2010 Auditing Released MCQs - With Explanations

2010 AICPA Newly Released Questions – Auditing
Following are multiple choice questions recently released by the AICPA. These
questions were released by the AICPA with letter answers only. Our editorial board has
provided the accompanying explanation.
Please note that the AICPA generally releases questions that it does NOT intend to use
again. These questions and content may or may not be representative of questions you
may see on any upcoming exams.
1
© 2010 DeVry/Becker Educational Development Corp. All rights reserved.
1.
Which of the following would be an appropriate title for a statement of revenue and expenses prepared
using an other comprehensive basis of accounting (OCBOA)?
a. Statement of operations.
b. Statement of income-regulatory basis.
c. Income statement.
d. Statement of activities.
Solution:
Choice "b" is correct. Other comprehensive basis of accounting financial statements include financial
statements prepared in accordance with a regulatory basis of accounting. An income statement prepared
in accordance with a regulatory basis of accounting could be entitled "Statement of income – regulatory
basis."
Choice "a" is incorrect. This is another term for an income statement under U.S. GAAP and is not an
appropriate title for a statement of revenue and expenses prepared using an other comprehensive basis
of accounting.
Choice "c" is incorrect. The income statement title is used under U.S. GAAP and is not an appropriate
title for a statement of revenue and expenses prepared using an other comprehensive basis of
accounting.
Choice "d" is incorrect. The Statement of Activities is the title used for a not-for-profit organization's
statement of revenues and expenses and is not an appropriate title for a statement of revenue and
expenses prepared using an other comprehensive basis of accounting.
2
2.
An accountant has been engaged to review a nonissuer's financial statements that contain several
departures from GAAP. Management is unwilling to revise the financial statements, and the accountant
believes that modification of the standard review report is inadequate to communicate the deficiencies.
Under these circumstances, the accountant should:
a. Determine the effects of the departures from GAAP and issue a special report on the financial
statements.
b. Express a disclaimer of opinion on the financial statements and advise the board of directors that the
financial statements should not be relied on.
c. Inform management that a review of the financial statements cannot be completed and request a
change from a review to a compilation engagement.
d. Withdraw from the engagement and provide no further services concerning these financial
statements.
Solution:
Choice "d" is correct. If the accountant believes that modification of the standard report is not adequate to
indicate the deficiencies in the financial statements taken as a whole, the accountant should withdraw
from the compilation or review engagement and provide no further services with respect to those financial
statements.
Choice "a" is incorrect. A special report refers to an audit report on financial statements that are prepared
in conformity with a comprehensive basis of accounting other than generally accepted accounting
principles, specified elements, accounts, or items of a financial statement, compliance with aspects of
contractual agreements or regulatory requirements related to audited financial statements, financial
presentations to comply with contractual agreements or regulatory provisions, or financial information
presented in prescribed forms or schedules that require a prescribed form of auditor's reports. Special
reports are not issued in review engagements.
Choice "b" is incorrect. A disclaimer of opinion is a report that can be issued when conducting an audit
and is not appropriate for reports issued in accordance with SSARs.
Choice "c" is incorrect. Management's unwillingness to revise the financial statements is not a
reasonable basis for requesting a change in the engagement. Note also that entity should request the
change in the engagement, not the accountant.
3
3.
An independent auditor must have which of the following?
a. A pre-existing and well-informed point of view with respect to the audit.
b. Technical training that is adequate to meet the requirements of a professional.
c. A background in many different disciplines.
d. Experience in taxation that is sufficient to comply with generally accepted auditing standards.
Solution:
Choice "b" is correct. The first general standard states that the auditor must have adequate technical
training and proficiency as an auditor.
Choice "a" is incorrect. The independent auditor should maintain an attitude of professional skepticism –
an unbiased and objective view with respect to the audit.
Choice "c" is incorrect. An auditor does not need to have a background in many different disciplines. The
auditor must have adequate technical training and proficiency as an auditor.
Choice "d" is incorrect. Generally accepted auditing standards do not require the independent auditor to
have experience in taxation; rather the auditor must have adequate technical training and experience as
an auditor.
4
4.
Which of the following conditions most likely would pose the greatest risk in accepting a new audit
engagement?
a. Staff will need to be rescheduled to cover this new client.
b. There will be a client-imposed scope limitation.
c. The firm will have to hire a specialist in one audit area.
d. The client's financial reporting system has been in place for 10 years.
Solution:
Choice "b" is correct. A client-imposed scope limitation indicates that the client might be hiding errors or
irregularities that could result in a material misstatement of the financial statements.
Choice "a" is incorrect. Rescheduling staff in response to acceptance of a new audit engagement is a
normal activity for CPA firms and does not impact audit risk.
Choice "c" is incorrect. The hiring of a specialist generally decreases risk.
Choice "d" is incorrect. The fact that the client's financial reporting system has been in place for 10 years
might be indicative that system's errors have been resolved and that the system has integrity.
5
5.
Which of the following information that comes to an auditor's attention most likely would raise a question
about the occurrence of illegal acts?
a. The exchange of property for similar property in a nonmonetary transaction.
b. The discovery of unexplained payments made to government employees.
c. The presence of several difficult-to-audit transactions affecting expense accounts.
d. The failure to develop adequate procedures that detect unauthorized purchases.
Solution:
Choice "b" is correct. The discovery of unexplained payments made to government employees would
raise a question about the occurrence of illegal acts.
Choice "a" is incorrect. Exchange of property for similar property in a nonmonetary transaction might be
indicative of a related party transaction, not an illegal act.
Choice "c" is incorrect. The presence of several difficult-to-audit transactions affecting expense accounts
is not indicative of illegal acts.
Choice "d" is incorrect. The failure to develop adequate procedures that detect unauthorized purchases
is an internal control weakness, not an illegal act.
6
6.
Which of the following steps should an auditor perform first to determine the existence of related parties?
a. Examine invoices, contracts, and purchasing orders.
b. Request a list of related parties from management.
c. Review the company's business structure.
d. Review proxy and other materials filed with the SEC.
Solution:
Choice "b" is correct. In order to determine the existence of related parties, the auditor must first request
that management provide a list of related parties.
Choice "a" is incorrect. Before an auditor examines invoices, contracts, and purchasing orders for
evidence of related party transactions, the auditor must first inquire of management regarding the identity
of related parties.
Choice "c" is incorrect. Reviewing the company's business structure is unlikely to provide information
regarding the existence of related parties. Business structure is occasionally deliberately designed to
obscure related party transactions.
Choice "d" is incorrect. Proxy and other materials filed with the SEC may provide evidence of related
party transactions. However, the auditor must first inquire of management regarding the identity of
related parties.
7
7.
Which of the following payroll control activities would most effectively ensure that payment is made only
for work performed?
a. Require all employees to record arrival and departure by using the time clock.
b. Have a payroll clerk recalculate all time cards.
c. Require all employees to sign their time cards.
d. Require employees to have their direct supervisors approve their time cards.
Solution:
Choice "d" is correct. A direct supervisor's approval of the time cards most effectively ensures that
payment is paid for work performed as the supervisor observes the employees and determines whether
employees are present and working.
Choice "a" is incorrect. All employees recording arrival and departure by using the time clock does not
ensure that the employees were actually present and/or working during the recorded time.
Choice "b" is incorrect. Having a payroll clerk recalculate all time cards provides assurance as to
mathematical accuracy but this does not ensure that the employees actually were present and/or working.
Choice "c" is incorrect. Requiring all employees to sign their time cards does not ensure that employees
actually worked or were present. An unscrupulous employee would claim that he/she worked by signing
the time card when in fact he/she did not work.
8
8.
Which of the following factors is most likely to affect the extent of the documentation of the auditor's
understanding of a client's system of internal controls?
a. The industry and the business and regulatory environments in which the client operates.
b. The degree to which information technology is used in the accounting function.
c. The relationship between management, the board of directors, and external stakeholders.
d. The degree to which the auditor intends to use internal audit personnel to perform substantive tests.
Solution:
Choice "b" is correct. The more complex the IT system, the more extensive the documentation (such as
flowcharts, narratives, questionnaires, decision tables, etc.). The less complex the IT system, more
limited documentation, such as a memorandum, may be sufficient.
Choice "a" is incorrect. The industry and the business and regulatory environments in which the client
operates are separate from a clients system of internal controls.
Choice "c" is incorrect. The relationship between management, the board of directors, and external
stakeholders would be part of the auditor's general understanding of the entity and its environment and
would not affect the extent of internal control documentation.
Choice "d" is incorrect. The degree to which the auditor intends to use internal audit personnel to perform
substantive tests does not impact the documentation of the auditor's understanding of a client's system of
internal controls.
9
9.
Green, CPA, is auditing the financial statements of Ajax Co. Ajax uses the DP Service Center to process
its payroll. DP's financial statements are audited by Blue, CPA, who recently issued a report on DP's
policies and procedures regarding the processing of other entity's transactions. In considering whether
Blue's report is satisfactory for Green's purposes, Green should:
a. Make inquiries concerning Blue's professional reputation.
b. Assess control risk at the maximum level.
c. Review the audit programs followed by Blue.
d. Perform tests of controls at the DP Service Center.
Solution:
Choice "a" is correct. In considering whether the service auditor's (Blue, CPA) report is satisfactory for
the user auditor (Green, CPA); the user auditor should make inquiries concerning the service auditor's
reputation.
Choice "b" is incorrect. Green would assess control risk only after considering the combined evidence
provided by the service auditor's report and the user auditor's own procedures and other factors. The
assessment of control risk is irrelevant in Green's consideration as to whether the service auditor's (Blue,
CPA) report is satisfactory for Green.
Choice "c" is incorrect. The user auditor (Green, CPA) has access to the report issued by the service
auditor (Blue, CPA), but would not have access to the audit programs followed by the service auditor.
Choice "d" is incorrect. Green, CPA has been hired to audit the financial statements of Ajax Co. and
therefore may test Ajax's controls. Green has not been hired to audit DP Service Center and therefore
cannot test DP's controls. The only information Green has related to DP's controls is the report issued by
Blue, CPA. In considering whether the service auditor's (Blue, CPA) report is satisfactory for the user
auditor (Green, CPA); the user auditor should make inquiries concerning the service auditor's reputation.
10
10.
Which of the following procedures is considered a test of controls?
a. An auditor reviews the entity's check register for unrecorded liabilities.
b. An auditor evaluates whether a general journal entry was recorded at the proper amount.
c. An auditor interviews and observes appropriate personnel to determine segregation of duties.
d. An auditor reviews the audit workpapers to ensure proper sign-off.
Solution:
Choice "c" is correct. Interviewing and observing appropriate personnel to determine segregation of
duties is a test of controls. Segregation of duties is a subcomponent of the control activities component of
internal control.
Choice "a" is incorrect. An auditor's review of the entity's check register for unrecorded liabilities is a
substantive test.
Choice "b" is incorrect. An auditor's evaluation as to whether a journal entry was recorded at the proper
amount is a substantive test.
Choice "d" is incorrect. An auditor's review of the audit workpapers to ensure proper sign-off is not a test
of the client's controls, but rather a procedure that provides quality control that the audit was adequately
performed.
11
11.
Which of the following would be a consideration in planning a sample for a test of subsequent cash
receipts?
a. Preliminary judgments about materiality levels.
b. The amount of bad debt write-offs in the prior year.
c. The size of the intercompany receivable balance.
d. The auditor's allowable risk of assessing control risk is too low.
Solution:
Choice "a" is correct. When planning a sample for a test of subsequent cash receipts, the auditor should
consider preliminary judgments about materiality levels.
Choice "b" is incorrect. The amount of bad debt write-offs in the prior year is not a consideration in
planning for a sample for a test of subsequent cash receipts. A test of subsequent cash receipts is
performed to assess the valuation of customer/trade accounts receivable.
Choice "c" is incorrect. The size of the intercompany accounts receivable balance is not a consideration
in planning a sample for a test of subsequent cash receipts. Intercompany accounts receivable are
eliminated upon consolidation and do not impact the valuation of accounts receivable.
Choice "d" is incorrect. The auditor's allowable risk of assessing control risk too low relates to tests of
controls and is not a consideration in planning for a sample for a test of subsequent cash receipts. A test
of subsequent cash receipts is a substantive test of details.
12
12.
An auditor's analytical procedures indicate a lower than expected return on an equity method investment.
This situation most likely could have been caused by:
a. An error in recording amortization of the excess of the investor's cost over the investment's underlying
book value.
b. The investee's decision to reduce cash dividends declared per share of its common stock.
c. An error in recording the unrealized gain from an increase in the fair value of available-for sale
securities in the income account for trading securities.
d. A substantial fluctuation in the price of the investee's common stock on a national stock exchange.
Solution:
Choice "a" is correct. Under equity method accounting, the amortization of the excess of the investor's
cost over the investment's underlying book value reduces the investor's income from the equity method
investment. If amortization is calculated incorrectly (i.e., the amortization is too high), this could lower the
return on the investment.
Choice "b" is incorrect. Under equity method accounting, dividends are recorded as a reduction of the
investor's investment in the balance sheet, not as income on the income statement. Therefore, the lower
dividend should not reduce the calculated return on the equity method investment.
Choice "c" is incorrect. Equity method investments are accounted for separate from investments
classified as trading or available-for-sale. Therefore, an error in the accounting for trading and available-
for-sale securities should have no impact on the calculated return on an equity method investment.
Choice "d" is incorrect. Equity method investments are not reported at fair value. Therefore, a substantial
fluctuation in the price of the investee's common stock would have no impact on the investor's return on
the equity method investment.
NOTE to students: The answer to this question (and your ability to perform a successful audit) depends
on your knowledge of financial accounting concepts. If you are unfamiliar with equity method accounting,
please consult the Financial 3 lecture in the Becker Financial materials.
13
13.
Under which of the following conditions may an auditor's observation procedure for inventory be
performed during or after the end of the period under audit?
a. When the client maintains periodic inventory records.
b. When the auditor finds minimal variations in client records and test counts in prior periods.
c. When total inventory has not varied more than 5% in the last five years.
d. When well-kept perpetual inventory records are checked by the client periodically by comparisons
with physical counts.
Solution:
Choice "d" is correct. Interim testing is permitted when the risk of material misstatement is low. An entity
has strong internal control over inventory and therefore low risk of material misstatement if the entity has
well kept perpetual inventory records that are checked periodically by comparisons with physical counts.
In this situation, the auditor could elect to perform the inventory observation at an interim date during the
period under audit, or after year-end. If the inventory observation is performed at an interim date, the
perpetual inventory records would allow the auditor to gather evidence regarding changes to inventory
between the interim date and year-end.
Choice "a" is incorrect. Interim testing is generally not appropriate when an entity maintains periodic
inventory records because periodic inventory records are only updated on the date when a physical
inventory is taken and the books are adjusted to actual. Subsequent transactions to inventory (purchases
and sales) are not recorded in the inventory account. If the inventory observation was performed at an
interim date, periodic inventory records would not allow the auditor to gather evidence regarding changes
to inventory between the interim date and year-end.
Choice "b" is incorrect. The auditor cannot rely upon the results of substantive procedures performed in
prior years when conducting an audit in the current year.
Choice "c" is incorrect. Whether or not total inventory has not varied more than 5% in the last five years
is irrelevant to whether the auditor's observation procedure for inventory be performed during or after the
end of the period under audit.
14
14.
Which of the following is a computer-assisted audit technique that permits an auditor to insert the
auditor's version of a client's program to process data and compare the output with the client's output?
a. Test data module.
b. Frame relay protocol.
c. Remote node router.
d. Parallel simulation.
Solution:
Choice "d" is correct. This is the definition of parallel simulation. The client's input data is processed
through both the auditor's version of the client's program and the client's program and the output is
compared.
Choice "a" is incorrect. Test data is data that the auditor develops to test programmed controls. For
example, if the client has a programmed control that requires a supervisory approval (a supervisor
password) for transactions over $500, the auditor would then create test data to determine if the system
would accept a transaction over $500 without a required supervisor password approval.
Choice "b" is incorrect. Frame relay protocol refers to the physical and logical link layers of digital
communication channels using packet switching methodology.
Choice "c" is incorrect. A remote node router is not a CAAT; it is a device used to connect physical
devices such as terminals and printers not connected to the main network.
15
15.
What is an auditor's primary method to corroborate information on litigation, claims, and assessments?
a. Examining legal invoices sent by the client's attorney.
b. Verifying attorney-client privilege through interviews.
c. Reviewing the response from the client's lawyer to a letter of audit inquiry.
d. Reviewing the written representation letter obtained from management.
Solution:
Choice "c" is correct. Reviewing the response from the client's lawyer to a letter of audit inquiry is the
auditor's primary method to corroborate information on litigation, claims, and assessments.
Choice "a" is incorrect. The legal invoice sent by the client's attorney indicates whether the attorney has
spent substantive attention to a particular matter and does not contain a detailed description of the
matter.
Choice "b" is incorrect. Verifying attorney-client privilege is not a method to corroborate information on
litigation, claims, and assessments.
Choice "d" is incorrect. The auditor would corroborate the client's statements regarding litigation claims,
and assessments, including those in the representation letter, with the response from the client's lawyer
to the letter of audit inquiry.
16
16.
Which of the following management roles would typically be acknowledged in a management
representation letter?
a. Management has the responsibility for the design of controls to detect fraud.
b. Management communicates its views on ethical behavior to its employees.
c. Management's knowledge of fraud is communicated to the audit committee.
d. Management's compensation is contingent upon operating results.
Solution:
Choice "a" is correct. Management acknowledges its responsibility for the design of controls to detect
and prevent fraud in its management representation letter.
Choice "b" is incorrect. The auditor should inquire of management how it communicates its views on
ethical behavior to employees as part of obtaining an understanding of the design of the entity's internal
control. This matter is not typically included in the management representation letter.
Choice "c" is incorrect. The management representation letter is concerned with representations made
by management to the auditors, not representations made by management to the audit committee.
Choice "d" is incorrect. This would not be communicated in a management letter. This is a risk factor
associated with fraudulent financial reporting.
17
17.
Before reissuing a compilation report on the financial statements of a nonissuer for the prior year, the
predecessor accountant is required to:
a. Make inquiries about actions taken at meetings of the board of directors during the current year.
b. Verify that the reissued report will not be used to obtain credit from a financial institution.
c. Review the successor accountant's working papers for matters affecting the prior year.
d. Compare the prior year's financial statements with those of the current year.
Solution:
Choice "d" is correct. Before reissuing a compilation report, the predecessor accountant is required to
read the financial statements of the current period and the successor's report. The predecessor
accountant is also required to compare the prior year's financial statements with those of the current year
before reissuing a compilation report. Finally, the predecessor accountant is required to obtain a letter
from the successor accountant that indicates whether the successor accountant is aware of any matter
that might have a material effect on the financial statements, including disclosures, reported on by the
predecessor accountant.
Choice "a" is incorrect. Making inquiries about actions taken at meetings of the board of directors during
the current year is not a required procedure.
Choice "b" is incorrect. Verifying that the reissued report will not be used to obtain credit from financial
institutions is not a required procedure.
Choice "c" is incorrect. Reviewing the successor accountant's workpapers for matters affecting the prior
year is not a required procedure.
18
18.
Which of the following procedures would a CPA ordinarily perform when reviewing the financial
statements of a nonissuer in accordance with Statements on Standards for Accounting and Review
Services (SSARS)?
a. Apply year-end cutoff tests for the sales and purchasing functions.
b. Compare the financial statements with budgets or forecasts.
c. Obtain an understanding of the entity's internal control components.
d. Document whether control risk is assessed at or below the maximum level.
Solution:
Choice "b" is correct. This is an analytical review procedure. Analytical review procedures are required
to be performed in a review engagement in accordance with SSARS.
Choice "a" is incorrect. This is an audit procedure, not a review procedure.
Choice "c" is incorrect. Obtaining an understanding of internal controls is an audit procedure not a review
procedure.
Choice "d" is incorrect. Documenting the assed level of control risk is an audit procedure, not a review
procedure.
19
19.
What type of evidence would provide the highest level of assurance in an attestation engagement?
a. Evidence secured solely from within the entity.
b. Evidence obtained from independent sources.
c. Evidence obtained indirectly.
d. Evidence obtained from multiple internal inquiries.
Solution:
Choice "b" is correct. Audit evidence obtained from independent sources outside of the entity is more
reliable.
Choice "a" is incorrect. Audit evidence obtained from independent sources outside the entity is more
reliable that internal evidence.
Choice "c" is incorrect. Audit evidence obtained directly by the auditor (observation) is more reliable than
evidence obtained indirectly (inquiry about the application of a control).
Choice "d" is incorrect. Audit evidence obtained from independent sources outside the entity is more
reliable than internal evidence. Note that the multiple internal sources could be in collusion.
20
20.
When performing a substantive test of a random sample of cash disbursements, an auditor is supplied
with a photocopy of vendor invoices supporting the disbursements for one particular vendor rather than
the original invoices. The auditor is told that the vendor's original invoices have been misplaced. What
should the auditor do in response to this situation?
a. Increase randomly the number of items in the substantive test to increase the reliance that may be
placed on the overall test.
b. Reevaluate the risk of fraud, and design alternate tests for the related transactions.
c. Increase testing by agreeing more of the payments to this particular vendor to the photocopies of its
invoices.
d. Count the missing original documents as misstatements, and project the total amount of the error
based on the size of the population and the dollar amount of the errors.
Solution:
Choice "b" is correct. The auditor should reevaluate the risk of fraud and design alternate tests for the
related transactions as the evidence (photocopy of vendor invoices) is not reliable.
Choice "a" is incorrect. It is not appropriate to "randomly" increase sample size. The reevaluation of
fraud risk might cause the auditor to increase the sample size using non-random statistical methods.
Choice "c" is incorrect. This is not appropriate as the auditor would be examining copies of invoices
(which could be fabricated for various improper purposes). Reliance could not be increased as the
evidence (photocopy of vendor invoices) is not reliable.
Choice "d" is incorrect. The missing documents may or may not be a misstatement. The auditor does not
know if there is or is not an error in the sample as the auditor does not have access to the original invoice.
Therefore, projection from a sample to the population would be inappropriate, unless the auditor has
performed appropriate alternative procedures and has determined that the cash disbursements are, in
fact, misstated.
21
21.
An auditor finds several errors in the financial statements that the client prefers not to correct. The
auditor determines that the errors are not material in the aggregate. Which of the following actions by the
auditor is most appropriate?
a. Document the errors in the summary of uncorrected errors, and document the conclusion that the
errors do not cause the financial statements to be misstated.
b. Document the conclusion that the errors do not cause the financial statements to be misstated, but
do not summarize uncorrected errors in the working papers.
c. Summarize the uncorrected errors in the working papers, but do not document whether the errors
cause the financial statements to be misstated.
d. Do not summarize the uncorrected errors in the working papers, and do not document a conclusion
about whether the uncorrected errors cause the financial statements to be misstated.
Solution:
Choice "a" is correct. The auditor should document the errors in the summary of uncorrected errors, and
document the conclusion that the errors do not cause the financial statements to be misstated.
Choice "b" is incorrect. The auditor is required to document both his/her conclusion and summarize
uncorrected errors in the working papers.
Choice "c" is incorrect. The auditor is required to summarize the uncorrected errors in the working papers
and document whether the errors cause the financial statements to be misstated.
Choice "d" is incorrect. The auditor is required to perform both of these procedures.
22
22.
When qualifying an opinion because of an insufficiency of audit evidence, an auditor should refer to the
situation in the:
Scope Notes to the
paragraph financial statements
a. Yes Yes
b. Yes No
c. No Yes
d. No No
Solution:
Choice "b" is correct. When a qualified opinion results from a limitation on the scope of the audit or an
insufficiency of audit evidence, the situation should be described in an explanatory paragraph preceding
the opinion paragraph and referred to in both the scope and opinion paragraphs of the auditor's report. It
is not appropriate for the scope of the audit to be explained in a note to the financial statements, since the
description of the audit scope is the responsibility of the auditor and not that of the client.
23
23.
An accountant compiled the financial statements of a nonissuer in accordance with Statements on
Standards for Accounting and Review Services (SSARS). If the accountant has an ownership interest in
the entity, which of the following statements is correct?
a. The accountant should refuse the compilation engagement.
b. A report need not be issued for a compilation of a nonissuer.
c. The accountant should include the disclaimer "I am an owner of the entity" in the report.
d. The accountant should include the statement "I am not independent with respect to the entity" in the
compilation report.
Solution:
Choice "d" is correct. An ownership interest in the entity makes the accountant not independent with
respect to the entity. An accountant is not precluded from issuing a report with respect to a compilation of
financial statements for an entity with respect to which the accountant is not independent. If the
accountant is not independent, he or she should specifically disclose the lack of independence.
Practitioners have the option, but are not required, to disclose the reasons for an independence
impairment in the report. If disclosure is made, then all reasons for independence impairment must be
presented.
Choice "a" is incorrect. The accountant need not refuse the compilation engagement but should instead
disclose the lack of independence in the compilation report.
Choice "b" is incorrect. A report must be issued for a compilation of a nonissuer, unless the financial
statements are not expected to be used by third parties, in which case an engagement letter must be
used.
Choice "c" is incorrect. This is inappropriate language for a compilation report when the accountant is not
independent.
24
24.
Which of the following is correct about reporting on compliance with laws and regulations in a financial
audit under Government Auditing Standards (the Yellow Book)?
a. Auditors are not required to report fraud, illegal acts, and other material noncompliance in the audit
report.
b. In some circumstances, auditors are required to report fraud and illegal acts directly to parties
external to the audited entity.
c. The auditor's key findings of the audit of the financial statements should be communicated in a
separate report.
d. The reporting standards in a governmental audit modify the auditor's responsibilities under generally
accepted auditing standards.
Solution:
Choice "b" is correct. In a variety of circumstances, auditors may be required to report directly to an entity
external to the audited entity (e.g., the grantor, inspectors general, etc.). Instances that require external
reporting might include situations in which management is unwilling to take corrective action with regard
to illegal acts, fraud or material non compliance or circumstances in which a specific requirement is
imposed by the grantor that requires that any discovery of illegal acts, fraud or material non compliance
by the auditor be reported to the grantor or others.
Choice "a" is incorrect. Auditors must report fraud, illegal acts and material non compliance in the audit
report.
Choice "c" is incorrect. Although the key findings associated with the audit of governmental financial
statements may be communicated in a separate report, the auditor has the latitude to include specific
findings and conclusions in the same report.
Choice "d" is incorrect. The reporting standard under GAGAS augment the standards associated with
reports on audited financial statements in several ways including a requirement that the auditor
specifically mention adherence to GAGAS. These standards do not, however, change or modify GAAS
reporting responsibilities.
25
25.
Reports are considered special reports when issued in conjunction with:
a. Interim financial information reviewed to determine whether material modifications should be made to
conform with GAAP.
b. Feasibility studies presented to illustrate an entity's results of operations.
c. Compliance with aspects of regulatory requirements related to audited financial statements.
d. Pro forma financial presentations designed to demonstrate the effects of hypothetical transactions.
Solution:
Choice "c" is correct. Special reports include the following:
• Financial statements that are prepared in conformity with a comprehensive basis of accounting
other than generally accepted accounting principles
• Specified elements, accounts, or items of a financial statement
• Compliance with aspects of contractual agreements or regulatory requirements related to audited
financial statements
• Financial presentations to comply with contractual agreements or regulatory provisions
• Financial information presented in prescribed forms or schedules that require a prescribed form of
auditor's reports
Choice "a" is incorrect. A report on interim financial information reviewed to determine whether material
modifications should be made to conform with GAAP is not included in the definition of a special report.
Note that special reports are audit engagements (not review engagements) or reports related to audit
engagements.
Choice "b" is incorrect. Reports related to feasibility studies presented to illustrate an entity's results of
operations are not special reports.
Choice "d" is incorrect. Reports on pro forma financial presentations designed to demonstrate the effects
of hypothetical transactions are attestation reports, not special reports.
26
26.
An accountant is required to comply with the provisions of Statements on Standards for Accounting and
Review Services (SSARS) when:
Compiling financial statements Reproducing client-prepared
generated through the use of financial statements, without
computer software modification, for the client
a. Yes Yes
b. Yes No
c. No Yes
d. No No
Solution:
Choice "b" is correct. An accountant is required to comply with SSARS when he/she submits financial
statements of a nonissuer to his or her client or to a third party. These statements can be prepared using
computer software. Reproducing client-prepared financial statements, without modification, for the client
does not constitute "submission" of financial statements.
27
27.
How does Office of Management and Budget Circular A-133, Audits of States, Local Governments, and
Non-profit Organizations, define a subrecipient?
a. As a nonfederal entity that provides a federal award to another entity to carry out a federal program.
b. As an individual who receives and expends federal awards received from a pass-through entity.
c. As a dealer, distributor, merchant, or other seller providing goods or services that are required for the
conduct of a federal program.
d. As a nonfederal entity that expends federal awards received from another entity to carry out a federal
program.
Solution:
Choice "d" is correct. A nonfederal entity that expends federal financial assistance administered by
another entity is a sub recipient. For example, a state might receive federal funds and in turn provides
those funds to a not-for-profit organization to accomplish an objective (e.g., mental health care, homeless
relief, etc.). The not-for-profit organization would be the sub recipient.
Choice "a" is incorrect. A nonfederal entity that receives a grant award and, in turn, contracts or provides
that award to another entity to carry out the program would be a recipient. For example, a state might
receive federal funds and in turn provides those funds to a not-for-profit organization to accomplish an
objective (e.g., mental health care, homeless relief, etc.). The state would be the grant recipient while the
not-for-profit organization would be the sub recipient.
Choice "b" is incorrect. An individual who receives and expends federal awards received from a pass-
through entity is a recipient.
Choice "c" is incorrect. A nonfederal entity compensated for goods or services with federal monies is a
vendor.
28
28.
Which of the following outcomes is a likely benefit of information technology used for internal control?
a. Processing of unusual or nonrecurring transactions.
b. Enhanced timeliness of information.
c. Potential loss of data.
d. Recording of unauthorized transactions.
Solution:
Choice "b" is correct. One of information technology's potential benefits is the enhanced timeliness of
information.
Choice "a" is incorrect. Manual controls are more appropriate for the processing of unusual or
nonrecurring transactions.
Choice "c" is incorrect. The potential loss of data is a risk of information technology, not a benefit of
information technology.
Choice "d" is incorrect. The recording of unauthorized transactions is a risk of information technology, not
a benefit.
29
29.
Analytical procedures are most appropriate when testing which of the following types of transactions?
a. Payroll and benefit liabilities.
b. Acquisitions and disposals of fixed assets.
c. Operating expense transactions.
d. Long-term debt transactions.
Solution:
Choice "c" is correct. Relationships involving income statement accounts tend to be more predictable
than relationships involving only balance sheet accounts because income statement accounts represent
transactions over a period of time, whereas balance sheet accounts represent amounts as of a point in
time.
Choice "a" is incorrect. Payroll and benefit liabilities are generally recalculated and are a balance sheet
account.
Choice "b" is incorrect. Acquisition and disposal of fixed assets are generally vouched to supporting
documentation. Fixed assets is a balance sheet account.
Choice "d" is incorrect. Long-term debt transactions are generally vouched to supporting documentation.
Long-term debt is a balance sheet account.
30
30.
During the audit of a new client, the auditor determined that management had given illegal bribes to
municipal officials during the year under audit and for several prior years. The auditor notified the client's
board of directors, but the board decided to take no action because the amounts involved were immaterial
to the financial statements. Under these circumstances, the auditor should:
a. Add an explanatory paragraph emphasizing that certain matters, while not affecting the unqualified
opinion, require disclosure.
b. Report the illegal bribes to the municipal official at least one level above those persons who received
the bribes.
c. Consider withdrawing from the audit engagement and disassociating from future relationships with
the client.
d. Issue an "except for" qualified opinion or an adverse opinion with a separate paragraph that explains
the circumstances.
Solution:
Choice "c" is correct. The auditor may conclude that withdrawal is necessary when the client does not
take the remedial action that the auditor considers necessary in the circumstances, even when the illegal
act is not material to the financial statements. Factors that should affect the auditor's conclusion include
the implications of the failure to take remedial action, which may affect the auditor's ability to rely on
management representations, and the effects of continuing association with the client. In reaching a
conclusion on such matters, the auditor may wish to consult with his own legal counsel.
Choice "a" is incorrect. Adding an explanatory paragraph emphasizing that certain matters, while not
affecting the unqualified opinion, require disclosure is not an option as management has committed an
illegal act and those charged with governance (board of directors) have not taken appropriate action.
Choice "b" incorrect. The auditor does not have a duty to report to parties outside of the entity with
certain exceptions.
Choice "d" is incorrect. Issuing an "except for" qualified opinion or an adverse opinion with a separate
paragraph that explains the circumstances is not an option as management has committed an illegal act
and those charged with governance (board of directors) have not taken appropriate action.
31
31.
Which of the following procedures would be most appropriate for testing the completeness assertion as it
applies to inventory?
a. Scanning perpetual inventory, production, and purchasing records.
b. Examining paid vendor invoices.
c. Tracing inventory items from the tag listing back to the physical inventory quantities.
d. Performing cutoff procedures for shipping and receiving.
Solution:
Choice "d" is correct. Performing cutoff procedures provides assurance that goods in transit (shipped or
received) are appropriately included or excluded from inventory and this procedure is most appropriate for
testing the completeness assertion.
Choice "a" is incorrect. Scanning perpetual inventory, production, and purchasing records would only
include transactions that have been recorded. The completeness assertion is focused on unrecorded
transactions.
Choice "b" is incorrect. Examining paid vendor invoices would exclude invoices from vendors for goods
received but not yet billed by the vendor.
Choice "c" is incorrect. Tracing items from the tag listing back to the physical inventory quantities is a test
for the existence of the inventory on the tag listing. For the completeness assertion, the auditor should
trace from the physical inventory quantities to the tag listing.
32
32.
Which of the following activities performed by a department supervisor most likely would help in the
prevention or detection of a payroll fraud?
a. Distributing paychecks directly to department employees.
b. Setting the pay rate for departmental employees.
c. Hiring employees and authorizing them to be added to payroll.
d. Approving a summary of hours each employee worked during the pay period.
Solution:
Choice "d" is correct. The approval of a summary of hours for each employee is performed by the
department supervisor as the department supervisor observes whether the amount of each employee's
reported hours is correct and whether the employee is being compensated for time actually worked.
Choice "a" is incorrect. The departmental supervisor approves payroll. If the departmental supervisor
distributed paychecks directly to departmental employees, then this would be incompatible functions – the
departmental supervisor would have access to assets (distributing paychecks) and also authorization of
the transaction (approval of payroll). The departmental supervisor could dismiss an employee and not
notify human resources, keep the dismissed employee's paycheck, and forge an endorsement on the
employee's check.
Choice "b" is incorrect. The pay rate is established by the human resource department. If the
departmental supervisor set the pay rates, then he/she could be in collusion with the employee and obtain
a kickback for paying an employee more than an established rate for a certain pay grade.
Choice "c" is incorrect. Hiring employees and authorizing them to be added to the payroll is performed by
the human resources department. If the departmental supervisor could hire employees, then he/she
could hire someone not qualified for the position and be in collusion with the employee and obtain a
kickback from the employee. A fictitious employee could also be "hired."
33
33.
An auditor is concerned about a policy of management override as a limitation of internal control. Which
of the following tests would best assess the validity of the auditor's concern?
a. Matching purchase orders to accounts payable.
b. Verifying that approved spending limits are not exceeded.
c. Tracing sales orders to the revenue account.
d. Reviewing minutes of board meetings.
Solution:
Choice "b" is correct. If spending limits are exceeded, then this would be evidence that the spending limit
control was violated and that management overrode internal control.
Choice "a" is incorrect. Matching purchase orders to accounts payable does not provide evidence
regarding management override of internal control.
Choice "c" is incorrect. Tracing sales orders to the revenue account provides evidence concerning the
completeness assertion of the revenue account and does not provide evidence of management override
of internal control.
Choice "d" is incorrect. Reviewing minutes of board meetings provides information about major issues
regarding the entity, such as mergers, but does not provide evidence regarding management override of
internal control.
34
34.
When an auditor plans to rely on controls that have changed since they were last tested, which of the
following courses of action would be most appropriate?
a. Test the operating effectiveness of such controls in the current audit.
b. Document that reliance and proceed with the original audit strategy.
c. Inquire of management as to the effectiveness of the controls.
d. Report the reliance in the report on internal controls.
Solution:
Choice "a" is correct. If the auditor plans to rely on controls that have changed since they were last
tested, the auditor should test the operating effectiveness of such controls in the current audit.
Choice "b" is incorrect. If the auditor plans to rely on controls that have changed since they were last
tested, the auditor should test the operating effectiveness of such controls in the current audit. The
auditor cannot document reliance on controls that have changed since they were last tested unless the
auditor has tested the controls.
Choice "c" is incorrect. If the auditor plans to rely on controls that have changed since they were last
tested, the auditor should test the operating effectiveness of such controls in the current audit. Inquiry
alone does not provide sufficient evidence to form a conclusion regarding the operating effectiveness of
controls.
Choice "d" is incorrect. The auditor does not report reliance on specific controls in the report on internal
controls.
35
35.
In which of the following circumstances would an auditor expect to find that an entity implemented
automated controls to reduce risks of misstatement?
a. When errors are difficult to predict.
b. When misstatements are difficult to define.
c. When large, unusual, or nonrecurring transactions require judgment.
d. When transactions are high-volume and recurring.
Solution:
Choice "d" is correct. Automated controls are more suitable than manual controls where transactions are
high-volume and recurring.
Choice "a" is incorrect. Manual controls are more appropriate when errors are difficult to predict.
Choice "b" is incorrect. Manual controls are more appropriate when misstatements are difficult to define.
Choice "c" is incorrect. Manual controls are more appropriate when there are large, unusual, or
nonrecurring transactions that require judgment.
36
36.
Which of the following explanations best describes why an auditor may decide to reduce tests of details
for a particular audit objective?
a. The audit is being performed soon after the balance sheet date.
b. Audit staff are experienced in performing the planned procedures.
c. Analytical procedures have revealed no unusual or unexpected results.
d. There were many transactions posted to the account during the period.
Solution:
Choice "c" is correct. If analytical procedures have revealed no unusual or unexpected results, the
auditor may decide to reduce tests of details for a particular audit objective. Substantive analytical review
procedures may be sufficient to reduce the planned level of detection risk to an acceptably low level.
Choice "a" is incorrect. This is irrelevant as to whether test of details should be increased or decreased.
The auditor should plan substantive procedures to be responsive to the planned level of detection risk.
Substantive procedures include tests of details and substantive analytical procedures.
Choice "b" is incorrect. This is irrelevant to whether tests of details should be increased or decreased.
The auditor should plan substantive procedures to be responsive to the planned level of detection risk.
Choice "d" is incorrect. Tests of details are more likely to be performed when a large number of
transactions were posted to an account during the period.
37
37.
During the confirmation of accounts receivable, an auditor receives a confirmation via the client's fax
machine. Which of the following actions should an auditor take?
a. Not accept the confirmation and select another customer's balance to confirm.
b. Not accept the confirmation and treat it as an exception.
c. Accept the confirmation and file it in the working papers.
d. Accept the confirmation but verify the source and content through a telephone call to the respondent.
Solution:
Choice "d" is correct. To restrict the risks associated with facsimile responses and treat the confirmations
as valid audit evidence, the auditor should consider taking certain precautions, such as verifying the
source and contents of a facsimile response in a telephone call to the purported sender.
Choice "a" is incorrect. The auditor could accept the confirmation and not select another customer's
balance to confirm provided certain additional procedures are performed, as described above.
Choice "b" is incorrect. The auditor could accept the confirmation and not treat it as an exception
provided certain additional procedures are performed, as described above.
Choice "c" is incorrect. The auditor would need to perform additional procedures before accepting the
confirmation.
38
38.
Which of the following tests of details most likely would help an auditor determine whether accounts
payable have been misstated?
a. Examining reported purchase returns that appear too low.
b. Examining vendor statements for amounts not reported as purchases.
c. Searching for customer-returned goods that were not reported as returns.
d. Reviewing bank transfers recorded as cash received from customers.
Solution:
Choice "b" is correct. Examining vendor invoices for amounts not reported as purchases is a procedure
to determine if accounts payable have been understated (completeness assertion). Accounts payable
would be understated for the amounts of purchases that were not reported.
Choice "a" is incorrect. Examining reported purchase returns that appear too low means that the
transactions have been recorded. The auditor would be more interested in purchase returns that have
not been reported.
Choice "c" is incorrect. Searching for customer-returned goods that were not reported as returns would
have an impact on accounts receivable and sales returns accounts – not accounts payable.
Choice "d" is incorrect. Reviewing bank transfers recorded as cash received from customers has an
impact on accounts receivable, not accounts payable.
39
39.
An audit client sells 15 to 20 units of product annually. A large portion of the annual sales occur in the
last month of the fiscal year. Annual sales have not materially changed over the past five years. Which
of the following approaches would be most effective concerning the timing of audit procedures for
revenue?
a. The auditor should perform analytical procedures at an interim date and discuss any changes in the
level of sales with senior management.
b. The auditor should inspect transactions occurring in the last month of the fiscal year and review the
related sale contracts to determine that revenue was posted in the proper period.
c. The auditor should perform tests of controls at an interim date to obtain audit evidence about the
operational effectiveness of internal controls over sales.
d. The auditor should review period-end compensation to determine if bonuses were paid to meet
earnings goals.
Solution:
Choice "b" is correct. Because a large portion of the annual sales occur in the last month of the fiscal
year and the number of transactions for the entire year is relatively small, the most effective audit
approach would be for the auditor to inspect transactions occurring in the last month of the year and
review the sales contracts to determine that revenue was posted in the proper period.
Choice "a" is incorrect. This is not as effective as most sales occur in the last month of the fiscal year.
Interim sales data would not be a reliable predictor of annual revenue. The predicted amount of annual
revenue most likely would be significantly less than the actual revenue and cause the auditor to perform
unneeded procedures.
Choice "c" is incorrect. In this case, since most sales occur in the last month, the auditor would then
again need to test controls during the final month to provide assurance that the controls were still
operating effectively. Additionally, since the transaction volume is so low, it would be more effective not
to test controls, but rather adopt a primarily substantive approach.
Choice "d" is incorrect. Reviewing period-end compensation to determine if bonuses were paid to meet
earnings goals is not relevant to the timing of audit procedures for revenue.
40
40.
An auditor should be aware of subsequent events that provide evidence concerning conditions that did
not exist at year end but arose after year end. These events may be important to the auditor because
they may:
a. Require adjustments to the financial statements as of the year end.
b. Have been recorded based on preliminary accounting estimates.
c. Require disclosure to keep the financial statements from being misleading.
d. Have been recorded based on year-end tests for asset obsolescence.
Solution:
Choice "c" is correct. Conditions that did not exist at year end but arose after year end are Type 2
(nonrecognized) subsequent events that must be disclosed to keep the financial statements from being
misleading.
Choice "a" is incorrect. An adjustment would not be required as the conditions did not exist at year end.
Type 1 (recognized) subsequent events require adjustment to the financial statement.
Choice "b" is incorrect. An adjustment based on preliminary accounting estimates would not have been
recorded as the conditions did not exist at year end.
Choice "d" is incorrect. This is not a subsequent event as the recording of obsolescence at year end is
based on the results of the performance of customary asset valuation tests – conditions that existed at
year end.
41
41.
Which of the following disagreements between the auditor and management do not have to be
communicated by the auditor to those charged with governance?
a. Disagreements regarding management's judgment about accounting estimates for goodwill.
b. Disagreements about the scope of the audit.
c. Disagreements in the application of accounting principles relating to software development costs.
d. Disagreements of the amount of the LIFO inventory layer based on preliminary information.
Solution:
Choice "d" is correct. Disagreements based upon preliminary information need not be communicated by
the auditor to those charged with governance.
Choice "a" is incorrect. Disagreements with management regarding the application of accounting
principles have to be communicated by the auditor to those charged with governance.
Choice "b" is incorrect. Disagreements about the scope of the audit have to be communicated by the
auditor to those charged with governance.
Choice "c" is incorrect. Disagreements in the application of accounting principles relating to software-
development costs must be communicated by the auditor to those charged with governance.
42
42.
Which of the following is required of an accountant in reviewing a company's financial statements under
Statements on Standards for Accounting and Review Services (SSARS)?
a. Obtain knowledge of the client's industry.
b. Send bank confirmations.
c. Obtain a signed engagement letter from the client.
d. Observe client's physical inventory.
Solution:
Choice "a" is correct. SSARS require the accountant to obtain knowledge of the client's industry.
Choice "b" is incorrect. This is an audit procedure, not a review procedure.
Choice "c" is incorrect. The accountant is required to obtain a signed management representation letter
from the client. SSARS 19, issued after this question appeared in a CPA exam, requires the practitioner
to obtain a written understanding with the client (engagement letter) for all review engagements. This is
effective for reviews of financial statements for periods ending on or after December 15, 2010.
Choice "d" is incorrect. Observation of a client's physical inventory is an audit procedure, not a review
procedure.
43
43.
Which of the following procedures should an accountant perform during an engagement to compile
prospective financial statements?
a. Test the entity's internal controls to determine if adequate controls exist so that financial projections
can be reasonably achieved.
b. Make inquiries prior to the date of the report about possible future transactions that may impact the
forecast once the report is issued.
c. Make inquiries about the accounting principles used in the preparation of the prospective financial
statements.
d. Compare the prospective financial statements with the entity's historical results for the prior year.
Solution:
Choice "c" is correct. An accountant performing an engagement to compile prospective financial
statements should make inquiries about the accounting principles used in the preparation of the
prospective financial statements.
Choice "a" is incorrect. The accountant does not test the entity's internal controls to determine if
adequate controls exist so that financial projections can be reasonably achieved. The test of an entity's
internal controls is an audit procedure, not a compilation procedure.
Choice "b" is incorrect. The practitioner has no responsibility to update the report for events and
circumstances occurring after the date of the report.
Choice "d" is incorrect. This is not a required procedure when compiling prospective financial statements.
44
44.
When applying analytical procedures during an audit, which of the following is the best approach for
developing expectations?
a. Considering unaudited account balances and ratios to calculate what adjusted balances should be.
b. Identifying reasonable explanations for unexpected differences before talking to client management.
c. Considering the pattern of several unusual changes without trying to explain what caused them.
d. Comparing client data with client-determined expected results to reduce detailed tests of account
balances.
Solution:
Choice "b" is correct. Identifying reasonable explanations for unexpected differences before talking to
client management helps the auditor in assessing if management's explanation is reasonable.
Management's explanation should always be corroborated with other evidence.
Choice "a" is incorrect. Unaudited account balances are less reliable.
Choice "c" is incorrect. Analytical procedures assume that plausible relationships among data may
reasonably be expected to exist and continue in the absence of known conditions to the contrary.
Conditions that might cause variations in these relationships include unusual events. Expectations
cannot be developed when there is no explanation of what caused a pattern of unusual changes.
Choice "d" is incorrect. Since the data is obtained from sources within the entity, it is not as reliable for
developing expectations.
45
45.
Which of the following statements is most accurate regarding sufficient and appropriate documentation?
a. Accounting estimates are not considered sufficient and appropriate documentation.
b. Sufficient and appropriate documentation should include evidence that the audit working papers have
been reviewed.
c. If additional evidence is required to document significant findings or issues, the original evidence is
not considered sufficient and appropriate and therefore should be deleted from the working papers.
d. Audit documentation is the property of the client, and sufficient and appropriate copies should be
retained by the auditor for at least five years.
Solution:
Choice "b" is correct. Sufficient and appropriate documentation should include evidence that the audit
working papers have been reviewed.
Choice "a" is incorrect. Accounting estimates are considered a significant finding or issue that should be
documented by the auditor.
Choice "c" is incorrect. Additional evidence supplements the original evidence. The original evidence
should not be deleted from the working papers.
Choice "d" is incorrect. Audit documentation is the property of the auditor. For audits of nonissuers, audit
documentation should be retained for at least five years. For audits of issuers, audit documentation
should be retained for at least seven years.
46
46.
If not already performed during the overall review stage of the audit, the auditor should perform analytical
procedures relating to which of the following transaction cycles?
a. Payroll.
b. Revenue.
c. Purchasing.
d. Inventory.
Solution:
Choice "b" is correct. If not already performed during the overall review stage of the audit, the auditor
should perform analytical review procedures relating to the revenue cycle because there is the
presumption of revenue fraud in all audits.
Choices "a", "c", and "d" are incorrect based on the above explanation.
47
47.
Which of the following services, if any, may an accountant who is not independent provide?
a. Compilations, but not reviews.
b. Reviews, but not compilations.
c. Both compilations and reviews.
d. No services.
Solution:
Choice "a" is correct. An accountant is not required to be independent when performing a compilation but
the accountant is required to be independent when performing a review. The accountant would state in
the compilation report that he/she is not independent.
48
48.
Which of the following situations would preclude an accountant from issuing a review report on a
company's financial statements in accordance with Statements on Standards for Accounting and Review
Services (SSARS)?
a. The owner of a company is the accountant's father.
b. The accountant was engaged to review only the balance sheet.
c. Land has been recorded at appraisal value instead of historical cost.
d. Finished-goods inventory does not include any overhead amounts.
Solution:
Choice "a" is correct. If the owner of the company is the accountant's father, the accountant would not be
independent. In order to issue a review report, the accountant must be independent.
Choice "b" is incorrect. The accountant can review only the balance sheet.
Choice "c" is incorrect. The accountant can issue a review report that may be modified for the departure
from GAAP.
Choice "d" is incorrect. The accountant can issue a review report that may be modified for the departure
from GAAP.
49
49.
Which of the following components is appropriate in a practitioner's report on the results of applying
agreed-upon procedures?
a. A list of the procedures performed, as agreed to by the specified parties identified in the report.
b. A statement that management is responsible for expressing an opinion.
c. A title that includes the phrase "independent audit."
d. A statement that the report is unrestricted in its use.
Solution:
Choice "a" is correct. A list of the procedures performed, as agreed to by the specified parties in the
report, is appropriate in a practitioner's report on the results of applying agreed-upon procedures.
Choice "b" is incorrect. An opinion is not expressed in a report on applying agreed-upon procedures.
The practitioner provides a listing of procedures and findings. Additionally, it is never appropriate for
management to express an opinion.
Choice "c" is incorrect. A report on the results of applying agreed-upon procedures is not an independent
audit and the practitioner states this in his/her report.
Choice "d" is incorrect. A report on the results of applying agreed-upon procedures is always restricted
use and the practitioner states this in his/her report.
50
50.
An auditor may report on condensed financial statements that are derived from a complete set of audited
financial statements only if the auditor:
a. Expresses an unqualified opinion on the audited financial statements from which the condensed
financial statements are derived.
b. Indicates whether the information is fairly stated in all material respects in relation to the complete
financial statements.
c. Determines that the condensed financial statements include all the disclosures necessary for the
complete set of financial statements.
d. Presents the condensed financial statements in comparative form with the prior-year's condensed
financial statements.
Solution:
Choice "b" is correct. An auditor may report on condensed financial statements that are derived from a
complete set of financial statements only if the auditor indicates whether the information is fairly stated in
all material respects in relation to the complete set of financial statements.
Choice "a" is incorrect. The auditor can issue a qualified opinion on the audited financial statements from
which the condensed financial statements are derived.
Choice "c" is incorrect. Condensed financial statements do not include all of the disclosures that are
included in a complete set of financial statements.
Choice "d" is incorrect. There is no requirement that prior year's condensed financial statements be
presented in comparative form with the current year's condensed financial statements.
51
51.
According to the AICPA Code of Professional Conduct, in which of the following circumstances may a
CPA serve on a company's board of directors?
a. The CPA audits a bank to which the company has applied for financing, and board approval is
required for said financing to occur.
b. The CPA is asked by the company to test the internal controls of the company and offers
compensation to the CPA for said services.
c. The CPA does not audit the company and has no other business connection with the company.
d. The CPA performs attestation services for a nonpublic company.
Solution:
Choice "c" is correct. According to the Code of Professional Conduct, a CPA may only serve on the
board of directors when the CPA does not audit the company and has no other business connections with
the company. A CPA's independence is impaired by business relationships with its client, including
service on the client's board of directors.
Choice "a" is incorrect. According to the Code of Professional Conduct, a CPA may not serve on a
company's board of directors if the CPA has any business connection with the company. The CPA would
have a business connection with the company if the CPA audited a bank to which the company has
applied for financing, and board approval is required for the financing to occur.
Choice "b" is incorrect. An auditor must be independent to perform any attestation service, including
testing internal controls. A CPA's independence is impaired by business relationships with its client,
including service on the client's board of directors.
Choice "d" is incorrect. An auditor must be independent to perform any attestation service, whether the
client is public or nonpublic. A CPA's independence is impaired by business relationships with its client,
including service on the client's board of directors.
52
52.
How many audits of public companies per year does a CPA firm that is registered with the Public
Company Accounting Oversight Board (PCAOB) have to perform before it receives an annual inspection
from the PCAOB?
a. One audit.
b. More than 10 audits.
c. More than 50 audits.
d. More than 100 audits.
Solution:
Choice "d" is correct. The Sarbanes-Oxley Act requires the PCAOB to perform an annual inspection of
each registered public accounting firm that regularly provides audit reports for more than 100 issuers.
53
53.
In which of the following situations is there a violation of client confidentiality under the AICPA Code of
Professional Conduct?
a. A member discloses confidential client information to a court in connection with arbitration
proceedings relating to the client.
b. A member discloses confidential client information to a professional liability insurance carrier after
learning of a potential claim against the member.
c. A member whose practice is primarily bankruptcy discloses a client's name.
d. A member uses a records retention agency to store clients' records that contain confidential client
information.
Solution:
Choice "c" is correct. An ethics ruling related to Rule 301 states that it is permissible for a member to
disclose the name of a client without the client's consent unless the disclosure of the client's name results
in the release of confidential information. The specific example given in the ethics ruling states that if a
member's practice is limited to bankruptcy matters, the disclosure of a client's name suggests that the
client may be experiencing financial difficulties, which could be confidential client information, and
therefore a violation of client confidentiality.
Choice "a" is incorrect. A member is required to disclose confidential client information if necessary to
comply with a validly issued subpoena or summons. Therefore, a disclosure of confidential client
information to a court in connection with arbitration proceedings related to the client would not violate
confidentiality rules.
Choice "b" is incorrect. A member is required to disclose confidential client information if necessary to
comply with a validly issued subpoena or summons. Therefore, a disclosure of confidential client
information to a professional liability insurance carrier after learning of a claim against the member would
not violate confidentiality rules.
Choice "d" is incorrect. The use of a records retention agency to store client records does not violate
confidentiality rules.
54
54.
Smith, CPA, is a partner of Johnson Accounting Firm. Johnson audited the books of Hometown Bank.
Smith's independence would be impaired under which of the following circumstances?
a. Smith is a director of Hometown Bank.
b. Smith has a collateralized automobile loan with Hometown Bank.
c. Smith had an account with Hometown Bank two years ago.
d. Smith and a Hometown Bank board member belong to the same church.
Solution:
Choice "a" is correct. Independence is impaired by business relationships with the client, including acting
as a director of the client.
Choice "b" is incorrect. Independence is not impaired by a fully collateralized car loan.
Choice "c" is incorrect. Independence is not impaired by an account that a member had with the client in
prior years. Additionally, independence is not impaired by an existing bank account that is fully insured
by the government.
Choice "d" is incorrect. Independence is not impaired because a member and the board member of a
client belong to the same church.
55
55.
Which of the following is a correct statement about the circumstances under which a CPA firm may or
may not disclose the names of its clients without the clients' express permission?
a. A CPA firm may disclose this information if the practice is limited to bankruptcy matters, so that
prospective clients with similar concerns will be able to contact current clients.
b. A CPA firm may disclose this information if the practice is limited to performing asset valuations in
anticipation of mergers and acquisitions.
c. A CPA firm may disclose this information unless disclosure would suggest that the client may be
experiencing financial difficulties.
d. A CPA firm may not disclose this information because the identity of its clients is confidential
information.
Solution:
Choice "c" is correct. An ethics ruling related to Rule 301 states that it is permissible for a member to
disclose the name of a client without the client's consent unless the disclosure of the client's name results
in the release of confidential information. The specific example given in the ethics ruling states that if a
member's practice is limited to bankruptcy matters, the disclosure of a client's name suggests that the
client may be experiencing financial difficulties, which could be confidential client information.
Confidential client information cannot be disclosed without the client's consent.
56

2010 Auditing Released MCQs - With Explanations

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2010 AICPA Newly Released Questions – Auditing

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