Auditing, 12e (Arens)
Chapter 19 Completing the Audit
19.1 Design and perform audit tests related to presentation and disclosure audit objectives
1) Which level of risk does the auditor normally assign to the presentation and disclosure-related
assertion of completeness for contingent liabilities and subsequent events?
A) low risk for inherent risks that required information may not be disclosed in the notes
B) medium for control risk with respect to identifying relevant events
C) medium with respect to providing adequate detail for the notes
D) high that all required information may not be disclosed in the notes
2) Which of the following is a required condition for a contingent liability to exist?
A) There is a potential liability to an employee of the client.
B) The amount of the future payment is known.
C) The liability resulted from known events.
D) The outcome has been resolved by a current event.
3) What situation represents a contingent liability for a company?
A) A candy company’s monthly production requires 1,000 kg of chocolate. The company
entered into a contract with a chocolate producer to purchase 6,000 kg of chocolate over the next
six months at the market price.
B) A bike company learned that a racer using its bike was seriously injured in an accident on
December 30th, 2012, as the front wheel of the bike was released in a curb as a result of a
manufacturing defect. The company has not received a claim at December 31st, 2012 but
management expects to receive a claim.
C) A restaurant received a $10,000 claim from a customer for emotional damages as a result of
poor service. The legal counsel of the restaurant indicated that the claim was not supported and
there was less than a 5% chance that the restaurant would have to pay.
D) A hotel chain was found guilty by a judge for not refunding customers with on-line
reservations. The hotel chain will have to pay $50,000 to various customers in the following
year.
4) When the proper disclosure in the financial statements of material contingencies is through
footnotes, the footnote should describe the nature of the contingency to the extent it is known
and
A) the auditor’s opinion as to the expected outcome.
B) the opinion of legal counsel or management as to the expected outcome.
C) an estimate of the amount or a statement that the amount cannot be estimated.
D) the steps client has taken to ensure that it doesn’t recur.
5) If the amount of a probable loss on a contingent liability is not determinable, the liability
should be
A) accrued and indicated in the body of the financial statements.
B) disclosed in footnotes, but not accrued.
C) neither accrued nor disclosed in footnotes.
D) disclosed in the auditor’s report but not disclosed on the financial statements.
6) If the amount of a probable loss on a contingent liability cannot be estimated, but the event is
likely, the liability should be
A) accrued and indicated in the body of the financial statements.
B) disclosed in footnotes, but not accrued.
C) neither accrued nor disclosed in footnotes.
D) disclosed in the auditor’s report but not disclosed on the financial statements.
7) If a potential loss on a contingent liability is likely and the amount of the loss can be
reasonably estimated, the liability should be
A) accrued and indicated in the body of the financial statements.
B) disclosed in footnotes, but not accrued.
C) neither accrued nor disclosed in footnotes.
D) disclosed in the auditor’s report but not disclosed on the financial statements.
8) Which of the following scenarios regarding a lawsuit filed against a client by a third party
would qualify as a “contingent liability”? A lawsuit has been filed
A) but not yet resolved.
B) and concluded with the client winning.
C) and concluded with a third party winning an award of $100,000, but the client hasn’t paid yet.
D) and concluded with a third party winning an award of $100,000, which the client paid after
the balance sheet date but before the statements are issued.
9) If a potential loss on a contingent liability is unlikely and the event will not likely have a
significant adverse financial effect, the liability should be
A) accrued and indicated in the body of the financial statements.
B) disclosed in footnotes, but not accrued.
C) neither accrued nor disclosed in footnotes.
D) disclosed in the auditor’s report but not disclosed on the financial statements.
10) IFRS uses specific terminology to refer to the likelihood of the occurrence of an
organizational event. Which of the following would need to provide for the (i.e. the financial
statements adjusted)?
A) outflow of resources is required, but cannot be reliably estimated
B) possibility that an outflow of resources is required
C) likelihood is remote
D) amount is yet to be confirmed
11) IFRS uses specific terminology to refer to the likelihood of the occurrence of an
organizational event. Which of the following would require note disclosure in the financial
statements adjusted?
A) likely to occur and the amount can be estimated
B) possible that an outflow of resources is not required
C) likelihood is remote
D) amount is yet to be confirmed
12) The auditor’s responsibility with regards to contingent liabilities is to
A) identify the appropriate accounting treatment.
B) decide on the appropriate accounting treatment.
C) prepare note disclosure.
D) evaluate the accounting treatment of known contingent liabilities.
13) When auditing contingent liabilities, the primary objective at the initial stage of the tests is to
determine
A) the materiality of any liability.
B) what constitutes adequate disclosure of the liability.
C) the likelihood of the liability.
D) the existence of the liability.
14) An agreement which commits the firm to a set of fixed conditions in the future regardless of
what happens to profits or the economy as a whole is a definition of a
A) contingent liability.
B) potentially hazardous agreement.
C) commitment.
D) conditional contract.
15) What audit approach is used to search for unknown commitments?
A) Include as part of the search for subsequent events
B) Conduct with substantive tests associated with the cutoff assertion
C) Perform as part of the audit of each cycle or audit area
D) Include with the legal letter sent to lawyers
16) Management furnishes the 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? Request that client
A) lawyers undertake a reconsideration of matters of litigation, claims, and assessments with
which they were consulted during the period under examination.
B) management send a letter of inquiry to those lawyers with whom management consulted
concerning litigation, claims, and assessments.
C) lawyers provide a legal opinion concerning the policies and procedures adopted by
management to identify, evaluate, and account for litigation, claims, and assessments.
D) management engage outside lawyers to suggest wording for the text of a footnote explaining
the nature and probable outcome of existing litigation, claims, and assessments.
17) There are two categories of lawsuits: an outstanding (or asserted) claim, and a(n)
A) possible or unasserted claim.
B) disputed claim among several parties.
C) settled claim.
D) claims that could result in material misstatements.
18) Which of the following procedures might be useful in discovering a contingent liability for a
lawsuit that management is intentionally neglecting to disclose?
A) Inquiries (orally and in writing) of management
B) Analyze legal expense and review invoices and statements from outside legal counsel
C) Review current and previous years’ Canada Revenue Agency correspondence
D) Obtain a letter of representation from management that it is not aware of any undisclosed
contingent liabilities
19) Which of the following substantive tests would the auditor conduct as a search for contingent
liabilities?
A) select an attribute sample of legal expenses for matching to invoices
B) select a dollar unit sample of legal expenses, for matching to invoices
C) inspect legal expense invoices, doing a census test of legal expenses
D) review a sample of legal invoices, looking for appropriate authorization for payment
20) The standard letter of confirmation sent to the client’s legal counsel should be prepared on
the
A) auditor’s stationery and signed by an audit partner.
B) lawyer’s stationery and signed by the lawyer.
C) client’s stationery and signed by a company official.
D) plain paper and be unsigned.
21) What action will a lawyer likely take if they have information about a law suit that was not
mentioned by the client?
A) in the legal letter, tell the auditor the number of suits, and request the auditor to contact the
client
B) request the client to notify the auditor about the lawsuit
C) they will not mention the lawsuits, they are confidential
D) the law firm will refuse to answer the legal letter, since it is incorrect
22) The auditor has sent inquiry letters to all of the client’s law firms. Two law firms stated that
the client was unlikely to win the lawsuits in question, whereas the client had said the opposite.
What action should the auditor take?
A) ask management for invoices supporting the omitted lawsuits
B) request a meeting with management and the respective law firms
C) ask the law firms to provide additional details with respect to the lawsuits
D) change control risk to maximum and increase substantive testing
23) The standard letter of confirmation from client’s legal counsel should ask for information
about the period of time
A) covered by client’s financial statements.
B) covered by client’s financial statements plus the preceding year.
C) covered by client’s financial statements plus the succeeding year.
D) approximately up to the date of the auditor’s report.
24) You sent a legal letter to a lawyer who had invoiced your client. The lawyer replied that “his
practice consists of conducting real estate closings, and so he could not respond to the letter.”
What impact does this have on the financial statement audit?
A) there is no impact upon the financial statement audit
B) the audit opinion will need to be qualified
C) the auditor will need to provide a denial of opinion
D) additional information is needed by reference to legal invoices from this lawyer
25) If a lawyer refuses to provide the auditor with information that is within the lawyer’s
jurisdiction and may directly affect the fair presentation of financial statements about material
existing lawsuits (asserted claims) or unasserted claims, the audit report would have to be
A) an adverse opinion.
B) a qualified opinion.
C) an unqualified opinion with an explanatory paragraph.
D) modified to reflect the lack of available evidence (ie. scope limitation).
26) The auditor has a responsibility to review transactions and activities occurring after the year-
end to determine whether anything occurred that might affect the valuation or disclosure of the
statements being audited. The auditing 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.
27) The auditor’s responsibility for “reviewing the subsequent events” of a client is normally
limited to the period of time beginning with the
A) balance sheet date and ending with the date of the auditor’s report.
B) start of the fiscal year under audit and ending with the balance sheet date.
C) start of the fiscal year under audit and ending with the date of the auditor’s report
D) balance sheet date and ending with the date the registration statement becomes effective.
28) Whenever subsequent events are used to evaluate the amounts included in the statements,
care must be taken to distinguish between conditions that existed at the balance sheet date and
those that come into being after the end of the year. The subsequent information should not be
incorporated directly into the statements if the conditions causing the change in valuation
A) did not take place until after year-end.
B) did take place before year-end.
C) occurred both before and after year-end.
D) are reimbursable through insurance policies.
29) The following events all occurred after the balance sheet date (6/30/12) but prior to the
auditor’s report (9/10/12). Which one would require an adjustment to the account balances as of
6/30/12?
A) Client will market a new series of equity securities ($2 million of preferred stock) on 8/1/12.
B) Unused equipment on the books at 6/30/12 for $100,000 was disposed of 7/31/12 for $60,000.
C) Securities costing $30,000 held for temporary investment on 6/30/12 declined in value by
one-third when the market took a plunge on 8/15/12.
D) Inventory valued at $100,000 on 6/30/12 was destroyed in a fire on 8/1/12.
30) Subsequent events affecting the valuation of assets ordinarily will require adjustments of the
financial statements under examination because such events typically represent the
A) culmination of conditions that existed at the balance sheet date.
B) final estimates of losses relating to casualties occurring in the subsequent events period.
C) discovery of new conditions occurring in the subsequent events period.
D) preliminary estimate of losses relating to new events that occurred subsequent to the balance
sheet date.
31) A client has a calendar year-end. Listed below are four events that occurred after December
31. Which one of these subsequent events might result in adjustment of the December 31
financial statements?
A) adoption of accelerated depreciation methods
B) write-off of a substantial portion of inventory as obsolete
C) collection of 90% of the accounts receivable existing at December 31
D) sale of a major subsidiary
32) 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 that is expected to double the sales volume
D) settlement of litigation in excess of the recorded liability
33) A client acquired 25% of its outstanding capital stock after year-end and prior to completion
of the auditor’s fieldwork. The auditor should
A) advise management to adjust the balance sheet to reflect the acquisition.
B) issue pro forma financial statements giving effect to the acquisition as if it had occurred at
year-end.
C) advise management to disclose the acquisition in the notes to the financial statements.
D) disclose the acquisition in the opinion paragraph of the auditor’s report.
34) The audit procedures for the subsequent events review can be divided into two categories:
(1) procedures normally integrated as a part of the verification of year-end account balances, and
(2) those performed specifically for the purpose of discovering subsequent events. Which of the
following procedures are in category 1?
A) Make inquiries of client regarding contingent liabilities.
B) Obtain a letter of representation written by client.
C) Examine subsequent period sales and purchases transactions to determine whether the cutoff
is accurate.
D) Review the minute book to determine the existence of any transaction related to year 1.
35) The audit procedures for the subsequent events review can be divided into two categories:
(1) procedures normally integrated as a part of the verification of year-end account balances, and
(2) those performed specifically for the purpose of discovering subsequent events. Which of the
following procedures are in category 2?
A) Examine subsequent-period sales and purchases transactions to determine whether the cutoff
is accurate.
B) Correspond with lawyers.
C) Test the collectability of accounts receivable by reviewing subsequent period cash receipts.
D) Compare the subsequent period purchase price of inventory with the recorded cost as a test of
lower-of-cost-or-market valuation.
36) Inquiries of management are used to help identify subsequent events. To help obtain
meaningful answers
A) the standard firm checklist should be followed.
B) these inquiries must be conducted with the proper client personnel.
C) the inquiries should be conducted by senior audit personnel.
D) they should be asked after the effective date of the audit report.
37) Kendra is inquiring about subsequent events with regards to lawsuits and contingent claims.
To obtain a meaningful answer, Kendra should hold the enquiry with
A) the Vice President, legal of the company.
B) the accountant in charge of the legal liability reconciliation.
C) the mail clerk.
D) the assistant controller.
38) As part of the review for subsequent events, the auditor will review financial statements
prepared after the balance sheet date. The purpose of this review is to examine changes after year
end and to look for
A) errors in capital versus maintenance charge allocations that occurred after the year end.
B) subsequent payments to accounts payable and long term debt.
C) subsequent receipts in accounts receivable, especially for the larger customers.
D) changes in the business relative to results for the same period in the year under audit.
39) As part of the review for subsequent events, the auditor will review financial statements
prepared after the balance sheet date. The statements should be discussed with management to
determine whether they
A) were approved by the controller prior to your review.
B) are mathematically correct, including calculation of depreciation.
C) are prepared on the same basis as the current-period statements.
D) were completed on a comparative basis, showing the last three years.
40) State the three conditions required for a contingent liability to exist.