could commence at an interim date. Editor’s note: This question is similar to question #70 in Chapter 26 in the 34th edition (5687). (Chapter 26-3-10; CBT Skill: 1; CSO: 1.11.2)

27. (c) Before an audit engagement has been completed, the client may ask the CPA to change the engagement to a compilation. In reaching a decision, the CPA should consider the client’s reasons for making the request, especially if either the client or circumstance have imposed a restriction on the scope of the audit. A change in the circumstances that caused the client to require an audit usually is considered an acceptable reason for change an audit to a review or compilation engagement. The CPA should consider whether the information affected by the scope restriction may be incorrect, incomplete, or otherwise unsatisfactory. When

correspondence with the client’s legal counsel is prohibited in an audit engagement, the CPA ordinarily is prohibited from

issuing a compilation report as well as an audit report. (Chapter 31-1-5; CBT Skill: 2; CSO: 1.1.6)

28. (d) Upon concluding that an auditing procedure was omitted, the auditor should first assess the importance of the omitted procedure to the auditor’s present ability to support the previously expressed opinion. Procedures that were performed may com- pensate for the omitted procedure. If the auditor can support the previously expressed opinion without the omitted procedure, further procedures are unneces- sary. If the auditor’s ability to support the previously expressed opinion is impaired and the auditor believes are persons currently relying, or likely to rely, on the report, the auditor should apply the omitted procedures or alternative procedures. The auditor, not management, determines whether there are persons currently relying, or likely to rely, on the report. Editor’s note: This question is similar to question #103 in Chapter 29 in the 34th edition (0332). (Chapter 29-7-4; CBT Skill: 3; CSO: 5.3.2)

29. (d) Statement presentation and disclosure concerns the proper classification, description, and disclosure in the financial statements (including footnotes). Valuation or allocation deals with whether assets and liabilities are valued properly and whether revenues and expenses are allocated appropriately between periods. With accounting for investments, the classification has an impact on the appropriate method of valuation in the financial statements. Rights and obligations concerns whether, at a given date, recoded assets indeed represent rights of the entity and liabilities represent obligations. Reviewing investment records regarding transfers between categories (internal documents) provides little evidence that ownership rights in the investments still exists at the balance sheet date, that the investment is not pledged as loan collateral, that the investments exist at the balance sheet date, or that an external transaction involving the investment occurred during the period. (Chapter 25-1-2; CBT Skill: 3; CSO: 3.1.8)

30. (d) An accountant is not precluded from issuing a compilation or review report on one financial statement and not on the others. Editor’s note: This question is similar to question #25 in Chapter 31 in the 34th edition (5697). (Chapter 31-1-1; CBT Skill: 1; CSO: 5.1.2)

31. (b) When supporting accounting records and files that should be readily available are not produced promptly when requested, it suggests either a hostile staff (poor control environment) or a poor information and communication system. Senior financial management should participate in the selection of accounting principles and determination of significant estimates. Related party transactions do not, in themselves, indicate misstatements.

Management’s excessive interest in updating the IT capabilities may lead to poor financial performance by the entity, but not necessarily misstatements in the financial statements. Editor’s note: This question is similar to question #53 in Chapter 22 in the 34th edition (2280). (Chapter 23-2-3; CBT Skill: 2; CSO:4.3.0)

32. (a) AICPA Trends & Techniques outline how various entities how various entities comply with GAAP. FASB Technical Bulletins elaborate on guidance in FASB statements, but they do not provide comprehensive guidance for something as general as disclosure requirements nor do they summarize how various entities comply with GAAP. AICPA Audit and Accounting Manuals outline various steps in auditing and accounting for an entity, typically by industry; they do not summarize how various entities comply with GAAP. FASB Statements of Financial Accounting Concepts (SFAC) are broad statements that guide standard-setters in developing Statements of Financial Accounting Standards (SFAS); they are very broad in scope and do not summarize how various entities comply with SFAS, which tend to be written after SFAC. Editor’s note: This question is similar to question #2 in Chapter 29 in the 34th edition (4289). (Chapter 29-1-1; CBT Skill: 1; CSO:1.2.5)

33. (a) Policies and procedures for making the decision as to whether or not to accept a new client are to minimize the chance of being associated with a client whose management lacks integrity. Monitoring significant deficiencies in the design and operation of the client’s internal control generally is beyond the scope of an audit. Identification of noncompliance with aspects of contractual agreements that affect the financial statements occurs during the evidence- gathering stage of an audit, not when the auditor is considering whether or not to accept a new client. Different policies and procedures provide reasonable assurance that personnel are adequately trained to fulfill their responsibilities. Editor’s note: This question is similar to question #7 in Chapter 21 in the34th edition (5097). (Chapter 21-4-2; CBT Skill: 1; CSO: 1.2.4)

34. (c) The AICPA’s sample report states, “…these financial statement were prepared on the basis of cash receipts and disbursements, which is a comprehensive basis of accounting other than generally accepted accounting principles.” The CPA need not explain or even agree that the basis of accounting is more useful or appropriate for financial statement readers nor refer to any footnote that describes management’s responsibility for the finan-

cial statements. Editor’s note: This question is similar to question #7 in Chapter 30 in the 34th edition (5700). (Chapter 30-2-2; CBT Skill: 1; CSO: 5.1.10)

35. (a) The AICPA’s sample engagement letter states, “At the conclusion of our audit, we will request certain written representations from you about the financial statements and matters related thereto.” Auditors generally do not discuss preliminary judgments about materiality or fraud risk with the client. Internal control activities that would reduce the auditor’s assessment of control risk generally would be discussed later in the audit, when the auditor has greater familiarity with the internal controls in place, typically when making recommendations to improve internal controls. (Chapter 22-1-3; CBT Skill: 3; CSO: 1.5.0)

36. (a) An important internal control is the separation of the duties of authorization, recordkeeping, and custody. As the payroll department prepares the payroll (recordkeeping) and has custody of the related assets, a payroll clerk is in a position to both perpetrate and conceal misappropriation of assets. Having the accounting department wire transfer funds (authorization) based on total from a payroll summary (recordkeeping) may be unusual, but the two mentioned types of duties are separated. With the treasurer supervises the use of a signature plate (custody) by the payroll department to prepare checks (recordkeeping), segregation of duties is maintained. With the chief financial officer signing checks (custody) prepared by the payroll department (recordkeeping), segregation of duties is maintained. Editor’s note: This question is similar to question #45 in Chapter 24 in the 34th edition (3914). (Chap- ter 24-3-4, also Chapter 23-1-3; CBT Skill: 3; CSO:2.2.0)

37. (a) A successor’s communications with the predecessor auditor concentrate on matters the successor feels will help in deciding whether to accept the engagement, such as facts that bear on the integrity of management, disagreements between the predecessor and management regarding significant matters, the predecessor understanding about why there was a change in auditors, and the predecessor’s communications to the audit committee. A successor must decide for him or herself: the methodology used in apply sampling techniques, an opinion on subsequent events, and perception of the competency and reliance on the client’s internal audit function. Editor’s note: This question is similar to question #38 in Chapter 22 in the 34th edition (0207). (Chapter 22-2-2; CBT Skill: 1; CSO: 1.3.0)

38. (c) Accurately assessing control risk before obtaining an understanding of internal controls is near impossible. Generally, an audit of a service organization doesn’t involve substantive procedures. Generally, an audit of a service organization results in the expression of an opinion; the result of an engagement to perform agreed-upon procedures is

a report merely of procedures performed and related findings. (Chapter 30-4-2, also see Chapter 31-7-1; CBT Skill: 1; CSO: 2.5.0)

39. (c) The auditor must inform the audit committee of any disagreements, whether or not resolved, with management about matters that, indi- vidually or in the aggregate, could have a significant impact on the financial statements. The auditor rarely discusses either the basis for the auditor’s judgment about materiality or justification for sampling methods selection with the client’s management or audit committee. The auditor must discuss the auditor’s judgment about the quality of a public company’s accounting principles and underlying estimates in the financial statements with the audit committee, not the quality of earnings. (Chapter 22-8-2; CBT Skill: 1; CSO: 3.7.0)

40. (b) An attest engagement is one in which a CPA in public practice is engaged to issue an exami- nation, review, or agreed-upon procedures report on subject matter or an assertion about subject matter that is the responsibility of another party. AT 600 established guidance concerning attest engagements on an entity’s compliance with requirements of specified laws, regulations, rules, contracts, etc. AT 100 specifically lists, as engagements to which attest standards are inapplicable, engagements preformed in accordance with Statements on Standards for Consulting Services, client advocacy engagements, and tax return preparation services. (Chapter 31-6-1, also, Chapter 31-7-5; CBT Skill: 3; CSO: 1.1.3)

41. (d) The client’s policies and procedures have a direct impact on the client’s operations and business. The client’s policies and procedures rarely have much impact on the method of sampling to be used, preliminary judgments about materiality levels, or the nature of reports to be rendered. (Chap- ter 22-3-1; CBT Skill: 1; CSO: 1.6.0)

42. (d) The question asks for a response that is not a limitation of the computer-access control. While not requiring employees to take regular vacations is a poor practice from an internal control standpoint, it does not reflect a limitation of the computer-access control. The ability to guess fellow employees’ passwords easily, the lack of a requirement to change passwords, and the ability to circumvent procedures to segregate duties reflect imitations of the computer-access controls. (Chap- ter 28-3-4; CBT Skill: 3; CSO: 2.4.0)

43. (d) An attest engagement is one in which a CPA in public practice is engaged to issue an exami- nation, review, or agreed-upon procedures report on

subject matter or an assertion about subject matter that is the responsibility of another party. AT 300

established guidance concerning attest engagements on financial forecasts and projections. Work for an employer is not an attest engagement. AT 100 specifically lists, as engagements to which attest standards are inapplicable, client advocacy engagements. (Chapter 31-6-1, also, Chapter 31-7-2; CBT Skill: 3; CSO: 3.9.0)

44. (a) When it is impractical to reduce detection risk to an acceptable level through substantive tests only, auditors generally gather evidential matter by performing tests of controls to use in assessing control risk and should consider the effect of the level of control risk on the audit report. In other words, if control risk is not at an acceptably low level to provide reasonable assurance that financial statements are free of material misstatements, the audit opinion cannot be unqualified. Increasing the sample size for substantive tests in this circumstance is impractical, if not ineffective; the question states that it is not possible to reduce detection risk solely by substantive tests of transactions. Changing the materiality level because it is not possible to reduce detection risk solely by substantive tests is inappropriate. Further, changing the materiality level does not have an effect on inherent risk, which is the susceptibility of an assertion to misstatement without any internal controls. Analytics performed by the auditor do not have an effect on control risk, which is the risk that the entity’s internal controls will not detect material misstatements in the financial statements. (Chapter 28-2-3; CBT Skill: 3; CSO: 2.7.0)

45. (c) The lack of misstatements at the interim date would not cause the auditor to increase the assessment of control risk. The auditor most likely would review supporting documents for new large balances and evaluate significant changes in year- end balances. Without an increase in the assessment of control risk, additional extensive procedures, such as sending confirmation to new customers and reviewing subsequent cash collections are unlikely. If the auditor planned to resend confirmations for any customer balances remaining at year end when interim confirmations returned from these same customers appeared reasonable, it is unlikely that the auditor would plan to confirm accounts receivable as of an interim date. (Chap- ter 22-5-3; CBT Skill: 3; CSO: 3.1.7)

46. (b) Competent evidence is both valid and relevant. All other things being equal, evidential matter obtained from independent sources outside of an entity provides greater assurance of reliability than evidence obtained solely within the entity. Account receivable confirmations typically come from independent parties. Inquiries made of management, by definition, involve a source within the entity. Analytics generally are performed on accounting information

provided or summarized by internal sources. Prior- year audit procedures have limited relevance to the current-year audit. Editor’s note: This question is similar to question #3 in Chapter 25 in the 34th edition (3922). (Chapter 25-1-5; CBT Skill: 1; CSO: 4.2.0)

47. (c) A basic premise underlying the application of analytics is that plausible relationships among data reasonably may be expected to exist and continue in the absence of known conditions to the contrary. The accounts receivable (A/R) turnover formula is net credit sales divided by average net A/R. In other words, A/R turnover is a measure of how many times in a year an entity collects what its credit sales. If the ratio increased, either average net A/R decreased or net credit sales increased. An increase in collections results in decreased average net A/R. The A/R aging is said to have deteriorated when collection times lengthen, an unusual circumstance if average net A/R decreased in proportion to sales. The elimination of a discount policy might decrease sales, but its relative impact on net credit sales and average net A/R is not known; in the absence of information to the contrary, assume that this did not have a significant impact on the ratio. A decrease in net credit sales would decrease the ratio. (Chapter 25-4-4, also see Appendix D; CBT Skill: 3; CSO: 3.1.2)

48. (c) The chief financial officer’s willingness to override the internal controls reveals a management philosophy that values meeting goals higher

than working within established procedures. Little time would be saved by adhering to approval procedures at most entities, indicating, at best, poor organization regarding the transactions. Elimination of the internal audit function, in itself, doesn’t indicate that controls are now inadequate, although this is a second-best answer. As the audit committee chair is unlikely to have been in a position to commit a dis- reputable act with regard to the entity under audit, the chair’s resignation probably doesn’t indicate personal misconduct. If an audit committee chair resigned in protest of entity misconduct, the chair likely would have informed the auditor directly of the reasons for the resignation. Check-run frequency rarely effects the quality of internal controls. (Chap- ter 23-1-3; CBT Skill: 3; CSO: 2.4.0)

49. (d) Failure by the client’s management to provide a representation letter covering all of the periods under review precludes the completion of a review. The accountant may issue a compilation report as an accountant is not required to verify, corroborate, or review information supplied for a compilation. (Chapter 31-1-3; CBT Skill: 2; CSO:4.1.0)

50. (c) In the legal letter, the client’s management requests that the client’s attorney, “…specifically confirm to our auditors that our understanding [of pending or threatened litigation and unasserted claims or assessments] is correct.” (Chapter 25-6-2; CBT Skill: 1; CSO: 3.3.0)

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