Type:
Test Bank
Resource:
Auditing and assurance services
Edition:
12th Edition
Author(s):
Alvin A. Arens Randal J. Elder Mark S. Beasly
TABLE OF CONTENTS I.
THE AUDITING PROFESSION. 1. The Demand for Audit and Other Assurance Services. 2. The CPA Profession. 3. Audit Reports. 4. Professional Ethics. 5. Legal Liability.
II.
THE AUDIT PROCESS. 6. Audit Responsibilities and Objectives. 7. Audit Evidence. 8. Audit Planning and Analytical Procedures. 9. Materiality and Risk. 10. Internal Control and Control Risk. 11. Fraud Auditing 12. The Impact of Information Technology on the Audit Process. 13. Overall Audit Plan and Audit Program.
III.
APPLICATION OF THE AUDIT PROCESS TO THE SALES AND COLLECTION CYCLE. 14. Audit of the Sales and Collection Cycle: Tests of Controls and Substantive Tests of Transactions. 15. Audit Sampling for Tests of Controls and Substantive Tests of Transactions. 16. Completing the Tests in the Sales and Collection Cycle: Accounts Receivable. 17. Audit Sampling for Tests of Details of Balances.
IV.
APPLICATION OF THE AUDIT PROCESS TO OTHER CYCLES. 18. Audit of the Payroll and Personnel Cycle. 19. Audit of the Acquisition and Payment Cycle: Tests of Controls, Substantive Tests of Transactions, and Accounts Payable. 20. Completing the Tests in the Acquisition and Payment Cycle: Verification of Selected Accounts. 21. Audit of the Inventory and Warehousing Cycle. 22. Audit of the Capital Acquisition and Repayment Cycle. 23. Audit of Cash Balances.
V.
COMPLETING THE AUDIT. 24. Completing the Audit.
VI.
OTHER ASSURANCE AND NONASSURANCE SERVICES. 25. Other Assurance Services. 26. Internal and Governmental Financial Auditing and Operational Auditing.
CHAPTER 1 Multiple-Choice Questions 1. easy c
Recording, classifying, and summarizing economic events in a logical manner for the purpose of providing financial information for decision making is commonly called: a. finance. b. auditing. c. accounting. d. economics.
2. easy c
In the audit of historical financial statements, which of the following accounting bases is the most common? a. Regulatory accounting principles. b. Cash basis of accounting. c. Generally accepted accounting principles. d. Liquidation basis of accounting.
3. easy b
Any service that requires a CPA firm to issue a report about the reliability of an assertion that is made by another party is a(n): a. accounting and bookkeeping service. b. attestation service. c. assurance service. d. tax service.
4. easy a
Three common types of attestation services are: a. audits, reviews, and “other” attestation services. b. audits, verifications, and “other” attestation services. c. reviews, verifications, and “other” attestation services. d. audits, reviews, and verifications.
5. (SOX) easy d
The organization that is responsible for providing oversight for auditors of public companies is called the ________. a. Auditing Standards Board. b. American Institute of Certified Public Accountants. c. Public Oversight Board. d. Public Company Accounting Oversight Board.
6. (SOX) easy c
The Sarbanes-Oxley Act applies to which of the following companies? a. All companies. b. Privately held companies. c. Public companies. d. All public companies and privately held companies with assets greater than $500 million.
7. medium d
Providing quantitative information that management and others can use to make decisions is the function of: a. management information systems. b. auditing. c. finance. d. accounting.
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8. medium d
An audit of historical financial statements most commonly includes the: a. balance sheet, the income statement, and the statement of cash flows. 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 c
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. a. nominal b. stated c. risk-free d. prevailing
10. medium b
The use of the Certified Public Accountant title is regulated by: a. the federal government. 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. medium c
An operational audit has as one of its objectives to: a. determine whether the financial statements fairly present the entity’s operations. 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. medium d
An audit of historical financial statements is most often performed to determine whether the: a. organization is operating efficiently and effectively. 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.
13. medium a
An examination of part of an organization’s procedures and methods for the purpose of evaluating efficiency and effectiveness is what type of audit? a. Operational audit. b. Compliance audit. c. Financial statement audit. d. Production audit.
14. medium b
An audit to determine whether an entity is following specific procedures or rules set down by some higher authority is classified as a(n): a. audit of financial statements. b. compliance audit. c. operational audit. d. production audit.
15. medium d
Which of the following is a type of audit evidence? a. Oral responses to the auditor from employees of the company under audit. b. Written communications from company employees or outsiders. c. Observations made by an auditor. d. Evidence may take any of the above forms.
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16. medium a
Which of the following services provides the lowest level of assurance on a financial statement? a. A review. b. An audit. c. Neither service provides assurance on financial statements. d. Each service provides the same level of assurance on financial statements.
17. medium c
The three requirements for becoming a CPA include all but which of the following? a. Uniform CPA examination requirement. b. Educational requirements. c. Character requirements. d. Experience requirement.
18. medium a
In “auditing” financial accounting data, the primary concern is with: a. determining whether recorded information properly reflects the economic events that occurred during the accounting period. 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 d
Financial statement users often receive unreliable financial information from companies. Which of the following is not a common reason for this? 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. challenging d
Which of the following is not a Trust Services principle as defined by the AICPA or CICA? a. Online privacy. b. Availability. c. Processing integrity. d. Operational integrity.
21. challenging c
Which one of the following is more difficult to evaluate objectively? a. Presentation of financial statements in accordance with generally accepted accounting principles. b. Compliance with government regulations. c. Efficiency and effectiveness of operations. d. All three of the above are equally difficult.
22. (SOX) challenging c
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? a. Reviews of quarterly financial statements. b. Preparation of corporate tax returns. c. Most consulting services. d. All of above are prohibited services.
23. challenging a
Which of the following audits can be regarded as generally being a compliance audit? a. IRS agents’ examinations of taxpayer returns. 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.
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24. challenging b
Which of the following can be significantly affected by an audit? a. Business risk. b. Information risk. c. The risk-free interest rate. d. All of these are correct.
25. challenging d
The trait that distinguishes auditors from accountants is the: a. auditor’s ability to interpret accounting principles generally accepted in the United States. 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.
26. challenging b
Attestation services on information technology include WebTrust services and SysTrust services. Which of the following statements most accurately describes SysTrust services? a. SysTrust services provide assurance on business processes, transaction integrity and information processes. b. SysTrust services provide assurance on system reliability in critical areas such as security and data integrity. c. Neither of the above statements accurately describes SysTrust services. d. Either of the above accurately describes SysTrust services.
Essay Questions 27. easy
Discuss the three primary requirements for becoming a CPA. Answer: 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.
1-4
29. medium
Discuss the differences and similarities between the roles of accountants and auditors. What additional expertise must an auditor possess beyond that of an accountant? Answer: The role of accountants is to record, classify, and summarize economic events in a logical manner for the purpose of providing financial information for decision making. To do this, accountants must have a sound understanding of the principles and rules that provide the basis for preparing the financial information. In addition, accountants are responsible for developing systems to ensure that the entity’s economic events are properly recorded on a timely basis and at a reasonable cost. 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.
30. medium
Discuss the similarities and differences between financial statement audits, operational audits, and compliance audits. Give an example of each type. Answer: Financial statement audits, operational audits, and compliance audits are similar in that each type of audit involves accumulating and evaluating evidence about information to ascertain and report on the degree of correspondence between the information and established criteria. The differences between each type of audit are the information being examined and the criteria used to evaluate the information. An example of a financial statement audit would be the annual audit of IBM Corporation, in which the external auditors examine IBM’s financial statements to determine the degree of correspondence between those financial statements and generally accepted accounting principles. An example of an operational audit would be an internal auditor’s evaluation of whether the company’s computerized payroll-processing system is operating efficiently and effectively. An example of a compliance audit would be an IRS auditor’s examination of an entity’s federal tax return to determine the degree of compliance with the Internal Revenue Code.
31. medium
Discuss the similarities and differences between the roles of independent auditors, GAO auditors, internal revenue agents, and internal auditors. Answer: The roles of all four types of auditors are similar in that they involve the accumulation and evaluation of evidence about information to ascertain and report on the degree of correspondence between the information and established criteria. The differences in their roles center around the information audited and the criteria used to evaluate that information. Independent auditors primarily audit companies’ financial statements. GAO auditors’ primary responsibility is to perform the audit function for Congress. IRS auditors are responsible for the enforcement of federal tax laws. Internal auditors primarily perform operational and compliance audits for their employing company.
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32. (SOX) medium
What is an engagement to attest on internal control over financial reporting? Answer: Section 404 of the Sarbanes-Oxley Act requires public companies to report management’s assessment of the effectiveness of internal control over financial reporting. The Act further requires auditors to attest to the effectiveness of internal control over financial reporting. This evaluation, which is integrated with the audit of financial statements, provides forward-looking information, because effective internal controls reduce the likelihood of future misstatements in the financial statements.
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. challenging
Attestation services fall into five categories. What are these categories? 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.
1-6
36. challenging
Discuss four factors that are likely to significantly reduce information risk in the next five to ten years. Answer: Four factors that are likely to significantly reduce information risk in the next five to ten years are: • technological advances, • more companies will go on-line, reducing the risk of investors obtaining outdated information, • new accounting and auditing standards, and • auditors will find more efficient and effective audit techniques.
Other Objective Answer Format Questions 37. easy a
The criteria by which an auditor evaluates the information under audit may vary with the information being audited. a. True b. False
38. easy b
The criteria used by an external auditor to evaluate published financial statements are known as generally accepted auditing standards. a. True b. False
39. (SOX) easy b
The Sarbanes-Oxley Act establishes standards related to the audits of privately held companies. a. True b. False
40. (SOX) easy a
The Sarbanes-Oxley Act is widely viewed as having ushered in sweeping changes to auditing and financial reporting. a. True b. False
41. easy b
Only companies that file annual statements with the Securities and Exchange Commission are required to have an annual external audit. a. True b. False
42. easy b
The financial statements most commonly audited by external auditors are the balance sheet, the income statement, and the statement of changes in retained earnings. a. True b. False
43. medium b
The primary purpose of a compliance audit is to determine whether the financial statements are prepared in compliance with generally accepted accounting principles. a. True b. False
44. medium a
Results of compliance audits are typically reported to someone within the organizational unit being audited rather than to a broad spectrum of outside users. a. True b. False
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45. medium b
The primary role of the United States General Accounting Office is the enforcement of the federal tax laws as defined by Congress and interpreted by the courts. a. True b. False
46. medium b
CPA firms are never allowed to provide bookkeeping services for audit clients. a. True b. False
47. (SOX) medium a
Section 404 of the Sarbanes-Oxley Act requires public companies to have an external auditor attest to their internal control over financial reporting. a. True b. False
48. (SOX) challenging b
The Sarbanes-Oxley Act requires a company’s chairman of the board of directors, CEO, and CFO to certify the company’s financial statements. a. True b. False
49. (SOX) challenging b
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. a. True b. False
50. challenging a
Most public companies’ audited financial statements are available on the SEC’s EDGAR database. a. True b. False
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CHAPTER 2 Multiple-Choice Questions 1. easy a
Which one of the following is not one of the three General Standards? a. Proper planning and supervision. b. Independence of mental attitude. c. Adequate training and proficiency. d. Due professional care.
2. easy b
Which one of the following is not a Field Work Standard? a. Adequate planning and supervision. b. Due professional care. c. Understand the entity and its environment including internal control. d. Sufficient appropriate audit evidence.
3. easy b
The General Standards stress the importance of: a. evidence accumulation. b. personal qualities the auditor should possess. c. communicating the auditor’s findings to the reader. d. all of the above.
4. easy d
The generally accepted auditing standard that requires “Adequate technical training and proficiency” is normally interpreted as requiring the auditor to have: a. formal education in auditing and accounting. b. adequate practical experience for the work being performed. c. continuing professional education. d. all of the above.
5. easy d
In any case in which the CPA or the CPA’s assistants are not qualified to perform the work, a professional obligation exists to: a. acquire the requisite knowledge and skills. b. suggest someone else who is qualified to perform the work. c. decline the engagement. d. any of the above.
6. (SOX) easy d
Members of the Public Company Accounting Oversight Board are appointed and overseen by: a. the U.S. Congress. b. the American Institute of Certified Public Accountants. c. the Auditing Standards Board. d. the Securities and Exchange Commission.
7. easy b
Statements on Auditing Standards provide auditors of privately held companies with ______ guidance regarding the conduct of financial statement audits. a. fairly extensive b. some limited c. practically no d. specific and detailed
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8. easy c
Which of the following statements most accurately captures the intent of the standards of field work? 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.
9. (SOX) easy c
Prior to the passage of the Sarbanes-Oxley Act, which of the following was responsible for establishing auditing standards? a. Securities and Exchange Commission b. American Institute of Certified Public Accountants c. Auditing Standards Board d. National Association of Accounting
10. (SOX) medium b
Standards issued by the Public Company Accounting Oversight Board must be followed by CPAs who audit: a. all companies in the United States. b. public companies only. c. private and public partnerships only. d. private companies only.
11. medium b
Which of the following is the least likely form of business for a CPA firm? a. General partnership b. General corporation c. Limited liability company d. Limited liability partnership
12. medium a
The Statements on Auditing Standards issued by the Auditing Standards Board: a. are interpretations of generally accepted auditing standards. 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.
13. medium d
An auditor need not abide by a particular auditing standard if the auditor believes that: a. the issue in question is immaterial in amount. b. the requirement of the standard is impractical to perform. c. the requirement of the standard is impossible to perform. d. any of the above three are correct.
14. (SOX) medium b
The Public Company Accounting Oversight Board does not: a. perform inspections of the quality controls at audit firms that audit public companies. b. establish auditing standards that must be followed by all CPAs. c. oversee auditors of public companies. d. perform any of the above functions.
15. medium b
The form that must be completed and filed with the Securities and Exchange Commission whenever a company experiences a significant event that is of interest to public investors is the: a. Form S-1. b. Form 8-K. c. Form 10-K. d. Form 10-Q.
2-2
16. medium a
The form that must be filed with the Securities and Exchange Commission whenever a company plans to issue new securities to the public is the: a. Form S-1. b. Form 8-K. c. Form 10-K. d. Form 10-Q.
17. medium c
The third general standard states that due care is to be exercised in the performance of an audit. This standard is generally interpreted to require: 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.
18. (SOX) medium d
If the Public Company Accounting Oversight Board (PCAOB) identifies a violation during its inspection of a registered accounting firm, which of the following may occur? a. The PCAOB could enforce some disciplinary action against the accounting firm. b. The PCAOB could report the matter to the Securities and Exchange Commission. c. The PCAOB could report the matter to the appropriate state accountancy board d. The PCAOB could take any or all of the above steps if it identifies a violation.
19. medium d
Which of the following statements best describes the primary purpose of Statements on Auditing Standards? a. They are guides intended to set forth auditing procedures that are applicable to a variety of situations. b. They are procedural outlines that are intended to narrow the areas of inconsistency and divergence of auditor opinion. c. They are authoritative statements, enforced through the Code of Professional Conduct, and are intended to limit the degree of auditor judgment. d. They are interpretations that are intended to clarify the meaning of “generally accepted auditing standards.”
20. medium a
Statements on Standards for Accounting and Review Services are issued by the: a. Accounting and Review Services Committee. b. Professional Ethics Executive Committee. c. Securities and Exchange Commission. d. Financial Accounting Standards Board.
21. medium c
Consulting Standards are issued by the: a. Accounting and Review Services Committee. b. Securities and Exchange Commission. c. Management Consulting Services Executive Committee. d. Financial Accounting Standards Board.
22. medium d
The auditor’s judgment concerning the overall fairness of presentation of financial position, results of operations, and changes in cash flow is applied within the framework of: a. quality control. 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.
23. medium c
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: a. continuing professional education. b. compliance with generally accepted reporting standards. c. a system of quality control. d. a system of peer review.
2-3
24. medium c
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: 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.
25. medium d
Williams & Co., a member of the Private Companies Practice Section, is to have a “peer review.” The peer review can be performed by: a. a CPA firm selected by Williams & Co. b. a review team selected by the state society. c. a only. d. either a or b.
26. medium a
Hansen Corporation’s stock is listed on a national stock exchange and registered with the Securities and Exchange Commission. Hansen’s management hires a CPA to perform an independent audit of Hansen’s financial statements. The primary objective of this audit is to provide assurance to the: a. investors in Hansen Corporation’s stock. b. stock exchange. c. Securities and Exchange Commission. d. management of Hansen Corporation.
27. medium a
Which of the following is not an essential component of quality control? a. Policies and procedures to ensure that firm personnel are actively engaged in marketing strategies. b. Policies and procedures to ensure that the work performed by firm personnel meet applicable professional standards. c. Policies to ensure that personnel maintain their independence in fact and in appearance. d. Policies that ensure that monitoring activities are effectively applied.
28. challenging c
Which of the following is true regarding the AICPA-approved practice monitoring programs? a. The Center for Public Company Audit Firms does not offer a peer review program. b. Firms registered with the PCAOB must not enroll in an AICPA-approved practice monitoring program. c. Public accounting firms must be enrolled in an AICPA-approved practice monitoring program for members in the firm to be eligible for membership in the AICPA. d. The AICPA peer review program is administered through the SEC.
29. challenging c
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. None of the above statements is correct.
30. (SOX) challenging a
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. 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.
31. challenging a
The SEC requirements of greatest interest to CPAs are set forth in the SEC’s: a. Regulation S-X and Accounting Series Releases. b. S-1 through S-16 forms. c. Director’s newsletter. d. Forms 8-K, 10-K, and 10-Q.
2-4
32. challenging d
The AICPA has authority to establish standards and rules in all but which of the following areas? a. Auditing standards applicable to financial statements of private companies. b. Compilation and review standards. c. Professional conduct. d. Auditing standards applicable to financial statements of private and public companies.
33. challenging c
Generally Accepted Auditing Standards (GAAS) and Statements on Auditing Standards (SAS) should be looked upon by practitioners as: 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.
34. challenging c
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? a. Adherence to quality control standards. b. Mandatory peer review. c. Partner rotation after a period of ten consecutive years. d. Continuing education.
35. challenging b
Statements on Auditing Standards issued by the AICPA’s Auditing Standards Board are: a. part of the generally accepted auditing standards under the AICPA Code of Professional Conduct. b. interpretations of generally accepted auditing standards and departures from such statements must be justified. c. interpretations of generally accepted auditing standards and such standards must be followed in every engagement. d. generally accepted auditing procedures that are not covered by the AICPA Code of Professional Conduct.
Essay Questions 36. easy
Distinguish between generally accepted auditing standards (GAAS) and generally accepted accounting principles (GAAP). What professional organization establishes GAAS? What professional organization establishes GAAP? 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.
37. easy
Discuss the relationship between quality control and generally accepted auditing standards. 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
2-5
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.
38. easy
Describe the various staff levels and responsibilities of a typical public accounting firm. Answer: • Staff assistant - Staff assistants, or staff accountants, perform most of the detailed audit work. • 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.
39. 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.
40. 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
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•
41. medium
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.
There are ten generally accepted auditing standards, divided into three categories. List, by category, each of these ten standards. Answer: General Standards • Adequate technical training and proficiency. • 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.
42. 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. Answer: Independent mental attitude refers to a state of mind in which the CPA is totally unbiased with respect to the client and the financial information under audit. Although internal auditors are employees of the organization for which their audits are performed, internal auditors should be independent of the function being examined and should report their findings to a level high enough in the organization to allow the auditor to be free from influence by the party, or parties, being examined.
43. (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.
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44. 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
Discuss the purpose of the Securities and Exchange Commission and its influence on setting generally accepted accounting principles. Answer: The overall purpose of the SEC is to assist in providing investors with reliable information upon which to make investment decisions. As a result of its authority for specifying financial reporting requirements, the SEC has considerable influence in setting generally accepted accounting principles. Although the SEC has taken the position that accounting principles should be set by the profession (FASB), the SEC’s opinion is generally considered in any major change in GAAP proposed by the FASB.
46. 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 47. easy b
Membership in the AICPA is restricted to CPAs who are currently practicing as independent auditors. a. True b. False
48. easy b
Membership in the AICPA is mandatory for all licensed practicing CPAs. a. True b. False
49. easy a
Any public accounting firm can be a member of the AICPA if the firm meets the membership requirements. a. True b. False
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50. easy b
Statements on Auditing Standards (SASs) are issued by the Public Company Accounting Oversight Board. a. True b. False
51. (SOX) easy b
Auditors of public companies should, in the absence of guidance issued by the PCAOB, follow auditing standards issued by the SEC. a. True b. False
52. (SOX) medium b
The U.S. Congress has oversight responsibility for the PCAOB. a. True b. False
53. medium b
Form 10-K must be filed with the SEC whenever a public company experiences a significant event. a. True b. False
54. medium b
In a limited liability partnership, partners are personally liable for liabilities arising from negligent acts of other partners, but not for liabilities arising from acts of other employees. a. True b. False
55. medium a
Limited liability companies are structured and taxed like a general partnership, but their owners have limited personal liability similar to that of a general corporation. a. True b. False
56. (SOX) medium b
All CPA firms registered with the PCAOB are required to undergo a peer review at least once every two years. a. True b. False
57. medium a
Statements on Auditing Standards (SASs) are considered to be interpretations of the ten generally accepted auditing standards. a. True b. False
58. (SOX) medium a
Any CPA firm that audits more than 100 public companies is required to have an annual inspection by the PCAOB. a. True b. False
59. medium a
The overall purpose of the Securities and Exchange Commission is to assist in providing investors with reliable information upon which to make investment decisions. a. True b. False
60. medium a
International Standards on Auditing are issued by the International Auditing Practices Committee. a. True b. False
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CHAPTER 3 Note to Instructors: Unless otherwise indicated in the text of a question, please assume that a question applies to audits of public and private companies. Questions that relate only to publiccompany matters will be noted by the phrase (Public) beside the question number. Multiple-Choice Questions 1. easy a
Auditing standards require that the audit report must be titled and that the title must: a. include the word “independent.” b. indicate if the auditor is a CPA. c. indicate if the auditor is a proprietorship, partnership, or incorporated. d. not include any discriminatory language.
2. easy a
To emphasize the fact that the auditor is independent, the addressee of the audit report is usually not: a. the company’s management. b. the stockholders of the client company. c. the board of directors of the client company. d. either b or c.
3. easy d
The purpose of the introductory paragraph in the standard unqualified report is: a. to identify the entity that was audited. b. to identify the financial statements that were audited and the dates and time periods covered by the report. c. to communicate the responsibilities of management in preparing the financial statements and to clarify the respective roles of management and the auditor. d. all of the above.
4. easy d
The scope paragraph of the standard unqualified audit report states that the audit is designed to: a. discover all errors and/or irregularities. 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. easy c
Which of the following is not an essential condition for issuing the standard unqualified audit opinion? a. All statements are included in the financial statements. b. The general standards have been followed in all respects. c. The financial statements are prepared in accordance with regulatory principles. d. Sufficient appropriate audit evidence has been accumulated.
6. easy d
The audit report date on a standard unqualified report indicates: a. the last day of the fiscal period. 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.
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7. easy d
As a result of management’s refusal to permit the auditor to physically examine inventory, the auditor has not accumulated sufficient appropriate evidence to conclude whether financial statements are stated in accordance with GAAP. The auditor must depart from the unqualified audit report because: 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.
8. easy d
An adverse opinion is issued when the auditor believes: a. some parts of the financial statements are materially misstated or misleading. 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.
9. easy d
A disclaimer of opinion may be issued in which of the following instances? a. The auditor has doubts related to an entity’s ability to continue as a going concern. b. There are highly material misstatements in the financial statements. c. The auditor’s scope has been restricted due to circumstances beyond the client’s control. d. A disclaimer may be issued for circumstances discussed in a and c.
10. easy d
Whenever an auditor issues a standard unqualified audit report, the implication is the auditor: a. does not know if the financial statements are presented fairly in accordance with GAAP. b. does not believe the financial statements are presented fairly in accordance with GAAP. c. believes the financial statements to be presented fairly in accordance with GAAP except for a specific aspect of them. d. believes the financial statements are presented fairly in accordance with GAAP.
11. easy c
If a misstatement is immaterial to the financial statements of the entity for the current period, but is expected to have a material effect in future periods, it is appropriate to issue a(n): a. adverse opinion. b. qualified opinion. c. unqualified opinion. d. disclaimer of opinion.
12. (Public) easy c
Whenever an auditor issues an audit report for a public company, the auditor can choose to issue a report in which of the following forms? 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. c. Either a or b. d. Neither a nor b.
13. easy b
When determining whether an exception is “highly material,” the extent to which the exception affects different elements of the financial statements must be considered. This concept is called: a. materiality. b. pervasiveness. c. financial analysis. d. ratio analysis.
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14. easy d
When the auditor believes a company’s financial statements are misleading because they were not prepared in conformity with GAAP, the auditor must issue a(n): a. qualified opinion. b. adverse opinion. c. disclaimer of opinion. d. qualified or an adverse opinion, depending on materiality.
15. (Public) easy c
If an auditor performs an audit of a public company, the scope paragraph should make reference to which standards? a. Accounting standards. b. Generally accepted auditing standards. c. Standards issued by the PCAOB (U.S.). d. Any of the above standards.
16. easy b
If an auditor performs an audit of a private company, the scope paragraph should make reference to which standards? a. Accounting standards. b. U.S. generally accepted auditing standards. c. Standards issued by the PCAOB (U.S.). d. Any of the above standards.
17. easy a
The only unqualified opinions which contain modified wording (excluding an explanatory paragraph) relate to: a. the use of other auditors. b. material uncertainties. c. substantial doubt about continuing as a going concern. d. lack of consistent application of GAAP.
18. easy c
The second standard of reporting requires the auditor to call attention to circumstances in which accounting principles have not been consistently observed in the current period relative to the preceding period. GAAP requires that changes in accounting principles be to a(n): a. more conservative principle. b. equal or better principle. c. preferable principle. d. principle allowed by the company’s auditing firm.
19. easy c
A CPA may wish to emphasize specific matters regarding the financial statements even though she intends to express an unqualified opinion. Normally, such explanatory information is: 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.
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20. easy d
An auditor who issues a qualified opinion because she was unable to obtain sufficient appropriate evidence should describe the limitations in an explanatory paragraph. The auditor should also refer to the limitation in the: Scope Opinion Notes to the paragraph paragraph financial statements a. Yes No Yes b. Yes Yes Yes c. No Yes No d. Yes Yes No
21. medium b
When the auditor evaluates the effect of a change in accounting principle, the materiality of the change should be evaluated based on: a. the prior years presented. b. the current year effect of the change. c. whatever basis the auditor considers appropriate. d. the effect on total assets.
22. medium b
Conditions requiring a departure from an unqualified audit report include all but which of the following? 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.
23. medium b
The introductory paragraph of the standard audit report states that the financial statements are: 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.
24. medium d
The introductory paragraph of the standard audit report states that the financial statements and the opinion expressed about those statements are: 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.
25. medium c
The introductory paragraph of the standard audit report states that the auditor is: a. responsible for the financial statements and the opinion on them. b. responsible for the financial statements. c. responsible for the opinion on the financial statements. d. jointly responsible for the financial statements with management.
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26. (Public) medium a
PCAOB Auditing Standard No. 2 requires the audit of internal control over financial reporting to be integrated with: 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.
27. medium d
The audit report indicates that (1) management is responsible for the content of the financial statements and (2) the auditor is responsible for evaluating the appropriateness of the accounting principles chosen by management. Which paragraph contains those statements? 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.
28. medium c
Which of the following is a false statement about the audit report? a. The opinion paragraph is related to the first and fourth reporting standards. b. The auditor is required to state a conclusion about whether the company followed generally accepted accounting principles. c. The opinion paragraph may follow any form deemed appropriate by the auditor. d. The auditor should express an opinion about the financial statements taken as a whole.
29. medium b
If the balance sheet of a company is dated December 31, 2007, the audit report is dated February 8, 2008, and both are released on February 15, 2008, this indicates that the auditor has searched for subsequent events that occurred up to: a. December 31, 2007. b. February 8, 2008. c. February 15, 2008. d. none of these.
30. medium a
Both disclaimers and adverse opinions are used: a. only when a condition is highly material. b. whether the condition affecting the financial statements is material or not. c. regardless of the auditor’s independence. d. regardless of client’s choice of a non-GAAP accounting method.
31. medium c
The least severe type of audit report for disclosing departures from GAAP is the: a. adverse opinion. b. disclaimer of opinion. c. qualified opinion. d. report on unaudited financial statements.
32. (Public) medium b
A combined report on financial statements and internal control over financial reporting includes all but which of the following types of paragraphs? a. Inherent limitations paragraph. b. Description paragraph. c. Opinion paragraph. d. Each of the above paragraphs is included.
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33. medium d
Whenever an auditor issues a qualified opinion, the implication is that the auditor: a. does not know if the financial statements are presented fairly. 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.
34. medium c
The necessity to issue a disclaimer of opinion may arise because of: a. a severe limitation on the scope of the audit. b. a lack of independence between the auditor and client. c. either a or b. d. neither a nor b.
35. medium c
Audit report language may be modified for which of the following conditions? a. Lack of consistent application of GAAP. b. Substantial doubt about continuing as a going concern. c. Reports involving other auditors. d. Emphasis of a matter.
36. medium b
When the auditor determines the financial statements are fairly stated and then determines that he is not independent, the auditor should issue: a. an adverse opinion. b. a disclaimer of opinion. c. either a qualified opinion or an adverse opinion. d. either a qualified opinion or an unqualified opinion with modified wording.
37. medium d
If the auditor lacks independence, a disclaimer of opinion must be issued: a. if the client requests it. b. only if it is highly material. c. only if it is material but not highly material. d. in all cases.
38. medium d
Misstatements must be compared with some measurement base before a decision can be made about materiality. A commonly accepted measurement base includes: a. net income. b. total assets. c. working capital. d. all of the above.
39. medium a
When comparing misstatements with a measurement base, the auditor must consider the pervasiveness of the misstatement. An example of a pervasive misstatement is a(n): a. understatement of inventory. 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.
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53. medium d
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: a. an unqualified opinion with an explanatory paragraph. b. a disclaimer of opinion. c. neither a nor b. d. either a or b.
54. medium c
An auditor may not issue a qualified opinion when: a. a scope limitation prevents the auditor from completing an important audit procedure. 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.
55. medium b
When a company’s financial statements contain a departure from GAAP with which the auditor concurs, the departure should be explained in: 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.
56. medium b
Which of the following representations does an auditor make explicitly and which implicitly when issuing an unqualified opinion? Conformity Adequacy of with GAAP disclosure a. Explicitly Explicitly b. Explicitly Implicitly c. Implicitly Explicitly d. Implicitly Implicitly
57. medium c
William Gregory, CPA, is the principal auditor for a multi-national corporation. Another CPA has examined and reported on the financial statements of a significant subsidiary of the corporation. Gregory is satisfied with the independence and professional reputation of the other auditor, as well as the quality of the other auditor’s examination. With respect to his report on the consolidated financial statements, taken as a whole, Gregory: 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.
58. medium d
A company has changed its method of inventory valuation from an unacceptable one to one in conformity with generally accepted accounting principles. The auditor’s report on the financial statements of the year of the change should include: 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.
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59. (Public) medium a
Sarbanes-Oxley requires auditors of a public company to audit a company’s financial statements and attest to management’s report on the effectiveness of internal control over financial reporting. What type of assurance does the auditor provide in this report? 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.
60. medium c
Whenever the client imposes restrictions on the scope of the audit, the auditor should be concerned that management may be trying to prevent discovery of misstatements. In such cases, the auditor will likely issue a: 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.
61. medium b
CPAs issue several types of “special audit reports.” Which of the following circumstances would not require the issuance of a special audit report? 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.
62. challenging b
Three of the paragraphs of the audit report modified for uncertainties are the same as the standard unqualified report. The explanatory paragraph that describes the uncertainty is added as the: a. first paragraph. b. fourth and last paragraph. c. third paragraph with the opinion paragraph last. d. second paragraph with the opinion paragraph last.
63. challenging b
When a qualified or adverse opinion is issued, the qualifying paragraph is inserted: a. between the introductory and scope paragraphs. 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.
64. challenging c
For the report containing a disclaimer for lack of independence, the disclaimer is in the: a. third or opinion paragraph. b. second or scope paragraph. c. first and only paragraph. d. fourth or explanatory paragraph.
65. challenging a
Which of the following is not a primary category of attestation report? a. Compilation report. b. Review report. c. Audit report. d. Special audit report based on a basis of accounting other than GAAP.
66. challenging
Most auditors believe that financial statements are “presented fairly” when the statements are in accordance with GAAP, and that it is also necessary to:
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