2005 auditing AICPA released questions

The auditor should report whether the information in the condensed financial statements is fairly stated, in all material respects, in relation to the financial statements from which it

Following are multiple choice questions recently released by the AICPA These questions were released by the AICPA with letter answers only Our editorial board has provided the accompanying explanations

Please note that the AICPA generally releases questions that it does NOT intend to use again These questions and content may or may not be representative of questions you may see on any upcoming exams

Choice "d" is incorrect A client's refusal to permit inquiry of outside legal counsel is a significant scope limitation that generally will result in a disclaimer of opinion A qualified opinion would not

be sufficient to address this situation

2

An auditor is reporting on condensed financial statements for an annual period that are derived from the audited financial statements of a publicly-held entity The auditor's opinion should indicate whether the information in the condensed financial statements is fairly stated in all material respects:

a In conformity with accounting principles generally accepted in the United States of America

b In relation to the complete financial statements

c In conformity with an other comprehensive basis of accounting

d In relation to supplementary filings under federal security statutes

Answer:

Choice "b" is correct The auditor should report whether the information in the condensed financial statements is fairly stated, in all material respects, in relation to the financial statements from which it has been derived

Choice "a" is incorrect Condensed financial statements do not include all of the disclosures required by GAAP, and therefore would not typically be presented in conformity with GAAP Choice "c" is incorrect Condensed financial statements are presented in less detail than

complete financial statements, but the fact pattern gives no indication that any comprehensive basis of accounting other than GAAP has been used

Choice "d" is incorrect The auditor should report whether the information in the condensed financial statements is fairly stated, in all material respects, in relation to the financial statements from which it has been derived, not in relation to supplementary filings under federal security statutes

3

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

a Identify specific internal control activities that are likely to prevent fraud

b Evaluate the reasonableness of the client's accounting estimates

c Discuss the timing of the audit procedures with the client's management

d Inquire of the client's attorney as to whether any unrecorded claims are probable of assertion

Answer:

Choice "c" is correct Procedures that an auditor may consider in planning the audit include discussing the type, scope, and timing of the audit with the client's management

Choice "a" is incorrect Identifying specific internal control activities that are likely to prevent fraud

is an audit procedure, but not an initial planning activity

Choice "b" is incorrect Evaluating the reasonableness of the client's accounting estimates is not

a planning activity It is part of the evidence gathered later in the audit process

Choice "d" is incorrect Inquiring of the client's attorney is not a planning activity It is part of the evidence gathered later in the audit process

4

When an auditor increases the assessed level of control risk because certain control activities were determined to be ineffective, the auditor most likely would increase the:

a Level of detection risk

b Extent of tests of details

c Level of inherent risk

d Extent of tests of controls

Answer:

Choice "b" is correct An increase in the assessed level of control risk requires a corresponding decrease in detection risk to maintain the same (presumably low) level of overall audit risk Increasing the extent of tests of details will result in a reduction in detection risk

Choice "a" is incorrect Increasing detection risk would result in a corresponding increase in overall audit risk, which is the opposite of the desired response

Choice "c" is incorrect The auditor cannot change the level of inherent risk, which is based on the nature of the related assertion

Choice "d" is incorrect If the auditor has already determined that certain control activities are ineffective, increasing the extent of those tests is not likely to be helpful The auditor needs to find a way to compensate for the increased level of control risk in order to keep overall audit risk

to a low level

5

An independent auditor asked a client's internal auditor to assist in preparing a standard financial institution confirmation request for a payroll account that had been closed during the year under audit After the internal auditor prepared the form, the controller signed it and mailed it to the bank What was the major flaw in this procedure?

a The internal auditor did not sign the form

b The form was mailed by the controller

c The form was prepared by the internal auditor

d The account was closed, so the balance was zero

Answer:

Choice "b" is correct The auditor should control the mailing of independent confirmations Choice "a" is incorrect It is appropriate for a member of management, such as the controller, to sign the confirmation request

Choice "c" is incorrect It is acceptable for an internal auditor to provide direct assistance to the external auditor, such as by preparing confirmation forms

Choice "d" is incorrect Confirmations may be sent to accounts that show a zero balance, to test for understatement errors or to obtain information about loans

b There are no reportable conditions identified during the prior-year's audit of which the audit

committee of the board of directors is unaware

c We do not intend to provide any information that may be construed to constitute a waiver of

the attorney-client privilege

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

Answer:

Choice "a" is correct It is appropriate for the representation letter to contain a statement

regarding subsequent events

Choice "b" is incorrect The representation letter typically includes information in four categories: financial statements; completeness; recognition, measurement, and disclosure; and subsequent events The communication of reportable conditions does not fall within these categories

Choice "c" is incorrect The representation letter typically includes information in four categories: financial statements; completeness; recognition, measurement, and disclosure; and subsequent events A waiver of attorney-client privilege does not fall within these categories

Choice "d" is incorrect While this may be an accurate statement, it is not something that would

be included in the management representation letter The representation letter typically includes information in four categories: financial statements; completeness; recognition, measurement, and disclosure; and subsequent events

7

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

Choice "b" is correct Inspection of plant and equipment by the auditor provides evidence

concerning the existence of the equipment; if the auditor can see it, it exists However, physical inspection does not provide any evidence concerning whether the amounts paid for plant and equipment are properly classified, described, and disclosed Only reviewing drafts of the financial statements will provide evidence regarding presentation and disclosure

Choice "a" is incorrect Physical inspection does not provide any evidence concerning whether the amounts paid for plant and equipment are properly classified, described, and disclosed Choice "c" is incorrect Physical inspection of equipment does not provide any evidence

concerning whether the amounts paid for the equipment are properly classified, described, and disclosed Only reviewing drafts of the financial statements gives evidence for presentation and disclosure However, inspection of plant and equipment by the auditor does provide evidence concerning the existence of the equipment; if the auditor can see it, it exists

Choice "d" is incorrect Inspection of plant and equipment by the auditor does provide evidence concerning the existence of the equipment: if the auditor can see it, it exists

8

When performing an engagement to review a nonpublic entity's financial statements, an

accountant most likely would:

a Obtain an understanding of the entity's internal control

b Limit the distribution of the accountant's report

c Confirm a sample of significant accounts receivable balances

d Ask about actions taken at board of directors' meetings

Answer:

Choice "d" is correct A review is based on inquiry and analytical procedures The accountant should inquire about actions authorized by the stockholders, the board of directors, or other management groups

Choice "a" is incorrect The accountant is not required to obtain an understanding of internal control in a review engagement under SSARS An understanding would be required in an audit

or in a review of the interim financial statements of a public entity, conducted under auditing standards

Choice "b" is incorrect Distribution of a review report is not limited; however, each page of the financial statements should be marked, "See Accountant's Review Report."

Choice "c" is incorrect Confirmation is an auditing procedure used to corroborate stated account balances A review is based on inquiry and analytical procedures, and would not include

9

Which of the following procedures would an auditor most likely perform to obtain assurance that slow-moving and obsolete items included in inventories are properly identified?

a Testing shipping and receiving cutoff procedures

b Confirming inventories at locations outside the entity's premises

c Examining an analysis of inventory turnover

d Tracing inventory observation test counts to perpetual listings

Answer:

Choice "c" is correct Examining an analysis of inventory turnover helps identify slow-moving, excess, defective, and obsolete items included in inventories In order for inventory to be

properly valued, these items may need to be written down

Choice "a" is incorrect Testing shipping and receiving cutoff provides evidence regarding

completeness of inventory and rights and obligations related to inventory, but it does not provide evidence regarding the identification and valuation of slow-moving and obsolete items

Choice "b" is incorrect Confirming inventories at locations outside the entity's premises provides evidence regarding existence and completeness of inventory, but it does not provide evidence regarding the identification and valuation of slow-moving and obsolete items

Choice "d" is incorrect Tracing inventory observation test counts to perpetual listings provides evidence regarding the completeness of inventory, but it does not provide evidence regarding the identification and valuation of slow-moving and obsolete items

b Discuss with the client's lawyer its philosophy of defending litigation, claims, and

assessments that have a high probability of being resolved unfavorably

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

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

Answer:

Choice "d" is correct The auditor should obtain assurance from management that it has

disclosed all unasserted claims that its lawyer has advised are probable of assertion

Choice "a" is incorrect The auditor should examine documents in the client's possession

concerning litigation, claims, and assessments, including correspondence and invoices from lawyers The auditor does not generally examine documents held by the client's lawyer

Choice "b" is incorrect If the lawyer has indicated that there is a high probability of a litigation, claim, or assessment being resolved unfavorably, the auditor would use this information, together with an estimate of the range of potential loss (if available), to evaluate management's financial statement presentation The auditor would not generally discuss with the client's lawyer its defense philosophy regarding such matters

Choice "c" is incorrect It is the auditor's responsibility (not the lawyer's) to determine whether litigation, claims, and assessments have been adequately recorded or disclosed in the financial statements

d The auditor need not search for reportable conditions but should document and

communicate any reportable conditions that are discovered

be performed They are not designed to discover reportable conditions

Choice "b" is incorrect Searching for reportable conditions is not part of an audit, and it would be inappropriate for the auditor to state that no reportable conditions were noted (even if

management requested such a statement.)

Choice "c" is incorrect Searching for reportable conditions is not part of an audit regardless of the assessment of control risk

12

Which of the following audit procedures most likely would assist an auditor in identifying

conditions and events that may indicate substantial doubt about an entity's ability to continue as a going concern?

a Reading the minutes of meetings of the stockholders and the board of directors

b Comparing the market value of property to amounts owed on the property

c Reviewing lease agreements to determine whether leased assets should be capitalized

d Inspecting title documents to verify whether any assets are pledged as collateral

Answer:

Choice "a" is correct The auditor should examine any evidence that appears contrary to the basic principle of going concern Reviewing the minutes from stockholder and board of director meetings is one procedure that is used in this regard

Choice "b" is incorrect Comparison of the market value of property to amounts owed on the property determines its net value, but would not necessarily indicate a going concern issue Choice "c" is incorrect Reviewing lease agreements to determine whether leased assets should

be capitalized is important in evaluating the financial statements, but it would not provide

evidence of going concern issues

Choice "d" is incorrect Inspecting title documents to verify whether any assets are pledged as collateral provides information regarding presentation and disclosure, but would not provide evidence of going concern issues

Choices "a", "b", and "d" are incorrect Inquiry and analytical review procedures would be

performed after a general understanding of the client is obtained This understanding will help

the accountant more appropriately tailor the inquiry and analytical review procedures to the specific client engagement

14

Which of the following statements is correct concerning an auditor's responsibility to report fraud?

a The auditor is required to communicate to the client's audit committee all minor fraudulent acts perpetrated by low-level employees, even if the amounts involved are inconsequential

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

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

d The disclosure of fraudulent activities to parties other than the client's senior management

and its audit committee is not ordinarily part of the auditor's responsibility

Answer:

Choice "d" is correct The disclosure of fraudulent activities to parties other than the client's

senior management and its audit committee is not ordinarily part of the auditor's responsibility

Choice "a" is incorrect Only fraud that causes a material misstatement of the financial

statements or fraud involving senior management should be reported to the audit committee Choice "b" is incorrect The disclosure of fraudulent activities to parties other than the client's

senior management and its audit committee is not ordinarily part of the auditor's responsibility

Although there are certain exceptions to this rule, disclosure to stockholders is not one of them Choice "c" is incorrect Fraudulent activities involving senior management of which the auditor becomes aware should be reported directly to the audit committee, not to the SEC (Only in certain limited circumstances would fraud be disclosed to the SEC via required regulatory

reports.)

15

Which of the following audit techniques ordinarily would provide an auditor with the least

assurance about the operating effectiveness of an internal control activity?

a Inquiry of client personnel

b Inspection of documents and reports

c Observation of client personnel

d Preparation of system flowcharts

Answer:

Choice "d" is correct Preparation of system flowcharts may aid in the auditor's understanding of internal control, but would not indicate whether controls were actually operating as designed Choices "a", "b", and "c" are incorrect Inquiry, inspection, observation (and reperformance) are all tests that may be used to evaluate the operating effectiveness of a control

16

Which of the following procedures most likely could assist an auditor in identifying related party transactions?

a Performing tests of controls concerning the segregation of duties

b Evaluating the reasonableness of management's accounting estimates

c Reviewing confirmations of compensating balance arrangements

d Scanning the accounting records for recurring transactions

Answer:

Choice "c" is correct Compensating balance arrangements may be maintained by or for related parties

Choice "a" is incorrect Performing tests of controls concerning the segregation of duties relates

to the allocation of responsibilities among company employees; related party transactions typically relate to transactions with affiliates, owners, or management

Choice "b" is incorrect Evaluating the reasonableness of management's accounting estimates would not provide any evidence of transaction with affiliates, owners, or management

Choice "d" is incorrect Related party transactions are more likely to be nonrecurring than recurring

17

In parallel simulation, actual client data are reprocessed using an auditor software program An advantage of using parallel simulation, instead of performing tests of controls without a computer,

is that:

19

An accountant's standard report on a compilation of a projection should not include a statement

that:

a There will usually be differences between the forecasted and actual results

b The hypothetical assumptions used in the projection are reasonable in the circumstances

c The accountant has no responsibility to update the report for future events and

Choice "a" is incorrect An accountant's standard report on a compilation of a projection does state that there will usually be differences between the forecasted and actual results

Choice "c" is incorrect An accountant's standard report on a compilation of a projection does state that the accountant has no responsibility to update the report for future events and

a Sales order file

b Customer order file

c Shipping document file

d Sales invoice file

Answer:

Choice "c" is correct Shipping documents provide evidence that a sale occurred, and therefore selecting from a population of shipping documents allows the auditor to test whether

corresponding invoices exist for each sale

Choices "a" and "b" are incorrect The existence of customer orders and sales orders does not necessarily imply that a sale occurred For example, the particular item requested may be out of stock In such cases, there would properly be no sales invoice

Choice "d" is incorrect Since the weakness the auditor is concerned about involves missing sales invoices, selecting from a sample of existing sales invoices would not identify this problem

21

An auditor examining inventory most likely would use variables sampling rather than attributes sampling to:

a Identify whether inventory items are properly priced

b Estimate whether the dollar amount of inventory is reasonable

c Discover whether misstatements exist in inventory records

d Determine whether discounts for inventory are properly recorded

procedures with respect to pricing were followed for each item in the sample

Choice "c" is incorrect Attribute sampling is used to test the attributes, or characteristics, of each item in a sample In this case, attribute sampling would be used to determine if inventory was properly recorded for each item in the sample

Choice "d" is incorrect Attribute sampling is used to test the attributes, or characteristics, of each item in a sample In this case, attribute sampling would be used to determine if discounts were properly applied to inventory for each item in the sample

22

"In connection with an audit of our financial statements, management has prepared, and

furnished to our auditors a description and evaluation of certain contingencies."

The foregoing passage most likely is from a(an):

a Audit inquiry letter to legal counsel

b Management representation letter

c Audit committee's communication to the auditor

d Financial statement footnote disclosure

management has prepared and furnished a list of contingencies

Choice "c" is incorrect The audit committee would not communicate to the auditor regarding the list of contingencies prepared by management

Choice "d" is incorrect It would be inappropriate to indicate in the footnotes whether specific information was provided by management to the auditor

23

Which of the following procedures would an auditor most likely perform in obtaining evidence

about subsequent events?

a Examine a sample of transactions that occurred since the year-end to verify the effectiveness

Choice "b" is correct In obtaining evidence about subsequent events, the auditor would most

likely inquire of management whether there have been significant changes in working ca6(g1anage0 )]TJ-0.0005 Tc -0n000c -0.5rm the tests 0.00bt4cihcg ne t 7w3(tantn)5(g)-1 ncr controls