2012 auditing AICPA released questions

The scope paragraph includes the following statements: audit prepared in accordance with GAAS; audit was planned and performed to obtain reasonable assurance that the financial statement

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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 explanation

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

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1

Which of the following audit procedures most likely would assist an auditor in identifying conditions and events that may indicate there could be substantial doubt about an entity's ability to continue as a going concern?

a Confirmation of accounts receivable from principal customers

b Reconciliation of interest expense with debt outstanding

c Confirmation of bank balances

d Review of compliance with terms of debt agreements

Solution:

Choice "d" is correct By reviewing the debt agreements, the auditor may discover that the entity is near

or in noncompliance with specific debt (financial) covenants This may cast doubt on whether the entity will be able to continue as a going concern

Choice "a" is incorrect This procedure would not provide information on whether the entity has a going concern issue but instead could detect errors in financial reporting by the entity

Choice "b" is incorrect The mere reconciliation of interest expense to the debt outstanding would not provide information regarding the entity's ability to function as a going concern

Choice "c" is incorrect Confirming bank balances could detect reporting errors but would not be a procedure to ascertain whether the entity has a going concern issue

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2

A principal auditor decides not to refer to the audit of another CPA who audited a subsidiary of the principal auditor's client After making inquiries about the other CPA's professional reputation and independence, the principal auditor most likely would:

a Document in the engagement letter that the principal auditor assumes no responsibility for the other

CPA's work

b Obtain written permission from the other CPA to omit the reference in the principal auditor's report

c Contact the other CPA and review the audit programs and working papers pertaining to the

subsidiary

d Add an explanatory paragraph to the auditor's report indicating that the subsidiary's financial

statements are not material to the consolidated financial statements

Solution:

Choice "c" is correct When the principal auditor accepts responsibility for the work performed by another auditor, the principal auditor must contact the other CPA and review the audit program and working papers pertaining to the subsidiary

Choice "a" is incorrect When a principal auditor decides not to reference another CPA who worked on the audit of a subsidiary, the principal auditor has assumed responsibility for the work performed by the other auditor

Choice "b" is incorrect Permission does not need to be obtained to assume responsibility for the work of the other CPA

Choice "d" is incorrect When the principal auditor assumes responsibility for the work of another auditor,

no reference to the other auditor or to the subsidiary's financial statements is made in the auditor's report

b Future assurance services

c Management's plans for disposal of assets

d A lawsuit for which judgment is not anticipated for 18 months

Solution:

Choice "c" is correct The nature of management's plan to sell or liquidate assets could provide valuable information to the auditor regarding whether or not the entity can continue to function as a going concern Choice "a" is incorrect Audit fees have no bearing on a client's going concern issue

Choice "b" is incorrect This item would not be directly relevant when determining if there is a going concern issue

Choice "d" is incorrect The future outcome of a pending lawsuit that is more than one year away is a contingency that would not have a significant impact on a going concern issue for a current audit Under U.S GAAP, the going concern period is one year

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4

In which of the following should an auditor's report refer to the lack of consistency when there is a change

in accounting principle that is significant?

a The scope paragraph

b The opinion paragraph

c An explanatory paragraph following the opinion paragraph

d An explanatory paragraph before the opinion paragraph

Solution:

Choice "c" is correct A justified lack of consistency caused by a material change in GAAP between periods would be reported in an explanatory paragraph after the opinion paragraph Under these

circumstances, the auditor issues a modified unqualified opinion

Choices "a", "b", and "d" are incorrect The proper treatment of a justified lack of consistency is to add an explanatory paragraph after the opinion paragraph

Choice "a" is incorrect The scope paragraph includes the following statements: audit prepared in accordance with GAAS; audit was planned and performed to obtain reasonable assurance that the financial statements are free from material misstatements; audit included examining evidence on a test basis, assessing the accounting principles used and management estimates; and, that the audit provides

a reasonable basis for opinion

Choice "b" is incorrect The opinion paragraph refers to the financial statements identified in the

introductory paragraph, an opinion on the fair presentation of the financial statements, and a statement regarding their conformity with U.S GAAP

Choice "d" is incorrect This information is included in the introductory paragraph and not in an

explanatory paragraph

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6

Zag Co issues financial statements that present financial position and results of operations but Zag omits the related statement of cash flows Zag would like to engage Brown, CPA, to audit its financial

statements without the statement of cash flows although Brown's access to all of the information

underlying the basic financial statements will not be limited Under these circumstances, Brown most likely would:

a Add an explanatory paragraph to the standard auditor's report that justifies the reason for the

omission

b Refuse to accept the engagement as proposed because of the client-imposed scope limitation

c Explain to Zag that the omission requires a qualification of the auditor's opinion

d Prepare the statement of cash flows as an accommodation to Zag and express an unqualified

opinion

Solution:

Choice "c" is correct The auditor would explain to the client that in order for the entity's financial

statements to be in conformity with GAAP, there must be adequate disclosures of all material matters including all financial statements and the supporting footnotes As a result, the auditor would tell Zag that without adequate disclosure of the entity's cash flows, the audit report would have issued a qualified or adverse audit opinion

Choice "a" is incorrect Missing the statements of cash flows would not result in an unqualified opinion with an additional explanatory paragraph because no statement of cash flows is a material departure from GAAP

Choice "b" is incorrect The auditor is not required to refuse to accept the engagement, but the client should be made aware that the missing statement of cash flows will result in a qualified or adverse opinion

Choice "d" is incorrect The responsibility to prepare the statement of cash flows is solely the client's

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7

An auditor is engaged to report on selected financial data that are included in a client-prepared document containing audited financial statements Under these circumstances, the report on the selected data should:

a State that the presentation is a comprehensive basis of accounting other than GAAP

b Restrict the use of the report to those specified users within the entity

c Be limited to data derived from the entity's audited financial statements

d Indicate that the data are subject to prospective results that may not be achieved

Choice "a" is incorrect A misstatement that is both material and pervasive is too significant to justify a qualified opinion

Choice "b" is incorrect An unqualified opinion cannot be issued because the financial statements are not fairly presented in conformity with GAAP

Choice "c" is incorrect A disclaimer opinion would not be used by the auditor for the above scenario as there are no apparent scope limitations to inhibit the auditor from rendering an opinion

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9

An auditor who is unable to form an opinion on a new client's opening inventory balances may issue an unqualified opinion on the current years:

a Income statement only

b Statement of cash flows only

c Balance sheet only

d Statement of shareholders' equity only

Solution:

Choice "c" is correct If the auditor is unable to form an opinion on a new client's opening inventory balances, the auditor will issue an opinion on the closing balance sheet only and will issue a disclaimer of opinion on the statements of income, retained earnings and cash flows

Choices "a", "b", and "d" are incorrect The auditor should issue a disclaimer of opinion on these financial statements if the auditor is unable to form an opinion regarding opening inventory balances

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10

An accountant who accepts an engagement to compile a financial projection most likely would make the client aware that the:

a Projection may not be included in a document with audited historical financial statements

b Accountant's responsibility to update the projection for future events and circumstances is limited to one year

c Projection omits all hypothetical assumptions and presents the most likely future financial position

d Engagement does not include an evaluation of the support for the assumptions underlying the

projection

Solution:

Choice "d" is correct When an accountant accepts a compilation engagement, he or she should indicate that it is limited in scope and would not include an opinion or assurance on the projected financial

statements or the related assumptions

Choice "a" is incorrect A projection may be included in a document with audited historical financial statements The compilation report would also be included with the document to make clear that the accountant provides no opinion or any other form of assurance

Choice "b" is incorrect Updating the projection is the responsibility of company management, not the accountant The compilation report specifically states that the accountant has no responsibility to update the report for events and circumstances occurring after the date of the report

Choice "c" is incorrect A projection is based on hypothetical assumptions

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11

The inability to complete which of the following activities most likely would prevent an accountant from accepting and completing an engagement for a review of financial statements performed in accordance

with Statements on Standards for Accounting and Review Services?

a Performing tests of details of major account balances

b Performing inquiries and analytical procedures

c Obtaining an understanding of internal control to assess control risk

d Having previous experience in the client's industry

Solution:

Choice "b" is correct The requirements of a review completed in accordance with SSARS include the requirement that inquiries be made to the appropriate individuals and analytical procedures be performed Choice "a" is incorrect The inability to perform detail testing on major account balances would not

prevent a review to be performed in accordance with SSARS Detail testing is an auditing procedure, not

a procedure performed during a review engagement

Choice "c" is incorrect Tests of internal control are performed in audit engagements and are not required for a review under SSARS

Choice "d" is incorrect While an accountant should obtain sufficient knowledge regarding the company's industry and business during the review engagement, he or she is not required to have previous

experience in the client's industry

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12

Which of the following procedures most likely would be performed in a review engagement of a

nonissuer's financial statements in accordance with Statements on Standards for Accounting and Review Services?

a Making inquiries of management

b Observing a year-end inventory count

c Assessing the internal control system

d Examining subsequent cash receipts

Solution:

Choice "a" is correct When performing a review, inquiries should be made with members of

management that have direct financial and accounting responsibilities For example, the inquiries would include: the accounting principles/practices used by the entity and the method of applying them; any unusual or complex situations that may affect the financial statements; material subsequent events; and, significant journal entries or adjustments

Choice "b" is incorrect This is an audit procedure that is not performed during a review engagement Choice "c" is incorrect Developing an understanding of the client's internal control system is not required

in a review engagement

Choice "d" is incorrect Examining cash receipts is an audit procedure that is not required in a review

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13

An accountant was asked by a potential client to perform a compilation of its financial statements The accountant is not familiar with the industry in which the client operates In this situation, which of the following actions is the accountant most likely to take?

a Request that management engage an independent industry expert to consult with the accountant

b Accept the engagement and obtain an adequate level of knowledge about the industry

c Decline the engagement

d Postpone accepting the engagement until the accountant has obtained an adequate level of

knowledge about the industry

Solution:

Choice "b" is correct An accountant can accept a compilation engagement with no previous experience

in the client's industry The accountant is then responsible for acquiring an adequate level of knowledge

of the industry's accounting principles and practices

Choice "a" is incorrect Requesting an industry consultant to assist the accountant is not necessary Choice "c" is incorrect Under the above scenario, the accountant is not required to decline the

engagement but should accept the engagement and then obtain knowledge of industry practices and related accounting principles

Choice "d" is incorrect The accountant can still accept the engagement but must acquire adequate knowledge during the compilation engagement

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14

To compile financial statements of a nonissuer in accordance with Statements on Standards for

Accounting and Review Services, an accountant should:

a Identify material misstatements in the financial statements

b Review bank statement reconciliations

c Make inquiries of significant customers, vendors, and creditors

d Obtain a general understanding of the client's business transactions

Solution:

Choice "d" is correct In order to compile a nonissuer's financial statements, the accountant should obtain

an understanding of the client's transaction types and frequency of transactions

Choice "a" is incorrect The accountant is not required to identify material misstatements in the financial statements for a compilation

Choice "b" is incorrect Reviewing banks statement reconciliations is an audit test and is not required for

a compilation

Choice "c" is incorrect Making inquiries would be done as part of a review, not a compilation

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15

A CPA firm would best provide itself reasonable assurance of meeting its responsibility to offer

professional services that conform with professional standards by:

a Establishing an understanding with each client concerning individual responsibilities in a signed engagement letter

b Assessing the risk that errors and fraud may cause the financial statements to contain material misstatements

c Developing specific audit objectives to support management's assertions that are embodied in the financial statements

d Maintaining a comprehensive system of quality control that is suitably designed in relation to its organizational structure

Solution:

Choice "d" is correct Statements of Quality Control Standards (SQCS) are issued to provide guidance with respect to audit quality control These standards indicate that the nature and extent of a firm's quality control policies and procedures are directly tied to its organizational structure So by maintaining a comprehensive system of quality control in relation to its organizational structure, the CPA firm would provide reasonable assurance that its professional services conform to the above standards

Choice "a" is incorrect Specific individual responsibilities are not outlined in an engagement letter Furthermore, the engagement letter does not provide reasonable assurance that the audit firm is meeting its responsibility to provide professional services that comply with professional standards This is done through a system of quality control

Choice "b" is incorrect Assessing the risk of material misstatement is part of an audit engagement and does not provide reasonable assurance that the audit firm is meeting its responsibility to provide

professional services that comply with professional standards This is done through a system of quality control

Choice "c" is incorrect Developing specific audit objectives to support management's assertions in the financial statements is an audit procedure that does not provide reasonable assurance that the audit firm

is meeting its responsibility to provide professional services that comply with professional standards This

is done through a system of quality control

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16

Which of the following items should be included in prospective financial statements issued in an

attestation engagement performed in accordance with Statements on Standards for Attestation Engagements?

a All significant assertions used to prepare the financial statements

b All significant assumptions used to prepare the financial statements

c Pro forma financial statements for the past two years

d Historical financial statements for the past three years

Solution:

Choice "b" is correct When performing an attestation engagement related to a client's prospective financial statements, the accountant should ensure that the client discloses all significant assumptions that are used for the prospective financial statements

Choice "a" is incorrect The client is not required to disclose the significant assertions used for the prospective financial statements, but must disclose the significant assumptions used

Choice "c" is incorrect Pro forma financial statements are not required in an attestation engagement related to prospective financial statements

Choice "d" is incorrect Historical financial statements are not required in an attestation engagement related to prospective financial statements

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17

Which of the following activities is an accountant not responsible for in review engagements performed in

accordance with Statements on Standards for Accounting and Review Services?

a Performing basic analytical procedures

b Remaining independent

c Developing an understanding of internal control

d Providing any form of assurance

Choice "b" is incorrect Independence is required in a review engagement

Choice "d" is incorrect In a review engagement, the accountant provides limited assurance that there are

no material modifications that should be made to the financial statements

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18

Which of the following items should be included in an auditor's report for financial statements prepared in conformity with another comprehensive basis of accounting (OCBOA)?

a A sentence stating that the auditor is responsible for the financial statements

b A title that includes the word "independent."

c The signature of the company controller

d A paragraph stating that the audit was conducted in accordance with OCBOA

Solution:

Choice "b" is correct The title of the OCBOA report should be "Independent Auditor's Report."

Choice "a" is incorrect The management of the company is responsible for the financial statements Choice "c" is incorrect Because the auditor is preparing the auditor's report under OCBOA, he or she would sign the report (not the company controller)

Choice "d" is incorrect The financial statements are prepared using the OCBOA The audit report would state that the audit was conducted in accordance with auditing standards generally accepted in the United States of America

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19

Which of the following procedures would be generally performed when evaluating the accounts receivable

balance in an engagement to review financial statements in accordance with Statements on Standards for Accounting and Review Services?

a Perform a reasonableness test of the balance by computing days' sales in receivables

b Vouch a sample of subsequent cash receipts from customers

c Confirm individually significant receivable balances with customers

d Review subsequent bank statements for evidence of cash deposits

Solution:

Choice "a" is correct When evaluating the accounts receivable balance under a review engagement, the accountant would perform analytical procedures such as computing the current period's days' sales in receivables ratio Once computed, this ratio could be compared to the client's prior period's ratio and /or

an industry average ratio to determine if the reported accounts receivable balance (and its relationship to sales) is reasonable

Choice "b" is incorrect Audit testing, which includes tests of accounting records by obtaining sufficient supporting auditing evidence, is not part of a review engagement

Choice "c" is incorrect Confirmation is an audit procedure that is not required in a review engagement Choice "d" is incorrect This audit procedure (test) would not be performed in a review engagement, but may be done in an audit engagement

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20

According to the AICPA Statements on Standards for Attestation Engagements, a public accounting firm

should establish quality control policies to provide assurance about which of the following matters related

to agreed-upon procedures engagements?

a Use of the report is not restricted

b The public accounting firm takes responsibility for the sufficiency of procedures

c The practitioner is independent from the client and other specified parties

d The practitioner sets the criteria to be used in the determination of findings

Solution:

Choice "c" is correct One of the conditions/policies that must exist in an agreed-upon procedures

attestation engagement is that the practitioner be independent from the client and other specified parties pertaining to the engagement

Choice "a" is incorrect The reporting requirements include a statement regarding the restriction of use of the report as it is intended solely for the specified parties

Choice "b" is incorrect A condition for agreed-upon procedures engagements is that the specified parties and not the auditor take responsibility for the sufficiency of the procedures for their purposes

Choice "d" is incorrect The specified parties define the criteria to be used to determine findings

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21

Hart, CPA, is engaged to review the year 2 financial statements of Kell Co., a nonissuer Previously, Hart audited Kell's year 1 financial statements and expressed a qualified opinion due to a scope limitation Hart decides to include a separate paragraph in the year 2 review report because comparative financial statements are being presented for year 2 and year 1 This separate paragraph should indicate the:

a Substantive reasons for the prior-year's qualified opinion

b Reason for changing the level of service from an audit to a review

c Consistency of application of accounting principles between year 2 and year 1

d Restriction on the distribution of the report for internal use only

Solution:

Choice "a" is correct Because comparative financial statements are being reported, and last year's audit engagement included a scope limitation on the audited financial statements, Hart should include a separate paragraph in the review report outlining the substantive reasons for the client's qualified report Choice "b" is incorrect An explanation of why the client is changing from an audit engagement last year,

to a review engagement this year, is not required

Choice "c" is incorrect A separate paragraph regarding the consistency of the application of accounting principles is not required in a review report unless there is a lack of consistency

Choice "d" is incorrect A review report is not generally restricted as to its use

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22

A CPA is engaged to audit the financial statements of a nonissuer After the audit begins, the client's management questions the extent of procedures and objects to the confirmation of certain contracts The client asks the accountant to change the scope of the engagement from an audit to a review Under

these circumstances, the accountant should do each of the following, except:

a Issue an accountant's review report with a separate paragraph discussing the change in engagement scope

b Consider the additional audit effort and cost required to complete the audit

c Evaluate the possibility that financial statement information affected by the limitation on work to be performed may be incorrect or incomplete

d Consider the reason given for the client's request and assess whether the request is reasonable

Solution:

Choice "a" is correct When an accountant determines that a change in the scope of an engagement from an audit to a review is appropriate, the accountant would issue a review report and would not refer to the original engagement, any procedures performed as part of the engagement, or any scope limitation Choices "b", "c", and "d" are incorrect All of these items should be considered by the accountant when determining whether the change in engagement is justified

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23

Obtaining an understanding of an internal control involves evaluating the design of the control and

determining whether the control has been:

Choice "b" is correct When evaluating a client's internal controls, the auditor must first obtain an

understanding of the design of the controls and then determine if the controls have been implemented Choice "a" is incorrect It is assumed that the design of the internal control has been authorized by client management

Choice "c" is incorrect Testing internal controls is not part of the understanding phase of internal control Choice "d" is incorrect Monitoring the ongoing effectiveness of internal controls is not part of the

understanding phase of internal control and is the responsibility of client management

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24

Which of the following is the best way to compensate for the lack of adequate segregation of duties in a small organization?

a Disclosing lack of segregation of duties to the external auditors during the annual review

b Replacing personnel every three or four years

c Requiring accountants to pass a yearly background check

d Allowing for greater management oversight of incompatible activities

Choice "c" is incorrect Performing accountants' background checks does not help the lack of

segregation of duties in smaller organizations

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25

Which of the following situations most likely represents the highest risk of a material misstatement arising from misappropriations of assets?

a A large number of bearer bonds on hand

b A large number of inventory items with low sales prices

c A large number of transactions processed in a short period of time

d A large number of fixed assets with easily identifiable serial numbers

Solution:

Choice "a" is correct Bearer bonds represent the highest risk of misappropriation of assets by an entity because they are unregistered with no records kept of the owner(s) or transactions involving ownership Historically, bearer bonds have been used to facilitate money laundering, tax evasion, and to conceal business transactions

Choice "b" is incorrect Having a large number of inventory items with low sales prices may result in asset misappropriation if the inventory items are easy to steal However, if the inventory items have a low sales price, it is unlikely that any misappropriation would be material

Choice "c" is incorrect Processing a large number of transactions in a short period of time does not necessarily lead to a high risk of misappropriation of assets

Choice "d" is incorrect Tagging fixed assets with easily identifiable serial numbers would decrease the risk of misappropriation of the fixed assets

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26

Which of the following procedures would an auditor most likely perform in the planning stage of an audit?

a Make a preliminary judgment about materiality

b Confirm a sample of the entity's accounts payable with known creditors

c Obtain written representations from management that there are no unrecorded transactions

d Communicate management's initial selection of accounting policies to the audit committee

Choice "c" is incorrect Written representations from management in the form of a representation letter are obtained at the end of the audit and not during the planning stage

Choice "d" is incorrect Audit committee communications can take place throughout the audit and not necessarily during the planning stage

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27

Under which of the following circumstances should an auditor consider confirming the terms of a large complex sale?

a When the assessed level of control risk over the sale is low

b When the assessed level of detection risk over the sale is high

c When the combined assessed level of inherent and control risk over the sale is moderate

d When the combined assessed level of inherent and control risk over the sale is high

Solution:

Choice "d" is correct The auditor would consider confirming a large complex sale when the risk of material misstatement (RMM) is high The risk of material misstatement includes both inherent risk and control risk If both inherent risk and control risk are high, then RMM is high and the auditor would

minimize detection risk by performing more reliable auditing procedures, such as confirmation of the terms of large complex sale

Choice "a" is incorrect When control risk is low, the overall risk of material misstatement is lower If the risk of material misstatement is low, the auditor is less likely to confirm the terms of a large complex sale Choice "b" is incorrect High detection risk implies a low risk of material misstatement If the risk of material misstatement is low, the auditor is less likely to confirm the terms of a large complex sale Choice "c" is incorrect If both inherent risk and control risk are moderate, then the risk of material

misstatement is moderate and the auditor would be less likely to confirm the terms of a large complex sale This is an audit procedure that is most likely to be performed when the risk of material misstatement

is high

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28

The understanding with the client regarding a financial statement audit generally includes which of the following matters?

a The expected opinion to be issued

b The responsibilities of the auditor

c The contingency fee structure

d The preliminary judgment about materiality

Solution:

Choice "b" is correct The understanding with the client includes an understanding of both the

responsibilities of the audit firm pertaining to the financial statement audit as well as the responsibilities of the entity's management

Choice "a" is incorrect The auditor should not provide the client with an expected audit opinion prior to or during a financial statement audit

Choice "c" is incorrect Contingent fees are prohibited when performing financial statement audits and would not be part of any discussion with the client

Choice "d" is incorrect When developing an audit strategy, the auditor will make a preliminary

assessment of materiality using his or her professional judgment This is part of the planning process and

is not included in the understanding with the client

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29

Each of the following is a type of known misstatement, except:

a An inaccuracy in processing data

b The misapplication of accounting principles

c Differences between management and the auditor's judgment regarding estimates

d A difference between the classification of a reported financial statement element and the classification according to generally accepted accounting principles

Solution:

Choice "c" is correct A known misstatement is a specific misstatement identified during the audit Differences between management and the auditor's judgment regarding estimates are an example of a likely misstatement, not a known misstatement

Choices "a", "b", and "d" are incorrect An inaccuracy in processing data, the misapplication of

accounting principles, and a difference between the classification of a reported financial statement

element and the classification according to GAAP are all examples of known misstatements