Chapter 1 The Role of the Public Accountant
True/False Questions
1. Independent audits of today place more emphasis on sampling for compliance with
laws and regulations than the audits of the 19th century.
Answer: True Difficulty: Medium
2. The American Institute of Certified Public Accountants issues CPA certificates and
permits CPAs to practice.
Answer: False Difficulty: Medium
3. A company is either audited by the GAO or internal auditors, but not both.
Answer: False Difficulty: Easy
4. The SEC does not pass on the merits of the securities that are registered with the
agency.
Answer: True Difficulty: Medium
5. The American Institute of Certified Public Accountants has the primary authority to
establish accounting standards.
Answer: False Difficulty: Easy
6. An annual peer review is a requirement of the AICPA.
Answer: False Difficulty: Medium
7. Many small companies elect to have their financial statements reviewed by a CPA
firm, rather than incur the cost of an audit.
Answer: True Difficulty: Easy
8. Staff assistants in CPA firms generally are responsible for planning and coordinating
audit engagements.
Answer: False Difficulty: Easy
Chapter 1 The Role of the Public Accountant
9. The Sarbanes-Oxley Act requires that auditors of publicly traded companies in the
United States perform an integrated audit that includes providing assurance on both
the financial statements and on compliance with laws and regulations.
Answer: False Difficulty: Medium
10. Auditing is frequently only a small part of the practice of local CPA firms.
Answer: True Difficulty: Medium
Multiple Choice Questions
11. A summary of findings rather than assurance is most likely to be included in a(n):
A) Agreed-upon procedures report.
B) Compilation report.
C) Examination report.
D) Review report.
Answer: A Difficulty: Medium
12. The Statements on Auditing Standards have been issued by the:
A) Auditing Standards Board.
B) Financial Accounting Standards Board.
C) Securities and Exchange Commission.
D) Federal Bureau of Investigation.
Answer: A Difficulty: Easy
13. The risk associated with a company's survival and profitability is referred to as:
A) Business Risk.
B) Information Risk.
C) Detection Risk.
D) Control Risk.
Answer: A Difficulty: Easy
Chapter 1 The Role of the Public Accountant
14. Historically, which of the following has the AICPA been most concerned with
providing?
A) Professional standards for CPAs.
B) Professional guidance for regulating financial markets.
C) Standards guiding the conduct of internal auditors.
D) Staff support to Congress.
Answer: A Difficulty: Medium
15. The organization charged with protecting investors and the public by requiring full
disclosure of financial information by companies offering securities to the public is
the:
A) Auditing Standards Board.
B) Financial Accounting Standards Board.
C) Government Accounting Standards Boards.
D) Securities and Exchange Commission.
Answer: D Difficulty: Medium
16. An engagement in which a CPA firm arranges for a critical review of its practices by
another CPA firm is referred to as a(n):
A) Peer Review Engagement.
B) Quality Control Engagement.
C) Quality Assurance Engagement.
D) Attestation Engagement.
Answer: A Difficulty: Easy
17. The serially-numbered pronouncements issued by the Auditing Standards Board over
a period of years are known as:
A) Auditing Statements of Position (ASPs).
B) Accounting Series Releases (ASRs).
C) Statements on Auditing Standards (SASs).
D) Statements on Auditing Principles (SAPs).
Answer: C Difficulty: Easy
Chapter 1 The Role of the Public Accountant
18. The General Accounting Office (GAO):
A) Is primarily concerned with rapid processing of all accounts payable incurred by
the federal government.
B) Conducts operational audits and reports the results to Congress.
C) Is a multinational organization of professional accountants.
D) Is primarily concerned with budgets and forecasts approved by the SEC.
Answer: B Difficulty: Easy
19. The risk that information is misstated is referred to as:
A) Information risk.
B) Inherent risk.
C) Relative risk.
D) Business risk.
Answer: A Difficulty: Easy
20. The risk that a company will not be able to meet its obligations when they become due
is referred to as:
A) Information risk.
B) Inherent risk.
C) Relative risk.
D) Business risk.
Answer: D Difficulty: Easy
21. Which of the following attributes most clearly differentiates a CPA who audits
management's financial statements as contrasted to management?
A) Integrity.
B) Competence.
C) Independence.
D) Keeping informed on current professional developments.
Answer: C Difficulty: Easy
Chapter 1 The Role of the Public Accountant
22. The attest function:
A) Is an essential part of every engagement by the CPA, whether performing
auditing, tax work, or other services.
B) Includes the preparation of a report of the CPA's findings.
C) Requires a consideration of internal control.
D) Requires a complete review of all transactions during the period under
examination.
Answer: B Difficulty: Medium
23. When compared to an audit performed prior to 1900, an audit today:
A) Is more likely to include tests of compliance with laws and regulations.
B) Is less likely to include consideration of the effectiveness of internal control.
C) Has bank loan officers as the primary financial statement user group.
D) Includes a more detailed examination of all individual transactions.
Answer: A Difficulty: Medium
24. Which of the following are issued by the Securities and Exchange Commission?
A) Accounting Research Studies.
B) Accounting Trends and Techniques.
C) Industry Audit Guides.
D) Financial Reporting Releases.
Answer: D Difficulty: Medium
25. Which of the following is not correct relating to the Sarbanes-Oxley Act?
A) It toughens penalties for corporate fraud.
B) It restricts the types of consulting CPAs may perform for audit clients.
C) It created the Public Company Accounting Oversight Board (PCAOB) as a
replacement for the Financial Accounting Standards Board.
D) It eliminates a significant portion of the accounting profession's system of selfregulation.
Answer: C Difficulty: Medium
Chapter 1 The Role of the Public Accountant
26. An operational audit differs in many ways from an audit of financial statements.
Which of the following is the best example of one of these differences?
A) The usual audit of financial statements covers the four basic statements, whereas
the operational audit is usually limited to either the balance sheet or the income
statement.
B) The boundaries of an operational audit are often drawn from an organization chart
and are not limited to a single accounting period.
C) Operational audits do not ordinarily result in the preparation of a report.
D) The operational audit deals with pre-tax income.
Answer: B Difficulty: Medium
27. The review of a company's financial statements by a CPA firm:
A) Is substantially less in scope of procedures than an audit.
B) Requires detailed analysis of the major accounts.
C) Is of similar scope as an audit and adds similar credibility to the statements.
D) Culminates in issuance of a report expressing the CPA's opinion as to the fairness
of the statements.
Answer: A Difficulty: Easy
28. Which statement is correct with respect to continuing professional education (CPE)
requirements of members of the AICPA?
A) Only members employed by the AICPA are required to take such courses.
B) Only members in public practice are required to take such courses.
C) Members, regardless of whether they are in public practice, are required to meet
such requirements.
D) There is no requirement for members to participate in CPE.
Answer: C Difficulty: Medium
29. The FDIC Improvement Act requires that management of large financial institutions
engage auditors to attest to assertions by management about the effectiveness of the
institution's internal controls over
A) Compliance with laws and regulations.
B) Financial reporting.
C) Effectiveness of operations.
D) Efficiency of operations.
Answer: B Difficulty: Medium
Chapter 1 The Role of the Public Accountant
30. Passage of the Sarbanes-Oxley Act led to the establishment of the:
A) Auditing Standards Board.
B) Accounting Enforcement Releases Board.
C) Public Company Accounting Oversight Board.
D) Securities and Exchange Commission.
Answer: C Difficulty: Medium
31. Which of the following professionals has primary responsibility for the performance
of an audit?
A) The managing partner of the firm.
B) The senior assigned to the engagement.
C) The manager assigned to the engagement.
D) The partner in charge of the engagement.
Answer: D Difficulty: Medium
32. Which of the following types of services is generally provided only by CPA firms?
A) Tax audits.
B) Financial statement audits.
C) Compliance audits.
D) Operational audits.
Answer: B Difficulty: Medium
33. The right to practice as a CPA is given by which of the following organizations?
A) State Boards of Accountancy.
B) The AICPA.
C) The SEC.
D) The General Accounting Office.
Answer: A Difficulty: Medium
34. Which of the following terms best describes the audit of a taxpayer's tax return by an
IRS auditor?
A) Operational audit.
B) Internal audit.
C) Compliance audit.
D) Government audit.
Answer: C Difficulty: Medium
Chapter 1 The Role of the Public Accountant
35. Which of the following best describes the reason why independent auditors report on
financial statements?
A) A management fraud may exist and it is more likely to be detected by independent
auditors.
B) Different interests may exist between the company preparing the statements and
the persons using the statements.
C) A misstatement of account balances may exist and is generally corrected as the
result of the independent auditors' work.
D) Poorly designed internal control may be in existence.
Answer: B Difficulty: Medium Source: AICPA
36. Governmental auditing often extends beyond examinations leading to the expression
of opinion on the fairness of financial presentation and includes audits of efficiency,
economy, effectiveness, and also:
A) Accuracy.
B) Evaluation.
C) Compliance.
D) Internal control.
Answer: C Difficulty: Hard Source: AICPA
37. Operational auditing is primarily oriented toward:
A) Future improvements to accomplish the goals of management.
B) The accuracy of data reflected in management's financial records.
C) The verification that a company's financial statements are fairly presented.
D) Past protection provided by existing internal control.
Answer: A Difficulty: Hard Source: AICPA
38. A typical objective of an operational audit is for the auditor 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.
Answer: C Difficulty: Hard Source: AICPA
Chapter 1 The Role of the Public Accountant
39. An integrated audit performed under the Sarbanes-Oxley Act requires that auditors
report on:
A)
B)
C)
D)
Financial Statements
Yes
Yes
No
No
Internal Control
Yes
No
Yes
No
Answer: C Difficulty: Medium
Essay Questions
40. The Sarbanes-Oxley Act of 2002 made significant reforms for public companies and
their auditors.
a. Describe the events that led up to the passage of the Act.
b. Describe the major changes made by the Act.
Difficulty: Hard
Answer:
a. The events leading up to the passage of the Sarbanes-Oxley Act include:
• A large number of misstatements of financial statements, many of which
resulted from fraudulent financial reporting. Notably including WorldCom and
Enron.
• The conviction of the Big 5 accounting firm of Arthur Andersen on charges of
destroying evidence.
b. The major reforms made the Act include:
• Tougher penalties for fraud.
• Restrictions on the types of consulting services that may be provided by
auditors to their public audit clients.
• The creation of the Public Company Accounting Oversight Board to create
auditing standards and oversee accounting firms that audit public companies.
• Requirements to report on internal control.
Chapter 1 The Role of the Public Accountant
41. Many people confuse the responsibilities of the independent auditors and the client's
management with respect to audited financial statements.
a. Describe management's responsibility regarding audited financial statements.
b. Describe the independent auditors' responsibility regarding audited financial
statements.
c. Evaluate the following statement: "If the auditors disagree with management
regarding an accounting principle used in the financial statements the auditors
should express their views in the notes to the financial statements."
Difficulty: Medium
Answer:
a. Management has primary responsibility for the fairness of the financial statements.
b. The auditors are responsible for performing an independent audit of the financial
statements and issuing a report on them in accordance with generally accepted
auditing standards.
c. The statement if false. The notes to the financial statements should contain only
representations of management. The auditors should express their reservations in
their report.
42. An investor is considering investing in one of two companies. The companies have
very similar reported financial position and results of operations. However, only one
of the companies has its financial statements audited.
a. Describe what creates the demand for an audit in this situation. Include a
discussion of how audited financial statements facilitate this investment
transaction, and the effect of the audit on business risk and information risk.
b. Identify the potential consequences to the company of not having its financial
statements audited.
Difficulty: Medium
Chapter 1 The Role of the Public Accountant
Answer:
a. Audits add credibility to the financial statements of the company. The individual
can invest in the company knowing that there is a low probability that the financial
statements depart materially from generally accepted accounting principles.
Audited financial statements facilitate this transaction by reducing risk related to
the investment. Specifically, audits reduce information risk--the risk that
information used to make the investment decision is misstated--related to the
financial statements. Audited financial statements do not directly affect business
risk, which is the risk that the company will not be able to meet its financial
obligations.
b. The potential consequences of not having an audit are:
• If the investor is particularly risk averse, he or she may not invest in the
company at all.
• If the investor decides to invest in the company, he or she will not be willing to
pay as high a price because the investor will want to be compensated for the
additional risk that is involved in relying upon unaudited financial statements.
Chapter 2 Professional Standards
True/False Questions
1. The generally accepted auditing standards of field work include a requirement that the
auditors obtain sufficient competent evidential matter.
Answer: True Difficulty: Easy
2. The auditors' report on a corporation's financial statements usually is addressed to the
president of the company.
Answer: False Difficulty: Easy
3. The auditors are primarily responsible for preparing the financial statements and
expressing an opinion on whether they follow generally accepted auditing standards.
Answer: False Difficulty: Medium
4. Partners in CPA firms usually have the responsibility for signing the audit report.
Answer: True Difficulty: Medium
5. An audit is more likely to detect tax evasion than violations of antitrust laws.
Answer: True Difficulty: Hard
6. The attestation standards do not supersede any of the generally accepted auditing
standards.
Answer: True Difficulty: Medium
7. A peer review is generally performed by employees of the AICPA.
Answer: False Difficulty: Medium
8. If the auditors discover illegal acts by a client, they ordinarily must immediately resign
from the engagement.
Answer: False Difficulty: Medium
9. An audit should be designed to provide reasonable assurance of detecting all illegal
acts.
Answer: False Difficulty: Medium
Chapter 2 Professional Standards
10. The pronouncements of the International Auditing Assurance Standards Board do not
override the national auditing standards of its members, even when financial
statements are issued by a multinational company.
Answer: True Difficulty: Medium
Multiple Choice Questions
11. Audits of financial statements are designed to obtain reasonable assurance of detecting
misstatement due to:
A)
B)
C)
D)
Fraudulent Financial Reporting
Yes
Yes
No
No
Misappropriation of Assets
Yes
No
Yes
No
Answer: A Difficulty: Hard
12. Which of the following has the highest level of accounting authority within the
“GAAP Hierarchy”?
A) Authoritative body pronouncements.
B) Pronouncements of bodies composed of expert accountants exposed for public
comment.
C) Pronouncements of bodies composed of expert accountants, not exposed for
public comment.
D) Pronouncements of the Federal Accounting Reserve Board.
Answer: A Difficulty: Easy
13. An attestation engagement:
A) Has as its primary source of standards the assurance standards.
B) Includes a report on subject matter, or on an assertion about subject matter.
C) Includes search and verification procedures for all major accounts.
D) Is ordinarily an examination, review or compilation engagement.
Answer: B Difficulty: Hard
Chapter 2 Professional Standards
14. An audit provides reasonable assurance of detecting which of the following types of
important illegal acts?
A)
B)
C)
D)
Direct Effect
Yes
Yes
No
No
Indirect Effect
Yes
No
Yes
No
Answer: B Difficulty: Medium
15. Which of the following is not a type of auditors' opinion?
A) Adverse.
B) Ordinary .
C) Qualified.
D) Unqualified.
Answer: B Difficulty: Medium
16. Which of the following is one of the elements of quality control?
A) Acceptance and continuance of clients and engagements.
B) Assurance of proper levels of association.
C) Due professional care.
D) Supervision.
Answer: A Difficulty: Hard
17. A procedure in which a quality control partner periodically tests the application of
quality control procedures is most directly related to which quality control element?
A) Engagement performance.
B) Independence, integrity and objectivity.
C) Monitoring.
D) Personnel management.
Answer: C Difficulty: Hard
Chapter 2 Professional Standards
18. Requirements for training, independence and due professional care are included in
which group of the generally accepted auditing standards?
A) Fieldwork.
B) General.
C) Reporting.
D) Quality control.
Answer: B
19. Which of the following is considered an interpretive publication in the GAAS
Hierarchy?
A) Appendices to Statements on Auditing Standards.
B) Statements on Auditing Standards.
C) Interpretations of FASB Standards.
D) Auditing articles explaining Statements on Auditing Standards in the Journal of
Accountancy.
Answer: A Difficulty: Hard
20. In which paragraph of an audit report are auditing standards generally accepted in the
United States explicitly mentioned in an audit report of a nonpublic company?
A)
B)
C)
D)
Scope
Yes
Yes
No
No
Opinion
Yes
No
Yes
No
Answer: B Difficulty: Medium
21. In which paragraph of an audit report are auditing standards generally accepted in the
United States explicitly mentioned in an audit report of a nonpublic company?
A)
B)
C)
D)
Scope
Yes
Yes
No
No
Opinion
Yes
No
Yes
No
Answer: D Difficulty: Hard
Chapter 2 Professional Standards
22. An audit should be designed to achieve reasonable assurance of detecting material
misstatements due to:
A) Errors.
B) Errors and fraud.
C) Errors, fraud, and those illegal acts with a direct effect on financial statement
amounts.
D) Errors, fraud and illegal acts.
Answer: C Difficulty: Hard
23. The expression "accounting principles generally accepted in the United States of
America":
A) Appears in both the scope paragraph and the opinion paragraph of the auditors'
report.
B) Appears in the introductory paragraph of the auditors' report.
C) Appears in the opinion paragraph of the auditors' report.
D) Does not appear in the auditors' report.
Answer: C Difficulty: Medium
24. To qualify as "generally accepted," an accounting principle must:
A) Have substantial authoritative support.
B) Be covered in one or more of the SASs issued by the AICPA.
C) Be set forth in a Financial Reporting Release issued by the SEC.
D) Have received the approval of the FASB.
Answer: A Difficulty: Medium
25. The generally accepted auditing standards adopted by the AICPA include a
requirement that the CPAs:
A) Assume responsibility for any losses to the client from fraud which existed during
the audit but was not detected by the auditors.
B) Follow accounting principles adopted by the SEC.
C) Not accept as audit clients companies which compete directly with one another.
D) Exercise due professional care in the performance of the examination and the
preparation of the report.
Answer: D Difficulty: Easy
Chapter 2 Professional Standards
26. Which of the following best describes a portion of the auditors' responsibility
regarding illegal acts by clients?
A) The auditors have a responsibility to discover all material illegal acts.
B) If audit procedures reveal illegal acts, the auditors should take appropriate actions.
C) If the auditors suspect illegal acts have been performed, they should conduct a
legal audit of the company.
D) The auditors' responsibility for the detection of all illegal acts is the same as their
responsibility regarding material misstatements due to errors and fraud.
Answer: B Difficulty: Medium
27. The auditors who find that the client has committed an illegal act would be most likely
to withdraw from the engagement when the:
A) Management fails to take appropriate corrective action.
B) Illegal act has material financial statement implications.
C) Illegal act has received widespread publicity.
D) Auditors cannot reasonably estimate the effect of the illegal act on the financial
statements.
Answer: A Difficulty: Medium
28. The first paragraph of the standard unqualified audit report is referred to as the:
A) Introductory paragraph.
B) Opening paragraph.
C) Opinion paragraph.
D) Scope paragraph.
Answer: A Difficulty: Easy
29. Primary responsibility for the financial statements lies with:
A)
B)
C)
D)
Auditors
Yes
Yes
No
No
Management
Yes
No
Yes
No
Answer: C Difficulty: Medium
Chapter 2 Professional Standards
30. When a conflict exists between an accounting principle supported by a pronouncement
of an authoritative body and an accounting principle supported by widely recognized
practice, which standard prevails?
A) The authoritative body pronouncement.
B) The widely recognized pronouncement.
C) Both are of equal authority and the form of the transaction prevails over its
substance.
D) Neither, other accounting literature must be consulted to determine the appropriate
accounting treatment.
Answer: A Difficulty: Medium
31. The auditors' report should indicate:
A) That the examination was made in accordance with auditing standards generally
accepted in the United States of America.
B) Any weakness in internal control observed by the auditors.
C) That accounting principles have been consistently applied.
D) That no illegal acts have been identified.
Answer: A Difficulty: Medium
32. Which of the following is not one of the five elements of quality control?
A) Engagement performance.
B) Personnel management.
C) Review.
D) Monitoring.
Answer: C Difficulty: Medium
33. A requirement that working papers be reviewed by the supervisor, and any
deficiencies be discussed with the preparer is an example of a quality control
procedure in the area of:
A) Acceptance and continuance of clients and engagements.
B) Engagement performance.
C) Personnel management.
D) Independence, integrity and objectivity.
Answer: B Difficulty: Hard
Chapter 2 Professional Standards
34. A requirement that all professional staff obtain a minimum number of hours of
continuing professional education each year is an example of a quality control
procedure in the area of:
A) Acceptance and continuance of clients and engagements.
B) Engagement performance.
C) Personnel management.
D) Independence, integrity and objectivity.
Answer: C Difficulty: Hard
35. The body that issues international pronouncements providing auditing procedural and
reporting guidance is the:
A) International Federation of Auditors.
B) Multinational Reporting Commission.
C) International Auditing and Assurance Standards Board.
D) Auditing Standards Board.
Answer: C Difficulty: Medium
36. To present fairly in conformity with generally accepted accounting principles the
financial statements must:
A) Be consistently applied.
B) Inform users of all matters that could materially affect a decision.
C) Reflect transactions and events within a range of reasonable limits.
D) Be considered preferable to the users of those financial statements.
Answer: C Difficulty: Medium
37. What is the general character of the three generally accepted auditing standards
classified as general standards?
A) Criteria for competence, independence, and professional care of individuals
performing the audit.
B) Criteria for the content of the financial statements and related footnote disclosures.
C) Criteria for the content of the auditors' report on financial statements and related
footnote disclosures.
D) The requirements for the planning of the audit and supervision of assistants, if
any.
Answer: A Difficulty: Medium Source: AICPA
Chapter 2 Professional Standards
38. The auditors' examination performed in accordance with generally accepted auditing
standards generally should:
A) Be expected to provide absolute assurance that illegal acts will be detected where
internal control is effective.
B) Be relied upon to disclose violations of truth in lending laws.
C) Encompass a plan to actively search for all illegalities which relate to operating
aspects.
D) Not be relied upon to provide absolute assurance that all illegal acts will be
detected.
Answer: D Difficulty: Medium Source: AICPA
39. When the auditors express an opinion on financial statements their responsibilities
extend to:
A) The underlying wisdom of their client's management decisions.
B) Whether the results of their client's operating decisions are fairly presented in the
financial statements.
C) Active participation in the implementation of the advice given to their client.
D) An ongoing responsibility for their client's solvency.
Answer: B Difficulty: Medium Source: AICPA
40. The standard short-form auditors' report generally includes an introductory paragraph,
a scope paragraph, and an opinion paragraph. In the report the auditors refer to both
accounting principles generally accepted in the U.S. and auditing standards generally
accepted in the U.S. In which of the paragraphs are these terms used?
A) GAAP in the scope paragraph and GAAS in the opinion paragraph.
B) GAAS in the scope paragraph and GAAP in the opinion paragraph.
C) GAAS in all paragraphs and GAAP in the scope paragraph.
D) GAAP in all paragraphs and GAAS in the opinion paragraph.
Answer: B Difficulty: Medium Source: AICPA
Chapter 2 Professional Standards
41. An investor reading the financial statements of The Sundby Corporation observes that
the statements are accompanied by an unqualified auditors' report. From this the
investor may conclude that:
A) Any disputes over significant accounting issues have been settled to the auditors'
satisfaction.
B) The auditors are satisfied that Sundby is operationally efficient.
C) The auditors have ascertained that Sundby's financial statements have been
prepared accurately.
D) Informative disclosures in the financial statements but not necessarily in the
footnotes are to be regarded as reasonably adequate.
Answer: A Difficulty: Hard Source: AICPA
42. The auditors' report may be addressed to the company whose financial statements are
being examined or to that company's:
A) Chief operating officer.
B) President.
C) Board of Directors.
D) Chief financial officer.
Answer: C Difficulty: Medium Source: AICPA
43. Which of the following best describes what is meant by generally accepted auditing
standards?
A) Acts to be performed by the auditors.
B) Measures of the quality of the auditors' performance.
C) Procedures to be used to gather evidence to support financial statements.
D) Audit objectives generally determined on audit engagements.
Answer: B Difficulty: Medium Source: AICPA
44. If an illegal act is discovered during the audit of a publicly held company, the auditors
should first:
A) Notify the regulatory authorities.
B) Determine who was responsible for the illegal act.
C) Intensify the examination to identify all illegal acts.
D) Report the act to high level personnel within the client's organization and to the
audit committee.
Answer: D Difficulty: Hard Source: AICPA
Chapter 2 Professional Standards
45. Which of the following is not required by the generally accepted auditing standard that
states that due professional care is to be exercised in the performance of the audit?
A) Observance of the standards of field work and reporting.
B) Critical review of the audit work performed at every level of supervision.
C) Degree of skill commonly possessed by others in the profession.
D) Responsibility for losses because of errors of judgment.
Answer: D Difficulty: Easy Source: AICPA
46. 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 which are applicable to a
variety of situations.
B) They are procedural outlines which 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.
D) They are interpretations which are intended which may be useful guidance to
auditors.
Answer: C Difficulty: Medium Source: AICPA
47. The primary responsibility for the adequacy of disclosure in the financial statements of
a publicly held company rests with the:
A) Partner assigned to the audit engagement.
B) Management of the company.
C) Auditor in charge of the fieldwork.
D) Securities and Exchange Commission.
Answer: B Difficulty: Easy Source: AICPA
48. Within the context of quality control, the primary purpose of continuing professional
education and training activities is to enable a CPA firm to provide personnel within
the firm with:
A) Technical training that assures proficiency as an auditor.
B) Professional education that is required in order to perform with due professional
care.
C) Knowledge required to fulfill assigned responsibilities and to progress within the
firm.
D) Knowledge required in order to perform a peer review.
Answer: C Difficulty: Hard Source: AICPA
Chapter 2 Professional Standards
49. In pursuing a CPA firm's quality control objectives, a CPA firm may maintain records
indicating which partners or employees of the CPA firm were previously employed by
the CPA firm's clients. Which quality control objective would this be most likely to
satisfy?
A) Acceptance and continuance of clients and engagements.
B) Engagement performance.
C) Personnel management.
D) Independence, integrity and objectivity.
Answer: D Difficulty: Hard Source: AICPA
50. A CPA firm establishes quality control policies and procedures for deciding whether
to accept a new client or continue to perform services for a current client. The primary
purpose for establishing such policies and procedures is:
A) To enable the auditor to attest to the integrity or reliability of a client.
B) To comply with the quality control standards established by regulatory bodies.
C) To minimize the likelihood of association with clients whose managements lack
integrity.
D) To lessen the exposure to litigation resulting from failure to detect fraud in client
financial statements.
Answer: C Difficulty: Medium Source: AICPA
51. Which of the following is not an element of quality control?
A) Documentation.
B) Personnel management.
C) Monitoring.
D) Engagement performance.
Answer: A Difficulty: Medium Source: AICPA
52. The generally accepted auditing standards established by the AICPA:
A) Have been accepted as interim standards by the Public Company Accounting
Oversight Board.
B) Provide accounting guidance for nonpublic companies.
C) Have been superseded by Public Company Accounting Oversight Board standards
for all audits.
D) Are now developed by the Securities and Exchange Commission.
Answer: A Difficulty: Medium
Chapter 2 Professional Standards
53. The Public Company Accounting Oversight Board has authority to establish which of
the following relating to public companies?
A)
B)
C)
D)
Attestation Standards
Yes
Yes
No
No
Ethics Standards
Yes
No
Yes
No
Answer: A Difficulty: Hard
54. Which of the following is least likely to be directly examined in an inspection
performed by the PCAOB?
A) Audit engagements.
B) Review engagements.
C) Compilation engagements.
D) CPA firm quality control system.
Answer: C Difficulty: Medium
55. As compared with the US nonpublic company audit report, the international audit
report:
A) Is briefer.
B) Includes enhanced explanation of the audit process.
C) Includes the name of the partner and managers on the audit, while the US report
includes only the CPA firm name.
D) Is dated as of year-end, whereas the US report is dated as of the last date of
significant field work.
Answer: B Difficulty: Hard
Chapter 2 Professional Standards
Essay Questions
56. Auditors must be concerned with both generally accepted auditing standards and
generally accepted accounting principles in performing an audit.
(a) Compare generally accepted auditing standards with generally accepted
accounting principles.
(b) Summarize two of the three generally accepted auditing standards known as the
general standards.
Difficulty: Easy
Answer:
(a) Generally accepted auditing standards are authoritative rules for measuring the
quality of audits. The ten generally accepted auditing standards were adopted by
the membership of the AICPA. Generally accepted accounting principles are
principles of measurement and presentation for financial statements that have
"substantial authoritative support."
(b) The general standards include (only two required):
• Technical training and proficiency
• Independence
• Exercise due professional care
57. The standard unqualified auditors' report consists of three paragraphs.
(a) Identify the three paragraphs and describe the purpose of each.
(b) Describe the manner in which the report should be titled and the significance of its
date.
Difficulty: Medium
Answer:
(a) Introductory paragraph--describes the financial statements being auditing and the
responsibilities of management and the auditors.
Scope paragraph--describes the nature of an audit and indicates whether the audit
was performed in accordance with generally accepted auditing standards.
Opinion paragraph--expresses the auditors' opinion on the financial statements.
(b) The report should be entitled "Independent Auditors' Report." The date is the "last
day of significant field work."
Chapter 2 Professional Standards
58. Auditors must consider the possibility of fraud by employees or management on every
audit engagement. They must also consider the possibility that the client has engaged
in illegal acts.
(a) Distinguish between employee and management fraud.
(b) Describe the auditors' responsibility for the detection of fraud in an audit.
(c) Describe the auditors' responsibility regarding illegal acts by a client.
Difficulty: Hard
Answer:
(a) Employee fraud is dishonest actions by lower level employees that occur within a
company despite management's efforts to prevent such actions. Management
fraud occurs when the top executives of a company deliberately deceive
stockholders, creditors, and the auditors by misstating the financial statements.
(b) The auditors have a responsibility to design the audit to provide reasonable
assurance of detecting material errors and fraud and to conduct the audit with due
care and skepticism.
(c) An audit cannot be relied upon to detect all illegal acts by the client. For illegal
acts which have a direct and material effect on the financial statement amounts, the
responsibility for detection is the same as that for errors and fraud--that is to
design the audit to provide reasonable assurance of detection. For illegal acts
having an indirect effect on the financial statement amounts, an audit provides no
assurance of detection.
Chapter 3 Professional Ethics
True/False Questions
1. The Rules portion of the AICPA Code of Professional Conduct must be followed by
only those members in private practice.
Answer: False Difficulty: Medium
2. The AICPA Code of Professional Conduct derives its authority from the Bylaws of the
AICPA.
Answer: True Difficulty: Medium
3. An immaterial loan from the CPA to an officer of a client impairs the independence of
the CPA.
Answer: True Difficulty: Medium
4. Financial interests of a CPA's nondependent children are attributed directly to the
CPA.
Answer: False Difficulty: Medium
5. Statements on Accounting and Review Services are enforceable under the AICPA
Code of Professional Conduct.
Answer: True Difficulty: Easy
6. CPAs may not advertise as to any special expertise other than in accounting, auditing,
and tax.
Answer: False Difficulty: Medium
7. A CPA may receive a commission for recommending a particular computer system to
an audit client.
Answer: False Difficulty: Easy
8. The communications between CPAs and their clients are privileged under federal law.
Answer: False Difficulty: Easy
Chapter 3 Professional Ethics
9. CPAs can advertise the fees only for their nonattest services.
Answer: False Difficulty: Easy
10. The American Institute of Certified Public Accountants has been the primary source
for ethical rules for internal auditors.
Answer: False Difficulty: Easy
Multiple Choice Questions
11. ABC Company is audited by the Phoenix office of Willingham CPAs. Which of the
following individuals would be least likely to be considered a “covered member” by
the independence standard?
A) Staff assistant on the audit.
B) An audit partner in the Eloi office.
C) A tax partner in Phoenix who performs no attest services for ABC Company or for
any other clients.
D) The partner in charge of Willingham CPAs (she does no work on the ABC
Company Audit).
Answer: B Difficulty: Hard
12. Which of the following statements is true with respect to the SEC's concept of
independence when an auditor both prepares financial statements and audits those
financial statements for a client?
A) The auditor is not independent.
B) The auditor is independent if he or she is able to maintain a level of professional
detachment.
C) The auditor can audit the financial statements only if the audit process does not
culminate in the expression of an opinion on the financial statements.
D) The auditor cannot audit the financial statements since a lack of integrity exists.
Answer: A Difficulty: Medium
Chapter 3 Professional Ethics
13. Auditors are periodically punished for holding an investment in a client. This violates
which ethical rule?
A) Integrity.
B) Independence.
C) Non compliance with GAAP.
D) Confidentiality.
Answer: B Difficulty: Easy
14. A small CPA firm provides audit services to a large local company. Almost eighty
percent of the CPA firm's revenues come from this client. Which statement is most
likely to be true?
A) Appearance of independence may be lacking.
B) The small CPA firm does not have the proficiency to perform a larger audit.
C) The situation is satisfactory if the auditor exercises due skeptical negative
assurance care in the audit.
D) The auditor should provide an “emphasis of a matter paragraph” to his/her audit
report adequately disclosing this information and then it may issue an unqualified
opinion.
Answer: A Difficulty: Easy
15. Contingency fee based pricing of accounting services is:
A) Always strictly prohibited in public accounting practice.
B) Never restricted in public accounting practice.
C) Prohibited for clients for whom attestation services are provided.
D) Considered an act discreditable to the profession.
Answer: C Difficulty: Hard
16. Which of the following is least likely to impair a CPA firm's independence with
respect to an audit client in the Oklahoma City of a national CPA firm?
A) A partner in the Oklahoma City office owns an immaterial amount of stock in the
client.
B) A partner in the Jersey City office owns 7% of the client's stock.
C) A partner in the Oklahoma City office, who does not work on the audit, previously
served as controller for the audit client.
D) A partner in the Chicago office is also the vice president of finance for the audit
client.
Answer: C Difficulty: Hard
Chapter 3 Professional Ethics
17. Which of the following family relationships is most likely to impair a CPA's
independence with respect to a particular audit client on which the CPA works as a
“covered member”?
A) A close relative has a material investment in that client of which the CPA is not
aware.
B) A cousin has an immaterial investment in the client of which the CPA is aware.
C) The CPA's father is president of the audit client.
D) The CPA's spouse participates in a savings plan sponsored by the client.
Answer: C Difficulty: Medium
18. Which of the following attributes is more closely associated with attestation services
performed by a CPA firm than with other lines of professional work?
A) Integrity.
B) Competence
C) Independence
D) Keeping informed on current professional developments.
Answer: C Difficulty: Medium
19. Which of the following types of employees must be independent of an audit client?
A) Staff assistants assigned to the engagement.
B) Senior auditors assigned to the office that performs the audit.
C) Managers assigned to an office that does not participate in the engagement.
D) All firm professionals, regardless of their position.
Answer: A Difficulty: Hard
20. Which of the following are not enforceable under the AICPA Code of Professional
Conduct?
A) Statements on Auditing Standards.
B) Statements on Standards for Accounting and Review Services.
C) Statements on Responsibilities in Tax Practice.
D) Statements of Standards for Consulting Services.
Answer: C Difficulty: Hard
Chapter 3 Professional Ethics
21. The AICPA allows which of the following:
A) Performance of bookkeeping services for clients.
B) Authorization of transactions for a client.
C) Preparation of client source documents.
D) Preparation and posting of journal entries without the client's approval.
Answer: A Difficulty: Hard
22. Which of the following forms of organization is most likely to protect the personal
assets of any partner or shareholder who has not been involved on an engagement
resulting in litigation?
A) Professional corporation.
B) Limited liability partnership.
C) Partnership.
D) Subchapter M Incorporation
Answer: B Difficulty: Medium
23. Jones & Company CPAs has one office. Which of the following is least likely to
impair independence with respect to an audit client?
A) The client owes the firm for two prior years' audit fees.
B) A partner in the CPA firm is the son of the president of the client.
C) The wife of a partner in the firm has a small direct financial interest in the client.
D) A partner in the firm has an investment in a mutual fund that has a direct interest
in the client.
Answer: D Difficulty: Hard
24. Which of the following acts by a CPA would not necessarily be considered an act
discreditable to the profession under Rule 501 of the AICPA Code of Professional
Conduct?
A) Prohibiting a client's new CPA firm from reviewing the audit working papers after
the client has requested the CPA to do so.
B) Engaging in discriminatory employment practices.
C) Robbing a convenience store.
D) Knowingly signing a false tax return.
Answer: A Difficulty: Easy
Chapter 3 Professional Ethics
25. Which of the following forms of advertising would be considered to be a violation of
Rule 502 of the AICPA Code of Professional Conduct?
A) Advertising including the types of services offered and the standard fees for the
services.
B) Advertising including the experience of the firm's professional staff.
C) Advertising including an indication that the firm has a close relationship with
several tax court judges.
D) Advertising including the percentage of the firm's staff that have CPA certificates.
Answer: C Difficulty: Medium
26. If a CPA violates the AICPA Code of Professional Conduct, the AICPA Trial Board
may do all of the following, except:
A) Admonish the offending member.
B) Suspend the offending member.
C) Expel the offending member.
D) Revoke the offending member's CPA certificate.
Answer: D Difficulty: Medium
27. Which of the following acts by a CPA would be most likely to be a violation of the
AICPA Code of Professional Conduct?
A) Assisting a client in preparing a financial forecast.
B) Forming a professional corporation to practice as a CPA.
C) Accepting a fee in a tax matter relating to an administrative proceeding.
D) A “covered member” owns an immaterial amount of stock in an audit client.
Answer: D Difficulty: Hard
28. In which of the following circumstances would a covered member be considered
independent when performing the audit of the financial statements of a new client for
the year ended December 31, 20X3?
A) The covered member resigned on January 17, 20X3 from the board of directors of
the client, prior to accepting the new audit engagement.
B) The covered member continues to hold an immaterial indirect financial interest in
the client.
C) The covered member continues to serve as a trustee for the client's pension plan
and has the authority to make investment decisions.
D) The covered member's spouse owns an immaterial amount of shares of common
stock in the client.
Answer: B Difficulty: Hard
Chapter 3 Professional Ethics
29. Independence is required of a CPA performing:
A) Audits, but not any other professional services.
B) All attestation services, but not other professional services.
C) All attestation and tax services, but not other professional services.
D) All professional services.
Answer: B Difficulty: Medium
30. A CPA should maintain objectivity and be free of conflicts of interest when
performing:
A) Audits, but not any other professional services.
B) All attestation services, but not other professional services.
C) All attestation and tax services, but not other professional services.
D) All professional services.
Answer: D Difficulty: Medium
31. Bill Pan, CPA, has posted the general ledger and has maintained the financial records
of Zorko Corporation. As a part of his responsibilities he has recorded journal entries
and made closing entries. Which of the following best summarize the AICPA and
SEC views as to the following question: Is audit independence impaired?
Item
A)
B)
C)
D)
AICPA
Yes
Yes
No
No
SEC
Yes
No
Yes
No
Answer: B Difficulty: Hard
32. In determining the scope and nature of services to be performed in public practice, a
CPA firm should:
A) Require independence for all services performed.
B) Determine that the performance of all services is consistent with the firm's
members' role as professionals.
C) Have in place internal control procedures.
D) Only perform accounting related services.
Answer: B Difficulty: Medium
Chapter 3 Professional Ethics
33. Independence of a CPA with respect to a client is not impaired if:
A) The CPA has a loan to an officer of the client.
B) The CPA has an immaterial direct interest in the client.
C) The CPA is trustee for the client's pension plan.
D) The CPA has an immaterial joint, closely held business investment with the client.
Answer: D Difficulty: Hard
34. A CPA firm may not designate itself as "members of the AICPA" unless:
A) All of its partners or shareholders are members of the Institute.
B) All of its professional staff are members of the Institute.
C) A majority of its professional staff are members of the Institute.
D) At least one partner or shareholder is a member of the Institute.
Answer: A Difficulty: Medium
35. While performing an audit, the auditors of a company that reports to the Securities and
Exchange Commission discovered material illegal acts and resigned due to the client's
refusal to disclose them. The auditors' reason for resignation should be disclosed
through:
Item
A)
B)
C)
D)
CPA Direct Communication
With Shareholders
Yes
Yes
No
No
The Process of Filing
a Form 8-K
Yes
No
Yes
No
Answer: C Difficulty: Hard
36. Pickens and Perkins, CPAs, decide to incorporate their practice of accountancy.
According to the AICPA Code of Professional Conduct, shares in the corporation can
be issued:
A) Only to persons qualified to practice public accounting.
B) Only to employees and officers of the firm.
C) Only to persons qualified to practice as CPAs and members of their immediate
families.
D) To the general public.
Answer: A Difficulty: Medium Source: AICPA
Chapter 3 Professional Ethics
37. Which of the following statements best describes why the profession of certified
public accountants has deemed it essential to promulgate a code of professional
conduct and to establish a mechanism for enforcing observation of the code?
A) A distinguishing mark of a profession is its acceptance of responsibility to the
public.
B) A prerequisite to success is the establishment of an ethical code that stresses
primarily the professional's responsibility to clients and colleagues.
C) A requirement of most state laws calls for the profession to establish a code of
ethics.
D) An essential means of self-protection for the profession is the establishment of
flexible ethical standards by the professions.
Answer: A Difficulty: Easy Source: AICPA
38. A CPA's retention of client records as a means of enforcing payment of an overdue
audit fee is an action that is:
A) Considered acceptable by the AICPA Code of Professional Conduct.
B) Ill advised since it would impair the CPA's independence with respect to the
client.
C) Considered discreditable to the profession.
D) A violation of generally accepted auditing standards.
Answer: C Difficulty: Medium Source: AICPA
39. The AICPA Code of Professional Conduct would be violated if a CPA accepted a fee
for services and the fee was:
A) Fixed by a public authority.
B) Based on a price quotation submitted in competitive bidding.
C) Based on performing work relating to judicial proceedings.
D) Payable if the audit of the financial statements led to a loan.
Answer: D Difficulty: Medium Source: AICPA
Chapter 3 Professional Ethics
40. An audit independence issue might be raised by the auditor's participation in
consulting services engagements. Which of the following statements is most
consistent with the profession's attitude toward this issue?
A) Information obtained as a result of a consulting services engagement is
confidential to that specific engagement and should not influence performance of
the attest function.
B) The decision as to loss of independence must be made by the client based on the
facts of the particular case.
C) The auditor should not make management decisions for an audit client.
D) The auditor who is asked to review management decisions, is also competent to
make these decisions and can do so without loss of independence.
Answer: C Difficulty: Hard Source: AICPA
41. The AICPA Code of Professional Conduct will ordinarily be considered to have been
violated when the CPA represents that specific consulting services will be performed
for a stated fee and it is apparent at the time of the representation that the:
A) Actual fee would be substantially higher.
B) Actual fee would be substantially lower than the fees charged by other CPAs for
comparable services.
C) Fee was a competitive bid.
D) CPA would not be independent.
Answer: A Difficulty: Medium Source: AICPA
42. The concept of materiality would be least important to an auditor when considering
the:
A) Decision whether to use positive or negative confirmations of accounts receivable.
B) Adequacy of disclosure of a client's illegal act.
C) Discovery of weaknesses in a client's internal control.
D) Effects of a direct financial interest in the client upon the CPA's independence.
Answer: D Difficulty: Hard Source: AICPA
43. When an accountant is not independent, the accountant is precluded from issuing a:
A) Compilation report.
B) Review report.
C) Management advisory report.
D) Tax planning report.
Answer: B Difficulty: Medium Source: AICPA
Chapter 3 Professional Ethics
44. Competence as a certified public accountant includes all of the following except:
A) Having the technical qualifications to perform an engagement.
B) Possessing the ability to supervise and to evaluate the quality of staff work.
C) Warranting the infallibility of the work performed.
D) Consulting others if additional technical information is needed.
Answer: C Difficulty: Easy Source: AICPA
45. The AICPA Code of Professional Conduct states that a CPA shall not disclose any
confidential information obtained in the course of a professional engagement except
with the consent of the client. This rule should be understood to preclude a CPA from
responding to an inquiry made by:
A) The trial board of the AICPA.
B) An investigative body of a state CPA society.
C) A CPA-shareholder of the client corporation.
D) An AICPA voluntary quality review body.
Answer: C Difficulty: Medium Source: AICPA
46. A client company has not paid its 20X3 audit fees. According to the AICPA Code of
Professional Conduct, in order for the auditor to be considered independent with
respect to the 20X4 audit, the 20X3 audit fees must be paid before the:
A) 20X3 report is issued.
B) 20X4 fieldwork is started.
C) 20X4 report is issued.
D) 20X5 fieldwork is started.
Answer: C Difficulty: Medium Source: AICPA
47. A CPA sole practitioner purchased stock in a client corporation and placed it in a trust
as an educational fund for the CPA's minor child. The trust securities were not
material to the CPA but were material to the child's personal net worth. Would the
independence of the CPA be considered to be impaired with respect to the client?
A) Yes, because the stock would be considered a direct financial interest and,
consequently, materiality is not a factor.
B) Yes, because the stock would be considered an indirect financial interest that is
material to the CPA's child.
C) No, because the CPA would not be considered to have a direct financial interest in
the client.
D) No, because the CPA would not be considered to have a material indirect financial
interest in the client.
Answer: A Difficulty: Hard Source: AICPA
Chapter 3 Professional Ethics
48. A primary purpose for establishing a code of conduct within a professional
organization is to:
A) Reduce the likelihood that members of the profession will be sued for substandard
work.
B) Ensure that all members of the profession perform at approximately the same level
of competence.
C) Demonstrate acceptance of responsibility to the interests of those served by the
profession.
D) Require members of the profession to exhibit loyalty in all matters pertaining to
the affairs of their organization.
Answer: C Difficulty: Medium Source: IIA
49. An accounting association established a code of ethics for all members. The most
likely primary purpose for establishing the code of ethics was to:
A) Outline criteria for professional behavior to maintain standards of competence,
morality, honesty, and dignity within the association.
B) Establish standards to follow for effective accounting practice.
C) Provide a framework within which accounting policies could be effectively
developed and executed.
D) Outline criteria that can be utilized in conducting interviews of potential new
accountants.
Answer: A Difficulty: Medium Source: IIA
Chapter 3 Professional Ethics
Essay Questions
50. The following is a list of circumstances that might be faced by a public accounting
firm. If the circumstance represents a violation of one of the rules of the AICPA Code
of Professional Conduct, provide the title of the rule. Write "no violation" in the space
if the circumstance does not represent a violation of a rule.
1
2
3
4
5
6
7
8
9
10
Circumstance
The dependent-son of a partner in a CPA firms owns
ten share of stock in an audit client.
In preparing a tax return, a CPA takes a deduction at
the client’s request, that the CPA believes is not
justified.
A CPA robs a bank.
A CPA owns 100 shares o f stock in a consulting client.
A CPA charges an audit fee that depends on the
amount of credit the client obtains.
A CPA advertises in a local newspaper.
A CPA issues an unqualif ied opinion on financial
statements that materially depart from an FASB
standard; the CPA believes that the departure is not
justified.
A CPA receives a commission for selling computer
equipment to an audit client.
A CPA discloses information about a client because
the information was subpoenaed.
A CPA does not follow generally accepted auditing
standards.
Difficulty: Hard
Rule Violated
Chapter 3 Professional Ethics
Answer:
1
2
3
4
5
6
7
8
9
10
Circumstance
The dependent-son of a partner in a CPA firms owns ten
share of stock in an audit client.
In preparing a tax return, a CPA takes a deduction at the
client’s request, that the CPA believes is not justified.
A CPA robs a bank.
A CPA owns 100 shares of stock in a consulting client.
A CPA charges an audit fee that depends on the amount
of credit the client obtains.
A CPA advertises in a local newspaper.
A CPA issues an unqualified opinion on financial
statements that materially depart from an FASB standard;
the CPA believes that the departure is not justified.
A CPA receives a commission for selling computer
equipment to an audit client.
A CPA discloses information about a client because the
information was subpoenaed.
A CPA does not follow generally accepted auditing
standards.
Rule Violated
Independence
Integrity and objectivity
Acts discreditable
No violation
Contingent fees
No violation
Accounting principles
Commissions and referral
fees
No violation
Compliance with standard
51. CPAs are allowed to advertise under the Rules of the AICPA Code of Professional
Conduct.
a. List the general guidelines regarding the nature of acceptable advertising.
b. Describe two specific forms of unacceptable advertising.
Difficulty: Medium
Answer:
a. Advertising is acceptable if it is not false, misleading, or deceptive.
b. Unacceptable forms of advertising include advertising that (only two required):
• Creates unjustified expectations of favorable results.
• Indicates an ability to influence a court or other official body.
• Misstates professional qualifications.
Chapter 3 Professional Ethics
52. The Sarbanes-Oxley Act of 2002 placed significant restrictions on the types of
consulting that may be performed by auditors for their public company audit clients.
a. List four types of services that are prohibited by the Act.
b. List three types of general consulting activities that would the AICPA Code of
Professional Conduct indicates impair the auditors' independence.
Difficulty: Hard
Answer:
a. Services prohibited by the Act include (4 required):
•
Bookkeeping or other services related to the accounting records or financial
statements.
•
Financial information systems design and implementation.
•
Appraisal, valuation and actuarial services.
•
Internal audit outsourcing services, management functions or human resources.
•
Various investment services.
•
Leal services and expert services unrelated to auditing.
b. Consulting functions that the AICPA Code of Professional Conduct indicate
impair independence include (3 required):
•
Authorizing, executing or consummating a transaction.
•
Preparing source documents.
•
Having custody of client assets.
•
Supervising client employees in their normal recurring activities.
•
Determining which recommendation should be implemented.
•
Reporting to the board of directors on behalf of management.
•
Serving as a client’s stock transfer or escrow agent, registrar, or its general
counsel.
Chapter 3 Professional Ethics
53. The AICPA's Code of Professional Conduct consists of two parts, Principles and
Rules.
a. Describe the purpose of each of the two parts.
b. Describe the disciplinary action that may be taken against a member who violates
the Code.
c. Must the Rules be followed by members of the AICPA that are not in public
practice? Explain your answer.
Difficulty: Medium
Answer:
a. Principles-goal-oriented, positively stated discussion of the profession's
responsibilities to the public, clients, and fellow practitioners. Rules--enforceable
applications of the principles.
b. For violations of the Code a member may be required to take remedial action, such
as attending continuing education programs. For more serious violations, the
member may be censured, suspended, or expelled.
c. The Rules apply to all members of the AICPA, unless the wording of the rule
indicates otherwise.
Chapter 4 Legal Liability of CPAs
True/False Questions
1. Fraud is defined as failure to use reasonable care in the performance of services.
Answer: False Difficulty: Easy
2. Most of the burden of affirmative proof is on the defendant under common law.
Answer: False Difficulty: Medium
3. The Ultramares v. Touche case held that auditors could be held liable to any foreseen
third party for ordinary negligence.
Answer: False Difficulty: Medium
4. The Securities Exchange Act of 1934 offers recourse against the auditors to a far
greater number of investors than does the Securities Act of 1933.
Answer: True Difficulty: Medium
5. The precedent set by the Hochfelder v. Ernst case is generally believed to have
increased auditors' legal liability.
Answer: False Difficulty: Hard
6. The auditors can be held liable for negligence in audits of financial statements, but not
in reviews of financial statements.
Answer: False Difficulty: Easy
7. The results of the Continental Vending Corporation case included the criminal
prosecution of auditors for gross negligence.
Answer: True Difficulty: Medium
8. Most charges made against auditors under common law are criminal.
Answer: False Difficulty: Medium
9. The Securities Act of 1934 includes provisions for criminal charges against persons
violating the Act.
Answer: True Difficulty: Medium
Chapter 4 Legal Liability of CPAs
10. The use of engagement letters is generally designed to prevent lawsuits by third parties
against the auditors.
Answer: False Difficulty: Medium
Multiple Choice Questions
11. A CPA issued an unqualified opinion on the financial statements of a company that
sold common stock in a public offering subject to the Securities Act of 1933. Based
on a misstatement in the financial statements, the CPA is being sued by an investor
who purchased shares of this public offering. Which of the following represents a
viable defense?
A) The investor has not proven CPA negligence.
B) The investor did not rely upon the financial statement.
C) The CPA detected the misstatement after the audit report date.
D) The misstatement is immaterial in the overall context of the financial statements.
Answer: D Difficulty: Hard
12. Which of the following is a correct statement related to CPA legal liability under
common law?
A) CPAs are normally liable to their clients, the shareholders, for either ordinary or
gross negligence.
B) CPAs are liable for either ordinary or gross negligence to identified third parties
for whose benefit the audit was performed.
C) CPAs may escape all personal liability through incorporation as a limited liability
corporation.
D) CPAs are guilty until they prove that they performed the audit with “good faith.”
Answer: B Difficulty: Medium
13. Under Section 10 of the 1934 Securities Exchange Act auditors are liable to security
purchasers for:
A) Lack of due diligence.
B) Existence of scienter.
C) Ordinary negligence.
D) Auditors have no liability to security purchasers under this act.
Answer: B Difficulty: Hard
Chapter 4 Legal Liability of CPAs
14. Jones, CPA, is in court defending himself against a lawsuit filed under the 1933
Securities Act. The charges have been filed by purchasers of securities covered under
that act. If the purchasers prove their required elements, in general Jones will have to
prove that:
A) He is not guilty of gross negligence.
B) He performed the audit with good faith.
C) He performed the audit with due diligence.
D) The plaintiffs did not show him to be negligent.
Answer: C Difficulty: Medium
15. An auditor knew that the purpose of her audit was to render reasonable assurance on
financial statements that were to be used for the application for a loan; the auditor did
not know the identity of the bank that would eventually give the loan. Under the
Restatement of Torts approach to liability the auditor is generally liable to the bank
which subsequently grants the loan for:
A) Lack of due diligence.
B) Lack of good faith.
C) Gross negligence, but not ordinary negligence.
D) Either ordinary or gross negligence.
Answer: D Difficulty: Hard
16. An auditor knew that the purpose of her audit was to render reasonable assurance on
financial statements that were to be used for the application for a loan; the auditor did
not know the identity of the bank that would eventually give the loan. Under the
foreseeable third party approach the auditor is generally liable to the bank which
subsequently grants the loan for:
A) Lack of due diligence.
B) Lack of good faith.
C) Gross negligence, but not ordinary negligence.
D) Either ordinary or gross negligence.
Answer: D Difficulty: Hard
Chapter 4 Legal Liability of CPAs
17. Which of the following forms of organization is most likely to protect the personal
assets of any partner, or shareholder who has not been involved on an engagement
resulting in litigation?
A) Professional corporation.
B) Limited liability partnership.
C) Partnership.
D) Subchapter M Incorporation.
Answer: B Difficulty: Medium
18. Under which common law approach are auditors most likely to be held liable for
ordinary negligence to a "reasonably foreseeable" third party?
A) Due Diligence Approach.
B) Ultramares Approach.
C) Restatement of Torts Approach.
D) Rosenblum Approach.
Answer: D Difficulty: Medium
19. Assume that $500,000 in damages are awarded to a plaintiff, and the CPA's
percentage of responsibility established at 10%, while others are responsible for the
other 90%. Assume the others have no financial resources. As a result the CPA has
been required to pay the entire $500,000. The auditor's liability is most likely based
upon which approach to assessing liability?
A) Absolute liability
B) Contributory negligence
C) Joint and several liability.
D) Proportional liability.
Answer: C Difficulty: Hard
20. Assume that $500,000 in damages are awarded to a plaintiff, and the CPA's
percentage of responsibility established at 10%, while others are responsible for the
other 90%. Assume the others have no financial resources. The CPA has been
required to pay $50,000. The auditor's liability is most likely based upon which
approach to assessing liability?
A) Absolute liability.
B) Contributory negligence.
C) Joint and several liability.
D) Proportional liability.
Answer: D Difficulty: Hard
Chapter 4 Legal Liability of CPAs
21. Assume that a client has encountered a $500,000 fraud and that the CPA's percentage
of responsibility established at 10%, while the company itself was responsible for the
other 90%. Under which approach to liability is the CPA most likely to avoid liability
entirely?
A) Absolute negligence.
B) Comparative negligence.
C) Contributory negligence.
D) Joint Negligence.
Answer: C Difficulty: Hard
22. In which of the following court cases was a precedent set increasing liability to third
parties arising from audits under common law?
A) Rosenblum v. Adler.
B) Hochfelder v. Ernst.
C) 1136 Tenants Corporation v. Rothenberg.
D) Continental Vending.
Answer: A Difficulty: Hard
23. The burden of proof that must be proven to recover losses from the auditors under the
Securities Exchange Act of 1934 is generally considered to be:
A) Less than the Securities Act of 1933.
B) The same as the Securities Act of 1933.
C) Greater than the Securities Act of 1933.
D) Indeterminate in relation to the Securities Act of 1933.
Answer: C Difficulty: Medium
24. CPAs should not be liable to any party if they perform their services with:
A) Ordinary negligence.
B) Regulatory providence.
C) Due professional care.
D) Good faith.
Answer: C Difficulty: Medium
Chapter 4 Legal Liability of CPAs
25. The Second Restatement of the Law of Torts provides for auditor liability to a limited
class of foreseen third parties for:
A) Only criminal acts.
B) Either ordinary or gross negligence.
C) Only gross negligence.
D) Only fraud.
Answer: B Difficulty: Medium
26. A principle that may reduce or entirely eliminate auditor liability to a client is:
A) Client constructive negligence.
B) Client contributory negligence.
C) Auditor ordinary negligence.
D) Auditor gross negligence.
Answer: B Difficulty: Medium
27. Under the Securities Act of 1933 the burden of proof that the plaintiff sustained a loss
must be proven by the:
A) Plaintiff.
B) Defendant.
C) SEC.
D) Jury.
Answer: A Difficulty: Medium
28. A case by a client against its CPA firm alleging negligence would be brought under:
A) The Securities Act of 1933.
B) The Securities Exchange Act of 1934.
C) The state blue sky laws.
D) Common law.
Answer: D Difficulty: Medium
Chapter 4 Legal Liability of CPAs
29. Assume that a CPA firm was negligent but not grossly negligent in the performance of
an engagement. Which of the following plaintiffs probably would not recover losses
proximately caused by the auditors' negligence?
A) A loss sustained by a client in a suit brought under common law.
B) A loss sustained by a lender not in privity of contract in a suit brought in a state
court which adheres to the Ultramares v. Touche precedent.
C) A loss sustained by initial purchasers of stock in a suit brought under the
Securities Act of 1933.
D) A loss sustained by a bank named as a third-party beneficiary in the engagement
letter in a suit brought under common law.
Answer: B Difficulty: Hard
30. Which of the following court cases highlighted the need for obtaining engagement
letters for professional services?
A) Ultramares v. Touche.
B) Rosenblum v. Adler.
C) Hochfelder v. Ernst.
D) 1136 Tenants Corporation v. Rothenberg.
Answer: D Difficulty: Medium
31. In which type of court case is proving "due diligence" essential to the auditors'
defense?
A) Court cases brought under the Securities Exchange Act of 1934.
B) Court cases brought by clients under common law.
C) Court cases brought by third parties under common law.
D) Court cases brought under the Securities Act of 1933.
Answer: D Difficulty: Medium
32. Which common law approach leads to increased CPA liability to "foreseeable" third
parties for ordinary negligence?
A) Ultramares v. Touche.
B) Restatement of Torts.
C) Rule 10b-5.
D) Rosenblum v. Adler.
Answer: D Difficulty: Medium
Chapter 4 Legal Liability of CPAs
33. Which of the following is the best defense that a CPA can assert against common law
litigation by a stockholder claiming fraud based on an unqualified opinion on
materially misstated financial statements?
A) Lack of due diligence.
B) Lack of gross negligence.
C) Contributory negligence on the part of the client.
D) A disclaimer contained in the engagement letter.
Answer: B Difficulty: Hard
34. Which of the following must be proven by the plaintiff in a case against a CPA under
the Section 11 liability provisions of the Securities Act of 1933?
A) The CPA knew of the misstatement.
B) The CPA was negligent.
C) Material misstatements were contained in the financial statements.
D) The unqualified opinion contained in the registration statement was relied upon by
the party suing the CPA.
Answer: C Difficulty: Hard
35. A CPA issued a standard unqualified audit report on the financial statements of a
client that the CPA knew was in the process of obtaining a loan. In a suit by the bank
issuing the loan the CPA's best defense would be that the:
A) Audit complied with generally accepted auditing standards.
B) Client was aware of the misstatements.
C) Bank was not the CPA's client.
D) Bank's identity was known to the CPA prior to completion of the audit.
Answer: A Difficulty: Hard
36. The Private Securities Litigation Reform Act of 1995 imposes proportionate liability
on the CPA who:
A) Unknowingly violates the 1934 Securities Exchange Act.
B) Knowingly or unknowingly violates the 1934 Securities Exchange Act.
C) Unknowingly violates the 1933 Securities Act.
D) Knowingly or unknowingly violates the 1933 Securities Act.
Answer: A Difficulty: Hard
Chapter 4 Legal Liability of CPAs
37. Which of the following is not correct relating to the Private Securities Litigation
Reform Act of 1995?
A) It provides certain small investors better recovery rights than it does large
investors.
B) It retains joint and several liability in certain circumstances.
C) It makes recovery against CPAs more difficult under common law litigation.
D) It eliminates securities fraud as an offense under civil RICO.
Answer: C Difficulty: Hard
38. A limited liability partnership form of organization:
A) Decreases liability of all partners of a CPA firm.
B) Has similar liability requirements to that of a professional corporation.
C) Eliminates personal liability for some, but not all, partners.
D) Eliminates personal liability for all partners.
Answer: C Difficulty: Hard
39. Which of the following is accurate with respect to litigation involving CPAs?
A) A CPA will not be found liable for an audit unless the CPA has audited all
affiliates of that company.
B) A CPA may not successfully assert as a defense that the CPA had no motive to be
part of a fraud.
C) A CPA may be exposed to criminal as well as civil liability.
D) A CPA is primarily responsible, while the client is secondarily responsible for the
notes in an annual report filed with the SEC.
Answer: C Difficulty: Medium Source: AICPA
40. Starr Corp. approved a plan of merger with Silo Corp. One of the determining factors
in approving the merger was the strong financial statements of Silo which were
audited by Cox & Co., CPAs. Starr had engaged Cox to audit Silo's financial
statements. While performing the audit, Cox failed to discover certain instances of
fraud which have subsequently caused Starr to suffer substantial losses. In order for
Cox to be liable under common law, Starr at a minimum must prove that Cox:
A) Acted recklessly or with lack of reasonable grounds for belief.
B) Knew of the instances of fraud.
C) Failed to exercise due care.
D) Was grossly negligent.
Answer: C Difficulty: Medium Source: AICPA
Chapter 4 Legal Liability of CPAs
41. Dexter and Co., CPAs, issued an unqualified opinion on the 20X3 financial statements
of Bart Corp. Late in 20X4, Bart determined that its treasurer had embezzled over
$1,000,000. Dexter was unaware of the embezzlement. Bart has decided to sue
Dexter to recover the $1,000,000. Bart's suit is based upon Dexter's failure to discover
the missing money while performing the audit. Which of the following is Dexter's
best defense?
A) That the audit was performed in accordance with GAAS.
B) Dexter had no knowledge of the embezzlement.
C) The financial statements were presented in conformity with GAAP.
D) The treasurer was Bart's agent and as such had designed the controls which
facilitated the embezzlement.
Answer: A Difficulty: Medium Source: AICPA
42. When performing an audit, a CPA:
A) Must exercise the level of care, skill, and judgment expected of a reasonably
prudent CPA under the circumstances.
B) Must strictly adhere to generally accepted accounting principles.
C) Is strictly liable for failures to discover client fraud.
D) Is not liable unless the CPA commits gross negligence or intentionally disregards
generally accepted auditing standards.
Answer: A Difficulty: Medium Source: AICPA
43. A CPA's duty of due care to a client most likely will be breached when a CPA:
A) Gives a client an oral report instead of a written report.
B) Gives a client incorrect advice based on an honest error of judgment.
C) Fails to give tax advice that saves the client money.
D) Fails to follow generally accepted auditing standards.
Answer: D Difficulty: Medium Source: AICPA
44. Under common law, which of the following statements most accurately reflects the
liability of a CPA who fraudulently gives an opinion on an audit of a client's financial
statements?
A) The CPA is liable only to third parties in privity of contract with the CPA.
B) The CPA is liable only to known users of the financial statements.
C) The CPA probably is liable to any person who suffered a loss as a result of the
fraud.
D) The CPA probably is liable to the client even if the client was aware of the fraud
and did not rely on the opinion.
Answer: C Difficulty: Hard Source: AICPA
Chapter 4 Legal Liability of CPAs
45. In a common law action against an accountant, lack of privity is a viable defense if the
plaintiff:
A) Is the client's creditor who sues the accountant for negligence.
B) Can prove the presence of gross negligence that amounts to a reckless disregard
for the truth.
C) Is the accountant's client.
D) Bases the action upon fraud.
Answer: A Difficulty: Hard Source: AICPA
46. If a CPA recklessly departs from the standards of due care when conducting an audit,
the CPA will be liable to third parties who are unknown to the CPA based on:
A) Ordinary negligence.
B) Gross negligence.
C) Strict liability.
D) Criminal deceit.
Answer: B Difficulty: Medium Source: AICPA
47. Hark, CPA, negligently failed to follow generally accepted auditing standards in
auditing Long Corporation's financial statements. Long's president told Hark that the
audited financial statements would be submitted to several, at this point undetermined,
banks to obtain financing. Relying on the statements, Third Bank gave Long a loan.
Long defaulted on the loan. In jurisdiction applying the Ultramares decision, if Third
sues Hark, Hark will:
A) Win because there was no privity of contract between Hark and Third.
B) Lose because Hark knew that a bank would be relaying the financial statements.
C) Win because Third was contributory negligent in granting the loan.
D) Lose because Hark was negligent in performing the audit.
Answer: A Difficulty: Hard Source: AICPA
48. Under the Ultramares rule, to which of the following parties will an accountant be
liable for ordinary negligence?
A)
B)
C)
D)
Parties in privity
Yes
Yes
No
No
Foreseen parties
Yes
No
Yes
No
Answer: B Difficulty: Hard Source: AICPA
Chapter 4 Legal Liability of CPAs
49. Quincy bought Teal Corp. common stock in an offering registered under the Securities
Act of 1933. Worth & Co., CPAs, gave an unqualified opinion on Teal's financial
statements that were included in the registration statement filed with the SEC. Quincy
sued Worth under the provisions of the 1933 Act that deal with omission of facts
required to be in the registration statement. Quincy must prove that:
A) There was fraudulent activity by Worth.
B) There was a material misstatement in the financial statements.
C) Quincy relied on Worth's opinion.
D) Quincy was in privity with Worth.
Answer: B Difficulty: Hard Source: AICPA
50. Bran, CPA, audited Frank Corporation. The shareholders sued both Frank and Bran
for securities fraud under the Federal Securities Exchange Act of 1934. The court
determined that there was securities fraud and that Frank was 80% at fault and Bran
was 20% at fault due to her negligence in the audit. Both Frank and Bran are solvent
and the damages were determined to be $1 million. What is the maximum liability of
Bran?
A) $0
B) $200,000
C) $500,000
D) $1,000,000
Answer: B Difficulty: Easy Source: AICPA
51. If a CPA recklessly departs from the standards of due care when conducting an audit,
the CPA will be liable to third parties who are unknown to the CPA based on
A) Negligence.
B) Gross negligence.
C) Strict liability.
D) Criminal deceit.
Answer: B Difficulty: Medium Source: AICPA
Chapter 4 Legal Liability of CPAs
52. The Public Company Accounting Oversight Board may conduct investigations and
disciplinary proceedings of:
A)
B)
C)
D)
Registered Public
Accounting Firms
Yes
Yes
No
No
Registered Public
Accounting Firm Employees
Yes
No
Yes
No
Answer: A Difficulty: Medium
Essay Questions
53. Auditors may be held liable to both their clients and third parties under common law.
a. What must a client prove to recover its losses from the auditors under common
law?
b. In a court that adheres to the precedent set by the Ultramares v. Touche case what
must an ordinary third party prove to recover losses from the auditors under
common law?
Difficulty: Medium
Answer:
a. To recover losses under common law, a client must prove:
• Losses,
• Reliance on the auditors' representations,
• That reliance was proximate cause of the losses, and
• Negligence on the part of the auditors.
b. To recover losses under common law, ordinary third parties must prove:
• Losses,
• Reliance on the auditors' report,
• That reliance was proximate cause of the losses, and
• Gross negligence on the part of the auditors.
Chapter 4 Legal Liability of CPAs
54. A CPA firm has audited the financial statements included in a Form S-1 filed with the
SEC under the Securities Act of 1933. Shortly thereafter, the company went bankrupt
and a class action lawsuit was filed by the initial investors against the CPA firm.
a. What should the plaintiff investors attempt to prove?
b. Must the plaintiffs prove that they relied on the financial statements included in the
Form S-1?
c. What must the CPA firm prove in order to be successful with respect to the firm's
defense?
Difficulty: Medium
Answer:
a. The plaintiff investors should attempt to prove:
• That they sustained losses, and
• That the financial statements were misleading.
b. No. The investors need not prove reliance.
c. The auditors must prove:
• "Due diligence" that is, that they had reasonable grounds to believe and did
believe that the financial statements were not misleading as of the effective
date,
• The plaintiffs' losses were not caused by misstated statements, or
• The plaintiffs knew of the financial statement misstatement when the securities
were purchased.
Chapter 4 Legal Liability of CPAs
55. A plaintiff may elect to bring a lawsuit against auditors under applicable statutes-including the Securities Act of 1933 and the Securities Exchange Act of 1934--and
under common law. For each circumstance, indicate the most likely source of CPA
liability by placing the appropriate letter in the third column.
a. The Securities Act of 1933
b. The Securities Exchange Act of 1934
c. Common Law
1
2
3
4
5
6
7
8
Circumstance
A CPA’s client is filing suit for negligence in
performing an audit.
A stockholder of a publicly-held company who
purchased the stock from another investor is filing suit
for losses sustained on the stock.
A bank that lent money to a company is filing suit for
misleading financial statements that were audited by
the CPA.
An investor is filing suit for losses sustained in the
purchase of publicly-traded bonds that were bought
from the company upon initial registration.
A stockholder who purchased stock of a public
company in an initial public offering is filing a suit for
losses sustained in the purchase of the stock.
A CPA’ s client is filing suit for losses sustained for
errors in a tax return prepared by the CPA.
A supplier who provided credit to the CPA’s publicly held client is filing suit for losses sustained when the
client could not pay the account.
An investor who purchased a corporate bond from
another investor on the New York Stock Exchange is
filing suit to recover losses.
Difficulty: Hard
Source of Liability
Chapter 4 Legal Liability of CPAs
Answer:
1
2
3
4
5
6
7
8
Circumstance
A CPA’s client is filing suit for negligence in
performing an audit.
A stockholder of a publicly-held company who
purchased the stock from another investor is filing suit
for losses sustained on the stock.
A bank that lent money to a company is filing suit for
misleading financial statements that were audited by
the CPA.
An investor is filing suit for losses sustained in the
purchase of publicly-traded bonds that were bought
from the company upon initial registration.
A stockholder who purchased stock of a public
company in an initial public offering is filing a suit for
losses sustained in the purchase of the stock.
A CPA’ s client is filing suit for losses sustained for
errors in a tax return prepared by the CPA.
A supplier who provided credit to the CPA’s publicly held client is filing suit for losses sustained when the
client could not pay the account.
An investor who purchased a corporate bond from
another investor on the New York Stock Exchange is
filing suit to recover losses.
Source of Liability
C
B
C
A
A
C
C
B
Chapter 4 Legal Liability of CPAs
56. Section 11 of the Securities Act of 1933, and Section 10 of the Securities Exchange
Act of 1934 make a CPA potentially liable to a purchaser of registered securities. For
items a through f, place a checkmark (√) under the column if the plaintiff must prove
its existence:
Plaintiffs must prove:
a. Financial statements were misleading
b. CPA did not perform with due
diligence
c. Plaintiff relied upon the financial
statements
d. CPA had scienter
e. Plaintiff suffered a loss
f. Plaintiff was the primary beneficiary
of the audit
Section 11
(1933 Securities
Act)
Section 10
(1934 Securities
Exchange Act)
Section 11
(1933 Securities
Act)
⌦
Section 10
(1934 Securities
Exchange Act)
⌦
Answer:
Plaintiffs must prove:
a. Financial statements were misleading
b. CPA did not perform with due
diligence
c. Plaintiff relied upon the financial
statements
d. CPA had scienter
e. Plaintiff suffered a loss
f. Plaintiff was the primary beneficiary
of the audit
⌦
⌦
⌦
⌦
Chapter 5 Audit Evidence and Documentation
True/False Questions
1. To be competent, evidence must be reliable and sufficient.
Answer: False Difficulty: Easy
2. The most reliable form of documentary evidence generally is considered to be
documents created by the client.
Answer: False Difficulty: Medium
3. A vendor's invoice is an example of documentary evidence created by a third party
and held by the client.
Answer: True Difficulty: Medium
4. In performing analytical procedures, the auditors may use dollar amounts, physical
quantities, or percentages.
Answer: True Difficulty: Medium
5. The primary purpose of a letter of representations is to obtain additional evidence
about specific accounts.
Answer: False Difficulty: Hard
6. The auditors should propose an adjusting journal entry for all material related-party
transactions.
Answer: False Difficulty: Hard
7. When inherent risk of an account is high, the auditors may perform additional
substantive tests to allow them to restrict detection risk to a lower level.
Answer: True Difficulty: Medium
8. Working papers of continuing audit interest usually are filed with the administrative
working papers.
Answer: False Difficulty: Medium
Chapter 5 Audit Evidence and Documentation
9. The use of lead schedules is designed to increase the detail of the working trial
balance.
Answer: False Difficulty: Easy
10. Adjusting journal entries are ordinarily recorded by the client, while reclassifying
journal entries need not be recorded.
Answer: True Difficulty: Medium
Multiple Choice Questions
11. To be effective, analytical procedures in the overall review stage of an audit
engagement should be performed by.
A) The staff accountant who performed the substantive auditing procedures.
B) A beginning staff accountant who has had no other work related to the
engagement.
C) A manager or partner who has a comprehensive knowledge of the client's business
and industry.
D) The CPA firm's quality control manager.
Answer: C Difficulty: Medium
12. The components of the risk of misstatement are:
A)
B)
C)
D)
Inherent Risk
Yes
Yes
Yes
No
Control Risk
Yes
Yes
No
Yes
Detection Risk
Yes
No
No
Yes
Answer: B Difficulty: Medium
13. Which of the following procedures is not a required planning procedure for a new
client previously audited by another auditor?
A) Attempting communication with the predecessor auditor.
B) Performing analytical procedures.
C) Obtaining an understanding of internal control to plan audit procedures.
D) Obtaining a written "engagement letter" from the client.
Answer: D Difficulty: Hard
Chapter 5 Audit Evidence and Documentation
14. Which of the following is correct concerning a "fraud risk factor"?
A) It may affect the auditor's assessment of fraud risk.
B) It requires modification of planned audit procedures.
C) It is also a material weakness in internal control.
D) If it involves senior management, it is likely to result in resignation of the auditor.
Answer: A Difficulty: Hard
15. When performing a financial statement audit, auditors are required to explicitly assess
the risk of material misstatement due to:
A) Fraud.
B) Errors.
C) Illegal Acts.
D) Business risk.
Answer: A Difficulty: Hard
16. As planning materiality is decreased, the auditor should plan more work on individual
accounts to.
A) Find smaller misstatements.
B) Find larger misstatements.
C) Increase the tolerable misstatement in the accounts.
D) Decrease the risk of assessing control risk too low.
Answer: A Difficulty: Medium
17. Which of the following is required documentation in an audit?
A) A written engagement letter formalizing the level of services to be provided.
B) A flowchart of the client's organization.
C) A written audit program.
D) A memo setting forth the scope of the audit.
Answer: C Difficulty: Hard
18. Which of the following is not considered to be an analytical procedure?
A) Comparisons of financial statement amounts with source documents.
B) Comparisons of financial statement amounts with nonfinancial data.
C) Comparisons of financial statement amounts with budgeted amounts.
D) Comparisons of financial statement amounts with comparable prior year amounts.
Answer: A Difficulty: Medium
Chapter 5 Audit Evidence and Documentation
19. The inspection of a vendor's invoice by the auditors is:
A) Direct evidence about occurrence of a transaction.
B) Physical evidence about occurrence of a transaction.
C) Documentary evidence about occurrence of a transaction.
D) Part of the client's accounting system.
Answer: C Difficulty: Medium
20. The auditors of Smith Electronics wish to limit the audit risk of material misstatement
in the test of accounts receivable to 5 percent. They believe that inherent risk is 100%,
and there is a 40% risk that material misstatement could have bypassed the client's
system of internal control. What is the maximum detection risk the auditors should
specify in their substantive tests of details of accounts receivable?
A) 5%.
B) 12.5%.
C) 42.7%.
D) 60%.
Answer: B Difficulty: Medium
21. Analytical procedures are required at the planning stage of all audits and as:
A) Tests of internal control.
B) Substantive tests.
C) A part of the final overall review.
D) Computer generated procedures.
Answer: C Difficulty: Easy
22. During financial statement audits, auditors seek to restrict which type of risk?
A) Control risk.
B) Detection risk.
C) Inherent risk.
D) Account risk.
Answer: B Difficulty: Medium
Chapter 5 Audit Evidence and Documentation
23. Which of the following are not considered a specialist by AICPA Professional
Standards:
A) Appraisers.
B) Internal auditors.
C) Engineers.
D) Geologists.
Answer: B Difficulty: Medium
24. A CPA wishes to use a representation letter as a substitute for performing other audit
procedures. Doing so:
A) Violates professional standards.
B) Is acceptable, but should only be done when cost justified.
C) Is acceptable, but only for non-public clients.
D) Is acceptable and desirable under all conditions.
Answer: A Difficulty: Easy
25. Which of the following best describes the problem with the use of published industry
averages for analytical procedures?
A) Lack of comparability.
B) Lack of sufficiency.
C) Lack of competence.
D) Lack of availability.
Answer: A Difficulty: Medium
26. Which of the following best describes the reason that auditors are concerned with the
detection of related party transactions?
A) The financial statements must often be adjusted for the effects of material related
party transactions.
B) Material related party transactions must be disclosed in the notes to the financial
statements.
C) The substance of related party transactions will differ from their form.
D) In a related party transaction one party has the ability to exercise significant
influence over the other party.
Answer: B Difficulty: Hard
Chapter 5 Audit Evidence and Documentation
27. Which of the following is generally true about the sufficiency of audit evidence?
A) The amount of evidence that is sufficient varies inversely with the competence of
the evidence.
B) The amount of evidence concerning a particular account varies inversely with the
materiality of the account.
C) The amount of evidence concerning a particular account varies inversely with the
inherent risk of the account.
D) When evidence is competent with respect to an account it is also sufficient.
Answer: A Difficulty: Hard
28. Which of the following is true about analytical procedures?
A) Performing analytical procedures results in the most reliable form of evidence.
B) Analytical procedures are tests of controls used to evaluate the quality of a client's
internal control structure.
C) Analytical procedures are used for planning, but they should not be used to obtain
evidence as to the reasonableness of specific account balances.
D) Analytical procedures are used in planning, as a substantive test of specific
accounts, and in the final review of the audited financial statements.
Answer: D Difficulty: Hard
29. Which of the following is a basic approach often used by auditors to evaluate the
reasonableness of accounting estimates?
A) Confirmation.
B) Observation.
C) Reviewing subsequent events or transactions.
D) Analyzing corporate organizational structure.
Answer: C Difficulty: Hard
30. An auditor is performing an analytical procedure that involves comparing a client's
account balances over time. This technique is referred to as:
A) Vertical analysis.
B) Horizontal analysis.
C) Cross-sectional analysis.
D) Comparison analysis.
Answer: B Difficulty: Easy
Chapter 5 Audit Evidence and Documentation
31. An auditor is performing an analytical procedure that involves comparing a client's
ratios with other companies in the same industry. This technique is referred to as:
A) Vertical analysis.
B) Horizontal analysis.
C) Cross-sectional analysis.
D) Comparison analysis.
Answer: C Difficulty: Easy
32. An auditor is performing an analytical procedure that involves developing commonsize financial statements. This technique is referred to as:
A) Vertical analysis.
B) Horizontal analysis.
C) Cross-sectional analysis.
D) Comparison analysis.
Answer: A Difficulty: Easy
33. Which of the following is not a basic approach often used by auditors to evaluate the
reasonableness of accounting estimates?
A) Confirmation of amounts.
B) Review of management's process of development.
C) Independent development of an estimate.
D) Review of subsequent events.
Answer: A Difficulty: Medium
34. The audit time budget is an example of:
A) A supporting schedule.
B) An administrative working paper.
C) A lead schedule.
D) A corroborative working paper.
Answer: B Difficulty: Easy
35. A schedule set up to combine similar general ledger accounts, the total of which
appears on the working trial balance as a single amount, is referred to as a:
A) Supporting schedule.
B) Lead schedule.
C) Corroborating schedule.
D) Reconciling schedule.
Answer: B Difficulty: Easy
Chapter 5 Audit Evidence and Documentation
36. Which of the following is not a function of working papers?
A) Provide support for the auditors' report.
B) Provide support for the accounting records.
C) Aid partners in planning and conducting future audits.
D) Document staff compliance with generally accepted auditing standards.
Answer: B Difficulty: Easy
37. A schedule listing account balances for the current and previous years, and columns
for adjusting and reclassifying entries proposed by the auditors to arrive at the final
amount that will appear in the financial statement, is referred to as a:
A) Working trial balance.
B) Lead schedule.
C) Summarizing schedule.
D) Supporting schedule.
Answer: A Difficulty: Easy
38. The auditors use analytical procedures during the course of an audit. The most
important phase of performing these procedures is the:
A) Computation of key ratios such as inventory turnover and gross profit percentages.
B) Investigation of significant variations and unusual relationships.
C) Comparison of client-computed statistics with industry data on a quarterly and
full-year basis.
D) Examination of the client data that generated the statistics that are analyzed.
Answer: B Difficulty: Medium
39. The auditors must obtain written client representations that normally should be signed
by:
A) The president and the chairperson of the board.
B) The treasurer and the internal auditor.
C) The chief executive officer and the chief financial officer.
D) The corporate counsel and the audit committee chairperson.
Answer: C Difficulty: Easy Source: AICPA
Chapter 5 Audit Evidence and Documentation
40. Which of the following ultimately determines the specific audit procedures necessary
to provide independent auditors with a reasonable basis for the expression of an
opinion?
A) The audit time budget.
B) The auditors' judgment.
C) Generally accepted accounting quality standards.
D) The auditors' working papers.
Answer: B Difficulty: Easy Source: AICPA
41. Failure to detect material dollar errors in the financial statements is a risk which the
auditors primarily mitigate by:
A) Performing substantive tests.
B) Performing tests of controls.
C) Assessing control risk.
D) Obtaining a client representation letter.
Answer: A Difficulty: Easy Source: AICPA
42. An independent auditor finds that the Simmer Corporation occupies office space, at no
charge, in an office building owned by a shareholder. This finding indicates the
existence of:
A) Management fraud.
B) Related party transactions.
C) Window dressing.
D) Weak internal control.
Answer: B Difficulty: Medium Source: AICPA
43. Which of the following would not necessarily be a related party transaction?
A) Payment of a bonus to the president.
B) Purchases from another corporation that is controlled by the corporation's chief
stockholder.
C) Loan from the corporation to a major stockholder.
D) Sale of land to the corporation by the spouse of a director.
Answer: A Difficulty: Easy Source: AICPA
Chapter 5 Audit Evidence and Documentation
44. The date of the management representation letter should coincide with the:
A) Date of the auditor's report.
B) Balance sheet date.
C) Date of the latest subsequent event referred to in the notes to the financial
statements.
D) Date of the engagement agreement.
Answer: A Difficulty: Medium Source: AICPA
45. An example of an analytical procedure is the comparison of:
A) Financial information with similar information regarding the industry in which the
entity operates.
B) Recorded amounts of major disbursements with appropriate invoices.
C) Results of a statistical sample with the expected characteristics of the actual
population.
D) EDP generated data with similar data generated by a manual accounting system.
Answer: A Difficulty: Medium Source: AICPA
46. When considering the use of management's written representations as audit evidence
about the completeness assertion, an auditor should understand that such
representations:
A) Complement, but do not replace, substantive tests designed to support the
assertion.
B) Constitute sufficient evidence to support the assertion when considered in
combination with a moderate assessed level of control risk.
C) Are generally sufficient evidential matter to support the assertion regardless of the
assessed level of control risk.
D) Replace the assessed level of control risk as evidence to support the assertions.
Answer: A Difficulty: Medium Source: AICPA
47. Which of the following expressions is least likely to be included in a client's
representation letter?
A) No events have occurred subsequent to the balance sheet date that require
adjustment to, or disclosure in, the financial statements.
B) The company has complied with all aspects of contractual agreements that would
have a material effect on the financial statements in the event of noncompliance.
C) Management acknowledges responsibility for illegal actions committed by
employees.
D) Management has made available all financial statements, including notes.
Answer: C Difficulty: Medium Source: AICPA
Chapter 5 Audit Evidence and Documentation
48. Which of the following statements is generally correct about the competence of
evidential matter?
A) The auditor's direct personal knowledge, obtained through observation and
inspection, is more persuasive than information obtained indirectly from
independent outside sources.
B) To be competent, evidential matter must be either valid or relevant, but need not
be both.
C) Accounting data alone may be considered sufficient competent evidential matter
to issue an unqualified opinion on financial statements.
D) Competence of evidential matter refers to the amount of corroborative evidence to
be obtained.
Answer: A Difficulty: Easy Source: AICPA
49. Which of the following statements relating to the competence of evidential matter is
always true?
A) Evidential matter gathered by an auditor from outside an enterprise is reliable.
B) Accounting data developed under satisfactory conditions of internal control are
more relevant than data developed under unsatisfactory internal control
conditions.
C) Oral representations made by management are not valid evidence.
D) Evidence gathered by auditors must be both valid and relevant to be considered
competent.
Answer: D Difficulty: Easy Source: AICPA
50. Which of the following is not a typical analytical procedure?
A) Study of relationships of the financial information with relevant nonfinancial
information.
B) Comparison of the financial information with similar information regarding the
industry in which the entity operates.
C) Comparison of recorded amounts of major disbursements with appropriate
invoices.
D) Comparison of the financial information with budgeted amounts.
Answer: C Difficulty: Medium Source: AICPA
Chapter 5 Audit Evidence and Documentation
51. Which of the following is not a primary purpose of audit working papers?
A) To coordinate the examination.
B) To assist in preparation of the audit report.
C) To support the financial statements.
D) To provide evidence of the audit work performed.
Answer: C Difficulty: Medium Source: AICPA
52. Concerning retention of working papers, the Sarbanes-Oxley Act:
A) has no provisions.
B) requires permanent retention.
C) requires retention for at least 7 years.
D) requires retention for a period of 4 or less years.
Answer: C Difficulty: Medium
53. During an audit engagement pertinent data are prepared and included in the audit
working papers. The working papers primarily are considered to be:
A) A client-owned record of conclusions reached by the auditors who performed the
engagement.
B) Evidence supporting financial statements.
C) Support for the auditors' representations as to compliance with generally accepted
auditing standards.
D) A record to be used as a basis for the following year's engagement.
Answer: C Difficulty: Medium Source: AICPA
54. Although the quantity, type, and content of working papers will vary with the
circumstances, the working papers generally would include the:
A) Copies of those client records examined by the auditor during the course of the
engagement.
B) Evaluation of the efficiency and competence of the audit staff assistants by the
partner responsible for the audit.
C) Auditor's comments concerning the efficiency and competence of client
management personnel.
D) Auditing procedures followed and the testing performed in obtaining evidential
matter.
Answer: D Difficulty: Medium Source: AICPA
Chapter 5 Audit Evidence and Documentation
55. The permanent file section of the working papers that is kept for each audit client most
likely contains:
A) Review notes pertaining to questions and comments regarding the audit work
performed.
B) A schedule of time spent on the engagement by each individual auditor.
C) Correspondence with the client's legal counsel concerning pending litigation.
D) Narrative descriptions of the client's accounting procedures and controls.
Answer: D Difficulty: Medium Source: AICPA
56. Working papers that record the procedures used by the auditor to gather evidence
should be:
A) Considered the primary support for the financial statements being examined.
B) Viewed as the connecting link between the books of account and the financial
statements.
C) Designed to meet the circumstances of the particular engagement.
D) Destroyed when the audited entity ceases to be a client.
Answer: C Difficulty: Easy Source: AICPA
57. In general, which of the following statements is correct with respect to ownership,
possession, or access to working papers prepared by a CPA firm in connection with an
audit?
A) The working papers may be obtained by third parties where they appear to be
relevant to issues raised in litigation.
B) The working papers are subject to the privileged communication rule which, in a
majority of jurisdictions, prevents third-party access to the working papers.
C) The working papers are the property of the client after the client pays the fee.
D) The working papers must be retained by the CPA firm for a period of ten years.
Answer: A Difficulty: Easy Source: AICPA
58. Confirmation would be most effective in addressing the existence assertion for the:
A) Addition of a milling machine to a machine shop.
B) Payment of payroll during regular course of business.
C) Inventory held on consignment.
D) Granting of a patent for a special process developed by the organization.
Answer: C Difficulty: Medium Source: AICPA
Chapter 5 Audit Evidence and Documentation
Use the following to answer questions 59-63:
In preparing for an audit of the retail footwear division of a major retail organization, the
auditor gathered the following information about the organization's stores:
Average sales per store
Average cost of goods sold per store
Number of stores
Average square feet per store
Average sales per full-time employee
Average wage related expense per store
Average net profit contribution per store
Northeast Southwest Mid-Central
All
Stores
Region
Region
Region
$736,000 $840,000
$760,000
$630,000
$375,000 $420,000
$325,000
$395,000
48
13
18
17
1,800
2,200
1,850
1,550
$137,000 $152,000
$140,000
$122,000
$ 98,000 $102,000
$ 82,000
$112,000
$238,000 $285,000
$320,000
$115,000
59. An auditor performs analytical procedures that involve comparing the gross margins
of various divisional operations with those of other divisions and with the individual
division's performance in previous years. The auditor notes a significant increase in
the gross margin at one division. The auditor does some preliminary investigation and
also notes that there were no changes in products, production methods, or divisional
management during the year. Based on the above information, the most likely cause
of the increase in gross margin would be:
A) An increase in the number of competitors selling similar products.
B) A decrease in the number of suppliers of the material used in manufacturing the
product.
C) An overstatement of year-end inventory.
D) An understatement of year-end accounts receivable.
Answer: C Difficulty: Hard Source: IIA
Chapter 5 Audit Evidence and Documentation
60. Management is concerned about the lower level of profitability in the Mid-Central
Region. Which of the following would be a reasonable possible explanation(s) of the
lower profitability for the Mid-Central Region?
I. The lower number of stores in the Mid-Central Region.
II. Sales employees are not as productive in generating sales as those in other regions.
III. The Mid-Central Region has a lower gross margin.
A)
B)
C)
D)
I only.
II only.
II and III only.
I, II and III.
Answer: C Difficulty: Medium Source: IIA
61. Based on the previous information, which of the following preliminary conclusions
can the auditor use as a basis for further investigations?
A) Sales per store are directly related to the size of the store.
B) Sale clerks are less productive in larger size stores.
C) Gross margin is directly related to the size of the store.
D) Average square feet of store correlates with the number of stores in the district.
Answer: A Difficulty: Medium Source: IIA
62. Which of the following statements is not correct regarding the auditor's further
analysis?
A) The Mid-Central Region has fewer average full-time equivalent employees per
store than the other regions per store.
B) The other regions all generate higher sales per square foot than the Mid-Central
Region.
C) The Mid-Central Region has the highest average wages per full-time equivalent
employee.
D) The largest contributor to total corporate profits is the Southwest Region.
Answer: B Difficulty: Medium Source: IIA
Chapter 5 Audit Evidence and Documentation
63. Management has centralized purchasing and uses a model based upon previous year's
sales with adjustments for trends in the market place, e.g., the trend to more casual
shoes. A staff auditor has suggested that the centralized purchasing may be one of the
reasons for the lower level of profitability in the Mid-Central Region. Which of the
following would be the best single audit procedure to address the staff auditor's
assertion?
A) Take a sample of receiving documents at stores and trace to purchase orders to
determine the length of time between the purchase and delivery of the goods.
B) Interview store managers in the Mid-Central Region to determine their attitude
toward centralized purchasing.
C) Perform an inventory count at selected stores in the Mid-Central Region and
determine if adjustments are needed to the perpetual records.
D) Perform a product-line analysis of sales and purchases in the Mid-Central Region
and compare with other regions.
Answer: D Difficulty: Hard Source: IIA
64. What type of transactions ordinarily have high inherent risk because they involve
management judgments or assumptions in formulating accounting balances?
A) Estimation.
B) Nonroutine.
C) Qualified.
D) Routine.
Answer: A Difficulty: Medium
65. Assertions with high inherent risk generally do not involve:
A) Complex calculations.
B) Difficult accounting issues.
C) Routine transactions.
D) Significant judgment by management.
Answer: C Difficulty: Medium
66. The date on which no information may be deleted from audit documentation is the
A) Client's year-end.
B) Documentation completion date.
C) Last date of significant fieldwork.
D) All of the above are incorrect in that no information may ever be deleted from
audit documentation.
Answer: B Difficulty: Medium
Chapter 5 Audit Evidence and Documentation
Essay Questions
67. Analytical procedures are substantive tests that may be used to provide evidence about
specific accounts and classes of transactions.
a. Describe three major types of comparisons the auditor might make in performing
analytical procedures.
b. At what stages of the audit are analytical procedures performed and what purpose
do they serve at each stage?
Difficulty: Medium
Answer:
a. Comparisons made in performing analytical procedures include (only three
required):
• Comparisons with prior years' data.
• Comparisons with budgets and forecasts.
• Comparisons with industry statistics.
• Comparisons with nonfinancial data.
• Comparisons of predictable relationships based on past history.
b. Analytical procedures may be performed:
1. During planning to identify items that require more audit attention.
2. Throughout the audit as a substantive test of accounts or classes of
transactions.
3. At the conclusion of the audit for an overall review of the audited financial
statements.
Chapter 5 Audit Evidence and Documentation
68. Audit working papers are an integral part of an examination in accordance with
generally accepted auditing standards.
a. Describe three major functions of the audit working papers.
b. Distinguish between the permanent working paper file and the current working
paper file.
Difficulty: Medium
Answer:
a. The functions of audit working papers include (only three required):
• Provide a means of assigning and coordinating audit work.
• Aid in review of the work.
• Provide support for the auditors' report.
• Document compliance with generally accepted auditing standards.
• Aid in planning and conducting future audits.
b. The permanent file is used to organize working papers of continuing audit interest
over a number of years.
The current file contains the administrative and evidence working papers for the year
under examination.
Chapter 5 Audit Evidence and Documentation
69. The following is an audit working paper prepared by an assistant on the Williams
audit:
Prepared by ___
Reviewed by ___
Williams Inc.
Bank Confirmation-General Account
12/31/0X
Balance per Bank @ 12/31/))X
Deposit in Transit – per A-1-2
Outstanding Checks – per A-1-3
Other – Note Collected by Bank
Bank Service Charge
$20,200.22 ♥
2,000.00 Γ
(5,200.00)
(10,000.00) √
(9.50)
Balance per Books @ 12/31/)0X
$8,990.69 ♥
ƒ Column footed.
√ Amount agrees to amount recorded as a deposit on the bank statement and
description agrees with receipt enclosed with 12/31/0X bank statement. This
note is the Wilde note receivable that was recorded as a receipt by the client in
the cash receipts journal on 1/3/0X. The receivable was appropriately credited
and properly reflected in the January cash receipts journal. No adjustment
needed as bank and books simply record this in different periods.
Γ Agreed to 12/31/0X bank statement.
♥ Agreed to general ledger.
A–1
Required: Prepare a list of review points as the preparer of this working. You may
assume that any other working papers referred to appropriate. You will receive credit
for proper points you bring up and lose credit for improper ones and omissions.
Difficulty: Hard
Chapter 5 Audit Evidence and Documentation
Answer:
The working paper's deficiencies include:
• “prepared by” is not initialed (“Rev. by” isn't either, but since we are still
performing the review it need not be).
• Title of schedule is wrong, this is not a bank confirmation, it is a bank
reconciliation.
• The ♥by Balance per Bank is incorrect for two reasons. First, the balance would
not be in the general ledger. Second, the balance per bank should be agreed to
either a bank confirmation, bank statement, or both.
• The bank service charge should be added, not subtracted.
• Concerning balance per books, two things are wrong. First it is not footed in that
the ƒ is missing. Second, it does not foot properly.
• The tickmark Γ is incorrect relating to the deposit in transit. If it was on the
12/31/0X bank statement, it would not be a deposit in transit.
• The √ description is not correct since it should be recorded as a cash receipt as of
12/31/OX if the bank collected it prior to year-end. It is handled on the
reconciliation properly, but the final comment is wrong.
Chapter 6 Planning the Audit
True/False Questions
1. Audit committees should be made up of the most qualified directors regardless of
whether they are part of management of the company.
Answer: False Difficulty: Hard
2. Analytical procedures are seldom used for planning an audit engagement because they
are substantive tests.
Answer: False Difficulty: Easy
3. Preliminary arrangements with clients should be set forth in the management letter.
Answer: False Difficulty: Easy
4. An audit plan includes a detailed listing of the audit procedures to be performed in the
verification of items in the financial statements.
Answer: False Difficulty: Medium
5. The auditors' tests of controls are designed to substantiate the fairness of specific
financial statement items.
Answer: False Difficulty: Medium
6. At least a portion of the auditors' consideration of internal control usually is performed
at an interim date rather than at the balance sheet date.
Answer: True Difficulty: Medium
7. The substantive approach to an audit is appropriate for many small businesses.
Answer: True Difficulty: Medium
8. Confirming a bank account establishes existence but not rights to the cash balance.
Answer: False Difficulty: Hard
9. The completeness of recording of assets is generally verified by tracing from the
source documents to the recorded entry.
Answer: True Difficulty: Hard
Chapter 6 Planning the Audit
10. Vouching the acquisition of assets is an audit procedure that is often performed to
establish the valuation of the assets.
Answer: True Difficulty: Hard
Multiple Choice Questions
11. Which of the following factors most likely would cause a CPA to not accept a new
audit engagement?
A) The prospective client has fired its prior auditor.
B) The CPA lacks a thorough understanding of the prospective client's operations and
industry.
C) The CPA is unable to review the predecessor auditor's working papers.
D) The prospective client is unwilling to make financial records available to the CPA.
Answer: D Difficulty: Medium Source: AICPA
12. Which of the following would most likely lead an auditor to conclude that a potential
audit engagement should be rejected?
A) The details of certain transactions are not maintained online.
B) Internal control is likely to allow certain types of misstatements.
C) It is unlikely that sufficient competent evidential matter will be available.
D) Management has a reputation for consulting with several accounting firms about
significant accounting issues.
Answer: C Difficulty: Medium Source: AICPA
13. Which of the following factors most likely would heighten an auditor's concern about
the risk of fraudulent financial reporting?
A) Large amounts of liquid assets that are easily convertible into cash.
B) Low growth and profitability as compared to other entity's in the same industry.
C) Financial management's participation in the initial selection of accounting
principles.
D) An overly complex organizational structure involving unusual lines of authority.
Answer: D Difficulty: Hard Source: AICPA
Chapter 6 Planning the Audit
14. Which of the following factors would most likely cause a CPA to decide not to accept
a new audit engagement?
A) Lack of understanding of the potential client's internal auditors' computer-assisted
audit techniques.
B) Management's disregard for internal control.
C) The existence of related party transactions.
D) Management's attempt to meet earnings per share growth rate goals.
Answer: B Difficulty: Hard
15. Which of the following matters is generally included in an auditor's engagement
letter?
A) Limitations of the engagement.
B) Factors to be considered in establishing preliminary judgments about materiality.
C) Management's liability for illegal acts committed by its employees.
D) The auditor's responsibility to obtain negative assurance relating to the occurrence
of illegal acts.
Answer: A Difficulty: Hard
16. Which of the following would heighten an auditor's concern about the risk of
fraudulent financial reporting?
A) Inability to generate positive cash flows from operations, while reporting large
increases in earnings.
B) Management's lack of interest in increasing the dividend paid on common stock.
C) Large amounts of liquid assets that are easily convertible into cash.
D) Inability to borrow necessary capital without obtaining waivers on debt covenants.
Answer: A Difficulty: Hard Source: AICPA
17. To best test existence, an auditor would sample from the:
A) General Ledger to source documents.
B) General Ledger to the financial statements.
C) Source documents to the general ledger.
D) Source documents to journals.
Answer: A Difficulty: Medium
Chapter 6 Planning the Audit
18. Which of the following is correct concerning requirements about auditor
communications about fraud?
A) Fraud that involves senior management should be reported directly to the audit
committee regardless of the amount involved.
B) All fraud with a material effect on the financial statements should be reported
directly by the auditor to the Securities and Exchange Commission.
C) Fraud with a material effect on the financial statements should ordinarily be
disclosed by the auditor through use of an "emphasis of a matter" paragraph added
to the audit report.
D) The auditor has no responsibility to disclose fraud outside the entity under any
circumstances.
Answer: A Difficulty: Hard
19. A predecessor auditor is required to attempt to initiate communication with the
successor auditor:
A)
B)
C)
D)
Prior to the Successor’s
Acceptance of the Engagement
Yes
Yes
No
No
Subsequent to the Successor’s
Acceptance of the Engagement
Yes
No
Yes
No
Answer: D Difficulty: Hard
20. Which measure of materiality (or both) considers quantitative considerations?
A)
B)
C)
D)
Planning
Yes
Yes
No
No
Evaluation
Yes
No
Yes
No
Answer: A Difficulty: Medium
Chapter 6 Planning the Audit
21. Audits of financial statements are designed to obtain reasonable assurance of detecting
material misstatements due to:
A)
B)
C)
D)
Errors
Yes
Yes
No
No
Misappropriation of Assets
Yes
No
Yes
No
Answer: A Difficulty: Medium
22. Which of the following is not one of the assertions made in financial statements by
management concerning each major account and class of transactions?
A) Relevance.
B) Existence.
C) Valuation.
D) Presentation and disclosure.
Answer: A Difficulty: Easy
23. When a company has changed auditors, according to the Professional Standards:
A) The successor auditor has the responsibility to initiate contact with the predecessor
auditor to ask about the client before the engagement is accepted; the predecessor
has no responsibility to initiate this contact, even when aware of matters bearing
on the integrity of management.
B) The predecessor must respond fully to all inquiries made by the successor auditor.
C) The successor must discuss with the predecessor matters bearing on the
engagement prior to accepting the engagement.
D) The successor may choose not to attempt any communication with the predecessor
auditor.
Answer: A Difficulty: Hard
24. Which of the following procedures is not performed as a part of planning an audit
engagement?
A) Reviewing the working papers of the prior year.
B) Performing analytical procedures.
C) Confirmation of all major accounts.
D) Designing an audit program.
Answer: C Difficulty: Hard
Chapter 6 Planning the Audit
25. The risk of a material misstatement occurring in an account, assuming an absence of
internal control, is referred to as:
A) Account risk.
B) Control risk.
C) Detection risk.
D) Inherent risk.
Answer: D Difficulty: Medium
26. Which of the following is least likely to be considered a financial statement audit risk
factor?
A) Management operating and financing decisions are dominated by top
management.
B) A new client with no prior audit history.
C) Rate of change in the entity's industry is rapid.
D) Profitability of the entity relative to its industry is inconsistent.
Answer: A Difficulty: Hard
27. Which of the following is an example of fraudulent financial reporting?
A) Company management falsifies inventory count tags thereby overstating ending
inventory and understating cost of goods sold.
B) An employee diverts customer payments to his personal use, concealing his
actions by debiting an expense account, thus overstating expenses.
C) An employee steals inventor and the "shrinkage" is recorded in cost of goods sold.
D) An employee "borrows" tools from the company and neglects to return them; the
cost is reported as a miscellaneous operating expense.
Answer: A Difficulty: Medium
28. Which of the following is most likely to be considered a risk factor relating to
fraudulent financial reporting?
A) Low turnover of senior management.
B) Extreme degree of competition within the industry.
C) Capital structure including various operating subsidiaries.
D) Sales goals in excess of any of the preceding three years.
Answer: B Difficulty: Hard
Chapter 6 Planning the Audit
29. Which of the following conditions identified during the audit increases the risk of
employee fraud?
A) Large amounts of cash in the bank.
B) Existence of a mandatory vacation policy for employees performing key
functions.
C) Inventory items of small size, but high value.
D) Presence of reconciling items on a client prepared year-end proof of cash.
Answer: C Difficulty: Medium
30. Which of the following statements is accurate about "fraud risk factors" considered
when conducting an audit?
A) Factors whose presence indicates that fraud exists.
B) Factors whose presence often have been observed in circumstances where frauds
have occurred.
C) Factors whose presence will require modification to planned audit procedures.
D) Factors obtained during the audit which lead to required communications with the
audit committee.
Answer: B Difficulty: Hard
31. Which of the following is not an example of a likely adjustment in the auditors'
overall audit approach when significant risk is found to exist?
A) Apply increased professional skepticism about material transactions.
B) Increase the assessed level of detection risk.
C) Assign personnel with particular skill to areas of high risk.
D) Obtain increased evidence about the appropriateness of management's selection of
accounting principles.
Answer: B Difficulty: Medium
32. Which of the following is least likely to be required on an audit?
A) Evaluate the business rationale for significant, unusual transactions.
B) Make a legal determination of whether fraud has occurred.
C) Review accounting estimates for biases.
D) Test appropriateness of journal entries and adjustments.
Answer: B Difficulty: Medium
Chapter 6 Planning the Audit
33. The risk that the auditors' procedures will lead them to conclude that a material
misstatement does not exist in an account balance when in fact such a misstatement
does exist is referred to as:
A) Account risk.
B) Control risk.
C) Detection risk.
D) Inherent risk.
Answer: C Difficulty: Medium
34. Which of the following statements is correct regarding the auditor's determination of
materiality?
A) The planning level of materiality should normally be the larger of the amount
considered for the balance sheet versus the income statement.
B) The auditors' planning level of materiality may be disaggregated into smaller
"tolerable misstatements" for the various accounts.
C) Auditors may use various rules of thumb to arrive at an evaluation level of
materiality, but not for determining the planning level of materiality.
D) The amount used for the planning should equal that used for evaluation.
Answer: B Difficulty: Hard
35. The auditors must consider materiality in planning an audit engagement. Materiality
for planning purposes is:
A) The auditors' preliminary estimate of the largest amount of misstatement that
would be material to any one of the client's financial statements.
B) The auditors' preliminary estimate of the smallest amount of misstatement that
would be material to any one of the client's financial statements.
C) The auditors' preliminary estimate of the amount of misstatement that would be
material to the client's balance sheet.
D) An amount that cannot be quantitatively stated since it depends on the nature of
the item.
Answer: B Difficulty: Medium
36. Which of the following topics is not normally included in an engagement letter?
A) The auditors' preliminary assessment of internal control.
B) The auditors' estimate of the fee for the engagement.
C) Limitations on the scope of the engagement.
D) A description of responsibility for the detection of fraud.
Answer: A Difficulty: Hard
Chapter 6 Planning the Audit
37. Which of the following is most likely to be an overall response to fraud risks identified
in an audit?
A) Only use certified public accountants on the engagement.
B) Place increased emphasis on the audit of objective transactions rather than
subjective transactions.
C) Supervise members of the audit team less closely and rely more upon judgment.
D) Use less predictable audit procedures.
Answer: D Difficulty: Hard
38. Which of the following is not an assertion that is made in the financial statements by
management concerning each major account and class of transaction?
A) Completeness.
B) Rights and obligations.
C) Legality.
D) Presentation and disclosure.
Answer: C Difficulty: Easy
39. Tests for unrecorded assets typically involve tracing from:
A) Source documents to recorded journal entries.
B) Source documents to observations.
C) Recorded journal entries to documents.
D) Recorded journal entries to observations.
Answer: A Difficulty: Hard
40. Tracing from source documents forward to ledgers is most likely to address which
assertion related to posted entries:
A) Completeness.
B) Existence.
C) Rights.
D) Valuation.
Answer: A Difficulty: Hard
Chapter 6 Planning the Audit
41. Determining that receivables are presented at net-realizable value is most directly
related to which management assertion?
A) Existence or occurrence.
B) Rights.
C) Valuation or allocation.
D) Presentation and disclosure.
Answer: C Difficulty: Medium
42. Which of the following is not a general objective for the audit of asset accounts?
A) Establishing existence of assets.
B) Establishing proper valuation of assets.
C) Establishing proper liabilities relating to assets.
D) Establishing the completeness of assets.
Answer: C Difficulty: Medium
43. Which of the following is not used by auditors to establish the completeness of
recorded assets?
A) Assessing control risk.
B) Tracing from source documents to entries in the accounting records.
C) Performing analytical procedures.
D) Vouching transactions.
Answer: D Difficulty: Hard
44. To test for unsupported entries in the journals, the direction of audit testing should be
to the:
A) Ledger entries.
B) Journal entries.
C) Original source documents.
D) Financial statements.
Answer: C Difficulty: Hard
45. A form filed with the SEC when a company changes auditors is a:
A) Form 8-K.
B) Form 10-K.
C) Form S-1.
D) Form B-1.
Answer: A Difficulty: Medium
Chapter 6 Planning the Audit
46. Which of the following is least likely to render material a quantitatively small
misstatement material?
A) Affects the registrant's compliance with regulatory requirements.
B) Masks a change in earnings or other trends.
C) Arises from an item not capable of precise measurement.
D) Masks a change in earnings or other trends.
Answer: C Difficulty: Hard
47. A successor auditor has accepted an engagement that was previously performed by a
predecessor auditor and, prior to accepting the engagement, has communicated with
the predecessor. When the successor believes that the predecessor has performed
satisfactory previous audits, which of the following is correct?
A) A second communication is required and must include details of previous audits.
B) Ordinarily the successor auditors may be able to accept the opening balances of
the current year with a minimum of verification work.
C) Absent ongoing litigation, a predecessor must provide all working papers
requested by the predecessor.
D) The client should be informed of the need to perform a detailed audit of all
opening balances.
Answer: B Difficulty: Hard
48. The first standard of field work recognizes that early appointment of the independent
auditors has many advantages to the auditors and the client. Which of the following
advantages is least likely to occur as a result of early appointment of the auditors?
A) The auditors will be able to plan the audit work so that it may be done
expeditiously.
B) The auditors will be able to complete substantive procedures prior to year-end.
C) The auditors will be able to better plan for the observation of the physical
inventories.
D) The auditors will be able to perform the examination more efficiently and will be
finished at an early date after the year-end.
Answer: B Difficulty: Medium Source: AICPA
Chapter 6 Planning the Audit
49. Preliminary arrangements agreed to by the auditors and the client should be reduced to
writing by the auditors. The best place to set forth these arrangements is in:
A) A memorandum to be placed in the permanent section of the auditing working
papers.
B) An engagement letter.
C) A client representation letter.
D) A confirmation letter attached to the constructive services letter.
Answer: B Difficulty: Easy Source: AICPA
50. The auditors are planning an audit engagement for a new client in a business that is
unfamiliar to the auditors. Which of the following would be the most useful source of
information for the auditors during the preliminary planning stage when they are
trying to obtain a general understanding of audit problems that might be encountered?
A) Client manuals of accounts and charts of accounts.
B) AICPA Industry Audit Guides.
C) Prior-year working papers of the predecessor auditors.
D) Latest annual and interim financial statements issued by the client.
Answer: C Difficulty: Hard Source: AICPA
51. The auditors will not ordinarily initiate discussion with the audit committee
concerning the:
A) Extent to which the work of internal auditors will influence the scope of the
examination.
B) Extent to which change in the company's organization will influence the scope of
the examination.
C) Details of potential problems which the auditors believe might cause a qualified
opinion.
D) Details of the procedures which the auditors intend to apply.
Answer: D Difficulty: Hard Source: AICPA
Chapter 6 Planning the Audit
52. Which statement is correct relating to a potential successor auditor's responsibility for
communicating with the predecessor auditors in connection with a prospective new
audit client?
A) The successor auditors have no responsibility to contact the predecessor auditors.
B) The successor auditors should obtain permission from the prospective client to
contact the predecessor auditors.
C) The successor auditors should contact the predecessors regardless of whether the
prospective client authorizes contact.
D) The successor auditors need not contact the predecessors if the successors are
aware of all available relevant facts.
Answer: B Difficulty: Medium Source: AICPA
53. Which of the following situations would most likely require special audit planning by
the auditors?
A) Some items of factory and office equipment do not bear identification numbers.
B) Depreciation methods used on the client's tax return differ from those used on the
books.
C) Assets costing less than $500 are expensed even though the expected life exceeds
one year.
D) Inventory is comprised of precious stones.
Answer: D Difficulty: Medium Source: AICPA
54. When planning an audit, an auditor should:
A) Consider whether the extent of substantive tests may be reduced based on the
results of the internal control questionnaire.
B) Make preliminary judgments about materiality levels for audit purposes.
C) Conclude whether changes in compliance with prescribed control procedures
justifies reliance on them.
D) Prepare a preliminary draft of the management representation letter.
Answer: B Difficulty: Medium Source: AICPA
55. An auditor who accepts an audit engagement and does not possess the industry
expertise of the business entity, should:
A) Engage financial experts familiar with the nature of the business entity.
B) Obtain a knowledge of matters that relate to the nature of the entity's business.
C) Refer a substantial portion of the audit to another CPA who will act as the
principal auditor.
D) First inform management that an unqualified opinion cannot be issued.
Answer: B Difficulty: Medium Source: AICPA
Chapter 6 Planning the Audit
56. With respect to the auditor's planning of a year-end audit, which of the following
statements is always true?
A) An engagement should not be accepted after the fiscal year-end.
B) An inventory count must be observed at the balance sheet date.
C) The client's audit committee should not be told of any specific audit procedures
which will be performed.
D) It is an acceptable practice to carry out parts of the examination at interim dates.
Answer: D Difficulty: Medium Source: AICPA
57. Hawkins requested permission to communicate with the predecessor auditor and
review certain portions of the predecessor auditor's working papers. The prospective
client's refusal to permit this will bear directly on Hawkins' decision concerning the:
A) Adequacy of the preplanned audit program.
B) Ability to establish consistency in application of accounting principles between
years.
C) Apparent scope limitation.
D) Integrity of management.
Answer: D Difficulty: Medium Source: AICPA
58. The auditor faces a risk that the audit will not detect material misstatements in the
financial statements. In regard to minimizing this risk, the auditor primarily relies on:
A) Substantive tests.
B) Tests of controls.
C) Internal control.
D) Statistical analysis.
Answer: A Difficulty: Easy Source: AICPA
59. An abnormal fluctuation in gross profit that might suggest the need for extended audit
procedures for sales and inventories would most likely be identified in the planning
phase of the audit by the use of:
A) Tests of transactions and balances.
B) An assessment of internal control.
C) Specialized audit programs.
D) Analytical procedures.
Answer: D Difficulty: Easy Source: AICPA
Chapter 6 Planning the Audit
60. Before accepting an audit engagement, a successor auditor should make specific
inquiries of the predecessor auditor regarding the predecessor's:
A) Awareness of the consistency in the application of generally accepted accounting
principles between accounting periods.
B) Evaluation of all matters of continuing accounting significance.
C) Opinion of any subsequent events occurring since the predecessor's audit report
was issued.
D) Understanding as to the reasons for the change of auditors.
Answer: D Difficulty: Medium Source: AICPA
61. Which of the following is least likely to be included in an auditor's inquiry of
management while obtaining information to identify the risks of material misstatement
due to fraud?
A) Are all financial reporting operations at one location?
B) Does it have knowledge of fraud or suspect fraud?
C) Does it have programs to mitigate fraud risks?
D) Has it reported to the audit committee the nature of the company's internal
control?
Answer: A Difficulty: Hard
62. To test for unsupported entries in the ledger, the direction of audit testing should be
from the:
A) Ledger entries.
B) Journal entries.
C) Externally generated documents.
D) Original source documents.
Answer: A Difficulty: Hard Source: AICPA
63. An auditor selects a sample from the file of shipping documents to determine whether
invoices were prepared. This test is performed to satisfy the audit objective of:
A) Accuracy.
B) Completeness.
C) Control.
D) Existence.
Answer: B Difficulty: Hard Source: AICPA
Chapter 6 Planning the Audit
64. Individuals who commit fraud are ordinarily able to rationalize the act and also have
an:
A)
B)
C)
D)
Incentive
Yes
Yes
No
No
Opportunity
Yes
No
Yes
No
Answer: A Difficulty: Easy
65. Which of the following is not a required source of information for the auditors'
assessment of fraud risk?
A) Discussion among audit team members.
B) Fraud risk factors.
C) Results of tests of controls.
D) Inquiry of management and others.
Answer: C Difficulty: Medium
66. Auditors must assess fraud risk on every audit and respond to the risks that are
identified. Which of the following is not a procedure required to further address the
fraud risk of management override of internal control?
A) Reviewing accounting estimates for biases.
B) Examining physical controls over assets.
C) Evaluating the business rationale for significant unusual transactions.
D) Examining journal entries and other adjustments for evidence of fraud.
Answer: B Difficulty: Medium
Chapter 6 Planning the Audit
Essay Questions
67. Engagement letters are used by most auditors in performing professional services.
a. Describe the purpose of an engagement letter.
b. List four items that are normally included in an engagement letter.
Difficulty: Medium
Answer:
a. The purpose of an engagement letter is to establish a written contract between the
auditors and the client. Thus, the letter tends to prevent misunderstandings
between those two parties.
b. Items that are normally included in an engagement letter include (only four
required):
• Name of the entity and statements to be examined.
• Scope of services.
• Description of responsibility for detecting fraud.
• Obligations of the client's staff to prepare schedules.
• Fee or method of determining fee.
• Provision for client's acceptance signature.
• Management's obligation to conclude about the materiality of misstatements
not recorded.
68. As a part of the planning process, the auditors often prepare an audit plan, an audit
program, and a time budget.
a. Describe an audit plan and explain its purpose.
b. Describe an audit program and explain its purpose.
c. Describe a time budget and explain its purpose.
Difficulty: Medium
Answer:
a. The audit plan is an overview of the engagement, outlining the nature and
characteristics of the client's business operations and the overall audit strategy.
The audit plan documents the major considerations in planning the engagement.
b. The audit program is a detailed listing of audit procedures to be performed in the
engagement. It is a tool for scheduling and controlling the work.
c. The time budget includes an estimate of the time required for each audit task. It
serves as a basis for the fee estimate, controls the audit work, and may be used to
evaluate performance by the audit staff.
Chapter 6 Planning the Audit
69. Audit Programs are developed from audit objectives that are derived from assertions
made by management in the financial statements.
a. List and describe three assertions made by management in financial statements.
b. Other than the auditors' consideration of internal control, list and describe three
general objectives for the audit of asset accounts.
Difficulty: Medium
Answer:
a. Assertions made by management in financial statements include (only three
required):
• Existence and occurrence--assets, liabilities, and owners' equity reflected in the
financial statements exist; the recorded transactions have occurred.
• Completeness--all transactions, assets liabilities, and owners' equity that should
be presented in the financial statements are included.
• Rights and obligations--the client has rights to assets and obligations to pay
liabilities that are included in the financial statements.
• Valuation or allocation--assets, liabilities, owners' equity, revenues, and
expenses are presented at amounts that are determined in accordance with
generally accepted accounting principles.
• Presentation and disclosure--accounts are described and classified in the
financial statements in accordance with generally accepted accounting
principles and all material disclosures are provided.
b. General objectives for the audit of asset accounts include (only three required):
• Establish the existence of assets.
• Establish that the company has the rights to the assets.
• Establish completeness of recorded assets.
• Determine the appropriate valuation of the assets.
• Establish the clerical accuracy of the underlying records.
• Determine the appropriate financial statement presentation and disclosure of
the assets.
Chapter 6 Planning the Audit
70. Auditors perform various tasks in planning an audit engagement. Provide an overall
description of how each task is performed and its purpose.
a. Obtain an understanding of the client's business.
b. Assess audit risk and materiality for the engagement.
c. Assess fraud risk.
d. Assess the risk of material misstatement of assertions about financial statement
accounts and classes of transactions.
Difficulty: Hard
Answer:
a. The auditors obtain an understanding of the client's business through procedures
such as inquiry of client personnel, observing client operations, studying AICPA
Audit and Accounting Guides and Industry Risk Alerts and other industry
publications, and reviewing prior annual reports, SEC filings, tax returns, and
interim financial statements. An understanding of the client's business is necessary
to the evaluation of the appropriateness of the client's transactions, accounting
principles used, and the estimates and assumptions embodied in the financial
statements.
b. Materiality for planning purposes is the auditors' preliminary estimate of the
smallest amount of misstatement that would affect the decisions of reasonable
users of the financial statements. The auditors use judgment to determine the
amount of planning materiality, usually based on some rule of thumb. Audit risk
is the possibility that the auditors will fail to modify the opinion on financial
statements that are materially misstated. The auditors assess this risk by
considering characteristics of management, operations, and the engagement.
Audit risk and materiality determine the overall scope of the engagement. The
lower the amount of planning materiality, the more extensive the scope of the
audit. The higher the risk of misstatement of the financial statements, the more
extensive the scope of the audit.
c. The auditors are required to assess fraud risk on every audit. This assessment is
based on information derived from (1) the discussion among the audit staff about
the risk of fraud, (2) inquiries of management, the audit committee, internal
auditors and others, (3) the results of planning analytical procedures, and
consideration of fraud risk factors. If the auditors identify fraud risks they may
respond with (1) an overall response to the way the audit is conducted, or (2) a
response specifically to address the identified risk. In all audits they must include
responses to further address the risk of management override of internal control.
Chapter 6 Planning the Audit
d. The auditors assess the risk of material misstatement (composed of inherent risk
and control risk) for each significant assertion about financial statement accounts
and classes of assertions by considering the nature of the account and the
effectiveness of the client's internal control in preventing misstatements of the
assertion. These risk assessments are used to determine the nature, timing, and
extent of the substantive tests that will reduce the detection risk to the appropriate
level.
71. Many auditors take an approach to assessing audit risk by beginning with an
assessment of business risks.
a. Define business risks.
b. Why have auditors found it effective to take the approach of assessing business
risks?
c. Identify a business risk and explain how it might affect the auditor's audit
procedures.
Answer:
a. Business risks are those that threaten management's ability to achieve the
organization's objectives.
b. Auditors have found this approach effective because significant business risks
often create related risks of material misstatement (inherent risks) that the auditors
should address in designing their audit procedures.
c. Students may provide a number of examples. The textbook provides the following:
Assume that the auditors have identified as a significant business risk and audit
risk that sales personnel, informally or through written side agreements, may be
modifying the terms of contracts with customers which may affect the amount of
revenue that should be recognized. The auditors must design tests that are focused
on determining whether such modifications of terms have been made, perhaps by
obtaining tailored confirmations from customers about the existence of such side
agreements.
Chapter 7 Internal Control
True/False Questions
1. Internal control is concerned with the reliability of financial information.
Answer: True Difficulty: Easy
2. The Foreign Corrupt Practices Act prohibits bribes to foreign corporate officials to
obtain business.
Answer: False Difficulty: Hard
3. Incompatible duties exist when an employee is in a position to perpetrate and conceal
errors or fraud.
Answer: True Difficulty: Easy
4. Internal auditors should preferably report to the chief accounting officer of the
company.
Answer: False Difficulty: Medium
5. Well-designed internal control will prevent all fraud by top management.
Answer: False Difficulty: Easy
6. CPA firms may use written narratives to describe internal control in their audit
working papers.
Answer: True Difficulty: Easy
7. The auditors' communication of internal control significant deficiencies should be
addressed only to senior management of the company.
Answer: False Difficulty: Easy
8. If the auditors' assessment of the design of internal control reveals that it cannot be
relied upon, the auditors are not required to prepare any documentation of internal
control for their working papers.
Answer: False Difficulty: Medium
Chapter 7 Internal Control
9. The relatively low number of types of transactions incurred by small firms makes the
segregation of duties impossible.
Answer: False Difficulty: Easy
10. In a financial statement audit, CPAs are required to assess the operating effectiveness
of most significant accounting oriented controls.
Answer: False Difficulty: Medium
Multiple Choice Questions
11. Which of the following matters would an auditor most likely consider to be a
significant deficiency to be communicated to the audit committee?
A) Management's failure to renegotiate unfavorable long-term purchase
commitments.
B) Recurring operating losses that may indicate going concern problems.
C) Evidence of a lack of objectivity by those responsible for accounting decisions.
D) Management's current plans to reduce its ownership equity in the entity.
Answer: C Difficulty: Medium Source: AICPA
12. In assessing the objectivity of a client's internal auditors, the CPA would be most
likely to consider internal auditor:
A) Education levels.
B) Experience.
C) Organizational status within the company.
D) Training and supervisory skills.
Answer: C Difficulty: Medium
13. What needs to be documented when control risk is assessed below the maximum
level?
A)
B)
C)
D)
Understanding of IC
Yes
No
Yes
Yes
Answer: C Difficulty: Hard
Assessed Level
Yes
Yes
No
No
Basis for Assessment
No
Yes
Yes
No
Chapter 7 Internal Control
14. After obtaining an understanding of internal control and arriving at a planned assessed
level of control risk, an auditor decided to perform tests of controls. The auditor most
likely decided that:
A) Additional evidence to support a reduction in the assessed level of control risk is
not available.
B) An increase in the assessed level of control risk is justified for certain financial
statement assertions.
C) It would be efficient to perform tests of controls that would result in a reduction in
planned substantive tests.
D) There were many internal control deficiencies that would allow misstatements to
enter the accounting system.
Answer: C Difficulty: Hard Source: AICPA
15. Which of the following is least likely to be evidence of operating effectiveness of
controls?
A) Cancelled supporting documents.
B) Confirmations of accounts receivable.
C) Records documenting usage of computer programs.
D) Signatures on authorization forms.
Answer: B Difficulty: Hard
16. Which of the following is not ordinarily a procedure for documenting an auditor's
understanding of internal control for planning purposes?
A) Checklist.
B) Flowchart.
C) Questionnaire.
D) Confirmation.
Answer: D Difficulty: Easy
17. Tests of controls do not ordinarily address:
A) By whom a control was applied.
B) How a control was applied.
C) The consistency with which a control was applied.
D) The cost effectiveness of the way a control was applied.
Answer: D Difficulty: Hard
Chapter 7 Internal Control
18. Which is most likely when the assessed level of control risk increases?
A) Change from performing substantive tests at year-end to an interim date.
B) Perform substantive tests directed inside the entity rather than tests directed
toward parties outside the entity.
C) Use the maximum number of dual purpose tests.
D) Use larger sample sizes for substantive tests.
Answer: D Difficulty: Medium
19. Which of the following must the auditor communicate to the audit committee?
A) Significant deficiencies and material weaknesses.
B) Only significant deficiencies.
C) Only material weaknesses.
D) Neither significant deficiencies nor material weaknesses.
Answer: A Difficulty: Medium
20. A client's internal control appears strong, but the CPA has chosen not to test it. The
planned assessed level of control risk is at what level?
A) Zero.
B) Low.
C) Moderate.
D) Maximum.
Answer: D Difficulty: Hard
21. Which of the following would be least likely to be regarded as a test of a control?
A) Tests of the additions to property by physical inspection.
B) Comparisons of the signatures on cancelled checks to the authorized check signer
list.
C) Tests of signatures on purchase orders.
D) Recalculation of payroll deductions.
Answer: A Difficulty: Hard
22. Which of the following is not considered one of the five major components of internal
control?
A) Risk assessment.
B) Segregation of duties.
C) Control activities.
D) Monitoring.
Answer: B Difficulty: Medium
Chapter 7 Internal Control
23. Which of the following statements is correct concerning the understanding of internal
control needed by auditors to plan the audit?
A) The auditors must understand the information system, not the accounting system.
B) The auditors must understand monitoring and all preliminary accounting controls.
C) The auditors must understand the control environment, the information system,
and must use judgment as to the control activities which must be considered.
D) The auditors must understand the control environment, risk assessment, and all
control activities.
Answer: C Difficulty: Hard
24. The effectiveness of controls is not generally tested by:
A) Inspection of documents and reports.
B) Performance of analytical procedures.
C) Observation of the application of accounting policies and procedures.
D) Inquiries of appropriate client personnel.
Answer: B Difficulty: Medium
25. On financial statement audits, it is required that the auditors obtain an understanding
of internal control, including:
A) Its operating effectiveness.
B) Whether it has been placed in operation.
C) Performing tests of controls for all material controls.
D) Its ability to provide reasonable assurance.
Answer: B Difficulty: Medium
26. The potential misstatement amount involved with a significant deficiency is:
A) Any amount.
B) More than inconsequential.
C) Greater than a tolerable misstatement.
D) A material amount.
Answer: B Difficulty: Hard
Chapter 7 Internal Control
27. This organization developed a set of criteria that provide management with a basis to
evaluate controls not only over financial reporting, but also over the effectiveness and
efficiency of operations and compliance with laws and regulations:
A) Foreign Corrupt Practices Corporation.
B) Committee of Sponsoring Organizations.
C) Cohen Commission.
D) Financial Accounting Standards Board.
Answer: B Difficulty: Medium
28. Which statement is correct concerning the definition of internal control developed by
the Committee of Sponsoring Organizations (COSO)?
A) Its applicability is largely limited to internal auditing applications.
B) It is recognized in the Statements on Auditing Standards.
C) It emphasizes the effectiveness and efficiency of operations over the reliability of
financial reporting.
D) It suggests that it is important to view internal control as an end product as
contrasted to a process or means to obtain an end.
Answer: B Difficulty: Hard
29. The definition of internal control developed by the Committee of Sponsoring
Organizations (COSO) includes controls related to the reliability of financial
reporting, the effectiveness and efficiency of operations, and:
A) Compliance with applicable laws and regulations.
B) Effectiveness of prevention of fraudulent occurrences.
C) Safeguarding of entity equity.
D) Incorporation of ethical business practice standards.
Answer: A Difficulty: Medium
30. Which statement is correct concerning the relevance of various types of controls to a
financial statement audit?
A) An auditor may ordinarily ignore the consideration of controls when a substantive
audit approach is used.
B) Controls over the reliability of financial reporting are ordinarily most directly
relevant to an audit, but other controls may also be relevant.
C) Controls over safeguarding assets and liabilities are of primary importance, while
controls over the reliability of financial reporting may also be relevant.
D) All controls are ordinarily relevant to an audit.
Answer: B Difficulty: Hard
Chapter 7 Internal Control
31. Which of the following is not a component of the control environment?
A) Integrity and ethical values.
B) Risk assessment.
C) Commitment to competence.
D) Organizational structure.
Answer: B Difficulty: Medium
32. Which of the following is not ordinarily considered a factor indicative of increased
financial reporting risk when an auditor is considering a client's risk assessment
policies?
A) Salaried sales personnel.
B) Implementation of a new information system.
C) Rapid growth of the organization.
D) Corporate restructuring.
Answer: A Difficulty: Medium
33. The Sarbanes-Oxley Act of 2002 requires that the audit committee:
A) Annually reassess control risk using information from the CPA firm.
B) Be directly responsible for the appointment, compensation and oversight of the
work of the CPA firm.
C) Require that the company's CPA firm rotate the partner in charge of the audit.
D) Review the level of management compensation.
Answer: B Difficulty: Medium
34. When tests of controls reveal that controls are operating as anticipated, it is most likely
that the assessed level of control risk will:
A) Be less than the planned assessed level of control risk.
B) Equal the planned assessed level of control risk.
C) Equal the actual control risk.
D) Be less than the actual control risk.
Answer: B Difficulty: Hard
Chapter 7 Internal Control
35. Under which circumstance is it likely that the extent of substantive procedures will be
expanded beyond that anticipated in the audit plan?
A) The auditors have determined that controls have been placed in operation but, in
accordance with the audit plan, have performed no tests of controls.
B) Certain controls do not leave a trail of documentary evidence.
C) Deviation rates were greater than zero and approached anticipated levels.
D) The operating effectiveness of certain controls was found to be less than expected,
although no material misstatements were identified.
Answer: D Difficulty: Hard
36. The provisions of the Foreign Corrupt Practices Act apply to:
A) All U.S. corporations.
B) All U.S. corporations that engage in foreign operations.
C) All corporations that must file under the Securities Exchange Act of 1934.
D) All U.S. partnerships and corporations.
Answer: C Difficulty: Medium
37. If the auditors do not perform tests of controls for certain assertions:
A) They have performed a substandard audit.
B) They are not required to communicate significant deficiencies relating to those
accounts to management and the board of directors.
C) They must issue a qualified opinion.
D) They must assess control risk at the maximum level for those assertions.
Answer: D Difficulty: Medium
38. During financial statement audits, the auditors' consideration of their clients' internal
control is integral to both assessing control risk and to:
A) Assessing inherent risk.
B) Planning the audit.
C) Assessing compliance with the Foreign Corrupt Practices Act.
D) Providing a reasonable basis for an opinion on compliance with applicable laws.
Answer: B Difficulty: Easy
Chapter 7 Internal Control
39. Which of the following comes closest to outlining the auditors' responsibility for
considering internal control in all financial statement audits?
A) An understanding of the control environment, information and communication,
risk assessment and monitoring is necessary; an understanding of control activities
is only necessary for areas in which the auditor is performing tests of controls.
B) The auditor must obtain an understanding of each of the five internal control
components sufficient to plan the audit.
C) When tests of controls have been performed, control risk must be assessed at a
level less than the maximum.
D) An understanding of the control environment is necessary, but no understanding of
the other components is necessary unless control risk is to be assessed at a level
less than the maximum.
Answer: B Difficulty: Medium
40. Which of the following is not a primary procedure auditors use to obtain sufficient
knowledge about the design of the relevant controls and to determine whether they
have been placed in operation?
A) Previous experience with the entity.
B) Inquiries of appropriate management personnel.
C) Performance of substantive tests.
D) Inspection of document and records.
Answer: C Difficulty: Medium
41. A control deficiency that adversely affects the company's ability to initiate, authorize,
record, process, or report external financial data reliably in accordance with generally
accepted accounting principles, such that there is more than a remote likelihood of a
more than inconsequential misstatement is a(n):
A) Control deficiency.
B) Inherent limitation.
C) Material weakness.
D) Significant deficiency.
Answer: D Difficulty: Medium
Chapter 7 Internal Control
42. For good internal control, which of the following functions should not be assigned to
the company's accounting department?
A) Reconciling accounting records with existing assets.
B) Recording financial transactions.
C) Signing payroll checks.
D) Preparing financial reports.
Answer: C Difficulty: Medium
43. Which of the following is not a responsibility that should be assigned to a company's
internal audit department?
A) Evaluating internal control.
B) Approving disbursements.
C) Reporting on the effectiveness of operating segments.
D) Investigating potential merger candidates.
Answer: B Difficulty: Hard
44. Which of the following is true about the auditors' consideration of internal control?
A) The auditors must assess control risk at a level lower than the maximum.
B) The auditors must prepare a flowchart description of internal control for their
working papers.
C) The auditors must obtain an understanding of the steps in processing major types
of transactions.
D) The auditors must perform tests of controls.
Answer: C Difficulty: Medium
45. Which of the following is an advantage of describing internal control through the use
of a standardized questionnaire?
A) Questionnaires highlight weaknesses in the system.
B) Questionnaires are more flexible than other methods of describing internal control.
C) Questionnaires usually identify situations in which internal control weaknesses are
compensated for by other strengths in the system.
D) Questionnaires provide a clearer and more specific portrayal of a client's system
than other methods of describing internal control.
Answer: A Difficulty: Medium
Chapter 7 Internal Control
46. Which of the following is not a factor that is considered in evaluating a client's overall
control environment?
A) The organizational structure.
B) The information system.
C) Management philosophy and operating style.
D) Board of directors.
Answer: B Difficulty: Medium
47. Which of the following would be least likely to be considered a benefit of effective
internal control?
A) Eliminating all employee fraud.
B) Restricting access to assets.
C) Detecting ineffectiveness.
D) Ensuring authorization of transactions.
Answer: A Difficulty: Medium
48. After documenting the client's prescribed internal control, the auditors will often
perform a walk-through of each transaction cycle. An objective of a walk-through is
to:
A) Verify that the controls have been placed in operation.
B) Replace tests of controls.
C) Evaluate the major strengths and weaknesses in the client's internal control.
D) Identify weaknesses to be communicated to management in the management
letter.
Answer: A Difficulty: Medium
49. The major components of internal control include all of the following, except:
A) Risk assessment.
B) The control environment.
C) Internal auditing.
D) Control activities.
Answer: C Difficulty: Medium
Chapter 7 Internal Control
50. Which of the following is correct with respect to control deficiencies discovered
during an audit?
A) Auditors must communicate and recommend corrections relating to all material
weaknesses in internal control.
B) All material weaknesses in internal control are also significant deficiencies.
C) All such matters must be communicated to the audit committee and regulatory
agencies.
D) All control deficiencies are also significant deficiencies.
Answer: B Difficulty: Hard
51. After considering the client's internal control the auditors have concluded that it is
well designed and is functioning as anticipated. Under these circumstances the
auditors would most likely:
A) Cease to perform further substantive tests.
B) Reduce substantive tests in areas where the internal control was found to be
effective.
C) Increase the extent of anticipated analytical procedures.
D) Perform all tests of controls to the extent outlined in the preplanned audit program.
Answer: B Difficulty: Easy Source: AICPA
52. The use of fidelity bonds protects a company from embezzlement loses and also:
A) Minimizes the possibility of employing persons with dubious records in positions
of trust.
B) Reduces the company's need to obtain expensive business interruption insurance.
C) Allows the company to substitute the fidelity bonds for various parts of internal
control.
D) Protects employees who made unintentional errors from possible monetary
damages resulting from such errors.
Answer: A Difficulty: Medium Source: AICPA
53. The independent auditors might consider the procedures performed by the internal
auditors because:
A) They are employees whose work must be reviewed during substantive testing.
B) They are employees whose work might affect the independent auditors' work.
C) Their work impacts upon the cost/benefit tradeoff in evaluating inherent
limitations.
D) Their degree of independence may be inferred by the nature of their work.
Answer: B Difficulty: Medium Source: AICPA
Chapter 7 Internal Control
54. In the consideration of internal control, the operating effectiveness of controls is tested
by:
A) Flowcharts verification.
B) Tests of controls.
C) Substantive tests.
D) Decision tables.
Answer: B Difficulty: Easy Source: AICPA
55. The auditors who become aware of an internal control significant deficiency are
required to communicate this to the:
A) Audit committee and client's legal counsel.
B) Board of directors and internal auditors.
C) Audit committee.
D) Internal auditors and senior management.
Answer: C Difficulty: Medium Source: AICPA
56. A material weakness is a significant deficiency that results in more than a remote
likelihood that what size of misstatement will not be prevented or detected?
A) Smaller than inconsequential.
B) Larger than inconsequential.
C) Tolerable.
D) Material.
Answer: D Difficulty: Medium
57. To provide for the greatest degree of independence in performing internal auditing
functions, an internal auditor most likely should report to the:
A) Financial vice-president.
B) Corporate controller.
C) Audit committee.
D) Corporate stockholders.
Answer: C Difficulty: Medium Source: AICPA
Chapter 7 Internal Control
58. Well-designed internal control that is functioning effectively is most likely to detect an
fraud arising from:
A) The fraudulent action of several employees.
B) The fraudulent action of an individual employee.
C) Informal deviations from the official organization chart.
D) Management fraud.
Answer: B Difficulty: Medium Source: AICPA
59. The program flowcharting symbol representing a decision is a:
A) Triangle.
B) Circle.
C) Rectangle.
D) Diamond.
Answer: D Difficulty: Medium Source: AICPA
60. Controls are not designed to provide assurance that:
A) Transactions are executed in accordance with management's authorization.
B) Fraud will be eliminated.
C) Access to assets is permitted only in accordance with management's authorization.
D) The recorded accountability for assets is compared with the existing assets at
reasonable intervals.
Answer: B Difficulty: Medium Source: AICPA
61. The scope of substantive tests as compared to the scope of tests of controls generally
vary:
A) In a parallel manner.
B) Inversely.
C) Directly.
D) Equally.
Answer: B Difficulty: Medium Source: AICPA
Chapter 7 Internal Control
62. A primary purpose of the auditor's consideration of internal control is to provide a
basis for:
A) Determining whether procedures and records that are concerned with the
safeguarding of assets are reliable.
B) Constructive suggestions to clients concerning improvements in internal control.
C) Determining the nature, extent, and timing of audit tests to be applied.
D) The expression of an opinion on compliance with laws and regulations.
Answer: C Difficulty: Medium Source: AICPA
63. Which of the following audit tests would be regarded as a test of a control?
A) Tests of the specific items making up the balance in a given general ledger
account.
B) Tests confirming receivables.
C) Tests of the signatures on canceled checks to board of director's authorizations.
D) Tests of the additions to property, plant, and equipment by physical inspection.
Answer: C Difficulty: Medium Source: AICPA
64. If the independent auditors decide that the work performed by the internal auditors
may have a bearing on their own procedures, they should consider the internal
auditors':
A) Competence and objectivity.
B) Efficiency and experience.
C) Independence and review skills.
D) Training and supervisory skills.
Answer: A Difficulty: Medium Source: AICPA
65. In the consideration of internal control, the auditor is basically concerned that it
provides reasonable assurance that:
A) Management can not override the system.
B) Operational efficiency has been achieved in accordance with management plans.
C) Misstatements have been prevented or detected.
D) Controls have not been circumvented by collusion.
Answer: C Difficulty: Medium Source: AICPA
Chapter 7 Internal Control
66. Which of the following is intended to detect deviations from prescribed controls?
A) Substantive tests specified by a standardized audit program.
B) Tests of controls designed specifically for the client.
C) Analytical procedures as set forth in an industry audit guide.
D) Computerized analytical procedures tailored for the configuration of the computer
equipment in use.
Answer: B Difficulty: Medium Source: AICPA
67. An auditor's purpose for performing tests of controls is to provide reasonable
assurance that:
A) Controls are operating effectively.
B) The risk that the auditor may unknowingly fail to modify the opinion on the
financial statements is minimized.
C) Transactions are executed in accordance with management's authorization and
access to assets is limited by a segregation of functions.
D) Transactions are recorded as necessary to permit the preparation of the financial
statements in conformity with generally accepted accounting principles.
Answer: A Difficulty: Medium Source: AICPA
68. Of the following statements about internal control, which one is not valid?
A) No one person should be responsible for the custodial responsibility and the
recording responsibility for an asset.
B) Transactions must be properly authorized before such transactions are processed.
C) Because of the cost/benefit relationship, a client may apply control procedures on
a test basis.
D) Control activities reasonably insure that collusion among employees can not
occur.
Answer: D Difficulty: Easy Source: AICPA
69. Tests of controls are most likely to be performed when:
A) Controls seem weak and must be properly documented.
B) Inadequate substantive tests exist to restrict audit risk to an acceptable level.
C) The auditor wishes to assess control risk at the maximum.
D) The client's control environment appears weak.
Answer: B Difficulty: Hard
Chapter 7 Internal Control
70. Which of the following would be least likely to be included in an auditor's tests of
controls?
A) Inspection.
B) Observation.
C) Inquiry.
D) Analytical procedures.
Answer: D Difficulty: Medium Source: AICPA
71. The internal control provisions of the Sarbanes-Oxley Act of 2002 apply to which
companies in the United States:
A) All companies.
B) SEC registrants.
C) Only those companies included in the Fortune 500.
D) All nonpublic companies.
Answer: B Difficulty: Medium
72. An integrated audit performed under Section 404b of the Sarbanes-Oxley Act
addresses financial statements and:
A) Compliance with laws.
B) Internal control over asset safeguarding.
C) Internal control over financial reporting.
D) Suitable criteria.
Answer: C Difficulty: Medium
73. A report on internal control performed in accordance with PCAOB Standard No. 2
includes an opinion on internal control for:
A) The entire year.
B) The prior quarter.
C) The “as of date.”
D) The end of each quarter.
Answer: C Difficulty: Hard
Chapter 7 Internal Control
74. When performing an audit of internal control under PCAOB Standard No. 2, auditors
evaluate control:
A)
B)
C)
D)
Design Effectiveness
Yes
Yes
No
No
Operating Effectiveness
Yes
No
Yes
No
Answer: A Difficulty: Medium
75. An integrated audit requires test of controls for all
A) Major accounts.
B) Assertions.
C) Accounts.
D) Controls.
Answer: A Difficulty: Hard
76. An auditors' opinion on internal control under PCAOB Standard No. 2 includes:
A)
B)
C)
D)
An opinion on management’s assessment
Yes
Yes
No
No
The auditor’s own opinion
Yes
No
Yes
No
Answer: A Difficulty: Medium
77. When performing an internal control audit under PCAOB Standard No. 2, one or more
material weaknesses in internal control that exist at year-end may result in what type
of report(s):
A)
B)
C)
D)
Qualified
Yes
Yes
No
No
Adverse
Yes
No
Yes
No
Answer: C Difficulty: Hard
Chapter 7 Internal Control
78. When performing an internal control audit under PCAOB Standard No. 2, one or more
material weaknesses in internal control that exist at year-end may result in what type
of report(s):
A)
B)
C)
D)
Qualified
Yes
Yes
No
No
Disclaimer
Yes
No
Yes
No
Answer: D Difficulty: Medium
Essay Questions
79. Independent auditors should consider the work of internal auditors in their assessment
of control risk.
a. Are internal auditors independent of management? Explain.
b. What is the difference between the primary objective of the independent auditors
and that of internal auditors? Explain.
c. Discuss the factors that should be considered by the independent auditors in
deciding how much, if any, reliance should be placed on the work of the internal
auditors.
Difficulty: Hard
Answer:
a. No. However, internal auditors may achieve independence from departments they
evaluate by reporting to a senior officer or the board of directors.
b. The independent auditors' objective is to express an opinion on the client's
financial statements. The internal auditors' primary objective is to aid
management in achieving the most efficient and effective administration of the
business.
c. In deciding the degree of reliance to be placed on the work of the internal auditors,
the independent auditors should consider the competence and objectivity of the
internal auditors, and evaluate their work.
Chapter 7 Internal Control
80. Auditors are required to consider a client's internal control.
a. Describe the two purposes of the auditors' consideration of a client's internal
control.
b. Even the best internal control has certain limitations. List three of those
limitations.
Difficulty: Medium
Answer:
a. The auditors' consideration of their clients' internal control is integral to both (1)
the planning of the audit and (2) the assessing of control risk.
b. The limitations of internal control include (only three required):
• Carelessness.* Misunderstanding of instructions.
• Top management may override the system
• Collusion among employees may circumvent controls dependent upon
segregation of duties.
• Cost considerations often limit the effectiveness of the design of the structure.
81. When considering a client's internal control, the auditors focus on its various
characteristics. For each of the following characteristics indicate the auditors'
responsibility under generally accepted auditing standards and the procedures used to
meet that responsibility.
a. The design of internal control.
b. Controls placed in operation.
c. The operating effectiveness of controls.
Difficulty: Medium
Answer:
a. The auditors have a responsibility to obtain an understanding of internal control
that is sufficient to plan the audit. An understanding of the design of the structure
is obtained by inspecting control manuals, organization charts, and job
descriptions, and by interviewing client personnel.
b. The auditors have a responsibility to determine whether internal control policies
and procedures are placed in operation in every audit. The auditors may determine
whether the controls have been placed in operation by observation, inspection, and
inquiry. Walk-through tests may also be used.
c. The auditors have a responsibility to determine the operating effectiveness of
controls that provide the basis for the auditors' assessment of control risk at levels
below the maximum. The auditors use observation, inspection, inquiry, and
reperformance to test the operating effectiveness of controls.
Chapter 7 Internal Control
82. Assume that you have assessed inherent risk for an audit area at a very high level.
While obtaining an understanding of internal control, you have determined that it
appears to be very strong. Nonetheless, due to the large number of transactions
involved, you have chosen not to test controls in the area.
a.
b.
c.
d.
e.
f.
At what level will the planned assessed level of control risk be established?
Describe the scope of tests of controls that will be performed.
At what level will the assessed level of control risk be established?
What must be documented in the working papers relating to internal control?
At what level will detection risk be established?
Describe the required scope of substantive tests, if any. Make certain to discuss
details of likely nature, timing and extent.
Difficulty: Hard
Answer:
a. Maximum, High or Highest.
b. None will be performed (because control risk is being assessed at the maximum
level).
c. Maximum, High or Highest
d. Control risk assessed at maximum (or high or highest) level. The auditor need not
document the reason for assessing control risk at the maximum (we delete points
from scores of students who state that the auditor needs to document the reason).
e. Minimum, low, or lowest
f. Nature--External sources rather than internal Timing--Year-end testing rather than
interim testing. Extent--Greatest extent
Chapter 8 Consideration of Internal Control
True/False Questions
1. Magnetic tape drives have the advantage of direct access to stored data.
Answer: False Difficulty: Medium
2. The operating system is an example of system software.
Answer: True Difficulty: Medium
3. For good internal control, programmers should not be given access to complete
program documentation.
Answer: False Difficulty: Medium
4. Data encryption is an example of data transmission control.
Answer: True Difficulty: Medium
5. Internal file labels are designed to prevent errors by programmers.
Answer: False Difficulty: Medium
6. For auxiliary storage when the computer is operating, minicomputers use hard disk
drives.
Answer: True Difficulty: Medium
7. Distributive data processing eliminates the need for data security.
Answer: False Difficulty: Easy
8. Most advanced computer systems do not have audit trails.
Answer: False Difficulty: Medium
9. Auditors usually begin their consideration of IT systems with tests of application
controls.
Answer: False Difficulty: Hard
Chapter 8 Consideration of Internal Control
10. Generalized audit software may be used for substantive tests or for tests of controls.
Answer: True Difficulty: Medium
Multiple Choice Questions
11. Which of the following procedures would an entity most likely include in its disaster
recovery plan?
A) Convert all data from external formats to an internal company format.
B) Maintain a program to prevent illegal activity.
C) Develop an auxiliary power supply to provide uninterrupted electricity.
D) Store duplicate copies of files in a location away from the computer center.
Answer: D Difficulty: Medium Source: AICPA
12. A service auditor's report on a service center should include a(n)
A) Detailed description of the service center's internal control.
B) Statement that the user of the report may assess control risk at the minimum level.
C) Indication that no assurance is provided.
D) Opinion on the operating effectiveness of the service center's internal control.
Answer: A Difficulty: Hard
13. The report of a service auditor may provide assurance on whether:
A)
B)
C)
D)
Controls are placed in operation
Yes
Yes
No
No
Operating effectiveness of controls
Yes
No
Yes
No
Answer: A Difficulty: Hard
14. Which of the following is a password security problem?
A) Users are assigned passwords when accounts are created, but do not change them.
B) Users have accounts on several systems with different passwords.
C) Users copy their passwords on note paper, which is kept in their wallets.
D) Users select passwords that are not listed in any online dictionary.
Answer: A Difficulty: Easy Source: AICPA
Chapter 8 Consideration of Internal Control
15. Which of the following is a software component of a computer system?
A) The operating system.
B) The storage unit.
C) The display terminal.
D) The optical scanner.
Answer: A Difficulty: Easy
16. Which of the following is least likely to be a general control over computer activities?
A) Procedures for developing new programs and systems.
B) Requirements for system documentation.
C) A change request log.
D) A control total.
Answer: D Difficulty: Medium
17. Which of the following computer related employees should not be allowed access to
program listings of application programs?
A) The systems analyst.
B) The programmer.
C) The operator.
D) The librarian.
Answer: C Difficulty: Hard
18. The advent of microcomputers has resulted in a(n):
A) Decentralization of data processing activities.
B) Increased concern over the accuracy of computerized processing.
C) Decrease in the number of local area networks.
D) Increase for general computer control activities.
Answer: A Difficulty: Medium
19. Which of the following is most likely to include user group development and
execution of certain computer applications?
A) Telecommunication transmission systems.
B) Database administration.
C) End user computing.
D) Electronic data interchange systems.
Answer: C Difficulty: Medium
Chapter 8 Consideration of Internal Control
20. Which of the following is not a data transmission control?
A) Echo checks.
B) Data encryption.
C) File labels.
D) Parity checks.
Answer: C Difficulty: Medium
21. Which of the following is an example of general computer control?
A) Input validation checks.
B) Control total.
C) Operations manual.
D) Generalized audit software.
Answer: C Difficulty: Medium
22. Which of the following would the auditors consider to be a weakness in an IT system?
A) Operators have access to terminals.
B) Programmers are allowed access to the file library.
C) Reprocessing of exceptions detected by the computer is handled by a data control
group.
D) More than one employee is present when the computer facility is in use.
Answer: B Difficulty: Medium
23. Which of the following is least likely to be tested with generalized audit software?
A) An aging of accounts receivable.
B) A schedule of inventory.
C) A depreciation schedule.
D) A computer operations manual.
Answer: D Difficulty: Easy
24. Which of the following would be least likely to be considered a desirable attribute of a
database management system?
A) Data redundancy.
B) Quick response to users' request for information.
C) Control of users' identification numbers and passwords.
D) Logging of terminal activity.
Answer: A Difficulty: Medium
Chapter 8 Consideration of Internal Control
25. A problem for a CPA associated with advanced IT systems is that:
A) The audit trail normally does not exist.
B) The audit trail is sometimes generated only in machine readable form.
C) The client's internal auditors may have been involved at the design stage.
D) Tests of controls are not possible.
Answer: B Difficulty: Easy
26. Which of the following testing techniques is more commonly used by internal auditors
than by independent auditors?
A) Integrated test facilities.
B) Test data.
C) Controlled programs.
D) Tagging and tracing transactions.
Answer: A Difficulty: Medium
27. General controls over IT systems are typically tested using:
A) Generalized audit software.
B) Observation, inspection, and inquiry.
C) Program analysis techniques.
D) Test data.
Answer: B Difficulty: Medium
28. Which of the following personnel is responsible for determining the computer
processing needs of the various users?
A) The application programmer.
B) The computer operator.
C) The systems analyst.
D) The computer operator.
Answer: C Difficulty: Medium
29. Which of the following testing techniques minimizes the possibility that the auditors
will contaminate a client's financial records?
A) Test data.
B) Integrated test facilities.
C) Controlled programs.
D) Tagging and tracing transactions.
Answer: C Difficulty: Hard
Chapter 8 Consideration of Internal Control
30. Which of the following is not a distinctive characteristic of advanced IT systems?
A) Data communication.
B) Integrated database.
C) Batch processing of transactions.
D) Distributive data processing.
Answer: C Difficulty: Medium
31. The best method of achieving internal control over advanced IT systems is through the
use of:
A) Batch controls.
B) Controls written into the computer system.
C) Equipment controls.
D) Documentation controls.
Answer: B Difficulty: Hard
32. Which of the following personnel is responsible for the proper functioning of the
security features built into the operating system?
A) The systems programmer.
B) The application programmer.
C) The computer operator.
D) The telecommunications specialist.
Answer: A Difficulty: Hard
33. Which of the following is not a data transmission control?
A) Data encryption.
B) Parity check.
C) Message acknowledgment techniques
D) Distributed data processing.
Answer: D Difficulty: Medium
34. Which of the following is not a programmed control?
A) Private lines.
B) Validity tests.
C) Self-checking numbers.
D) Limit tests.
Answer: A Difficulty: Medium
Chapter 8 Consideration of Internal Control
35. A system in which the end user is responsible for the development and execution of
the computer application that he or she uses is referred to as:
A) Microcomputing.
B) End-user computing.
C) Distributed computing.
D) Decentralized computing.
Answer: B Difficulty: Easy
36. In a client/server environment, the “client” is most likely to be the:
A) Supplier of the computer system.
B) Computers of various users.
C) Computer that contains the networks software and provides services to a server.
D) Database administrator.
Answer: B Difficulty: Medium
37. When designing the physical layout of a data processing center, which of the
following would be least likely to be a necessary control that is considered?
A) Design of controls to restrict access.
B) Adequate physical layout space for the operating system.
C) Inclusions of an adequate power supply system with surge protection.
D) Consideration of risks related to other uses of electricity in the area.
Answer: B Difficulty: Medium
38. A data warehouse is an example of:
A) On-line analytical processing.
B) On-line transaction processing.
C) Essential information batch processing.
D) Decentralized processing.
Answer: A Difficulty: Hard
39. An example of an access control is a:
A) Check digit.
B) Password.
C) Test facility.
D) Read only memory.
Answer: B Difficulty: Medium
Chapter 8 Consideration of Internal Control
40. End-user computing is most likely to occur on which of the following types of
computers?
A) Mainframe.
B) Macrocomputers.
C) Personal computers.
D) Personal reference assistants.
Answer: C Difficulty: Medium
41. Auditing through the computer is most likely to be used when:
A) Input transactions are batched and system logic is straightforward.
B) Processing primarily consists of sorting the input data and updating the master file
sequentially.
C) Processing is primarily on line and updating is real-time.
D) Outputs are in hard copy form.
Answer: C Difficulty: Medium Source: IIA
42. Which of the following computer system risks would be increased by the installation
of a database system?
A) Programming errors.
B) Data entry errors.
C) Improper data access.
D) Loss of power.
Answer: C Difficulty: Hard Source: IIA
43. Parallel simulation programs used by the auditors for testing programs:
A) Must simulate all functions of the production computer-application system.
B) Cannot be developed with the aid of generalized audit software.
C) Can use live data or test data.
D) Is generally restricted to data base environments.
Answer: C Difficulty: Medium Source: IIA
Chapter 8 Consideration of Internal Control
44. Auditing by testing the input and output of a computer system instead of the computer
program itself will:
A) Not detect program errors which do not show up in the output sampled.
B) Detect all program errors, regardless of the nature of the output.
C) Provide the auditors with the same type of evidence.
D) Not provide the auditors with the confidence in the results of the auditing
procedures.
Answer: A Difficulty: Medium Source: AICPA
45. If a control total were to be computed on each of the following data items, which
would best be identified as a hash total for a payroll computer application?
A) Net pay.
B) Department numbers.
C) Hours worked.
D) Total debits and total credits.
Answer: B Difficulty: Medium Source: AICPA
46. Smith Corporation has numerous customers. A customer file is kept on disk storage.
Each account in the customer file contains name, address, credit limit, and account
balance. The auditor wishes to test this file to determine whether credit limits are
being exceeded. The best procedure for the auditor to follow would be to:
A) Develop test data that would cause some account balance to exceed the credit limit
and determine if the system properly detects such situations.
B) Develop a program to compare credit limits with account balances and print out
the details of any account with a balance exceeding its credit limit.
C) Require a printout of all account balances so they can be manually checked against
the credit limits.
D) Request a printout of a sample of account balances so they can be individually
checked against the credit limits.
Answer: B Difficulty: Medium Source: AICPA
47. In their consideration of a client's IT controls, the auditors will encounter general
controls and application controls. Which of the following is an application control?
A) The operations manual.
B) Hash total.
C) Systems documentation.
D) Control over program changes.
Answer: B Difficulty: Hard Source: AICPA
Chapter 8 Consideration of Internal Control
48. When erroneous data are detected by computer program controls, such data may be
excluded from processing and printed on an exception report. The exception report
should most probably be reviewed and followed up on by the:
A) Supervisor of computer operations.
B) Systems analyst.
C) Data control group.
D) Computer programmer.
Answer: C Difficulty: Medium Source: AICPA
49. The purpose of using generalized computer programs is to test and analyze a client's
computer:
A) Systems.
B) Equipment.
C) Records.
D) Processing logic.
Answer: C Difficulty: Hard Source: AICPA
50. An auditor may decide not to perform tests of controls related to the control activities
within the computer portion of the client's internal control. Which of the following
would not be a valid reason for choosing to omit such test?
A) The controls duplicate operative controls existing elsewhere.
B) There appear to be major weaknesses that would preclude reliance on the stated
procedure.
C) The time and dollar costs of testing exceed the time and dollar savings in
substantive testing if the tests show the controls to be operative.
D) The controls appear adequate.
Answer: D Difficulty: Medium Source: AICPA
51. A control feature in a computer system requires the central processing unit (CPU) to
send signals to the printer to activate the print mechanism for each character. The
print mechanism, just prior to printing, sends a signal back to the CPU verifying that
the proper print position has been activated. This type of data transmission is referred
to as:
A) Echo control.
B) Validity control.
C) Signal control.
D) Check digit control.
Answer: A Difficulty: Easy Source: AICPA
Chapter 8 Consideration of Internal Control
52. Which of the following constitutes a weakness in the internal control of a computer
system?
A) One generation of backup files is stored in an off-premises location.
B) Machine operators distribute error messages to the control group.
C) Machine operators do not have access to the complete systems manual.
D) Machine operators are supervised by the programmer.
Answer: D Difficulty: Medium Source: AICPA
53. The completeness of computer-generated sales figures can be tested by comparing the
number of items listed on the daily sales report with the number of items billed on the
actual invoices. This process uses:
A) Self-checking numbers.
B) Control totals.
C) Validity tests.
D) Process tracing data.
Answer: B Difficulty: Medium Source: AICPA
54. Internal control is ineffective when computer department personnel:
A) Participate in computer software acquisition decisions.
B) Design documentation for computerized systems.
C) Originate changes in master files.
D) Provide physical security for program files.
Answer: C Difficulty: Medium Source: AICPA
55. Which of the following is likely to be of least importance to an auditor in considering
the internal control in a company with computer processing?
A) The segregation of duties within the computer center.
B) The control over source documents.
C) The documentation maintained for accounting applications.
D) The cost/benefit of data processing operations.
Answer: D Difficulty: Easy Source: AICPA
Chapter 8 Consideration of Internal Control
56. In the weekly computer run to prepare payroll checks, a check was printed for an
employee who had been terminated the previous week. Which of the following
controls, if properly utilized, would have been most effective in preventing the error or
ensuing its prompt detection?
A) A control total for hours worked, prepared from time cards collected by the
timekeeping department.
B) Requiring the treasurer's office to account for the numbers of the prenumbered
checks issued to the computer department for the processing of the payroll.
C) Use of a check digit for employee numbers.
D) Use of a header label for the payroll input sheet.
Answer: A Difficulty: Medium Source: AICPA
57. A company's labor distribution report requires extensive corrections each month
because of labor hours charged to inactive jobs. Which of the following data
processing input controls appears to be missing?
A) Completeness test.
B) Validity test.
C) Limit test.
D) Control total.
Answer: B Difficulty: Medium Source: IIA
58. Passwords for microcomputer software programs are designed to prevent:
A) Inaccurate processing of data.
B) Unauthorized access to the computer.
C) Incomplete updating of data files.
D) Unauthorized use of the software.
Answer: D Difficulty: Medium Source: IIA
59. The capability for computers to communicate with physically remote terminals is an
important feature in the design of modern business information systems. Which of the
following risks associated with the use of telecommunications systems is minimized
through the use of a password control system?
A) Unauthorized access to system program and data files.
B) Unauthorized physical availability of remote terminals.
C) Physical destruction of system program and data files.
D) Physical destruction of remote terminals.
Answer: A Difficulty: Medium Source: IIA
Chapter 8 Consideration of Internal Control
60. Consider the following computer applications:
(1) At a catalog sales firm, as phone orders are entered into their computer, both
inventory and credit are immediately checked.
(2) A manufacturer's computer sends the coming week's production schedule and parts
orders to a supplier's computer.
Which statement below is true for these applications?
A) Both applications are examples of EDI.
B) Both applications are examples of on-line real-time processing.
C) The first application is an example of EDI and the second is an example of on-line
real-time.
D) The first application is an example of on-line real-time and the second is an
example of EDI.
Answer: D Source: IIA
Essay Questions
61. Many auditors use generalized audit software to assist them in the examination of
clients' computer records.
a. Describe what is meant by generalized audit software.
b. List two advantages of the use of generalized audit software.
c. List three functions that may be performed with this type of software.
Difficulty: Hard
Answer:
a. Generalized audit software packages are simple programming languages that assist
in the audit of clients' computer records.
b. Advantages of the use of generalized audit software include (only two required):
• Auditors are able to directly test computerized records.
• Auditors are able to test items more efficiently than manually.
• Auditors do not need extensive training to use the packages.
c. Functions that may be performed by generalized audit software packages include
(only three required):
• Examine records for overall quality, completeness, and valid conditions.
• Rearrange data and perform analyses.
• Select audit samples.
• Compare data on separate files.
• Compare the results of audit procedures with the client's records.
Chapter 8 Consideration of Internal Control
62. Auditors are now faced with examining clients that have database systems.
a. Describe a database system, including its major advantage.
b. Identify policies and procedures that may be established to provide control over
that aspect over a database system.
Difficulty: Medium
Answer:
a. In a data-base system separate files are replaced with an integrated data-base that
is shared by many application programs.
b. Controls over data-base systems include:
• A system of user identification numbers and passwords should be used to
restrict specific data to authorized personnel.
• Terminal activity should be logged by the operating system for subsequent
review for unauthorized access to data.
• The responsibility for updating specific data should be assigned to a specific
department.
63. Various characteristics of IT systems can present special audit risks. Explain each of
the following characteristics of an IT system and the special audit risks that they
present.
a. Data base system.
b. Distributive data processing.
c. End user computing.
Difficulty: Medium
Answer:
a. A system that eliminates data redundancy by storing data for two or more
applications in an integrated data-base.
Special risks include:
• Improper access to data.
• Improper alteration of data.
b. A system in which information and programs are shared by a number of users.
Special risks include:
• Improper access to data.
• Improper alteration of data.
c. A system in which user departments are responsible for developing and executing
computer applications that generate information for the same users.
Special risks include:
• Improper access to data.
• Unreliable user developed programs.
Chapter 9 Audit Sampling
True/False Questions
1. Stratification of the population generally results in a more efficient sampling plan.
Answer: True Difficulty: Medium
2. Discovery sampling is equivalent to an attributes sampling plan with a specified
expected deviation rate of 0 percent.
Answer: True Difficulty: Medium
3. Increases in the number of deviations in an attributes sample results in an increase in
the achieved upper deviation rate of the attributes sample.
Answer: True Difficulty: Medium
4. The definition of a "deviation" for a test of a control should include only those
deviations that result in misstatements in the financial statements.
Answer: False Difficulty: Hard
5. Statistical sampling cannot be used to test all control activities.
Answer: True Difficulty: Medium
6. Using ratio and difference estimation for a sample is an example of a dual purpose
test.
Answer: False Difficulty: Medium
7. Increases in the tolerable misstatement result in a decreased sample size when using
mean-per-unit estimation.
Answer: True Difficulty: Medium
8. The mean book value of the items included in a mean-per-unit sample is not directly
used in the evaluation of sample results.
Answer: True Difficulty: Hard
Chapter 9 Audit Sampling
9. When evaluating the results of a variables sampling plan, the projected misstatement is
calculated and compared to the tolerable misstatement.
Answer: True Difficulty: Easy
10. Auditors project the misstatements found in the sample to the population when using
statistical sampling, but not when using nonstatistical sampling.
Answer: False Difficulty: Medium
Multiple Choice Questions
Use the following to answer questions 11-13:
The 10,000 accounts receivable of DEF Company have a total book value of $120,000. A
CPA has selected and audited a sample of 100 accounts with a total book value of $1,000 and
an audited value of $1,200.
11. Using the difference estimation technique, estimated total audited value of the
population is:
A) $100,000.
B) $120,000.
C) $140,000.
D) $144,000
Answer: C Difficulty: Medium
12. Using the ratio estimation technique, the estimated total audited value of the
population is:
A) $100,000.
B) $120,000.
C) $140,000.
D) $144,000
Answer: D Difficulty: Medium
Chapter 9 Audit Sampling
13. Using the mean-per-unit estimation technique, the estimated total audited value of the
population is:
A) $100,000.
B) $120,000.
C) $140,000.
D) $144,000.
Answer: B Difficulty: Medium
14. Using the mean-per-unit estimation method an auditor has properly calculated the
estimated total audited value of a population as $200,000. Her sample included 200 of
the population's 40,000 items. She found that, in her sample the average audited value
was $1 less than the average book value. What was the average audited value in the
sample?
A) $4.
B) $5.
C) $6.
D) $10.
Answer: B Difficulty: Hard
15. Using difference estimation, an auditor has taken a sample of 200 from a population's
40,000 items; that population has a book value of $200,000. She found that in her
sample the average audited value was $4.20, while the average book value was $5.20.
What is the estimated total audited value of the population?
A) $160,000.
B) $161,538.
C) $168,000.
D) $200,000.
Answer: A Difficulty: Medium
16. Using ratio estimation, an auditor has taken a sample of 200 from a population's
40,000 items; that population has a book value of $200,000. She found that in her
sample the average audited value was $4.20, while the average book value was $5.20.
What is the estimated total audited value of the population?
A) $160,000.
B) $161,538.
C) $168,000.
D) $200,000.
Answer: B Difficulty: Medium
Chapter 9 Audit Sampling
17. Using mean-per-unit estimation, an auditor has taken a sample of 200 from a
population's 40,000 items; that population has a book value of $200,000. She found
that in her sample the average audited value was $4.20, while the average book value
was $5.20. What is the estimated total audited value of the population?
A) $160,000.
B) $161,538.
C) $168,000.
D) $200,000.
Answer: C Difficulty: Medium
18. If the projected misstatement in a nonstatistical sampling is $8,000, while the tolerable
misstatement is $9,000, what would an auditor likely conclude?
A) Since the projected misstatement is less than the tolerable misstatement, the
account is not misstated.
B) Since the projected misstatement is less than the tolerable misstatement, the
account is misstated.
C) The risk is high that the account is materially misstated.
D) The analysis has been improperly performed since the projected misstatement is
unequal to the tolerable misstatement.
Answer: C Difficulty: Hard
19. A dual purpose test simultaneously.
A) Addresses two different accounts.
B) Functions as a substantive test and as a test of controls.
C) Functions as an analytical procedure and a substantive test.
D) Substantiates an ending balance and the transactions making up the balance.
Answer: B Difficulty: Medium
Use the following to answer questions 20-21:
The 1000 accounts receivable of Winco Company have a total book value of $20,000
(Average book value = $20). Bob Duffo, CPA, has selected and audited a sample of 50
accounts with the following mean values:
1. Book value of $19.
2. Audited value of $19.60.
Chapter 9 Audit Sampling
20. What is the estimated total audited value using mean per unit sampling?
A) $19,000.
B) $19,600.
C) $20,000.
D) $20,632.
Answer: B Difficulty: Medium
21. What is the estimated total audited value using difference estimation sampling?
A) $19,387.
B) $19,400.
C) $19,600.
D) $20,600.
Answer: D Difficulty: Hard
22. If all other factors specified in an attributes sampling plan remain constant, decreasing
the tolerable rate and decreasing the risk of assessing control risk too low would have
what effect on sample size?
A) Increase.
B) Remain the same.
C) Decrease.
D) Indeterminate, depends upon exact change being made.
Answer: A Difficulty: Hard
23. If all other factors specified in an attributes sampling plan remain constant, decreasing
the tolerable rate and increasing the estimated population deviation rate would have
what effect on sample size?
A) Increase.
B) Remain the same.
C) Decrease.
D) Indeterminate, depends upon exact change being made.
Answer: A Difficulty: Hard
Chapter 9 Audit Sampling
24. An increase in the tolerable misstatement has what effect on the planned allowance for
sampling risk?
A) Increases.
B) Decreases.
C) No effect.
D) Indeterminate.
Answer: A Difficulty: Medium
25. Which of the following is not generally used for selecting samples?
A) Random number tables.
B) Random number generators.
C) Physical representation numbers.
D) Systematic selection.
Answer: C Difficulty: Easy
26. In performing a test of a control last year the auditors specified a tolerable deviation
rate of X percent. This year the auditors have specified a tolerable rate of less than X
percent. Assuming that all other factors remain the same, which of the following is
true regarding the relationship between this year's sample size compared to last year's
sample size?
A) This year's sample is larger than last year's sample.
B) This year's sample is smaller than last year's sample.
C) This year's sample is equal to last year's sample.
D) This year's sample is indeterminate in relation to last year's sample.
Answer: A Difficulty: Medium
27. The auditor using nonstatistical attributes sampling, but who nevertheless has chosen
the sample in conformity with random selection procedures:
A) Need not consider the risk of assessing control risk too low.
B) Has committed a nonsampling error.
C) Will have to use discovery sampling techniques to evaluate the results.
D) Should compare the deviation rate of the sample to the tolerable rate.
Answer: D Difficulty: Medium
Chapter 9 Audit Sampling
28. When performing tests of controls over authorization of cash receipts, which of the
following sampling methods would be most appropriate?
A) Attributes.
B) Ratio.
C) Stratified.
D) Variables.
Answer: A Difficulty: Easy
29. Which of the following statistical sampling techniques involves taking samples in a
series of stages?
A) Systematic sampling.
B) Sequential sampling.
C) Continuous sampling.
D) Multiple location sampling.
Answer: B Difficulty: Easy
30. Which of the following is generally not true about statistical sampling as compared to
nonstatistical sampling?
A) Statistical samples are more representative of the population.
B) Statistical sample plans involve additional costs of evaluation.
C) Statistical sampling allows a more objective evaluation of sample results.
D) Statistical sampling may assist the auditors in designing more efficient samples.
Answer: A Difficulty: Medium
31. When using statistical sampling, which of the following need not be known to
evaluate the results of an attributes sample?
A) Sample size.
B) Risk of assessing control risk too low.
C) Number of deviations in the population.
D) Number of deviations found in the sample.
Answer: C Difficulty: Easy
Chapter 9 Audit Sampling
32. When the auditors have decided to use statistical rather than nonstatistical sampling, a
disadvantage is that:
A) Designing efficient samples is more difficult.
B) The costs of training staff may be higher.
C) Sampling without replacement must be used.
D) Objectively evaluating results is impossible.
Answer: B Difficulty: Easy
33. Changing from a sampling plan using random selection with replacement to random
selection without replacement has what effect on the required sample size?
A) Increases.
B) Decreases
C) No effect.
D) An indeterminate effect.
Answer: B Difficulty: Medium
34. When the auditors have chosen to test a control, what relationship will the tolerable
rate normally have when compared to the expected rate of deviations in the sample?
A) Exceed.
B) Equal.
C) Be less than.
D) Indefinite.
Answer: A Difficulty: Hard
35. Increases in the planned allowance for sampling risk have what effect on required
sample size?
A) Increases.
B) Decreases.
C) No effect.
D) Indeterminate.
Answer: B Difficulty: Medium
Chapter 9 Audit Sampling
36. When using sampling for tests of controls, which of the following audit consequences
may follow?
A) If sample results indicate that the control is operating effectively, but in fact it is
not, control risk will be assessed too low.
B) If sample results indicate that the control is operating effectively, but in fact it is
not, control risk will be assessed too high.
C) If sample results indicate that the control is not operating effectively, but in fact it
is operating effectively, the audit is likely to be faulty because of reduced
substantive tests.
D) If sample results indicate that the control is not operating effectively, but in fact it
is operating effectively, control risk will be assessed too low.
Answer: A Difficulty: Hard
37. The auditors expect a population deviation rate of billing errors of two percent, and
have established a tolerable rate of five percent. The sampling approach most likely to
be used is:
A) Attributes sampling.
B) Stratified sequential sampling.
C) Discovery sampling.
D) None, as sampling does not seem appropriate in this situation.
Answer: A Difficulty: Easy
38. The auditors expect a population deviation rate of billing errors of eight percent, and
have established a tolerable rate of five percent. The sampling approach most likely to
be used is:
A) Attributes sampling.
B) Stratified random sampling.
C) Variables sampling.
D) None, as sampling does not seem appropriate in this situation.
Answer: D Difficulty: Medium
39. Which of the following may be used to reduce the risk of nonsampling errors?
A) Increasing the size of audit samples.
B) Stratifying audit samples.
C) Adequately planning audit samples.
D) Using statistical sampling techniques.
Answer: C Difficulty: Medium
Chapter 9 Audit Sampling
40. Which of the following types of risk is of critical importance to auditors in performing
tests of controls?
A) The risk of assessing control risk too low.
B) The risk of assessing control risk too high.
C) The risk of incorrect acceptance.
D) The risk of incorrect rejection.
Answer: A Difficulty: Medium
41. The auditors' failure to recognize a misstatement in an amount or a deviation in an
internal control data processing procedure is described as a:
A) Statistical error.
B) Sampling misstatement.
C) Standard error of the mean.
D) Nonsampling error.
Answer: D Difficulty: Easy
42. What effect does obtaining a sample with a standard deviation larger than that
estimated during planning have on the adjusted allowance for sampling risk?
A) Increases.
B) Decreases.
C) No effect.
D) Indeterminate.
Answer: B Difficulty: Hard
Use the following to answer questions 43-45:
The 2000 accounts receivable of ABC Company have a total book value of $40,000. Bob
Rotter, CPA, has selected and audited a sample of 100 accounts with a total book value of
$1,950. The audited value of the 100 accounts in the sample is $1,875.
43. Using the mean-per-unit estimation technique, Rotter's estimate (to the nearest dollar)
of year-end accounts receivable balance would be:
A) $37,500
B) $38,462
C) $38,500
D) $41,600
Answer: A Difficulty: Medium
Chapter 9 Audit Sampling
44. Using the ratio estimation technique, Rotter's estimate (to the nearest dollar) of yearend accounts receivable balance would be:
A) $37,500
B) $38,462
C) $38,500
D) $41,600
Answer: B Difficulty: Hard
45. Using the difference estimation technique, Rotter's estimate (to the nearest dollar) of
year-end accounts receivable balance would be:
A) $37,500
B) $38,462
C) $38,500
D) $41,600
Answer: C Difficulty: Hard
46. The 3000 accounts receivable of DEF Company have a total book value of $60,000.
Bob Smith, CPA, has selected and audited a sample of 100 accounts with a total book
value of $2,100. Using the difference estimation technique, Smith has properly
estimated a projected misstatement of an overstatement of $6,000 for the entire
population. The audited value of Smith's sample is:
A) $1,700
B) $1,800
C) $1,900
D) $2,300
Answer: C Difficulty: Hard
47. The 3000 accounts receivable of DEF Company have a total book value of $60,000.
Bob Smith, CPA, has selected and audited a sample of 100 accounts with a total book
value of $2,100. Using the difference estimation technique, Smith has properly
estimated a projected misstatement of a $9,000 overstatement for the entire
population. The estimated total audited value of the population is:
A) $51,000
B) $58,000
C) $60,000
D) $69,000
Answer: A Difficulty: Medium
Chapter 9 Audit Sampling
48. The 4000 accounts receivable of GHI Company have a total book value of $60,000.
Bob Smith, CPA, has selected and audited a sample of 100 accounts with a total book
value of $1,600. Using the mean-per-unit estimation technique, Smith has properly
estimated a projected misstatement of a $8,000 overstatement for the entire
population. The audited value of Smith's sample is:
A) $1,300
B) $1,400
C) $1,600
D) $1,800
Answer: A Difficulty: Hard
49. Which of the following is a correct statement with respect to evaluating results when
using nonstatistical sampling for substantive tests?
A) When the projected misstatement exceeds the tolerable misstatement, the auditor
should conclude that the population is not misstated.
B) The closer the projected misstatement is to the tolerable misstatement, the higher
the risk of material misstatement.
C) When the projected misstatement is equal to zero, the auditors may conclude with
certainty that no misstatements exist in the account.
D) When the projected misstatement percentage exceeds the risk of incorrect
acceptance the auditors will generally conclude that the population is materially
misstated.
Answer: B Difficulty: Medium
50. Assume a mean-per-unit estimation variables sampling application with a tolerable
misstatement of $70,000 and a book value of $700,000. After performing the
sampling plan, the auditors calculated an adjusted allowance for sampling risk of
$45,000 and a point estimate of the population's total audited value to be $650,000.
Based on these results, the auditor would:
A) Because the tolerable misstatement exceeds the adjusted allowance for sampling
risk, conclude that the population does not contain a material misstatement.
B) Because the total audited value ± tolerable misstatement includes the book value,
conclude that the population does not contain a material misstatement.
C) Because the tolerable misstatement exceeds the adjusted allowance for sampling
risk, conclude that there is too great a risk that the account balance is materially
misstated.
D) Because the total audited value ± adjusted allowance for sampling risk does not
include the book value, conclude that there is too great a risk that the account
balance is materially misstated.
Answer: D Difficulty: Hard
Chapter 9 Audit Sampling
51. Assume a mean-per-unit estimation variables sampling application with a tolerable
misstatement of $70,000 and a book value of $700,000. After performing the
sampling plan, the auditors calculated an adjusted allowance for sampling risk of
$45,000 and a point estimate of the population's total audited value to be $640,000.
The projected misstatement based on this sample is:
A) $ 5,000
B) $45,000
C) $60,000
D) $70,000
Answer: C Difficulty: Medium
52. The auditors have audited a sample with a standard deviation of audited values larger
than they had originally estimated. In this situation, to maintain the risk of incorrect
acceptance at its predetermined level without increasing the size of the sample, which
of the following statements is correct?
A) The adjusted allowance for sampling risk will be smaller than had been planned.
B) The adjusted allowance for sampling risk will be larger than had been planned.
C) The risk of incorrect rejection will necessarily decrease.
D) The size of the population must be decreased.
Answer: A Difficulty: Hard
53. In the past, the auditors have found that the book value of a receivable account has
been related to the amount the account is misstated (i.e., large accounts have large
misstatements and small accounts have small misstatements). Which of the following
techniques is most likely to be efficient?
A) Mean-per-unit estimation.
B) Ratio estimation.
C) Difference estimation.
D) Sequential sampling estimation.
Answer: B Difficulty: Medium
54. Which of the following statements is correct concerning the use of nonstatistical
sampling for substantive tests?
A) Its use is generally acceptable only for populations with an immaterial book value.
B) It requires the use of structured sample size selection techniques to be acceptable.
C) It may be especially useful in circumstances in which the combination of inherent
and control risk is at the maximum level.
D) Results will be projected to the population.
Answer: D Difficulty: Medium
Chapter 9 Audit Sampling
55. Which of the following situations will result in the auditors concluding that the risk of
material misstatement is too high when using nonstatistical sampling for substantive
tests?
A) The projected misstatement exceeds the tolerable misstatement.
B) The allowance for sampling risk exceeds the projected misstatement.
C) The risk of incorrect acceptance exceeds the risk of incorrect rejection.
D) The tolerable misstatement exceeds the sample net misstatement.
Answer: A Difficulty: Hard
56. During the final planning of the accounts receivable program a CPA specified a
tolerable misstatement of $30,000, instead of the $20,000 contained in the preliminary
audit program. What would be the impact of this change?
A) A decrease in population standard deviation.
B) An increase in sample standard deviation.
C) An increase in required sample size.
D) A decrease in the required sample size.
Answer: D Difficulty: Medium
57. Which of the following is an advantage of systematic selection over random number
selection?
A) It provides a stronger basis for statistical conclusions.
B) It enables the auditor to use the more efficient "sampling with replacement" tables.
C) There may be correlation between the location of items in the population, the
feature of sampling interest, and the sampling interval.
D) It does not require establishment of correspondence between random numbers and
items in the population.
Answer: D Difficulty: Medium Source: AICPA
58. Statistical sampling generally may be applied to test internal control when the client's
internal control procedures:
A) Depend primarily on appropriate segregation of duties.
B) Are carefully reduced to writing and are included in client accounting manuals.
C) Leave an audit trail in the form of evidence of compliance.
D) Enable the detection of material fraud in the accounting records.
Answer: C Difficulty: Medium Source: AICPA
Chapter 9 Audit Sampling
59. To determine sample size in an attribute sampling application, what must be specified?
A) Population mean, expected error rate, allowance for sampling risk.
B) Allowance for sampling risk, risk of assessing control risk too low, standard
deviation.
C) Allowance for sampling risk, risk of assessing control risk too low, expected
deviation rate.
D) Population mean, standard deviation, allowance for sampling risk.
Answer: C Difficulty: Hard Source: IIA
60. The tolerable deviation rate in sampling for tests of controls is:
A) Used to determine the probability of the auditor's conclusion based upon reliance
factors.
B) The probability that the financial statements are not materially in error.
C) A measure of the reliability of substantive tests.
D) The rate the auditor will tolerate without modifying the planned assessment of
control risk.
Answer: D Difficulty: Easy
61. In testing accounts receivable, an auditor sends out positive confirmation requests to
100 randomly selected customers. A customer returns the confirmation indicating that
the balance is correct when, in fact, the balance is overstated. This is an example of:
A) Projected misstatement.
B) Sampling error.
C) Standard error.
D) Nonsampling error.
Answer: D Difficulty: Medium Source: IIA
Chapter 9 Audit Sampling
62. An auditor wishes to estimate inventory shrinkage by weighing a sample of inventory
items. From experience, the auditor knows that a few specific items are subject to
unusually large amounts of shrinkage. In using statistical sampling, the auditor's best
course of action is to:
A) Eliminate any of the items known to be subject to unusually large amounts of
shrinkage.
B) Increase the sample size to lessen the effect of the items subject to unusually large
amounts of shrinkage.
C) Stratify the inventory population so that items subject to unusually large amounts
of shrinkage are reviewed separately.
D) Continue to draw new samples until a sample is drawn which includes none of the
items known to be subject to large amounts of shrinkage.
Answer: C Difficulty: Hard Source: IIA
63. If all other factors specified in an attributes sampling plan remain constant, changing
the specified tolerable rate from 6% to 10%, and changing the specified risk of
assessing control risk too low from 3% to 7% would cause the required sample size to:
A) Increase.
B) Remain the same.
C) Decrease.
D) Change by 4%.
Answer: C Difficulty: Hard Source: AICPA
64. Which of the following factors does an auditor need to consider in planning a
particular audit sample for a test of control?
A) Number of items in the population.
B) Total dollar amount of the items to be sampled.
C) Acceptable level of risk of assessing control risk too low.
D) Tolerable misstatement.
Answer: C Difficulty: Medium Source: AICPA
65. When using a statistical sampling plan, the auditors would probably require a smaller
sample if the:
A) Population increases.
B) Desired allowance for sampling risk decreases.
C) Desired risk of incorrect acceptance increases.
D) Expected deviation rate increases.
Answer: C Difficulty: Medium Source: AICPA
Chapter 9 Audit Sampling
66. Which of the following statements is correct concerning statistical sampling in tests of
controls?
A) The population size has little effect on determining sample size except for very
small populations.
B) The expected population deviation rate has little or no effect on determining
sample size except for very small populations.
C) As the population size doubles, the sample size also should double.
D) For a given tolerable rate, a larger sample size should be selected as the expected
population deviation rate decreases.
Answer: A Difficulty: Medium Source: AICPA
67. An advantage of using statistical sampling techniques is that such techniques:
A) Mathematically measure risk.
B) Eliminate the need for judgmental decisions.
C) Define the values of allowance for sampling risk and tolerable misstatement
required to provide audit satisfaction.
D) Have been established in the courts to be superior to judgmental sampling.
Answer: A Difficulty: Medium Source: AICPA
68. In assessing sampling risk, the risk of incorrect rejection and the risk of assessing
control risk too high relate to the:
A) Efficiency of the audit.
B) Effectiveness of the audit.
C) Selection of the sample.
D) Audit quality controls.
Answer: A Difficulty: Medium Source: AICPA
69. When performing a test of a control over cash disbursements, a CPA may use a
systematic sampling technique with a start at any randomly selected item. The biggest
disadvantage of this type of sampling is that the items in the population:
A) Must be recorded in a systematic pattern before the sample can be drawn.
B) May occur in a systematic pattern and destroy the sample randomness.
C) May systematically occur more than once in the sample.
D) Must be systematically replaced in the population after sampling.
Answer: B Difficulty: Easy Source: AICPA
Chapter 9 Audit Sampling
70. While performing a substantive test of details during an audit, the auditor determined
that the sample results supported the conclusion that the recorded account balance was
materially misstated. It was, in fact, not materially misstated. This situation illustrates
the risk of:
A) Incorrect acceptance.
B) Incorrect rejection.
C) Assessing control risk too high.
D) Assessing control risk too low.
Answer: B Difficulty: Medium Source: AICPA
71. An auditor plans to examine a sample of 20 checks for counter signatures as
prescribed by the client's control procedures. One of the checks in the chosen sample
of 20 cannot be found. The auditor should consider the reasons for this limitation and:
A) Evaluate the results as if the sample size had been 19.
B) Treat the missing check as a deviation for the purpose of evaluating the sample.
C) Treat the missing check in the same manner as the majority of the other 19 checks,
i.e., countersigned or not.
D) Choose another check to replace the missing check in the sample.
Answer: B Difficulty: Medium Source: AICPA
72. There are many kinds of statistical estimates that an auditor may find useful, but
basically every statistical estimate in auditing is of either a quantity or of an error rate.
The statistical terms that roughly correspond to "quantities" and "occurrence rate",
respectively, are:
A) Attributes and variable.
B) Variables and attributes.
C) Constants and attributes.
D) Constants and variables.
Answer: B Difficulty: Easy Source: AICPA
73. Which of the following best illustrates the concept of sampling risk?
A) A randomly chosen sample may not be representative of the population as a whole
on the characteristic of interest.
B) An auditor may select audit procedures that are not appropriate to achieve the
specific objective.
C) An auditor may fail to recognize deviations in the documents examined for the
chosen sample.
D) The documents related to the chosen sample may not be available for inspection.
Answer: A Difficulty: Easy Source: AICPA
Chapter 9 Audit Sampling
74. Which of the following statistical selection techniques is least desirable for use by an
auditor?
A) Systematic selection.
B) Stratified selection.
C) Block selection.
D) Sequential selection.
Answer: C Difficulty: Medium Source: AICPA
75. Various factors influence the sample size for a substantive test of details of an account
balance. All other factors being equal, which of the following would lead to a larger
sample size?
A) Lower assessment of control risk.
B) Greater reliance on analytical procedures.
C) Smaller expected frequency of misstatements.
D) Smaller measure of tolerable misstatement.
Answer: D Difficulty: Hard Source: AICPA
76. An important statistic to consider when using a statistical sampling audit plan is the
population variability. The population variability is measured by the:
A) Sample mean.
B) Standard deviation.
C) Standard error of the sample mean.
D) Estimated population total minus the actual population total.
Answer: B Difficulty: Easy Source: AICPA
77. In variables estimation sampling, the sample standard deviation is used to calculate the
A) Point estimate of central tendency.
B) Tainting of the sample interval.
C) Risk of incorrect acceptance.
D) Adjusted allowance for sampling risk.
Answer: D Difficulty: Easy Source: AICPA
Chapter 9 Audit Sampling
78. Use of the ratio estimation sampling technique to estimate dollar amounts is
inappropriate when:
A) The total book value is known and corresponds to the sum of all the individual
book values.
B) A book value for each sample item is unknown.
C) There are some observed differences between audited values and book values.
D) The audited values are nearly proportional to the book value.
Answer: B Difficulty: Medium Source: AICPA
Essay Questions
79. Audit sampling is used in conjunction with many audit tests, and may be performed on
a statistical or nonstatistical basis.
a. Define the term audit sampling.
b. List and explain two advantages of the use of statistical sampling as compared to
nonstatistical sampling.
Difficulty: Medium
Answer:
a. Audit sampling is performing a test on less than 100 percent of an audit population
to make a conclusion about a characteristic of the population.
b. Statistical sampling may assist the auditors in (only two required):
• •Designing efficient samples.
• Measuring the sufficiency of the evidence obtained.
• Objectively evaluating sample results (measuring sampling risk).
Chapter 9 Audit Sampling
80. Teal Corporation has 2,000 accounts receivable, with a total book value of $200,000.
Ricardo Ramaro, CPA, has selected and audited a sample of 100 of the accounts with
a combined book value of $10,100; the total of their audited values was $11,000.
Using the mean-per-unit method, calculate the:
a. Accounts receivable estimated audited value.
b. Projected misstatement.
Difficulty: Medium
Answer:
a. The accounts receivable estimated audited value is calculated as:
Estimated total audited value
=
=
=
Mean audited value x Number of accounts
$110 x 2,000 accounts
$220,000
b. The projected misstatement is calculated as the difference between the estimated
total audited value and the book value, calculated as follows:
Projected Misstatement
=
=
=
Est. total audited value - Book value of population
$220,000 - $200,000
$20,000 overstatement
Chapter 9 Audit Sampling
81. The auditors are using mean-per-unit sampling to evaluate the reasonableness of the
book value of the accounts receivable of Smith, Inc. Smith has 10,000 receivable
accounts with a total book value of $800,000. The auditors estimate the population's
standard deviation as being equal to $25. After examining the overall audit plan, the
auditors believe that the account's tolerable misstatement is $40,000, and that a risk of
incorrect rejection of .10 (risk coefficient = 1.64) and a risk of incorrect acceptance of
.15 (risk coefficient = 1.04) should be used.
Required:
a. Calculate the required sample size.
Now ignore your sample size calculation in part "a," and assume that your answer
was a sample size of 289 (the square root of 289 is 17) and that you obtained the
following results:
Average audited value of items in sample: $76
Average book value of items in sample: $78
Standard Deviation in the sample (audited values): $24
Standard Deviation in the sample (book values): $26
b. Using mean-per-unit sampling, calculate the projected misstatement for the
population.
c. Using mean-per-unit sampling, calculate the adjusted allowance for sampling risk
and use it to form a statistical conclusion concerning the book value of the
population ($800,000). That is, calculate an interval and either "accept" or "reject"
the client's book value.
Difficulty: Hard
Chapter 9 Audit Sampling
Answer:
a. The required sample size is calculated by first calculating the allowance for
sampling risk and then using it into the sample size formula as follows:
⎛
⎞
Tolerable misstatement
⎟⎟
Planned ASR = ⎜⎜
⎝ 1 + ( Incorrect accep tan ce coefficient / Incorrect rejection coefficient ⎠
⎛
⎞
$40,000
⎟⎟ = $24,480
Planned ASR = ⎜⎜
⎝ 1 + (1.04 / 1.64) ⎠
⎛ Population size * Incorrect rejection coefficient * Est. st. dev. ⎞
⎟⎟
Sample Size = ⎜⎜
Planned allowance for sampling risk
⎝
⎠
2
2
⎛ 10,000 * 1.64 * $25 ⎞
Sample Size = ⎜⎜
⎟⎟ = 281 items
$24,480
⎠
⎝
b. The projected misstatement is calculated by first calculating the estimated total
audited value and then subtracting it from the book value as follows:
Estimated total audited value = (Mean of audited values) x (Number of accounts)
Estimated total audited value = ($76) x (10,000 accounts) = $760,000
Projected misstatement = Estimated total audited value - Book value of population
= $800,000 - $760,000
= $40,000 overstatement
c. The adjusted allowance for sampling risk (ASR) may be calculated as follows:
⎛ N * Incorrect accept. coef * Est. std. dev. ⎞
⎟
Adjusted ASR = Tolerable Misstatement − ⎜
⎜
⎟
Sample
size
⎝
⎠
⎛ 10,000 * 1.04 * $24 ⎞
⎟⎟
Adjusted ASR = $40,000 − ⎜⎜
289
⎝
⎠
Adjusted AR = $25,318
The acceptance interval is $760,000 $25,318. Accordingly, the population is
rejected because its book value of $800,000 is outside the interval.
Chapter 10 Cash and Financial Investments
True/False Questions
1. The auditors should count small petty cash funds at year-end to make sure that balance
is not understated on the financial statements.
Answer: False Difficulty: Easy
2. Control over the receipt of cash sales is best achieved when two or more employees
participate in each transaction.
Answer: True Difficulty: Easy
3. Mailroom personnel of a company should prepare a control listing of incoming cash
receipts and deposit them intact daily.
Answer: False Difficulty: Medium
4. Signed checks should be returned to the cash disbursements clerk for mailing.
Answer: False Difficulty: Medium
5. Lapping of accounts receivable by an employee is not possible when there is adequate
segregation of duties with respect to cash disbursements.
Answer: False Difficulty: Medium
6. Confirmations for cash balances should be mailed only to the financial institutions
with which the client has a cash balance at year-end.
Answer: False Difficulty: Hard
7. A proof of cash is an audit procedure that is performed on almost every engagement.
Answer: False Difficulty: Medium
8. A compensating balance agreement generally requires that cash be reclassified as a
noncurrent asset.
Answer: False Difficulty: Medium
Chapter 10 Cash and Financial Investments
9. Verification of cash and other liquid assets be verified on the same date may prevent
substitution of one form of asset for another.
Answer: True Difficulty: Easy
10. For investments in securities accounted for by the equity method, the auditors are
primarily concerned with verifying the market value of the investments.
Answer: False Difficulty: Medium
Multiple Choice Questions
11. An auditor's analytical procedures have revealed that the accounts receivable of a
client have doubled since the end of the prior year. However, the allowance for
doubtful accounts, as a percentage of accounts receivable remained about the same.
Which of the following client explanations most likely would satisfy the auditor?
A) Credit standards were liberalized in the current year.
B) Twice as many accounts receivable were written off in the prior year as compared
to this year.
C) A greater percentage of accounts were currently listed in the “more than 90 days
overdue” category than in the prior year.
D) The client opened a second retail outlet in the current year and its credit sales
approximately equaled the older, established outlet.
Answer: D Difficulty: Medium Source: AICPA
12. By preparing a four-column bank reconciliation ("proof of cash") at year-end, an
auditor will generally be able to detect:
A) An unrecorded deposit made at the bank at the end of the month.
B) A second payment of an account payable which had already been paid in full two
months earlier.
C) An embezzlement of cash receipts not recorded in the cash receipts journal
before they had been deposited into the bank.
D) A receivable collected that had previously been written off as uncollectible.
Answer: A Difficulty: Hard
Chapter 10 Cash and Financial Investments
13. Kiting would least likely be detected by:
A) Analyzing details of large cash deposits around year end.
B) Comparing customer remittance advices with recorded disbursements in the cash
disbursements journal.
C) Preparing a four-column bank reconciliation for all major cash accounts.
D) Preparing a schedule of interbank transfers by using the client's records and bank
statements around year end.
Answer: B Difficulty: Hard
14. Your client left the cash receipts journal open after year-end for an extra day and
included January 1 cash receipts in the 12/31/XX totals. All of those cash receipts
were due to cash sales. Assuming the client uses a periodic inventory system with a
12/31/XX count of the physical inventory, which of the following is most likely to be
true relating to the year XX financial statements?
A) Sales are understated.
B) Accounts receivable are understated.
C) Inventory is overstated.
D) Net income is overstated.
Answer: D Difficulty: Medium
15. An internal control questionnaire indicates that an approved receiving report is
required to accompany every check request for payment of merchandise. Which of
the following procedures provides the best evidence on operating effectiveness?
A) Select and examine receiving reports and test whether the related canceled checks
are dated no earlier than the receiving reports.
B) Select and examine receiving reports and test whether the related canceled checks
are dated no later than the receiving reports.
C) Select and examine canceled checks and test whether the related receiving reports
are dated no earlier than the checks.
D) Select and examine canceled checks and test whether the related receiving reports
are dated no later than the checks.
Answer: D Difficulty: Hard
Chapter 10 Cash and Financial Investments
16. By preparing a four-column bank reconciliation ("proof of cash") at year-end, an
auditor will generally not be able to detect:
A) An unrecorded deposit made at the bank at the end of the month.
B) A second payment of an account payable which had already been paid in full two
months earlier.
C) An unrecorded check cashed during that month.
D) A bank charge during the month not recorded on the books.
Answer: B Difficulty: Hard
17. Which procedure is an auditor most likely to use to detect a check outstanding at yearend that was not recorded as outstanding on the year-end bank reconciliation?
A) Prepare a bank transfer schedule using the client's cash receipts and cash
disbursements journal.
B) Receive a cutoff statement directly from the client's bank.
C) Prepare a four column bank reconciliation using the year-end bank statement.
D) Confirm the year end balance using the standard form to confirm account balance
information with financial institutions.
Answer: B Difficulty: Hard
18. An auditor may obtain information on the December 31 month end balance per bank
in which of the following?
A)
B)
C)
D)
Standard Confirmation Form
Yes
Yes
No
No
January 1-10 Cutoff Statement
Yes
No
Yes
No
Answer: A Difficulty: Medium
19. An auditor may obtain information on the December 31 month end balance per bank
in which of the following?
A)
B)
C)
D)
December 31 Bank Statement
Yes
Yes
No
No
Answer: B Difficulty: Medium
Schedule of Bank (Cash) Transfers
Yes
No
Yes
No
Chapter 10 Cash and Financial Investments
20. Which of the following is correct concerning “window dressing” for cash?
A) A segregation of duties within the cash function effectively eliminates its
occurrence.
B) It generally involves manipulation of inventory.
C) It is illegal, and an audit is designed to provide reasonable assurance of its
detection.
D) Many forms of it require no action by the auditors.
Answer: D Difficulty: Hard
21. Which of the following statements is not correct?
A) Cash is important to the audit process because of its vulnerability to
misappropriation, despite the fact that the balance at the balance sheet date may be
immaterial.
B) Payroll cash account balances kept on an imprest basis are more easily controlled
than others not so kept.
C) Confirmation of cash should only be performed as of the balance statement date
because the auditor expresses an opinion as of that date.
D) Reviewing interbank transfers is important to the auditor because of the possibility
that the client may be engaged in kiting.
Answer: C Difficulty: Hard
22. The auditors use a bank cutoff statement to compare:
A) Deposits in transit on the year-end cash general ledger account to deposits in the
cash receipts journal.
B) Checks dated prior to year-end to the outstanding checks listed on the year-end
bank reconciliation.
C) Deposits listed on the cutoff statement to disbursements in the cash disbursements
journal.
D) Checks dated subsequent to year-end to the outstanding checks listed on the yearend bank statement.
Answer: B Difficulty: Hard
23. A practical and effective audit procedure for the detection of lapping is:
A) Preparing an interbank transfer schedule.
B) Comparing recorded cash receipts in detail against items making up the bank
deposit as shown on duplicate deposit slips validated by the bank.
C) Tracing recorded cash receipts to postings in customers' ledger cards.
D) Preparing a proof of cash.
Answer: B Difficulty: Hard
Chapter 10 Cash and Financial Investments
24. Which of the following is not a control that generally is established over cash
transactions?
A) Separating cash handling from recordkeeping.
B) Centralizing the receipt of cash.
C) Depositing each day's receipts intact.
D) Obtaining a receipt for every disbursement.
Answer: D Difficulty: Medium
25. Which of the following is not a control that generally is established over cash
receipts?
A) To prevent abstraction of cash, a control listing of cash receipts should be
prepared by mailroom personnel.
B) To insure accurate posting, the accounts receivable clerk should post the
customers' receipts from customers' checks.
C) To insure accuracy of the accounts receivable records, the records should be
reconciled monthly to the accounts receivable controlling account.
D) To prevent theft of cash, receipts should be deposited daily.
Answer: B Difficulty: Medium
26. Tracing recorded sales transactions in the sales journal to the shipping documents
(bills of lading) provides evidence about the:
A) Completeness of recording of sales transactions.
B) Occurrence of sales transactions.
C) Billing of all sales transactions.
D) Presentation of payables.
Answer: B Difficulty: Medium
27. By preparing a four-column bank reconciliation ("proof of cash") for the last month of
the year, an auditor will generally be able to detect:
A) An unrecorded check written at the beginning of the month which was cashed
during the period covered by the reconciliation.
B) A cash sale which was not recorded on the books and was stolen by a bookkeeper.
C) An embezzlement of unrecorded cash receipts on receivables before they had been
deposited into the bank.
D) A credit sale which has been recorded twice in the sales journal.
Answer: A Difficulty: Hard
Chapter 10 Cash and Financial Investments
28. In October, three months before year-end, the bookkeeper erroneously recorded the
receipt of a one year bank loan with a debit to cash and a credit to miscellaneous
revenue. Select the most effective method for detecting this type of error.
A) Foot the cash receipts journal for October.
B) Send a bank confirmation as of year-end.
C) Prepare a bank reconciliation as of year-end.
D) Prepare a bank transfer schedule as of year-end.
Answer: B Difficulty: Hard
29. Jones embezzled $10,000 from his company's account in Bank A. At year-end he hid
the shortage by making a deposit on December 31 in Bank A, drawn on Bank B. He
has not recorded the transaction on the books. This is an example of:
A) Lapping.
B) Kiting.
C) Effective cash management.
D) Related party transactions.
Answer: B Difficulty: Hard
30. Jones embezzled $10,000 from his company's account in Bank A. At year-end he hid
the shortage by making a deposit on December 31 in Bank A, drawn on Bank B. He
has not recorded the transaction on the books. Which of the following is most likely
to be effective in detecting this fraud?
A) Bank confirmation.
B) Bank transfer schedule prepared using only the cash receipts and cash
disbursements journals.
C) Comparison of bank cutoff statement to the cash receipts and disbursements
records.
D) Receivable confirmation.
Answer: C Difficulty: Hard
31. Which of the following is not a universal rule for achieving internal control over cash?
A) Separate recordkeeping from accounting for cash to the extent possible.
B) Deposit each day's cash receipts intact.
C) Separate cash handling from recordkeeping.
D) Have monthly bank reconciliations prepared by employees not responsible for the
issuance of checks.
Answer: A Difficulty: Medium
Chapter 10 Cash and Financial Investments
32. Which of the following is not a control over cash disbursements?
A) Disbursements should be made by check.
B) A check protecting machine should be used.
C) Documents supporting the payment of a disbursement should be canceled by the
person preparing the check to prevent reuse.
D) Voided checks should be defaced and filed with paid checks.
Answer: C Difficulty: Medium
33. Which of the following is the best audit procedure for the detection of lapping?
A) Comparison of postings of cash receipts to accounts with the details of cash
deposits.
B) Confirmation of the cash balance.
C) Reconciliation of the cash account balances.
D) Preparing a proof of cash.
Answer: A Difficulty: Hard
34. Which of the following manipulations of cash transactions would overstate the cash
balance on the financial statements?
A) Understatement of outstanding checks.
B) Overstatement of outstanding checks.
C) Understatement of deposits in transit.
D) Overstatement of bank services charges.
Answer: A Difficulty: Medium
35. Which of the following is not confirmed on the standard form used for cash balances
at financial institutions?
A) Cash checking account balances.
B) Cash savings account balances.
C) Loans payable.
D) Securities held for the client by the financial institution.
Answer: D Difficulty: Medium
36. Internal control over marketable securities is enhanced when:
A) Securities are held by the cashier.
B) Securities are registered in the name of the custodian.
C) Detailed records of securities are maintained by the custodian of the securities.
D) Securities are held under joint control of two or more officials.
Answer: D Difficulty: Medium
Chapter 10 Cash and Financial Investments
37. In a manufacturing company which one of the following audit procedures would give
the least assurance of the existence of the assets in the general ledger balance of
investment in stocks and bonds at the audit date?
A) Confirmation from the broker.
B) Inspection of year-end brokers' statements.
C) Vouching all changes during the year to brokers' advises and statements.
D) Examination of paid checks issued in payment of securities purchased.
Answer: D Difficulty: Hard Source: AICPA
38. The Standard Form to Confirm Account Balances with Financial Institutions includes
information on all of the following except:
A) Date due of a direct liability.
B) The principal amount paid on a direct liability.
C) Description of collateral for a direct liability.
D) The interest rate of a direct liability.
Answer: B Difficulty: Hard Source: AICPA
39. The auditors should insist that a representative of the client be present during the
physical examination of securities in order to:
A) Lend authority of the auditor's directives.
B) Detect forged securities.
C) Coordinate the return of all securities to proper locations.
D) Acknowledge the receipt of securities returned.
Answer: D Difficulty: Medium Source: AICPA
40. The auditors' count of the client's cash should be coordinated to coincide with the:
A) Consideration of the internal controls with respect to cash.
B) Close of business on the balance sheet date.
C) Count of investment securities.
D) Count of inventories.
Answer: C Difficulty: Medium Source: AICPA
Chapter 10 Cash and Financial Investments
41. The auditors compare information on canceled checks with information contained in
the cash disbursement journal. The objective of this test is to determine that:
A) Recorded cash disbursement transactions are properly authorized.
B) Proper cash purchase discounts have been recorded.
C) Cash disbursements are for goods and services actually received.
D) No discrepancies exist between the data on the checks and the data in the journal.
Answer: D Difficulty: Easy Source: AICPA
42. Jones was engaged to audit the financial statements of Gamma Corporation for the
year ended June 30, 200X. Having completed an examination of the investment
securities, which of the following is the best method of verifying the accuracy of
recorded dividend income?
A) Tracing recorded dividend income to cash receipts records and validated deposit
slips.
B) Utilizing analytical techniques and statistical sampling.
C) Comparing recorded dividends with amounts appearing on federal information
form 1099s.
D) Comparing recorded dividends with a standard financial reporting service's record
of dividends.
Answer: D Difficulty: Hard Source: AICPA
43. Which of the following is one of the better auditing techniques that might be used by
an auditor to detect kiting?
A) Review composition of authenticated deposit slips.
B) Review subsequent bank statements and canceled checks received directly from
the banks.
C) Prepare a schedule of bank transfers.
D) Prepare year-end bank reconciliations.
Answer: C Difficulty: Medium Source: AICPA
44. Which one of the following would the auditor consider to be an incompatible
operation if the cashier receives remittances from the mailroom?
A) The cashier prepares the daily deposit.
B) The cashier makes the daily deposit at a local bank.
C) The cashier posts the receipts to the accounts receivable subsidiary ledger.
D) The cashier endorses the checks.
Answer: C Difficulty: Hard Source: AICPA
Chapter 10 Cash and Financial Investments
45. As one of the year-end audit procedures, the auditor instructed the client's personnel to
prepare a confirmation request for a bank account that had been closed during the
year. After the client's treasurer has signed the request, it was mailed by the assistant
treasurer. What is the major flaw in this audit procedure?
A) The confirmation request was signed by the treasurer.
B) Sending the request was meaningless because the account was closed before the
year end.
C) The request was mailed by the assistant treasurer.
D) The CPA did not sign the confirmation request before it was mailed.
Answer: C Difficulty: Easy Source: AICPA
46. On receiving the bank cutoff statement, the auditor should trace:
A) Deposits in transit on the year-end bank reconciliation to deposits in the cash
receipts journal.
B) Checks dated prior to year end to the outstanding checks listed on the year-end
bank reconciliation.
C) Deposits listed on the cutoff statement to deposits in the cash receipts journal.
D) Checks dated subsequent to year end to the outstanding checks listed on the yearend bank reconciliation.
Answer: B Difficulty: Medium Source: AICPA
47. To gather evidence regarding the balance per bank in a bank reconciliation, an auditor
could examine all of the following except
A) Cutoff bank statement.
B) Year-end bank statement.
C) Bank confirmation.
D) General ledger.
Answer: D Difficulty: Medium Source: AICPA
Chapter 10 Cash and Financial Investments
48. Which of the following cash transfers results in a misstatement of cash at December
31, 19X7?
Bank Transfer Schedule
Disbursement
Receipt
Recorded
Paid by
Recorded
Received
bank
in books
by bank
in books
A)
12/31/X7
1/4/X8
12/31/X7
12/31/X7
B)
1/4/X8
1/5/X8
12/31/X7
1/4/X8
C)
12/31/X7
1/5/X8
12/31/X7
1/4/X8
D)
1/4/X8
1/11/X8
1/4/X8
1/4/X8
A)
B)
C)
D)
Transfer A
Transfer B
Transfer C
Transfer D
Answer: B Difficulty: Medium Source: AICPA
49. Contact with banks for the purpose of opening company bank accounts should
normally be the responsibility of the corporate:
A) Board of Directors.
B) Treasurer.
C) Controller.
D) Executive Committee.
Answer: B Difficulty: Hard Source: AICPA
50. Properly designed internal control will permit the same employee to:
A) Receive and deposit checks, and also approve write-offs of customer accounts.
B) Approve vouchers for payment, and also receive and deposit cash.
C) Reconcile the bank statements, and also receive and deposit cash.
D) Sign checks, and also cancel supporting documents.
Answer: D Difficulty: Medium Source: AICPA
51. Which of the following procedures in the cash disbursements cycle should not be
performed by the accounts payable department?
A) Comparing the vendor's invoice with the receiving report.
B) Canceling supporting documentation after payment.
C) Verifying the mathematical accuracy of the vendor's invoice.
D) Preparing the check for signature by an authorized person.
Answer: B Difficulty: Medium Source: AICPA
Chapter 10 Cash and Financial Investments
52. The Parmalat fraud case apparently involved
A) A fraudulent cash confirmation.
B) Kiting of funds between India and Pakistan.
C) A bank reconciliation performed by the client that systematically understated cash.
D) Major unrecorded disbursements for equipment.
Answer: A Difficulty: Medium
53. Banks may process electronic “substitute checks” in place of customer written hard
copy checks due to the:
A) Check Clearing for the 21st Century Act
B) Public Company Accounting Oversight Board's Standard No. 2.
C) Foreign Corrupt Practices Act.
D) Sarbanes-Oxley Act
Answer: A Difficulty: Easy
Essay Questions
54. In the audit of a client's financial statements, the auditors must be concerned with the
possibility that client personnel might be engaged in kiting or lapping.
a. Define lapping and describe an audit procedure that might detect lapping.
b. Define kiting and describe an audit procedure that might detect kiting.
Difficulty: Medium
Answer:
a. Lapping is the concealment of a cash shortage by delaying the recording of cash
receipts. It involves posting receipts to the wrong account.
Procedures for detecting lapping include (only one required):
• Details of cash receipts may be compared to postings to the accounts
receivable subsidiary records, preferably on a surprise basis.
• Confirmation of accounts receivable.
b. Kiting is manipulation causing an amount of cash to be included simultaneously in
the balance of two or more bank accounts.
To detect kiting the auditors prepare and verify a schedule of bank transfers.
Chapter 10 Cash and Financial Investments
55. Since financial investments are assets with a high degree of inherent risk, companies
must establish effective internal control over their investments.
a. Describe the functions that should be segregated to provide good internal control
over financial investments.
b. Describe two other internal control policies that should be established for financial
investments.
Difficulty: Medium
Answer:
a. The functions that should be segregated with respect to financial investments are:
1. Authorization of purchases and sales,
2. Custody of the securities, and
3. Maintaining records of investments.
b. Other internal controls include (only two required):
• Establishing formal investment policies.
• Maintaining a complete detailed record of investments and revenue from
investments.
• Registration of securities in the name of the company.
• Periodic physical inspection.
• Joint control over securities, or use of an independent custodian.
• Preparation of a budget of investment revenue.
• Determination of appropriate accounting by competent personnel.
Chapter 10 Cash and Financial Investments
56. Listed below are four interbank cash transfers, indicated by the letters a, b, c and d, of
a client for late December 20X1, and early January 20X2. Your answer choice for the
next two questions should be selected from this list.
a.
b.
c.
d.
Bank Account One
Disbursing Date
(Month/Day)
Per Bank
Per Books
1/02
12/30
1/04
12/31
1/03
12/31
1/02
1/02
Bank Account Two
Receiving Date
(Month/Day)
Per Bank
Per Books
12/31
12/30
1/02
12/31
1/02
1/02
12/31
1/02
For each of transfers a through d indicate whether cash is understated, unaffected, or
overstated by the transfer and provide a brief example of what could cause the
situation in which cash is either understated or overstated.
Difficulty: Hard
Answer:
a. Unaffected.
b. Unaffected.
c. Understated. Although there are a number of possible situations, one is that in
which a check is written on the disbursing bank on the last day of December with a
credit to cash, and an associated debit to some expense account so as to decrease
reported profits (and taxes) for the year.
d. Overstated. One situation is that in which an employee has misappropriated funds
during the year, and draw a check transferring funds to the account with the
shortage so as to cover the shortage. As of December 31, the shortage is replaced,
with no reduction as yet recorded in the account on which it is drawn.
Chapter 10 Cash and Financial Investments
57. In many financial statements audits, auditing financial investments involves complex
tasks requiring specialized skill and knowledge.
a. List three audit tasks related to the audit of financial investments that may require
specialized skill or knowledge.
b. Define the term “financial derivative.”
c. List the two general purposes that a client might acquire a financial derivative.
Difficulty: Hard
Answer:
a. Audit tasks requiring specialized skill or knowledge (only three required):
• Identifying controls at service organizations that provide financial services for
the client.
• Obtaining an understanding of information systems for securities and
derivatives that are highly dependent on computer technology.
• Applying complex accounting principles.
• Understanding the methods of determining fair values of financial investments'
• Assessing inherent risk and control risk for assertions about derivatives used
for hedging.
b. Derivatives are financial instruments that “derive” their value form other financial
instruments, underlying assets, or indices.
c. Clients engage in financial derivative transactions for two major purposes:
• Hedging--to hedge changes in value of an existing asset or liability or of a
prospective future transaction.
• Speculating--to bet on the change in value of another financial instrument, an
asset, or an indices.
Chapter 11 Accounts Receivable, Notes…
True/False Questions
1. The department approving a sales transaction should be the shipping department.
Answer: False Difficulty: Easy
2. Accounts receivable that are written-off should not be turned over to a collection
agency.
Answer: False Difficulty: Easy
3. An aged trial balance of accounts receivable may provide evidence on the adequacy of
the allowance for uncollectible accounts.
Answer: True Difficulty: Easy
4. Confirmation of accounts receivable by direct communication with the debtor tests the
existence of accounts receivable.
Answer: True Difficulty: Easy
5. Confirmation requests should contain a "business reply" envelope addressed to the
auditors at the client's address.
Answer: False Difficulty: Medium
6. CPAs use negative accounts receivable confirmations more frequently than positive
accounts receivable confirmations.
Answer: False Difficulty: Medium
7. Confirmation of accounts receivable provides some assurance that no lapping or other
manipulation affecting accounts receivable is being carried on.
Answer: True Difficulty: Medium
8. Analytical procedures are used by auditors to gain evidence about the adequacy of the
allowance for uncollectible accounts.
Answer: True Difficulty: Medium
Chapter 11 Accounts Receivable, Notes…
9. When it is impossible to confirm accounts receivable, the auditors may be able to
satisfy themselves as to the existence of accounts receivable by alternative procedures.
Answer: True Difficulty: Medium
10. Material accounts receivable from related parties should be stated separately from
other receivables.
Answer: True Difficulty: Easy
Multiple Choice Questions
11. To test the existence assertion for recorded receivables, an auditor would select a
sample from the.
A) Sales orders file.
B) Customer purchase orders.
C) Accounts receivable subsidiary ledger.
D) Shipping documents (bills of lading) file.
Answer: C Difficulty: Hard
12. Which of the following is least likely to be typically considered to be an alternate
procedure for handling nonreplies to accounts receivable confirmations?
A) Examine bills of lading.
B) Physically examine items sold.
C) Examine correspondence.
D) Examine subsequent cash receipts.
Answer: B Difficulty: Medium
13. Your client performed the physical count of inventory as of November 30, one month
prior to year-end. Subsequently, your client closed the sales journal on 12/29/XX, two
days before year end, and reported those two days' credit sales in January of the next
year. Assuming the client uses a perpetual inventory system which of the following is
most likely to be overstated relating to the year XX financial statements?
A) Sales.
B) Cash.
C) Inventory.
D) Accounts receivable.
Answer: C Difficulty: Hard
Chapter 11 Accounts Receivable, Notes…
14. Which of the following would be least likely to diminish the validity of evidence
obtained through confirmation of accounts receivable?
A) The confirmations are sent on the client's letterhead.
B) The confirmations are mailed to customers by the internal auditors.
C) The client's mailroom personnel closely monitor and inspect confirmations during
mailing.
D) The return address on the envelope used to send the confirmation request is that of
the client.
Answer: A Difficulty: Medium
15. When control risk for the existence assertion is assessed at a high level ("maximum"),
which of the following is a likely effect with respect to the auditors' confirmation of
receivables?
A) The account balances as of year end will generally be confirmed.
B) The auditors will in general use blank rather than positive confirmations.
C) The auditors will be required to confirm accounts as of an interim date (during the
year under audit) and as of year end.
D) Confirmations will not in general be used as the auditor will rely primarily upon
support such as vendors' invoices, purchase orders and receiving reports.
Answer: A Difficulty: Medium
16. What type of error is the CPA most likely to discover when he/she examines all
shipping reports dated in January of 20X1, shipped FOB shipping point, which were
recorded in December of 20X0 as credit sales?
A) Accounts receivable are overstated at December 31, 20X0.
B) Accounts receivable are understated at December 31, 20X0.
C) Operating expenses are overstated for the 12 months ended December 31, 20X0.
D) Sales returns and allowance are overstated at December 31, 20X0.
Answer: A Difficulty: Medium
Chapter 11 Accounts Receivable, Notes…
17. Which of the following fraudulent activities most likely could be perpetrated due to
the lack of effective internal control over the revenue cycle?
A) Fictitious transactions may be recorded that cause an understatement of revenues
and an overstatement of receivables.
B) Claims received from customers for goods returned (and unpaid for) may be
intentionally recorded in other customers' accounts permitting a misappropriation
of cash.
C) Authorization of credit memos by personnel who receive cash may permit the
misappropriation of cash.
D) The failure to prepare shipping documents may lead to an understatement of
inventory balances.
Answer: C Difficulty: Hard
18. Which of the following is not typically considered to be an alternate procedure for
handling nonreplies to accounts receivable confirmations?
A) Examine sales invoices.
B) Inclusion of the information in the engagement letter.
C) Examine correspondence.
D) Examine any subsequent cash receipts.
Answer: B Difficulty: Medium
19. A client might overstate December 31 accounts receivable balances by dating and
recording January transactions in December. Such entries recorded in which journal
are most likely to achieve this end?
A) Cash receipts.
B) Payroll.
C) Purchases.
D) Sales.
Answer: D Difficulty: Medium
20. Which of the following is a likely procedure to test the adequacy of the allowance for
doubtful accounts?
A) Examine cash receipts received after year-end.
B) Confirm receivables.
C) Examine dates of purchase orders.
D) Foot the receivables lead schedule.
Answer: A Difficulty: Medium
Chapter 11 Accounts Receivable, Notes…
21. Which of the following is most likely to be used in determining a proper amount to be
included in the allowance for doubtful accounts?
A) Accounts receivable divided by Cost of goods sold.
B) Aging of accounts receivable.
C) Cash Sales divided by Accounts receivable
D) Year 2 accounts receivable compared to year one accounts receivable.
Answer: B Difficulty: Medium
22. For effective internal control, the billing function should not be performed by the:
A) Sales department.
B) Accounting department.
C) Finance department.
D) Data processing departments.
Answer: A Difficulty: Medium
23. Which procedure would be of most assistance to an auditor discovering a large credit
sale that has erroneously been recorded twice?
A) Footing the sales journal.
B) Sending accounts receivable confirmations.
C) Tracing the total sales in the sales journal to the general ledger.
D) Observation of the physical inventory count at year-end.
Answer: B Difficulty: Medium
24. An audit basically consists of having the auditor form an opinion regarding
management's financial statement assertions. The auditor therefore develops general
and specific program steps to apply to the accounts and transactions. In a particular
case, s/he might do this by:
A) Tracing sales invoices to shipping documents to tests the completeness of reported
sales.
B) Tracing shipping documents to sales invoices to test the occurrence of reported
sales.
C) Tracing sales invoices to shipping documents to test the occurrence of reported
sales.
D) Tracing sales invoices to shipping documents to test the completeness of recorded
accounts receivable.
Answer: C Difficulty: Hard
Chapter 11 Accounts Receivable, Notes…
25. After the CPAs have selected particular accounts receivable for confirmation:
A) As a control measure, the CPAs should carefully list the audited values of all of
those accounts before turning the letters over to the client to type and mail.
B) It is important that every account selected that has a material balance ultimately be
verified by confirmation or the application of alternative procedures; immaterial
balances never require any follow-up through alternative procedures.
C) All requests for confirmation should be mailed in envelopes bearing the CPA
firm's return address and should include a return envelope addressed to the CPA
firm.
D) All differences between confirmation replies and book values should be reconciled
by the CPAs, rather than the client.
Answer: C Difficulty: Medium
26. The confirmation of accounts receivable is most closely associated with
A) Business risk.
B) Detection risk.
C) Inherent risk.
D) Relative risk.
Answer: B Difficulty: Medium
27. Which of the following manipulations would understate receivables on the financial
statements?
A) Understatement of cash sales.
B) Closing the sales journal prior to year-end.
C) Closing the cash receipts journal prior to year-end.
D) Underestimating the allowance for doubtful accounts.
Answer: B Difficulty: Easy
28. You were surprised to note that approximately 95% of returned positive accounts
receivable confirmations indicated that the customers thought that they owed a larger
balance than the amount that had been printed by your client on the confirmation.
This might be explained by the fact that:
A) The cash receipts journal was closed before year-end.
B) The cash receipts journal was held open after year-end.
C) There are many unrecorded liabilities.
D) The sales journal was held open after year-end.
Answer: B Difficulty: Medium
Chapter 11 Accounts Receivable, Notes…
29. Which of the following procedures is least likely to help auditors to assess the
adequacy of management's accounting estimate of the allowance for doubtful
accounts?
A) Investigate confirmation exceptions for indication of amounts in dispute.
B) Review accounts which have been written off as uncollectible prior to year-end.
C) Investigate credit ratings for large accounts receivable.
D) Discuss with the credit manager the current status of doubtful accounts.
Answer: B Difficulty: Hard
30. Which of the following is consistent with effective internal control over sales
transactions?
A) The accounting department prepares a shipping report authorizing the shipment of
goods.
B) The accounting department accounts for all receiving reports.
C) The billing department accounts for all shipping documents.
D) The accounts payable department annually approves the extension of credit to
customers.
Answer: C Difficulty: Hard
31. Tracing recorded sales transactions to the bills of lading provides evidence about the:
A) Completeness of sales transactions.
B) Collectibility of sales transactions.
C) Occurrence of sales transactions.
D) Billing of all sales transactions.
Answer: C Difficulty: Medium
32. To obtain the best evidence regarding the completeness of recorded accounts
receivable, the auditors:
A) Trace a sample of the bills of lading to sales invoices.
B) Confirm a sample of accounts payable.
C) Review the aging of accounts receivable.
D) Trace a sample of recorded sales to shipping documents.
Answer: A Difficulty: Medium
Chapter 11 Accounts Receivable, Notes…
33. Which of the following generally provides the least evidence regarding the valuation
of accounts receivable?
A) Reviewing an aging of accounts receivable.
B) Examination of cash receipts subsequent to the balance sheet date.
C) Confirming current (0-30 day) year-end accounts receivable.
D) Reviewing credit files for selected account.
Answer: C Difficulty: Hard
34. Which of the following would indicate the need to use positive accounts receivable
confirmations?
A) A large population consisting of small balances.
B) Good internal control over accounts receivable.
C) Most accounts are with large reputable companies.
D) A large number of accounts receivable are in dispute.
Answer: D Difficulty: Medium
35. Which of the following is not true about the confirmation of accounts receivable?
A) Confirmation requests should bear the auditors' return address.
B) Confirmation requests should be signed by the auditors.
C) Confirmation requests should be mailed directly by the auditors.
D) Confirmation requests should include a return envelope addressed to the office of
the auditors.
Answer: B Difficulty: Easy
36. Which of the following is not true about the auditors' verification of notes receivable?
A) The interest revenue on notes receivable is usually audited by independent
computation.
B) Inspecting the notes is sufficient evidence of existence of the notes.
C) The auditors may evaluate the collectibility of notes by inspecting credit files.
D) Confirmation of notes payable to banks may be accomplished in conjunction with
the confirmation of cash balances.
Answer: B Difficulty: Medium
Chapter 11 Accounts Receivable, Notes…
37. To verify that all sales that have been shipped to customers have been recorded, a test
of transactions should be completed on a representative sample drawn from:
A) The sales journal.
B) The billing clerk's file of sales orders.
C) Duplicate copies of sales invoices.
D) The shipping clerk's file of duplicate copies of bills of lading.
Answer: D Difficulty: Medium
38. Auditors may use positive and/or negative forms of confirmation requests for accounts
receivable. Of the following, which combination is it most likely that the auditors will
use?
A) The positive form for small balances, and the negative form for large balances.
B) The positive form used for large balances and the negative form for the small
balances.
C) The positive form used for trade receivables and the negative form for other
receivables.
D) The positive form when controls related to receivables are satisfactory, and the
negative form when controls related to receivables are unsatisfactory.
Answer: B Difficulty: Easy
39. The auditors obtain audit evidence for accounts receivable by using positive or
negative confirmation requests. Under which of the following circumstances might
the negative form of the accounts receivable confirmation be useful?
A) A substantial number of accounts are in disputes.
B) The combination of inherent risk and control risk is high.
C) Client records include a large number of relatively small balances.
D) The auditors believe that recipients of the requests are unlikely to give them
consideration.
Answer: C Difficulty: Easy Source: AICPA
40. When scheduling the audit work to be performed on an engagement, the auditors
should consider confirming accounts receivable balances at an interim date if:
A) Subsequent collections are to be reviewed.
B) Internal control over receivables is good.
C) Negative confirmations are to be used.
D) There is a simultaneous examination of cash and accounts receivable.
Answer: B Difficulty: Medium Source: AICPA
Chapter 11 Accounts Receivable, Notes…
41. It is sometimes impossible for the auditors to use normal accounts receivable
confirmation procedures. In such situations the best alternative procedure the auditors
might resort to would be:
A) Examining subsequent receipts of year-end accounts receivable.
B) Reviewing accounts receivable aging schedules prepared at the balance sheet date
and at a subsequent date.
C) Requesting that management increase the allowance for uncollectible accounts by
an amount equal to some percentage of the balance in those accounts that cannot
be confirmed.
D) Applying analytical procedures to accounts receivable and sales on a year-to-year
basis.
Answer: A Difficulty: Hard Source: AICPA
42. The audit working papers often include a client-prepared, aged trial balance of
accounts receivable as of the balance sheet date. This aging is best used by the
auditors to:
A) Consider internal control over credit sales.
B) Test the accuracy of recorded charge sales.
C) Estimate credit losses.
D) Verify the validity of the recorded receivables.
Answer: C Difficulty: Medium Source: AICPA
43. Which of the following is not a primary objective of the auditors in the examination of
accounts receivable?
A) Determine the approximate realizable value.
B) Consider the adequacy of internal control.
C) Establish the existence of receivables.
D) Determine the expected day of collection of each of the receivables.
Answer: D Difficulty: Medium Source: AICPA
44. Once a CPA has determined that accounts receivable have increased due to slow
collections in a "tight money" environment, the CPA would be likely to:
A) Increase the balance in the allowance for bad debts accounts.
B) Review the going concern ramifications.
C) Review the credit and collection policy.
D) Expand tests of collectibility.
Answer: D Difficulty: Hard Source: AICPA
Chapter 11 Accounts Receivable, Notes…
45. Which of the following sets of duties would ordinarily be considered basically
incompatible in terms of good internal control?
A) Preparation of monthly statements to customers and maintenance of the accounts
payable subsidiary ledger.
B) Posting to the general ledger and approval of additions and terminations relating to
the payroll.
C) Custody of unmailed signed checks and maintenance of expense subsidiary ledger.
D) Collection of receipts on account and maintaining accounts receivable records.
Answer: D Difficulty: Medium Source: AICPA
46. Tracing copies of sales invoices to shipping documents will provide evidence that all
A) Shipments to customers were recorded as receivables.
B) Billed sales were shipped.
C) Debits to the subsidiary accounts receivable ledger are for sales shipped.
D) Shipments to customers were billed.
Answer: B Difficulty: Medium Source: AICPA
47. Which of the following is the best argument against the use of negative accounts
receivable confirmations?
A) The cost-per-response is excessively high.
B) There is no way of knowing if the intended recipients received them.
C) Recipients are likely to feel that in reality the confirmation is a subtle request for
payment.
D) The inference drawn from receiving no reply may not be correct.
Answer: D Difficulty: Medium Source: AICPA
48. When there are a large number of relatively small account balances, negative
confirmation of accounts receivable is feasible if the combination of inherent risk and
control risk is:
A) Low, and the individuals receiving the confirmation requests are unlikely to give
them adequate consideration.
B) High, and the individuals receiving the confirmation requests are likely to give
them adequate consideration.
C) High, and the individuals receiving the confirmation requests are unlikely to give
them adequate consideration.
D) Low, and the individuals receiving the confirmation requests are likely to give
them adequate consideration.
Answer: D Difficulty: Medium Source: AICPA
Chapter 11 Accounts Receivable, Notes…
49. An auditor should perform alternative procedures to substantiate the existence of
accounts receivable when:
A) No reply to a positive confirmation request is received.
B) No reply to a negative confirmation request is received.
C) Collectibility of the receivables is in doubt.
D) Pledging of the receivables is probable.
Answer: A Difficulty: Easy Source: AICPA
50. Johnson is engaged in the audit of a utility which supplies power to a residential
community. All accounts receivable balances are small and internal control is
effective. Customers are billed bi-monthly. In order to determine the validity of the
accounts receivable balances at the balance sheet date, Johnson would most likely:
A) Examine evidence of subsequent cash receipts instead of sending confirmation
requests.
B) Send positive confirmation requests.
C) Send negative confirmation requests.
D) Use statistical sampling instead of sending confirmation requests.
Answer: C Difficulty: Medium Source: AICPA
51. A CPA examines a sample of copies of December and January sales invoices for the
initials of the person who verified the quantitative data. This is an example of a:
A) Test of a control.
B) Substantive test.
C) Cutoff test.
D) Statistical test.
Answer: A Difficulty: Easy Source: AICPA
52. Which of the following is not one of the criteria for revenue recognition?
A) Collectibility is certain.
B) Delivery has occurred or services have been rendered.
C) Evidence of an arrangement exists and is persuasive.
D) A fixed or determinable price to buyer exists.
Answer: A Difficulty: Hard
Chapter 11 Accounts Receivable, Notes…
53. In your review of ABC Company's financials, you note that Receivables have
increased approximately 200% from the previous year, while Cash has declined.
Further investigation reveals that 70% of ABC's receivables were booked within 7
days of the end of the quarter. If financial statement fraud is involved, which type is
most likely?
A) Fictitious revenues
B) Timing differences
C) Improper asset valuations
D) Improper disclosures
Answer: A Difficulty: Hard
54. Recognizing a loan received as revenue instead of as a liability has a positive effect on
the reported financial statements for all of the following except:
A) It understates liabilities.
B) It overstates revenues
C) It overstates net income.
D) It overstates assets.
Answer: D Difficulty: Hard
55. Which of the following revenue related transactions is not linked to the accounts
indicated?
A) Recognize revenues too early--accounts receivable and revenue.
B) Understate allowance for doubtful accounts--Bad debt expense, allowance for
doubtful accounts.
C) Don't write off uncollectible receivables--sales returns, sales discounts.
D) Don't record discounts given to customers--Cash, sales discounts, accounts
receivable.
Answer: C Difficulty: Medium
56. The individual looking for guidance on revenue recognition is most likely to
appropriately review:
A) APB 99.
B) SAB 104.
C) ASR 44bx
D) B1 Document
Answer: B Difficulty: Medium
Chapter 11 Accounts Receivable, Notes…
Essay Questions
57. Confirmation of accounts receivable is generally accepted auditing procedure. In
performing this procedure, auditors use positive confirmations or negative
confirmations or a combination of both.
a. Describe three conditions which should exist for the auditors to use the negative
form of request.
b. If a response is not received to an initial positive confirmation request, describe the
action that should be taken by the auditors, including a discussion of alternative
auditing procedures.
Difficulty: Medium
Answer:
a. The conditions that should exist for the auditors to use negative confirmation
requests include:
1. The combined assessed level of inherent and control risk is low,
2. A large number of small balances, and
3. Reason to believe the person receiving the confirmation will give it
consideration.
b. If the initial response to a positive confirmation is not received, the auditors
should:
1. Send a second request.
2. Consider sending a third request or telephoning the customer.
3. For significant nonrespondents perform alternative auditing procedures
including:
• Examining subsequent cash receipts.
• Vouching transactions making up the account balance to invoices and
shipping documents.
• Establishing the validity of the customer.
Chapter 11 Accounts Receivable, Notes…
58. Internal control over sales transactions is very important to the effectiveness of an
organization.
a. For effective control over credit sales, describe four major functions that should be
segregated.
b. In addition to adequate segregation of duties, describe two other internal controls
over sales transactions.
Difficulty: Medium
Answer:
a. Functions that should be segregated to provide for effective internal control over
sales transactions include (only four required):
• Authorization of sales.
• Credit approval.
• Issuance of merchandise from stock.
• Shipping of merchandise.
• Billing of accounts.
• Maintenance of accounting records.
b. Other internal controls over sales transactions include (only two required):
• Verification of invoices.
• Prenumbered shipping documents that are accounted for by the billing
department.
• Credit approval obtained prior to shipment of goods.
• Mailing of monthly customer statements.
• Control over written-off receivables.
Chapter 11 Accounts Receivable, Notes…
59. Fraudulent sales are occasionally recorded at year-end as a means of overstating
financial results. As examples, companies may engage in inappropriate bill and hold
transactions or channel stuffing.
a. Describe two conditions that might indicate the recording of fraudulent sales.
b. Define bill and hold transactions and describe the audit significance of such
transactions.
c. Define channel stuffing and describe the audit significance of this practice.
Difficulty: Hard
Answer:
a. The following conditions may indicate the recording of fraudulent transactions:
• Unusually large increases in year-end sales to a single customer or a few.
• Large increases in revenue and receivables along with increases in gross profit
margins that are inconsistent with the client's experience or industry averages.
• Inappropriate changes in accounting principles that result in an increase in
recorded revenue.
• Substantial sales returns following the balance sheet date.
b. Bill and hold transactions are sales that are billed but goods are not shipped. The
audit significance is that stringent accounting requirements must be met for the
transaction to qualify as sales.
c. Channel stuffing involves providing large inducements to resellers to buy
substantially more inventory than they can resell in a normal period of time. The
audit significance is that an adequate allowance for sales returns must be
established to appropriately account for the transactions.
Chapter 12 Inventories and Cost of Goods Sold
True/False Questions
1. Observation of inventories is a generally accepted auditing standard.
Answer: False Difficulty: Easy
2. The receiving department should accept only goods for which there is an approved
purchase order on hand.
Answer: True Difficulty: Medium
3. For good internal control over purchase transactions, purchases should be made from
approved vendors by the department needing the goods.
Answer: False Difficulty: Medium
4. Auditors should not review the client's planning of the physical inventory.
Answer: False Difficulty: Medium
5. The proper cutoff of inventories is best achieved when the client uses prenumbered
purchase orders.
Answer: False Difficulty: Medium
6. The lower of cost or market test by the auditors is generally designed to assure that
inventories are not valued above their net realizable values.
Answer: True Difficulty: Easy
7. When the auditors cannot satisfy themselves as to the accuracy of ending inventory
and a material misstatement may exist, they normally may still give an unqualified
opinion on the client's income statement.
Answer: False Difficulty: Medium
8. To test the client's cutoff of inventories, the auditors will make a record of the serial
number of the final receiving and shipping documents used prior to the taking of the
physical inventory.
Answer: True Difficulty: Medium
Chapter 12 Inventories and Cost of Goods Sold
9. The use of a tagging system for inventory taking is designed to prevent double
counting of goods.
Answer: True Difficulty: Easy
10. The examination of warehouse receipts is not sufficient verification of a material
amount of goods stored in public warehouses.
Answer: True Difficulty: Medium
Multiple Choice Questions
11. An auditor suspects that certain client employees are ordering merchandise for
themselves over the Internet without recording the purchase or receipt of the
merchandise. When vendors' invoices arrive, one of the employees approves the
invoices for payment. After the invoices are paid, the employee destroys the invoices
and the related vouchers. In gathering evidence regarding the fraud, the auditor most
likely would select items for testing from the file of all
A) Cash disbursements.
B) Approved vouchers.
C) Receiving reports.
D) Vendors' invoices.
Answer: A Difficulty: Medium Source: AICPA
12. Which of the following is not true relating to the auditors' observation of the client's
physical inventory?
A) The auditors should evaluate the client's planning of the physical inventory.
B) The auditors should make certain that consigned items from suppliers are included
in physical inventory totals.
C) The auditors should evaluate the adequacy of the client's counting procedures.
D) The auditors should take test counts of the client's inventory.
Answer: B Difficulty: Easy
Chapter 12 Inventories and Cost of Goods Sold
13. A receiving department compares inventory items received with copies of purchase
orders. The purchase orders list the name of the vendor and do not list the quantities
of the material ordered. Using the purchase orders, the receiving department is most
likely to detect:
A) Deliveries for which no purchase order was issued.
B) Unapproved sales orders.
C) Partial deliveries.
D) Deliveries of a greater quantity of items than those ordered.
Answer: A Difficulty: Hard
14. To measure how effectively a client employs its assets, an auditor calculates inventory
turnover by dividing the average inventory into:
A) Net sales.
B) Cost of good sold.
C) Operating income.
D) Gross sales.
Answer: B Difficulty: Medium
15. Which of the following audit procedures most likely would provide assurance that a
manufacturing entity's inventory valuation is proper?
A) Testing the entity's computation of standard overhead rates.
B) Obtaining confirmation of inventories pledged under loan agreements.
C) Reviewing a cutoff procedure for inventories.
D) Tracing test counts to the entity's inventory listing.
Answer: A Difficulty: Hard
16. A client uses a periodic inventory system. Would one expect a credit to which of the
following accounts at the point of sale?
A)
B)
C)
D)
Sales
Yes
Yes
Yes
No
Inventory
Yes
No
No
No
Answer: B Difficulty: Easy
Chapter 12 Inventories and Cost of Goods Sold
17. A client uses a perpetual inventory system. Would one expect a credit to which of the
following accounts at the point of sale?
A)
B)
C)
D)
Sales
Yes
Yes
Yes
No
Inventory
Yes
No
No
No
Answer: A Difficulty: Easy
18. Which of the following would an auditor most likely question included in calculation
of the overhead rate for a company that manufactures a product?
A) Factory supervisor salary.
B) Indirect materials.
C) Miscellaneous expense.
D) Sales expense.
Answer: D Difficulty: Easy
19. A “bill and hold” scheme is most likely to include:
A) Shipment of items to a customer beyond what the customer has ordered.
B) Recording as sales items that the company retains as of year-end.
C) Billing of items that are held by customers for future revenue production purposes.
D) Selling items at substantial discounts near year-end.
Answer: B Difficulty: Hard
20. Which of the following is an auditor least likely to consider a departure from generally
accepted accounting principles?
A) Valuing inventory at cost.
B) Including in inventory items that are consigned out to vendors, but not yet sold.
C) Using standard cost as the measure of inventory cost.
D) Including in inventory items shipped subsequent to year-end, but for which valid
orders did exist at year-end.
Answer: B Difficulty: Medium
Chapter 12 Inventories and Cost of Goods Sold
21. Which of the following is least likely to be accurate statement concerning
characteristics of an audit?
A) An analysis of inventory turnover addresses whether the proper method of
determining inventory costs--as contrasted to market values--is being applied.
B) Characteristics of the double entry bookkeeping system make it possible to test for
overstated sales when tests of accounts receivable are being performed.
C) The direction of tests for overstatement errors is generally directed from the
recorded entry to source documents.
D) Use of a perpetual rather than a periodic inventory system is likely to affect the
nature of cutoff errors made at year-end.
Answer: A Difficulty: Hard
22. Which of the following is not a reason for the special significance attached by the
auditors to the verification of inventories?
A) The determination of inventory valuation directly affects net income.
B) The existence of inventories is inherently difficult to substantiate.
C) Special valuation problems often exist for inventories.
D) Inventories are often the largest current asset of an enterprise.
Answer: B Difficulty: Hard
23. Which of the following is true about the auditors' observation of the client's physical
inventory?
A) The count must be made at year-end.
B) The auditors should supervise the client's personnel.
C) The auditors' observation addresses the existence assertion.
D) The auditors should justify any omission of the observation in the audit report.
Answer: C Difficulty: Medium
24. In verifying debits to perpetual inventory records of a non-manufacturing firm, the
auditor would be most interested in examining the:
A) Purchases journal.
B) Purchase requisitions.
C) Purchase orders.
D) Vendors' invoices.
Answer: D Difficulty: Hard
Chapter 12 Inventories and Cost of Goods Sold
25. In verifying credits to perpetual inventory records of a non-manufacturing firm, the
auditor would be most interested in examining the:
A) Shipping documents.
B) Receiving reports.
C) Purchase orders.
D) Vendors' invoices.
Answer: A Difficulty: Hard
26. The client's physical count of inventories is lower than the inventory quantities in the
perpetual records. This could be the result of a failure to record:
A) Purchases.
B) Purchase discounts.
C) Sales.
D) Sales discounts.
Answer: C Difficulty: Medium
27. An auditor has accounted for a sequence of inventory tags and is now going to trace
information on a representative number of tags to the inventory summary sheets.
Which assertion does this procedure relate to most directly?
A) Legality.
B) Completeness.
C) Valuation.
D) Presentation.
Answer: B Difficulty: Medium
28. The use of a "blind" purchase order is designed to prevent errors by the:
A) Purchase department.
B) Receiving department.
C) Stores department.
D) Accounting department.
Answer: B Difficulty: Medium
Chapter 12 Inventories and Cost of Goods Sold
29. An auditor performs a test to determine whether all merchandise for which the client
was billed was received. The population for this test consists of all:
A) Merchandise received.
B) Vendor's invoices.
C) Canceled checks.
D) Receiving reports.
Answer: B Difficulty: Medium Source: AICPA
30. To assure that all purchases are authorized before payment is made, accounting
department personnel should match the vendor's invoice to:
A) The purchase requisition.
B) The receiving report.
C) The purchase order.
D) The voucher.
Answer: C Difficulty: Medium
31. Which of the following is true about the auditors' observation of the client's physical
inventory?
A) The auditors should plan the physical inventory.
B) The auditors should segregate damaged and obsolete goods.
C) The auditors should evaluate the adequacy of the client's counting procedures.
D) The auditors should supervise the client's personnel.
Answer: C Difficulty: Medium
32. Which of the following is not a procedure that typically is used by the auditors in their
examination of a client's goods held in the custody of a public warehouse?
A) Confirmation.
B) Obtaining reports on internal control at the warehouse.
C) Observation.
D) Corresponding with the state agency regarding the authenticity of the public
warehouse.
Answer: D Difficulty: Medium
Chapter 12 Inventories and Cost of Goods Sold
33. Which of the following best describes the reason that the auditors record their
inventory test counts in the working papers?
A) To document every test count.
B) For subsequent comparison with the completed inventory listing.
C) To document compliance with generally accepted accounting principles.
D) For use in subsequent audits.
Answer: B Difficulty: Medium
34. Which of the following best describes the auditors' response to a client's use of
statistical sampling techniques to estimate the inventory?
A) The auditors should satisfy themselves as to the statistical validity of the
technique, and the reasonableness of the allowance for sampling risk and sampling
error used.
B) The auditors should qualify their opinion, because the client must perform a
complete count of the inventory.
C) The auditors should increase the extent of their test counts to compensate for the
use of a statistical technique.
D) The auditors should withdraw from the engagement.
Answer: A Difficulty: Medium
35. Which of the following best describes the reason for the auditors' review of the client's
cost accounting system?
A) To obtain evidence regarding the quantities of good described as work-in-process.
B) To obtain evidence about the valuation of work-in-process, finished goods, and
cost of goods sold.
C) To obtain evidence about the profit margin on specific jobs.
D) To obtain evidence about compliance with Cost Accounting Standards.
Answer: B Difficulty: Medium
36. Effective internal control for purchases generally can be achieved in a well-planned
organizational structure with a separate purchasing department that has:
A) The ability to prepare payment vouchers based on the information on a vendor's
invoice.
B) The responsibility of reviewing purchase orders issued by user departments.
C) The authority to make purchases of requisitioned materials and services.
D) A direct reporting responsibility to controller of the organization.
Answer: C Difficulty: Hard Source: AICPA
Chapter 12 Inventories and Cost of Goods Sold
37. Purchase cutoff procedures should be designed to test that merchandise is included in
the inventory of the client company, if the company:
A) Has paid for the merchandise.
B) Has physical possession of the merchandise.
C) Holds legal title to the merchandise.
D) Holds the shipping documents for the merchandise issued in the company's name.
Answer: C Difficulty: Medium Source: AICPA
38. Which of the following is an internal control weakness for a company whose
inventory of supplies consists of a large number of individual items?
A) Supplies of relatively little value are expensed when purchased.
B) The cycle basis is used for physical counts.
C) The storekeeper is responsible for maintenance of perpetual inventory records.
D) Perpetual inventory records are maintained only for items of significant value.
Answer: C Difficulty: Hard Source: AICPA
39. The auditors will usually trace the details of the test counts made during the
observation of the physical inventory taking to a final inventory schedule. This audit
procedure is undertaken to provide evidence that items physically present and
observed by the auditors at the time of the physical inventory count are:
A) Owned by the client.
B) Not obsolete.
C) Physically present at the time of the preparation of the final inventory schedule.
D) Included in the final inventory schedule.
Answer: D Difficulty: Medium Source: AICPA
40. An internal control questionnaire indicates that an approved receiving report is
required to accompany every check request for payment of merchandise. Which of
the following procedures provides the greatest assurance that this control is operating
effectively?
A) Select and examine receiving reports and ascertain that the related canceled checks
are dated no earlier than the receiving reports.
B) Select and examine receiving reports and ascertain that the related canceled checks
are dated no later than the receiving reports.
C) Select and examine canceled checks and ascertain that the related receiving reports
are dated no earlier than the checks.
D) Select and examine canceled checks and ascertain that the related receiving reports
are dated no later than the checks.
Answer: D Difficulty: Hard Source: AICPA
Chapter 12 Inventories and Cost of Goods Sold
41. A client's physical count of inventories was higher than the inventory quantities per
the perpetual records. This situation could be the result of the failure to record:
A) Sales.
B) Sales discounts.
C) Purchases.
D) Purchase returns.
Answer: C Difficulty: Medium Source: AICPA
42. Which one of the following procedures would not be appropriate for the auditors in
discharging their responsibilities concerning the client's physical inventories?
A) Confirmation of goods in the hands of public warehouses.
B) Supervising the taking of the annual physical inventory.
C) Carrying out physical inventory procedures at an interim date.
D) Obtaining written representation from the client as to the existence, quality, and
dollar amount of the inventory.
Answer: B Difficulty: Medium Source: AICPA
43. To best ascertain that a company has properly included merchandise that it owns in its
ending inventory, the auditors should review and test the:
A) Terms of the open purchase orders.
B) Purchase cutoff procedures.
C) Contractual commitments made by the purchasing department.
D) Purchase invoices received on or around year end.
Answer: B Difficulty: Medium Source: AICPA
44. Which of the following is not one of the independent auditor's objectives regarding the
examination of inventories?
A) Verifying that inventory counted is owned by the client.
B) Verifying that the client has used proper inventory pricing.
C) Ascertaining the physical quantities of inventory on hand.
D) Verifying that all inventory owned by the client is on hand at the time of the
count.
Answer: D Difficulty: Medium Source: AICPA
Chapter 12 Inventories and Cost of Goods Sold
45. Purchase cutoff procedures should be designed to test whether all inventory:
A) Owned by the company was recorded.
B) On the year end balance sheet was carried at lower of cost or market.
C) On the year end balance sheet was paid for by the company.
D) Owned by the company is in the possession of the company.
Answer: A Difficulty: Medium Source: AICPA
46. Which of the following is an effective control that encourages receiving department
personnel to count and inspect all merchandise received?
A) Quantities ordered are excluded from the receiving department copy of the
purchase order.
B) Vouchers are prepared by accounts payable department personnel only after they
match item counts on the receiving report with the purchase order.
C) Receiving department personnel are expected to match and reconcile the receiving
report with the purchase order.
D) Internal auditors periodically examine, on a surprise basis, the receiving
department copies of receiving reports.
Answer: A Difficulty: Easy Source: AICPA
47. The accuracy of perpetual inventory records may be established, in part, by comparing
perpetual inventory records with:
A) Purchase requisitions.
B) Receiving reports.
C) Purchase orders.
D) Vendor payments.
Answer: B Difficulty: Medium Source: AICPA
48. An inventory turnover analysis is useful to the auditor because it may detect:
A) Inadequacies in inventory pricing.
B) Methods of avoiding cyclical holding cost.
C) The optimum automatic reorder points.
D) The existence of obsolete merchandise.
Answer: D Difficulty: Medium Source: AICPA
Chapter 12 Inventories and Cost of Goods Sold
49. After accounting for a sequence of inventory tags, an auditor traces a sample of tags to
the physical inventory listing to obtain evidence that all items:
A) Included in the listing have been counted.
B) Represented by inventory tags are included in the listing.
C) Included in the listing are represented by inventory tags.
D) Represented by inventory tags are bona fide.
Answer: B Difficulty: Medium Source: AICPA
Essay Questions
50. In auditing a client's inventory, the auditors must be concerned with the detection of
goods that are both damaged and obsolete.
a. Why are the auditors concerned with detecting damaged and obsolete goods?
b. How do the auditors test for damaged goods in the client's inventory?
c. How do the auditors test for obsolete goods in the client's inventory?
Difficulty: Medium
Answer:
a. Auditors are concerned about detecting damaged and obsolete inventory because
the recorded cost of these goods may be significantly greater than their net
realizable value.
b. Auditors test for damaged goods by inquiry of client personnel and observation
during the client's physical inventory.
c. Tests for obsolescence include:
1. Review of perpetual inventory records,
2. Analytical procedures, such as calculation of ratios, such as inventory turnover,
and
3. Inquiry of client personnel.
Chapter 12 Inventories and Cost of Goods Sold
51. Observation of a client's inventory is a generally accepted auditing procedure that
should be performed whenever it is possible.
a. What part should the auditors play in planning the physical inventory?
b. Describe the procedures performed by the auditors during their observation of a
client's physical inventory.
c. Why do the auditors document their inventory test counts in their working papers?
Difficulty: Medium
Answer:
a. The auditors should review the client's planning of the physical inventory and
make suggestions for improvement.
b. During the inventory observation the auditors:
1. Evaluate whether the inventory procedures are followed that assure that all
items are counted and nothing is counted twice.
2. Be alert for goods that appear to be damaged or obsolete.
3. Obtain information to test the client's cutoff of purchases and sales.
4. Make test counts and record them in their working papers.
5. Make inquiries regarding goods on consignment.
6. Obtain tag control information and record the information in the working
papers.
c. The auditors document their test counts in the working papers to later test the
accuracy of the final inventory listing.
Chapter 13 Property, Plant, and Equipment
True/False Questions
1. The auditors' approach to the audit of property, plant and equipment largely results
from the fact that relatively few transactions occur.
Answer: True Difficulty: Easy
2. A major control procedure related to plant and equipment is a budget for depreciation.
Answer: False Difficulty: Medium
3. Evidence of continued ownership of property is obtained by vouching payments to a
mortgage trustee.
Answer: True Difficulty: Medium
4. The auditors typically observe all major items of property, plant and equipment every
year.
Answer: False Difficulty: Medium
5. Material purchases of assets from an affiliated company should be disclosed in the
financial statements.
Answer: True Difficulty: Easy
6. Idle equipment will generally need to be reclassified as a current asset.
Answer: False Difficulty: Easy
7. The primary purpose of internal control over plant and equipment is to safeguard the
assets from theft.
Answer: False Difficulty: Medium
8. A typical procedure in the audit of property is examination of public records to verify
the ownership of the property.
Answer: False Difficulty: Hard
Chapter 13 Property, Plant, and Equipment
9. Even when internal control is weak, a significant portion of the audit work on
property, plant and equipment may be performed at an interim date.
Answer: True Difficulty: Hard
10. In the audit of depletion the auditors must often rely on the work of specialists.
Answer: True Difficulty: Medium
Multiple Choice Questions
11. An auditor has identified numerous debits to accumulated depreciation of equipment.
Which of the following is most likely?
A) The estimated remaining useful lives of equipment were increased.
B) Plant assets were retired during the year.
C) The prior year's deprecation expense was erroneously understated.
D) Overhead allocations were revised at year-end.
Answer: B Difficulty: Hard
12. In testing for unrecorded retirements of equipment, an auditor might.
A) Select items of equipment from the accounting records and then attempt to locate
them during the plant tour.
B) Compare depreciation expense with the prior year's depreciation expense.
C) Trace equipment items observed during the plant tour to the equipment subsidiary
ledger.
D) Scan the general journal for unusual equipment retirements.
Answer: A Difficulty: Medium
13. A plant manager would be most likely to provide information on which of the
following?
A) Adequacy of the provision for uncollectible accounts.
B) Appropriateness of physical inventory valuation techniques.
C) Existence of obsolete inventory.
D) Deferral of certain purchases of office supplies.
Answer: C Difficulty: Medium
Chapter 13 Property, Plant, and Equipment
14. Which of the following would be least likely to address control over the initiation and
execution of equipment transactions?
A) Requests for major repairs are approved by a higher level than the department
initiating the request.
B) Prenumbered purchase orders are used for equipment and periodically accounted
for.
C) Requests for purchases of equipment are reviewed for consideration of soliciting
competitive bids.
D) Procedures exist to restrict access to equipment.
Answer: D Difficulty: Hard
15. When there are numerous property and equipment transactions during the year, an
auditor who plans to assess control risk at a low level usually performs:
A) Tests of controls and extensive tests of property and equipment balances at the end
of the year.
B) Analytical procedures for current year property and equipment transactions.
C) Tests of controls and limited tests of current year property and equipment
transactions.
D) Analytical procedures for property and equipment balances at the end of the year.
Answer: C Difficulty: Hard
16. Which of the following best describes the auditors' approach to the audit of the ending
balance of property, plant and equipment for a continuing nonpublic client?
A) Direct audit of the ending balance.
B) Agreement of the beginning balance to prior year's working papers and audit of
significant changes in the accounts.
C) Audit of changes in the accounts since inception of the company.
D) Audit of selected purchases and retirements for the last few years.
Answer: B Difficulty: Medium
17. Which of the following is not a control that should be established for purchases of
equipment?
A) Establishing a budget for capital acquisitions.
B) Requiring that the department in need of the equipment order the equipment.
C) Requiring that the receiving department receive the equipment.
D) Establishing an accounting policy regarding the minimum dollar amount of
purchase that will be considered for capitalization.
Answer: B Difficulty: Medium
Chapter 13 Property, Plant, and Equipment
18. Which of the following is not one of the auditors' objectives in auditing depreciation?
A) Establishing the reasonableness of the client's replacement policy.
B) Establishing that the methods used are appropriate.
C) Establishing that the methods are consistently applied.
D) Establishing the reasonableness of depreciation computations.
Answer: A Difficulty: Easy
19. Which of the following is the best evidence of continuous ownership of property?
A) Examination of the deed.
B) Examination of rent receipts from lessees of the property.
C) Examination of the title policy.
D) Examination of canceled check in payment for the property.
Answer: B Difficulty: Hard
20. Which of the following best describes the auditors' typical observation of plant and
equipment?
A) The auditors observe a physical inventory of plant and equipment, annually.
B) The auditors observe all additions to plant and equipment made during the year.
C) The auditors observe all major plant and equipment items in the clients' accounts
each year.
D) The auditors observe major additions to plant and equipment made during the
year.
Answer: D Difficulty: Medium
21. Which of the following is used to obtain evidence that the client's equipment accounts
are not understated?
A) Analyzing repairs and maintenance expense accounts.
B) Vouching purchases of plant and equipment.
C) Recomputing depreciation expense.
D) Analyzing the miscellaneous revenue account.
Answer: A Difficulty: Hard
Chapter 13 Property, Plant, and Equipment
22. Which of the following is not a test primarily used to test property, plant and
equipment accounts for overstatement?
A) Investigation of reductions in insurance coverage.
B) Review of property tax bills.
C) Examination of retirement work orders prepared during the year.
D) Vouching retirements of plant and equipment.
Answer: D Difficulty: Hard
23. A continuing audit client's property, plant and equipment and accounts receivable
accounts have approximately the same year-end balance. In this circumstance, when
compared to property, plant and equipment one would normally expect the audit of
accounts receivable to require:
A) More audit time.
B) Less audit time.
C) Approximately the same amount of audit time.
D) Similar confirmation procedures.
Answer: A Difficulty: Medium
24. When comparing an initial audit with a subsequent year audit for a particular client,
the scope of audit procedures for which of the following accounts would be expected
to decrease the most?
A) Accounts receivable.
B) Cash.
C) Marketable securities.
D) Property, plant and equipment.
Answer: D Difficulty: Medium
25. When performing an audit of the property, plant and equipment accounts, an auditor
should expect which of the following to be most likely to indicate a departure from
generally accepted accounting principles?
A) Repairs have been capitalized to repair equipment that had broken down.
B) Interest has been capitalized for self-constructed assets.
C) Assets have been acquired from affiliated corporations with the related
transactions recorded and described in the financial statements.
D) The cost of freight-in on an acquisition has been capitalized.
Answer: A Difficulty: Medium
Chapter 13 Property, Plant, and Equipment
26. The most likely technique for the current year audit of goodwill which was acquired
three years ago by a continuing audit client:
A) Confirmation.
B) Observation.
C) Recomputation.
D) Inquiry.
Answer: C Difficulty: Medium
27. For which of the following accounts is it most likely that most of the audit work can
be performed in advance of the balance sheet date?
A) Accounts receivable.
B) Cash.
C) Current marketable securities.
D) Property, plant and equipment.
Answer: D Difficulty: Medium
28. The auditors may expect a proper debit to goodwill due to:
A) Purchase of a trademark.
B) Establishment of an extraordinarily profitable product.
C) A business combination.
D) Capitalization of human resources.
Answer: C Difficulty: Medium
29. Which of the following is a customary audit procedure for the verification of the legal
ownership of real property?
A) Examination of correspondence with the corporate counsel concerning acquisition
matters.
B) Examination of ownership documents registered and on file at a public hall of
records.
C) Examination of corporate minutes and resolutions concerning the approval to
acquire property, plant and equipment.
D) Examination of deeds and title guaranty policies on hand.
Answer: D Difficulty: Medium Source: AICPA
Chapter 13 Property, Plant, and Equipment
30. In violation of company policy, Lowell Company erroneously capitalized the cost of
painting its warehouse. The auditors examining Lowell's financial statements would
most likely detect this when:
A) Discussing capitalization policies with Lowell's controller.
B) Examining maintenance expense accounts.
C) Observing, during the physical inventory observation, that the warehouse had been
painted.
D) Examining the construction work orders supporting items capitalized during the
year.
Answer: D Difficulty: Medium Source: AICPA
31. Which of the following best describes the independent auditors' approach to obtaining
satisfaction concerning depreciation expense in the income statement?
A) Verify the mathematical accuracy of the amounts charged to income as a result of
depreciation expense.
B) Determine the method for computing depreciation expense and ascertain that is in
accordance with generally accepted accounting principles.
C) Reconcile the amount of depreciation expense to those amounts credited to
accumulated depreciation accounts.
D) Establish the basis for depreciable assets and verify the depreciation expense.
Answer: D Difficulty: Medium Source: AICPA
32. The auditors are least likely to learn of retirements of equipment through which of the
following?
A) Review of the purchase returns and allowances account.
B) Review of depreciation.
C) Analysis of the debits to the accumulated depreciation account.
D) Review of insurance policy riders.
Answer: A Difficulty: Hard Source: AICPA
33. For which of the following ledger accounts would the auditor be most likely to
analyze the details to identify understatements of equipment acquisitions?
A) Service Revenue.
B) Sales.
C) Repairs and maintenance expense.
D) Sales salaries expense.
Answer: C Difficulty: Medium Source: AICPA
Chapter 13 Property, Plant, and Equipment
34. Which of the following is the most important control procedure over acquisitions of
property, plant, and equipment?
A) Establishing a written company policy distinguishing between capital and revenue
expenditures.
B) Using a budget to forecast and control acquisitions and retirements.
C) Analyzing monthly variances between authorized expenditures and actual costs.
D) Requiring acquisitions to be made by user departments.
Answer: B Difficulty: Medium Source: AICPA
35. In the examination of property, plant, and equipment, the auditor tries to determine all
of the following except the:
A) Extent of the control risk.
B) Extent of property abandoned during the year.
C) Adequacy of replacement funds.
D) Reasonableness of the depreciation.
Answer: C Difficulty: Easy Source: AICPA
36. Property acquisitions that are misclassified as maintenance expense would most likely
be detected by an internal control system that provides for:
A) Investigation of variances within a formal budgeting system.
B) Review and approval of the monthly depreciation entry by the plant supervisor.
C) Segregation of duties of employees in the accounts payable department.
D) Examination by the internal auditors of vendor invoices and canceled checks for
property acquisitions.
Answer: A Difficulty: Medium Source: AICPA
Chapter 13 Property, Plant, and Equipment
Essay Questions
37. Plant and equipment are not as inherently risky as are other assets, such as inventories
and accounts receivable. However, a company should still endeavor to maintain
effective internal control over plant and equipment.
a. Describe the principal purpose of internal controls relating to plant and equipment.
b. List and describe four major controls applicable to plant and equipment.
Difficulty: Hard
Answer:
a. The principal purpose of internal controls relating to plant and equipment is to
obtain maximum efficiency from the dollars invested in plant assets.
b. The following are major internal controls for plant and equipment (only four
required):
• Use of a plant budget to forecast and control acquisitions and retirements.
• Maintaining subsidiary ledger of property.
• Establishing a system of authorizations for acquisitions.
• A written statement of company policy distinguishing between capital and
revenue expenditures.
• A policy requiring all purchases of plant and equipment through normal
purchasing and receiving procedures.
• Periodic physical inventories.
• A system of retirement procedures, including serially numbered retirement
work orders.
Chapter 13 Property, Plant, and Equipment
38. Auditors should obtain evidence that there are no significant amounts of unrecorded
retirements of property, plant and equipment.
a. Describe two ways that the auditors obtain evidence that there are no significant
amounts of unrecorded retirements of property (land).
b. Describe three ways that the auditors obtain evidence that there are no significant
amounts of unrecorded retirements of equipment.
Difficulty: Hard
Answer:
a. The auditors obtain evidence that there are no significant amounts of unrecorded
retirements of property by (only two required):
• Examination of property tax bills.
• Vouching rent receipts from lessees.
• Examination of payments to mortgagee or trustee.
b. The auditors obtain evidence that there are no significant amounts of unrecorded
retirements of equipment by (only three required):
• For major purchases, investigate related retirements.
• Analyze the Miscellaneous Revenue account to locate cash proceeds from sale
of equipment.
• For discontinued operations, investigate related retirements.
• Inquire of executives and supervisors.
• Investigate reductions in insurance coverage.
Chapter 14 Accounts Payable
True/False Questions
1. Overstatement of financial results can involve failure to record a transaction.
Answer: True Difficulty: Medium
2. Confirmation of accounts payable is a required generally accepted auditing procedure.
Answer: False Difficulty: Medium
3. The primary objective of the auditors' examination of accounts payable is to determine
whether payments are made on a timely basis.
Answer: False Difficulty: Easy
4. The evidence regarding accounts payable in the client's possession is generally more
reliable than that for accounts receivable.
Answer: True Difficulty: Medium
5. Information regarding the proper cutoff of accounts payable is generally obtained in
conjunction with the audit of inventories.
Answer: True Difficulty: Medium
6. Accounts payable from an officer should be classified separately from other accounts
payable.
Answer: True Difficulty: Easy
7. It is more important to maintain effective internal control over accounts payable as it
is to maintain effective internal control over accounts receivable.
Answer: False Difficulty: Medium
8. For effective internal control over accounts payable, the purchasing department should
approve invoices for payment.
Answer: False Difficulty: Medium
9. Accounts payable generally present the auditors with difficult valuation problems.
Answer: False Difficulty: Easy
Chapter 14 Accounts Payable
10. The confirmation of existing accounts payable does not prove the completeness of
recorded accounts payable.
Answer: True Difficulty: Medium
Multiple Choice Questions
11. Assume that the auditors are concerned about disbursement transactions that have
been recorded for improper amounts. Which procedure(s) would possibly identify
these transactions?
Answer: D Difficulty: Hard
12. Which of the following best describes a voucher prepared under good internal control?
A) A document prepared by Stores that indicates amount to be purchased.
B) A document prepared by Receiving that indicates the quantity received and
approves payment.
C) A document prepared by Accounts Payable authorizing a cash disbursement.
D) A document received by Purchasing, from a supplier, indicating quantity of goods
purchased and amount due.
Answer: C Difficulty: Medium
13. An auditor wishes to perform tests of controls on a client's cash disbursements relating
to accounts payable. If the control procedures leave no audit trail of documentary
evidence, the auditor most likely will test the procedures by:
A) Confirmation and observation.
B) Observation and inquiry.
C) Analytical procedures and confirmation.
D) Inquiry and analytical procedures.
Answer: B Difficulty: Medium
Chapter 14 Accounts Payable
14. Which of the following tests of controls most likely would help assure an auditor that
goods shipped are properly billed?
A) Scan the sales journal for sequential and unusual entries.
B) Examine shipping documents for matching sales invoices.
C) Compare the accounts receivable ledger to daily sales summaries.
D) Inspect unused sales invoices for consecutive pre-numbering.
Answer: B Difficulty: Hard
15. Which of the following audit procedures is best for identifying unrecorded trade
accounts payable?
A) Reviewing cash disbursements recorded subsequent to the balance sheet date to
determine whether the related payable applies to the prior period.
B) Investigating payables recorded just prior to and just subsequent to the balance
sheet date to determine whether they are supported by receiving reports.
C) Examining unusual relationships between monthly accounts payable balances and
recorded cash payments.
D) Reconciling vendors' statements to the file of receiving reports to identify items
received just prior to the balance sheet date.
Answer: A Difficulty: Hard
16. An entity's internal control requires for every check request that there be an approved
voucher, supported by a prenumbered purchase order, and a prenumbered receiving
report. To determine whether checks are being issued for unauthorized expenditures,
an auditor most likely would select for testing from the population of:
A) Purchase orders.
B) Canceled checks.
C) Receiving reports.
D) Approved vouchers.
Answer: B Difficulty: Hard Source: AICPA
17. A client recorded a payable for a large purchase twice. Which of the following
controls would be most likely to detect this error in a timely and efficient manner?
A) Footing the purchases journal.
B) Reconciling vendors' monthly statements with subsidiary payable ledger accounts.
C) Tracing totals from the purchases journal to the ledger accounts.
D) Sending written quarterly confirmations to all vendors.
Answer: B Difficulty: Medium Source: AICPA
Chapter 14 Accounts Payable
18. When an auditor finds a debit to accounts payable, which of the following accounts is
most likely to be credited?
A) Accounts Receivable.
B) Accrued liabilities.
C) Cash
D) Cost of goods sold.
Answer: C Difficulty: Easy
19. Which of the following is an example of an accrued liability?
A) Accounts payable.
B) Notes payable.
C) Prepaid Insurance.
D) Product warranty liability.
Answer: D Difficulty: Medium
20. A likely analytical procedure to test the accuracy of purchase discounts would be to
compute the ratio of cash discounts earned to
A) Accounts payable.
B) Notes payable.
C) Purchases.
D) Sales discounts.
Answer: C Difficulty: Easy
21. Auditors may choose not to confirm accounts payable because:
A) Confirmation obtains evidence identical to that obtained by cutoff tests.
B) Other reliable external evidence to support the balances is likely to be available.
C) A reading of the corporate minutes reveals that confirmation is unnecessary.
D) The balances due will have changed between the year-end and the date of
confirmation.
Answer: B Difficulty: Hard
22. The assertion most directly addressed when performing the search for unrecorded
liabilities is:
A) Completeness.
B) Existence.
C) Presentation.
D) Rights.
Answer: A Difficulty: Medium
Chapter 14 Accounts Payable
23. Which of the following manipulations would understate accounts payable on the
financial statements?
A) Overstatement of purchases
B) Closing the cash disbursements journal prior to year-end
C) Leaving the cash receipts journal open after year-end
D) Overstating purchase returns.
Answer: D Difficulty: Medium
24. Which statement is correct with respect to accounts payable confirmations?
A) The negative form is used in most circumstances
B) Accounts with new suppliers are always confirmed
C) They are a required auditing procedure
D) They are more frequently used in situations in which some vendors don't send
monthly statements.
Answer: D Difficulty: Medium
25. The confirmation of accounts payable is most closely associated with:
A) Assertion risk.
B) Detection risk.
C) Inherent risk.
D) Relative risk.
Answer: B Difficulty: Medium
26. Which of the following audit procedures is aimed most directly at testing the
completeness assertion for accounts payable:
A) Footing the list of accounts payable.
B) Examining underlying documentation for cash disbursements in the period after
year-end.
C) Tracing shipping reports issued on or before year-end to related customer purchase
orders and invoices.
D) Tracing shipping reports after year-end to related customer purchase orders and
invoices.
Answer: B Difficulty: Hard
Chapter 14 Accounts Payable
27. Which of the following best describes the auditors' approach to the audit of accrued
liabilities?
A) Test computations.
B) Confirmation.
C) Observation.
D) A low planned assessed level of control risk.
Answer: A Difficulty: Medium
28. Which of the following statements is correct regarding accounts payable and the
auditor's procedures?
A) Because it is generally more difficult to discover a transaction that has not been
recorded than to discover one that has been recorded incorrectly, the audit
objective of completeness drives many of the substantive procedures applied to
these balances.
B) A judgment whether an unrecorded payable should be recorded before the
financial statements are prepared depends entirely upon the source of the payable.
C) The confirmation of accounts payable selected from the year-end trial balance of
such accounts is most effective in discovering unrecorded liabilities.
D) Unrecorded payables are often discovered through examining vouchers payable
entered into the voucher register prior to the balance sheet date.
Answer: A Difficulty: Medium
29. Which of the following assertions is of principle concern to the auditors in the
examination of accounts payable?
A) Existence.
B) Completeness.
C) Valuation.
D) Authorization.
Answer: B Difficulty: Medium
30. Which of the following best describes the specific accounts payable that are selected
for confirmation?
A) Accounts with large balances.
B) Accounts with zero balances.
C) Accounts with a large amount of activity regardless of their balance.
D) Accounts for which vendor statements are available.
Answer: C Difficulty: Medium
Chapter 14 Accounts Payable
31. Most of the audit work on accounts payable is typically performed:
A) Before the balance sheet date.
B) At the balance sheet date in conjunction with inventory cutoff tests.
C) After the balance sheet date.
D) Simultaneously with the audit of accrued liabilities.
Answer: C Difficulty: Medium
32. When the auditors discover an understatement of liabilities, they would most likely
also expect to find an:
A) Understatement of assets.
B) Understatement of owners' equity.
C) Overstatement of expenses.
D) Understatement of revenues.
Answer: A Difficulty: Medium
33. Which of the following procedures for detecting unrecorded transactions at the client's
December 31 year-end is least likely to result in discovery of an unrecorded year-end
account payable?
A) Examination of invoices received after year-end.
B) Examination of vouchers payable entered in the January voucher register.
C) Examination of January receiving reports prepared for goods shipped FOB
destination in December to the client.
D) Confirmation of year-end accounts payable.
Answer: C Difficulty: Hard
34. For good internal control, a copy of a receiving report should be sent to all of the
following departments except:
A) Accounts payable.
B) Purchasing.
C) Stores.
D) Shipping.
Answer: D Difficulty: Hard
Chapter 14 Accounts Payable
35. Auditors should be aware that a voucher system may result in which of the following
at year-end:
A) Understatement of liabilities.
B) Overstatement of assets.
C) Understatement of owners' equity.
D) Overstatement of expenses.
Answer: A Difficulty: Medium
36. Accrued liabilities generally differ from accounts payable in that accrued liabilities:
A) Accumulate over time.
B) Are usually confirmed at year-end.
C) Depend upon the existence of a transaction for original recording of the account.
D) Are never included in cost of goods sold.
Answer: A Difficulty: Medium
37. The form typically used to confirm accounts payable:
A) Does not require a response from the vendor.
B) Confirms the balance recorded by the client at year-end.
C) Requires the vendor to indicate the amount of the payable.
D) Is the same as the form used to confirm accounts receivable.
Answer: C Difficulty: Medium
38. Which of the following is a control procedure that is usually applied to accounts
payable?
A) Periodic confirmation of accounts payable.
B) Mailing statements to vendors detailing their account.
C) Periodic aging of accounts payable.
D) Reconciliation of vendor statements with accounts payable.
Answer: D Difficulty: Medium
39. Which of the following is the best control procedure to prevent the payment of an
invoice twice?
A) Review of supporting documentation by the person signing the check.
B) Requiring dual signatures on checks.
C) Use of a check protector.
D) Reconciliation of vendor statements to accounts payable.
Answer: A Difficulty: Medium
Chapter 14 Accounts Payable
40. The auditors' search for unrecorded liabilities is completed:
A) During an interim period.
B) At the balance sheet date.
C) Subsequent to the balance sheet date.
D) At any time during the examination.
Answer: C Difficulty: Easy
41. When the auditors select a sample of items from the vouchers payable register for the
last month of the period under audit and trace these items to underlying documents,
the auditors are gathering evidence primarily in support of the assertion that:
A) Recorded obligations were paid.
B) Incurred obligations were recorded in the correct period.
C) Recorded obligations occurred prior to year-end.
D) Cash disbursements were recorded as incurred obligation.
Answer: C Difficulty: Medium Source: AICPA
42. Internal control over accounts payable is improved when:
A) Purchase orders show approved prices.
B) Informal bids are obtained.
C) Annual trial balance of accounts payable subsidiary ledgers is required.
D) Payment is made upon approval of the purchasing agent.
Answer: A Difficulty: Medium Source: AICPA
43. With properly designed internal control, the same employee should not be permitted
to:
A) Sign checks and cancel supporting documents.
B) Receive merchandise and prepare a receiving report.
C) Prepare disbursement vouchers and sign checks.
D) Initiate a request to order merchandise and approve merchandise received.
Answer: C Difficulty: Medium Source: AICPA
44. Unrecorded liabilities are most likely to be found during the review of which of the
following documents?
A) Unpaid bills.
B) Shipping records.
C) Bills of lading.
D) Unmatched sales invoices.
Answer: A Difficulty: Easy Source: AICPA
Chapter 14 Accounts Payable
45. Which of the following procedures is least likely to be completed before the balance
sheet date?
A) Observation of inventory.
B) Review of internal control over cash disbursements.
C) Search for unrecorded liabilities.
D) Confirmation of receivables.
Answer: C Difficulty: Medium Source: AICPA
46. Which of the following audit procedures is least likely to detect an unrecorded
liability?
A) Analysis and recomputation of interest expense.
B) Analysis and recomputation of depreciation expense.
C) Mailing of a cash confirmation form.
D) Reading of the minutes of meetings of the board of directors.
Answer: B Difficulty: Medium Source: AICPA
47. The auditor will most likely perform extensive tests for possible understatement of:
A) Revenues.
B) Assets.
C) Liabilities.
D) Capital.
Answer: C Difficulty: Easy Source: AICPA
Chapter 14 Accounts Payable
Essay Questions
48. The auditors may decide to confirm accounts payable on an audit engagement.
a. Describe two reasons why the confirmation of accounts payable is not a generally
accepted auditing procedure.
b. Describe the audit circumstances in which the auditors are likely to decide to
confirm accounts payable.
c. Describe the types of accounts payable the auditors are likely to select for
confirmation.
Difficulty: Medium
Answer:
a. Confirmation of accounts payable is not a generally accepted auditing procedure
because:
1. The auditors' primary objective with respect to accounts payable is establishing
completeness, and confirmation is primarily a test of existence, and
2. There is a large amount of reliable evidence in the client's possession
supporting the amount of accounts payable, such as vendors' statements.
b. The auditors are likely to decide to confirm accounts payable when the extent of
the evidence available in the client's possession is not sufficient.
c. The auditors select accounts that are more likely to be in error, such as accounts
with a high degree of activity. Accounts with zero balances may also be selected.
Chapter 14 Accounts Payable
49. A major concern of the auditors is obtaining evidence about the completeness of
recorded accounts payable.
a. Describe the reason that the auditors are concerned with the completeness of
accounts payable.
b. Describe three ways in which the auditors establish the completeness of accounts
payable.
Difficulty: Medium
Answer:
a. The auditors are concerned about completeness of accounts payable because the
company's financial strength is exaggerated by an understatement of liabilities.
b. Procedures used to establish the completeness of recorded accounts payable
include (only three required):
• Confirmation of accounts payable.
• Reconciliation of liabilities with vendor statements.
• Comparison of cash payments subsequent to the balance sheet date with the
accounts payable trial balance.
• Investigation of unmatched invoices and unbilled receiving reports.
• Investigation of invoices received subsequent to the balance sheet date.
Chapter 15 Debt and Equity Capital
True/False Questions
1. The formal documentation creating bond indebtedness is called the indenture.
Answer: True Difficulty: Easy
2. Registered bondholders receive periodic interest payments without any action on their
part.
Answer: True Difficulty: Easy
3. The auditors are required to confirm bond holdings directly with the bondholders.
Answer: False Difficulty: Easy
4. The auditors should determine that the issuance of bonds was approved by the
company's stockholders.
Answer: False Difficulty: Medium
5. Long-term liabilities that are maturing must always be classified as a current liability.
Answer: False Difficulty: Medium
6. Corporations maintain either a stock certificate book or a stockholders' ledger.
Answer: False Difficulty: Easy
7. Dividends should be authorized by the stockholders of the corporation.
Answer: False Difficulty: Hard
8. The auditors generally refer to provisions in the partnership agreement when auditing
the allocation of partnership income.
Answer: True Difficulty: Easy
9. When an independent registrar and stock transfer agent is used, it is likely that the
auditor will confirm the number of shares outstanding with those parties rather than
the shareholders.
Answer: True Difficulty: Medium
Chapter 15 Debt and Equity Capital
10. For a continuing client, the auditors will often find that audit time required for capital
stock is small in relation to the dollars recorded in the accounts.
Answer: True Difficulty: Medium
Multiple Choice Questions
11. A registrar/transfer agent system relating to capital stock is most likely used by:
A) A small, nonpublic company.
B) A large, publicly traded company.
C) All companies must use this type of system.
D) No companies use this system anymore.
Answer: B Difficulty: Medium
12. In auditing long-term debt, an auditor would be most likely to:
A) Perform analytical procedures on the bond prenumbered discount accounts.
B) Examine documentation of assets purchased with bond proceeds for liens.
C) Compare interest expense with the long-term debt amount for reasonableness.
D) Confirm the existence of individual long-term debt holders at year-end.
Answer: C Difficulty: Medium
13. An auditor obtains evidence of stockholders' equity transactions for a publicly traded
company by reviewing the entity's:
A) Minutes of board of directors meetings.
B) Registrar's record of interbank transfers.
C) Canceled stock certificates.
D) Treasury stock certificate book.
Answer: A Difficulty: Medium
14. Which of the following most likely would approve the issuance of notes payable?
A) Controller.
B) Payroll.
C) Personnel.
D) Treasurer.
Answer: D Difficulty: Medium
Chapter 15 Debt and Equity Capital
15. Internal control over bonds payable is best when:
A) The company utilizes the services of a bond trustee.
B) The company segregates approval from issuance of the bonds.
C) Bonds are countersigned by two officers.
D) Bonds are serially numbered.
Answer: A Difficulty: Medium
16. The auditor's program to examine interest-bearing debt most likely will include steps
that require:
A) Comparing the book value of the debt to its year-end market value.
B) Vouching borrowing and repayment transactions.
C) Verifying the proper presentation of the debt through the use of confirmations.
D) Inspecting the accounts payable subsidiary ledger for unrecorded interest-bearing
debt.
Answer: B Difficulty: Medium
17. Bond transactions are normally confirmed with:
A) Individual holders of retired bonds.
B) Recomputation procedures performed using interest expense.
C) The bond trustee.
D) Comparisons of retired bonds with those outstanding.
Answer: C Difficulty: Medium
18. Company A does not employ an independent stock transfer agent, but rather issues its
own stock and maintains its stock records. When outstanding shares are transferred
from one holder to another the certificate of the selling shareholder should be:
A) Canceled (generally by perforation) and attached to the certificate book.
B) Destroyed to prevent fraudulent reissuance.
C) Retained by the selling shareholder.
D) Sent to the state's registrar of investment securities.
Answer: A Difficulty: Hard
19. Which of the following procedures is least likely in the audit of capital stock?
A) Examine all outstanding stock certificates for completeness.
B) Account for the proceeds from stock issues.
C) Reconcile shares outstanding with the general ledger.
D) Evaluate compliance with stock option plans.
Answer: A Difficulty: Hard
Chapter 15 Debt and Equity Capital
20. When the auditors obtain an understanding of internal control for the financing cycle
documentation will frequently include a written description as well as a(n):
A) List of audit objectives.
B) Decision table.
C) Summary of tests of controls.
D) Internal control questionnaire.
Answer: D Difficulty: Medium
21. Which of the following is not a primary objective in the audit of interest-bearing debt?
A) Establish the completeness of recorded interest-bearing debt.
B) Establish the legality of outstanding debt.
C) Determine that debt is properly valued.
D) Determine that the presentation and disclosure of interest-bearing debt is
appropriate.
Answer: B Difficulty: Medium
22. In which of the following accounts would one expect a related party transaction to be
easiest to detect?
A) Accounts receivable.
B) Accounts payable.
C) Notes payable.
D) Cash.
Answer: C Difficulty: Hard
23. For audit purposes, a corporation's articles of incorporation are normally:
A) Copied and placed on the owners' equity lead schedule.
B) Copied and placed in the permanent file.
C) Confirmed with the transfer agent.
D) Ignored since they are not normally considered to be related to the internal control
structure.
Answer: B Difficulty: Medium
24. The audit approach for acquired treasury stock will normally include:
A) Confirmation with shareholders.
B) Inspection of certificates.
C) Inspection of cash receipts entries.
D) Recomputation of all gains and losses.
Answer: B Difficulty: Hard
Chapter 15 Debt and Equity Capital
25. Changes in capital stock accounts should normally be approved by:
A) The board of directors.
B) The audit committee.
C) The stockholders.
D) The president.
Answer: A Difficulty: Medium
26. For a large publicly traded client the auditors' examination of capital stock accounts
will not normally include:
A) Analysis of capital stock accounts.
B) Confirmation of shares issued with the independent registrar.
C) Accounting for the proceeds of major stock issues.
D) Reconciliation of a stock certificate book with the general ledger.
Answer: D Difficulty: Medium
27. For a corporation that does not utilize the services of an independent registrar and
stock transfer agent, which of the following represents a weakness in internal control
over stock issuance?
A) Stock certificates are prenumbered.
B) Stock certificates are signed immediately upon receipt from the printer.
C) Stock certificates are in the exclusive custody of a responsible officer.
D) Stock certificates require the signature of two officers.
Answer: B Difficulty: Medium
28. A primary responsibility of a registrar of capital stock is to:
A) Determine that dividends paid do not exceed the amount allowable by law.
B) Act as an independent third party between the board of directors and outside
investors concerning merger, acquisition, and other major decisions.
C) Avoid any overissuance of stock.
D) Maintain detailed stockholder records and carrying out transfers of stock
ownership.
Answer: C Difficulty: Hard
Chapter 15 Debt and Equity Capital
29. When an auditor determines whether there are restrictions on retained earnings
resulting from loans, this audit procedure most likely is intended to verify
management's assertion of:
A) Completeness.
B) Existence or occurrence.
C) Valuation or allocation.
D) Presentation and disclosure.
Answer: D Difficulty: Medium
30. Which of the following is an auditor is most likely to confirm which of the following
from the transfer agent and registrar?
A) Total shares of stock issued.
B) Restrictions on the payment of dividends.
C) Total market value of outstanding shares of stock.
D) Gains from sale of treasury stock.
Answer: A Difficulty: Hard
31. The auditors' program for the examination of long-term debt should include steps that
require the:
A) Verification of the existence of the bondholders.
B) Examination of any bond trust indenture.
C) Inspection of the accounts payable subsidiary ledger.
D) Investigation of credits to the bond interest income accounts.
Answer: B Difficulty: Medium Source: AICPA
32. During an audit of a publicly-held company, the auditors should obtain written
confirmation regarding debenture transactions from the:
A) Debenture holders.
B) Client's attorney.
C) Internal auditors.
D) Trustee.
Answer: D Difficulty: Medium Source: AICPA
Chapter 15 Debt and Equity Capital
33. Auditors often request that the audit client send a letter of inquiry to those attorneys
who have been consulted with respect to litigation, claims, or assessments. The
primary reason for this request is to provide the auditor with:
A) An estimate of the dollar amount of the probable loss.
B) An expert opinion as to whether a loss is possible, probable or remote.
C) Information concerning the progress of cases to date.
D) Corroborative evidential matter.
Answer: D Difficulty: Hard Source: AICPA
34. The primary reason for preparing a reconciliation between interest-bearing obligations
outstanding during the year and interest expense presented in the financial statements
is to:
A) Evaluate internal control over securities.
B) Determine the validity of prepaid interest expense.
C) Ascertain the reasonableness of imputed interest.
D) Detect unrecorded liabilities.
Answer: D Difficulty: Medium Source: AICPA
35. An audit program for the examination of the retained earnings account should include
a step that requires verification of the:
A) Market value used to charge retained earnings to account for a two-for-one stock
split.
B) Approval of the adjustment to the beginning balance as a result of a write-down of
an account receivable.
C) Authorization for both cash and stock dividends.
D) Gain or loss resulting from disposition of treasury shares.
Answer: C Difficulty: Hard Source: AICPA
36. During its fiscal year, a company issued, at a discount, a substantial amount of firstmortgage bonds. When performing audit work in connection with the bond issue, the
independent auditor should:
A) Confirm the existence of the bondholders.
B) Review the minutes for authorization.
C) Trace the net cash received from the issuance to the bond revenue account.
D) Inspect the records maintained by the bond trustee.
Answer: B Difficulty: Hard Source: AICPA
Chapter 15 Debt and Equity Capital
37. When no independent stock transfer agent is employed and the corporation issues its
own stocks and maintains stock records, canceled stock certificates should:
A) Be defaced to prevent reissuance and attached to their corresponding stubs.
B) Not be defaced but segregated from other stock.
C) Be destroyed to prevent fraudulent reissuance.
D) Be defaced and sent to the Secretary of State.
Answer: A Difficulty: Medium Source: AICPA
38. An auditor should trace corporate stock issuances and treasury stock transactions to
the:
A) Numbered stock certificates.
B) Articles of incorporation.
C) Transfer agent's records.
D) Minutes of the board of directors.
Answer: D Difficulty: Hard Source: AICPA
39. The auditor can best verify a client's bond sinking fund transactions and year-end
balance by
A) Confirmation with individual holders of retired bonds.
B) Confirmation with the bond trustee.
C) Recomputation of interest expense, interest payable, and amortization of bond
discount or premium.
D) Examination and count of the bonds retired during the year.
Answer: B Difficulty: Hard Source: AICPA
Chapter 15 Debt and Equity Capital
Essay Questions
40. To establish effective internal control over a corporation's stock transactions, the
corporation should utilize the services of a independent registrar and transfer agent.
a. Describe the functions performed by the stock registrar.
b. Describe the functions performed by the transfer agent.
c. Describe the information that is typically requested by the auditors in a
confirmation sent to the registrar.
Difficulty: Medium
Answer:
a. The stock registrar controls the corporation's issuance of stock to avoid
overissuance.
b. The stock transfer agent maintains the detail stockholder records and handles the
transfer of stock from one shareholder to another.
c. The auditors typically confirm the following information with the stock registrar
and transfer agent:
• The number of shares issued.
• The number of shares held in the company name, or the number of shares
outstanding.
Chapter 15 Debt and Equity Capital
41. In the audit of interest-bearing debt auditors identify audit objectives and then
determine appropriate audit procedures.
a. List the audit objectives for substantive tests of interest-bearing debt.
b. List seven substantive tests for interest-bearing debt to help the auditors meet the
audit objectives.
Answer:
a. The audit objectives for substantive tests of interest-bearing debt are:
1. Determine the existence of recorded interest-bearing debt.
2. Establish the completeness of recorded interest-bearing debt.
3. Determine that the client has obligations to pay the recorded interest-bearing
debt.
4. Establish the clerical accuracy of schedules of interest-bearing debt.
5. Determine that the valuation of interest-bearing debt is in accordance with
generally accepted accounting principles.
6. Determine that the presentation and disclosure of interest-bearing debt are
appropriate, including disclosure of the major provisions of loan agreements.
b. Substantive tests for interest-bearing debt include (seven required):
1. Obtain analyses of interest-bearing debt and related accounts.
2. Examine copies of notes payable and supporting documents.
3. Confirm interest-bearing debt.
4. Vouch borrowing and repayment transactions.
5. Perform analytical procedures.
6. Test computations of interest expense, interest payable, and amortization of
discount and premium.
7. Evaluate whether debt provisions have been met.
8. Verify authority for issuance of debt to corporate minutes.
9. Review notes payable paid or renewed after the balance sheet date.
10. Perform procedures to identify notes payable to related parties.
11. Send confirmation letters about financing arrangements.
12. Evaluate financial statement presentation and disclosure.
Chapter 16 Auditing Operations
True/False Questions
1. Analytical procedures are often used for verification of income statement accounts.
Answer: True Difficulty: Easy
2. The Miscellaneous Revenue account should only be analyzed if it is material in
amount.
Answer: False Difficulty: Medium
3. Internal control over payroll is enhanced when the personnel department distributes
payroll checks.
Answer: False Difficulty: Easy
4. The auditors have a responsibility to report on all FASB-required supplementary
information.
Answer: False Difficulty: Medium
5. Subsequent events that provide additional evidence as to conditions that existed at the
balance sheet date may result in adjusting journal entries.
Answer: True Difficulty: Medium
6. Dual dating of an audit report extends the auditors' liability for disclosure through the
later date for all areas of the financial statements.
Answer: False Difficulty: Medium
7. If management fails to list an unasserted claim in the letter of inquiry to a lawyer, the
lawyer is not required to inform the auditors of the omission.
Answer: True Difficulty: Medium
8. Normally, general risk contingencies need not be disclosed in the financial statements.
Answer: True Difficulty: Medium
Chapter 16 Auditing Operations
9. If not adjusted, a situation in which the total likely misstatement in the financial
statements exceeds a material amount is likely to lead to an audit report modification.
Answer: True Difficulty: Easy
10. Common to future purchase commitments is the fact that they should be recorded as
liabilities at discounted values as of year-end.
Answer: False Difficulty: Medium
Multiple Choice Questions
11. Analytical procedures are a required as a part of the.
A) Detailed tests of balances.
B) Internal control assessment.
C) Overall review at the conclusion of the audit.
D) Substantive testing.
Answer: C Difficulty: Medium
12. The statement that best expresses the auditor's responsibility with respect to events
occurring between the balance sheet date and the end of his audit is that:
A) The auditor has no responsibility for events occurring in the subsequent period
unless these events affect transactions recorded on or before the balance sheet
date.
B) The auditor's responsibility is to determine that a proper cutoff has been made and
that transactions recorded on or before the balance sheet date actually occurred.
C) The auditor is fully responsible for events occurring in the subsequent period and
should extend all detailed procedures through the last day of field work.
D) The auditor is responsible for determining that a proper cutoff has been made and
performing a general review of events occurring in the subsequent period.
Answer: D Difficulty: Hard
Chapter 16 Auditing Operations
13. Shortly after year-end Zero Corporation was informed of the bankruptcy of Bingo.
Zero Corporation showed a receivable of $10,000 due from Bingo as of year-end—
none of which seems recoverable. The receivable had been questionable for some
time as Bingo had been experiencing financial difficulties for the past several years.
Yet, Bingo's bankruptcy did not occur until after Zero Corporation's year-end. Under
these circumstances:
A)
B)
C)
D)
The financial
statements should be
adjusted
Yes
Yes
No
No
The event requires financial
statement disclosure, but no
adjustment
No
No
Yes
Yes
The auditor’s report should
be modified for a lack of
consistency
No
Yes
Yes
No
Answer: A Difficulty: Hard
14. In auditing the balance sheet, most revenue and expense accounts are also audited.
Which accounts are most likely to be audited when auditing Accounts Receivable?
A) Sales and Cost of Goods Sold.
B) Interest and Bad Debt Expense.
C) Sales and Bad Debt Expense.
D) Interest and Cost of Goods Sold.
Answer: C Difficulty: Medium
15. Auditors should perform audit procedures relating to subsequent events?
A) Through year end.
B) Through issuance of the audit report.
C) Through the last day of field work.
D) For a reasonable period after year end.
Answer: C Difficulty: Easy
Chapter 16 Auditing Operations
16. Which of the following procedures would an auditor most likely perform while
evaluating audit findings at the conclusion of an audit?
A) Obtain assurance from the entity's attorney that all material litigation has been
disclosed in the financial statements.
B) Verify the clerical accuracy of the entity's proof of cash and its bank cutoff
statement.
C) Determine whether reportable conditions have corrected.
D) Develop an estimate of the total likely misstatement in the financial statements.
Answer: D Difficulty: Medium
17. Which of the following ledger accounts would be least likely to be analyzed in detail
by auditors?
A) Miscellaneous revenue.
B) Professional fees.
C) Travel expense.
D) Repairs and maintenance.
Answer: C Difficulty: Hard
18. The audit of which of the following balance sheet accounts does not normally result in
verification of an income statement account?
A) Cash.
B) Accounts receivable.
C) Property, plant and equipment.
D) Intangible assets.
Answer: A Difficulty: Hard
19. An example of an internal control weakness is to assign the payroll department the
responsibility for:
A) Preparing the payroll expense distribution.
B) Preparing the payroll checks.
C) Authorizing increases in pay.
D) Preparing journal entries for payroll expense.
Answer: C Difficulty: Medium
Chapter 16 Auditing Operations
20. An example of an internal control weakness is to assign the personnel department
responsibility for:
A) Distribution of paychecks.
B) Hiring personnel.
C) Authorizing deductions from pay.
D) Interviewing employees for jobs.
Answer: A Difficulty: Easy
21. Which of the following audit procedures is aimed at determining whether every name
on the company payroll is an employee actually on the job?
A) A surprise observation of a paycheck distribution.
B) A test of payroll extensions.
C) Analytical comparisons of budgeted to actual payroll expense.
D) Comparison of payee names on canceled payroll checks with the payroll register.
Answer: A Difficulty: Medium
22. Which of the following is not a procedure that is designed to provide evidence about
the existence of loss contingencies?
A) Obtaining a lawyers' letter.
B) Confirming accounts payable.
C) Reviewing the minutes of board of directors' meetings.
D) Review correspondence with banks.
Answer: B Difficulty: Medium
23. Which of the following types of matters do not generally require disclosure in the
financial statements?
A) General risk contingencies.
B) Commitments.
C) Loss contingencies.
D) Liabilities to related parties.
Answer: A Difficulty: Medium
Chapter 16 Auditing Operations
24. Material loss contingencies should be recorded in the financial statements if available
information indicates it is probable that a loss had been sustained prior to the balance
sheet date and the amount of such loss can be reasonably estimated. These
considerations will affect the audit report as follows:
A) If a loss has been recorded in accordance with these criteria, the auditor may issue
an unqualified opinion but is required to point out the contingency in an
explanatory paragraph of the report.
B) If a loss meets these criteria but is disclosed in the financial statement notes rather
than being recorded therein, the auditor may issue an unqualified opinion, but is
required to point out the contingency in an explanatory paragraph of the report.
C) If a loss meets these criteria but is disclosed in the financial statement notes rather
than being recorded therein, the auditor may issue an unqualified opinion, but
should consider adding an explanatory paragraph as a means of emphasizing the
disclosure.
D) If a loss is probable but the amount cannot be reasonably estimated and is
disclosed in the notes to the financial statements rather than being recorded
therein, the auditor may issue an unqualified opinion.
Answer: D Difficulty: Hard
25. A refusal by a lawyer to furnish information related to litigation included in the letter
of inquiry is likely to result in:
A) Confirmation of related lawsuits with the claimants.
B) Qualification of the audit report.
C) An assessment that loss of the litigation is probable.
D) An adverse opinion.
Answer: B Difficulty: Medium
26. If, after issuing an audit report, the auditors find that they have failed to perform
certain significant audit procedures they should first:
A) Attempt to determine whether their report is still being relied upon by third
parties.
B) Notify regulatory agencies.
C) Notify legal counsel.
D) Wait until the beginning of the next year's audit to determine whether
misstatements have occurred.
Answer: A Difficulty: Medium
Chapter 16 Auditing Operations
27. Which of the following is not a procedure that auditors typically perform to search for
significant events during the subsequent period?
A) Review minutes of board of directors' meeting.
B) Review the latest available interim financial statements.
C) Inquire about any unusual adjustments made subsequent to the balance sheet date.
D) Review changes in internal control during the period subsequent to the balance
sheet date.
Answer: D Difficulty: Hard
28. Which of the following subsequent events might require an adjustment to the client's
financial statements?
A) A business combination with another company.
B) Loss on the sale of a closely-held investment.
C) Loss of plant and equipment due to a fire.
D) Retirement of bonds payable at a loss.
Answer: B Difficulty: Medium
29. Authorization of which of the following is least likely to be found during a review of
the minutes of the board of directors?
A) Dividends.
B) New debt issuance.
C) New bank accounts.
D) Writeoff of trade accounts receivable.
Answer: D Difficulty: Medium
30. Which of the following is not a procedure normally performed while completing the
audit?
A) Obtain a lawyer's letter.
B) Obtain a representations letter.
C) Perform an overall review using analytical procedures.
D) Obtain confirmation of capital stockholdings from shareholders.
Answer: D Difficulty: Medium
Chapter 16 Auditing Operations
31. Auditors must communicate internal control "significant deficiencies" to:
A) The audit committee.
B) The shareholders.
C) The SEC.
D) The Federal Trade Commission.
Answer: A Difficulty: Medium
32. Which of the following procedures is not a procedure that is completed near the end of
the engagement?
A) Review cash transactions.
B) Review to identify subsequent events.
C) Obtain the lawyer's letter.
D) Obtain the letter of representations.
Answer: A Difficulty: Medium
33. Which of the following information must be reported on in the auditors' report?
A) FASB-required supplementary information.
B) Other information in client-prepared documents.
C) Information accompanying financial statements in auditor-submitted documents.
D) GASB-required supplementary information.
Answer: C Difficulty: Medium
34. In evaluating whether there is a sufficiently low probability of material misstatement
in the financial statements, the auditors accumulate:
A) Likely misstatements in the financial statements.
B) Known misstatements in the financial statements.
C) Known, projected and other estimated misstatements in the financial statements.
D) Known, projected and potential misstatements in the financial statements.
Answer: C Difficulty: Hard
35. The review of audit working papers by the audit partner is normally completed:
A) Prior to year-end.
B) Immediately as each working paper is completed.
C) Near the completion of field work.
D) After issuance of the audit report, but prior to required subsequent event review
procedures.
Answer: C Difficulty: Easy
Chapter 16 Auditing Operations
36. One reason why the independent auditors perform analytical procedures on the client's
operations is to identify:
A) Weaknesses of a material nature in internal control.
B) Non-compliance with prescribed control procedures.
C) Improper separation of accounting and other financial duties.
D) Unusual transactions.
Answer: D Difficulty: Medium Source: AICPA
37. Which of the following is an analytical procedure that should be applied to the income
statement?
A) Select sales and expense items and trace amounts to related supporting documents.
B) Ascertain that the net income amount in the statement of cash flows agrees with
the net income amount in the income statement.
C) Obtain from the proper client representatives, the beginning and ending inventory
amounts that were used to determine costs of sales.
D) Compare the actual revenues and expenses with the corresponding figures of the
previous year and investigate significant differences.
Answer: D Difficulty: Easy Source: AICPA
38. It would be appropriate for the payroll accounting department to be responsible for
which of the following functions?
A) Approval of employee time records.
B) Maintenance of records of employment, discharges, and pay increases.
C) Preparation of periodic governmental reports as to employees' earnings and
withholding taxes.
D) Distribution of paychecks to employees.
Answer: C Difficulty: Medium Source: AICPA
39. Which of the following is the best reason why the auditors should consider observing
a client's distribution of regular payroll checks?
A) Separation of payroll duties is less than adequate for effective internal control.
B) Total payroll costs are a significant part of total operating costs.
C) The auditors did not observe the distribution of the entire regular payroll during
the audit in the prior year.
D) Employee turnover is excessive.
Answer: A Difficulty: Medium Source: AICPA
Chapter 16 Auditing Operations
40. To minimize the opportunities for fraud, unclaimed cash payroll should be:
A) Deposited in a safe deposit box.
B) Held by the payroll custodian.
C) Deposited in a special bank account.
D) Held by the controller.
Answer: C Difficulty: Easy Source: AICPA
41. The purpose of segregating the duties of distributing payroll checks and hiring
personnel is to:
A) Separate the custody of assets from the accounting for those assets.
B) Establish clear lines of authority and responsibility.
C) Separate duties within the accounting function.
D) Separate the authorization of transactions from the custody of related assets.
Answer: D Difficulty: Easy Source: IIA
42. A CPA reviews a client's payroll procedures. The CPA would consider internal
control to be less than effective if a payroll department supervisor was assigned the
responsibility for:
A) Reviewing and approving time reports for subordinate employees.
B) Distributing payroll checks to employees.
C) Hiring subordinate employees.
D) Initiating requests for salary adjustments for subordinate employees.
Answer: B Difficulty: Medium Source: AICPA
43. A common audit procedure in the audit of payroll transactions involves tracing
selected items from the payroll journal to employee time cards that have been
approved by supervisory personnel. This procedure is designed to provide evidence in
support of the audit proposition that:
A) Only bona fide employees worked and their pay was properly computed.
B) Jobs on which employees worked were charged with the appropriate labor cost.
C) Internal control relating to payroll disbursements are operating effectively.
D) All employees worked the number of hours for which their pay was computed.
Answer: D Difficulty: Medium Source: AICPA
Chapter 16 Auditing Operations
44. Which of the following material events occurring subsequent to the balance sheet date
would require an adjustment to the financial statements before they could be issued?
A) Sale of long-term debt or capital stock.
B) Loss of a plant as a result of a flood.
C) Major purchase of a business which is expected to double the sales volume.
D) Settlement of litigation in excess of the recorded liability.
Answer: D Difficulty: Medium Source: AICPA
45. With respect to issuance of an audit report which is dual dated for a subsequent event
occurring after the completion of field work but before issuance of the auditors' report,
the auditors' responsibility for events occurring subsequent to the completion of field
work is:
A) Extended to include all events occurring until the date of the last subsequent event
referred to.
B) Limited to the specific event referred to.
C) Limited to all events occurring through the date of issuance of the report.
D) Extended to include all events occurring through the date of submission of the
report to the client.
Answer: B Difficulty: Medium Source: AICPA
46. An auditor's decision concerning whether or not to "dual date" the audit report is based
upon the auditor's willingness to:
A) Extend auditing procedures.
B) Accept responsibility for year-end adjusting entries.
C) Permit inclusion of a note captioned: event (unaudited) subsequent to the date of
the auditor's report.
D) Assume responsibility for resolving all events subsequent to the issuance of the
auditor's report.
Answer: A Difficulty: Medium Source: AICPA
47. Auditors often request that the audit client send a letter of inquiry to those attorneys
who have been consulted with respect to litigation, claims, or assessments. The
primary reason for this request is to provide the auditors with:
A) An estimate of the dollar amount of the probable loss.
B) An expert opinion as to whether a loss is possible, probable or remote.
C) Information concerning the progress of cases to date.
D) Corroborative evidential matter.
Answer: D Difficulty: Hard Source: AICPA
Chapter 16 Auditing Operations
48. The auditors' primary means of obtaining corroboration of management's information
concerning litigation is a:
A) Letter of audit inquiry to the client's lawyer.
B) Letter of corroboration from the auditor's lawyer upon review of the legal
documentation.
C) Confirmation of claims and assessments from the other parties to the litigation.
D) Confirmation of claims and assessments from an officer of the court presiding
over the litigation.
Answer: A Difficulty: Medium Source: AICPA
49. Which of the following auditing procedures is ordinarily performed last?
A) Reading of the minutes of the directors' meetings.
B) Confirming accounts payable.
C) Obtaining a management representation letter.
D) Testing of the purchasing function.
Answer: C Difficulty: Easy Source: AICPA
50. The auditors' best course of action with respect to "other financial information"
included in a client prepared annual report containing the auditors' report is to:
A) Indicate in the auditors' report, that the "other financial information" is unaudited.
B) Consider whether the "other financial information" is accurate by performing a
limited review.
C) Obtain written representations from managements as to the material accuracy of
the "other financial information."
D) Read and consider the manner of presentation of the "other financial information."
Answer: D Difficulty: Hard Source: AICPA
Chapter 16 Auditing Operations
51. In the course of the audit of financial statements for the purpose of expressing an
opinion thereon, the auditors will normally prepare a schedule of unadjusted
differences for which the auditors did not propose adjustment when they were
identified. What is the primary purpose served by this schedule?
A) To point out to the responsible client officials the errors made by various company
personnel.
B) To summarize the adjustments that must be made before the company can prepare
and submit its federal tax return.
C) To identify the potential financial statement effects of misstatement or disputed
items that were considered immaterial when discovered.
D) To summarize the misstatements made by the company so that corrections can be
made after the audited financial statements are released.
Answer: C Difficulty: Hard Source: AICPA
52. An auditor will ordinarily examine invoices from lawyers primarily in order to:
A) Substantiate accruals.
B) Assess the legal ramifications of litigation in progress.
C) Estimate the dollar amount of contingent liabilities.
D) Identify possible unasserted litigation, claims and assessments.
Answer: D Difficulty: Medium Source: AICPA
53. The auditor's primary means of obtaining corroboration of management's information
concerning litigation is a:
A) Letter of audit inquiry to the client's lawyer.
B) Letter of corroboration from the auditor's lawyer upon review of the legal
documentation.
C) Confirmation of claims and assessments from the other parties to the litigation.
D) Confirmation of claims and assessments from an officer of the court presiding
over the litigation.
Answer: A Difficulty: Medium Source: AICPA
Chapter 16 Auditing Operations
Essay Questions
54. Auditors must be concerned with events that occur subsequent to the balance sheet
date, because the events may need to be reflected in the financial statements.
a. Describe the two general types of subsequent events.
b. What is the auditors' responsibility with respect to detecting subsequent events?
c. List three audit procedures that are used by the auditors to search for subsequent
events.
Difficulty: Medium
Answer:
a. The two types of subsequent events are:
Type 1--events that provide additional evidence about conditions that existed at the
balance sheet date and affect the estimates included in the statements.
Type 2--events that provide evidence about conditions that arose subsequent to the
balance sheet date and require disclosure in the financial statements.
b. Auditors have a responsibility to search for material subsequent events to the last
day of field work (the date of the auditors' report).
c. Procedures that are used to search for subsequent events include (only three
required):
• Review interim financial statements.
• Review minutes of directors' and stockholders' meetings.
• Make inquiries of officers.
• Obtain a letter from the client's attorney.
• Obtain a letter of representations from management.
Chapter 16 Auditing Operations
55. Auditors are concerned with the existence of loss contingencies that may affect the
client's financial statements. One way that the auditors obtain evidence about existing
loss contingencies is through the lawyer's letter.
a. Describe the information that the auditors wish to obtain about the litigation being
handled by a lawyer.
b. Describe three other procedures that are used by auditors to discover existing loss
contingencies.
Difficulty: Hard
Answer:
a. The auditors wish to obtain the following information about litigation:
1. A description of the litigation situation and the accounting period to which it
relates,
2. The estimated amount of loss, and
3. The probability of occurrence of the loss.
b. Other procedures used by auditors to detect loss contingencies include (only three
required):
• Review the minutes of directors' meetings.
• Review correspondence with financial institutions.
• Obtain a representations letter from the client.
• Review prior tax returns.
Chapter 16 Auditing Operations
56. The auditors' responsibility for information that accompanies audited financial
statements varies with the nature of the information and the nature of the document.
a. Describe the auditors' responsibility regarding FASB-required supplementary
information.
b. Describe the auditors' responsibility regarding other information in client-prepared
documents.
c. Describe the auditors' responsibility regarding information accompanying financial
statements in auditor-prepared documents.
Difficulty: Medium
Answer:
a. The auditors have a responsibility to perform a review of FASB-required
supplementary information, and include an indication in their report when they are
unable to perform the procedures or when they have reservations about the
information.
b. The auditors have a responsibility to read other information for inconsistency with
information contained in the financial statements and obvious misstatements.
Reservations with respect to the information may be expressed in the auditors'
report.
c. The auditors have a responsibility to report on all information accompanying
financial statements in auditor-prepared documents.
Chapter 17 Auditors' Reports
True/False Questions
1. Audit reports should be dated the date on which the financial statements are issued.
Answer: False Difficulty: Easy
2. When the auditors are unable to comply with generally accepted auditing standards,
they should issue an opinion that is unqualified, but include an additional explanatory
paragraph in the report.
Answer: False Difficulty: Medium
3. When evaluating the results of audit tests, materiality depends upon both the dollar
amount and the nature of the item.
Answer: True Difficulty: Easy
4. A public company's financial statements should be prepared following standards of the
Public Company Accounting Oversight Board.
Answer: False Difficulty: Hard
5. If financial statements fail to disclose a material fact, the auditors may disclose the
information in an explanatory paragraph and issue an unqualified opinion on the
statements.
Answer: False Difficulty: Medium
6. If financial statements contain a material departure from generally accepted
accounting principles, the auditors usually should not issue an unqualified opinion.
Answer: True Difficulty: Easy
7. A "very material" change from one generally accepted accounting principle to another
generally accepted accounting principle usually results in an adverse opinion by the
auditors.
Answer: False Difficulty: Medium
8. When there is a significant question about a company's ability to remain a going
concern, the report issued is usually unqualified with an explanatory paragraph.
Answer: True Difficulty: Medium
Chapter 17 Auditors' Reports
9. A client imposed scope limitation will generally result in a disclaimer of opinion.
Answer: True Difficulty: Medium
10. Regulation S-X governs the form and content of financial statements filed with the
SEC.
Answer: True Difficulty: Easy
Multiple Choice Questions
11. Which of the following is not explicitly included in an audit report? .
A) A statement that he auditor believes that his or her audit provides a reasonable
basis for expressing negative assurance.
B) A statement that the auditor's responsibility is to express an opinion on the
financial statements.
C) A statement that the financial statements in the report are the responsibility of
management.
D) A title with the word "independent."
Answer: A Difficulty: Easy
12. When an auditor has concluded there is substantial doubt about an entity's ability to
continue as a going concern for a reasonable period of time beyond the current
financial statement date (9/30/X1), the auditor's responsibility includes:
A) Preparing prospective financial information to verify whether management's plans
can be effectively implemented.
B) Projecting conditions and events from one year prior to this year's date (9/30/X0)
to 9/30/X1.
C) Issuing an adverse or negative assurance opinion, depending upon materiality, due
to the possible effects on the financial statements.
D) Considering the adequacy of disclosure about the entity's possible inability to
continue as a going concern.
Answer: D Difficulty: Medium
Chapter 17 Auditors' Reports
13. When an auditor issues an adverse opinion an explanatory paragraph is added. In
addition, which, if any, paragraphs to the report are modified?
A)
B)
C)
D)
Introductory
Yes
No
No
No
Scope
No
Yes
No
No
Opinion
Yes
Yes
Yes
No
Answer: C Difficulty: Medium
14. When an auditor issues a qualified report due to a scope limitation an explanatory
paragraph is added. In addition, which, if any, paragraphs to the report are modified?
A)
B)
C)
D)
Introductory
Yes
Yes
No
No
Scope
Yes
No
Yes
Yes
Opinion
Yes
Yes
Yes
No
Answer: C Difficulty: Medium
15. When an auditor issues an unqualified report, but adds an emphasis of a matter
paragraph to the report, which, if any, paragraphs to the report are modified?
A)
B)
C)
D)
Introductory
Yes
No
No
No
Scope
Yes
Yes
No
No
Opinion
Yes
Yes
Yes
No
Answer: D Difficulty: Medium
16. An explanatory paragraph relating to a scope limitation should be placed.
A) After the opinion paragraph.
B) Prior to the opinion paragraph.
C) Either before or after the opinion paragraph.
D) An audit report modified for a scope limitation does not include an explanatory
paragraph.
Answer: B Difficulty: Easy
Chapter 17 Auditors' Reports
17. After considering an entity's negative trends and financial difficulties, an auditor has
substantial doubt about the entity's ability to continue as a going concern. The auditor's
considerations relating to management's plans for dealing with the adverse effects of
these conditions most likely would include management's plans to:
A) Increase current dividend distributions.
B) Reduce existing lines of credit.
C) Increase ownership equity.
D) Purchase assets formerly leased.
Answer: C Difficulty: Medium Source: AICPA
18. When a CPA does not confirm material accounts receivable, but is satisfied by the
application of alternative auditing procedures, she normally should:
A) Issue an unqualified opinion, but disclose elsewhere in the report this departure
from a customary procedure.
B) Issue an unqualified opinion with no reference to this omission but be prepared to
defend the action.
C) Issue a qualified opinion or a disclaimer, depending on the materiality of the
receivables.
D) Issue an adverse opinion.
Answer: B Difficulty: Medium
19. When a client declines to disclose essential information in the financial statements or
notes, the CPA should:
A) Provide the information in the audit report, if practicable, and qualify the opinion
because of a limitation on the scope of the audit.
B) Provide the information in the audit report, if practicable, and qualify the opinion
because of a departure from GAAP.
C) Issue a disclaimer of opinion because the client has interfered with the auditor's
function of assessing the adequacy of disclosure.
D) Issue an unqualified opinion, but inform the reader by including the omitted
information in the audit report.
Answer: B Difficulty: Medium
Chapter 17 Auditors' Reports
20. CPA Firm A has performed most of the audit of Consolidated Company's financial
statements and qualifies as the principal auditor. CPA Firm B did the remainder of the
work. Firm A wishes to assume full responsibility for Firm B's work. Which of the
following statements is correct?
A) Such assumption of responsibility violates the profession's standards.
B) In such circumstances, when appropriate requirements have been met, Firm A
should issue a standard unqualified opinion on the financial statements.
C) In such circumstances, when appropriate requirements have been met, Firm A
should issue an unqualified opinion on the financial statements but should make
appropriate reference to Firm B in the audit report.
D) CPA firm A should normally qualify its audit report on the basis of the scope
limitation involved when another CPA firm is involved.
Answer: B Difficulty: Medium
21. Which of the following is most accurate with respect to a CPA's responsibility in
considering a going concern question on audits?
A) Perform analytical procedures aimed particularly at assessing whether bankruptcy
is probable.
B) Issue a report with a "going concern" modification when failure is at least
reasonably probable.
C) Based on audit procedures performed, assess whether there is substantial doubt
about the entity's ability to continue as a going concern.
D) Determine that related uncertainties are properly disclosed and make no mention
in the audit report.
Answer: C Difficulty: Medium
Chapter 17 Auditors' Reports
22. The Rotter Company changed accounting principles in 20X4 from those followed in
20X3. The auditor believes that the new principles are not in conformity with GAAP,
and therefore that the 20X4 financial statements are misleading. The change
(including its dollar effect) has been described in the notes to the 20X4 statements,
which are being presented by themselves. Under these circumstances, in reporting on
the 20X4 financial statements, the auditor should:
A) Express an adverse opinion with an explanatory paragraph disclosing the reason
(the accounting change) for the opinion.
B) Express an unqualified opinion with an explanatory paragraph and disclose the
accounting change from 20X3 and its effect on the financial statements.
C) Disclaim an opinion and explain all of the reasons therefore.
D) Express an adverse opinion regarding the 20X4 financial statements, without an
explanatory paragraph disclosing the reason therefore since it will be included in
the notes to the statements.
Answer: A Difficulty: Hard
23. When financial statements are affected by a material departure from generally
accepted accounting principles, the auditors should:
A) Issue an unqualified report with an explanatory paragraph.
B) Withdraw from the engagement.
C) Issue an "except for" qualification or an adverse opinion.
D) Issue an "except for" qualification or a disclaimer of opinion.
Answer: C Difficulty: Medium
24. Which of the following accounting changes requires explanatory language regarding
consistency in the auditors' report?
A) A change in the estimated useful lives of a class of fixed assets.
B) A write-off of a patent because future benefits do not appear to exist.
C) A change from the straight line method of depreciation to an accelerated method
for a class of fixed assets.
D) A change in calculating bad debt expense from one percent to two percent of
credit sales.
Answer: C Difficulty: Medium
Chapter 17 Auditors' Reports
25. The first paragraph of a standard unqualified audit report is referred to as the:
A) Introductory paragraph.
B) Scope paragraph.
C) Opinion paragraph.
D) Explanatory paragraph.
Answer: A Difficulty: Easy
26. A scope restriction is least likely to result in a(an):
A) Qualified opinion.
B) Disclaimer of opinion.
C) Adverse opinion.
D) Standard unqualified opinion.
Answer: C Difficulty: Medium
27. Which of the following is least likely to result in explanatory language being added to
an unqualified auditor's report on a client that sells jewelry through a retail store?
A) A decision by the auditor to emphasize that the client is a part of a larger
organization.
B) Reliance placed upon a specialist to evaluate the diamonds.
C) A change from FIFO to specific identification accounting for inventory.
D) A question as to whether the client will be able to remain a going concern.
Answer: B Difficulty: Hard
28. Which of the following statements is correct with respect to explanatory paragraphs?
A) They always precede the opinion paragraph.
B) They always follow the opinion paragraph.
C) Sometimes they precede and sometimes they follow the opinion paragraph.
D) They always precede the scope paragraph.
Answer: C Difficulty: Easy
29. A client has changed the salvage values of a number of its fixed assets. The auditors
believe that the salvage values are realistic. The appropriate report is:
A) Standard unqualified.
B) Unqualified with explanatory language as to consistency.
C) Qualified for consistency.
D) Disclaimer.
Answer: A Difficulty: Hard
Chapter 17 Auditors' Reports
30. Which of the following would be most likely to be an appropriate addressee for an
audit report?
A) The shareholders of the corporation whose financial statements were examined.
B) A third party who requested that a copy of the audit report be sent to her.
C) The president of the corporation whose financial statements were examined.
D) The chief financial officer.
Answer: A Difficulty: Easy
31. The term "except for" in an audit report is:
A) Used in an adverse opinion.
B) No longer considered appropriate.
C) Used in a qualified opinion
D) Used for an unqualified opinion when an explanatory paragraph is added.
Answer: C Difficulty: Easy
32. The unqualified standard audit report of a nonpublic company does not explicitly state
that:
A) The financial statements are the responsibility of the company's management.
B) The audit was conducted in accordance with accounting principles generally
accepted in the United States of America.
C) The auditors believe that the audit provides a reasonable basis for their opinion.
D) An audit includes assessing the accounting principles used.
Answer: B Difficulty: Hard
33. Which of the following is not a difference between the audit report of a nonpublic and
public company?
A) The nonpublic company report includes the word “Registered” in the title.
B) The nonpublic company report refers to standards of the PCAOB.
C) The nonpublic company report has an additional paragraph referring to the client's
fraud prevention procedures.
D) The nonpublic company report must include the city and state in which the report
has been issued.
Answer: C Difficulty: Medium
Chapter 17 Auditors' Reports
34. If audited financial statements include a balance sheet and an income statement, but do
not include a statement of cash flows:
A) The auditors may still issue an unqualified opinion.
B) The auditors should issue an "except for" qualification for the departure from
generally accepted accounting principles.
C) The auditors should issue an opinion "subject to" the information that would have
been contained in the statement of cash flows.
D) The auditors should refuse to issue an opinion on only the two financial
statements.
Answer: B Difficulty: Medium
35. Which of the following circumstances generally results in the issuance of a report that
is other than unqualified?
A) Circumstances have significantly limited the scope of the auditors' procedures.
B) The principal auditors for the engagement are relying on the work of other
auditors.
C) The financial statements depart from a standard established by the FASB because
the auditors have concluded that application of the standard would result in
materially misleading financial statements.
D) The auditors have decided to emphasize the fact that the company has engaged in
material amounts of related party transactions.
Answer: A Difficulty: Medium
36. Which of the following modifications of the auditors' report does not include an
additional paragraph?
A) The report is qualified because the financial statements contain a material
departure from generally accepted accounting principles.
B) The report includes an emphasis of a matter.
C) The audit report indicates a division of responsibility between two CPA firms.
D) The report is qualified because the scope of the auditors' work was restricted.
Answer: C Difficulty: Medium
Chapter 17 Auditors' Reports
37. If the predecessor auditors fail to reissue their audit report on comparative financial
statements the successor auditors should:
A) Express a qualified opinion on the comparative financial statements audited by the
predecessor auditors.
B) Reproduce the predecessor auditors' report and include it with the new set of
financial statements.
C) Have the client omit the comparative financial statements.
D) Refer to the report of the predecessor auditors.
Answer: D Difficulty: Hard
38. An audit client has refused to allow the auditors to perform a generally accepted
auditing procedure. The circumstance would normally result in the issuance of:
A) A disclaimer of opinion.
B) An adverse opinion.
C) An "except for" qualification of the report.
D) An unqualified report with explanatory language.
Answer: A Difficulty: Medium
39. Which of the following is a "registration statement" that is filed with the SEC by a
company planning to issue securities to the public?
A) Form 8-K.
B) Form S-1.
C) Form 10-Q.
D) Form 10-K.
Answer: B Difficulty: Easy
40. If principal auditors make no reference to other auditors whose work they have relied
on as a part of the basis for their report, the principal auditors:
A) Are not required to investigate the professional reputation of the other auditors.
B) Are issuing an inappropriate report.
C) Are assuming full responsibility for the work of the other auditors.
D) Are issuing a qualified opinion.
Answer: C Difficulty: Medium
Chapter 17 Auditors' Reports
41. After performing all necessary procedures the predecessor auditors reissue a priorperiod report on financial statements at the request of the client without revising the
original wording. The predecessor auditors should:
A) Delete the date of the report.
B) Dual-date the report.
C) Use the reissue date.
D) Use the date of the previous report.
Answer: D Difficulty: Hard Source: AICPA
42. When an adverse opinion is expressed, the opinion paragraph should include a direct
reference to:
A) A note to the financial statements which discusses the basis for the opinion.
B) The scope paragraph which discusses the basis for the opinion rendered.
C) A separate paragraph which discusses the basis for the opinion rendered.
D) The consistency in the application of generally accepted accounting principles.
Answer: C Difficulty: Medium Source: AICPA
43. Under which of the following set of circumstances might the auditors disclaim an
opinion?
A) The financial statements contain a departure from generally accepted accounting
principles, the effect of which is material.
B) The principal auditors decide to make reference to the report of another auditor
who audited a subsidiary.
C) There has been a material change between periods in the method of application of
accounting principles.
D) There are significant scope limitations on the audit.
Answer: D Difficulty: Medium Source: AICPA
44. The management of Stanley Corporation has decided not to account for a material
transaction in accordance with the provisions of a recent statement of the FASB. They
have set forth their reasons in note "B" of the financial statements, which clearly
demonstrates that due to unusual circumstances the financial statements would
otherwise have been misleading. The auditors' report will probably contain a(an):
A) Qualified opinion and an explanatory paragraph with a reference to note "B".
B) Unqualified opinion and an explanatory paragraph.
C) Adverse opinion and an explanatory paragraph.
D) "Except for" opinion and an explanatory paragraph.
Answer: B Difficulty: Hard Source: AICPA
Chapter 17 Auditors' Reports
45. The auditors include explanatory language in an otherwise unqualified report in order
to emphasize that the entity being reported upon is a subsidiary of another business
enterprise. The inclusion of this explanatory language:
A) Is appropriate and would not negate the unqualified opinion.
B) Is considered a qualification of the report.
C) Is a violation of generally accepted reporting standards if this information is
disclosed in notes to the financial statements.
D) Necessitates a revision of the opinion paragraph to include the phrase "with the
foregoing explanation."
Answer: A Difficulty: Medium Source: AICPA
46. It is not appropriate for the auditors' report to refer a reader to a financial statement
note for details regarding a(an):
A) Change in accounting principle.
B) Limitation in the scope of the audit.
C) Uncertainty.
D) Related party transaction.
Answer: B Difficulty: Medium Source: AICPA
47. Which of the following best describes the reference to the expression "taken as a
whole" in the fourth generally accepted auditing standard of reporting?
A) It applies equally to a complete set of financial statements and to each individual
financial statement.
B) It applies only to a complete set of financial statements.
C) It applies equally to each item in each financial statement.
D) It applies equally to each material item in each financial statement.
Answer: A Difficulty: Hard Source: AICPA
48. Which of the following will not result in qualification of the auditors' report due to a
scope limitation?
A) Restrictions imposed by the client.
B) Reliance placed upon the report of other auditors.
C) Inability to obtain sufficient competent evidential matter.
D) Inadequacy in the accounting records.
Answer: B Difficulty: Hard Source: AICPA
Chapter 17 Auditors' Reports
49. For a continuing audit client, when a complete set of financial statements is presented
on a comparative basis for two years, the auditors' opinion would refer to:
A) Only the current year under audit.
B) Either one or both years at the option of the auditors.
C) Each of the two years plus the preceding year.
D) Each of the years in the two-year period.
Answer: D Difficulty: Medium Source: AICPA
50. Which of the following representations does an auditor make explicitly and which
implicitly when issuing an unqualified opinion on public company financial
statements?
A)
B)
C)
D)
Conformity with
PCAOB Standards
Explicitly
Implicitly
Implicitly
Explicitly
Adequacy
of disclosure
Explicitly
Implicitly
Explicitly
Implicitly
Answer: D Difficulty: Medium
51. For a particular entity's financial statements to be presented fairly in conformity with
generally accepted accounting principles, it is not required that the principles selected:
A) Be appropriate in the circumstances for the particular entity.
B) Reflect transactions in a manner that presents the financial statements within a
range of acceptable limits.
C) Present information in the financial statements that is classified and summarized
in a reasonable manner.
D) Be applied on a basis consistent with those followed in the prior year.
Answer: D Difficulty: Medium Source: AICPA
Chapter 17 Auditors' Reports
52. In which of the following circumstances would an adverse opinion be appropriate?
A) The auditor is not independent with respect to the enterprise being audited.
B) The statements are not in conformity with generally accepted accounting
principles because they omit a statement of changes in financial position.
C) The statements are not in conformity with generally accepted accounting
principles regarding pension plans.
D) A client-imposed scope limitation prevents the auditor from complying with
generally accepted auditing standards.
Answer: C Difficulty: Medium Source: AICPA
53. An independent auditor has concluded that a substantial doubt remains about a client's
ability to continue as a going concern, but the client's financial statements have
properly disclosed all of its solvency problems. The auditor would probably issue
a(an):
A) Unqualified opinion with an appropriate explanatory paragraph.
B) "Except for" qualified opinion.
C) Standard unqualified opinion.
D) Adverse opinion.
Answer: A Difficulty: Medium Source: AICPA
54. A limitation on the scope of the audit sufficient to preclude an unqualified opinion will
always result when management:
A) Asks the auditor to report on the balance sheet and not on the other basic financial
statements.
B) Refuses to permit its lawyer to respond to the letter of audit inquiry.
C) Discloses material related party transactions in the notes to the financial
statements.
D) Knows that confirmation of accounts receivable is not feasible.
Answer: B Difficulty: Medium Source: AICPA
Chapter 17 Auditors' Reports
55. Doe, an independent auditor, was engaged to perform an audit of the financial
statements of Ally Incorporated one month after its fiscal year had ended. Although
the inventory count was not observed by Doe, and accounts receivable were not
confirmed by direct communication with debtors, Doe was able to gain satisfaction by
applying alternative auditing procedures. Doe's audit report will probably contain:
A) A standard unqualified opinion.
B) An unqualified opinion and an explanatory paragraph.
C) Either a qualified opinion or a disclaimer of opinion.
D) An "except for" qualification.
Answer: A Difficulty: Hard Source: AICPA
56. The fourth reporting standard requires the auditor's report to contain either an
expression of opinion regarding the financial statements, taken as a whole, or an
assertion to the effect that an opinion cannot be expressed. The objective of the fourth
standard is to prevent:
A) The CPA from reporting on one basic financial statement and not the others.
B) Misinterpretations regarding the degree of responsibility that the auditor is
assuming.
C) The CPA from expressing different opinions on each of the basic financial
statements.
D) Management from reducing its final responsibility for the basic financial
statements.
Answer: B Difficulty: Medium Source: AICPA
57. The principal auditor is satisfied with the independence and professional reputation of
the other auditor who has audited a subsidiary. To indicate the division of
responsibility, the principal auditor should modify:
A) The introductory, scope, and opinion paragraphs of the report.
B) Only the scope paragraph of the report.
C) Only the opinion paragraph of the report.
D) Only the opinion paragraph of the report and include an explanatory paragraph.
Answer: A Difficulty: Medium Source: AICPA
Chapter 17 Auditors' Reports
58. Morgan, CPA, is the principal auditor for a multinational corporation. Another CPA
has examined and reported on the financial statements of a significant subsidiary of
the corporation. Morgan is satisfied with the independence and professional
reputation of the other auditor, as well as the quality of the other auditor's audit. With
respect to Morgan's report on the consolidated financial statements, taken as a whole,
Morgan:
A) Must not refer to the audit of the other CPA.
B) Must refer to the audit of the other CPA.
C) May refer to the audit of the other CPA.
D) May refer to the audit of the other CPA, in which case Morgan must include in the
audit report on the consolidated financial statements a qualified opinion with
respect to the audit of the other CPA.
Answer: C Difficulty: Medium Source: AICPA
59. When reporting on comparative financial statements where the financial statements of
the prior period have been examined by a predecessor auditor whose report is not
presented, the successor auditor should indicate in the report:
A) The reasons why the predecessor auditor's report is not presented.
B) The identity of the predecessor auditor who examined the financial statements of
the prior year.
C) Whether the predecessor auditor's review of the current year's financial statements
revealed any matter that might have a material effect on the successor auditor's
opinion.
D) The type of opinion expressed by the predecessor auditor.
Answer: D Difficulty: Hard Source: AICPA
60. If an accounting change has no material effect on the financial statements in the
current year, but the change is reasonably certain to have a material effect in later
years, the change should be:
A) Referred to in the auditor's report for the current year.
B) Disclosed in the notes to the financial statements of the current year.
C) Disclosed in the notes to the financial statements and referred to in the auditor's
report for the current year.
D) Treated as a subsequent event.
Answer: B Difficulty: Hard Source: AICPA
Chapter 17 Auditors' Reports
61. When financial statements of a prior period are presented on a comparative basis with
financial statements of the current period, the continuing auditor is responsible for:
A) Expressing dual dated opinions.
B) Updating the report on the previous financial statements only if there has not been
a change in the opinion.
C) Updating the report on the previous financial statements only if the previous report
was qualified and the reasons for the qualification no longer exist.
D) Updating the report on the previous financial statements regardless of the opinion
previously issued.
Answer: D Difficulty: Hard Source: AICPA
62. An auditor has been asked to report on the balance sheet of Kane Company but not on
the other basic financial statements. The auditor will have access to all information
underlying the basic financial statements. Under these circumstances, the auditor:
A) May accept the engagement because such engagements merely involve limited
reporting objectives.
B) May accept the engagement but should disclaim an opinion because of an inability
to apply the procedures considered necessary.
C) Should refuse the engagement because there is a client-imposed scope limitation.
D) Should refuse the engagement because of a departure from generally accepted
auditing standards.
Answer: A Difficulty: Medium Source: AICPA
63. When the auditor is unable to determine the amounts associated with the illegal acts of
client personnel because of an inability to obtain adequate evidence, the auditor should
issue a(an):
A) "Subject to" qualified opinion.
B) Disclaimer of opinion.
C) Adverse opinion.
D) Unqualified opinion with a separate explanatory paragraph.
Answer: B Difficulty: Medium Source: AICPA
Chapter 17 Auditors' Reports
64. If the principal auditor decides to make reference to the other auditor's audit, the
introductory paragraph must specifically indicate the:
A) Magnitude of the portion of the financial statements examined by the other
auditor.
B) Name of the other auditor.
C) Name of the consolidated subsidiary examined by the other auditor.
D) Type of opinion expressed by the other auditor.
Answer: A Difficulty: Medium Source: AICPA
65. Which of the following will result in explanatory language as to consistency in the
auditor's report, regardless of whether the item is fully disclosed in the financial
statements?
A) A change in accounting estimate.
B) A change from an unacceptable accounting principle to a generally accepted one.
C) Correction of an error not involving a change in accounting principle.
D) A change in classification.
Answer: B Difficulty: Easy Source: AICPA
66. An auditor's report on comparative financial statements should be dated as of the date
of the:
A) Issuance of the report.
B) Completion of the auditor's most recent field work.
C) Latest financial statements being reported on.
D) Last related-party transaction disclosed in the statements.
Answer: B Difficulty: Medium Source: AICPA
67. In which of the following circumstances would an auditor be most likely to express an
adverse opinion?
A) The statements are not in conformity with the FASB Statements regarding the
capitalization of leases.
B) Information comes to the auditor's attention that raises substantial doubt about the
entity's ability to continue in existence.
C) The chief executive officer refuses the auditor access to minutes of board of
directors' meetings.
D) Tests of controls show that the entity's internal control is so poor that it can not be
relied upon.
Answer: A Difficulty: Medium Source: AICPA
Chapter 17 Auditors' Reports
Essay Questions
68. William & Plaud are principle auditors for the Lowell Corporation. One of the
subsidiaries of Lowell Corporation, Wilson Manufacturing Co., is audited by Lyle &
Adams.
a. If William & Plaud make reference in their report to reliance on the report of other
auditors are they qualifying their opinion? Explain.
b. Regardless of whether William & Plaud make reference to reliance on the report of
the other auditors, they should perform certain procedures with respect to Lyle and
Adams' audit. What are these procedures?
Difficulty: Easy
Answer:
a. No. The auditors are indicating a division of responsibility between them and the
other auditors.
b. The auditors should:
• Make inquiries concerning the other auditors' professional reputation.
• Obtain a letter from the other auditors stating that they are aware of the use of
their report and that they are independent with respect to the client.
69. Upon completing an audit, the auditors should issue an opinion on the client's financial
statements.
a. List the conditions that permit the issuance of an unqualified opinion on the
financial statements.
b. Describe three situations in which the auditors may modify their standard report
and still issue an unqualified opinion.
Difficulty: Medium
Answer:
a. The conditions that permit issuance of an unqualified opinion include:
1. The financial statements are presented in conformity with generally accepted
accounting principles, including adequate disclosure.
2. The audit was performed in accordance with generally accepted auditing
standards and there were no significant scope limitations preventing the
auditors from gathering the evidence necessary to support their opinion.
Chapter 17 Auditors' Reports
b. Modifications of the auditors' report that do not result in qualification include
(only three required):
• Reliance upon other auditors (shared responsibility audits).
• Emphasis of a matter.
• Departure from an officially recognized accounting principle because
application would result in materially misleading financial statements.
• A question about a company's ability to remain a going concern.
• GAAP not consistently applied.
70. Identify the deficiencies (including both incorrect statements and omissions) contained
in the auditors' report on a nonpublic company as drafted below. You will receive
credit for those you properly identify, and lose credit for those you identify which
aren't actually deficiencies.
Auditors' Report
To the Board of Directors and Management
XYZ Company
We have reviewed the consolidated balance sheet of XYZ Company as of December
31, 20XX, and the related statements of income, retained earnings, and cash flows for
the year then ended. Our responsibility is to express an opinion on these financial
statements based on our audit.
We conducted our audit in accordance with generally accepted accounting standards.
Those standards require that we plan and perform the audit to obtain absolute
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.
In our opinion, the financial statements referred to above present the financial position
of XYZ Company as of December 31, 20XX, and the results of operations and its cash
flows for the year then ended in conformity with auditing standards generally accepted
in the United States of America applied on a consistent basis with the preceding year.
Art Youngster & Co.
Certified Public Accountants
Phoenix, Arizona
December 31, 20XX
Difficulty: Hard
Chapter 17 Auditors' Reports
Answer:
The report contains the following deficiencies:
1. Introductory paragraph
• In sentence 1, the word "reviewed" should be "audited."
• The sentence on the responsibility of management is omitted.
2. Scope Paragraph
• Sentence 1 should state that the audit was performed in accordance with
auditing standards generally accepted in the United States of America.
• Sentence 2 should state that an audit provides "reasonable," not "absolute"
assurance.
3. Opinion Paragraph
• "Auditing standards" should be "accounting principles.”
• No mention of consistency should be made.
4. Other
• The word "independent" should be included in the report's title.
• The report should be dated as of the last day of field work, not the last day of
the year being audited.
Chapter 17 Auditors' Reports
71. Use the accompanying solution sheet to reply to all of the situations below. Unless
indicated otherwise, assume that material amounts are involved.
1. A company has departed from GAAP for what the auditor considers to be
unjustified reasons.
2. A company's inventory records were deficient and the auditor was required to
satisfy herself that the inventory was properly stated using alternative procedures.
She is satisfied with the results of those procedures.
3. In auditing a client, an auditor has determined that substantial doubt exists about
an entity's ability to continue as a going concern.
4. A principal auditor decides not to take responsibility for the work of another CPA
who audited a 70% owned subsidiary and issued an unqualified opinion. The total
assets and revenues of the subsidiary are 5% and 8%, respectively, of the total
assets and revenues of the entity being audited.
5. A company changes from FIFO to LIFO for inventory valuation and the auditor
concurs with the change. The change has a material effect on the comparability of
the entity's financial statements this year, but is expected to have an immaterial
effect in the future.
6. A client is issuing two years of comparative financial statements. The first year
was audited by another auditor who, after performing the appropriate procedures,
has updated and reissued her audit report. (NOTE: You are replying as to the
proper report to be issued at the end of the second year.)[3]
7. A company has included incorrect other information in a client prepared document
containing audited statements. The financial statements are correct, but the
president's letter is incorrect.
8. A client has changed its estimate of likely doubtful accounts from 2% of credit
sales to 3%. The auditor believes the change to be reasonable.[2]
Reply as to the following three factors relating to the appropriate audit report(s) for
each of the situations. More than one type of opinion and placement of explanatory
paragraph reply may be appropriate.
Circumstances--Other auditors, going concern, consistency, emphasis of a matter,
justified departure from GAAP, unjustified departure from GAAP, Scope Limitation
(1 of these must be selected except for numbers 6 and 7).
Types of Opinion
A. Standard unqualified
B. Unqualified with an explanatory paragraph
C. Unqualified with explanatory language, but no explanatory paragraph.
D. Qualified
E. Disclaimer
F. Adverse
Chapter 17 Auditors' Reports
If more than one type of opinion is appropriate list each.
Placement of explanatory paragraph--before opinion paragraph, after opinion
paragraph, either before or after the opinion paragraph, not applicable since there is
no explanatory paragraph. (If more than one type of opinion was appropriate, provide
a separate reply for placement of explanatory paragraph for each.)
Circumstance
1
2
3
4
5
6
7
8
Type Opinion(s)
Placement of Explanatory Paragraph
Type Opinion(s)
Placement of Explanatory Paragraph
Comparative Statements
Other Information
Answer:
Circumstance
1
Unjustified Departure
from GAAP
2
Scope Limitation
3
Going Concern
B or E
4
Other Auditors
C
Not applicable
5
Consistency
B
After
6
Comparative Statements
A
Not applicable
7
Other Information
B
Either
8
Consistency
A
Not applicable
D or F
Before/Before
A
Not applicable
After/Before
Chapter 18 Integrated Audits of Public Companies
True/False Questions
1. Section 404 of the Sarbanes-Oxley Act of 2002 includes internal control reporting
requirements for both management and auditors.
Answer: True Difficulty: Easy
2. The Sarbanes-Oxley Act changed auditor association with a client's internal control
from the review to the audit form of association.
Answer: False Difficulty: Medium
3. The amount involved with a significant deficiency is at least a material amount.
Answer: False Difficulty: Medium
4. The “as of date” for internal control reporting is ordinarily the last day of the fiscal
year.
Answer: True Difficulty: Easy
5. The lack of effective antifraud programs is always considered a material weakness.
Answer: False Difficulty: Hard
6. PCAOB Standard No. 2 suggests that auditors emphasize nonroutine transactions as
contrasted to routine transactions in their consideration of internal control.
Answer: False Difficulty: Hard
7. An auditor's report on internal control ordinarily includes assurance both on
management's assessment and on internal control itself.
Answer: True Difficulty: Medium
8. Tests of operating effectiveness ordinarily include reperformance of the application of
controls.
Answer: True Difficulty: Easy
Chapter 18 Integrated Audits of Public Companies
9. A client imposed scope limitation relating to the audit of internal control ordinarily
results in a qualified report.
Answer: False Difficulty: Medium
10. If management's report on internal control expresses an adverse assessment due to the
existence of material weakness, the auditors would agree with that assessment and
provide an unqualified opinion on it.
Answer: True Difficulty: Hard
Multiple Choice Questions
11. Which of the following is most likely to be considered a material weakness in internal
control?
A) An ineffective control environment.
B) Restatement of previously issued financial statements due to a change in
accounting principles.
C) Inadequate controls over non-systematic transactions.
D) Weaknesses in risk assessment.
Answer: A Difficulty: Hard
12. Which must management communicate to the audit committee?
A)
B)
C)
D)
Known Material Weaknesses
Yes
Yes
No
No
Answer: A Difficulty: Medium
Known Significant Deficiencies
Yes
No
Yes
No
Chapter 18 Integrated Audits of Public Companies
13. Which must the auditor communicate to the audit committee?
A)
B)
C)
D)
Known Material Weaknesses
Yes
Yes
No
No
Known Significant Deficiencies
Yes
No
Yes
No
Answer: A Difficulty: Medium
14. Walkthroughs provide the auditors with primary evidence to:
A)
B)
C)
D)
Confirm their understanding
effectiveness of controls
Yes
Yes
No
No
Substantiate account balances
Yes
No
Yes
No
Answer: B Difficulty: Medium
15. Walkthroughs provide evidence that helps the auditor to:
A)
B)
C)
D)
Evaluate design effectiveness
of controls
Yes
Yes
No
No
Confirm whether controls have
been placed in operation
Yes
No
Yes
No
Answer: A Difficulty: Easy
16. According to PCAOB Standard No. 2, Determining the allowance for doubtful
accounts is referred to as a(n):
A) Substantive transaction.
B) Routine transaction.
C) Nonroutine transaction.
D) Estimation transaction.
Answer: D Difficulty: Medium
Chapter 18 Integrated Audits of Public Companies
17. The framework most likely to be used by the client in its internal control assessment is
the:
A) COSO internal control framework.
B) COSO enterprise risk management framework.
C) FASB 37 internal control definitional framework.
D) AICPA internal control analysis manager.
Answer: A Difficulty: Easy
18. A material weakness that exists at year end will result in what type of audit report on
internal control?
A) Adverse.
B) Qualified.
C) Unqualified.
D) Unqualified with explanatory language.
Answer: A Difficulty: Medium
19. Assume that an auditor is focusing on two weaknesses in internal control. Although
neither is by itself a material weakness, two significant deficiencies in combination
represent a material weakness. The client effectively remediates one of them prior to
year-end but does not have time to remediate the other prior to year-end. What type of
audit report on internal control is appropriate?
A) Adverse.
B) Qualified.
C) Unqualified.
D) Unqualified with explanatory language.
Answer: C Difficulty: Hard
20. Which of the following is defined as a weakness in internal control that allows more
than a remote likelihood of misstatement that is more than inconsequential, but less
than material?
A) Control deficiency.
B) Material weakness.
C) Reportable condition.
D) Significant deficiency.
Answer: D Difficulty: Easy
Chapter 18 Integrated Audits of Public Companies
21. Which of the following would most likely be included in a SEC 10K filing in which a
material weakness in internal control exists?
A)
B)
C)
D)
Financial Statement:
Audit Report
Unqualified
Unqualified
Qualified
Adverse
Internal Control
Audit Report
Adverse
Qualified
Qualified
Unqualified
Answer: A Difficulty: Hard
22. An auditor identified a material weakness in internal control in August. The client
was informed and the client corrected the material weakness prior to year-end
(December 31); the auditor agrees that the correction eliminates the material weakness
prior to year-end. The appropriate audit report on internal control under a PCAOB
Standard No. 2 audit of internal control is:
A) Adverse.
B) Unqualified.
C) Disclaimer.
D) Qualified.
Answer: B Difficulty: Easy
23. An auditor identified a material weakness in internal control in December. The client
was informed and the client corrected the material weakness shortly after year-end
(December 31); the auditor agrees that the correction eliminates the material weakness
as of January 31. The appropriate audit report on internal control under a PCAOB
Standard No. 2 audit of internal control is:
A) Adverse.
B) Unqualified.
C) Unqualified with explanatory language relating to the material weakness.
D) Qualified.
Answer: A Difficulty: Medium
Chapter 18 Integrated Audits of Public Companies
24. An auditor identified a significant deficiency in internal control in December. The
client was informed and the client corrected the significant deficiency shortly after
year-end (December 31); the auditor agrees that the correction eliminates the
significant deficiency as of January 31. The appropriate audit report on internal
control under a PCAOB Standard No. 2 audit of internal control is:
A) Adverse.
B) Unqualified.
C) Unqualified with explanatory language relating to the significant deficiency.
D) Qualified.
Answer: B Difficulty: Hard
25. Which of the following must be included in management's report internal control
under section 404 of the Sarbanes/Oxley Act of 2002?
A) It is management's responsibility to eliminate or publicly report on significant
deficiencies in internal control.
B) A detailed description of the COSO criteria.
C) Management's assessment of the operating effectiveness for the period from the
beginning to the end of the fiscal year under audit.
D) Identification of the framework used for evaluating internal control.
Answer: D Difficulty: Medium
26. Which of the following is a strong indicator that a material weakness in internal
control exists?
A) Restatement of previously issued financial statements to reflect a correction.
B) Inadequate controls over non-routine transactions.
C) Inadequate controls over the period-end financial reporting process.
D) Weaknesses in a control activity.
Answer: A Difficulty: Hard
27. A circumstance caused scope limitation in a Sarbanes/Oxley 404 internal control audit
is most likely to result in a(n):
A) Adverse opinion.
B) Qualified opinion.
C) Unqualified opinion with explanatory language.
D) All of the above are equally likely.
Answer: B Difficulty: Medium
Chapter 18 Integrated Audits of Public Companies
28. Under PCAOB Standard No. 2, what are the auditor's communication requirements to
the audit committee with respect to material weaknesses?
A) All must be communicated in written form.
B) All must be communicated in written form or orally.
C) Only those that violate the Foreign Corrupt Practices Act need be communicated,
but in written form.
D) Only those that violate the Foreign Corrupt Practices Act need be communicated,
in written form or orally.
Answer: A Difficulty: Medium
29. A material weakness because the oversight of the external financial reporting function
by the audit committee is ineffective will ordinarily result in communication to:
PCAOB
A)
B)
C)
D)
Yes
Yes
No
No
Stock Exchange Company is
Listed On
Yes
No
Yes
No
Answer: D Difficulty: Easy
30. Deficiencies in internal control identified by the auditor that are lesser than significant
deficiencies
A) Must be communicated to the board of directors, the audit committee, and
management.
B) Must be reported to the audit committee and management.
C) Must be communicated to management, with the audit committee only informed
of the communication to management.
D) Need not be disclosed unless they in aggregate equal (at least) a significant
deficiency.
Answer: C Difficulty: Hard
Chapter 18 Integrated Audits of Public Companies
31. Which is least likely to be a question asked of employee personnel during a
walkthrough?
A) Have you ever been asked to override the process?
B) Have you assessed the operating effectiveness of the system?
C) What do you do when you find an error?
D) What are you looking for to determine if there is an error?
Answer: B Difficulty: Hard
32. Which of the following fits most directly under the control activities components of
the COSO IC framework?
A) Company-level controls dealing with tone at the top.
B) Overall methods for assigning authority and responsibility.
C) The control environment.
D) Accounting for shipping documents to ensure that all sales are recorded.
Answer: D Difficulty: Medium
33. Consider a company whose sales are initiated by customers either through the Internet,
or in a retail store. Which of the following is correct?
A) These types of sales represent two major classes of transactions within the sales
process.
B) These types of sales represent two sales processes within a major evaluation
processing cycle.
C) These sales represent a sales assertion on completeness.
D) These events represent nonroutine transactions that must be investigated in detail.
Answer: A Difficulty: Hard
34. According to PCAOB Standard No. 2, calculating depreciation expense or adjusting
for foreign currencies is referred to as:
A) Substantive transactions.
B) Routine transactions.
C) Nonroutine transactions.
D) Estimation transactions.
Answer: C Difficulty: Medium
Chapter 18 Integrated Audits of Public Companies
35. A material weakness involves more than a remote likelihood that what size
misstatement will not be prevented or detected?
A) Immaterial.
B) Material.
C) More than inconsequential.
D) Substantial.
Answer: B Difficulty: Medium
36. A control deficiency that is not a significant deficiency is most likely to result in what
form of audit opinion on internal control?
A) Adverse.
B) Qualified.
C) Unqualified.
D) Unqualified with explanatory language.
Answer: A Difficulty: Easy
37. Under a PCAOB Standard No. 2 internal control audit, which of the following is least
likely to indicate a significant deficiency relating to a client's antifraud programs?
A) No program for anonymous submissions of alleged fraud.
B) Audit committee active engagement in discussions on the topic of fraud.
C) Senior management delegates to lower levels responsibility for oversight of
antifraud programs.
D) Lack of audit committee interaction with the internal audit department.
Answer: B Difficulty: Medium
38. The minimum likelihood of loss involved in the consideration of a control deficiency
is:
A) Remote.
B) More than remote.
C) Probable.
D) Not considered.
Answer: D Difficulty: Hard
Chapter 18 Integrated Audits of Public Companies
39. The minimum likelihood of loss involved in the consideration of a possible significant
deficiency is:
A) Remote.
B) More than remote.
C) Probable.
D) Not considered.
Answer: B Difficulty: Easy
40. The minimum likelihood of loss involved in the consideration of a possible material
weakness is:
A) Remote.
B) More than remote.
C) Probable.
D) Not considered.
Answer: B Difficulty: Easy
Chapter 18 Integrated Audits of Public Companies
Essay Questions
41. Categorize the following
At least a
significant
deficiency
and a strong
indicator of a
material
weakness
a. Ineffective oversight of external
reporting by the audit committee
b. An ineffective internal audit function
c. Lack of effective antifraud programs
d. Lack of effective controls over the
period-end financial reporting process
e. A deviation identified during tests of
controls
f. Significant deficiencies previously
communicated that have gone uncorrected
for a reasonable period of time
g. An ineffective control environment
h. A chief internal auditor who reports
directly to the audit committee
At least a
significant
deficiency
Neither of
preceding
2 columns
Chapter 18 Integrated Audits of Public Companies
Answer:
a. Ineffective oversight of external
reporting by the audit committee
b. An ineffective internal audit function
c. Lack of effective antifraud programs
d. Lack of effective controls over the
period-end financial reporting process
e. A deviation identified during tests of
controls
f. Significant deficiencies previously
communicated that have gone
uncorrected for a reasonable period of
time
g. An ineffective control environment
h. A chief internal auditor who reports
directly to the audit committee
At least a
At least a
significant
significant
deficiency
deficiency
and a strong
indicator of a
material
weakness
X
Neither of
preceding
2 columns
X
X
X
X
X
X
X
Chapter 19 Additional Assurance Services: Historical Financial
Information
True/False Questions
1. An audit opinion on cash basis financial statements is an example of a special report.
Answer: True Difficulty: Easy
2. The balance sheet for an individual may be titled a Statement of Financial Condition.
Answer: True Difficulty: Medium
3. The auditors should take exception to assets presented at their estimate current values
in personal financial statements.
Answer: False Difficulty: Medium
4. Personal financial statements may be compiled or reviewed, but they should not be
audited.
Answer: False Difficulty: Easy
5. A compilation of financial statement provides limited assurance regarding the
financial statements.
Answer: False Difficulty: Medium
6. Compiled financial statements may omit note disclosures.
Answer: True Difficulty: Medium
7. The auditors must issue a compilation report if they prepare a client's financial
statements and submit them to a client who intends to use them for external purposes.
Answer: True Difficulty: Hard
8. In a compilation report on a prescribed form, the accountants should take exception to
all departures from generally accepted accounting principles.
Answer: False Difficulty: Medium
9. Letters to underwriters should not contain negative assurances.
Answer: False Difficulty: Medium
Chapter 19 Additional Assurance Services: Historical Financial
Information
10. When a U.S.-based organization prepares financial statements which are for use in
another country, a U.S. report, modified to reflect the accounting principles of the
other country, may be issued.
Answer: True Difficulty: Medium
Multiple Choice Questions
11. Which of the following is correct relating to compiled financial statements when third
party reliance upon those statements is anticipated?
A) A compilation report must be issued.
B) Omission of note disclosures is unacceptable.
C) A written engagement letter is required.
D) Each page of the financial statements should have a restriction such as "Restricted
for Management's Use Only".
Answer: A Difficulty: Medium
12. Which communication option(s) may be used when an accountant submits compiled
financial statements to be used only by management?
A)
B)
C)
D)
Compilation Report
Yes
Yes
No
No
Written Engagement Letter
Yes
No
Yes
No
Answer: A Difficulty: Hard
13. A compilation report is not required when compiled financial statements are expected
to be used by:
A) Management only.
B) Management and third parties.
C) Third parties only.
D) A compilation report is required whenever financial statements are compiled.
Answer: A Difficulty: Medium
Chapter 19 Additional Assurance Services: Historical Financial
Information
14. It is the end of his client's first quarter and Bill Smith, CPA is performing a
compilation of his client's interim financial statements. He has discovered that the
client does not wish to present notes to the financial statements. The appropriate CPA
report includes:
A) Qualified opinion ("subject to" the omission of the notes).
B) Compilation report with an adverse opinion due to inadequate disclosure.
C) Standard compilation report.
D) Compilation report with an indication that all required disclosures under GAAP
may not be presented with the statements.
Answer: D Difficulty: Medium
15. Which of the following is correct concerning financial statements prepared in the
United States for use in another country?
A) The auditor must follow GAAP of both the United States and of the other country.
B) The type of audit report issued depends upon whether it is for use primarily
outside the United States.
C) The audit must only follow US GAAP.
D) Auditors from the other country must be involved with the audit to assure
adequate performance of that country's standards.
Answer: B Difficulty: Medium
16. For a CPA, a client imposed scope limitation during a review of financial statements is
most likely to result in:
A) Resignation from the engagement.
B) Issuance of a disclaimer of opinion.
C) Issuance of an adverse opinion.
D) Only an explanatory paragraph added to report, with no change in the assurance
provided.
Answer: A Difficulty: Hard
Chapter 19 Additional Assurance Services: Historical Financial
Information
17. Interim information of public companies.
A) Must be as comprehensive as that filed annually with the Securities and Exchange
Commission.
B) Must be reviewed by CPAs before it is filed with the Securities and Exchange
Commission.
C) Must be reviewed continuously by CPAs using continuous auditing techniques.
D) Requires no accountant association until it becomes a part of the companies'
annual financial information.
Answer: B Difficulty: Medium
18. In which of the following types of reports do the auditors express negative assurance?
A) Letters for underwriters.
B) Reports on audits of financial statements on a comprehensive basis other than
generally accepted accounting principles.
C) Reports on audits of specified accounts.
D) Reports on condensed financial statements.
Answer: A Difficulty: Hard
19. An assertion that is particularly difficult to audit with respect to personal financial
statements is:
A) Existence.
B) Rights.
C) Completeness.
D) Presentation and disclosure.
Answer: C Difficulty: Medium
20. In which of the following types of reports do accountants provide no explicit
assurance?
A) Compilations.
B) Reviews.
C) Examinations.
D) Audits.
Answer: A Difficulty: Easy
Chapter 19 Additional Assurance Services: Historical Financial
Information
21. Which of the following types of services is most likely to result in a restricted use
report?
A) Compilations.
B) Reviews.
C) Agreed-upon procedures.
D) Audits.
Answer: C Difficulty: Medium
22. Which of the following statements is correct with respect to an audit report issued for
financial statements to be used primarily outside of the United States?
A) The report should follow the U.S. format, modified as appropriate.
B) The report should follow the format of the other country.
C) The report may follow either the U.S. format, modified as appropriate, or may
follow the format of the other country.
D) The report should follow the attestation examination report format.
Answer: C Difficulty: Medium
23. A "comfort letter" to an investment banking firm will normally not:
A) Express negative assurance.
B) Be included with the registration statement for the securities.
C) Include the CPA's opinion as to whether the audited financial statements comply
in all material respects with applicable requirements of the related securities acts.
D) Include a statement as to the auditors' independence.
Answer: B Difficulty: Medium
24. When the auditors are associated with the financial statements of a public company,
but have not audited the financial statements, they should:
A) Issue a compilation report.
B) Issue a disclaimer of opinion.
C) Issue a qualified opinion.
D) Not issue any report.
Answer: B Difficulty: Hard
Chapter 19 Additional Assurance Services: Historical Financial
Information
25. Which of the following is an appropriate form of report for auditors who have audited
the financial statements of a company when they are not independent?
A) A simple disclaimer of opinion.
B) A disclaimer of opinion, with an indication of the lack of independence.
C) An audit opinion.
D) A qualified audit opinion.
Answer: B Difficulty: Medium
26. Which of the following does not result in a modification of a compilation report?
A) A lack of independence on the part of the auditors.
B) A departure from generally accepted accounting principles.
C) A lack of adequate disclosure in the financial statements.
D) A lack of consistent application of generally accepted accounting principles.
Answer: D Difficulty: Hard
27. Which of the following requires modification of a review report:
A) A change in accounting principles.
B) A substantial doubt about a company's ability to continue as a going concern.
C) A departure from generally accepted accounting principles.
D) A change in an accounting estimate.
Answer: C Difficulty: Hard
28. Which of the following is correct when a company is issuing condensed financial
statements developed from audited financial statements?
A) Such condensed statements should always have a CPA's report associated with
them when audited financial statements exist.
B) The CPA may issue a report on whether the condensed information is fairly stated
in all material respects in relation to the basic financial statements.
C) The CPA should perform a compilation and review of the condensed financial
statements.
D) The CPA who has audited the financial statements who is asked to report on the
condensed statements should decline the engagement because the condensed
statements do not include all disclosures necessary under generally accepted
accounting principles.
Answer: B Difficulty: Hard
Chapter 19 Additional Assurance Services: Historical Financial
Information
29. Financial statements that are developed from and summarize the overall information
presented in audited financial statements are referred to as
A) Agreed-upon procedure financial statements.
B) Compiled financial statements.
C) Condensed financial statements.
D) Reviewed financial statements.
Answer: C Difficulty: Medium
30. The term "special reports" may include all of the following except reports on financial
statements:
A) Of a partnership which follows accounting practices used to file its tax return.
B) Prepared for limited purposes such as a report that relates to certain aspects of
financial statements.
C) Of an organization that has limited the scope of the auditor's examination.
D) Of an organization which maintains its accounts and prepares its statements on a
cash or other comprehensive basis of accounting which is materially at variance
with accounting practices customarily followed in preparing accrual-basis
statements.
Answer: C Difficulty: Hard Source: AICPA
31. Whenever special reports, filed on a printed form designed by authorities, call upon
the independent auditors to make an assertion that the auditors believe is not justified,
the auditors should:
A) Submit a short-form report with explanations.
B) Reword the form or attach a separate report.
C) Submit the form with questionable items clearly omitted.
D) Withdraw from the engagement.
Answer: B Difficulty: Medium Source: AICPA
32. During a review of the financial statements of a non-public entity, the CPA finds that
the financial statements contain a material departure from generally accepted
accounting principles. If management refuses to correct the financial statement
presentations, the CPA should:
A) Disclose the departure in a separate paragraph of the report.
B) Issue an adverse opinion.
C) Attach a note explaining the effects of the departure.
D) Issue a compilation report.
Answer: A Difficulty: Medium Source: AICPA
Chapter 19 Additional Assurance Services: Historical Financial
Information
33. The accountants' compilation report should be dated as of the date of:
A) Completion of fieldwork.
B) Completion of the compilation.
C) Transmittal of the compilation report.
D) The latest subsequent event referred to in the notes to the financial statements.
Answer: B Difficulty: Medium Source: AICPA
34. A modification of the CPA's report on a review of the interim financial statements of a
publicly-held company would be necessitated by which of the following?
A) An uncertainty.
B) Lack of consistency.
C) Reference to another accountant.
D) Inadequate disclosure.
Answer: D Difficulty: Medium Source: AICPA
35. A CPA should not normally refer to which one of the following subjects in a "comfort
letter" to underwriters?
A) The independence of the CPA.
B) Changes in financial-statement items during a period subsequent to the date and
period of the latest financial statements in the registration statement.
C) Unaudited financial statements and schedules in the registration statement.
D) Management's determination of line of business classifications.
Answer: D Difficulty: Hard Source: AICPA
36. Inquiry and analytical procedures ordinarily performed during a review of a nonpublic
entity's financial statements include:
A) Analytical procedures designed to identify reportable conditions related to internal
control.
B) Inquires concerning actions taken at meetings of the stockholders and the board of
directors.
C) Analytical procedures designed to test the accounting records by obtaining
corroborating evidential matter.
D) Inquiries of knowledgeable outside parties such as the client's attorneys and
bankers.
Answer: B Difficulty: Medium Source: AICPA
Chapter 19 Additional Assurance Services: Historical Financial
Information
37. Which of the following would not be included in a CPA's report based upon a review
of the financial statements of a nonpublic entity?
A) A statement that the review was in accordance with generally accepted auditing
standards.
B) A statement that all information included in the financial statements are the
representations of management.
C) A statement describing the nature of the procedures performed.
D) A statement describing the auditor's conclusions based upon the results of the
review.
Answer: A Difficulty: Medium Source: AICPA
38. The objective of a review of interim financial information is to provide the accountant
with a basis for reporting whether:
A) A reasonable basis exists for expressing an updated opinion regarding the
financial statements that were previously audited.
B) Material modifications should be made to conform with generally accepted
accounting principles.
C) The financial statements are presented fairly in accordance with standards of
interim reporting.
D) The financial statements are presented fairly in accordance with generally
accepted accounting principles.
Answer: B Difficulty: Medium Source: AICPA
39. If the auditor believes that financial statements prepared on the entity's income tax
basis are not suitably titled, the auditor should:
A) Issue a disclaimer of opinion.
B) Explain in the notes to the financial statements the terminology used.
C) Issue a compilation report.
D) Modify the auditor's report to disclose any reservations.
Answer: D Difficulty: Easy Source: AICPA
Chapter 19 Additional Assurance Services: Historical Financial
Information
40. An auditor's report on financial statements prepared in accordance with a
comprehensive basis of accounting other than generally accepted accounting
principles should include all of the following except:
A) Reference to the note to the financial statements that describes the basis of
preparation of the financial statements.
B) Disclosure that the audit was performed in accordance with generally accepted
auditing standards.
C) An opinion as to whether the basis of accounting used is appropriate under the
circumstances.
D) An opinion as to whether the financial statements are presented fairly in
conformity with the basis of accounting described.
Answer: C Difficulty: Medium Source: AICPA
41. When an auditor reports on financial statements prepared on an entity's income tax
basis, the auditor's report should:
A) Disclose that the income tax basis is a comprehensive basis of accounting other
than generally accepted accounting principles.
B) Disclaim an opinion on whether the statements were examined in accordance with
generally accepted auditing standards.
C) Not express an opinion on whether the statements are presented in conformity
with the comprehensive basis of accounting used.
D) Include an explanation of how the results of operations differ from the cash
receipts and disbursements basis of accounting.
Answer: A Difficulty: Medium Source: AICPA
42. An auditor's report would be designated as a special report when it is issued in
connection with financial statements that are:
A) For an interim period and are subjected to a review.
B) Unaudited and are prepared from a client's accounting records.
C) Prepared in accordance with a comprehensive basis of accounting other than
generally accepted accounting principles.
D) Purported to be in accordance with generally accepted accounting principles but
do not include a presentation of the statement of cash flows.
Answer: C Difficulty: Medium Source: AICPA
Chapter 19 Additional Assurance Services: Historical Financial
Information
43. The underwriter of a securities offering may request that an auditor perform specified
procedures and supply certain assurances concerning unaudited information contained
in a registration statement. The auditor's response to such a request if commonly
called a:
A) Report under federal security statutes.
B) Comfort letter.
C) Review of interim financial information.
D) Compilation report for underwriters.
Answer: B Difficulty: Easy Source: AICPA
44. Comfort letters are ordinarily signed by the:
A) Client.
B) Client's lawyer.
C) Independent auditor.
D) Internal auditor.
Answer: C Difficulty: Easy Source: AICPA
45. Which of the following circumstances requires modification of the accountant's report
on a review of interim financial information of publicly held entity?
A)
B)
C)
D)
Inconsistent Accounting
Principle Application
Yes
Yes
No
No
Inadequate Disclosure
Yes
No
Yes
No
Answer: C Difficulty: Hard Source: AICPA
46. If compiled financial statements presented in conformity with the cash receipts and
disbursements basis of accounting do not disclose the basis of accounting used, the
accountant should:
A) Disclose the basis in the notes to the financial statements.
B) Clearly label each page "Unaudited."
C) Disclose the basis of accounting in the accountant's report.
D) Recompile the financial statements using generally accepted accounting
principles.
Answer: C Difficulty: Hard Source: AICPA
Chapter 19 Additional Assurance Services: Historical Financial
Information
47. An auditor is reporting on cash basis financial statements. These statements are best
referred to in his opinion by which of the following descriptions?
A) Financial position and results of operation arising from cash transactions.
B) Assets and liabilities arising from cash transactions, and revenue collected and
expenses paid.
C) Balance sheet and income statement resulting from cash transactions.
D) Cash balance sheet and the source and application of funds.
Answer: B Difficulty: Medium Source: AICPA
48. Which of the following should not be included in an accountant's standard report
based upon the compilation of an entity's financial statements?
A) A statement that a compilation is limited to presenting in the form of financial
statements information that is the representation of management.
B) A statement that the compilation was performed in accordance with standards
established by the American Institute of CPAs.
C) A statement that the accountant has not audited or reviewed the financial
statements.
D) A statement that the accountant does not express an opinion but expresses only
limited assurance on the financial statements.
Answer: D Difficulty: Hard Source: AICPA
49. Each page of the financial statements compiled by an accountant should include a
reference such as:
A) See accompanying accountant's notes.
B) Unaudited, see accountant's disclaimer.
C) See accountant's compilation report.
D) Subject to compilation restrictions.
Answer: C Difficulty: Easy Source: AICPA
50. During a review of the financial statements of a nonpublic entity, the CPA finds that
the financial statements contain a material departure from generally accepted
accounting principles. If management refuses to correct the financial statement
presentations, the CPA should:
A) Disclose the departure in a separate paragraph of the report.
B) Issue an adverse opinion.
C) Attach a note explaining the effects of the departure.
D) Issue a compilation report.
Answer: A Difficulty: Hard Source: AICPA
Chapter 19 Additional Assurance Services: Historical Financial
Information
51. Which of the following is an auditor least likely to inquire about when performing a
review of a nonpublic company?
A) Significant transactions near the end of the period.
B) Communications with regulatory agencies.
C) That financial statements are prepared in conformity with a special basis of
accounting.
D) Questions that have arisen in applying review procedures.
Answer: C Difficulty: Medium
52. When performing a review of a nonpublic company, the auditors must obtain in a
representation letter acknowledgement of management for its responsibility for reach
of the following except:
A) Responsibility for identifying illegal acts committed by employees.
B) Responsibility for the financial statements conforming with generally accepted
accounting principles.
C) Responsibility to prevent and detect fraud.
D) Knowledge of any actual or suspected fraud that is material.
Answer: A Difficulty: Hard
Chapter 19 Additional Assurance Services: Historical Financial
Information
Essay Questions
53. The financial statements of nonpublic companies may be compiled or reviewed by the
CPAs.
a. Describe a compilation of financial statements.
b. Describe a review of financial statements.
c. Describe three procedures that are performed in the review of a nonpublic
company's financial statements.
Difficulty: Medium
Answer:
a. A compilation is limited to taking the representations of management and putting
them in the form of financial statements.
b. A review of financial statements involves the performance of inquiry and
analytical procedures to provide the accountants with a reasonable basis for
expressing limited assurance that the financial statements are in accordance with
generally accepted accounting principles.
c. Procedures performed in the review of financial statements include (only three
required):
• Inquiries of officers and other executives.
• Analytical procedures applied to financial data by reference to prior financial
data, budgets, and other operating data.
• Inquiries concerning actions taken in meetings of stockholders, board of
directors, and committees of the board.
• Additional procedures if the accountants become aware that the information
may be incorrect, incomplete, or otherwise unsatisfactory.
Chapter 19 Additional Assurance Services: Historical Financial
Information
54. One may envisions a continuum of assurance ranging from absolute assurance to no
assurance. In between may be reasonable assurance, limited assurance, and a
summary of findings with no other assurance.
a. What level of assurance is provided in the CPA's report by each of the following
types of engagements?
• Examinations
• Audits
• Review
• Agreed-upon procedures
• Compilations
b. What type of assurance is provided on financial statements prepared following a
comprehensive basis of accounting other than generally accepted accounting
principles?
Difficulty: Hard
Answer:
a. Assurance provided:
• Examinations--reasonable assurance
• Audits--reasonable assurance
• Review--limited assurance
• Agreed-upon procedures--summary of findings
• Compilations--no assurance
b. The assurance provided is dependent upon the nature of the service provided.
With financial statements the options (and assurance) possible are audit
(reasonable assurance), review (limited assurance), and compilations (no
assurance). Additionally, agreed-upon procedures could be applied to various
elements, accounts or items of the financial statements (a summary of findings
would be provided).
Chapter 19 Additional Assurance Services: Historical Financial
Information
55. Items a through j present various phrases or characteristics that may apply to audits,
reviews, and compilations. Place check mark in the cell if the phrase or characteristic
applies to the listed service:
Chapter 19 Additional Assurance Services: Historical Financial
Information
Answer:
Chapter 20 Additional Assurance Services: Other Information
True/False Questions
1. Assurance services improve the quality of information or its context for decision
makers.
Answer: True Difficulty: Easy
2. Attestation services are similar, but go beyond assurance services in scope of
procedures and reporting.
Answer: False Difficulty: Medium
3. Independence is required for the performance of all assurance services.
Answer: True Difficulty: Medium
4. Practitioners may report on either an assertion about the subject matter, or on the
subject matter for most attestation engagements.
Answer: True Difficulty: Medium
5. Attestation risk, like audit risk consists of three components--inherent risk, control
risk, and substantiation risk.
Answer: False Difficulty: Medium
6. The attestation standards prohibit the examination of prospective financial statements.
Answer: False Difficulty: Medium
7. A practitioner may be engaged to perform a review of management's discussion and
analysis for an annual or an interim period.
Answer: True Difficulty: Medium
8. A WebTrust seal assures consumers that they will be satisfied with their purchases.
Answer: False Difficulty: Easy
9. Trust Services are a part of the AICPA's vision that increased trust in annual historical
financial statements is necessary.
Answer: False Difficulty: Medium
Chapter 20 Additional Assurance Services: Other Information
10. SysTrust engagements relate only to database systems.
Answer: False Difficulty: Medium
Multiple Choice Questions
11. Which of the following is least likely to be included in an agreed-upon procedures
attestation engagement report?
A) The specified party takes responsibility for the sufficiency of procedures.
B) Use of the report is restricted.
C) Limited assurance on the information presented.
D) A summary of procedures performed.
Answer: C Difficulty: Medium
12. Conditions exist that result in a material deviation from the criteria against which the
subject matter was evaluated during an examination performed following the
attestation standards. The CPA's conclusion may be on:
A)
B)
C)
D)
Subject Matter
Yes
Yes
No
No
Written Assertion
Yes
No
Yes
No
Answer: B Difficulty: Medium
13. Suitable criteria in an attestation engagement may be available:
A)
B)
C)
D)
Publicly In CPA’s Report
Yes
Yes
yes
No
No
Yes
No
No
Answer: A Difficulty: Hard
Chapter 20 Additional Assurance Services: Other Information
14. When performing an attestation examination engagement, which of the following is
not always required?
A) Assertion.
B) Practitioner independence.
C) Subject matter.
D) Suitable criteria.
Answer: A Difficulty: Hard
15. Which of the following engagements is most likely to consider availability, security,
integrity, and maintainability of a company's computer systems?
A) Internal control over financial reporting.
B) Trust Services.
C) WebsiteAsssociate.
D) Financial statement audit.
Answer: B Difficulty: Medium
16. Which of the following are Trust Services principles?
A)
B)
C)
D)
Security
Yes
Yes
No
No
Availability
Yes
No
Yes
No
Answer: A Difficulty: Hard
17. Which of the following is the least likely to be considered subject matter of an
attestation engagement?
A) Assertion.
B) Behavior.
C) Historical event.
D) Systems and processes.
Answer: A Difficulty: Medium
Chapter 20 Additional Assurance Services: Other Information
18. Arel, CPA, was engaged by a group of royalty recipients to apply agreed-upon
procedures to financial data supplied by Modit Co. regarding Modit's written assertion
about its compliance with contractual requirements to pay royalties. Arel's report on
these agreed-upon procedures should contain a (an).
A) Disclaimer of opinion about the fair presentation of Modit's financial statements.
B) List of the procedures performed (or reference thereto) and Arel's findings.
C) Opinion about the effectiveness of Modit's internal control activities concerning
royalty payments.
D) Acknowledgment that the sufficiency of the procedures is solely Arel's
responsibility.
Answer: B Difficulty: Medium
19. Assurance services performed for decision makers may address the:
A)
B)
C)
D)
Quality of information Context of information
Yes
Yes
Yes
No
No
Yes
No
No
Answer: A Difficulty: Medium
20. Which of the following is not necessarily an attest engagement?
A) An elder care engagement.
B) A WebTrust engagement.
C) An examination of internal control over financial reporting.
D) A review of management's discussion and analysis.
Answer: A Difficulty: Hard
21. Which of the following are required on all attestation engagements?
A)
B)
C)
D)
Suitable Criteria
Yes
Yes
No
No
Subject Matter
Yes
No
Yes
No
Answer: A Difficulty: Medium
Chapter 20 Additional Assurance Services: Other Information
22. Which of the following is not currently an acceptable form of association with
prospective financial statements?
A) Compilation.
B) Review.
C) Agreed-upon procedures.
D) Examination.
Answer: B Difficulty: Medium
23. When a practitioner examines projected financial statements, the practitioner's report
should include a separate paragraph that:
A) Describes the limitations on the usefulness of the presentation.
B) Provides an explanation of the differences between an examination and a review.
C) States that the accountant is responsible for events and circumstances for a period
not exceeding one year after the report's date.
D) Disclaims an opinion on whether the assumptions provide a reasonable basis for
the projection.
Answer: A Difficulty: Hard
24. Which of the following is correct relating to an engagement to apply agreed-upon
procedures to prospective financial statements?
A) Use of the report is restricted to the specified users.
B) Such engagements are permissible for forecasts but not for projections.
C) Responsibility for the adequacy of the procedures performed is taken by the
practitioner.
D) Such engagements are not permissible under the professional standards.
Answer: A Difficulty: Medium
25. When a financial forecast fails to disclose a significant assumption used to prepare that
forecast, which of the following reports become appropriate?
A)
B)
C)
D)
Qualified
Yes
Yes
No
No
Adverse
Yes
No
Yes
No
Answer: C Difficulty: Hard
Chapter 20 Additional Assurance Services: Other Information
26. When reporting upon a review engagements on an entity's management discussion and
analysis, the report is ordinarily:
A) A general use report.
B) A restricted use report.
C) Required to include a disclaimer of opinion.
D) Included with the entity's report on internal control over financial reporting.
Answer: B Difficulty: Medium
27. When management presents a written assertion on internal control effectiveness, it
evaluates the company's internal control using reasonable criteria for internal control,
referred to as.
A) Control environment criteria.
B) Tone criteria.
C) Control criteria
D) Integrated criteria.
Answer: C Difficulty: Easy
28. When compared to the consideration of internal control for purposes of an audit, an
examination of management's assertion about the effectiveness of an entity's internal
control may be expected to require a(n):
A) Increased scope of tests of balances.
B) Increased scope of tests of controls.
C) Greater reliance upon analytical procedures.
D) Increased emphasis on fairness of future presentation.
Answer: B Difficulty: Hard
29. Which of the following is least likely to result in modification of an opinion on
management's assertion about the effectiveness of an entity's internal control?
A) Significant circumstance imposed scope limitations.
B) Significant management imposed scope limitations.
C) Reportable conditions that are not also material weaknesses in internal control
D) Material weaknesses in internal control.
Answer: C Difficulty: Hard
Chapter 20 Additional Assurance Services: Other Information
30. Providing assurance using a series of reports provided simultaneously or shortly after
the related information is released is referred to as:
A) Continuous auditing.
B) Serial auditing.
C) Systems reliability auditing.
D) Simultaneity auditing.
Answer: A Difficulty: Easy
31. The organization established to identify, develop and communicate new assurance
service opportunities is the:
A) Assurance Services Executive Committee.
B) Attestation Standards board.
C) Auditing Standards Board.
D) Counsel of Executives.
Answer: A Difficulty: Medium
32. Many new services assurance services are performed in accordance with Statements
on
A) Standards for Attestation Services.
B) Generally Accepted Assurance Standards.
C) Auditing Standards.
D) Accounting for other Assurance Services.
Answer: A Difficulty: Medium
33. Independence is required when performing:
A)
B)
C)
D)
Attest Services
Yes
Yes
No
No
Assurance Services
Yes
No
Yes
No
Answer: A Difficulty: Medium
Chapter 20 Additional Assurance Services: Other Information
34. A practitioner's unqualified opinion based upon an examination may ordinarily be on:
A)
B)
C)
D)
Subject Matter
Yes
Yes
No
No
Assertion
Yes
No
Yes
No
Answer: A Difficulty: Medium
35. Which attest engagement aligns most directly with a financial statement audit in terms
of assurance provided?
A) Agreed-upon procedures.
B) Evaluation.
C) Examination.
D) Review.
Answer: C Difficulty: Easy
36. The WebTrust engagement relates most directly to
A) Financial statements maintained on the Internet.
B) Health care facilities.
C) Risk assurance procedures.
D) Electronic commerce systems.
Answer: D Difficulty: Easy Source: AICPA
37. Under the attestation standards, in which of the following circumstances is a review
report least likely to be issued?
A) Criteria are agreed-upon or only available to specified users.
B) Established criteria exist, but other criteria are used.
C) The subject matter departs from the criteria.
D) A significant limitation on the scope of the engagement has occurred.
Answer: D Difficulty: Hard
Chapter 20 Additional Assurance Services: Other Information
38. To accept an engagement to examine a client's MD&A for annual financial statements,
the practitioners ordinarily must have:
A) Audited the most recent financial statement period to which the MD&A applies.
B) Determined that the client reports to the Securities and Exchange Commission.
C) Performed a detailed analysis of the client's controls over decision making.
D) Reviewed the quarterly MD&A information.
Answer: A Difficulty: Hard
39. A CPA who wishes to perform a WebTrust engagement need not:
A) Agree to adhere to the WebTrust professional standards.
B) Participate in a quality assurance program.
C) Pass an examination on WebTrust principles and criteria.
D) Take continuing education courses on the WebTrust program.
Answer: C Difficulty: Medium
40. The five principles of a reliable system considered in a Trust Services engagement
include, availability, security, processing integrity, online privacy, and:
A) Control
B) Confidentiality.
C) Relevance.
D) Reliability.
Answer: B Difficulty: Medium
41. When a CPA is associated with a forecast, all of the following should be disclosed
except the:
A) Sources of information.
B) Character of the work performed by the CPA.
C) Major assumptions in the preparation of the forecast.
D) Probability of achieving estimates.
Answer: D Difficulty: Medium Source: AICPA
42. Which of the following is a prospective financial statement for general use upon which
a practitioner may appropriately report?
A) Financial projection.
B) Partial presentation.
C) Pro forma financial statement.
D) Financial forecast.
Answer: D Difficulty: Medium Source: AICPA
Chapter 20 Additional Assurance Services: Other Information
43. The party responsible for assumptions identified in the preparation of prospective
financial statements is usually:
A) A third-party lending institution.
B) The client's management.
C) The reporting accountant.
D) The client's independent auditor.
Answer: B Difficulty: Easy Source: AICPA
44. Given one or more hypothetical assumptions, a responsible party may prepare an
entity's expected financial position, results of operations, and changes in financial
position. Such prospective financial statements are known as:
A) Pro forma financial statements.
B) Financial projections.
C) Partial Presentation.
D) Financial forecasts.
Answer: B Difficulty: Medium Source: AICPA
45. Accepting an engagement to examine an entity's financial projection most likely
would be appropriate if the projection were to be distributed to:
A) All employees who work for the entity.
B) Potential stockholders who request a prospectus or a registration statement.
C) A bank with which the entity is negotiating for a loan.
D) All stockholders of record as of the report date.
Answer: C Difficulty: Hard Source: AICPA
Chapter 20 Additional Assurance Services: Other Information
Essay Questions
46. The Warren Corporation wants to enhance the market value of its stock by including
in its annual report a financial forecast for the next year. They also would like to have
their auditors examine the forecast.
a. Define a financial forecast.
b. Is an examination of a financial forecast similar in scope to a review of financial
statements? Explain.
Difficulty: Medium
Answer:
a. A financial forecast is "an estimate of the most probable financial position, results
of operations, and changes in financial position for one or more future periods."
b. No. An examination of a financial forecast involves an extensive examination of
the assumptions underlying the forecast, to satisfy the CPAs that management has
identified all key assumptions and that the assumptions are suitably supported.
47. Practitioners may be engaged to attest to an entity's internal control over financial
reporting.
a. Comment on the accuracy of this statement: Accountants may be engaged to
examine, review, or perform agreed-upon procedures on an entity's internal control
over financial reporting.
b. Describe the nature of the four paragraphs included in an accountant's examination
report on internal control over financial reporting.
c. Describe two circumstances in which practitioners would issue an examination
report that is other than the unqualified standards report on internal control.
Difficulty: Medium
Answer:
a. A CPA may examine or perform agreed-upon procedures on an entity's internal
control over financial reporting, but a review of this information is not allowed.
b. A CPA's report on internal control contained the following four paragraphs:
• The first paragraph is an introductory paragraph that describes the assertion
being examined.
• The second paragraph is a scope paragraph that describes the nature of an
examination of an entity's internal control over financial reporting.
• The third paragraph describes the inherent limitations of internal control.
• The fourth paragraph expresses the CPA's opinion on management's assertion
about internal control.
Chapter 20 Additional Assurance Services: Other Information
c. Internal control reports are modified for the following reasons (only two required):
• A qualified report is issued when the scope of the accountant's procedures has
been restricted.
• A disclaimer of opinion is issued when the scope of the accountant's
procedures has been restricted by the client, or severely limited by the
circumstances.
• An adverse report is issued when the accountants become aware of a material
weakness that is not acknowledged in management's report.
• A modified report is issued when the accountants become aware of a material
weakness that is acknowledged in management's report.
Chapter 21 Internal, Operational
True/False Questions
1. The work of internal auditors is primarily for the benefit of management and the board
of directors.
Answer: True Difficulty: Easy
2. The first internal auditors were primarily concerned with operational auditing.
Answer: False Difficulty: Medium
3. The passage of the Foreign Corrupt Practices Act increased the demand for internal
auditing.
Answer: True Difficulty: Easy
4. Evaluation of internal control is one of the general sections of the IIA's Standards of
the Professional Practice of Internal Auditing.
Answer: False Difficulty: Hard
5. In operational auditing, the preliminary survey serves as a guide for the development
of the audit program.
Answer: True Difficulty: Medium
6. When no weaknesses in internal control are discovered during an operational audit, the
appropriate report will be either standard unqualified or unqualified with explanatory
language.
Answer: False Difficulty: Medium
7. Operational audits are primarily concerned with whether an organization follows
appropriate laws and regulations.
Answer: False Difficulty: Medium
8. Compliance procedures are tests of an organization's controls.
Answer: False Difficulty: Hard
Chapter 21 Internal, Operational
9. In an audit in accordance with Government Auditing Standards, the auditors are
required to perform additional compliance procedures beyond those required by
generally accepted auditing standards.
Answer: False Difficulty: Hard
10. In an audit in accordance with the Single Audit Act of 1984, the auditors must test
compliance with the significant requirements of all major programs.
Answer: True Difficulty: Medium
Multiple Choice Questions
11. When auditing an entity's financial statements in accordance with Government
Auditing Standards (the “Yellow Book”), an auditor is required to report on:
I. Noteworthy accomplishments of the program.
II. The scope of the auditor's testing of internal controls.
A)
B)
C)
D)
I only.
II only.
Both I and II.
Neither I nor II.
Answer: B Difficulty: Hard Source: AICPA
12. When auditing an entity's financial statements in accordance with Government
Auditing Standards (the “Yellow Book”), an auditor is required to report on:
I. Recommendations for actions to improve operations.
II. The scope of the auditor's tests of compliance with laws and regulations.
A)
B)
C)
D)
I only.
II only.
Both I and II.
Neither I nor II.
Answer: B Difficulty: Hard Source: AICPA
Chapter 21 Internal, Operational
13. A comprehensive examination of an operating unit or a complete organization to
evaluate its systems, controls, and performance, as measured by management's
objectives.
A) Compilation.
B) Consultation.
C) Operational Audit.
D) “Yellow Book” audit.
Answer: C Difficulty: Medium
14. An audit in accordance with the Single Audit Act does not involve reporting upon:
A) Compliance with provisions of laws that may have a direct and material affect on
each major federal financial assistance program.
B) Financial statements.
C) Internal control over operations.
D) Schedule of expenditures of federal awards.
Answer: C Difficulty: Hard
15. Under the Single Audit Act, the auditor must apply procedures to test for compliance
and test the effectiveness of controls for:
A)
B)
C)
D)
Major Programs
Yes
Yes
No
No
NonMajor Programs
Yes
No
Yes
No
Answer: B Difficulty: Medium
16. Internal auditing is considered to be part of an organization's:
A) Accounting system.
B) Control activities.
C) Monitoring.
D) External controls.
Answer: C Difficulty: Medium
Chapter 21 Internal, Operational
17. Which of the following is not one of the attribute standards of the IIA's Standards for
the Professional Practice of Internal Auditing?
A) Independence and objectivity.
B) Outsourcing.
C) Proficiency and professional care.
D) Purpose, authority, and responsibility.
Answer: B Difficulty: Medium
18. Which of the following is not required of an individual seeking to become a certified
internal auditor?
A) Two years work experience in internal auditing or its equivalent.
B) Successful completion of a two-day examination.
C) A baccalaureate degree from an accredited college.
D) One year of supervisory experience.
Answer: D Difficulty: Medium
19. For the highest degree of independence the director of internal auditing should report
directly to:
A) The controller.
B) The audit committee of the board of directors.
C) The executive vice-president.
D) The chief accountant.
Answer: B Difficulty: Easy
20. The operational auditors' preliminary conclusions about potential problem areas are
summarized as:
A) The definition of purpose.
B) The audit program.
C) The preliminary survey.
D) The audit report.
Answer: C Difficulty: Medium
Chapter 21 Internal, Operational
21. A legal aid society provides free legal aid to low-income individuals with funds
passed-through the state welfare department from the U.S. Department of Health and
Human Services. In this situation which organization is the primary recipient of the
funds?
A) The state welfare department.
B) The Department of Health and Human Services.
C) The legal aid society.
D) The individual receiving the aid.
Answer: A Difficulty: Hard
22. In an audit in accordance with Government Auditing Standards, the auditors are
required to provide a report on:
A) Compliance with general requirements.
B) The schedule of financial assistance received.
C) The organization's internal control.
D) Findings and questioned costs.
Answer: C Difficulty: Medium
23. Which of the following types of audits is designed to determine that an organization
has complied with the specific requirements of major financial assistance programs?
A) An audit in accordance with Government Auditing Standards.
B) A single audit.
C) An audit in accordance with generally accepted auditing standards.
D) An operational audit.
Answer: B Difficulty: Medium
24. Compliance auditing procedures are:
A) Tests of controls.
B) Observation procedures.
C) Substantive procedures.
D) Confirmation procedures.
Answer: C Difficulty: Medium
Chapter 21 Internal, Operational
25. In an audit in accordance Government Auditing Standards, the auditors are required to
provide a report on:
A) Compliance applicable to major federal programs.
B) The Schedule of financial assistance received.
C) Compliance with laws and regulations which are required to be tested by generally
accepted auditing standards.
D) Internal control systems used in administering federal assistance programs.
Answer: C Difficulty: Medium
26. In an audit in accordance with generally accepted auditing standards, the auditors must
test compliance with those laws and regulations that:
A) Have a direct and material effect on the financial statements.
B) Have a direct and material effect on major federal programs.
C) Have a material direct or indirect effect on the financial statements.
D) Have a material effect on major or nonmajor programs.
Answer: A Difficulty: Medium
27. Requirements of federal financial assistance programs that involve significant national
policy are known as:
A) Specific requirements.
B) Major program requirements.
C) General requirements.
D) Primary requirements.
Answer: C Difficulty: Medium
28. Costs paid with federal assistance that appear to be in violation of a law or regulation
are known as:
A) Questioned costs.
B) Noncompliance costs.
C) Improper costs.
D) Illegal costs.
Answer: A Difficulty: Medium
Chapter 21 Internal, Operational
29. When performing an audit of a city in accordance with the Single Audit Act, an
auditor should adhere to:
A) Standards for the Professional Practice of Internal Auditing.
B) Government Auditing Standards.
C) Operational Auditing Standards.
D) Financial Accounting Standards.
Answer: B Difficulty: Hard
30. A primary purpose of operational auditing standards is to provide:
A) A means of assurance that internal control is operating effectively.
B) Aid to the independent auditor in conducting the audit of financial statements.
C) The results of internal examinations of financial and accounting matters to the
company's top-level management.
D) A measure of management performance in meeting organizational goals.
Answer: D Difficulty: Medium
31. The primary purpose of the internal auditors' evaluation of internal control is to:
A) Determine if management has planned and implemented activities needed to attain
goals and objectives.
B) Determine the extent of tests of controls needed during field work.
C) Identify areas for fraud investigation.
D) Determine if employees have incompatible duties that have compromised the
control environment.
Answer: A Difficulty: Hard Source: IIA
32. According to the IIA's Standards, an internal auditor's working papers should be
reviewed by the:
A) Management of the department being audited.
B) Management of the internal auditing department.
C) Audit committee of the board of directors.
D) Management of the organization's security division.
Answer: B Difficulty: Medium Source: IIA
Chapter 21 Internal, Operational
33. Management is beginning to take corrective action on personnel department
deficiencies reported during the last internal audit. According to the IIA's Standards,
the internal auditor should:
A) Oversee the corrective action.
B) Postpone the next audit of the personnel department until the corrective action is
completed.
C) Refrain from judging whether the corrective action will remedy the deficiencies.
D) Follow up to see that the corrective action satisfies the audit recommendations.
Answer: D Difficulty: Medium Source: IIA
34. The internal auditing department provides information about control and quality of
performance to:
A) Management and the board of directors.
B) A level in the organization sufficient to ensure acceptance of all recommendations.
C) Outside agencies for regulatory and financial compliance.
D) Any member of the organization upon request.
Answer: A Difficulty: Easy Source: IIA
35. The GAO standards of reporting for governmental financial audits incorporate the
AICPA standards of reporting and prescribe supplemental standards to satisfy the
unique needs of governmental audits. Which of the following is a supplemental
reporting standard for audits in accordance with Government Auditing Standards?
A) A report on the auditor's understanding of the entity's internal control and
assessment of control risk should be issued.
B) Material indications of illegal acts should be reported in a document with
distribution restricted to senior officials of the entity audited.
C) Instances of abuse, fraud, mismanagement, and waste should be reported to the
organization with legal oversight authority over the entity audited.
D) All privileged and confidential information discovered should be reported to the
senior officials of the organization that arranged for the audit.
Answer: A Difficulty: Medium Source: AICPA
Chapter 21 Internal, Operational
36. Kent is auditing an entity's compliance with requirements governing a major federal
financial assistance program in accordance with the Single Audit Act. Kent detected
noncompliance with requirements that have a material effect on that program. Kent's
report on compliance should express a(an):
A) Unqualified opinion with a separate explanatory paragraph.
B) Qualified opinion or an adverse opinion.
C) Adverse opinion or a disclaimer of opinion.
D) Limited assurance on the items tested.
Answer: B Difficulty: Medium Source: AICPA
37. The scope of an internal audit is initially defined by the:
A) Audit objectives.
B) Scheduling and time estimates.
C) Preliminary survey.
D) Audit program.
Answer: A Difficulty: Medium Source: IIA
38. An operational audit report which deals with the scrap disposal function in a
manufacturing company is most likely to address:
A) The efficiency and effectiveness of the scrap disposal function and include any
findings requiring corrective action.
B) Whether the scrap material inventory is reported as a current asset.
C) Whether the physical inventory count of the scrap material agrees with the
recorded amount.
D) Whether the scrap materials inventory is valued at the lower of cost or market.
Answer: A Difficulty: Medium Source: IIA
39. Interviewing operating personnel, identifying he objectives of the auditee, identifying
standards used to evaluate performance, and assessing the risk inherent in the auditee's
operations are activities typically performed in which phase of an internal audit?
A) The fieldwork phase.
B) The preliminary survey phase.
C) The audit programming phase.
D) The reporting phase.
Answer: B Difficulty: Medium Source: IIA
Chapter 21 Internal, Operational
40. In governmental accounting, emphasis is placed on:
A) Total assets owned by the governmental entity.
B) Generating income form funds employed.
C) Expenditures of funds.
D) The flow of funds through the income statement.
Answer: C Difficulty: Hard Source: IIA
41. Which of the following best describes the scope of internal auditing as it has
developed to date?
A) Internal auditing involves appraising the economy and efficiency with which
resources are employed.
B) Internal auditing involves evaluating compliance with policies, plans, procedures,
laws, and regulations.
C) Internal auditing has evolved to verifying the existence of assets and reviewing the
means of safeguarding assets.
D) Internal auditing has evolved to more of an operational orientation from a
financial orientation.
Answer: D Difficulty: Hard Source: IIA
42. In planning an audit, an on-site survey could assist with all of the following, except:
A) Obtaining auditee comments and suggestions on control problems.
B) Obtaining preliminary information on internal control.
C) Identifying areas for audit emphasis.
D) Evaluating the effectiveness of the internal control.
Answer: D Difficulty: Hard Source: IIA
Chapter 21 Internal, Operational
Essay Questions
43. Internal auditors are an important part of the internal control structures of all types of
organizations.
a. Describe the objectives of an internal auditing function.
b. Explain two ways that internal auditors may maintain independence with respect to
the activities that they audit.
Difficulty: Medium
Answer:
a. Internal auditing is an independent, objective assurance and consulting activity
designed to add value and improve an organization's operations. It helps an
organization accomplish its objectives by bringing a systematic, disciplined
approach to evaluate and improve the effectiveness of risk management, control,
and governance processes.
b. The internal auditors maintain independence by:
Ensuring that the organizational status of the internal auditing department is
sufficient to permit the accomplishment of its objectives, and
Policies and procedures regarding the assignment of internal auditors to
assignments.
Chapter 21 Internal, Operational
44. Operational auditing has grown in importance over the last few decades.
a. Define operational auditing.
b. Who are the major users of operational audit reports.
c. List the phases of an operational audit.
Difficulty: Hard
Answer:
a. An operational audit is a comprehensive examination of an operating unit or a
complete organization to evaluate its performance, as measured by management's
objectives. It focuses on effectiveness, efficiency, and economy.
b. The major users of operational reports are top management, including the board of
directors and, especially in the case of governmental organizations, Congress.
c. The phases in an operational audit include:
• Definition of purpose.
• Familiarization.
• Preliminary survey.
• Program development.
• Reporting the findings.
• Follow-up.
45. Many government and nonprofit organizations are required to have an audit in
accordance with Government Auditing Standards.
c. Who develops Government Auditing Standards?
d. Describe the requirements of an audit in accordance with Government Auditing
Standards.
e. Describe the auditors' responsibilities for testing for compliance with laws and
regulations in an audit in accordance with Government Auditing Standards.
Difficulty: Hard
Chapter 21 Internal, Operational
Answer:
a. The United States General Accounting Office (GAO) establishes Government
Auditing Standards.
b. The requirements of an audit in accordance with Government Auditing Standards
include:
• Perform audit procedures required by generally accepted auditing standard.
• Communicate the nature of the audit and level of assurance provided to outside
individuals or organizations requiring the audit services.
• Consider the results of previous audits and follow-up on significant findings
and recommendations in prior-year audit reports.
• Provide additional audit documentation.
• Perform audit procedures to provide reasonable assurance of detecting material
violations of provisions of contracts and grants.
• Issue written reports on compliance with laws and regulations and on internal
control.
• In some cases, report fraudulent or illegal acts directly to a government agency
or another third party.
c. Under Government Auditing Standards the auditors must perform test of
compliance with laws and regulations that have a direct and material effect on the
financial statements--the same as under generally accepted auditing standards.