Solution manual principles of accounting by arens elder beasley

Answer: Generally accepted auditing standards are general guidelines to help auditors meet their professional responsibilities in the audit of historical financial statements.. Generally

Chapter 1

Multiple-Choice Questions

1

easy

Recording, classifying, and summarizing economic events in a logical manner for the purpose

of providing financial information for decision making is commonly called:

c a Regulatory accounting principles

b Cash basis of accounting

c Generally accepted accounting principles

d Liquidation basis of accounting

4 Three common types of attestation services are:

easy a audits, reviews, and “other” attestation services

a b audits, verifications, and “other” attestation services

c reviews, verifications, and “other” attestation services

d audits, reviews, and verifications

5 (SOX)

easy

The organization that is responsible for providing oversight for auditors of public companies is called the

d a Auditing Standards Board

b American Institute of Certified Public Accountants

c Public Oversight Board

d Public Company Accounting Oversight Board

6 (SOX) The Sarbanes-Oxley Act applies to which of the following companies?

easy a All companies

c b Privately held companies

8 An audit of historical financial statements most commonly includes the:

medium a balance sheet, the income statement, and the statement of cash flows

d b income statement, the statement of cash flows, and the statement of net working capital

c statement of cash flows, the balance sheet, and the retained earnings statement

d balance sheet, the income statement, and the statement of cash flows

9

medium

The _ rate may be defined as approximately the rate a bank could earn by investing

in U.S treasury notes for the same length as the length of a business loan

b stated

c risk-free

d prevailing

10 The use of the Certified Public Accountant title is regulated by:

medium a the federal government

b b state law through a licensing department or agency of each state

c the American Institute of Certified Public Accountants through the licensing departments

of the tax and auditing committees

d the Securities and Exchange Commission

11 An operational audit has as one of its objectives to:

medium a determine whether the financial statements fairly present the entity’s operations

c b evaluate the feasibility of attaining the entity’s operational objectives

c make recommendations for improving performance

d report on the entity’s relative success in attaining profit maximization

12 An audit of historical financial statements is most often performed to determine whether the: medium a organization is operating efficiently and effectively

d b entity is following specific procedures or rules set down by some higher authority

c management team is fulfilling its fiduciary responsibilities to shareholders

d none of these choices

15 Which of the following is a type of audit evidence?

medium a Oral responses to the auditor from employees of the company under audit

d b Written communications from company employees or outsiders

c Observations made by an auditor

d Evidence may take any of the above forms

16 Which of the following services provides the lowest level of assurance on a financial statement? medium a A review

c Neither service provides assurance on financial statements

d Each service provides the same level of assurance on financial statements

17 The three requirements for becoming a CPA include all but which of the following?

medium a Uniform CPA examination requirement

b determining if fraud has occurred

c determining if taxable income has been calculated correctly

d analyzing the financial information to be sure that it complies with government requirements

19

medium

Financial statement users often receive unreliable financial information from companies Which

of the following is not a common reason for this?

d a Complex business transactions

b Large amounts of data

c Lack of firsthand knowledge about the business

d Each of these choices is a common reason for unreliable financial information

20 Which of the following is not a Trust Services principle as defined by the AICPA or CICA?

challenging a Online privacy

b Compliance with government regulations

c Efficiency and effectiveness of operations

d All three of the above are equally difficult

22 (SOX)

challenging

The Sarbanes-Oxley Act prohibits a CPA firm that audits a public company from providing which of the following types of services to that company?

c a Reviews of quarterly financial statements

b Preparation of corporate tax returns

c Most consulting services

d Tax services

23 Which of the following audits can be regarded as generally being a compliance audit?

challenging a IRS agents’ examinations of taxpayer returns

a b GAO auditor’s evaluation of the computer operations of governmental units

c An internal auditor’s review of a company’s payroll authorization procedures

d A CPA firm’s audit of the local school district

24 Which of the following can be significantly affected by an audit?

challenging a Business risk

b b Information risk

c The risk-free interest rate

d Inherent risk

25 The trait that distinguishes auditors from accountants is the:

challenging a auditor’s ability to interpret accounting principles generally accepted in the United States

d b auditor’s education beyond the Bachelor’s degree

c auditor’s ability to interpret FASB Statements

d auditor’s accumulation and interpretation of evidence related to a company’s financial statements

c ysTrust services provide assurance on internal control over financial reporting

d SysTrust services provide assurance as to whether accounting personnel are following procedures prescribed by the company controller

The three primary requirements for becoming a CPA are:

Educational requirement An undergraduate degree with a major in accounting is

required Most states now require 150 semester hours for licensure and some states require 150 semester hours before taking the CPA exam

Uniform CPA examination requirement This is a four-part exam with components on

auditing and attestation, financial accounting and reporting, regulation, and business environment and concepts

Experience requirement The experience requirement varies from state to state with

some states requiring no experience, while other states require up to two years of audit experience

28

easy

Two types of attestation services provided by CPA firms are audits and reviews Discuss the similarities and differences between these two types of attestation services Which type provides the least assurance?

Answer:

Two primary types of attestation services are: audits of historical financial statements and reviews of historical financial statements While both services involve the accumulation and evaluation of evidence regarding assertions made by management in the company’s financial statements, a review involves a less extensive examination and provides a lower level of assurance about the client’s financial statements than an audit

The role of auditors is to determine whether the financial information prepared by accountants properly reflects the economic events that occurred To do this, the auditor must not only understand the principles and rules that provide the basis for preparing financial information, but must also possess expertise in the accumulation and evaluation

of audit evidence It is this latter expertise that distinguishes auditors from accountants

an entity’s federal tax return to determine the degree of compliance with the Internal Revenue Code

33

challenging

To do an audit, it is necessary for information to be in a verifiable form and some criteria by which the auditor can evaluate the information (A) What information and criteria would an independent CPA firm use when auditing a company’s historical financial statements? (B) What information and criteria would an Internal Revenue Service auditor use when auditing that same company’s tax return? (C) What information and criteria would an internal auditor use when performing an operational audit to evaluate whether the company’s computerized payroll processing system is operating efficiently and effectively?

Answer:

(A) The information used by a CPA firm in a financial statement audit is the financial information in the company’s financial statements The most commonly used criteria are accounting principles generally accepted in the United States

(B) The information used by an IRS auditor is the financial information in the company’s federal tax return The criteria are the internal revenue code and interpretations

(C) The information used by an internal auditor when performing an operational audit of the payroll system could include various items such as the number of errors made, costs incurred by the payroll department, and number of payroll records processed each month The criteria would consist of company standards for departmental efficiency and effectiveness

34

challenging

Explain what is meant by information risk, and discuss the four causes of this risk

Answer:

Information risk is the possibility that information upon which a business decision is made

is inaccurate Four causes of information risk are:

remoteness of information, biases and motives of the provider, voluminous data, and

complex exchange transactions

35 Attestation services fall into five categories What are these categories?

challenging Answer:

The five categories of attestation services include:

audits of historical financial statements, attestation on internal control over financial reporting, reviews of historical financial statements,

attestation services on information technology, and other attestation services that may be applied to a broad range of subject matter

new accounting and auditing standards, and auditors will find more efficient and effective audit techniques

Other Objective Answer Format Questions

The criterion that is most likely to be used as a framework in evaluating a company’s internal

control over financial reporting under Section 404 of the Sarbanes-Oxley Act is the Enterprise

Risk Management framework

Chapter 2

Multiple-Choice Questions

1 Which one of the following is not one of the three General Standards?

easy a Proper planning and supervision

a b Independence of mental attitude

c Adequate training and proficiency

d Due professional care

2 Which one of the following is not a Field Work Standard?

easy a Adequate planning and supervision

b b Due professional care

c Understand the entity and its environment including internal control

d Sufficient appropriate audit evidence

3 The General Standards stress the importance of:

easy a evidence accumulation

b b personal qualities the auditor should possess

c communicating the auditor’s findings to the reader

d general supervision of the audit

4

easy

The generally accepted auditing standard that requires “Adequate technical training and proficiency” is normally interpreted as requiring the auditor to have:

a a formal education in auditing and accounting

b worked for an entity similar to the entity being audited

c independence in mental attitude

d a graduate degree in a business field

5 (SOX) Members of the Public Company Accounting Oversight Board are appointed and overseen by: easy a the U.S Congress

d b the American Institute of Certified Public Accountants

c the Auditing Standards Board

d the Securities and Exchange Commission

7

easy

Which of the following statements most accurately captures the intent of the standards of field work?

c a Field work standards are primarily concerned with personal attributes necessary during the

conduct of the audit

b Field work standards provide extensive guidance regarding the conduct of an audit

c Field work standards are primarily directed at the auditor’s planning, understanding of internal control, and evidence accumulation

d Field work standards are primarily concerned with the conduct of substantive testing as opposed to testing of internal controls

8 (SOX)

easy

Prior to the passage of the Sarbanes-Oxley Act, which of the following was responsible for establishing auditing standards?

c a Securities and Exchange Commission

b Public Company Accounting Oversight Board

c Auditing Standards Board

d National Association of Accounting

9 (SOX)

medium

Standards issued by the Public Company Accounting Oversight Board must be followed by CPAs who audit:

b a both private and public companies

b public companies only

c private companies, public companies, and nonprofit entities

d private companies only

10 Which of the following is the least likely form of business for a CPA firm?

medium a General partnership

b b General corporation

c Limited liability company

d Limited liability partnership

11 The Statements on Auditing Standards issued by the Auditing Standards Board:

medium a are interpretations of generally accepted auditing standards

a b are the equivalent of laws for audit practitioners

c must be followed in all situations

d are optional guidelines which an auditor may choose to follow or not follow when conducting an audit

12 An auditor need not abide by a particular auditing standard if the auditor believes that:

medium a the issue in question is immaterial in amount

a b more expertise is needed to fulfill the requirement

c the requirement of the standard has not been addressed by the PCAOB

d any of the above three are correct

13 (SOX) The Public Company Accounting Oversight Board does not:

medium a perform inspections of the quality controls at audit firms that audit public companies

b b establish auditing standards that must be followed by CPAs on all audits

c oversee auditors of public companies

d perform any of the above functions

c a objective review of the adequacy of the technical training of firm personnel

b thorough review of the existing internal control structure

c critical review of work done at every level of supervision

d periodic review of a CPA firm’s quality control procedures

17 (SOX)

medium

Assume the Public Company Accounting Oversight Board (PCAOB) identifies a violation during its inspection of a registered accounting firm

d a The PCAOB may not enforce some disciplinary action against the accounting firm

b The PCAOB may not report the matter to the Securities and Exchange Commission

c The PCAOB may not report the matter to the appropriate state accountancy board

d The PCAOB may not suspend the license to practice of the CPA guilty of the violation

19 Statements on Standards for Accounting and Review Services are issued by the:

medium a Accounting and Review Services Committee

a b Professional Ethics Executive Committee

c Securities and Exchange Commission

d Financial Accounting Standards Board

20 Consulting Standards are issued by the:

medium a Accounting and Review Services Committee

c b Securities and Exchange Commission

c Management Consulting Services Executive Committee

d Financial Accounting Standards Board

b generally accepted auditing standards which include the concept of materiality

c the auditor’s evaluation of the audited company’s internal control

d generally accepted accounting principles

22

medium

A basic objective of a CPA firm is to provide professional services to conform to professional standards Reasonable assurance of achieving this basic objective is provided through:

c a continuing professional education

b compliance with generally accepted reporting standards

c a system of quality control

d a system of peer review

23

medium

Within the context of quality control, the primary purpose of continuing professional education and training activities is to enable a CPA firm to provide its personnel with:

c a technical training that assures proficiency as a valuation expert

b professional education that is required in order to perform with due professional care

c knowledge required to fulfill assigned responsibilities

d knowledge required to perform a peer review

24

medium

Williams & Co., a member of the Private Companies Practice Section, is to have a “peer review.” The peer review can be performed by:

d a a CPA firm selected by Williams & Co

b a review team selected by the state society

a investors in Hansen Corporation’s stock

b stock exchange

c Securities and Exchange Commission

d management of Hansen Corporation

26 Which of the following is not an essential component of quality control?

c Policies to ensure that personnel maintain their independence in fact and in appearance

d Policies that ensure that monitoring activities are effectively applied

27 Which of the following is true regarding the AICPA-approved practice monitoring programs? challenging a The Center for Public Company Audit Firms does not offer a peer review program

c b Firms registered with the PCAOB must not enroll in an AICPA-approved practice

Which of the following statements is true as it relates to limited liability partnerships?

a Only senior partners are liable for the partnership’s debts

b Partners have no liability in a limited liability partnership arrangement

c Partners are personally liable for the acts of those under their supervision

d All partners must be AICPA members

29 (SOX)

challenging

If an auditor of a public company cannot find guidance issued by the PCAOB on a particular audit matter, the auditor should generally seek guidance from which of the following sources?

a a Statements on Auditing Standards

b Statements on Standards for Accounting and Review Services

c Regulations issued by the Securities and Exchange Commission

d The AICPA Code of Professional Conduct

30 The SEC requirements of greatest interest to CPAs are set forth in the SEC’s:

challenging a Regulation S-X and Accounting Series Releases

d a Auditing standards applicable to financial statements of private companies

b Compilation and review standards

c a ideals to work towards, but which are not achievable

b maximum standards that denote excellent work

c minimum standards of performance that must be achieved on each audit engagement

d benchmarks to be used on all audits, reviews, and compilations

33

challenging

Which one of the following is not a requirement for belonging to the Private Companies Practice Section of the American Institute of Certified Public Accountants?

c a Adherence to quality control standards

b Mandatory peer review

c Partner rotation after a period of ten consecutive years

Answer:

Generally accepted auditing standards are general guidelines to help auditors meet their professional responsibilities in the audit of historical financial statements They are considered to be the minimum standards of performance for auditors to follow and are established by the Auditing Standards Board of the American Institute of Certified Public Accountants for private companies and by the Public Company Accounting Oversight Board for public companies Generally accepted accounting principles are the guidelines which an entity’s management normally follows when preparing historical financial statements GAAP is established by the Financial Accounting Standards Board

36 Discuss the relationship between quality control and generally accepted auditing standards

easy

Answer:

For a CPA firm, quality control encompasses the methods used to make sure that the firm meets its professional responsibilities to clients Quality control is closely related to, but distinct from, GAAS A CPA firm must make sure that GAAS are followed on every audit Quality controls are the procedures used by the CPA firm that help it meet requirements demanded by GAAS on every engagement in a consistent manner

Senior or In-charge auditor - Seniors coordinate and are responsible for the audit field

work, including the supervision and review of staff assistants’ work

Manager - Managers assist the senior plan and manage the audit, review the senior’s

work, and manages relations with the client A manager may be responsible for multiple engagements at the same time

Partner - Partners review the overall audit work and they are involved in all

significant audit decisions As owners of the firm, partners are ultimately responsible for conducting the audit and serving the client

38

medium

Discuss the five elements of quality control Who establishes the standards for quality control? Answer:

Independence, integrity and objectivity - Personnel on engagement should maintain

independence in fact and in appearance, perform all professional responsibilities with integrity and maintain objectivity in performing their professional responsibilities

Personnel management - Policies and procedures should be established to provide the

firm with reasonable assurance that all new personnel are qualified to perform their work, work is assigned to personnel who have adequate training, and personnel should participate in continuing professional education

Acceptance and continuation of clients and engagements - Policies and procedures

should be established for deciding whether to accept or continue a client relationship These policies should minimize the risk of associating with a client whose management lacks integrity

Engagement performance - Policies and procedures should exist to ensure that

engagement personnel perform work that meets applicable professional standards and the firm’s standards of quality

Monitoring - Policies and procedures should exist to ensure that the other four quality

control elements are being effectively applied

Quality control standards are established by the Auditing Standards Board for auditors

of private companies and by the Public Company Accounting Oversight Board for auditors of public companies

39

medium

Describe the six organizational structures available to CPA firms

Answer:

CPA firms can take one of six organizational forms:

Proprietorship This form is limited to firms with only one owner

General partnership This form is similar to a proprietorship, except that it applies to

multiple owners

General corporation Unlike a general partnership, shareholders in a general

corporation are liable only to the extent of their investment in the corporation

Professional corporation Professional corporations can have one or more

shareholders Personal liability protection for shareholders in professional corporations varies widely from state to state

Limited liability company This form combines the most favorable attributes of a

general corporation and a general partnership LLCs are taxed like a general partnership, but its owners have limited personal liability like shareholders of a general corporation

Limited liability partnership An LLP is structured and taxed like a general

partnership However, the personal liability protection of an LLP is less than that of a general corporation or an LLC, but it is greater than a general partnership Many accounting firms now operate as LLPs

Independence in mental attitude

Due professional care

Standards of Fieldwork Adequate planning and supervision

Understand the entity and its environment including internal control

Sufficient appropriate audit evidence

Standards of Reporting Whether statements were prepared in accordance with GAAP

Circumstances when GAAP was not consistently followed

Adequacy of informative disclosures

Expression of opinion on financial statements as a whole

41

medium

In the context of auditing, explain what is meant by an independent mental attitude Discuss how internal auditors can have an independent mental attitude when they are employed by the company they audit

to be free from influence by the party, or parties, being examined

42 (SOX)

medium

The Sarbanes-Oxley Act established the Public Company Accounting Oversight Board (PCAOB) What are the PCAOB’s primary functions? Who performed these functions prior to the PCAOB?

Answer:

The PCAOB has responsibility for providing oversight auditors of public companies, establishing auditing and quality control standards for public company audits and

performing inspections of the quality controls at audit firms performing those audits These functions were formerly the responsibility of the American Institute of Certified Public Accountants

43

challenging

What are four of the major functions of the AICPA?

Answer:

Major functions of the AICPA include:

Establishing standards and rules that practicing CPAs must follow These standards consist of auditing standards for auditors of private companies, compilation and

review standards, other attestation standards, and the Code of Professional Conduct Research and publication AICPA publications include the Journal of Accountancy, industry audit guides, periodic updates of the Codification of Statements on Auditing

Standards, and the Code of Professional Conduct

Promoting the accounting profession

Developing specialist certifications

Writing and grading the uniform CPA examination

Providing continuing education seminars for its members

45

challenging

The purpose of the AICPA’s CPA Vision Project is to help CPAs make sense of our changing and complex world The Project has identified core values that CPAs must be aware of in the future What are the top five core values?

Answer:

Continuing education and lifelong learning Competence

Integrity Attuned to broad business issues Objectivity

Other Objective Answer Format Questions

Chapter 3

Multiple-Choice Questions

1 Auditing standards require that the audit report must be titled and that the title must:

easy a include the word “independent.”

a b indicate if the auditor is a CPA

c indicate if the auditor is a proprietorship, partnership, or incorporated

d indicate the type of audit opinion issued

3 The purpose of the introductory paragraph in the standard unqualified report is:

easy a to identify that the type of opinion issued is unqualified

b b to identify the financial statements audited and the dates and time periods covered by the

report

c to indicate the CPA followed applicable audit standards

d to indicate all the financial statements are in accordance with GAAP

4 The scope paragraph of the standard unqualified audit report states that the audit is designed to: easy a discover all errors and/or irregularities

d b discover material errors and/or irregularities

c conform to generally accepted accounting principles

d obtain reasonable assurance whether the statements are free of material misstatement

5 The audit report date on a standard unqualified report indicates:

easy a the last day of the fiscal period

d b the date on which the financial statements were filed with the Securities and Exchange

Commission

c the last date on which users may institute a lawsuit against either client or auditor

d the last day of the auditor’s responsibility for the review of significant events that occurred subsequent to the date of the financial statements

a the financial statements have not been prepared in accordance with GAAP

b the scope of the audit has been restricted by circumstances beyond either the client’s or auditor’s control

c the auditor has lost independence

d the scope of the audit has been restricted

7 An adverse opinion is issued when the auditor believes:

easy a some parts of the financial statements are materially misstated or misleading

d b the financial statements would be found to be materially misstated if an investigation were

performed

c the auditor is not independent

d the overall financial statements are so materially misstated that they do not present fairly the financial position or results of operations and cash flows in conformity with GAAP

c a A combined report on financial statements and internal control over financial reporting

b Separate reports on financial statements and internal control over financial reporting

b Generally accepted auditing standards

c Standards issued by the PCAOB (U.S.)

d Any of the above standards

b U.S generally accepted auditing standards

c Standards issued by the PCAOB (U.S.)

d Any of the above standards

15 GAAP requires that changes in accounting principles be to a:

medium a more conservative principle

c b principle with equal authoritative support

c preferable principle

d principle detailed in a FASB pronouncement

16

easy

A CPA may wish to emphasize specific matters regarding the financial statements even though

an unqualified opinion will be issued Normally, such explanatory information is:

c a included in the scope paragraph

b included in the opinion paragraph

c included in a separate paragraph in the report

d included in the introductory paragraph

Scope Opinion Notes to the paragraph paragraph financial statements

b a the prior years presented

b the current year effect of the change

c guidelines included in GAAS

d the effect on total assets

19

medium

Conditions requiring a departure from an unqualified audit report include all but which of the following?

b a Management refused to allow the auditor to confirm significant accounts receivable for

which there were no alternative procedures performed

b Management decided not to allow the auditor to confirm significant accounts receivable, but the auditor obtained sufficient appropriate evidence by examining subsequent cash receipts

c The audit partner’s dependent child received a gift of 100 shares of a client’s stock for her birthday from a grandparent

d Management has determined that fixed assets should be reported in the balance sheet at their replacement values rather than historical costs The auditors do not concur

20 The introductory paragraph of the standard audit report states that the financial statements are: medium a the responsibility of the auditor

b b the responsibility of management

c the joint responsibility of management and the auditor

d none of the above

21

medium

The introductory paragraph of the standard audit report states that the financial statements and the opinion expressed about those statements are:

d a the responsibility of the auditor

b the responsibility of management

c the joint responsibility of management and the auditor

d none of the above

22 The introductory paragraph of the standard audit report states that the auditor is:

medium a responsible for the financial statements and the opinion on them

c b responsible for the financial statements

c responsible for the opinion on the financial statements

d jointly responsible for the financial statements with management

23 (Public)

medium

PCAOB Auditing Standard No 2 requires the audit of internal control over financial reporting

to be integrated with:

a a the audit of the financial statements

b the quarterly review of financial information

c the review of annual financial statements

d none of the above

a Both are in the introductory paragraph

b Both are in the scope paragraph

c Both are in the opinion paragraph

d None of the above are true

d Each of the above paragraphs is included

27 Whenever an auditor issues a qualified opinion, the implication is that the auditor:

medium a does not know if the financial statements are presented fairly

d b does not believe the financial statements are presented fairly

c believes the financial statements are presented fairly

d believes the financial statements are presented fairly “except for” a specific aspect of them

28 The necessity to issue a disclaimer of opinion may arise because of:

medium a a severe limitation on the scope of the audit

c b a lack of independence between the auditor and client

d either a qualified opinion or an unqualified opinion with modified wording

30 If the auditor lacks independence, a disclaimer of opinion must be issued:

medium a if the client requests it

d b only if it is highly material

c only if it is material but not highly material

b understatement of retained earnings caused by a miscalculation of dividends payable

c misclassification of notes payable as a long-term liability when it should be current

d misclassification of salary expense as a selling expense when it should be allocated equally to both selling and administrative expense

33

medium

The dollar amount of some misstatements cannot be accurately measured For example, if the client were unwilling to disclose an existing lawsuit, the auditor must estimate the likely effect on:

b users of the financial statements

c the auditor’s exposure to lawsuits

d management’s future decisions

34 Whenever there is a scope restriction, the appropriate response is to issue a(n):

medium a disclaimer of opinion

b Loss of major customers

c Significant recurring operating losses

d Working capital deficiencies

a may issue either an unqualified or a qualified opinion

b must issue an adverse opinion with “except for” in the opinion paragraph

c may issue an unqualified opinion

d must issue a qualified opinion with “except for” in the opinion paragraph

37 When a disclaimer is issued because the auditor lacks independence:

medium a no report title is included on the report

d b a one-paragraph audit report is issued

c the only reason cited for issuing the disclaimer is the lack of independence

d all of the above are correct

c a Change in accounting principle, such as a change from LIFO to FIFO

b Change in reporting entity, such as the inclusion of an additional company in combined financial statements

c Change in an estimate, such as a decrease in the life of an asset for depreciation purposes

d Correction of errors by changing from non-GAAP to GAAP

a six months from the date of the financial statements

b one year from the date of the financial statements

c six months from the date of the audit report

d one year from the date of the audit report

43

medium

When the auditor concludes that there is substantial doubt about the entity’s ability to continue

as a going concern, the appropriate audit report would be:

d a an unqualified opinion with an explanatory paragraph

b a disclaimer of opinion

c neither a nor b

d either a or b

44 An auditor may not issue a qualified opinion when:

medium a a scope limitation prevents the auditor from completing an important audit procedure

c b the auditor’s report refers to the work of a specialist

c the auditor lacks independence with respect to the audited entity

d an accounting principle at variance with GAAP is used

45

medium

When a company’s financial statements contain a departure from GAAP with which the auditor concurs, the departure should be explained in:

b a the scope paragraph

b an explanatory paragraph that appears before the opinion paragraph

c the opinion paragraph

d an explanatory paragraph after the opinion paragraph

a must not refer to the examination of the other auditor

b must refer to the examination of the other auditor

c may refer to the examination of the other auditor

d may refer to the examination of the other auditor, in which case Gregory must include in the auditor’s report on the consolidated financial statements a qualified opinion with respect to the examination of the other auditor

a no reference to consistency

b a reference to a prior period adjustment in the opinion paragraph

c an explanatory paragraph that justifies the change and explains the impact of the change

on reported net income

d an explanatory paragraph explaining the change

a Positive assurance on the financial statements and on the effectiveness of internal control over financial reporting

b Positive assurance on the financial statements and negative assurance on the effectiveness

of internal control over financial reporting

c Limited assurance on the financial statements and on the effectiveness of internal control over financial reporting

d There is no guidance on what level of assurance to provide

a disclaimer of opinion in all cases

b qualification of both scope and opinion in all cases

c disclaimer of opinion whenever materiality is in question

d qualification of both scope and opinion whenever materiality is in question

51

medium

CPAs issue several types of “special audit reports.” Which of the following circumstances

would not require the issuance of a special audit report?

b a The client’s financial statements are prepared using the cash basis

b The client’s financial statements are prepared using the accrual basis

c The CPA has been retained to audit only the current assets

d The CPA has been retained to review the internal control system, not the financial statements

52 When a qualified or adverse opinion is issued, the qualifying paragraph is inserted:

medium a between the introductory and scope paragraphs

b b between the scope and opinion paragraphs

c after the opinion paragraph, as a fourth paragraph

d immediately after the address, as the first paragraph

53 For the report containing a disclaimer for lack of independence, the disclaimer is in the:

challenging a third or opinion paragraph

c b second or scope paragraph

c first and only paragraph

d fourth or explanatory paragraph

54 Which of the following is not a primary category of attestation report?

challenging a Compilation report

b a determine that they are not in violation of FASB statements

b examine the substance of transactions and balances for possible misinformation

c review the statements using the accounting principles promulgated by the SEC

d assure investors that net income reported this year will be exceeded in the future

56 In which of the following situations would the auditor most likely issue an unqualified report? challenging a The client valued ending inventory by using the replacement cost method

d b The client valued ending inventory by using the Next-In-First-Out (NIFO) method

c The client valued ending inventory at selling price rather than historical cost

d The client valued ending inventory by using the First-In-First-Out (FIFO) method, but showed the replacement cost of inventory in the Notes to the Financial Statements

57 Which of the following statements is true?

c The auditor is required to issue a disclaimer of opinion for a material uncertainty and for

a going concern problem

d The auditor has the option, but is not required, to issue a disclaimer of opinion for a material uncertainty or for a going concern problem

58

medium

The most common case in which conditions beyond the client’s and auditor’s control cause a scope restriction is an engagement:

a a agreed upon after the client’s balance sheet date

b where the client won’t allow the auditor to confirm receivables for fear of offending its

When the auditor cannot perform procedures and the amounts are so material that a disclaimer

of opinion rather than a qualified opinion is required, the:

d a opinion paragraph will state “does not present fairly.”

b opinion paragraph will state “presents fairly.”

c scope paragraph will be unchanged from the standard unqualified opinion

d scope paragraph will be deleted

d a inform the reader that disclosure is not adequate, and to issue an adverse opinion

b inform the reader that disclosure is not adequate, and to issue a qualified opinion

c present the information in the audit report and issue an unqualified or qualified opinion

d present the information in the audit report and to issue a qualified or an adverse opinion

62

challenging

The “unqualified report with explanatory paragraph” and the “unqualified report with modified wording”:

c a arise as a result of an incomplete audit

b arise when the financial statements are not “presented fairly.”

c meet the criteria of a complete audit with satisfactory results

d meet the criteria of a complete audit but with unsatisfactory results

b Reports involving other auditors

c Auditor disagrees with client’s departure from GAAP

d Lack of consistent application of GAAP

64

challenging

Which of the following is not one of the principal CPA firm’s alternatives when issuing a report

if a different CPA firm performed part of the audit?

a a Issue a joint report signed by both CPA firms

b Make no reference to the other CPA firm in the audit report, and issue the standard unqualified opinion

c Make reference to the other auditor in the report by using modified wording (a shared opinion or report)

d A qualified opinion or disclaimer, depending on materiality, is required if the principal auditor is not willing to assume any responsibility for the work of the other auditor

65 Which of the following statements is not true?

challenging a A one-paragraph report is generally used when the auditor is not independent

c b A three-paragraph report ordinarily indicates there are no exceptions in the audit

c More than three paragraphs in the report indicates there must be some type of qualification in the audit

d An unqualified opinion with an explanation or modified wording would require more

than three paragraphs

b A change in the estimate of provisions for warranty costs

c The change from the cost method to the equity method of accounting for investments in common stock

d A change in depreciation method which has no effect on current year’s financial statements but is certain to affect future years

a There is a material scope limitation, and the auditor is not independent

b There is a material GAAP violation, and the auditor is not independent

c There is a material scope limitation, and there is substantial doubt about the company’s ability to continue as a going concern

d There is a substantial doubt about the company’s ability to continue as a going concern, and information about the causes of the uncertainties is not adequately disclosed in a footnote

No

Yes

No

No Yes

70

Medium Indicate which changes would require an explanatory paragraph in the audit report

b

Change in the estimated life of an asset

Variation in the format of the financial statements

The CPA makes reference to the work of another auditor to indicate shared responsibility in an unqualified opinion

74

Challenging Indicate which changes would require an explanatory paragraph in the audit report

b

The existence of related party transactions

Important events occurring subsequent to the balance sheet date

75

Medium Which auditor report would require only one paragraph?

c

Disclaimer due to lack of independence

Adverse opinion due to departure from GAAP

76

Medium Which auditor report would require only one paragraph?

b

Disclaimer due to scope restriction

Qualified opinion due to scope restriction

78

Challenging Which auditor report must have at least four paragraphs?

c

Qualified opinion due to scope restriction

Disclaimer due to a scope restriction

80

Medium Which auditor report must have at least four paragraphs?

d

Disclaimer due to lack of independence

Report required due to omission of the Statement of Cash Flows

81

Medium A CPA would express a qualified opinion with at least four paragraphs for:

c

An unjustified accounting change

A justified accounting change, properly accounted for

82

Medium A CPA would express an unqualified opinion with at least four paragraphs for:

d

An unjustified accounting change

A justified accounting change, properly accounted for

83

Medium The reasons for expressing a qualified opinion due to a departure from GAAP are expressed

in a paragraph

b a preceding the scope paragraph

b following the scope paragraph

c following the opinion paragraph

d either preceding or following the opinion paragraph, depending on materiality

84

Medium In which situation would the auditor be choosing between “except for” qualified opinion

and an adverse opinion?

d a The auditor lacks independence

b A client-imposed scope restriction

c A circumstance-imposed scope restriction

d Lack of full disclosure required by footnotes

When determining the appropriate audit report to issue, the auditor considers three levels

of materiality for a given condition These three levels are (1) immaterial, (2) material without overshadowing the financial statements as a whole, and (3) highly material For conditions involving a GAAP violation, the materiality level of the violation influences whether an unqualified, qualified, or adverse opinion is issued For conditions involving a scope restriction, the materiality of the restriction influences whether an unqualified report, a qualified scope and opinion report, or a disclaimer of opinion is issued

The five conditions that justify issuing a standard unqualified report are:

All statements—balance sheet, income statement, statement of retained earnings, and statement of cash flows—are included in the financial statements

The three general standards of GAAS have been followed in all respects on the engagement

Sufficient appropriate audit evidence has been accumulated and the auditor can conclude that the three fieldwork standards have been followed

The financial statements are presented in accordance with GAAP

There are no circumstances requiring the addition of an explanatory paragraph or modification of the wording of the report

87

medium

There are three conditions requiring a departure from an unqualified audit report Discuss each

of these three conditions and state the appropriate audit report for each condition

Answer:

The three conditions requiring a departure from an unqualified report are:

a scope restriction imposed by the client or by circumstances beyond the auditor’s or client’s control which prevents the auditor from accumulating sufficient evidence to reach a conclusion regarding whether financial statements are stated in accordance with GAAP In this condition, the auditor would issue either a qualified scope and opinion report, or a disclaimer of opinion

the financial statements were not prepared in accordance with GAAP In this condition, the auditor would issue a qualified opinion if the GAAP violation were moderately material, or an adverse opinion if the GAAP violation were highly material

the auditor is not independent In this condition, the auditor must issue a disclaimer

of opinion

88

medium

In certain circumstances, an auditor will issue an unqualified report, but the wording will differ from that of a standard unqualified report Discuss each of the five circumstances when an auditor would issue an unqualified report with an explanatory paragraph or modified wording Answer:

An unqualified report with an explanatory paragraph or modified wording is appropriate in the following circumstances:

Lack of consistent application of GAAP When the client has not followed generally

accepted accounting principles consistently in the current period in relation to the preceding period, an unqualified opinion with an explanatory paragraph following the opinion paragraph is appropriate

Substantial doubt about continuing as a going concern When an auditor concludes

there is substantial doubt about the client’s ability to continue as a going concern, an unqualified opinion with an explanatory paragraph following the opinion paragraph

is appropriate The auditor also has the option of issuing a disclaimer of opinion

A departure from GAAP with which the auditor concurs If adherence to GAAP

would result in misleading financial statements, an unqualified opinion with an explanatory paragraph is appropriate

Emphasis of a matter If the auditor wants to emphasize specific matters in the audit

report, an explanatory paragraph discussing those matters may be added to an unqualified report

Reports involving other auditors When an auditor relies upon a different CPA firm

to perform part of the audit, the auditor can indicate that responsibility for the audit is shared with another CPA firm by modifying the wording of an unqualified report

89

medium

An audit report prepared by Garrett and Brown, CPAs, is provided below The audit for the year ended December 31, 2007 was completed on March 1, 2008, and the report was issued to Javlin Corporation, a private company, on March 13, 2008 List any deficiencies in this report Do not rewrite the report

We have examined the accompanying financial statements of Dalton Corporation as of December 31, 2007 These financial statements are the responsibility of the company’s management Our responsibility is to express an opinion on these statements based on our audit

We conducted our audit in accordance with generally accepted accounting principles Those principles require that we plan and perform the audit to provide reasonable assurance about whether the financial statements are free of misstatement An audit includes examining,

on a test basis, evidence supporting the amounts and disclosures in the financial statements We believe that our audit provides a reasonable basis for our opinion

In our opinion, except for the effects of not capitalizing certain lease obligations that should be capitalized in order to conform with generally accepted accounting principles, the financial statements referred to above present accurately the financial position of Jacob Corporation as of December 31, 2007, in conformity with accounting principles generally accepted in the United States of America

Garrett and Brown, CPAs March, 2008

Answer:

The audit report contains the following deficiencies:

The report title is missing

The report is not addressed to anyone and should be addressed to shareholders or the board of directors

The introductory paragraph should refer to an “audit,” not an “examination.”

The introductory paragraph should list the financial statements that were audited The introductory paragraph refers to the wrong company

The scope paragraph should state the audit was conducted in accordance with auditing standards generally accepted in the United States of America, not generally accepted accounting principles

“Those principles …” should read “Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatements.”

The scope paragraph should contain the following phrase: “An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.”

Following the scope paragraph, there should be an explanatory paragraph that discusses the GAAP violation related to the failure to capitalize certain lease obligations

In the opinion paragraph, the auditor should state that the financial statements present

fairly…, not present accurately…

In the opinion paragraph, the phrase “…in all material respects…” should be included

In the opinion paragraph, the phrase “…and the results of its operations and its cash flows for the year then ended…” should be included

The audit report should be dated March 13, 2008

90

medium

Discuss the differences regarding how matters affecting consistency and matters affecting comparability are referred to in the audit report Provide two examples of each type of change Answer:

The auditor should disclose a material lack of consistent application of GAAP by adding

an explanatory paragraph after the unqualified opinion paragraph The explanatory paragraph should discuss the nature of the change and should refer to the footnote in the financial statements that discusses the change Changes that affect comparability, but not consistency, require no such explanatory paragraph in the audit report, assuming the change is disclosed in the footnotes

Examples of changes affecting consistency include changes in accounting principles, changes in reporting entities, and correction of errors involving accounting principles Examples of changes affecting comparability include changes in an estimate, error corrections not involving accounting principles, variations in the format and presentation

of financial information, and changes because of substantially different transactions or events

91 (Public)

medium

The following is a portion of an adverse audit report issued for a public company (Note: A separate report was issued on the effectiveness of internal control over financial reporting.)

Independent Auditor’s Report

To the shareholders of Wallace Corporation

We have audited the accompanying balance sheet of Wallace Corporation as of December

31, 2007, and the related statements of income, retained earnings, and cash flows for the year then ended These financial statements are the responsibility of the company’s management Our responsibility is to express an opinion on these financial statements based on our audit

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States) Those standards require that we plan and perform the audit to obtain reasonable 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

The company has excluded from property and debt in the accompanying balance sheet certain lease obligations that, in our opinion, should be capitalized in order to conform with generally accepted accounting principles If these lease obligations were capitalized, property would be increased by $14,500,000, long-term debt by $13,200,000, and retained earnings by

$1,300,000 as of December 31, 2007, and net income and earnings per share would be increased

by $1,300,000 and $2.25, respectively, for the year then ended

of December 31, 2007, or the results of its operations and its cash flows for the year then ended

92

medium

The following is a portion of a qualified audit report issued for a private company:

Independent Auditor’s Report

To the shareholders of Tamarak Corporation

We have audited the accompanying balance sheet of Tamarak Corporation as of October

31, 2007, and the related statements of income, retained earnings, and cash flows for the year then ended These financial statements are the responsibility of the company’s management Our responsibility is to express an opinion on these financial statements based on our audit

We conducted our audit in accordance with auditing standards generally accepted in the United States of America Those standards require that we plan and perform the audit to obtain reasonable 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

The company has included in property and debt in the accompanying balance sheet certain lease obligations that, in our opinion, should be expensed in order to conform with generally accepted accounting principles If these lease obligations were capitalized, property would be decreased by $4,000,000, long-term debt by $2,000,000, and retained earnings by $180,000 as

of October 31, 2005, and net income and earnings per share would be decreased by $180,000 and $.62, respectively, for the year then ended

93 (Public)

medium

The following is a portion of a qualified scope and opinion report due to a scope restriction (Note: A separate report was issued on the effectiveness of internal control over financial reporting.)

Independent Auditor’s Report

To the shareholders of Fast Times Corporation

We have audited the accompanying balance sheet of Fast Times Corporation as of September

30, 2007, and the related statements of income, retained earnings, and cash flows for the year then ended These financial statements are the responsibility of the company’s management Our responsibility is to express an opinion on these financial statements based on our audit Except as discussed in the following paragraph, we conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States) Those standards require that we plan and perform the audit to obtain reasonable 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

We were unable to obtain audited financial statements supporting the company’s investment in

a foreign affiliate stated at $1,040,000, or its equity in earnings of that affiliate of $501,000, which is included in net income, as described in Note 14 to the financial statements Because of the nature of the company’s records, we were unable to satisfy ourselves as to the carrying value of the investment or the equity in its earnings by means of other auditing procedures

in all material respects, the financial position of Fast Times Corporation as of September

30, 2007, and the results of its operations and its cash flows for the year then ended in conformity with generally accepted accounting principles

94

medium

Your CPA firm has completed the fieldwork for the 2007 audit of Sharp Corporation, a private company with an October year-end You were preparing to draft a standard, unqualified audit report when you discovered that the audit manager on the Sharp engagement owns 10 shares of Sharp’s common stock Prepare the appropriate report

Answer:

We are not independent with respect to Sharp Corporation, and the accompanying balance sheet as of October 31, 2007, and the related statements of income, retained earnings, and cash flows for the year then ended were not audited by us Accordingly, we do not express

Describe the standard unqualified report to be issued for an audit of a private company Begin

by specifying the seven parts of the report, and then discuss the contents of each part

Answer:

The parts of the standard unqualified report are as follows:

Report title The title must include the word “independent.” Examples of appropriate

titles are “independent auditor’s report,” or “report of independent accountant.”

Report address The report is usually addressed to the company’s stockholders or

board of directors It should not be addressed to company management

Introductory paragraph There are three important components of the introductory

paragraph First, it states that an audit was performed Second, it lists the financial statements that were audited and their dates Third, it states that management is responsible for the financial statements, and that the auditor is responsible for expressing an opinion on those statements based on an audit

Scope paragraph The scope paragraph is a factual statement about what was done

during the audit It first states that auditing standards generally accepted in the United States of America were followed by the auditor It then states that an audit is designed to obtain reasonable assurance about whether the statements are free of material misstatement It concludes by stating that the auditor evaluated the appropriateness of the accounting principles used, and estimates made, by management, and of the financial statement disclosures and presentations given

Opinion paragraph This paragraph states the auditor’s opinion concerning whether

the financial statements present fairly the client’s financial position and results of its operations and cash flows in conformity with generally accepted accounting

principles

Name of CPA firm Typically, the name of the CPA firm, and not the name of an

individual auditor, is used

Audit report date The audit report is normally dated as of the last day of fieldwork

96

challenging

Presented below is an independent auditor’s report for a private company prepared by the firm

of Harrington and Perry, LLP

In our opinion, the financial statements referred to above accurately present the financial position of EPM, Inc., in conformity with generally accepted accounting principles

Harrington and Perry, LLP December 31, 2007

Other information:

EPM, Inc., is a for-profit corporation and publishes comparative financial statements for distribution to shareholders, potential investors, and the general public The client has a calendar year-end For the most recent audit, the auditor completed all significant fieldwork on March 5,

2008 and issued the audit report on March 16, 2008 During 2007, EPM changed its method of depreciating long-term assets and properly reflected the effect of the change in the current year’s financial statements, restated the prior year’s financial statements, and properly discussed the change in a footnote (Note 4) to those statements The auditors are satisfied that the change was preferable

Required:

Consider all the facts given and rewrite the complete auditor’s report, including report title, address, body of report, name of firm, and audit report date