2011 auditing AICPA released questions

An entity's comparative financial statements include the financial statements of the prior year that were audited by a predecessor auditor whose report is not presented.. Explain to the

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Following are multiple choice questions and simulations 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

An entity's comparative financial statements include the financial statements of the prior year that were audited by a predecessor auditor whose report is not presented If the predecessor's report was qualified, the successor should:

a Issue an updated comparative audit report indicating the division of responsibility

b Explain to the client that comparative financial statements may not be presented under these

(ii) The date of the predecessor auditor's report;

(iii) The type of opinion expressed by the predecessor auditor; and

(iv) The substantive reason(s) for other than an unqualified report

Choice "a" is incorrect The comparative audit report does not need to be updated for this situation Choice "b" is incorrect There is no requirement that the comparative financial statements NOT be issued

in such circumstances

Choice "c" is incorrect There is nothing preventing the successor auditor from referencing the prior year's statements in this situation

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3

As a condition of obtaining a loan from First National Bank, Maxim Co is required to submit an audited balance sheet but not the related statements of income, retained earnings, or cash flows Maxim would like to engage a CPA to audit only its balance sheet Under these circumstances, the CPA:

a May not audit only Maxim's balance sheet if the amount of the loan is material to the financial

statements taken as a whole

b May not audit only Maxim's balance sheet if Maxim is a nonissuer

c May audit only Maxim's balance sheet if the CPA disclaims an opinion on the other financial

statements

d May audit only Maxim's balance sheet if access to the information underlying the basic financial statements is not limited

Solution:

Choice "d" is correct The auditor may report on one basic financial statement and not the others, as long

as access is not limited to information underlying the basic financial statement This is considered a limited reporting engagement

Choice "a" is incorrect Materiality only comes into play when dealing with a piecemeal opinion, not an opinion on one entire statement

Choice "b" is incorrect If Maxim is a nonissuer, it would not need to abide by GAAP, thus many of the financial statement requirements would not apply

Choice "c" is incorrect A disclaimer of opinion on the other statements is not required as long as there is

no limitation on the information underlying the basic financial statements

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4

Which of the following statements is correct concerning analytical procedures used in planning an audit engagement?

a They often replace the tests of controls that are performed to assess control risk

b They usually use financial and nonfinancial data aggregated at a high level

c They usually involve the comparison of assertions developed by management to ratios calculated by

Choice "d" is incorrect Analytical procedures do not generally help an auditor develop their preliminary judgment about materiality

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5

Which of the following statements is ordinarily correct about the sample size in statistical sampling when testing controls?

a The expected population deviation rate has little effect on determining the sample size

b As the population size doubles, the sample size should also double

c As the tolerable deviation rate increases, the sample size should also increase

d The population size has little effect on the sample size

Solution:

Choice "d" is correct Population size is not an issue in determining a sample size, provided the

population is relatively large (i.e., greater than 5,000 items)

Choice "a" is incorrect The expected population deviation rate will have a direct impact on the sample size

Choice "b" is incorrect Although the population size may have a direct relationship with the sample size,

it generally will not be in exact proportion

Choice "c" is incorrect As the tolerable deviation rate increases, the sample size will decrease

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6

Which of the following statements is correct regarding internal control?

a A well-designed internal control environment ensures the achievement of an entity's control

Choice "b" is correct Since management generally has the authority to implement and assign

responsibilities under the internal controls, they will generally also have the ability to circumvent those internal controls This is an inherent limitation of internal control

Choice "a" is incorrect Although the design of an internal control system is important, it needs to be paired with the proper implementation and monitoring, and even then cannot ensure that the entity's internal control objectives will be met

Choice "c" is incorrect Internal control structures generally rely in some manner on segregation of duties Because of this, collusion by two or more people can generally destroy this segregation of duties and thus potentially cause circumvention of the internal controls that may not be immediately detected

Choice "d" is incorrect No internal control system can guarantee the detection of all errors and fraud The purpose of an internal control system is to significantly reduce the likelihood that errors or fraud will

be committed and go undetected

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7

General Retailing, a nonissuer, has asked Ford, CPA, to compile its financial statements that omit

substantially all disclosures required by GAAP Ford may comply with General's request provided the omission is clearly indicated in Ford's report and the:

a Distribution of the financial statements and Ford's report is restricted to internal use only

b Reason for omitting the disclosures is acknowledged in the notes to the financial statements

c Omitted disclosures would not influence any potential creditor's conclusions about General's financial position

d Omission is not undertaken with the intention of misleading the users of General's financial

statements

Solution:

Choice "d" is correct The accountant may compile financial statements that omit substantially all

disclosures provided that:

(1) The accountant's report clearly indicates the omission by including a fourth paragraph disclosing such omissions This paragraph should state that if the disclosures were included, they might influence the user's conclusions, and should indicate that the financial statements are not

designed for those who are uninformed about the omitted disclosures; and

(2) To the accountant's knowledge, the omission is not intended to mislead any person who might be expected to use such financial statements

Choice "a" is incorrect Internal use restriction is not required in such circumstances

Choice "b" is incorrect Disclosure of the reason for omission of the disclosures is not a requirement Choice "c" is incorrect This answer discusses only the creditors while the correct answer discusses a broader range of users, in general

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8

When assessing internal auditors' objectivity, an independent auditor should:

a Consider the policies that prohibit the internal auditors from auditing areas where they were recently assigned

b Review the internal auditors' reports to determine that their conclusions are consistent with the work performed

c Verify that the internal auditors' assessment of control risk is comparable to the independent auditor's assessment

d Evaluate the quality of the internal auditors' working paper documentation and their recent audit recommendations

Solution:

Choice "a" is correct Objectivity is reflected by the organizational level to which an internal auditor reports, as well as by policies prohibiting audits of areas where the internal auditor lacks independence Choice "b" is incorrect Reviewing the internal auditor's conclusions does not lead to the assessment of objectivity This would be part of the supervision and review function

Choice "c" is incorrect The fact that the internal auditor's assessment of control risk matches the external auditor's assessment is not relevant to the decision of whether they are objective

Choice "d" is incorrect Quality of work does not guarantee the objectivity of an internal auditor

Choices "b", "c", and "d" are incorrect per above explanation

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10

In auditing contingent liabilities, which of the following procedures would an auditor most likely perform?

a Confirm the details of outstanding purchase orders

b Apply analytical procedures to accounts payable

c Read the minutes of the board of directors' meetings

d Perform tests of controls on the cash disbursement activities

Solution:

Choice "c" is correct In auditing contingent liabilities, an auditor would want to review the minutes of meetings of stockholders, board of directors, and other executive committees in order to find out about communication that may have been transmitted on such issues

Choice "a" is incorrect This step will not likely help to determine if any contingent liabilities exist Choice "b" is incorrect This step will not likely help to determine if any contingent liabilities exist Choice "d" is incorrect This step will not likely help to determine if any contingent liabilities exist

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An auditor believes 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 Purchase production facilities currently being leased from a third party

b Postpone expenditures to upgrade its information technology system

c Pay cash dividends that are in arrears to the preferred stockholders

d Increase the useful lives of plant assets for depreciation purposes

Solution:

Choice "b" is correct When an auditor believes that there is substantial doubt about an entity's ability to continue as a going concern, the auditor is required to consider management's plans for dealing with the conditions or events that led to the auditor's belief, including:

i Plans to borrow money or restructure debt

ii Plans to sell assets

iii Plans to delay or reduce expenditures

iv Plans to increase ownership equity

Choice "a" is incorrect Making a decision to purchase rather than continue leasing would generally not

be a mitigating factor for the concern over whether a company can continue as a going concern

Choice "c" is incorrect Making a decision to pay cash dividends would generally not be a mitigating factor for the concern over whether a company can continue as a going concern

Choice "d" is incorrect Making a decision to increase the useful life estimate of capital assets would not

be considered a genuine mitigating factor for the concern over whether a company can continue as a going concern In fact, it would likely concern the auditor that the management was trying to cover up their financial results through the use of an unreasonable estimate

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12

An auditor concludes that there is substantial doubt about an entity's ability to continue as a going

concern for a reasonable period of time The entity's financial statements adequately disclose its financial difficulties Under these circumstances, the auditor's report is required to include an explanatory

paragraph that specifically uses the phrase(s):

"Except for the effects "Possible discontinuance

of such adjustments" of the entity's operations"

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13

After issuing an auditor's report, an auditor becomes aware of facts that existed at the report date that would have affected the report had the auditor known of the facts at the time What is the first thing the auditor should do?

a Notify each member of the board of directors that the auditor's report may not be associated with the financial statements from this point forward

b Issue revised financial statements and auditor's report describing the reason for the revision in a note

to the financial statements

c Determine whether there are persons currently relying on, or likely to rely on, the financial statements and whether those persons would attach importance to the information

d Notify regulatory agencies having jurisdiction over the client that the auditor's report should not be relied upon from this point forward

Solution:

Choice "c" is correct If an auditor becomes aware of material information that would have affected the report, and that persons are currently relying or are likely to rely on the financial statements covered by the report, the auditor should take appropriate action In order to do this, the auditor must first determine whether there are indeed persons relying or likely to rely on the financial statements

Choice "a" is incorrect This step would occur only if necessary after it is determined that there were persons currently relying or likely to rely on the financial statements covered by the report

Choice "b" is incorrect This step would occur only if necessary after it is determined that there were persons currently relying or likely to rely on the financial statements covered by the report

Choice "d" is incorrect This step would occur only if necessary it is determined that there were persons currently relying or likely to rely on the financial statements covered by the report

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A company hires one of its board members, a CPA, to issue accounting reports for the company Assuming any required disclosures are made, which of the following reports may the CPA issue without violating independence rules?

Choice "b" is incorrect A review would not be allowed in cases where the auditor's independence is impaired, as it would be in this situation

Choice "c" is incorrect An audit would not be allowed in cases where the auditor's independence is impaired, as it would be in this situation

Choice "d" is incorrect An agreed upon procedures engagement would not be allowed in cases where the auditor's independence is impaired, as it would be in this situation

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16

A CPA purchased stock in a client corporation and placed it in a trust as an educational fund for the CPA's minor child The trust securities are not material to the CPA's wealth but are material to the child's personal net worth According to the AICPA Code of Professional Conduct, would this action impair the CPA's independence with the client?

a No, because the CPA would not have a direct financial interest in the client

b Yes, because the stock would be a direct financial interest and materiality is a factor

c Yes, because the stock would be an indirect financial interest and materiality is not a factor

d Yes, because the stock would be a direct financial interest and materiality is not a factor

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17

Which of the following analytical procedures most likely would be used during the planning stage of an audit?

a Comparing current-year to prior-year sales volumes

b Reading the financial statements and notes and considering the adequacy of evidence

c Comparing the current-year ratio of aggregate salaries paid to the number of employees to the year's ratio

prior-d Reading the letter from the client's attorney and considering the threat of litigation

Solution:

Choice "a" is correct The comparison of current year to prior year sales volumes would be a good analytical procedure to perform during the planning stage as it would give the auditor information regarding changes in the client's business during the period

Choice "b" is incorrect This would not be considered an analytical procedure

Choice "c" is incorrect Although this is an analytical procedure, it would likely be one performed during the specific review of salaries expense, as opposed to one performed during the planning stage Choice "d" is incorrect This would not be considered an analytical procedure

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18

Which of the following should an auditor do when control risk is assessed at the maximum level?

a Perform fewer substantive tests of details

b Perform more tests of controls

c Document the assessment

d Document the control structure more extensively

Solution:

Choice "c" is correct When an auditor assesses control risk at the maximum level, the assessment should be documented and the auditor should make decisions to potentially perform more substantive procedures

Choice "a" is incorrect When control risk is assessed at the maximum level, more, not fewer substantive tests of details would be performed

Choice "b" is incorrect All tests of controls should have been performed before assessing the control risk

at the maximum level

Choice "d" is incorrect All control structure documentation should have been performed prior to

assessing the control risk at the maximum level

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19

The company being audited has an internal auditor that is both competent and objective The

independent auditor wants to assign tasks for the internal auditor to perform Under these circumstances, the independent auditor may:

a Allow the internal auditor to perform tests of internal controls

b Allow the internal auditor to audit a major subsidiary of the company

c Not assign any task to the internal auditor because of the internal auditor's lack of independence

d Allow the internal auditor to perform analytical procedures, but not be involved with any tests of details

Solution:

Choice "a" is correct When planning the audit, the auditor should consider the extent of involvement of the client's internal auditors in the performance of the audit Although they can be involved with tests of controls and of details (i.e., substantive tests), their involvement should generally be limited

Choice "b" is incorrect When planning the audit, the auditor should consider the extent of involvement of the client's internal auditors in the performance of the audit Although they can be involved with tests of controls and of details (i.e., substantive tests), their involvement should generally be limited

Choice "c" is incorrect Independence is not required, nor can it be obtained by an internal auditor Choice "d" is incorrect When planning the audit, the auditor should consider the extent of involvement of the client's internal auditors in the performance of the audit Although they can be involved with tests of controls and of details (i.e., substantive tests), their involvement should generally be limited

c Assessing control risk too low

d Assessing control risk too high

Solution:

Choice "b" is correct The risk of incorrect acceptance is the risk that the sample supports the conclusion that the recorded account balance is not materially misstated when in fact it is materially misstated (i.e., sample results fail to identify an existing material misstatement)

Choice "a" is incorrect Incorrect acceptance would be the opposite of the above situation

Choice "c" is incorrect Control risk deals with internal controls, not account balances

Choice "d" is incorrect Control risk deals with internal controls, not account balances

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21

According to the AICPA Code of Professional Conduct, which of the following actions by a CPA most likely involves an act discreditable to the profession?

a Refusing to provide the client with copies of the CPA's workpapers

b Auditing financial statements according to governmental standards despite the client's preferences

c Accepting a commission from a nonattest function client

d Retaining client records after the client demands their return

Solution:

Choice "d" is correct Retaining client owned records after the client demands their return is a violation of Rule 501 – discreditable acts

Choice "a" is incorrect As the CPA's workpapers are technically owned by the CPA, there is no

requirement to turn them over to the client

Choice "b" is incorrect This would not be considered a discreditable act Failure to follow such

standards may be considered an act discreditable

Choice "c" is incorrect This is not a violation, as the client is a nonattest client

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22

When planning a review of an audit client's interim financial statements, which of the following procedures should the accountant perform to update the accountant's knowledge about the entity's business and its internal control?

a Perform analytical procedures on selected accounts by comparing the interim amounts to the

amounts for the previous audited fiscal year end

b Inquire of the entity's outside legal counsel about the status of any previous pending litigation and any new litigation involving the entity

c Select a sample of material revenue transactions occurring during the interim period and examine supporting documentation

d Consider the results of audit procedures performed with respect to the current-year's financial

statements

Solution:

Choice "d" is correct Considering the results of audit procedures that have previously been performed and how they correspond to the current year's financial statements is a step that may be performed during the planning stage to update the accountant's knowledge of the client

Choice "a" is incorrect Analytical procedures performed on specific accounts would more likely be done during the testing stage of the review, not during the planning stage

Choice "b" is incorrect Inquiry of the client's legal counsel is not required in a review engagement Choice "c" is incorrect Examination of supporting documentation for specific transactions would not be performed during a review; this is an audit procedure A review consists principally of inquiry and

analytical procedures

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23

An accountant has been engaged to compile pro forma financial statements During the accountant's acceptance procedures, it is discovered that the accountant is not independent with respect to the company What action should the accountant take with regard to the compilation?

a The accountant should discuss the lack of independence with legal counsel to determine whether it is appropriate to accept the engagement

b The accountant should disclose the lack of independence in the accountant's compilation report

c The accountant should withdraw from the engagement

d The accountant should compile the pro forma financial statements but should not provide a

compilation report

Solution:

Choice "b" is correct An accountant who is not independent with respect to an entity may compile financial statements for such an entity and issue a report The last paragraph of the report should

disclose this lack of independence and may disclose the reasons for the lack

Choice "a" is incorrect As there is no requirement for independence in a compilation engagement, there

is no need for legal counsel

Choice "c" is incorrect Withdrawal is not required, as independence is not required in compilation engagements

Choice "d" is incorrect A compilation report is required if the compilation engagement is completed

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24

In an accountant's review of interim financial information, the accountant typically performs each of the

following, except:

a Reading the available minutes of the latest stockholders' meeting

b Applying financial ratios to the interim financial information

c Inquiring of the accounting department's management

d Obtaining corroborating external evidence

Solution:

Choice "d" is correct When performing a review engagement, the accountant should perform procedures

to accumulate evidence to provide a reasonable basis for obtaining limited assurance that there are no material modifications that should be made to the financial statements in order for the statements to be in conformity with the applicable financial reporting framework The accountant should use professional judgment to determine the nature, timing and extent of review procedures, which consist primarily of inquiry and analytical procedures As such, obtaining corroborating external evidence would generally not be required

Choices "a", "b", and "c" are incorrect per the above explanation

Choice "b" is incorrect Independence is not impaired in a financial institution client by a fully

collateralized car loan with a financial institution client

Choice "d" is incorrect A covered member's spouse and dependents are also generally subject to Rule 101; however this does not extend to grandparents

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26

A primary objective of analytical procedures used in the final review stage of an audit is to:

a Identify account balances that represent specific risks relevant to the audit

b Gather evidence from tests of details to corroborate financial statement assertions

c Detect fraud that may cause the financial statements to be misstated

d Assist the auditor in evaluating the overall financial statement presentation

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27

Which of the following conditions or events most likely would cause an auditor to have substantial doubt about an entity's ability to continue as a going concern?

a Significant related party transactions are pervasive

b Usual trade credit from suppliers is denied

c Arrearages in preferred stock dividends are paid

d Restrictions on the disposal of principal assets are present

Solution:

Choice "b" is correct Denial of usual trade credit is one example of a financial difficulty that may be indicative of substantial doubt about an entity's ability to continue as a going concern

Choice "a" is incorrect Pervasive significant related party transactions, by themselves, are not

necessarily indicative of an entity's ability to continue as a going concern

Choice "c" is incorrect The ability to pay arrearages in preferred stock dividends would be indicative of financial health and would not create substantial doubt about an entity's ability to continue as a going concern

Choice "d" is incorrect Restrictions on the disposal of principal assets would not cause an auditor to have substantial doubt about an entity's ability to continue as a going concern

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Accepting an engagement to compile a financial projection most likely would be inappropriate if the projection is to be distributed to:

a The entity's principal stockholder, to the exclusion of the other stockholders

b Potential stockholders in an offering statement

c A financial institution in a loan application

d A state or federal regulatory agency

Solution:

Choice "b" is correct Financial projections are appropriate only for limited use Limited use means that the financial statements will only be used by the responsible party alone or by parties negotiating directly with the responsible party (the issuing company)

Choices "a", "c", and "d" are incorrect per the above explanation

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29

Which of the following statements extracted from a client's lawyer's letter concerning litigation, claims, and assessments most likely would cause the auditor to request clarification?

a "We believe that the possible liability to the company is nominal in amount."

b "We believe that the action can be settled for less than the damages claimed."

c "We believe that the plaintiff's case against the company is without merit."

d "We believe that the company will be able to defend this action successfully."

Solution:

Choice "b" is correct This statement seems to give some indication that the lawyer believes that there is

at least some likelihood that there may be a known or estimable amount and that the case may actually result in a liability

Choice "a" is incorrect This statement does not indicate that an amount may be known that would allow the auditor to report anything on the financial statements

Choice "c" is incorrect This statement seems to indicate a remote likelihood of any liability arising from this case, thus no disclosure would be needed

Choice "d" is incorrect This statement seems to indicate a remote likelihood of any liability arising from this case, thus no disclosure would be needed

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After considering management's plans, an auditor concludes that there is substantial doubt about a client's ability to continue as a going concern for a reasonable period of time The auditor's responsibility includes:

a Disclaiming an opinion on the financial statements due to the indications of possible financial

Choice "a" is incorrect There is no requirement to disclaim an opinion solely due to a going concern issue

Choice "b" is incorrect The auditor does not have a responsibility to communicate to the audit committee whether management's plans can or cannot be effectively implemented

Choice "d" is incorrect A qualified or adverse opinion is only required in situations where there is no adequate disclosure

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31

Which of the following procedures would an auditor most likely perform to obtain evidence about the occurrence of subsequent events?

a Determine whether inventory ordered before the year end was included in the physical count

b Inquire about payroll checks that were recorded before year end but cashed after year end

c Investigate changes in capital stock recorded after year end

d Review tax returns prepared by management after year end

Solution:

Choice "c" is correct A change in capital stock that is recorded after the year end is an example of a subsequent that might require disclosure in the footnotes to the financial statements

Choice "a" is incorrect The inventory issue discussed in this solution would not be considered a

subsequent event because the inventory was ordered before year-end

Choice "b" is incorrect If the payroll checks were recorded prior to year end, there is no subsequent event issue

Choice "d" is incorrect Tax returns prepared after year end would not be considered a subsequent event issue

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When an auditor decides to confirm accounts receivable balances rather than individual invoices, it most likely would be beneficial to include with the confirmations:

a Copies of the client's shipping documents that support the account balances

b Lists of the customers' recent payments that the client has already recorded

c Client-prepared statements of account that show the details of the account balances

d Copies of the customers' purchase orders that support the account balances

Solution:

Choice "c" is correct When confirming the total accounts receivable balance, it is beneficial to include a client-prepared statement of account that shows the details of the account balances so that the

confirmation recipients can more easily verify the receivable balance

Choice "a" is incorrect The client's shipping documents would not generally be helpful to allow a respondent to be able to confirm an existing balance

Choice "b" is incorrect Listing client payments that had already been recorded would generally not be relevant in confirming unpaid invoices

Choice "d" is incorrect The customer's purchase orders would not generally be helpful to allow a respondent to be able to confirm an existing balance