Lancaster & Co. CPAs is auditing the financial statements of Cooper Corporation.
During the course of the audit, Cooper Corporation sent the following memo to the
engagement partner:
We have requested $1 million worth of products from Ladd Corporation with credit
terms of net 30 days. Ladd has requested audited financial statements for its credit
decision. We notified Ladd that our annual audit was in process and we would provide
the audited financial statements to them as soon as they were completed.
Which of the following statements is true with regards to this memo?
A. The memo is an amendment to the engagement letter and makes Ladd Corporation a
primary beneficiary of the audited financial statements.
B. The memo may move Ladd Corporation closer to a primary beneficiary and
reposition them as third party with a standing to sue, depending on the jurisdiction of
any future lawsuits.
C. The memo is only a courtesy and does not alter the terms of the engagement letter or
change the nature of Ladd Corporation’s standing to sue.
D. The memo is an additional contract placing Ladd in privity of contract.
As a result of sampling procedures applied as tests of controls, an auditor incorrectly
assesses control risk lower than appropriate. The most likely explanation for this
situation is that
A. the deviation rates of both the auditor’s sample and the population exceed the
tolerable rate of deviation.
B. the deviation rates of both the auditor’s sample and the population are less than the
tolerable rate of deviation.
C. the deviation rate in the auditor’s sample is less than the tolerable rate of deviation,
but the deviation rate in the population exceeds the tolerable rate of deviation.
D. the deviation rate in the auditor’s sample exceeds the tolerable rate of deviation, but
the deviation rate in the population is less than the tolerable rate of deviation.
Which of the following is not true with respect to the use of statistical and nonstatistical
sampling?
A. Statistical sampling allows the auditor to quantitatively measure the sufficiency of
evidence gathered.
B. Statistical sampling does not require auditors to utilize extensive judgment during
the sampling process.
C. Statistical sampling allows the auditor to make quantitative statements with respect
to the results of the sampling procedures.
D. Both statistical and nonstatistical sampling are permissible under generally accepted
auditing standards.
The auditor selects a sample of recorded sales invoices and vouches them to shipping
documents. This procedure is related to which of the following assertions?
A. Occurrence.
B. Completeness.
C. Accuracy.
D. Cutoff.
Which of the following best describes auditors’ responsibilities with respect to
evaluating the going-concern status of the entity?
A. Auditors are required to specifically gather evidence with respect to going-concern
status and separately report on the entity’s ability to continue as a going concern.
B. Auditors are required to specifically gather evidence with respect to going-concern
status and modify their report on the financial statements if substantial doubts exist.
C. Auditors are required to consider evidence obtained during the audit that may
provide information with respect to going-concern status and separately report on the
entity’s ability to continue as a going concern.
D. Auditors are required to consider evidence obtained during the audit that may
provide information with respect to going-concern status and modify their report on the
financial statements if substantial doubts exist.
The method of sample selection in which a random starting point is selected and a fixed
number of items are bypassed prior to the next item being selected is referred to as
A. block selection.
B. haphazard selection.
C. systematic random selection.
D. unrestricted random selection.
The confirmation of customers’ accounts receivable rarely provides reliable evidence
about the completeness assertion because
A. many customers merely sign and return the confirmation without verifying its
details.
B. recipients usually respond only if they disagree with the information on the request.
C. customers may not be inclined to report understatement errors in their accounts.
D. auditors typically select many accounts with low recorded balances to be confirmed.
Records of stock and bond certificates are usually maintained by the company’s
A. treasurer.
B. chief financial officer.
C. transfer agent.
D. registrar.
When auditing inventories, an auditor would least likely verify that
A. all inventory owned by the client is on hand at the time of the count.
B. the client has used proper inventory pricing.
C. the financial statement presentation of inventories is appropriate.
D. damaged goods and obsolete items have been properly accounted for.
The typical functions of the personnel and payroll cycle would not include
A. labor relations.
B. report of attendance and work performed.
C. allocation to cost of goods sold.
D. payroll accounting.
The sample size for a test of controls varies inversely with
A. expected population deviation rate: Yes; tolerable rate of deviation: Yes.
B. expected population deviation rate: No; tolerable rate of deviation: No.
C. expected population deviation rate: Yes; tolerable rate of deviation: No.
D. expected population deviation rate: No; tolerable rate of deviation: Yes.
The concept of _________ recognizes that a GAAS audit may fail to detect all material
misstatements.
A. absolute assurance
B. due care
C. reasonable assurance
D. risk of material misstatement
A proof of cash
A. is required by GAAS.
B. can be used to test the transactions process.
C. is most helpful when control risk for cash is low.
D. always detects lapping.
Which of the following is NOT a principle of Trust Service engagements?
A. Security from unauthorized use
B. Availability of the system, products, or services
C. Proficiency in preparing transactions
D. Confidentiality of information
An auditor is testing control procedures that are evidenced on an entity’s vouchers by
matching random numbers with voucher numbers. If a random number matches the
number of a voided voucher, that voucher ordinarily should be replaced by another
voucher in the random sample if the voucher
A. constitutes a deviation.
B. has been properly voided.
C. cannot be located.
D. represents an immaterial dollar amount.
To prevail in an action brought under common law, the plaintiff must show all of the
following except
A. he or she was damaged or suffered a loss.
B. the financial statements contained a material misstatement.
C. auditors knew the financial statements contained a material misstatement.
D. he or she relied on the financial statements.
An audit team uses the assessed risk of material misstatement to
A. evaluate the effectiveness of the entity’s internal control policies and activities.
B. identify transactions and account balances where inherent risk is at the maximum.
C. indicate whether materiality thresholds for planning and evaluation purposes are
sufficiently high.
D. determine the acceptable level of detection risk for financial statement assertions.
In planning a statistical sample for a test of controls, an auditor increased the expected
population deviation rate from the rates observed in prior audits because of the results
of prior tests of controls and the overall control environment. The auditor most likely
would then increase the planned
A. tolerable rate of deviation.
B. allowance for sampling risk.
C. risk of overreliance.
D. sample size.
Which of the following components of the audit risk model is most closely associated
with attributes sampling?
A. Audit risk
B. Control risk
C. Detection risk
D. Inherent risk
Nonsampling risk normally occurs during which step of the sampling process?
A. Defining the population
B. Selecting sample items
C. Measuring sample items
D. Evaluating sample results
Which of the following is an important consideration during the planning of the audit?
A. Considering the independence of members of the audit team
B. Performing some of the audit procedures prior to the end of the year under audit
C. Considering the ability and expertise of the audit team with respect to accounting
and auditing issues in the client’s industry
D. Considering the impact of tests of controls on the overall assessment of control risk
Effective control over the cash payroll function would mandate which of the following?
A. The payroll clerk should fill the envelopes with cash and include a computation of
the net wages.
B. The paymaster should be retain unclaimed payroll envelopes.
C. Each employee should be asked to sign a receipt for wages received.
D. A separate checking account for payroll should be maintained.
Which of the following should an auditor do when control risk is assessed at the
maximum level?
A. Perform fewer substantive tests of details
B. Perform more tests of controls
C. Document the assessment
D. Document the control structure more extensively
In connection with the audit of an issue of long-term bonds payable, the audit team
should
A. determine whether bondholders are persons other than owners, directors, or officers
of the company issuing the bond.
B. calculate the effective interest rate to see if it is substantially the same as the rates for
similar issues.
C. decide whether the bond issue was made without violating state or local law.
D. ascertain that the client has obtained the opinion of counsel on the legality of the
issue.
Which of the following questions included in an internal control questionnaire would
evaluate the valuation objective of revenues?
A. Is customer credit approved before orders are shipped?
B. Are sales orders prenumbered?
C. Are shipping documents required before a customer invoice is sent?
D. Are payments received from the customer deposited in the bank in a timely manner?
Following the audit report release date, auditors became aware of facts existing at the
report date that would have affected the reports had auditors then been aware of such
facts. What is the most appropriate initial course of action that auditors should take?
A. Determine whether there are persons relying or likely to rely on the financial
statements who would attach importance to the information.
B. Request that management disclose the newly-discovered information by issuing
revised financial statements.
C. Issue revised pro forma financial statements taking into consideration the newly
discovered information.
D. Give public notice that auditors are no longer associated with financial statements.
In reporting on a nonpublic entity’s internal control over financial reporting, an
accountant should include a paragraph that describes the
A. documentary evidence regarding the control environment factors.
B. changes in the entity’s internal control since the prior report.
C. potential benefits from the accountant’s suggested improvements.
D. inherent limitations of internal control.
Small and Tall, CPAs completed the December 31, 2014 audit of Big Company on
February 10, 2015. After the audit report release date, an outstanding lawsuit against
Big Company was settled for materially more than recorded in the December 31, 2014
financial statements. The amount recorded in the financial statements represented the
best estimate of management and the company’s attorneys at the time the audit was
completed. Based on this new information, Small and Tall, CPAs should
A. determine whether persons are currently relying on the auditors’ reports.
B. advise the client to make appropriate changes in the financial statements and reissue
them.
C. notify each member of the board of directors of Big Company.
D. take no action since the event took place after the audit report release date.
Which of the following methods for determining inventory cost is not allowed by
GAAP?
A. Average cost.
B. FIFO.
C. LIFO.
D. Standard cost.
Which of the following questions would be inappropriate for an auditor to ask a client
when exhibiting an appropriate level of professional skepticism while completing an
audit procedure related to the internal control system?
A. What can go wrong in this process?
B. Which of your employees is a fraudster?
C. What else is important to know about this process?
D. What happens when a key employees goes on vacation?
Write-offs of doubtful accounts should be approved by
A. the salesperson.
B. the credit manager.
C. the treasurer.
D. the cashier.
When fraud risk is significant, and management cooperation is unsatisfactory, the
auditors will most likely
A. perform extended audit procedures.
B. consult with fraud examiners.
C. report directly to the Securities and Exchange Commission within one day.
D. withdraw from the engagement.
Items 1 through 6 represent an auditor’s observed changes in certain financial statement
ratios or amounts from the prior year’s ratios or amounts. For each observed change,
select the most likely explanation or explanations from the list of explanations
provided. Answers on the list may be selected once, more than once, or not at all.
Auditor’s observed changes (considered independent of each other).
1. Inventory turnover increased substantially from the prior year. (Select 3 explanations)
2. Accounts receivable turnover decreased substantially from the prior year. (Select 3
explanations)
3. Allowance for doubtful accounts increased from the prior year, but allowance for
doubtful accounts as a percentage of accounts receivable decreased from the prior year.
(Select 3 explanations)
4. Long term debt increased from the prior year, but interest expense increased a larger
than proportionate amount than long term debt. (Select 1 explanation)
5. Operating income increased from the prior year although the entity was less
profitable than in the prior year. (Select 2 explanations)
6. Gross margin percentage was unchanged from the prior year although gross margin
increased from the prior year. (Select 1 explanation)
Auditors should disclose the substantive reasons for expressing an adverse opinion on
the entity’s financial statements in an additional paragraph
A. preceding the Auditor’s Responsibility section.
B. preceding the opinion paragraph.
C. following the opinion paragraph.
D. within the footnotes to the financial statements.
Red Corporation had a temporary cash squeeze near its balance-sheet date. It needed
cash badly for a seasonal dip in sales. However, a loan covenant requiring a certain
debt/equity ratio would be violated if any additional money were borrowed. To remedy
this, the top two officers of the Corporation set up another corporation, Pink Inc., Red
made a large sale of inventory to Pink at cost. Pink used the inventory as collateral for a
three-month loan from a local bank. The money from the loan was used to pay Red for
the accounts receivable resulting from the ‘sale.” The officers intended to have Red buy
back the inventory from Pink at the end of the three-month period at a price that would
allow Pink to pay off the loan plus interest.
a. How would this transaction designed by the two officers enable Red to maintain its
required debt/equity ratio while obtaining the cash it needed?
b. What tests of controls and substantive tests would enable an auditor to detect this
scheme?
Define what is meant by the term ‘subsequent event”. In addition, identify the two types
of subsequent events and indicate how auditors should modify the engagement for the
discovery of subsequent events.
A subsequent event is an event that occurs between the date of the financial statements
and the date of the auditors’ report that may affect the presentation and disclosure in the
client’s financial statements.
Match each statement or description with the term to which it is most likely related.
Each term is associated with only one statement.
1. Attorney letters.
2. Interim audit work.
3. Communication with individuals charged with governance.
4. Management letter.
5. Written representations.
6. Engagement quality review.
A. Audit procedures performed several weeks or months before the date of the financial
statements.
B. There have been no irregularities involving management or employees who have
significant roles in the client’s internal control.
C. Audit documentation and financial statements, including footnotes, are reviewed by
a partner who did not participate on the audit.
D. Based on the facts, known to us, after a full investigation, it is our opinion that no
liability will be established against this entity.
E. Includes statements regarding auditors’ judgment of the quality of the client’s
accounting principles.
F. We discussed the following recommendation for streamlining the receiving
department document flow with Ms. Phyllis Cook, receiving department supervisor.
With a sample of open and closed production cost reports, vouching labor cost to
________________________________ is a test for ____________________________.
According to auditing standards, specific relevant aspects of an internal control system
for making estimates include:
– Management communication of the need for proper accounting estimates.
– Accumulation of relevant, sufficient, and reliable data for estimates.
– Preparation of estimates by qualified personnel.
– Adequate review and approval by appropriate levels of authority.
– Comparison of prior estimates with subsequent results to assess the reliability of the
estimation outcomes.
– Consideration by management of whether particular accounting estimates are
consistent with the company’s operational plans.
a. How would the auditor test these control activities over the production of estimates?
b. What substantive audit procedures would the auditor use to test the accounting
estimates?
Below are some situations in which it would be preferable to use either monetary unit
sampling or classical variables sampling. Using the letters M (for monetary unit
sampling) or C (for classical variables sampling).
___ 1. Several sampling units in the population have a zero or negative balance.
___ 2. The auditor would like to examine a smaller number of items.
___ 3. The account balance is susceptible to understatement error.
___ 4. The account balance includes a few logical units with very large dollar balances.
___ 5. The auditor is able to form a reasonable estimate of the variability of the
population.
___ 6. The auditor would like to ensure that the sampling method provides a
conservative (higher) estimate of misstatement in the account balance.
___ 7. The account balance is susceptible to overstatement error.
A fraud examination has four main objectives: (1) determining whether a fraud exists,
(2) determining ______________________, _________________________________,
and ________________________________.
Dual direction testing involves samples of transactions selected to obtain evidence
about control over _________________________________ in one direction and
control over _________________________________ in the other direction.
Records of interest rates and bonds payable are maintained by the
_____________________________ and the ____________________________.