Auditing and Assurance Services, 16e (Arens/Elder/Beasley)
Chapter 24 Completing the Audit
24.1 Learning Objective 24-1
1) Auditors often integrate procedures for presentation and disclosure objectives with
A)
Tests for transaction-related
objectives
Tests for balance-related objectives
Yes
Yes
B)
Tests for transaction-related
objectives
Tests for balance-related objectives
No
No
C)
Tests for transaction-related
objectives
Tests for balance-related objectives
Yes
No
D)
Tests for transaction-related
objectives
Tests for balance-related objectives
No
Yes
2) The auditor’s primary concern relative to presentation and disclosure-related objectives is
A) accuracy.
B) existence.
C) completeness.
D) occurrence.
3) An auditor is reconciling the amounts included in the long-term debt footnotes to the
information examined and supported in the audit files for long-term debt. Which audit objective
is being satisfied?
A) accuracy and valuation
B) occurrence and rights and obligations
C) completeness
D) classification and understandability
4) Which of the following is an accurate statement regarding presentation and disclosure?
A) Auditors generally set the risk as low that all required information may not be completely
disclosed in the footnotes.
B) Audit tests performed in earlier audit phases provides sufficient appropriate evidence about
contingent liabilities and subsequent events.
C) Auditors do not conduct tests of controls related to disclosures when the initial assessment of
control risk is below maximum.
D) In phase IV (completing the audit), auditors evaluate whether the overall presentation of the
financial statements and related footnotes complies with accounting standards.
5) When an auditor reviews the financial statements to determine if assets are properly classified
between current and noncurrent, he is satisfying the audit objective of occurrence and rights and
obligations.
24.2 Learning Objective 24-2
1) If a potential loss on a contingent liability is remote, the liability usually is
A) disclosed in footnotes, but not accrued.
B) neither accrued nor disclosed in footnotes.
C) accrued and indicated in the body of the financial statements.
D) disclosed in the auditor’s report but not disclosed on the financial statements.
2) A commitment is best described as
A) an agreement to commit the firm to a set of fixed conditions in the future.
B) an agreement to commit the firm to a set of fixed conditions in the future that depends on
company profitability.
C) an agreement to commit the firm to a set of fixed conditions in the future that depends on
current market conditions.
D) a potential future obligation to an outside party for an as yet to be determined amount.
3) Which of the following groups has the responsibility for identifying and deciding the
appropriate accounting treatment for recording or disclosing contingent liabilities?
A) auditors
B) legal counsel
C) management
D) management and the auditors
4) You are auditing Rodgers and Company. You are aware of a potential loss due to
noncompliance with environmental regulations. Management has assessed that there is a 40%
chance that a $10M payment could result from the non-compliance. The appropriate financial
statement treatment is to
A) accrue a $4 million liability.
B) disclose a liability and provide a range of outcomes.
C) since there is less than a 50% chance of occurrence, ignore.
D) since there is greater that a remote chance of occurrence, accrue the $10 million.
5) Which of the following is a contingent liability with which an auditor is particularly
concerned?
A)
Notes receivable discounted
Product warranties
Yes
Yes
B)
Notes receivable discounted
Product warranties
No
No
C)
Notes receivable discounted
Product warranties
Yes
No
D)
Notes receivable discounted
Product warranties
No
Yes
6) Audit procedures related to contingent liabilities are initially focused on
A) accuracy.
B) completeness.
C) existence.
D) occurrence.
7) With which of the following client personnel would it generally not be appropriate to inquire
about commitments or contingent liabilities?
A) controller
B) president
C) accounts receivable clerk
D) vice president of sales
8) Inquiries of management regarding the possibility of unrecorded contingencies will be useful
in uncovering
A)
Management’s intentional failure to
disclose existing contingencies.
When management does not
comprehend accounting disclosure
requirements.
Yes
Yes
B)
Management’s intentional failure to
disclose existing contingencies.
When management does not
comprehend accounting disclosure
requirements.
No
No
C)
Management’s intentional failure to
disclose existing contingencies.
When management does not
comprehend accounting disclosure
requirements.
Yes
No
D)
Management’s intentional failure to
disclose existing contingencies.
When management does not
comprehend accounting disclosure
requirements.
No
Yes
9) Which of the following is not considered a commitment?
A) agreements to purchase raw materials
B) pension plans
C) agreements to lease facilities at set prices
D) Each of the above is a commitment.
10) If an auditor concludes there are contingent liabilities, then he or she must evaluate the
A)
Materiality of the potential liability.
Yes
B)
Materiality of the potential liability.
No
C)
Materiality of the potential liability.
Yes
D)
Materiality of the potential liability.
No
11) One of the primary approaches in dealing with uncertainties in loss contingencies uses a(n)
________ threshold.
A) monetary
B) materiality
C) probability
D) analytical
12) If the auditor concludes that there are contingent liabilities, he or she must evaluate the
significance of the potential liability and the nature of the disclosure needed in the financial
statements. Which of the following statements is not true?
A) The potential liability is sufficiently well known in some instances to be included in the
financial statements as an actual liability.
B) Disclosure may be unnecessary if the contingency is highly remote or immaterial.
C) A CPA firm often obtains a separate evaluation of the potential liability from its own legal
counsel rather than relying on management or management’s attorneys.
D) The client’s attorneys must remain independent when evaluating the likelihood of losing the
lawsuit.
13) When using the probability threshold for contingencies, the likelihood of the occurrence of
the event is classified as
A) not likely, likely, or highly likely.
B) remote, reasonably possible, or probable.
C) slight, moderate, great.
D) remote, likely, possible.
14) When dealing with contingencies,
A) all contingencies must be disclosed or footnoted.
B) the auditor must exercise considerable professional judgment when evaluating whether the
client has applied the appropriate treatment.
C) it is easy for the auditor to uncover contingencies without management’s cooperation.
D) the review for contingent liabilities is only performed at the beginning and the end of the
audit.
15) Which of the following is not a common audit procedure used to search for contingent
liabilities?
A) examine letters of credit
B) examine payroll reports
C) review internal revenue agent reports
D) analyze legal expense
16) Contingent liability disclosure in the footnotes of the financial statements would normally be
made when
A) the outcome of the accounting event is deemed probable, but a reasonable estimation as to the
amount cannot be made by the client or auditor.
B) a reasonable estimation of the loss can be made, but the outcome is not probable.
C) the outcome of the accounting event is deemed probable, and a reasonable estimation as to the
amount can be made.
D) the outcome of the accounting event as well as a reasonable estimation of the loss cannot be
made.
17) Three conditions are required for a contingent liability to exist. Which of the following is not
one of those conditions?
A) There is a potential future payment to an outside party or the impairment of an asset that
resulted from an existing condition.
B) The outcome must be resolved by a third-party.
C) There is uncertainty about the amount of the future payment or impairment.
D) The outcome will be resolved by some future event or events.
18) Distinguish between contingent liabilities and commitments.
19) Define the term contingent liability and discuss the criteria accountants and auditors use to
classify these accounting events.
20) With what types of contingencies might an auditor be concerned?
21) What are the three required conditions for a contingent liability to exist?
22) An environmental clean-up lawsuit is pending against your client. What information about
the lawsuit would you as the auditor need in order to determine the proper accounting treatment?
23) Discuss three audit procedures commonly used to search for contingent liabilities.
24) A lawsuit has been filed against your client. If, in the opinion of legal counsel, the likelihood
your client will lose the lawsuit is remote, no financial statement accrual or disclosure of the
potential loss would generally be required.
25) Current professional auditing standards make it clear that management, not the auditor, is
responsible for identifying and deciding the appropriate accounting treatment for contingent
liabilities.
26) Many of the audit procedures for finding contingencies are usually performed as an integral
part of various segments of the audit rather than as a separate activity near the end of the audit.
27) The probability threshold for dealing with uncertainty in loss contingencies uses the terms
likely and unlikely.
28) The first stop in the audit of contingencies is to determine the amount of the contingency.
24.3 Learning Objective 24-3
1) Auditors will generally send a standard inquiry to the client’s attorney letter to
A) only those attorneys who have devoted substantial time to client matters during the year.
B) every attorney that the client has been involved with in the current or preceding year, plus any
attorney the client engages on occasion.
C) every attorney whose legal fees for the year exceed a materiality threshold.
D) only the attorney who represents the client in proceeding where the client is defendant.
2) What needs to be included in a standard inquiry to the client’s attorney letter sent to a client’s
legal counsel?
A)
Any pending threatened
litigation with which the
attorney has had significant
involvement
The amount of legal fees paid
by the client to the attorney
Yes
Yes
B)
Any pending threatened
litigation with which the
attorney has had significant
involvement
The amount of legal fees paid
by the client to the attorney
No
No
C)
Any pending threatened
litigation with which the
attorney has had significant
involvement
The amount of legal fees paid
by the client to the attorney
Yes
No
D)
Any pending threatened
litigation with which the
attorney has had significant
involvement
The amount of legal fees paid
by the client to the attorney
No
Yes
3) Auditors, as part of completing the audit, will request the client to send a standard inquiry to
the client’s attorney letter to those attorneys the company has been consulting with during the
year under audit regarding legal matters of concern to the company. The primary reason the
auditor requests this information is to
A) determine the range of probable loss for asserted claims.
B) obtain a professional opinion about the expected outcome of existing lawsuits and the likely
amount of the liability, including court costs.
C) obtain an outside opinion of the probability of losses in determining accruals for
contingencies.
D) obtain an outside opinion of the probability of losses in determining the proper footnote
disclosure.
4) The standard inquiry to the client’s attorney should be prepared on
A) plain paper (no letterhead) and be unsigned.
B) lawyer’s stationery and signed by the lawyer.
C) auditor’s stationery and signed by an audit partner.
D) client’s letterhead and signed by a company official.
5) What is one of the main reasons an attorney may refuse to provide auditors with complete
information about contingent liabilities?
A)
The attorneys refuse to
disclose information they
consider confidential.
The attorneys refuse to
respond due to a lack of
knowledge about matters
involving contingent
liabilities.
Yes
Yes
B)
The attorneys refuse to
disclose information they
consider confidential.
The attorneys refuse to
respond due to a lack of
knowledge about matters
involving contingent
liabilities.
No
No
C)
The attorneys refuse to
disclose information they
consider confidential.
The attorneys refuse to
respond due to a lack of
knowledge about matters
involving contingent
liabilities.
Yes
No
D)
The attorneys refuse to
disclose information they
consider confidential.
The attorneys refuse to
respond due to a lack of
knowledge about matters
involving contingent
liabilities.
No
Yes
6) An attorney is aware of a violation of a patent agreement that could result in a significant loss
to the client if it were known. This is an example of a(n)
A) commitment.
B) unasserted claim.
C) pending litigation.
D) subsequent event.
7) Management furnishes the independent auditor with information concerning litigation, claims,
and assessments. Which of the following is the auditor’s primary means of initiating action to
corroborate such information?
A) Request that client lawyers undertake a reconsideration of matters of litigation, claims, and
assessments with which they were consulted during the period under examination.
B) Request that client management send a standard inquiry to the client’s attorney letter to those
lawyers with whom management consulted concerning litigation, claims, and assessments.
C) Request that client lawyers provide a legal opinion concerning the policies and procedures
adopted by management to identify, evaluate, and account for litigation, claims, and assessments.
D) Request that client management engage outside attorneys to suggest wording for the text of a
footnote explaining the nature and probable outcome of existing litigation, claims, and
assessments.
8) If an attorney refuses to provide the auditor with information about material existing lawsuits
or unasserted claims,
A) the attorney may face sanctions from the American Bar Association.
B) the auditors must modify their audit report to reflect the lack of available evidence.
C) the attorney can no longer represent the client.
D) the auditor must withdraw from the engagement.
9) As directed by the Sarbanes-Oxley Act,
A) an attorney must report material violations of federal securities law to the public company’s
chief legal counsel or chief executive officer.
B) attorneys cannot breach confidentiality rules even if a client is committing a crime or a fraud.
C) if the audit committee fails to remedy any material violations of the federal securities law, the
attorney must report the violation to the SEC.
D) All of the above are required by Sarbanes-Oxley.
10) Attorneys in recent years have become reluctant to provide certain information to auditors
because of their own exposure to legal liability for providing incorrect or confidential
information. State the two main reasons that attorneys refuse to provide the auditors with
complete information.
11) State three items that should be included in a standard inquiry to the client’s attorney letter.
12) When preparing a standard inquiry to the client’s attorney letter, the client’s letterhead should
be used, and the letter should be signed by the client company’s officials.
13) In a standard inquiry to the client’s attorney letter, the attorney is requested to communicate
about contingencies up to the balance sheet date.
14) If an attorney refuses to provide the auditor with information about material existing lawsuits
or unasserted claims, current professional standards require that the auditor consider the refusal
as a scope limitation.
24.4 Learning Objective 24-4
1) The auditor has a responsibility to review transactions and activities occurring after the
balance sheet date to determine whether anything occurred that might affect the statements being
audited. The procedures required to verify these transactions are commonly referred to as the
review for
A) contingent liabilities.
B) subsequent year’s transactions.
C) late unusual occurrences.
D) subsequent events.
2) Which type of subsequent event requires consideration by management and evaluation by the
auditor?
A)
Subsequent events that have a direct
effect on the financial statements and
require adjustment
Subsequent events that do not have a
direct effect on the financial
statements but for which disclosure
may be required
Yes
Yes
B)
Subsequent events that have a direct
effect on the financial statements and
require adjustment
Subsequent events that do not have a
direct effect on the financial
statements but for which disclosure
may be required
No
No
C)
Subsequent events that have a direct
effect on the financial statements and
require adjustment
Subsequent events that do not have a
direct effect on the financial
statements but for which disclosure
may be required
Yes
No
D)
Subsequent events that have a direct
effect on the financial statements and
require adjustment
Subsequent events that do not have a
direct effect on the financial
statements but for which disclosure
may be required
No
Yes