Chapter 17 Auditors' Reports - CPA Diary



Chapter 17

Auditors' Reports

 

True / False Questions

 

1. Audit reports should be dated the date on which the financial statements are issued. 

True    False

 

2. When the auditors are unable to comply with generally accepted auditing standards, they should issue an opinion that is unqualified, but include an additional explanatory paragraph in the report. 

True    False

 

3. When evaluating the results of audit tests, materiality depends upon both the dollar amount and the nature of the item. 

True    False

 

4. A public company's financial statements should be prepared following standards of the Public Company Accounting Oversight Board. 

True    False

 

5. If financial statements fail to disclose a material fact, the auditors may disclose the information in an explanatory paragraph and issue an unqualified opinion on the statements. 

True    False

 

6. If financial statements contain a material departure from generally accepted accounting principles, the auditors usually should not issue an unqualified opinion. 

True    False

 

7. A "very material" change from one generally accepted accounting principle to another generally accepted accounting principle usually results in an adverse opinion by the auditors. 

True    False

 

8. When there is a significant question about a company's ability to remain a going concern, the report issued is usually unqualified with an explanatory paragraph. 

True    False

 

9. A client imposed scope limitation will generally result in a disclaimer of opinion. 

True    False

 

10. Regulation S-X governs the form and content of financial statements filed with the SEC. 

True    False

 

 

Multiple Choice Questions

 

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

A. A statement that he auditor believes that his or her audit provides a reasonable basis for expressing negative assurance.

B. A statement that the auditor's responsibility is to express an opinion on the financial statements.

C. A statement that the financial statements in the report are the responsibility of management.

D. A title with the word "independent."

 

12. When an auditor has concluded there is substantial doubt about an entity's ability to continue as a going concern for a reasonable period of time beyond the current financial statement date (9/30/X1), the auditor's responsibility includes: 

A. Preparing prospective financial information to verify whether management's plans can be effectively implemented.

B. Projecting conditions and events from one year prior to this year's date (9/30/X0) to 9/30/X1.

C. Issuing an adverse or negative assurance opinion, depending upon materiality, due to the possible effects on the financial statements.

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

 

13. When the auditor of a nonpublic company issues an adverse opinion an explanatory paragraph is added. In addition, which, if any, paragraphs to the report are modified?  [pic]  

A. Option A

B. Option B

C. Option C

D. Option D

 

14. When an auditor issues a qualified report on financial statements due to a scope limitation an explanatory paragraph is added. In addition, which, if any, paragraphs to the report are modified?

[pic]  

A. Option A

B. Option B

C. Option C

D. Option D

 

15. When an auditor issues an unqualified report on financial statements, but adds an emphasis of a matter paragraph to the report, which, if any, paragraphs to the report are modified?

[pic]  

A. Option A

B. Option B

C. Option C

D. Option D

 

16. An explanatory paragraph relating to a scope limitation in the audit of the financial statements of a nonpublic company should be placed 

A. After the opinion paragraph.

B. Prior to the opinion paragraph.

C. Either before or after the opinion paragraph.

D. An audit report modified for a scope limitation does not include an explanatory paragraph.

 

17. After considering an entity's negative trends and financial difficulties, an auditor has substantial doubt about the entity's ability to continue as a going concern. The auditor's considerations relating to management's plans for dealing with the adverse effects of these conditions most likely would include management's plans to: 

A. Increase current dividend distributions.

B. Reduce existing lines of credit.

C. Increase ownership equity.

D. Purchase assets formerly leased.

 

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

A. Issue an unqualified opinion, but disclose elsewhere in the report this departure from a customary procedure.

B. Issue an unqualified opinion with no reference to this omission but be prepared to defend the action.

C. Issue a qualified opinion or a disclaimer, depending on the materiality of the receivables.

D. Issue an adverse opinion.

 

19. When an auditor of financial statements has substantial doubt about an entity's ability to continue as a going concern because of the probable discontinuance of operations, the auditor most likely would express a qualified opinion if 

A. The effects of the adverse financial conditions likely will cause a bankruptcy filing.

B. Information about the entity's ability to continue as a going concern is not disclosed.

C. Management has no plans to reduce or delay future expenditures.

D. Negative trends and recurring operating losses appear to be irreversible.

 

20. An auditor of financial statements believes that there is substantial doubt about an entity's ability to continue as a going concern for a reasonable period of time. In evaluating the entity's plans for dealing with the adverse effects of future conditions and events, the auditor most likely would consider, as a mitigating factor, the entity's plans to 

A. Repurchase the entity's stock at a price below its book value.

B. Issue stock options to key executives.

C. Lease rather than purchase operating facilities.

D. Accelerate the due date of an existing mortgage.

 

21. Which of the following 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. Performing cutoff tests of sales transactions with customers with long-standing receivable balances.

B. Evaluating the entity's procedures for identifying and recording related party transactions.

C. Inspecting title documents to verify whether any real property is pledged as collateral.

D. Inquiring of the entity's legal counsel about litigation, claims, and assessments.

 

22. When a client declines to disclose essential information in the financial statements or notes, the auditor of the financial statements should: 

A. Provide the information in the audit report, if practicable, and qualify the opinion because of a limitation on the scope of the audit.

B. Provide the information in the audit report, if practicable, and qualify the opinion because of a departure from GAAP.

C. Issue a disclaimer of opinion because the client has interfered with the auditor's function of assessing the adequacy of disclosure.

D. Issue an unqualified opinion, but inform the reader by including the omitted information in the audit report.

 

23. CPA Firm A has performed most of the audit of Consolidated Company's financial statements and qualifies as the principal auditor. CPA Firm B did the remainder of the work. Firm A wishes to assume full responsibility for Firm B's work. Which of the following statements is correct? 

A. Such assumption of responsibility violates the profession's standards.

B. In such circumstances, when appropriate requirements have been met, Firm A should issue a standard unqualified opinion on the financial statements.

C. In such circumstances, when appropriate requirements have been met, Firm A should issue an unqualified opinion on the financial statements but should make appropriate reference to Firm B in the audit report.

D. CPA firm A should normally qualify its audit report on the basis of the scope limitation involved when another CPA firm is involved.

 

24. Which of the following is most accurate with respect to a CPA's responsibility in considering a going concern question on financial statement audits? 

A. Perform analytical procedures aimed particularly at assessing whether bankruptcy is probable.

B. Issue a report with a "going concern" modification when failure is at least reasonably probable.

C. Based on audit procedures performed, assess whether there is substantial doubt about the entity's ability to continue as a going concern.

D. Determine that related uncertainties are properly disclosed and make no mention in the audit report.

 

25. The Rotter Company changed accounting principles in 20X4 from those followed in 20X3. The auditor believes that the new principles are not in conformity with GAAP, and therefore that the 20X4 financial statements are misleading. The change (including its dollar effect) has been described in the notes to the 20X4 statements, which are being presented by themselves. Under these circumstances, in reporting on the 20X4 financial statements, the auditor should: 

A. Express an adverse opinion with an explanatory paragraph disclosing the reason (the accounting change) for the opinion.

B. Express an unqualified opinion with an explanatory paragraph and disclose the accounting change from 20X3 and its effect on the financial statements.

C. Disclaim an opinion and explain all of the reasons therefore.

D. Express an adverse opinion regarding the 20X4 financial statements, without an explanatory paragraph disclosing the reason therefore since it will be included in the notes to the statements.

 

26. When financial statements are affected by a material departure from generally accepted accounting principles, the auditors should: 

A. Issue an unqualified report with an explanatory paragraph.

B. Withdraw from the engagement.

C. Issue an "except for" qualification or an adverse opinion.

D. Issue an "except for" qualification or a disclaimer of opinion.

 

27. Which of the following accounting changes requires explanatory language regarding consistency in the auditors' report? 

A. A change in the estimated useful lives of a class of fixed assets.

B. A write-off of a patent because future benefits do not appear to exist.

C. A change from the straight line method of depreciation to an accelerated method for a class of fixed assets.

D. A change in calculating bad debt expense from one percent to two percent of credit sales.

 

28. The first paragraph of a standard unqualified audit report for a nonpublic client is referred to as the: 

A. Introductory paragraph.

B. Scope paragraph.

C. Opinion paragraph.

D. Explanatory paragraph.

 

29. A scope restriction is least likely to result in a(an): 

A. Qualified opinion.

B. Disclaimer of opinion.

C. Adverse opinion.

D. Standard unqualified opinion.

 

30. Which of the following is least likely to result in explanatory language being added to an unqualified auditor's report on the financial statements of a client that sells jewelry through a retail store? 

A. A decision by the auditor to emphasize that the client is a part of a larger organization.

B. Reliance placed upon a specialist to evaluate the diamonds.

C. A change from FIFO to specific identification accounting for inventory.

D. A question as to whether the client will be able to remain a going concern.

 

31. Which of the following statements is correct with respect to explanatory paragraphs in reports on audits of the financial statements of nonpublic companies? 

A. They always precede the opinion paragraph.

B. They always follow the opinion paragraph.

C. Sometimes they precede and sometimes they follow the opinion paragraph.

D. They always precede the scope paragraph.

 

32. A client has changed the salvage values of a number of its fixed assets. The auditors believe that the salvage values are realistic. The appropriate report on the financial statements is: 

A. Standard unqualified.

B. Unqualified with explanatory language as to consistency.

C. Qualified for consistency.

D. Disclaimer.

 

33. Which of the following would be most likely to be an appropriate addressee for an audit report? 

A. The shareholders of the corporation whose financial statements were examined.

B. A third party who requested that a copy of the audit report be sent to her.

C. The president of the corporation whose financial statements were examined.

D. The chief financial officer.

 

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

A. Used in an adverse opinion.

B. No longer considered appropriate.

C. Used in a qualified opinion

D. Used for an unqualified opinion when an explanatory paragraph is added.

 

35. The unqualified standard audit report of a nonpublic company does not explicitly state that: 

A. The financial statements are the responsibility of the company's management.

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

C. The auditors believe that the audit provides a reasonable basis for their opinion.

D. An audit includes assessing the accounting principles used.

 

36. Which of the following is not a difference between the audit report of a nonpublic and public company? 

A. The nonpublic company report includes the word "Registered" in the title.

B. The nonpublic company report refers to standards of the PCAOB.

C. The nonpublic company report has an additional paragraph referring to the client's fraud prevention procedures.

D. The nonpublic company report must include the city and state in which the report has been issued.

 

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

A. The auditors may still issue an unqualified opinion.

B. The auditors should issue an "except for" qualification for the departure from generally accepted accounting principles.

C. The auditors should issue an opinion "subject to" the information that would have been contained in the statement of cash flows.

D. The auditors should refuse to issue an opinion on only the two financial statements.

 

38. Which of the following circumstances generally results in the issuance of a report that is other than unqualified? 

A. Circumstances have significantly limited the scope of the auditors' procedures.

B. The principal auditors for the engagement are relying on the work of other auditors.

C. The financial statements depart from a standard established by the FASB because the auditors have concluded that application of the standard would result in materially misleading financial statements.

D. The auditors have decided to emphasize the fact that the company has engaged in material amounts of related party transactions.

 

39. Which of the following modifications of the auditors' report does not include an additional paragraph? 

A. The report is qualified because the financial statements contain a material departure from generally accepted accounting principles.

B. The report includes an emphasis of a matter.

C. The audit report indicates a division of responsibility between two CPA firms.

D. The report is qualified because the scope of the auditors' work was restricted.

 

40. If the predecessor auditors fail to reissue their audit report on comparative financial statements the successor auditors should: 

A. Express a qualified opinion on the comparative financial statements audited by the predecessor auditors.

B. Reproduce the predecessor auditors' report and include it with the new set of financial statements.

C. Have the client omit the comparative financial statements.

D. Refer to the report of the predecessor auditors.

 

41. An audit client has refused to allow the auditors to perform a generally accepted auditing procedure. The circumstance would normally result in the issuance of: 

A. A disclaimer of opinion.

B. An adverse opinion.

C. An "except for" qualification of the report.

D. An unqualified report with explanatory language.

 

42. Which of the following is a "registration statement" that is filed with the SEC by a company planning to issue securities to the public? 

A. Form 8-K.

B. Form S-1.

C. Form 10-Q.

D. Form 10-K.

 

43. If principal auditors make no reference to other auditors whose work they have relied on as a part of the basis for their report, the principal auditors: 

A. Are not required to investigate the professional reputation of the other auditors.

B. Are issuing an inappropriate report.

C. Are assuming full responsibility for the work of the other auditors.

D. Are issuing a qualified opinion.

 

44. After performing all necessary procedures the predecessor auditors reissue a prior-period report on financial statements at the request of the client without revising the original wording. The predecessor auditors should: 

A. Delete the date of the report.

B. Dual-date the report.

C. Use the reissue date.

D. Use the date of the previous report.

 

45. When an adverse opinion is expressed, the opinion paragraph should include a direct reference to: 

A. A note to the financial statements which discusses the basis for the opinion.

B. The scope paragraph which discusses the basis for the opinion rendered.

C. A separate paragraph which discusses the basis for the opinion rendered.

D. The consistency in the application of generally accepted accounting principles.

 

46. Under which of the following set of circumstances might the auditors disclaim an opinion? 

A. The financial statements contain a departure from generally accepted accounting principles, the effect of which is material.

B. The principal auditors decide to make reference to the report of another auditor who audited a subsidiary.

C. There has been a material change between periods in the method of application of accounting principles.

D. There are significant scope limitations on the audit.

 

47. The management of Stanley Corporation has decided not to account for a material transaction in accordance with the provisions of a recent statement of the FASB. They have set forth their reasons in note "B" of the financial statements, which clearly demonstrates that due to unusual circumstances the financial statements would otherwise have been misleading. The auditors' report on the financial statements will probably contain a(an): 

A. Qualified opinion and an explanatory paragraph with a reference to note "B".

B. Unqualified opinion and an explanatory paragraph.

C. Adverse opinion and an explanatory paragraph.

D. "Except for" opinion and an explanatory paragraph.

 

48. The auditors include explanatory language in an otherwise unqualified report in order to emphasize that the entity being reported upon is a subsidiary of another business enterprise. The inclusion of this explanatory language: 

A. Is appropriate and would not negate the unqualified opinion.

B. Is considered a qualification of the report.

C. Is a violation of generally accepted reporting standards if this information is disclosed in notes to the financial statements.

D. Necessitates a revision of the opinion paragraph to include the phrase "with the foregoing explanation."

 

49. It is not appropriate for the auditors' report to refer a reader to a financial statement note for details regarding a(an): 

A. Change in accounting principle.

B. Limitation in the scope of the audit.

C. Uncertainty.

D. Related party transaction.

 

50. Which of the following best describes the reference to the expression "taken as a whole" in the fourth generally accepted auditing standard of reporting? 

A. It applies equally to a complete set of financial statements and to each individual financial statement.

B. It applies only to a complete set of financial statements.

C. It applies equally to each item in each financial statement.

D. It applies equally to each material item in each financial statement.

 

51. Which of the following will not result in qualification of the auditors' report due to a scope limitation? 

A. Restrictions imposed by the client.

B. Reliance placed upon the report of other auditors.

C. Inability to obtain sufficient competent evidential matter.

D. Inadequacy in the accounting records.

 

52. For a continuing audit client, when a complete set of financial statements is presented on a comparative basis for two years, the auditors' opinion would refer to: 

A. Only the current year under audit.

B. Either one or both years at the option of the auditors.

C. Each of the two years plus the preceding year.

D. Each of the years in the two-year period.

 

53. Which of the following representations does an auditor make explicitly and which implicitly when issuing an unqualified opinion on public company financial statements?  [pic]  

A. Option A

B. Option B

C. Option C

D. Option D

 

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

A. Be appropriate in the circumstances for the particular entity.

B. Reflect transactions in a manner that presents the financial statements within a range of acceptable limits.

C. Present information in the financial statements that is classified and summarized in a reasonable manner.

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

 

55. In which of the following circumstances would an adverse opinion be appropriate? 

A. The auditor is not independent with respect to the enterprise being audited.

B. The statements are not in conformity with generally accepted accounting principles because they omit a statement of changes in financial position.

C. The statements are not in conformity with generally accepted accounting principles regarding pension plans.

D. A client-imposed scope limitation prevents the auditor from complying with generally accepted auditing standards.

 

56. An independent auditor has concluded that a substantial doubt remains about a client's ability to continue as a going concern, but the client's financial statements have properly disclosed all of its solvency problems. The auditor would probably issue a(an): 

A. Unqualified opinion with an appropriate explanatory paragraph.

B. "Except for" qualified opinion.

C. Standard unqualified opinion.

D. Adverse opinion.

 

57. A limitation on the scope of the audit sufficient to preclude an unqualified opinion will always result when management: 

A. Asks the auditor to report on the balance sheet and not on the other basic financial statements.

B. Refuses to permit its lawyer to respond to the letter of audit inquiry.

C. Discloses material related party transactions in the notes to the financial statements.

D. Knows that confirmation of accounts receivable is not feasible.

 

58. Doe, an independent auditor, was engaged to perform an audit of the financial statements of Ally Incorporated one month after its fiscal year had ended. Although the inventory count was not observed by Doe, and accounts receivable were not confirmed by direct communication with debtors, Doe was able to gain satisfaction by applying alternative auditing procedures. Doe's audit report will probably contain: 

A. A standard unqualified opinion.

B. An unqualified opinion and an explanatory paragraph.

C. Either a qualified opinion or a disclaimer of opinion.

D. An "except for" qualification.

 

59. The fourth reporting standard requires the auditor's report to contain either an expression of opinion regarding the financial statements, taken as a whole, or an assertion to the effect that an opinion cannot be expressed. The objective of the fourth standard is to prevent: 

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

B. Misinterpretations regarding the degree of responsibility that the auditor is assuming.

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

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

 

60. The principal auditor is satisfied with the independence and professional reputation of the other auditor who has audited a subsidiary. To indicate the division of responsibility, the principal auditor should modify: 

A. The introductory, scope, and opinion paragraphs of the report.

B. Only the scope paragraph of the report.

C. Only the opinion paragraph of the report.

D. Only the opinion paragraph of the report and include an explanatory paragraph.

 

61. Morgan, CPA, is the principal auditor for a multinational corporation. Another CPA has examined and reported on the financial statements of a significant subsidiary of the corporation. Morgan is satisfied with the independence and professional reputation of the other auditor, as well as the quality of the other auditor's audit. With respect to Morgan's report on the consolidated financial statements, taken as a whole, Morgan: 

A. Must not refer to the audit of the other CPA.

B. Must refer to the audit of the other CPA.

C. May refer to the audit of the other CPA.

D. May refer to the audit of the other CPA, in which case Morgan must include in the audit report on the consolidated financial statements a qualified opinion with respect to the audit of the other CPA.

 

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

A. The reasons why the predecessor auditor's report is not presented.

B. The identity of the predecessor auditor who examined the financial statements of the prior year.

C. Whether the predecessor auditor's review of the current year's financial statements revealed any matter that might have a material effect on the successor auditor's opinion.

D. The type of opinion expressed by the predecessor auditor.

 

63. If an accounting change has no material effect on the financial statements in the current year, but the change is reasonably certain to have a material effect in later years, the change should be: 

A. Referred to in the auditor's report for the current year.

B. Disclosed in the notes to the financial statements of the current year.

C. Disclosed in the notes to the financial statements and referred to in the auditor's report for the current year.

D. Treated as a subsequent event.

 

64. When financial statements of a prior period are presented on a comparative basis with financial statements of the current period, the continuing auditor is responsible for: 

A. Expressing dual dated opinions.

B. Updating the report on the previous financial statements only if there has not been a change in the opinion.

C. Updating the report on the previous financial statements only if the previous report was qualified and the reasons for the qualification no longer exist.

D. Updating the report on the previous financial statements regardless of the opinion previously issued.

 

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

A. May accept the engagement because such engagements merely involve limited reporting objectives.

B. May accept the engagement but should disclaim an opinion because of an inability to apply the procedures considered necessary.

C. Should refuse the engagement because there is a client-imposed scope limitation.

D. Should refuse the engagement because of a departure from generally accepted auditing standards.

 

66. When the auditor is unable to determine the amounts associated with the illegal acts of client personnel because of an inability to obtain adequate evidence, the auditor should issue a(an): 

A. "Subject to" qualified opinion.

B. Disclaimer of opinion.

C. Adverse opinion.

D. Unqualified opinion with a separate explanatory paragraph.

 

67. If the principal auditor decides to make reference to the other auditor's audit, the introductory paragraph must specifically indicate the: 

A. Magnitude of the portion of the financial statements examined by the other auditor.

B. Name of the other auditor.

C. Name of the consolidated subsidiary examined by the other auditor.

D. Type of opinion expressed by the other auditor.

 

68. Which of the following will result in explanatory language as to consistency in the auditor's report, regardless of whether the item is fully disclosed in the financial statements? 

A. A change in accounting estimate.

B. A change from an unacceptable accounting principle to a generally accepted one.

C. Correction of an error not involving a change in accounting principle.

D. A change in classification.

 

69. An auditor's report on comparative financial statements should be dated as of the date of the: 

A. Issuance of the report.

B. Accumulation of sufficient appropriate audit evidence.

C. Latest financial statements being reported on.

D. Last related-party transaction disclosed in the statements.

 

70. In which of the following circumstances would an auditor of financial statements be most likely to express an adverse opinion? 

A. The statements are not in conformity with the FASB Statements regarding the capitalization of leases.

B. Information comes to the auditor's attention that raises substantial doubt about the entity's ability to continue in existence.

C. The chief executive officer refuses the auditor access to minutes of board of directors' meetings.

D. Tests of controls show that the entity's internal control is so poor that it can not be relied upon.

 

 

Essay Questions

 

71. William & Plaud are principle auditors for the Lowell Corporation. One of the subsidiaries of Lowell Corporation, Wilson Manufacturing Co., is audited by Lyle & Adams.

a. If William & Plaud make reference in their report to reliance on the report of other auditors are they qualifying their opinion? Explain.

b. Regardless of whether William & Plaud make reference to reliance on the report of the other auditors, they should perform certain procedures with respect to Lyle and Adams' audit. What are these procedures? 

 

 

 

 

72. Upon completing an audit, the auditors should issue an opinion on the client's financial statements.

a. List the conditions that permit the issuance of an unqualified opinion on the financial statements.

b. Describe three situations in which the auditors may modify their standard report and still issue an unqualified opinion. 

 

 

 

 

73. Identify the deficiencies (including both incorrect statements and omissions) contained in the auditors' report on a nonpublic company as drafted below. You will receive credit for those you properly identify, and lose credit for those you identify which aren't actually deficiencies.

Auditors' Report

To the Board of Directors and Management

XYZ Company

We have reviewed the consolidated balance sheet of XYZ Company as of December 31, 20XX, and the related statements of income, retained earnings, and cash flows for the year then ended. Our responsibility is to express an opinion on these financial statements based on our audit.

We conducted our audit in accordance with generally accepted accounting standards. Those standards require that we plan and perform the audit to obtain absolute assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present the financial position of XYZ Company as of December 31, 20XX, and the results of operations and its cash flows for the year then ended in conformity with auditing standards generally accepted in the United States of America applied on a consistent basis with the preceding year.

Art Youngster & Co.

Certified Public Accountants

Phoenix, Arizona

December 31, 20XX 

 

 

 

 

74. Use the accompanying solution sheet to reply to all of the situations below that relate to the audit of financial statements of nonpublic companies. Unless indicated otherwise, assume that material amounts are involved.

A company has departed from GAAP for what the auditor considers to be unjustified reasons.

A company's inventory records were deficient and the auditor was required to satisfy herself that the inventory was properly stated using alternative procedures. She is satisfied with the results of those procedures.

In auditing a client, an auditor has determined that substantial doubt exists about an entity's ability to continue as a going concern.

A principal auditor decides not to take responsibility for the work of another CPA who audited a 70% owned subsidiary and issued an unqualified opinion. The total assets and revenues of the subsidiary are 5% and 8%, respectively, of the total assets and revenues of the entity being audited.

A company changes from FIFO to LIFO for inventory valuation and the auditor concurs with the change. The change has a material effect on the comparability of the entity's financial statements this year, but is expected to have an immaterial effect in the future.

A client is issuing two years of comparative financial statements. The first year was audited by another auditor who, after performing the appropriate procedures, has updated and reissued her audit report. (NOTE: You are replying as to the proper report to be issued at the end of the second year.)[3]

A company has included incorrect other information in a client prepared document containing audited statements. The financial statements are correct, but the president's letter is incorrect.

A client has changed its estimate of likely doubtful accounts from 2% of credit sales to 3%. The auditor believes the change to be reasonable.[2]

Reply as to the following three factors relating to the appropriate audit report(s) for each of the situations. More than one type of opinion and placement of explanatory paragraph reply may be appropriate.

Circumstances--Other auditors, going concern, consistency, emphasis of a matter, justified departure from GAAP, unjustified departure from GAAP, Scope Limitation (1 of these must be selected except for numbers 6 and 7).

Types of Opinion

A. Standard unqualified

B. Unqualified with an explanatory paragraph

C. Unqualified with explanatory language, but no explanatory paragraph.

D. Qualified

E. Disclaimer

F. Adverse

If more than one type of opinion is appropriate list each.

Placement of explanatory paragraph--before opinion paragraph, after opinion paragraph, either before or after the opinion paragraph, not applicable since there is no explanatory paragraph. (If more than one type of opinion was appropriate, provide a separate reply for placement of explanatory paragraph for each.)

 [pic]  

 

 

 

 

Chapter 17 Auditors' Reports Answer Key

 

 

True / False Questions

 

1. Audit reports should be dated the date on which the financial statements are issued. 

FALSE

 

Difficulty: Easy

 

2. When the auditors are unable to comply with generally accepted auditing standards, they should issue an opinion that is unqualified, but include an additional explanatory paragraph in the report. 

FALSE

 

Difficulty: Medium

 

3. When evaluating the results of audit tests, materiality depends upon both the dollar amount and the nature of the item. 

TRUE

 

Difficulty: Easy

 

4. A public company's financial statements should be prepared following standards of the Public Company Accounting Oversight Board. 

FALSE

 

Difficulty: Hard

 

5. If financial statements fail to disclose a material fact, the auditors may disclose the information in an explanatory paragraph and issue an unqualified opinion on the statements. 

FALSE

 

Difficulty: Medium

 

6. If financial statements contain a material departure from generally accepted accounting principles, the auditors usually should not issue an unqualified opinion. 

TRUE

 

Difficulty: Easy

 

7. A "very material" change from one generally accepted accounting principle to another generally accepted accounting principle usually results in an adverse opinion by the auditors. 

FALSE

 

Difficulty: Medium

 

8. When there is a significant question about a company's ability to remain a going concern, the report issued is usually unqualified with an explanatory paragraph. 

TRUE

 

Difficulty: Medium

 

9. A client imposed scope limitation will generally result in a disclaimer of opinion. 

TRUE

 

Difficulty: Medium

 

10. Regulation S-X governs the form and content of financial statements filed with the SEC. 

TRUE

 

Difficulty: Easy

 

 

Multiple Choice Questions

 

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

A. A statement that he auditor believes that his or her audit provides a reasonable basis for expressing negative assurance.

B. A statement that the auditor's responsibility is to express an opinion on the financial statements.

C. A statement that the financial statements in the report are the responsibility of management.

D. A title with the word "independent."

 

Difficulty: Easy

 

12. When an auditor has concluded there is substantial doubt about an entity's ability to continue as a going concern for a reasonable period of time beyond the current financial statement date (9/30/X1), the auditor's responsibility includes: 

A. Preparing prospective financial information to verify whether management's plans can be effectively implemented.

B. Projecting conditions and events from one year prior to this year's date (9/30/X0) to 9/30/X1.

C. Issuing an adverse or negative assurance opinion, depending upon materiality, due to the possible effects on the financial statements.

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

 

Difficulty: Medium

 

13. When the auditor of a nonpublic company issues an adverse opinion an explanatory paragraph is added. In addition, which, if any, paragraphs to the report are modified?  [pic]  

A. Option A

B. Option B

C. Option C

D. Option D

 

Difficulty: Medium

 

14. When an auditor issues a qualified report on financial statements due to a scope limitation an explanatory paragraph is added. In addition, which, if any, paragraphs to the report are modified?

 [pic]  

A. Option A

B. Option B

C. Option C

D. Option D

 

Difficulty: Medium

 

15. When an auditor issues an unqualified report on financial statements, but adds an emphasis of a matter paragraph to the report, which, if any, paragraphs to the report are modified?

 [pic]  

A. Option A

B. Option B

C. Option C

D. Option D

 

Difficulty: Medium

 

16. An explanatory paragraph relating to a scope limitation in the audit of the financial statements of a nonpublic company should be placed 

A. After the opinion paragraph.

B. Prior to the opinion paragraph.

C. Either before or after the opinion paragraph.

D. An audit report modified for a scope limitation does not include an explanatory paragraph.

 

Difficulty: Easy

 

17. After considering an entity's negative trends and financial difficulties, an auditor has substantial doubt about the entity's ability to continue as a going concern. The auditor's considerations relating to management's plans for dealing with the adverse effects of these conditions most likely would include management's plans to: 

A. Increase current dividend distributions.

B. Reduce existing lines of credit.

C. Increase ownership equity.

D. Purchase assets formerly leased.

 

Difficulty: Medium

Source: AICPA

 

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

A. Issue an unqualified opinion, but disclose elsewhere in the report this departure from a customary procedure.

B. Issue an unqualified opinion with no reference to this omission but be prepared to defend the action.

C. Issue a qualified opinion or a disclaimer, depending on the materiality of the receivables.

D. Issue an adverse opinion.

 

Difficulty: Medium

 

19. When an auditor of financial statements has substantial doubt about an entity's ability to continue as a going concern because of the probable discontinuance of operations, the auditor most likely would express a qualified opinion if 

A. The effects of the adverse financial conditions likely will cause a bankruptcy filing.

B. Information about the entity's ability to continue as a going concern is not disclosed.

C. Management has no plans to reduce or delay future expenditures.

D. Negative trends and recurring operating losses appear to be irreversible.

 

Difficulty: Medium

Source: AICPA

 

20. An auditor of financial statements believes that there is substantial doubt about an entity's ability to continue as a going concern for a reasonable period of time. In evaluating the entity's plans for dealing with the adverse effects of future conditions and events, the auditor most likely would consider, as a mitigating factor, the entity's plans to 

A. Repurchase the entity's stock at a price below its book value.

B. Issue stock options to key executives.

C. Lease rather than purchase operating facilities.

D. Accelerate the due date of an existing mortgage.

 

Difficulty: Medium

Source: AICPA

 

21. Which of the following 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. Performing cutoff tests of sales transactions with customers with long-standing receivable balances.

B. Evaluating the entity's procedures for identifying and recording related party transactions.

C. Inspecting title documents to verify whether any real property is pledged as collateral.

D. Inquiring of the entity's legal counsel about litigation, claims, and assessments.

 

Difficulty: Easy

Source: AICPA

 

22. When a client declines to disclose essential information in the financial statements or notes, the auditor of the financial statements should: 

A. Provide the information in the audit report, if practicable, and qualify the opinion because of a limitation on the scope of the audit.

B. Provide the information in the audit report, if practicable, and qualify the opinion because of a departure from GAAP.

C. Issue a disclaimer of opinion because the client has interfered with the auditor's function of assessing the adequacy of disclosure.

D. Issue an unqualified opinion, but inform the reader by including the omitted information in the audit report.

 

Difficulty: Medium

 

23. CPA Firm A has performed most of the audit of Consolidated Company's financial statements and qualifies as the principal auditor. CPA Firm B did the remainder of the work. Firm A wishes to assume full responsibility for Firm B's work. Which of the following statements is correct? 

A. Such assumption of responsibility violates the profession's standards.

B. In such circumstances, when appropriate requirements have been met, Firm A should issue a standard unqualified opinion on the financial statements.

C. In such circumstances, when appropriate requirements have been met, Firm A should issue an unqualified opinion on the financial statements but should make appropriate reference to Firm B in the audit report.

D. CPA firm A should normally qualify its audit report on the basis of the scope limitation involved when another CPA firm is involved.

 

Difficulty: Medium

 

24. Which of the following is most accurate with respect to a CPA's responsibility in considering a going concern question on financial statement audits? 

A. Perform analytical procedures aimed particularly at assessing whether bankruptcy is probable.

B. Issue a report with a "going concern" modification when failure is at least reasonably probable.

C. Based on audit procedures performed, assess whether there is substantial doubt about the entity's ability to continue as a going concern.

D. Determine that related uncertainties are properly disclosed and make no mention in the audit report.

 

Difficulty: Medium

 

25. The Rotter Company changed accounting principles in 20X4 from those followed in 20X3. The auditor believes that the new principles are not in conformity with GAAP, and therefore that the 20X4 financial statements are misleading. The change (including its dollar effect) has been described in the notes to the 20X4 statements, which are being presented by themselves. Under these circumstances, in reporting on the 20X4 financial statements, the auditor should: 

A. Express an adverse opinion with an explanatory paragraph disclosing the reason (the accounting change) for the opinion.

B. Express an unqualified opinion with an explanatory paragraph and disclose the accounting change from 20X3 and its effect on the financial statements.

C. Disclaim an opinion and explain all of the reasons therefore.

D. Express an adverse opinion regarding the 20X4 financial statements, without an explanatory paragraph disclosing the reason therefore since it will be included in the notes to the statements.

 

Difficulty: Hard

 

26. When financial statements are affected by a material departure from generally accepted accounting principles, the auditors should: 

A. Issue an unqualified report with an explanatory paragraph.

B. Withdraw from the engagement.

C. Issue an "except for" qualification or an adverse opinion.

D. Issue an "except for" qualification or a disclaimer of opinion.

 

Difficulty: Medium

 

27. Which of the following accounting changes requires explanatory language regarding consistency in the auditors' report? 

A. A change in the estimated useful lives of a class of fixed assets.

B. A write-off of a patent because future benefits do not appear to exist.

C. A change from the straight line method of depreciation to an accelerated method for a class of fixed assets.

D. A change in calculating bad debt expense from one percent to two percent of credit sales.

 

Difficulty: Medium

 

28. The first paragraph of a standard unqualified audit report for a nonpublic client is referred to as the: 

A. Introductory paragraph.

B. Scope paragraph.

C. Opinion paragraph.

D. Explanatory paragraph.

 

Difficulty: Easy

 

29. A scope restriction is least likely to result in a(an): 

A. Qualified opinion.

B. Disclaimer of opinion.

C. Adverse opinion.

D. Standard unqualified opinion.

 

Difficulty: Medium

 

30. Which of the following is least likely to result in explanatory language being added to an unqualified auditor's report on the financial statements of a client that sells jewelry through a retail store? 

A. A decision by the auditor to emphasize that the client is a part of a larger organization.

B. Reliance placed upon a specialist to evaluate the diamonds.

C. A change from FIFO to specific identification accounting for inventory.

D. A question as to whether the client will be able to remain a going concern.

 

Difficulty: Hard

 

31. Which of the following statements is correct with respect to explanatory paragraphs in reports on audits of the financial statements of nonpublic companies? 

A. They always precede the opinion paragraph.

B. They always follow the opinion paragraph.

C. Sometimes they precede and sometimes they follow the opinion paragraph.

D. They always precede the scope paragraph.

 

Difficulty: Easy

 

32. A client has changed the salvage values of a number of its fixed assets. The auditors believe that the salvage values are realistic. The appropriate report on the financial statements is: 

A. Standard unqualified.

B. Unqualified with explanatory language as to consistency.

C. Qualified for consistency.

D. Disclaimer.

 

Difficulty: Hard

 

33. Which of the following would be most likely to be an appropriate addressee for an audit report? 

A. The shareholders of the corporation whose financial statements were examined.

B. A third party who requested that a copy of the audit report be sent to her.

C. The president of the corporation whose financial statements were examined.

D. The chief financial officer.

 

Difficulty: Easy

 

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

A. Used in an adverse opinion.

B. No longer considered appropriate.

C. Used in a qualified opinion

D. Used for an unqualified opinion when an explanatory paragraph is added.

 

Difficulty: Easy

 

35. The unqualified standard audit report of a nonpublic company does not explicitly state that: 

A. The financial statements are the responsibility of the company's management.

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

C. The auditors believe that the audit provides a reasonable basis for their opinion.

D. An audit includes assessing the accounting principles used.

 

Difficulty: Hard

 

36. Which of the following is not a difference between the audit report of a nonpublic and public company? 

A. The nonpublic company report includes the word "Registered" in the title.

B. The nonpublic company report refers to standards of the PCAOB.

C. The nonpublic company report has an additional paragraph referring to the client's fraud prevention procedures.

D. The nonpublic company report must include the city and state in which the report has been issued.

 

Difficulty: Medium

 

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

A. The auditors may still issue an unqualified opinion.

B. The auditors should issue an "except for" qualification for the departure from generally accepted accounting principles.

C. The auditors should issue an opinion "subject to" the information that would have been contained in the statement of cash flows.

D. The auditors should refuse to issue an opinion on only the two financial statements.

 

Difficulty: Medium

 

38. Which of the following circumstances generally results in the issuance of a report that is other than unqualified? 

A. Circumstances have significantly limited the scope of the auditors' procedures.

B. The principal auditors for the engagement are relying on the work of other auditors.

C. The financial statements depart from a standard established by the FASB because the auditors have concluded that application of the standard would result in materially misleading financial statements.

D. The auditors have decided to emphasize the fact that the company has engaged in material amounts of related party transactions.

 

Difficulty: Medium

 

39. Which of the following modifications of the auditors' report does not include an additional paragraph? 

A. The report is qualified because the financial statements contain a material departure from generally accepted accounting principles.

B. The report includes an emphasis of a matter.

C. The audit report indicates a division of responsibility between two CPA firms.

D. The report is qualified because the scope of the auditors' work was restricted.

 

Difficulty: Medium

 

40. If the predecessor auditors fail to reissue their audit report on comparative financial statements the successor auditors should: 

A. Express a qualified opinion on the comparative financial statements audited by the predecessor auditors.

B. Reproduce the predecessor auditors' report and include it with the new set of financial statements.

C. Have the client omit the comparative financial statements.

D. Refer to the report of the predecessor auditors.

 

Difficulty: Hard

 

41. An audit client has refused to allow the auditors to perform a generally accepted auditing procedure. The circumstance would normally result in the issuance of: 

A. A disclaimer of opinion.

B. An adverse opinion.

C. An "except for" qualification of the report.

D. An unqualified report with explanatory language.

 

Difficulty: Medium

 

42. Which of the following is a "registration statement" that is filed with the SEC by a company planning to issue securities to the public? 

A. Form 8-K.

B. Form S-1.

C. Form 10-Q.

D. Form 10-K.

 

Difficulty: Easy

 

43. If principal auditors make no reference to other auditors whose work they have relied on as a part of the basis for their report, the principal auditors: 

A. Are not required to investigate the professional reputation of the other auditors.

B. Are issuing an inappropriate report.

C. Are assuming full responsibility for the work of the other auditors.

D. Are issuing a qualified opinion.

 

Difficulty: Medium

 

44. After performing all necessary procedures the predecessor auditors reissue a prior-period report on financial statements at the request of the client without revising the original wording. The predecessor auditors should: 

A. Delete the date of the report.

B. Dual-date the report.

C. Use the reissue date.

D. Use the date of the previous report.

 

Difficulty: Hard

Source: AICPA

 

45. When an adverse opinion is expressed, the opinion paragraph should include a direct reference to: 

A. A note to the financial statements which discusses the basis for the opinion.

B. The scope paragraph which discusses the basis for the opinion rendered.

C. A separate paragraph which discusses the basis for the opinion rendered.

D. The consistency in the application of generally accepted accounting principles.

 

Difficulty: Medium

Source: AICPA

 

46. Under which of the following set of circumstances might the auditors disclaim an opinion? 

A. The financial statements contain a departure from generally accepted accounting principles, the effect of which is material.

B. The principal auditors decide to make reference to the report of another auditor who audited a subsidiary.

C. There has been a material change between periods in the method of application of accounting principles.

D. There are significant scope limitations on the audit.

 

Difficulty: Medium

Source: AICPA

 

47. The management of Stanley Corporation has decided not to account for a material transaction in accordance with the provisions of a recent statement of the FASB. They have set forth their reasons in note "B" of the financial statements, which clearly demonstrates that due to unusual circumstances the financial statements would otherwise have been misleading. The auditors' report on the financial statements will probably contain a(an): 

A. Qualified opinion and an explanatory paragraph with a reference to note "B".

B. Unqualified opinion and an explanatory paragraph.

C. Adverse opinion and an explanatory paragraph.

D. "Except for" opinion and an explanatory paragraph.

 

Difficulty: Hard

Source: AICPA

 

48. The auditors include explanatory language in an otherwise unqualified report in order to emphasize that the entity being reported upon is a subsidiary of another business enterprise. The inclusion of this explanatory language: 

A. Is appropriate and would not negate the unqualified opinion.

B. Is considered a qualification of the report.

C. Is a violation of generally accepted reporting standards if this information is disclosed in notes to the financial statements.

D. Necessitates a revision of the opinion paragraph to include the phrase "with the foregoing explanation."

 

Difficulty: Medium

Source: AICPA

 

49. It is not appropriate for the auditors' report to refer a reader to a financial statement note for details regarding a(an): 

A. Change in accounting principle.

B. Limitation in the scope of the audit.

C. Uncertainty.

D. Related party transaction.

 

Difficulty: Medium

Source: AICPA

 

50. Which of the following best describes the reference to the expression "taken as a whole" in the fourth generally accepted auditing standard of reporting? 

A. It applies equally to a complete set of financial statements and to each individual financial statement.

B. It applies only to a complete set of financial statements.

C. It applies equally to each item in each financial statement.

D. It applies equally to each material item in each financial statement.

 

Difficulty: Hard

Source: AICPA

 

51. Which of the following will not result in qualification of the auditors' report due to a scope limitation? 

A. Restrictions imposed by the client.

B. Reliance placed upon the report of other auditors.

C. Inability to obtain sufficient competent evidential matter.

D. Inadequacy in the accounting records.

 

Difficulty: Hard

Source: AICPA

 

52. For a continuing audit client, when a complete set of financial statements is presented on a comparative basis for two years, the auditors' opinion would refer to: 

A. Only the current year under audit.

B. Either one or both years at the option of the auditors.

C. Each of the two years plus the preceding year.

D. Each of the years in the two-year period.

 

Difficulty: Medium

Source: AICPA

 

53. Which of the following representations does an auditor make explicitly and which implicitly when issuing an unqualified opinion on public company financial statements?  [pic]  

A. Option A

B. Option B

C. Option C

D. Option D

 

Difficulty: Medium

 

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

A. Be appropriate in the circumstances for the particular entity.

B. Reflect transactions in a manner that presents the financial statements within a range of acceptable limits.

C. Present information in the financial statements that is classified and summarized in a reasonable manner.

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

 

Difficulty: Medium

Source: AICPA

 

55. In which of the following circumstances would an adverse opinion be appropriate? 

A. The auditor is not independent with respect to the enterprise being audited.

B. The statements are not in conformity with generally accepted accounting principles because they omit a statement of changes in financial position.

C. The statements are not in conformity with generally accepted accounting principles regarding pension plans.

D. A client-imposed scope limitation prevents the auditor from complying with generally accepted auditing standards.

 

Difficulty: Medium

Source: AICPA

 

56. An independent auditor has concluded that a substantial doubt remains about a client's ability to continue as a going concern, but the client's financial statements have properly disclosed all of its solvency problems. The auditor would probably issue a(an): 

A. Unqualified opinion with an appropriate explanatory paragraph.

B. "Except for" qualified opinion.

C. Standard unqualified opinion.

D. Adverse opinion.

 

Difficulty: Medium

Source: AICPA

 

57. A limitation on the scope of the audit sufficient to preclude an unqualified opinion will always result when management: 

A. Asks the auditor to report on the balance sheet and not on the other basic financial statements.

B. Refuses to permit its lawyer to respond to the letter of audit inquiry.

C. Discloses material related party transactions in the notes to the financial statements.

D. Knows that confirmation of accounts receivable is not feasible.

 

Difficulty: Medium

Source: AICPA

 

58. Doe, an independent auditor, was engaged to perform an audit of the financial statements of Ally Incorporated one month after its fiscal year had ended. Although the inventory count was not observed by Doe, and accounts receivable were not confirmed by direct communication with debtors, Doe was able to gain satisfaction by applying alternative auditing procedures. Doe's audit report will probably contain: 

A. A standard unqualified opinion.

B. An unqualified opinion and an explanatory paragraph.

C. Either a qualified opinion or a disclaimer of opinion.

D. An "except for" qualification.

 

Difficulty: Hard

Source: AICPA

 

59. The fourth reporting standard requires the auditor's report to contain either an expression of opinion regarding the financial statements, taken as a whole, or an assertion to the effect that an opinion cannot be expressed. The objective of the fourth standard is to prevent: 

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

B. Misinterpretations regarding the degree of responsibility that the auditor is assuming.

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

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

 

Difficulty: Medium

Source: AICPA

 

60. The principal auditor is satisfied with the independence and professional reputation of the other auditor who has audited a subsidiary. To indicate the division of responsibility, the principal auditor should modify: 

A. The introductory, scope, and opinion paragraphs of the report.

B. Only the scope paragraph of the report.

C. Only the opinion paragraph of the report.

D. Only the opinion paragraph of the report and include an explanatory paragraph.

 

Difficulty: Medium

Source: AICPA

 

61. Morgan, CPA, is the principal auditor for a multinational corporation. Another CPA has examined and reported on the financial statements of a significant subsidiary of the corporation. Morgan is satisfied with the independence and professional reputation of the other auditor, as well as the quality of the other auditor's audit. With respect to Morgan's report on the consolidated financial statements, taken as a whole, Morgan: 

A. Must not refer to the audit of the other CPA.

B. Must refer to the audit of the other CPA.

C. May refer to the audit of the other CPA.

D. May refer to the audit of the other CPA, in which case Morgan must include in the audit report on the consolidated financial statements a qualified opinion with respect to the audit of the other CPA.

 

Difficulty: Medium

Source: AICPA

 

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

A. The reasons why the predecessor auditor's report is not presented.

B. The identity of the predecessor auditor who examined the financial statements of the prior year.

C. Whether the predecessor auditor's review of the current year's financial statements revealed any matter that might have a material effect on the successor auditor's opinion.

D. The type of opinion expressed by the predecessor auditor.

 

Difficulty: Hard

Source: AICPA

 

63. If an accounting change has no material effect on the financial statements in the current year, but the change is reasonably certain to have a material effect in later years, the change should be: 

A. Referred to in the auditor's report for the current year.

B. Disclosed in the notes to the financial statements of the current year.

C. Disclosed in the notes to the financial statements and referred to in the auditor's report for the current year.

D. Treated as a subsequent event.

 

Difficulty: Hard

Source: AICPA

 

64. When financial statements of a prior period are presented on a comparative basis with financial statements of the current period, the continuing auditor is responsible for: 

A. Expressing dual dated opinions.

B. Updating the report on the previous financial statements only if there has not been a change in the opinion.

C. Updating the report on the previous financial statements only if the previous report was qualified and the reasons for the qualification no longer exist.

D. Updating the report on the previous financial statements regardless of the opinion previously issued.

 

Difficulty: Hard

Source: AICPA

 

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

A. May accept the engagement because such engagements merely involve limited reporting objectives.

B. May accept the engagement but should disclaim an opinion because of an inability to apply the procedures considered necessary.

C. Should refuse the engagement because there is a client-imposed scope limitation.

D. Should refuse the engagement because of a departure from generally accepted auditing standards.

 

Difficulty: Medium

Source: AICPA

 

66. When the auditor is unable to determine the amounts associated with the illegal acts of client personnel because of an inability to obtain adequate evidence, the auditor should issue a(an): 

A. "Subject to" qualified opinion.

B. Disclaimer of opinion.

C. Adverse opinion.

D. Unqualified opinion with a separate explanatory paragraph.

 

Difficulty: Medium

Source: AICPA

 

67. If the principal auditor decides to make reference to the other auditor's audit, the introductory paragraph must specifically indicate the: 

A. Magnitude of the portion of the financial statements examined by the other auditor.

B. Name of the other auditor.

C. Name of the consolidated subsidiary examined by the other auditor.

D. Type of opinion expressed by the other auditor.

 

Difficulty: Medium

Source: AICPA

 

68. Which of the following will result in explanatory language as to consistency in the auditor's report, regardless of whether the item is fully disclosed in the financial statements? 

A. A change in accounting estimate.

B. A change from an unacceptable accounting principle to a generally accepted one.

C. Correction of an error not involving a change in accounting principle.

D. A change in classification.

 

Difficulty: Easy

Source: AICPA

 

69. An auditor's report on comparative financial statements should be dated as of the date of the: 

A. Issuance of the report.

B. Accumulation of sufficient appropriate audit evidence.

C. Latest financial statements being reported on.

D. Last related-party transaction disclosed in the statements.

 

Difficulty: Medium

Source: AICPA

 

70. In which of the following circumstances would an auditor of financial statements be most likely to express an adverse opinion? 

A. The statements are not in conformity with the FASB Statements regarding the capitalization of leases.

B. Information comes to the auditor's attention that raises substantial doubt about the entity's ability to continue in existence.

C. The chief executive officer refuses the auditor access to minutes of board of directors' meetings.

D. Tests of controls show that the entity's internal control is so poor that it can not be relied upon.

 

Difficulty: Medium

Source: AICPA

 

 

Essay Questions

 

71. William & Plaud are principle auditors for the Lowell Corporation. One of the subsidiaries of Lowell Corporation, Wilson Manufacturing Co., is audited by Lyle & Adams.

a. If William & Plaud make reference in their report to reliance on the report of other auditors are they qualifying their opinion? Explain.

b. Regardless of whether William & Plaud make reference to reliance on the report of the other auditors, they should perform certain procedures with respect to Lyle and Adams' audit. What are these procedures? 

a. No. The auditors are indicating a division of responsibility between them and the other auditors.

b. The auditors should:

( Make inquiries concerning the other auditors' professional reputation.

( Obtain a letter from the other auditors stating that they are aware of the use of their report and that they are independent with respect to the client.

 

Difficulty: Easy

 

72. Upon completing an audit, the auditors should issue an opinion on the client's financial statements.

a. List the conditions that permit the issuance of an unqualified opinion on the financial statements.

b. Describe three situations in which the auditors may modify their standard report and still issue an unqualified opinion. 

a. The conditions that permit issuance of an unqualified opinion include:

1. The financial statements are presented in conformity with generally accepted accounting principles, including adequate disclosure.

2. The audit was performed in accordance with generally accepted auditing standards and there were no significant scope limitations preventing the auditors from gathering the evidence necessary to support their opinion.

b. Modifications of the auditors' report that do not result in qualification include (only three required):

( Reliance upon other auditors (shared responsibility audits).

( Emphasis of a matter.

( Departure from an officially recognized accounting principle because application would result in materially misleading financial statements.

( A question about a company's ability to remain a going concern.

( GAAP not consistently applied.

 

Difficulty: Medium

 

73. Identify the deficiencies (including both incorrect statements and omissions) contained in the auditors' report on a nonpublic company as drafted below. You will receive credit for those you properly identify, and lose credit for those you identify which aren't actually deficiencies.

Auditors' Report

To the Board of Directors and Management

XYZ Company

We have reviewed the consolidated balance sheet of XYZ Company as of December 31, 20XX, and the related statements of income, retained earnings, and cash flows for the year then ended. Our responsibility is to express an opinion on these financial statements based on our audit.

We conducted our audit in accordance with generally accepted accounting standards. Those standards require that we plan and perform the audit to obtain absolute assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present the financial position of XYZ Company as of December 31, 20XX, and the results of operations and its cash flows for the year then ended in conformity with auditing standards generally accepted in the United States of America applied on a consistent basis with the preceding year.

Art Youngster & Co.

Certified Public Accountants

Phoenix, Arizona

December 31, 20XX 

The report contains the following deficiencies:

1. Introductory paragraph

( In sentence 1, the word "reviewed" should be "audited."

( The sentence on the responsibility of management is omitted.

2. Scope Paragraph

( Sentence 1 should state that the audit was performed in accordance with auditing standards generally accepted in the United States of America.

( Sentence 2 should state that an audit provides "reasonable," not "absolute" assurance.

3. Opinion Paragraph

( "Auditing standards" should be "accounting principles."

( No mention of consistency should be made.

4. Other

( The word "independent" should be included in the report's title.

( The report should be dated as of the last day of field work, not the last day of the year being audited.

 

Difficulty: Hard

 

74. Use the accompanying solution sheet to reply to all of the situations below that relate to the audit of financial statements of nonpublic companies. Unless indicated otherwise, assume that material amounts are involved.

A company has departed from GAAP for what the auditor considers to be unjustified reasons.

A company's inventory records were deficient and the auditor was required to satisfy herself that the inventory was properly stated using alternative procedures. She is satisfied with the results of those procedures.

In auditing a client, an auditor has determined that substantial doubt exists about an entity's ability to continue as a going concern.

A principal auditor decides not to take responsibility for the work of another CPA who audited a 70% owned subsidiary and issued an unqualified opinion. The total assets and revenues of the subsidiary are 5% and 8%, respectively, of the total assets and revenues of the entity being audited.

A company changes from FIFO to LIFO for inventory valuation and the auditor concurs with the change. The change has a material effect on the comparability of the entity's financial statements this year, but is expected to have an immaterial effect in the future.

A client is issuing two years of comparative financial statements. The first year was audited by another auditor who, after performing the appropriate procedures, has updated and reissued her audit report. (NOTE: You are replying as to the proper report to be issued at the end of the second year.)[3]

A company has included incorrect other information in a client prepared document containing audited statements. The financial statements are correct, but the president's letter is incorrect.

A client has changed its estimate of likely doubtful accounts from 2% of credit sales to 3%. The auditor believes the change to be reasonable.[2]

Reply as to the following three factors relating to the appropriate audit report(s) for each of the situations. More than one type of opinion and placement of explanatory paragraph reply may be appropriate.

Circumstances--Other auditors, going concern, consistency, emphasis of a matter, justified departure from GAAP, unjustified departure from GAAP, Scope Limitation (1 of these must be selected except for numbers 6 and 7).

Types of Opinion

A. Standard unqualified

B. Unqualified with an explanatory paragraph

C. Unqualified with explanatory language, but no explanatory paragraph.

D. Qualified

E. Disclaimer

F. Adverse

If more than one type of opinion is appropriate list each.

Placement of explanatory paragraph--before opinion paragraph, after opinion paragraph, either before or after the opinion paragraph, not applicable since there is no explanatory paragraph. (If more than one type of opinion was appropriate, provide a separate reply for placement of explanatory paragraph for each.)

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Difficulty: Hard

 

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