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3) When comparing misstatements with a measurement base, the auditor must consider the
pervasiveness of the misstatement. Of the following examples, the most pervasive misstatement
is a(n)
A) understatement of inventory.
B) understatement of retained earnings caused by a miscalculation of dividends payable.
C) misclassification of notes payable as a long-term liability when it should be current.
D) misclassification of salary expense as a selling expense.
4) The dollar amount of some misstatements cannot be accurately measured. For example, if the
client were unwilling to disclose an existing lawsuit, the auditor must estimate the likely effect
on
A) net income.
B) users of the financial statements.
C) the auditor's exposure to lawsuits.
D) management's future decisions.
5) If most or all users' decisions that are based on the financial statements are likely to be
significantly affected, the materiality level is
A) unrestricted.
B) material.
C) pervasive.
D) risky.
6) When a client fails to follow GAAP, the audit report can be unmodified, qualified, or adverse
depending on the materiality. What factors affect materiality that an auditor should consider?
A) the dollar amount in comparison to a base
B) if the misstatement can be measured
C) the nature of the item
D) All the above are factors an auditor should consider regarding materiality.
7) Which of the following is a correct statement regarding materiality?
A) There are well-defined guidelines that enable auditors to determine if something is material.
B) Misstatements must be compared with some benchmark before a decision can be made about
the materiality level of the failure of a company to follow GAAP.
C) Pervasiveness is not considered when comparing potential misstatements with a base or
benchmark.
D) To evaluate overall materiality, the auditor does not combine all unadjusted misstatements.
8) Management has recorded prepaid insurance as an asset in the previous year. This year, to
reduce record-keeping costs, it expenses insurance. If the amount is immaterial to the financial
statements,
A) a disclaimer opinion is issued.
B) a a qualified opinion is issued.
C) a standard unmodified opinion audit report is issued.
D) no audit report can be issued.
9) The highest level of materiality exists when
A) users are likely to make incorrect decisions if they rely on the overall financial statements.
B) there has been a departure from GAAP.
C) amounts are material but do not overshadow the financial statements as a whole.
D) a scope limitation has been imposed.
10) Discuss how materiality affects audit reporting decisions.
11) Materiality is essential when an auditor considers his/her determination of the appropriate
report for a given set of circumstances.
12) A pervasive exception is one that affects different parts of the financial statements.
13) An item with a "psychological" effect (e.g., where the item maintains an increasing earnings
trend) is a qualitative factor that may affect the auditors decision regarding materiality.
14) As misstatements become more pervasive, the likelihood of issuing a disclaimer rather than a
qualified opinion increases.
15) It is typically more difficult to evaluate the materiality of potential misstatements resulting
from a scope limitation than for failure to follow GAAP.
3.7 Learning Objective 3-7
1) A restriction on the scope of the auditor's examination requires
A) a qualifying paragraph to be included in the introduction.
B) a qualifying paragraph preceding the opinion paragraph.
C) a disclaimer opinion.
D) a basis for a qualified opinion paragraph.
2) An auditor who issues a qualified opinion because sufficient appropriate evidence was not
obtained should describe the limitations in an explanatory paragraph. The auditor should also
modify the
A)
Scope paragraph
Opinion paragraph
Notes to the financial
statements
Yes
No
Yes
B)
Scope paragraph
Opinion paragraph
Notes to the financial
statements
No
Yes
Yes
C)
Scope paragraph
Opinion paragraph
Notes to the financial
statements
No
Yes
No
D)
Scope paragraph
Opinion paragraph
Notes to the financial
statements
Yes
Yes
No
3) When an auditor issues a qualified report due to a scope limitation an explanatory paragraph is
normally added. Which, if any, of the following paragraphs are also modified?
A)
Introductory
Scope
Opinion
Yes
Yes
Yes
B)
Introductory
Scope
Opinion
Yes
Yes
No
C)
Introductory
Scope
Opinion
No
Yes
No
D)
Introductory
Scope
Opinion
No
Yes
Yes
4) When a qualified or adverse opinion is issued, the qualifying paragraph is inserted
A) between the introductory and scope paragraphs.
B) between the scope and opinion paragraphs.
C) after the opinion paragraph, as a fourth paragraph.
D) immediately after the address, as the first paragraph.
5) When the client fails to include information that is necessary for the fair presentation of
financial statements in the body of the statements or in the footnotes,
A) it is the auditor's responsibility to present the information in the audit report.
B) the auditor should issue a qualified or an adverse opinion.
C) the qualification is put in an added paragraph preceding the opinion.
D) all of the above
6) If the financial statements include an income statement and a balance sheet but exclude the
statement of cash flows, the auditors
A) can issue an unqualified report.
B) should issue a qualified opinion due to the departure from GAAP.
C) should issue a qualified opinion because the missing statement of cash flows constitutes a
scope limitation.
D) should include the statement of cash flows, modify the report and issue an unqualified
opinion.
7) Which of the following is incorrect concerning scope limitations?
A) If client imposed, the auditor should be concerned about the client trying to prevent discovery
of a material misstatement.
B) An unqualified opinion can result if auditors can perform alternative procedures and are
satisfied that the information is fairly stated.
C) The most common circumstance imposed scope restriction is due to the client changing their
auditors.
D) The most common circumstance imposed scope limitation is when the auditor is appointed
after the balance sheet date.
8) When dealing with materiality and scope limitation conditions,
A) a disclaimer of opinion must be issued.
B) it is easier to evaluate the materiality of potential misstatements resulting from a scope
limitation than for failure to follow GAAP.
C) scope limitations imposed by the client are always considered material.
D) a unqualified opinion may still be issued depending on the materiality of the scope limitation.
9) When a pervasive scope limitation exists,
A) a disclaimer of opinion rather than a qualified opinion is generally required.
B) the auditor's responsibility paragraph is modified to indicate that the auditor was not able to
obtain sufficient appropriate evidence to express an audit opinion.
C) sections of the auditor's responsibility paragraph are eliminated to avoid stating anything that
might lead readers to believe that other parts of the financial statements might be fairly stated.
D) all of the above
10) When there is a scope restriction, what type of audit report can be issued?
A) unmodified opinion
B) qualification of scope and opinion
C) disclaimer of opinion
D) any of the above
11) Subsequent to the close of Spacely Sprockets fiscal year ending October 31, 2016, a major
debtor has declared bankruptcy due to a series of events. The receivable is significantly material
in relation to the financial statements, and recovery is doubtful. The debtor had confirmed the
full amount due to Spacely Sprocket at the balance sheet date. Because the account was
confirmed at the balance sheet date, Spacely refuses to disclose any information in relation to
this subsequent event. The CPA believes that all other accounts were stated fairly at the balance
sheet date. In addition, Spacely changed their method of inventory valuation from FIFO to LIFO.
This change was disclosed in Note X to the financial statements. Accordingly, what type of
opinion should be expressed?
A) unqualified with an explanatory paragraph
B) qualified due to a GAAP departure
C) qualified due to a scope limitation
D) a combination of B and C
12) For the report containing a disclaimer for lack of independence, the disclaimer is in the
A) second or scope paragraph.
B) third or opinion paragraph.
C) first and only paragraph.
D) fourth or explanatory paragraph.
13) When an adverse opinion is issued, a scope paragraph would be
A) qualified.
B) unchanged.
C) deleted.
D) expanded to identify the additional procedures which the auditor performed.
14) After the balance sheet date but prior to issuance of the auditor's report the auditor learns that
the client's facility in a foreign country has been expropriated. Management refuses to disclose
this information in a financial statement footnote or present pro-forma data as to the effect of the
event. The auditor should
A) add a footnote to the financial statements.
B) disclaim an opinion due to the client imposed scope limitation.
C) provide the information in the report and modify the opinion.
D) issue an unqualified opinion but provide the information in the auditor report.
15) The following is a portion of an adverse audit report issued for a public company. (Note: A
separate report was issued on the effectiveness of internal control over financial reporting.)
Independent Auditor's Report
To the shareholders of Wallace Corporation
We have audited the accompanying balance sheet of Wallace Corporation as of December 31,
2016, and the related statements of income, retained earnings, and cash flows for the year then
ended. These financial statements are the responsibility of the company's management. Our
responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes assessing the accounting principles
used and significant estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis for our opinion.
The company has excluded from property and debt in the accompanying balance sheet certain
lease obligations that, in our opinion, should be capitalized in order to conform with generally
accepted accounting principles. If these lease obligations were capitalized, property would be
increased by $14,500,000, long-term debt by $13,200,000, and retained earnings by $1,300,000
as of December 31, 2016, and net income and earnings per share would be increased by
$1,300,000 and $2.25, respectively, for the year then ended.
Required:
Complete the above adverse audit report by preparing the opinion paragraph. Do not date or sign
the report.
16) The following is the introductory paragraph, and the Basis for Qualified Opinion paragraph
for Fast Times Corporation, a nonpublic company.
Independent Auditor's Report
To the shareholders of Fast Times Corporation
We have audited the accompanying balance sheet of Fast Times Corporation as of September 30,
2016, and the related statements of income, retained earnings, and cash flows for the year then
ended, and the related notes to the financial statements.
Basis for Qualified Opinion
We were unable to obtain audited financial statements supporting the company's investment in a
foreign affiliate stated at $1,040,000, or its equity in earnings of that affiliate of $501,000, which
is included in net income, as described in Note 14 to the financial statements. Because of the
nature of the company's records, we were unable to satisfy ourselves as to the carrying value of
the investment or the equity in its earnings by means of other auditing procedures.
Required:
Prepare the opinion paragraph for the above audit report. Do not date or sign the report.
17) Your CPA firm has completed the fieldwork for the 2016 audit of Sharp Corporation, a
private company with an October year-end. You were preparing to draft a standard, unqualified
audit report when you discovered that the audit manager on the Sharp engagement owns 10
shares of Sharp's common stock. Prepare the appropriate report.
18) Assume you are the partner in charge of the 2016 audit of Becker Corporation, a private
company. The audit report has not yet been prepared. In each independent situation following (1-
8), indicate the appropriate action (a-g) to be taken. The possible actions are as follows:
a. Issue an unmodified opinion audit report.
b. Qualify both the scope and opinion paragraphs.
c. Qualify the opinion paragraph.
d. Issue an unmodified opinion with an explanatory paragraph.
e. Issue an unmodified opinion with revised wording (no explanatory paragraph).
f. Issue an adverse opinion.
g. Disclaim an opinion.
The situations are as follows:
________ 1. Becker Corporation carries its property, plant, and equipment accounts at current
market values. Current market values exceed historical cost by a highly material amount, and the
effects are pervasive throughout the financial statements.
________ 2. Management of Becker Corporation refuses to allow you to observe, or make, any
counts of inventory. The recorded book value of inventory is highly material.
________ 3. You were unable to confirm accounts receivable with Becker's customers.
However, because of detailed sales and cash receipts records, you were able to perform reliable
alternative audit procedures.
________ 4. One week before the end of fieldwork, you discover that the audit manager on the
Becker engagement owns a material amount of Becker's common stock.
________ 5. You relied upon another CPA firm to perform part of the audit. Although you were
the principal auditor, the other firm audited a material portion of the financial statements. You
wish to refer to (but not name) the other firm in your report.
________ 6. You have substantial doubt about Becker's ability to continue as a going concern.
________ 7. Becker Corporation changed its method of computing depreciation in 2016. You
concur with the change and the change is properly disclosed in the financial statement footnotes.
________ 8. Ten days after the balance sheet date, one of Becker's buildings was destroyed by a
fire. Becker refuses to disclose this information in a footnote to the financial statements, but you
believe disclosure is required to conform with GAAP. The amount of the uninsured loss was
material, but not highly material.
