uOttawa Mid-Term Examination #1 ADM3349 M AUDITING THEORY February 9, 2009 Professor: B. Church INSTRUCTIONS 1. Books and notes are not permitted. Coleuatous are petted 3. Complete all questions 4 Wate inpen 5. Answer ell questions ditetlyon th examination pape 6. Follow the suggested time fiames for each question. Questo Marla Suggeated Tine Gale T i TO minutes 5 Sonate 3 5 Sonate a D Dane 5 0 Tommie Teal 7 WO aes viNAME: STUDENT #: ‘Siatement of Academic Integrity ‘The School of Management does not condone academic fraud, an actbya student that may result na false academic evaluation of that student or of another student. Without Limiting the generality ofthis definition, academic fraud occurs when a student commuts any ofthe following offences: plagiarism or cheating of eny kind, use of books, notes, mathematical tables, dictionaries or other study aid unless an explicit wnitten note to the contrary appears ‘on the exam, to have in hishher possession cameres, radios (radios with head sets), tape recorders, pages, cell phones, or any other communication device which has not been. previously authorized in waiting ‘Statement to be signed by the student: Thave reed the text on academic integrity and I pledge not to have committed or attempted to ‘commut academic fraud in this examination. Signed Note: en examination copy or boollet without that signed statement will not be graded and will ceive a final exem grade of zero, viQUESTION 1 (10 marks - 15 minutes) Discuss the conflict between the need for an audit frm to perform quality services and its dese to ale a profit in the context of the investor's need for veliable information. viQUESTION? (15 marks - 20 minutes) ‘The second examination standard requires that auditors obtain “a sufficient understanding of intemal contol ...to plan the audit." This requirement encompasses obtaining en understanding of | the control envizonment, the accounting system, and the contol policies and jmocedures Required: A) What aze some of the reasons for dbtaining an understanding of en audit clients intemal ‘control? (5 marks) 'B) What audit woxk is required for an auditor to be able to assess control risk below maximum? (5 marks) ————ov—e— (©) Should an auditor alwayg try to obtain enough evidence tobe able to assess conto risk below smaximnun? Explain. (5 marks)QUESTIONS (16 marks - 20 minutes) ‘Muay & Co, CAs, completed the audit of Classic, Inc.on March 1, 2001 for a January 31, 2001 fiscal year end. The audit team hed no significant problems and found no material ‘misstatements. Muay has audited Classic, Inc. for several yeaus and has experienced no ‘problems with the audit The audit prtner determined that standard unqualified audit repost was appropiate. The audit eport, drafted by! M. Nu, a staff assistant, is provided below. “We have audited the consolidated belance sheet of Classi, Inc. end subsidiaries as of January 31, 2001 en the related consolidated statements of cesh flows and reteined eamings forthe year then ended. These financial statements are the responsibilty ofthe companys management. ‘We conducted ou audit maccordance with the standaris in te CICA (Canadian Insitute of Chartered Accountents!) Handbook. Those standards require that we plan and perform an aut 0 obtain absolute asswance whether the financial statements ae fice of material misstatement. An aucit includes examining, on test bass, evidence supporting the emounts end diseloswes in the ‘nancial statements. An cud also includes assessing the internal contol, the accounting ‘principles sed, end significant estimates made by management, as wel as evaluating the overall financial statement presentation. We believe that our audits provide an unconditional basis for Inout opinion, these financial statements conectly show the financial position of Classic, Ine ‘and consolidated subsidiaries at January 31,2001 and the rsulis ofits operations fo the yeans then ended.” ‘Required: Identify the deficiencies and enor in the draft report. Do not rewaite the report, but ‘utilize the following table format and be specific as to what is wrong or missing | (Omission and Explanation SS a ee oraclaesaineTenEE [reteayscopeaeuing ama pee sano od | Se aa eT [Scope paragraph -The paragraph shoud notrefertointemalcontols” —SSSSC«S ae ee oR STN ee ee aac aad [Ruiner ee | vi‘QUESTION 4 G0 marks - 30 minutes) Circle the eter corresponding to the best response. 1. Which ofthe following best deseribes the main reason that independent auditors report on a companys financial statements? ‘A. Management fraud may exist within the company and itis Likely thatthe independent auditors will detect it. C. Misstated account balances maybe conected asthe result of the independent audit work D. The accounting system fiom which the financial statements are derived may have a poorly designed system of intemal contol. 2. The audit's judgment as to the overall faimess of financial position, results of operations, ‘and cash flows is applied within the framework of A. Quality contol. B Generally accepted auditing stendards that include the concept of materiality. (C. The auditor's evaluation ofthe intemal contol of the audited company. 3. Self regulation as applied to the auditing profession means ‘A. The profession advises the government on the laws which should be applied tothe profession, B. The profession is solely responsible for disciplining any member found tobe engaged in wrong doing D. The profession exists to protect the best interests of ts members and not the best interests of the public 4 On which of the following reasons do many people blame forthe profession's problems in the post-Enzon world? ‘A Inadequate taining of yrofessional accountants B. The lack of focus on fraud investigation by extemal auditor. D. New stock trading technology causing major swings in the cepital markets. 5. Which ofthe following statements is not a reporting standard for an assurance engagement? ‘A.Acconclusion whether the assertion is presented in conformity with established or stated citer B.A statement of whether the practitioner has significant reservations about the engagement. Identification ofthe asserton(s) being reported on.6. Which of the following statements best explains an unqualified report opinion? ‘A. The financial statements contain a departure from GAAP. B. The auditor was unable to complete the work necessary to form a complete opinion. C. The auditor was not awae of any easons not to believe the statements are conect. 1. According to the fourth reporting standard in the generally accepted auditing standards (GAAS), when the opinion contains a reservation the auditor must ‘A. withdraw fiom the engagement. C give an adverse opinion, D. qualify the xeport ‘8. The audit program prepared by the independent auditors prior to the stant of field work is considered appropriate documentation of B Supervision Information evaluation, D. Quality essuance 9. Which of the following best explains practical materiality? A Meaty ane lene eile on rcenge ape each sy C. Matenality is calculated after nsk is assessed. D. Materiality should be canzied forward fiom year to year to ensue consistency. 10. Because ofthe zisk of material misstatement, an audit of financial statements in accordance with generally accepted auditing standards should be planned and performed with an attitude of A. Objective Judgment. B Independent integnit D. Impartial conservatism, 11 Which of the following is not included inthe scope paragraph ofthe standard audit report? B Standards require that we plan and perform the audit to obtain xeesonable essuance C. An audit also includes assessing the accounting principles used. D. Anaudit includes examining, ona test basis, evidence supporting the amounts and discloswes, vi12. If financial statements contain a very material departwze from GAAP such thatthe financial statements are vistualy useless, the auditor can render a (an) ‘A. qualified "except for" opinion with reference to the depart. B adverse opinion with scope lintation reference. C. adverse opinion with reference to the departure, D. denial of opinion. 13. When an auditor denies an opinion on audited financial statements the report would ‘A. modify the introductory paragraph B include an extra paragraph ex} the altemative procedures camred out ‘D. include an exta paragraph explaining the departure from GAAP, 14, An auditor most likely would issue a denial of opinion because of ‘A. inadequate disclosure of material infonnation, BB the omission ofthe statement of cashflows. Ca material cups fom gnc cong principles 15. CA has been engeged to audit the financial statements of Marchano Ltd, a manufacturer of toys, Several individuals are suing the companybecause of a toy that injured chileven. The company has not disclosed the Iawruit in its financial statements. The type of audit report ineued. shouldbe A. Adverse 16, Which ofthe following is not an impediment to CA's independence in appearance? A. The CA received set of professional quality, graphite golf clubs from a client as an ‘expression of apyreciation forthe quality ofthe work performed. B. The CA is sung the client for non-payment of fees. C. The fees fiom one audit client comprise sixty-five percent ofthe CAs total billings for the 3 17. Under common law, which of the following statements most accwately eflects the lisbility ofa CA who gives a fraudulent opinion on an aucit ofa clients financial statements? A. The CA is liable only to third paties who are in privity of contact with the CA. B The CA is lnble only to known users ofthe financial statements C. The CA probably is liable to any person who suffered a loss as a result of the fraud. 1D. The CA probably i Liable to the client even if the client was aware of the fiaud and did not relyon the opinion,18. ACA maybe lisble to any purchaser ofa security ifthe CA issued a clean opinion on materially misstated financial statements. CA usually will ot be lable tothe purchaser A. If the purchaser is gulty of contributory negligence C. Unless the purchaser cen prove puvaty wath the CA. 'D. Unless the purchaser can prove scienfer on the put of the CA. 19. While conducting an audit, Lanson Associates CAs failed to detect a material misstatement in its client's financial statements. Leison's unqualified opinion was included with the financial statements ina regishtion statement and prospectus for public offering of securities made by the client. Lazson knew that its opinion and the financial statements would be used for this ‘pupose, Ina suitbya puchaser ageinst Larson for common lew negligence, Lazson's best defence would be thatthe: B Client was aware of the misstatements C. Purchaser was not in privity of contact with Larson, Identity ofthe puchaser was not lnown to Larson at the time of the audit. 20. Youhave just acquired a new client and have discussed vanious services that you will ‘perfoma for the clint including the enstual audit and preparation of corporate fax tums. What documentation should you obtain from the client in order to educe any misunderstendings over the type of services being performed? A. Management letter 21. The valuation assertion includes B Ensunng all nwventory i counted. C. Making sue that all receivables relate to sales during the year D. The method of presenting short term and long term liabilities 22. Factors that an auditor might take into account in determining the level of inherent risk ae: ‘A. Management philosophy and operating style. B Classes of transactions and systems employed The reliability of evidence which can be obtained. 23. According to COSO, intemal contol inckudes the following components: A. Control activities and inherent risks B Inston one end extemal ivluences _D. Financial reporting and contol activities.24, The probability that an auditor will give an inappropriate opinion on the financial statements best desenbes A Adit isk, B Inherent nek, ©. Control risk, D. Detection nik 25 In the planning stage, analytical procedures are used to ‘A. Assess overall reasonableness of the financial statements. C Detemnine the mathematical comectness ofthe financial statements D. Provide dxect evidence about the belances in accounts. 26. Assume that application of analytical procedures revealed significant unexplained differences between recorded amounts and the auditors expectations. If management is unable to provide an acceptable explanation, the auditor should Consider the matter a scope lintation | C Intensify the audit wath the expectation of detecting management fraud, D. Withdraw from the engagement. 27. The stiongest form of audit evidence | B. Evidence gathered duectly fiom independent third patie. Evidence produced by independent third puties. D. Comprehensive analysis performed by the auditor 28. One of the auditor's primary concems with regard to intemal contols is: ‘A. The degree to which the intemal controls are working as designed, 'B. The posmibility of an inherent risk which has tobe contolled ) D. The amount of substantive work to be saved by testing controls instead. 29. Key contols axe those: B.Over physical access. C On which the auditor intends to vey D. Designed by the audit committee to prevent management fraud, 30. Contol tests should be applied to samples of transactions and control procedures: ‘A. Which occured during the interim audit so that they provide dixect auditors knowledge B Selected by management as being representative ofall hansactions processed. 1D. Which ocew yrimanly close to xeporting period ends such as year end or quarter end. <QUESTIONS — (10 marks, 2 marks each) For each of the following independent situations: 1 Identify whether itis an accounting (GAAP) problem or auditing (scope) problem 2 ‘Descnbe the specific type of problem and 3 Indicate the appropiate form of reservation in the auditor's report Assume each situation is material ‘The auditor was appointed on January 25, 2009 forthe 2008 fiscal year audit (year-end December 31°). As result the eucifor has missed the clint’ yer-end ventory count, snd was warble to physically verify the inventory on hand Assim no other appropriate axudit evidence is available fo substantiate the belance. The recorded cost for inventory on Ind at yearend is material fo the client's financil statements b. Theclient has stated that although the fair mazket value ofits stock mazket long-term, awestments has been felling steadily forthe past two yeaxs, they aze not going to write down the value of their investment (cuently recorded at origina cost) despite the evidence of permanent impairment. ¢. Asazesultof communicating with the client's lawyer, the auditor has become aware of pending product lisility lawsuit against the client. The client claims the suit has no foundation and has not disclosed it in thei financial statements, 4 The client has material inventories held at fifty different geographical locations. Because the audit fees will increas, the client has decided that the auditors ae nat to count inventories nor conduct altemative procedures for year end inventory balances, . During the year end auelt, youead inthe newspaper that a major customer of your client tas declared bankruptcy. You notice that there is no allowance esteblished on the amount receivable. You discuss this with the comptollex who informs you that its not possible to take enllowance because the net income figure has already been used to calculate bonuses, Situation | GAAP or Scope ‘Type of Problem, Appropriate Problem Reservation Qlyemarky Qlvemarky mark) — BP — viLh