Chapter 16 Auditing Operations and Completing the Audit



Chapter 16

Auditing Operations and Completing the Audit

 

True / False Questions

 

1. Analytical procedures are often used for verification of income statement accounts. 

True    False

 

2. The Miscellaneous Revenue account should only be analyzed if it is material in amount. 

True    False

 

3. Internal control over payroll is enhanced when the personnel department distributes payroll checks. 

True    False

 

4. The auditors have a responsibility to report on all FASB-required supplementary information. 

True    False

 

5. Subsequent events that provide additional evidence as to conditions that existed at the balance sheet date may result in adjusting journal entries. 

True    False

 

6. Dual dating of an audit report extends the auditors' liability for disclosure through the later date for all areas of the financial statements. 

True    False

 

7. If management fails to list an unasserted claim in the letter of inquiry to a lawyer, the lawyer is not required to inform the auditors of the omission. 

True    False

 

8. Normally, general risk contingencies need not be disclosed in the financial statements. 

True    False

 

9. If not adjusted, a situation in which the total likely misstatement in the financial statements exceeds a material amount is likely to lead to an audit report modification. 

True    False

 

10. Common to future purchase commitments is the fact that they should be recorded as liabilities at discounted values as of year-end. 

True    False

 

 

Multiple Choice Questions

 

11. Analytical procedures are required as a part of the 

A. Detailed tests of balances.

B. Internal control assessment.

C. Overall review at the conclusion of the audit.

D. Substantive testing.

 

12. The statement that best expresses the auditor's responsibility with respect to events occurring between the balance sheet date and the end of his audit is that: 

A. The auditor has no responsibility for events occurring in the subsequent period unless these events affect transactions recorded on or before the balance sheet date.

B. The auditor's responsibility is to determine that a proper cutoff has been made and that transactions recorded on or before the balance sheet date actually occurred.

C. The auditor is fully responsible for events occurring in the subsequent period and should extend all detailed procedures through the last day of field work.

D. The auditor is responsible for determining that a proper cutoff has been made and performing a general review of events occurring in the subsequent period.

 

13. Shortly after year-end Zero Corporation was informed of the bankruptcy of Bingo. Zero Corporation showed a receivable of $10,000 due from Bingo as of year-end—none of which seems recoverable. The receivable had been questionable for some time as Bingo had been experiencing financial difficulties for the past several years. Yet, Bingo's bankruptcy did not occur until after Zero Corporation's year-end. Under these circumstances:  [pic]  

A. Option A

B. Option B

C. Option C

D. Option D

 

14. In auditing the balance sheet, most revenue and expense accounts are also audited. Which accounts are most likely to be audited when auditing Accounts Receivable? 

A. Sales and Cost of Goods Sold.

B. Interest and Bad Debt Expense.

C. Sales and Bad Debt Expense.

D. Interest and Cost of Goods Sold.

 

15. Auditors should perform audit procedures relating to subsequent events? 

A. Through year end.

B. Through issuance of the audit report.

C. Through the last day of field work.

D. For a reasonable period after year end.

 

16. Which of the following procedures would an auditor most likely perform while evaluating audit findings at the conclusion of an audit? 

A. Obtain assurance from the entity's attorney that all material litigation has been disclosed in the financial statements.

B. Verify the clerical accuracy of the entity's proof of cash and its bank cutoff statement.

C. Determine whether reportable conditions have corrected.

D. Develop an estimate of the total likely misstatement in the financial statements.

 

17. Which of the following ledger accounts would be least likely to be analyzed in detail by auditors? 

A. Miscellaneous revenue.

B. Professional fees.

C. Travel expense.

D. Repairs and maintenance.

 

18. When auditing the statement of cash flows of a profitable, growing company which combination is most likely?

[pic]  

A. Option A

B. Option B

C. Option C

D. Option D

 

19. The audit of which of the following balance sheet accounts does not normally result in verification of an income statement account? 

A. Cash.

B. Accounts receivable.

C. Property, plant and equipment.

D. Intangible assets.

 

20. An example of an internal control weakness is to assign the payroll department the responsibility for: 

A. Preparing the payroll expense distribution.

B. Preparing the payroll checks.

C. Authorizing increases in pay.

D. Preparing journal entries for payroll expense.

 

21. An example of an internal control weakness is to assign the personnel department responsibility for: 

A. Distribution of paychecks.

B. Hiring personnel.

C. Authorizing deductions from pay.

D. Interviewing employees for jobs.

 

22. Which of the following audit procedures is aimed at determining whether every name on the company payroll is an employee actually on the job? 

A. A surprise observation of a paycheck distribution.

B. A test of payroll extensions.

C. Analytical comparisons of budgeted to actual payroll expense.

D. Comparison of payee names on canceled payroll checks with the payroll register.

 

23. Which of the following is not a procedure that is designed to provide evidence about the existence of loss contingencies? 

A. Obtaining a lawyers' letter.

B. Confirming accounts payable.

C. Reviewing the minutes of board of directors' meetings.

D. Review correspondence with banks.

 

24. Which of the following types of matters do not generally require disclosure in the financial statements? 

A. General risk contingencies.

B. Commitments.

C. Loss contingencies.

D. Liabilities to related parties.

 

25. Material loss contingencies should be recorded in the financial statements if available information indicates it is probable that a loss had been sustained prior to the balance sheet date and the amount of such loss can be reasonably estimated. These considerations will affect the audit report as follows: 

A. If a loss has been recorded in accordance with these criteria, the auditor may issue an unqualified opinion but is required to point out the contingency in an explanatory paragraph of the report.

B. If a loss meets these criteria but is disclosed in the financial statement notes rather than being recorded therein, the auditor may issue an unqualified opinion, but is required to point out the contingency in an explanatory paragraph of the report.

C. If a loss meets these criteria but is disclosed in the financial statement notes rather than being recorded therein, the auditor may issue an unqualified opinion, but should consider adding an explanatory paragraph as a means of emphasizing the disclosure.

D. If a loss is probable but the amount cannot be reasonably estimated and is disclosed in the notes to the financial statements rather than being recorded therein, the auditor may issue an unqualified opinion.

 

26. A refusal by a lawyer to furnish information related to litigation included in the letter of inquiry is likely to result in: 

A. Confirmation of related lawsuits with the claimants.

B. Qualification of the audit report.

C. An assessment that loss of the litigation is probable.

D. An adverse opinion.

 

27. If, after issuing an audit report, the auditors find that they have failed to perform certain significant audit procedures they should first: 

A. Attempt to determine whether their report is still being relied upon by third parties.

B. Notify regulatory agencies.

C. Notify legal counsel.

D. Wait until the beginning of the next year's audit to determine whether misstatements have occurred.

 

28. Which of the following is not a procedure that auditors typically perform to search for significant events during the subsequent period? 

A. Review minutes of board of directors' meeting.

B. Review the latest available interim financial statements.

C. Inquire about any unusual adjustments made subsequent to the balance sheet date.

D. Review changes in internal control during the period subsequent to the balance sheet date.

 

29. Which of the following subsequent events might require an adjustment to the client's financial statements? 

A. A business combination with another company.

B. Loss on the sale of a closely-held investment.

C. Loss of plant and equipment due to a fire.

D. Retirement of bonds payable at a loss.

 

30. Authorization of which of the following is least likely to be found during a review of the minutes of the board of directors? 

A. Dividends.

B. New debt issuance.

C. New bank accounts.

D. Writeoff of trade accounts receivable.

 

31. Which of the following is not a procedure normally performed while completing the audit? 

A. Obtain a lawyer's letter.

B. Obtain a representations letter.

C. Perform an overall review using analytical procedures.

D. Obtain confirmation of capital stockholdings from shareholders.

 

32. Auditors must communicate internal control "significant deficiencies" to: 

A. The audit committee.

B. The shareholders.

C. The SEC.

D. The Federal Trade Commission.

 

33. Which of the following procedures is not a procedure that is completed near the end of the engagement? 

A. Review cash transactions.

B. Review to identify subsequent events.

C. Obtain the lawyer's letter.

D. Obtain the letter of representations.

 

34. Which of the following information must be reported on in the auditors' report? 

A. FASB-required supplementary information.

B. Other information in client-prepared documents.

C. Information accompanying financial statements in auditor-submitted documents.

D. GASB-required supplementary information.

 

35. In evaluating whether there is a sufficiently low probability of material misstatement in the financial statements, the auditors accumulate: 

A. Likely misstatements in the financial statements.

B. Known misstatements in the financial statements.

C. Known, projected and other estimated misstatements in the financial statements.

D. Known, projected and potential misstatements in the financial statements.

 

36. Specific misstatement in one of a client's 2,000 accounts receivable is referred to as a(n): 

A. Extrapolation difference.

B. Known misstatement.

C. Likely misstatement.

D. Projected misstatement.

 

37. The review of audit working papers by the audit partner is normally completed: 

A. Prior to year-end.

B. Immediately as each working paper is completed.

C. Near the completion of field work.

D. After issuance of the audit report, but prior to required subsequent event review procedures.

 

38. Management estimates the company's allowance for doubtful accounts as $200,000, and the auditors develop an estimate that suggests that the amount should be between $230,000 and $250,000. The known misstatement in this situation is: 

A. $0

B. $30,000

C. $40,000

D. $50,000

 

39. Management estimates the company's allowance for doubtful accounts as $200,000, and the auditors develop an estimate that suggests that the amount should be between $230,000 and $250,000. The likely misstatement in this situation is: 

A. $0

B. $30,000

C. $40,000

D. $50,000

 

40. An approach that quantifies the total likely misstatement as of the current year-end based on the effects of reflecting misstatements during the current year (and not considering any unadjusted previous year misstatements) is referred to as the: 

A. Evaluation materiality approach.

B. Iron curtain approach.

C. Projected misstatement approach.

D. Rollover approach.

 

41. An approach that quantifies the total likely misstatement as of the current year-end based on the effects of reflecting all misstatements existing in the balance sheet at the end of the current year, irrespective of whether the misstatements occurred in the current or previous years is referred to as the: 

A. Evaluation materiality approach.

B. Iron curtain approach.

C. Projected misstatement approach.

D. Rollover approach.

 

42. A client's previous two years of financial statements understated estimated warranty payable by $30,000 and $50,000 respectively, immaterial amounts. This year the auditors estimate that the accrual is understated by an additional $60,000. In this year's audit $100,000 represents a material amount. Assuming that the entire understatement is to be recorded, following SEC SAB 108 the decrease in this year's income due to these understatements is: 

A. $0

B. $60,000

C. $110,000

D. $140,000

 

43. A client's previous two years financial statements understated estimated warranty payable by $30,000 and $50,000 respectively, immaterial amounts. This year the auditors estimate that the accrual is understated by an additional $60,000. In this year's audit $55,000 represents a material amount. Assuming that the entire understatement is to be recorded, following SEC SAB 108 the decrease in this year's income due to these understatements is: 

A. $0

B. $60,000

C. $110,000

D. $140,000

 

44. One reason why the independent auditors perform analytical procedures on the client's operations is to identify: 

A. Weaknesses of a material nature in internal control.

B. Non-compliance with prescribed control procedures.

C. Improper separation of accounting and other financial duties.

D. Unusual transactions.

 

45. Which of the following is an analytical procedure that should be applied to the income statement? 

A. Select sales and expense items and trace amounts to related supporting documents.

B. Ascertain that the net income amount in the statement of cash flows agrees with the net income amount in the income statement.

C. Obtain from the proper client representatives, the beginning and ending inventory amounts that were used to determine costs of sales.

D. Compare the actual revenues and expenses with the corresponding figures of the previous year and investigate significant differences.

 

46. It would be appropriate for the payroll accounting department to be responsible for which of the following functions? 

A. Approval of employee time records.

B. Maintenance of records of employment, discharges, and pay increases.

C. Preparation of periodic governmental reports as to employees' earnings and withholding taxes.

D. Distribution of paychecks to employees.

 

47. Which of the following is the best reason why the auditors should consider observing a client's distribution of regular payroll checks? 

A. Separation of payroll duties is less than adequate for effective internal control.

B. Total payroll costs are a significant part of total operating costs.

C. The auditors did not observe the distribution of the entire regular payroll during the audit in the prior year.

D. Employee turnover is excessive.

 

48. To minimize the opportunities for fraud, unclaimed cash payroll should be: 

A. Deposited in a safe deposit box.

B. Held by the payroll custodian.

C. Deposited in a special bank account.

D. Held by the controller.

 

49. The purpose of segregating the duties of distributing payroll checks and hiring personnel is to: 

A. Separate the custody of assets from the accounting for those assets.

B. Establish clear lines of authority and responsibility.

C. Separate duties within the accounting function.

D. Separate the authorization of transactions from the custody of related assets.

 

50. A CPA reviews a client's payroll procedures. The CPA would consider internal control to be less than effective if a payroll department supervisor was assigned the responsibility for: 

A. Reviewing and approving time reports for subordinate employees.

B. Distributing payroll checks to employees.

C. Hiring subordinate employees.

D. Initiating requests for salary adjustments for subordinate employees.

 

51. A common audit procedure in the audit of payroll transactions involves tracing selected items from the payroll journal to employee time cards that have been approved by supervisory personnel. This procedure is designed to provide evidence in support of the audit proposition that: 

A. Only bona fide employees worked and their pay was properly computed.

B. Jobs on which employees worked were charged with the appropriate labor cost.

C. Internal control relating to payroll disbursements are operating effectively.

D. Employees worked the number of hours for which their pay was computed.

 

52. Which of the following material events occurring subsequent to the balance sheet date would require an adjustment to the financial statements before they could be issued? 

A. Sale of long-term debt or capital stock.

B. Loss of a plant as a result of a flood.

C. Major purchase of a business which is expected to double the sales volume.

D. Settlement of litigation in excess of the recorded liability.

 

53. With respect to issuance of an audit report which is dual dated for a subsequent event occurring after the completion of field work but before issuance of the auditors' report, the auditors' responsibility for events occurring subsequent to the completion of field work is: 

A. Extended to include all events occurring until the date of the last subsequent event referred to.

B. Limited to the specific event referred to.

C. Limited to all events occurring through the date of issuance of the report.

D. Extended to include all events occurring through the date of submission of the report to the client.

 

54. An auditor's decision concerning whether or not to "dual date" the audit report is based upon the auditor's willingness to: 

A. Extend auditing procedures.

B. Accept responsibility for year-end adjusting entries.

C. Permit inclusion of a note captioned: event (unaudited) subsequent to the date of the auditor's report.

D. Assume responsibility for resolving all events subsequent to the issuance of the auditor's report.

 

55. Auditors often request that the audit client send a letter of inquiry to those attorneys who have been consulted with respect to litigation, claims, or assessments. The primary reason for this request is to provide the auditors with: 

A. An estimate of the dollar amount of the probable loss.

B. An expert opinion as to whether a loss is possible, probable or remote.

C. Information concerning the progress of cases to date.

D. Corroborative audit evidence.

 

56. The auditors' primary means of obtaining corroboration of management's information concerning litigation is a: 

A. Letter of audit inquiry to the client's lawyer.

B. Letter of corroboration from the auditor's lawyer upon review of the legal documentation.

C. Confirmation of claims and assessments from the other parties to the litigation.

D. Confirmation of claims and assessments from an officer of the court presiding over the litigation.

 

57. Which of the following auditing procedures is ordinarily performed last? 

A. Reading of the minutes of the directors' meetings.

B. Confirming accounts payable.

C. Obtaining a management representation letter.

D. Testing of the purchasing function.

 

58. Which of the following is not correct relating to representation letters? 

A. They are ordinarily dated as of the date of the audit report.

B. They are signed by members of top management.

C. They must be obtained for audits.

D. They often serve as a substitute for the application of other procedures.

 

59. The date the auditor grants the client permission to use the audit report in connection with the financial statements is the: 

A. Last day of significant field work.

B. Report cutoff date.

C. Report release date.

D. Representation date.

 

60. Which of the following statements ordinarily is not included among the written client representations made by the chief executive officer and the chief financial officer? 

A. "Sufficient audit evidence has been made available to the auditor to permit the issuance of an unqualified opinion."

B. "There are no unasserted claims or assessments that our lawyer has advised us are probable of assertion and must be disclosed."

C. "We have no plans or intentions that may materially affect the carrying value or classification of assets and liabilities."

D. "No events have occurred subsequent to the balance sheet date that would require adjustment to, or disclosure in, the financial statements."

 

61. To which of the following matters would materiality limits not apply when obtaining written client representations? 

A. Violations of state labor regulations.

B. Disclosure of line-of-credit arrangements.

C. Information about related party transactions.

D. Instances of fraud involving management.

 

62. The auditors' best course of action with respect to "other financial information" included in a client prepared annual report containing the auditors' report is to: 

A. Indicate in the auditors' report, that the "other financial information" is unaudited.

B. Consider whether the "other financial information" is accurate by performing a limited review.

C. Obtain written representations from managements as to the material accuracy of the "other financial information."

D. Read and consider the manner of presentation of the "other financial information."

 

63. In the course of the audit of financial statements for the purpose of expressing an opinion thereon, the auditors will normally prepare a schedule of unadjusted differences for which the auditors did not propose adjustment when they were identified. What is the primary purpose served by this schedule? 

A. To point out to the responsible client officials the errors made by various company personnel.

B. To summarize the adjustments that must be made before the company can prepare and submit its federal tax return.

C. To identify the potential financial statement effects of misstatement or disputed items that were considered immaterial when discovered.

D. To summarize the misstatements made by the company so that corrections can be made after the audited financial statements are released.

 

64. An auditor will ordinarily examine invoices from lawyers primarily in order to: 

A. Substantiate accruals.

B. Assess the legal ramifications of litigation in progress.

C. Estimate the dollar amount of contingent liabilities.

D. Identify possible unasserted litigation, claims and assessments.

 

65. The auditor's primary means of obtaining corroboration of management's information concerning litigation is a: 

A. Letter of audit inquiry to the client's lawyer.

B. Letter of corroboration from the auditor's lawyer upon review of the legal documentation.

C. Confirmation of claims and assessments from the other parties to the litigation.

D. Confirmation of claims and assessments from an officer of the court presiding over the litigation.

 

 

Essay Questions

 

66. Auditors must be concerned with events that occur subsequent to the balance sheet date, because the events may need to be reflected in the financial statements.

a. Describe the two general types of subsequent events.

b. What is the auditors' responsibility with respect to detecting subsequent events?

c. List three audit procedures that are used by the auditors to search for subsequent events. 

 

 

 

 

67. Auditors are concerned with the existence of loss contingencies that may affect the client's financial statements. One way that the auditors obtain evidence about existing loss contingencies is through the lawyer's letter.

a. Describe the information that the auditors wish to obtain about the litigation being handled by a lawyer.

b. Describe three other procedures that are used by auditors to discover existing loss contingencies. 

 

 

 

 

68. The auditors' responsibility for information that accompanies audited financial statements varies with the nature of the information and the nature of the document.

a. Describe the auditors' responsibility regarding FASB-required supplementary information.

b. Describe the auditors' responsibility regarding other information in client-prepared documents.

c. Describe the auditors' responsibility regarding information accompanying financial statements in auditor-prepared documents. 

 

 

 

 

Chapter 16 Auditing Operations and Completing the Audit Answer Key

 

 

True / False Questions

 

1. Analytical procedures are often used for verification of income statement accounts. 

TRUE

 

Difficulty: Easy

 

2. The Miscellaneous Revenue account should only be analyzed if it is material in amount. 

FALSE

 

Difficulty: Medium

 

3. Internal control over payroll is enhanced when the personnel department distributes payroll checks. 

FALSE

 

Difficulty: Easy

 

4. The auditors have a responsibility to report on all FASB-required supplementary information. 

FALSE

 

Difficulty: Medium

 

5. Subsequent events that provide additional evidence as to conditions that existed at the balance sheet date may result in adjusting journal entries. 

TRUE

 

Difficulty: Medium

 

6. Dual dating of an audit report extends the auditors' liability for disclosure through the later date for all areas of the financial statements. 

FALSE

 

Difficulty: Medium

 

7. If management fails to list an unasserted claim in the letter of inquiry to a lawyer, the lawyer is not required to inform the auditors of the omission. 

TRUE

 

Difficulty: Medium

 

8. Normally, general risk contingencies need not be disclosed in the financial statements. 

TRUE

 

Difficulty: Medium

 

9. If not adjusted, a situation in which the total likely misstatement in the financial statements exceeds a material amount is likely to lead to an audit report modification. 

TRUE

 

Difficulty: Easy

 

10. Common to future purchase commitments is the fact that they should be recorded as liabilities at discounted values as of year-end. 

FALSE

 

Difficulty: Medium

 

 

Multiple Choice Questions

 

11. Analytical procedures are required as a part of the 

A. Detailed tests of balances.

B. Internal control assessment.

C. Overall review at the conclusion of the audit.

D. Substantive testing.

 

Difficulty: Medium

 

12. The statement that best expresses the auditor's responsibility with respect to events occurring between the balance sheet date and the end of his audit is that: 

A. The auditor has no responsibility for events occurring in the subsequent period unless these events affect transactions recorded on or before the balance sheet date.

B. The auditor's responsibility is to determine that a proper cutoff has been made and that transactions recorded on or before the balance sheet date actually occurred.

C. The auditor is fully responsible for events occurring in the subsequent period and should extend all detailed procedures through the last day of field work.

D. The auditor is responsible for determining that a proper cutoff has been made and performing a general review of events occurring in the subsequent period.

 

Difficulty: Hard

 

13. Shortly after year-end Zero Corporation was informed of the bankruptcy of Bingo. Zero Corporation showed a receivable of $10,000 due from Bingo as of year-end—none of which seems recoverable. The receivable had been questionable for some time as Bingo had been experiencing financial difficulties for the past several years. Yet, Bingo's bankruptcy did not occur until after Zero Corporation's year-end. Under these circumstances:  [pic]  

A. Option A

B. Option B

C. Option C

D. Option D

 

Difficulty: Hard

 

14. In auditing the balance sheet, most revenue and expense accounts are also audited. Which accounts are most likely to be audited when auditing Accounts Receivable? 

A. Sales and Cost of Goods Sold.

B. Interest and Bad Debt Expense.

C. Sales and Bad Debt Expense.

D. Interest and Cost of Goods Sold.

 

Difficulty: Medium

 

15. Auditors should perform audit procedures relating to subsequent events? 

A. Through year end.

B. Through issuance of the audit report.

C. Through the last day of field work.

D. For a reasonable period after year end.

 

Difficulty: Easy

 

16. Which of the following procedures would an auditor most likely perform while evaluating audit findings at the conclusion of an audit? 

A. Obtain assurance from the entity's attorney that all material litigation has been disclosed in the financial statements.

B. Verify the clerical accuracy of the entity's proof of cash and its bank cutoff statement.

C. Determine whether reportable conditions have corrected.

D. Develop an estimate of the total likely misstatement in the financial statements.

 

Difficulty: Medium

 

17. Which of the following ledger accounts would be least likely to be analyzed in detail by auditors? 

A. Miscellaneous revenue.

B. Professional fees.

C. Travel expense.

D. Repairs and maintenance.

 

Difficulty: Hard

 

18. When auditing the statement of cash flows of a profitable, growing company which combination is most likely?

[pic]  

A. Option A

B. Option B

C. Option C

D. Option D

 

Difficulty: Hard

 

19. The audit of which of the following balance sheet accounts does not normally result in verification of an income statement account? 

A. Cash.

B. Accounts receivable.

C. Property, plant and equipment.

D. Intangible assets.

 

Difficulty: Hard

 

20. An example of an internal control weakness is to assign the payroll department the responsibility for: 

A. Preparing the payroll expense distribution.

B. Preparing the payroll checks.

C. Authorizing increases in pay.

D. Preparing journal entries for payroll expense.

 

Difficulty: Medium

 

21. An example of an internal control weakness is to assign the personnel department responsibility for: 

A. Distribution of paychecks.

B. Hiring personnel.

C. Authorizing deductions from pay.

D. Interviewing employees for jobs.

 

Difficulty: Easy

 

22. Which of the following audit procedures is aimed at determining whether every name on the company payroll is an employee actually on the job? 

A. A surprise observation of a paycheck distribution.

B. A test of payroll extensions.

C. Analytical comparisons of budgeted to actual payroll expense.

D. Comparison of payee names on canceled payroll checks with the payroll register.

 

Difficulty: Medium

 

23. Which of the following is not a procedure that is designed to provide evidence about the existence of loss contingencies? 

A. Obtaining a lawyers' letter.

B. Confirming accounts payable.

C. Reviewing the minutes of board of directors' meetings.

D. Review correspondence with banks.

 

Difficulty: Medium

 

24. Which of the following types of matters do not generally require disclosure in the financial statements? 

A. General risk contingencies.

B. Commitments.

C. Loss contingencies.

D. Liabilities to related parties.

 

Difficulty: Medium

 

25. Material loss contingencies should be recorded in the financial statements if available information indicates it is probable that a loss had been sustained prior to the balance sheet date and the amount of such loss can be reasonably estimated. These considerations will affect the audit report as follows: 

A. If a loss has been recorded in accordance with these criteria, the auditor may issue an unqualified opinion but is required to point out the contingency in an explanatory paragraph of the report.

B. If a loss meets these criteria but is disclosed in the financial statement notes rather than being recorded therein, the auditor may issue an unqualified opinion, but is required to point out the contingency in an explanatory paragraph of the report.

C. If a loss meets these criteria but is disclosed in the financial statement notes rather than being recorded therein, the auditor may issue an unqualified opinion, but should consider adding an explanatory paragraph as a means of emphasizing the disclosure.

D. If a loss is probable but the amount cannot be reasonably estimated and is disclosed in the notes to the financial statements rather than being recorded therein, the auditor may issue an unqualified opinion.

 

Difficulty: Hard

 

26. A refusal by a lawyer to furnish information related to litigation included in the letter of inquiry is likely to result in: 

A. Confirmation of related lawsuits with the claimants.

B. Qualification of the audit report.

C. An assessment that loss of the litigation is probable.

D. An adverse opinion.

 

Difficulty: Medium

 

27. If, after issuing an audit report, the auditors find that they have failed to perform certain significant audit procedures they should first: 

A. Attempt to determine whether their report is still being relied upon by third parties.

B. Notify regulatory agencies.

C. Notify legal counsel.

D. Wait until the beginning of the next year's audit to determine whether misstatements have occurred.

 

Difficulty: Medium

 

28. Which of the following is not a procedure that auditors typically perform to search for significant events during the subsequent period? 

A. Review minutes of board of directors' meeting.

B. Review the latest available interim financial statements.

C. Inquire about any unusual adjustments made subsequent to the balance sheet date.

D. Review changes in internal control during the period subsequent to the balance sheet date.

 

Difficulty: Hard

 

29. Which of the following subsequent events might require an adjustment to the client's financial statements? 

A. A business combination with another company.

B. Loss on the sale of a closely-held investment.

C. Loss of plant and equipment due to a fire.

D. Retirement of bonds payable at a loss.

 

Difficulty: Medium

 

30. Authorization of which of the following is least likely to be found during a review of the minutes of the board of directors? 

A. Dividends.

B. New debt issuance.

C. New bank accounts.

D. Writeoff of trade accounts receivable.

 

Difficulty: Medium

 

31. Which of the following is not a procedure normally performed while completing the audit? 

A. Obtain a lawyer's letter.

B. Obtain a representations letter.

C. Perform an overall review using analytical procedures.

D. Obtain confirmation of capital stockholdings from shareholders.

 

Difficulty: Medium

 

32. Auditors must communicate internal control "significant deficiencies" to: 

A. The audit committee.

B. The shareholders.

C. The SEC.

D. The Federal Trade Commission.

 

Difficulty: Medium

 

33. Which of the following procedures is not a procedure that is completed near the end of the engagement? 

A. Review cash transactions.

B. Review to identify subsequent events.

C. Obtain the lawyer's letter.

D. Obtain the letter of representations.

 

Difficulty: Medium

 

34. Which of the following information must be reported on in the auditors' report? 

A. FASB-required supplementary information.

B. Other information in client-prepared documents.

C. Information accompanying financial statements in auditor-submitted documents.

D. GASB-required supplementary information.

 

Difficulty: Medium

 

35. In evaluating whether there is a sufficiently low probability of material misstatement in the financial statements, the auditors accumulate: 

A. Likely misstatements in the financial statements.

B. Known misstatements in the financial statements.

C. Known, projected and other estimated misstatements in the financial statements.

D. Known, projected and potential misstatements in the financial statements.

 

Difficulty: Hard

 

36. Specific misstatement in one of a client's 2,000 accounts receivable is referred to as a(n): 

A. Extrapolation difference.

B. Known misstatement.

C. Likely misstatement.

D. Projected misstatement.

 

Difficulty: Hard

 

37. The review of audit working papers by the audit partner is normally completed: 

A. Prior to year-end.

B. Immediately as each working paper is completed.

C. Near the completion of field work.

D. After issuance of the audit report, but prior to required subsequent event review procedures.

 

Difficulty: Easy

 

38. Management estimates the company's allowance for doubtful accounts as $200,000, and the auditors develop an estimate that suggests that the amount should be between $230,000 and $250,000. The known misstatement in this situation is: 

A. $0

B. $30,000

C. $40,000

D. $50,000

 

Difficulty: Hard

 

39. Management estimates the company's allowance for doubtful accounts as $200,000, and the auditors develop an estimate that suggests that the amount should be between $230,000 and $250,000. The likely misstatement in this situation is: 

A. $0

B. $30,000

C. $40,000

D. $50,000

 

Difficulty: Medium

 

40. An approach that quantifies the total likely misstatement as of the current year-end based on the effects of reflecting misstatements during the current year (and not considering any unadjusted previous year misstatements) is referred to as the: 

A. Evaluation materiality approach.

B. Iron curtain approach.

C. Projected misstatement approach.

D. Rollover approach.

 

Difficulty: Hard

 

41. An approach that quantifies the total likely misstatement as of the current year-end based on the effects of reflecting all misstatements existing in the balance sheet at the end of the current year, irrespective of whether the misstatements occurred in the current or previous years is referred to as the: 

A. Evaluation materiality approach.

B. Iron curtain approach.

C. Projected misstatement approach.

D. Rollover approach.

 

Difficulty: Hard

 

42. A client's previous two years of financial statements understated estimated warranty payable by $30,000 and $50,000 respectively, immaterial amounts. This year the auditors estimate that the accrual is understated by an additional $60,000. In this year's audit $100,000 represents a material amount. Assuming that the entire understatement is to be recorded, following SEC SAB 108 the decrease in this year's income due to these understatements is: 

A. $0

B. $60,000

C. $110,000

D. $140,000

 

Difficulty: Hard

 

43. A client's previous two years financial statements understated estimated warranty payable by $30,000 and $50,000 respectively, immaterial amounts. This year the auditors estimate that the accrual is understated by an additional $60,000. In this year's audit $55,000 represents a material amount. Assuming that the entire understatement is to be recorded, following SEC SAB 108 the decrease in this year's income due to these understatements is: 

A. $0

B. $60,000

C. $110,000

D. $140,000

 

Difficulty: Hard

 

44. One reason why the independent auditors perform analytical procedures on the client's operations is to identify: 

A. Weaknesses of a material nature in internal control.

B. Non-compliance with prescribed control procedures.

C. Improper separation of accounting and other financial duties.

D. Unusual transactions.

 

Difficulty: Medium

Source: AICPA

 

45. Which of the following is an analytical procedure that should be applied to the income statement? 

A. Select sales and expense items and trace amounts to related supporting documents.

B. Ascertain that the net income amount in the statement of cash flows agrees with the net income amount in the income statement.

C. Obtain from the proper client representatives, the beginning and ending inventory amounts that were used to determine costs of sales.

D. Compare the actual revenues and expenses with the corresponding figures of the previous year and investigate significant differences.

 

Difficulty: Easy

Source: AICPA

 

46. It would be appropriate for the payroll accounting department to be responsible for which of the following functions? 

A. Approval of employee time records.

B. Maintenance of records of employment, discharges, and pay increases.

C. Preparation of periodic governmental reports as to employees' earnings and withholding taxes.

D. Distribution of paychecks to employees.

 

Difficulty: Medium

Source: AICPA

 

47. Which of the following is the best reason why the auditors should consider observing a client's distribution of regular payroll checks? 

A. Separation of payroll duties is less than adequate for effective internal control.

B. Total payroll costs are a significant part of total operating costs.

C. The auditors did not observe the distribution of the entire regular payroll during the audit in the prior year.

D. Employee turnover is excessive.

 

Difficulty: Medium

Source: AICPA

 

48. To minimize the opportunities for fraud, unclaimed cash payroll should be: 

A. Deposited in a safe deposit box.

B. Held by the payroll custodian.

C. Deposited in a special bank account.

D. Held by the controller.

 

Difficulty: Easy

Source: AICPA

 

49. The purpose of segregating the duties of distributing payroll checks and hiring personnel is to: 

A. Separate the custody of assets from the accounting for those assets.

B. Establish clear lines of authority and responsibility.

C. Separate duties within the accounting function.

D. Separate the authorization of transactions from the custody of related assets.

 

Difficulty: Easy

Source: IIA

 

50. A CPA reviews a client's payroll procedures. The CPA would consider internal control to be less than effective if a payroll department supervisor was assigned the responsibility for: 

A. Reviewing and approving time reports for subordinate employees.

B. Distributing payroll checks to employees.

C. Hiring subordinate employees.

D. Initiating requests for salary adjustments for subordinate employees.

 

Difficulty: Medium

Source: AICPA

 

51. A common audit procedure in the audit of payroll transactions involves tracing selected items from the payroll journal to employee time cards that have been approved by supervisory personnel. This procedure is designed to provide evidence in support of the audit proposition that: 

A. Only bona fide employees worked and their pay was properly computed.

B. Jobs on which employees worked were charged with the appropriate labor cost.

C. Internal control relating to payroll disbursements are operating effectively.

D. Employees worked the number of hours for which their pay was computed.

 

Difficulty: Medium

Source: AICPA

 

52. Which of the following material events occurring subsequent to the balance sheet date would require an adjustment to the financial statements before they could be issued? 

A. Sale of long-term debt or capital stock.

B. Loss of a plant as a result of a flood.

C. Major purchase of a business which is expected to double the sales volume.

D. Settlement of litigation in excess of the recorded liability.

 

Difficulty: Medium

Source: AICPA

 

53. With respect to issuance of an audit report which is dual dated for a subsequent event occurring after the completion of field work but before issuance of the auditors' report, the auditors' responsibility for events occurring subsequent to the completion of field work is: 

A. Extended to include all events occurring until the date of the last subsequent event referred to.

B. Limited to the specific event referred to.

C. Limited to all events occurring through the date of issuance of the report.

D. Extended to include all events occurring through the date of submission of the report to the client.

 

Difficulty: Medium

Source: AICPA

 

54. An auditor's decision concerning whether or not to "dual date" the audit report is based upon the auditor's willingness to: 

A. Extend auditing procedures.

B. Accept responsibility for year-end adjusting entries.

C. Permit inclusion of a note captioned: event (unaudited) subsequent to the date of the auditor's report.

D. Assume responsibility for resolving all events subsequent to the issuance of the auditor's report.

 

Difficulty: Medium

Source: AICPA

 

55. Auditors often request that the audit client send a letter of inquiry to those attorneys who have been consulted with respect to litigation, claims, or assessments. The primary reason for this request is to provide the auditors with: 

A. An estimate of the dollar amount of the probable loss.

B. An expert opinion as to whether a loss is possible, probable or remote.

C. Information concerning the progress of cases to date.

D. Corroborative audit evidence.

 

Difficulty: Hard

Source: AICPA

 

56. The auditors' primary means of obtaining corroboration of management's information concerning litigation is a: 

A. Letter of audit inquiry to the client's lawyer.

B. Letter of corroboration from the auditor's lawyer upon review of the legal documentation.

C. Confirmation of claims and assessments from the other parties to the litigation.

D. Confirmation of claims and assessments from an officer of the court presiding over the litigation.

 

Difficulty: Medium

Source: AICPA

 

57. Which of the following auditing procedures is ordinarily performed last? 

A. Reading of the minutes of the directors' meetings.

B. Confirming accounts payable.

C. Obtaining a management representation letter.

D. Testing of the purchasing function.

 

Difficulty: Easy

Source: AICPA

 

58. Which of the following is not correct relating to representation letters? 

A. They are ordinarily dated as of the date of the audit report.

B. They are signed by members of top management.

C. They must be obtained for audits.

D. They often serve as a substitute for the application of other procedures.

 

Difficulty: Medium

 

59. The date the auditor grants the client permission to use the audit report in connection with the financial statements is the: 

A. Last day of significant field work.

B. Report cutoff date.

C. Report release date.

D. Representation date.

 

Difficulty: Easy

 

60. Which of the following statements ordinarily is not included among the written client representations made by the chief executive officer and the chief financial officer? 

A. "Sufficient audit evidence has been made available to the auditor to permit the issuance of an unqualified opinion."

B. "There are no unasserted claims or assessments that our lawyer has advised us are probable of assertion and must be disclosed."

C. "We have no plans or intentions that may materially affect the carrying value or classification of assets and liabilities."

D. "No events have occurred subsequent to the balance sheet date that would require adjustment to, or disclosure in, the financial statements."

 

Difficulty: Hard

Source: AICPA

 

61. To which of the following matters would materiality limits not apply when obtaining written client representations? 

A. Violations of state labor regulations.

B. Disclosure of line-of-credit arrangements.

C. Information about related party transactions.

D. Instances of fraud involving management.

 

Difficulty: Hard

Source: AICPA

 

62. The auditors' best course of action with respect to "other financial information" included in a client prepared annual report containing the auditors' report is to: 

A. Indicate in the auditors' report, that the "other financial information" is unaudited.

B. Consider whether the "other financial information" is accurate by performing a limited review.

C. Obtain written representations from managements as to the material accuracy of the "other financial information."

D. Read and consider the manner of presentation of the "other financial information."

 

Difficulty: Hard

Source: AICPA

 

63. In the course of the audit of financial statements for the purpose of expressing an opinion thereon, the auditors will normally prepare a schedule of unadjusted differences for which the auditors did not propose adjustment when they were identified. What is the primary purpose served by this schedule? 

A. To point out to the responsible client officials the errors made by various company personnel.

B. To summarize the adjustments that must be made before the company can prepare and submit its federal tax return.

C. To identify the potential financial statement effects of misstatement or disputed items that were considered immaterial when discovered.

D. To summarize the misstatements made by the company so that corrections can be made after the audited financial statements are released.

 

Difficulty: Hard

Source: AICPA

 

64. An auditor will ordinarily examine invoices from lawyers primarily in order to: 

A. Substantiate accruals.

B. Assess the legal ramifications of litigation in progress.

C. Estimate the dollar amount of contingent liabilities.

D. Identify possible unasserted litigation, claims and assessments.

 

Difficulty: Medium

Source: AICPA

 

65. The auditor's primary means of obtaining corroboration of management's information concerning litigation is a: 

A. Letter of audit inquiry to the client's lawyer.

B. Letter of corroboration from the auditor's lawyer upon review of the legal documentation.

C. Confirmation of claims and assessments from the other parties to the litigation.

D. Confirmation of claims and assessments from an officer of the court presiding over the litigation.

 

Difficulty: Medium

Source: AICPA

 

 

Essay Questions

 

66. Auditors must be concerned with events that occur subsequent to the balance sheet date, because the events may need to be reflected in the financial statements.

a. Describe the two general types of subsequent events.

b. What is the auditors' responsibility with respect to detecting subsequent events?

c. List three audit procedures that are used by the auditors to search for subsequent events. 

a. The two types of subsequent events are:

Type 1--events that provide additional evidence about conditions that existed at the balance sheet date and affect the estimates included in the statements.

Type 2--events that provide evidence about conditions that arose subsequent to the balance sheet date and require disclosure in the financial statements.

b. Auditors have a responsibility to search for material subsequent events to the last day of field work (the date of the auditors' report).

c. Procedures that are used to search for subsequent events include (only three required):

( Review interim financial statements.

( Review minutes of directors' and stockholders' meetings.

( Make inquiries of officers.

( Obtain a letter from the client's attorney.

( Obtain a letter of representations from management.

 

Difficulty: Medium

 

67. Auditors are concerned with the existence of loss contingencies that may affect the client's financial statements. One way that the auditors obtain evidence about existing loss contingencies is through the lawyer's letter.

a. Describe the information that the auditors wish to obtain about the litigation being handled by a lawyer.

b. Describe three other procedures that are used by auditors to discover existing loss contingencies. 

a. The auditors wish to obtain the following information about litigation:

1. A description of the litigation situation and the accounting period to which it relates,

2. The estimated amount of loss, and

3. The probability of occurrence of the loss.

b. Other procedures used by auditors to detect loss contingencies include (only three required):

( Review the minutes of directors' meetings.

( Review correspondence with financial institutions.

( Obtain a representations letter from the client.

( Review prior tax returns.

 

Difficulty: Hard

 

68. The auditors' responsibility for information that accompanies audited financial statements varies with the nature of the information and the nature of the document.

a. Describe the auditors' responsibility regarding FASB-required supplementary information.

b. Describe the auditors' responsibility regarding other information in client-prepared documents.

c. Describe the auditors' responsibility regarding information accompanying financial statements in auditor-prepared documents. 

a. The auditors have a responsibility to perform a review of FASB-required supplementary information, and include an indication in their report when they are unable to perform the procedures or when they have reservations about the information.

b. The auditors have a responsibility to read other information for inconsistency with information contained in the financial statements and obvious misstatements. Reservations with respect to the information may be expressed in the auditors' report.

c. The auditors have a responsibility to report on all information accompanying financial statements in auditor-prepared documents.

 

Difficulty: Medium

 

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